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Fifth Circuit Agrees That Custom Homebuilder Must Capitalize CEO's Salary.

(Parker Tax Publishing October 1, 2015)

A custom homebuilder was subject to the uniform capitalization rules and the salary of the president and CEO was also subject to capitalization because a substantial amount of his time and activities directly benefitted, or were incurred by reason of, production activities. Frontier Custom Builders, Inc. v. Comm'r, 2015 PTC 334 (5th Cir. 2015).

Frontier Custom Builders (Frontier) is a custom homebuilder that uses subcontractors for the physical home construction of its custom homes. It did not capitalize many of the costs it incurred in building its custom homes in 2005 but rather deducted those costs. According to Frontier, custom homebuilding is different from speculative homebuilding and this difference kept its custom homebuilding activities out of the reach of the uniform capitalization (UNICAP) rules of Code Sec. 263A.

The Tax Court held that Frontier's use of subcontractors for the physical home construction was not enough to exempt Frontier from capitalizing costs under the UNICAP rules. The creative design of custom homes, the court stated, is ancillary to the actual physical work on the land and was as much a part of a development project as digging a foundation or completing a structure's frame. Therefore, the court rejected Frontier's argument and found Frontier to be a producer of real property subject to Code Sec. 263A. As a result, the court held that Frontier had to capitalize all direct and certain indirect costs of production; capitalize a portion of the cost of its officer's compensation; capitalize a portion of the cost of its nonofficer employees' compensation; and capitalize a portion of its other expenses incurred. Frontier appealed.

On appeal, Frontier argued that it was exempt from the requirements in Code Sec. 263A because its primary business during the year at issue was sales and marketing, not production-related services. Frontier also argued that any production-related costs incurred by its subcontractors were not attributable to Frontier for purposes of Code Sec. 263A. In addition, Frontier contended that even if it was subject to Code Sec. 263A, the compensation of its president and CEO, Wayne Bopp, should not be capitalized because his work related to overall management, overall company policy, general financial accounting, strategic business planning, and marketing, selling, or advertising.

The Fifth Circuit agreed with the Tax Court's decision that most of the amounts deducted by Frontier in 2005 were capitalizable service costs. With respect to the issue of Bopp's salary, the court reasoned that, although many of Bopp's hours were spent managing the company, the record reflected that a substantial portion of Bopp's activities directly benefitted, or were incurred by reason of, production.

Some of his activities, the court noted, included: designing homes that were later produced; creating the processes and procedures for building homes; selecting developers and reviewing subcontractors; resolving issues that arose at worksites during production; selecting and installing the home design software; meeting weekly with project managers to stay apprised of production timelines; and evaluating project managers' productivity reports. These activities were sufficient, the court concluded, to support the capitalization of Bopp's compensation.

For a discussion of the costs that must be capitalized under the UNICAP rules, see Parker Tax ¶242,425. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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