Accounting for real estate development projects under generally accepted accounting principles (GAAP) demands knowledge of regulatory requirements from various accounting bodies; bodies like the Accounting Principles Board, Emerging Issues Task Force, Financial Accounting Standards Board, and American Institute of Certified Public Accountants (AICPA), to name a few.

The costs accrued with the development of a project are accounted in different ways, depending on the nature of the costs and the stage of the project.

Some costs are expensed as period costs, some are capitalized when incurred as costs of the project, while others are recorded as prepaid expenses and expensed in the period in which the related revenues are recognized.

Let’s focus our attention on the three stages of a real estate development project.

Pre-development Stage

The pre-development stage can be thought of as the period before any construction is initiated. A perfect place to begin the discussion of accounting is at the birth of the entity that will own the project.

It’s quite common for the key executives of a real estate development project to use a legal entity to establish direct ownership of the project — usually an entity that limits liability.

The start-up costs related to the formation of this legal entity should be expensed as incurred. The start-up costs include the related filing fees, legal fees, and other regulatory fees.

Pre-development costs related to a real estate development project include:

  • Survey costs
  • Changes in zoning
  • Market studies
  • Debt financing costs
  • Equity partner acquisition costs
  • Marketing

GAAP requires that all costs associated with a project that are incurred prior to the acquisition of a property or before the entity obtains an option to acquire the property should be be capitalized if all of these three conditions are met:

  • Costs directly relate to the specific property.
  • Costs would be capitalized if the property were already acquired.
  • Property acquisition or an option thereof is highly likely.

Other pre-development costs that fall in line with the above criteria for capitalization include costs incurred for zoning changes of the site and costs to obtain financing e.g. loan fees, origination fees, and points. More often than not, the developer begins marketing the project prior to the start or completion of construction. In that case, marketing and other selling costs would be incurred at different stages of development.

Development Stage

The development stage is the busiest stage of the three. Coincidentally, it happens to be the longest period in the project development process. The accounting during this period is of utmost importance, in terms of management and cost control.

Adequate care should be given to ensure that costs are recorded in the correct cost category. Examples of costs incurred during this stage include:

  • Architectural and engineering
  • Marketing
  • Cost of site
  • Contingencies
  • Actual construction
  • Insurance and taxes
  • General and maintenance
  • Licenses and permits

Typically in a construction project, a comprehensive budget is prepared with amounts for each of the cost categories listed above. The project’s construction, management, accounting, and finance teams meet periodically to review the budget with the actual costs incurred to ensure that costs incurred are recorded in the correct cost category or trade and also that the budget and amount left to complete the project are still reasonable.

In some instances, costs might be related to more than one project. If a developer, for instance, is developing an office complex with various buildings, and bills for certain costs, such as surveys or architects for the whole complex, they are billed together. These costs are still capitalized, but they would have to be allocated among the individual buildings.

Other costs to be capitalized during the development stage can include financing costs such as origination fees, points, and guaranty fees.

Post-development Stage

The post-development stage is the period when the project is nearly complete and is ready for its intended use. For example, if this is a condominium project, the buyers can now move in; if it’s a rental property, the lessees, if any, can now assume possession of the spaces.

The majority of expenses during this stage, such as salaries and wages, cleaning, security, utilities, water, and real estate taxes, are expensed as incurred. Additionally, certain capital improvements made after the project is complete are, in most cases, capitalized and depreciated over the project’s useful life.
Key Takeaway: Given the information above, it takes little convincing that the expertise of a qualified CPA, with experience in accounting for real estate development projects, needs to be retained from the planning to final stages of the project.

For more information on how the Onisko & Scholz team can help with your current (or future) real estate development project, get in touchwith us today.

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