Asserting that the agreement is not intended to create a construction contract

Asserting that the agreement is not intended to

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unit. Asserting that the agreement is not intended to create a construction contract between the Buyer and the Sponsor, some industry participants have argued that pre-sale agreements are instead contingent 4 call options granted to the Buyer from the Sponsor with the Buyer’s deposit taking the form of the option premium. Reflecting this economic reality, many developers use option terminology in their pre-sale agreements to reflect the substance of the terms and to minimize the expectation of Buyers. While structuring a pre-sale agreement as a call option more accurately reflects the intent of the parties, it may not completely solve the issue. First, the Regulations explicitly provide that a contract will be considered a long- term contract, and will be subject to the percentage of completion rules, 4 The contingency inherent in this option is the Sponsor’s completion of construction. when construction is necessary for the taxpayer’s contractual obligations to be fulfilled. The Regulations go on to say that the characterization of the agreement between parties is irrelevant in determining whether the percentage of completion method applies. Additionally, while it may not have been the intention to include legitimate options as long-term contracts, there is no explicit exception that would exclude an option from the definition. The percentage of completion rules apply to any contract (possibly including an option contract) for the manufacture, building, installation or construction of property, if it is not completed within the same year. Therefore, it is possible that an option contract could still be viewed as a long- term construction contract for purposes of the percentage of completion rules assuming the contract is considered valid and construction is a necessary component to fulfill the terms contained therein. Pre-sale agreements are not binding, so they are not long term contracts Another frequently raised argument is that a pre-sale agreement is not a binding contract and therefore the percentage of completion should not apply. The rationale behind this position includes one of the following: (1) the contract is not binding when the Sponsor is under no mandatory obligation to actually complete construction, or can abandon the project under certain circumstances, or (2) the contract is legally invalid, either because it excludes the remedy of specific performance for the Buyer, or for other reasons, or (3) considering other areas of tax law, the contract is not binding since it is either unenforceable under local law, or because it limits damages to a specified amount. One such analogy points to the Regulations for bonus depreciation which provides that a contract is not binding if damages are limited to less than 5% of the contract price.
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