Real Estate Developer

I recently acquired a corporate client (C Corp.) who buys
residential real estate, fixes it up and resells it. His
previous CPA put most of his operating expenses (property
taxes, mortgage interest, sales expenses, etc.) into the
general & admin. section of the P & L. Last year (2005) he
had to change accountants and the new one put all that into
cost of goods sold. Needless to say there is a vast
difference between the gross profit sections of the 2004 and
2005 returns.

What is the preferred way (that will make IRS happy) of
reporting these expenses? I tend to side with the first
accountant who specialized in this area.

Both accountants showed the property assets in "other
assets" on the balance sheet. I would treat this as
inventory since that is what it is. I guess my manufacturing
background is coming out. Is there a reason it is not shown
in inventory?

Also my client is buying property to flip in Texas. He plans
to hold it for a while until the market recovers to a level
where he can recover his costs and make a profit. If he
rents the property out for the convenience of his company
while he is holding it, does he have to take depreciation?
The property was acquired in the normal course of business
and will be sold at an appreciated price. The rental is just
to get some income to cover costs while it is being held.

Linda Dorfmont E.A., CFP, CSA

Reply to
This is similar to a client here who bought more than a 100 acres for development. Each commercial parcel was of a different size, and the residential lots more or less equal in size. All costs had to be first identified with the parcels affected and then capitalized according to acreage of each parcel. Thus all lost were part of inventory. Even the interest was capitalized, thus there was very little g&a expense.
I don't see any way out of taking allowable depreciation as a matter of course. After all, a bird in the hand is worth.... two.. uh... how does that go? ChEAr$, Harlan
Reply to
Harlan Lunsford
Conflicting rules.
One rule is that you should pick a legitimate method and stick with it. Another rule is usually these expenses are part of COGS.
If I had been doing this from the beginning it all would go into COGS. At this late date, I'd leave it alone unless you determine the previous method was wrong. Your other question: Since you treat the houses as inventory, you would not depreciate inventory. Your answer would be even easier if the house was acquired and sold the same year. That's because you do not depreciate anything acquired and sold the same year.
Reply to
Arthur Kamlet
I found this to be an interesting post because I knew there would be several ways to view this problem. Now I'll play devil's advocate by introducing another "solution"; Technically, the person preparing the 2005 return apparently did not seek/receive permission to file for a change in accounting method. Even if a method is flawed, changing it requires permission. Therefore, consideration should be given to amending the 2005 return to use the old method, then file 2006 and 2007 the same "wrong" way since the time to apply for an accounting change has lapsed for these year too. Finally, for 2008, make application to change the accounting method and give the taxpayer the 4 years to make up the tax increase difference. The obvious problem with this solution is explaining why the 2005 return is being amended. It will necessitate admitting what items and why they are being changed, which might be questioned:-) Mike
btw, I think that saying is ...."worth two in a bush" if you didn't know but just didn't want to use the "b" word?
Reply to
James Lewis

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