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.”
Frontier argued that its business model centered on sales and
marketing, and not production-related services. It also contended
that its activities were outside the scope of section 263A, because
it did not employ the tradespeople who build the homes. The Tax
Court noted that before Frontier sells a home, it builds it, and
that before it builds a home, it designs it. The court concluded
that Frontier’s use of subcontractors was not enough to
exempt the taxpayer from Section 263A.
After concluding that Section 263A applied to Frontier, the Tax Court addressed in detail the application of Section 263A to officers’ compensation, nonofficer employees’ compensation, taxes, employee benefits, insurance, utilities, telephone, tools, computers and other homebuilding-related expenses incurred by Frontier. The portion of such expenses that could be allocated to production activities was required to be capitalized.
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