When you build a spec home you are creating an asset that will be sold to another person. Spec homes are built in anticipation of a sale; therefore, a construction contract does not exist. You do not use the rules for Home Construction contracts, which are contracts to build a home with four or fewer residential units.
When you build a spec home, all the direct and indirect costs are accumulated. These costs are called the basis of the property and cannot be deducted until the home is sold. The costs that must be included in the basis of the home are:
- Labor, and
- Allocated indirect costs (See table of indirect costs)
A custom home built on land owned by the contractor is a construction contract because the home must be built to fulfill the contract with the buyer. As with spec homes, you accumulate the costs of the home and postpone the deduction of the basis until the contract is completed.
Title does not transfer until settlement, therefore, income is reported and basis is deducted at settlement.
A custom home built on land owned by the buyer is a construction contract because the home must be built to fulfill the contract with the buyer. Title to the work transfers as it is performed.