Selecting the right accounting method for your business is an important step in laying the groundwork for a profitable future. Residential homebuilders in particular have several options from which to choose, but there are a few factors to keep in mind when reviewing those options:
- The length of the contract;
- The completion status of the contract; and
- The average annual gross receipts of your company.
Often, contractors will use two different methods of accounting – one for long-term contracts and one for the rest. Many contractors will try to use the cash method of accounting, but it is important to recognize the limitations of this method. It is only available for certain taxpayers, such as a C corporation or a partnership that has a C corporation as a partner. The cash method cannot be used if your company’s average gross receipts are in excess of $10 million or if your inventories constitute 10 to 15 percent of those gross receipts. If the cash method is not an option for your company due to these factors, the accrual method of accounting is your next option.
There are specific considerations for accounting in the residential homebuilding industry, so it’s important to ask three things:
- Do you have home construction contracts or do you have general construction contracts? If you have general construction contracts, you must refer to your average gross receipts (remember the threshold of $10 million gross receipts discussed above) to determine if you are considered a large or small taxpayer.
- Do you build custom homes on the builders land? These projects must be accounted for under the completed contract method.
- Do you build custom homes on the buyer’s land? These projects can be accounted for under either the completed contract method or the accrual method.
If you’ve settled on an accounting method and ever wish to change it, remember that you must apply to make that change with the IRS by filing the correct paperwork.
Have questions about finding the right accounting method for your residential homebuilding business? Your RKL advisor can walk you through the consideration process to make sure you select the appropriate method for your company’s unique needs and operations.
