Custom Homebuilder Required To Capitalize Certain Costs

In Frontier Custom Builders Inc. v. Commissioner, T.C. Memo 2013-231 (Sept. 30, 2013), the Tax Court held that the taxpayer was required to capitalize all direct and certain indirect costs of production under Section 263A.
As a custom homebuilder, Frontier designed custom homes and subcontracted the physical labor to tradespeople who actually built the homes. On its 2005 tax return, Frontier capitalized direct material and labor costs, and post-production-period costs, but claimed deductions for salaries, year-end bonuses and other miscellaneous expenses. The IRS issued a notice of deficiency to Frontier, making adjustments under the rules of section 263A.

Section 263A requires taxpayers that produce real property to capitalize certain direct and indirect costs related to production. Under Section 263A(g)(1), the term “produce” means to “construct, build, install, manufacture, develop or improve.”