Love it or hate it, GAAP is part of our lives; for those CPAs specializing in real estate, there is a lot of detail to get a handle on and this makes it especially complicated. Over the next few weeks, our resident CPA, Hardik Shah, will give you the benefit of his expertise of his many years working in real estate accounting.The key resources of authoritative GAAP relating to real estate transactions include:
Rules, concepts, and illustrations:
GAAP distinguishes between retail land sales and real estate sales other than retail land sales. Under the full accrual method of accounting for land sales, the following must be satisfied before profits may be recognized:
Retail land sales not accounted for by the full accrual method should be accounted for and reported using the percentage-of-completion or the installment method. The criteria for their applicability are based on the collectability of the seller's receivable from the land sales and the seller's remaining obligations.
Profit recognition for other sales of real estate by the full accrual and several other methods is all delineated in the subsequent discussions. This recognition is dependent on whether a sale has been consummated, the degree of the buyer's investment in the property being sold, whether the seller’s receivable is subject to future subordination, and the extent of the seller's continuing involvement with the property after the sale.
GAAP enumerates the standards for recognition of profit on all real estate sales transactions, including real estate with property improvements and integral equipment, without regard to the nature of the seller's business. ASC 360-20-15-3 notes that property improvements and integral equipment refer to any physical structures or equipment attached to the real estate that cannot be removed and used separately without incurring significant costs (e.g., an office building, a manufacturing facility, a power plant, timberlands or farms [land with trees or crops attached to it]). Natural assets that have been extracted from the land, such as soil, gas, and coal, are excluded from this guidance. The following transactions are also excluded from this guidance:
The provisions of GAAP in this area distinguish between retail land sales and real estate sales other than retail land sales. ASC 76-605-25-1 notes that the former are sales, on a volume basis, of lots that are subdivisions of large tracts of land. They are characterized by (1) very small down payments; (2) the inability of the seller to enforce the sales contract or the buyer's note against the buyer's general credit; (3) return of the buyer's down payment if the cancellation is made within an established cancellation period; and (4) defaults by the buyer after the cancellation, resulting in recovery of the land by the seller and forfeiture of at least some of the principal payments by the buyer. Amounts retained by the seller are determined by federal and state laws.
Examples of real estate sales transactions that are not retail land:
We will discuss real estate sales other than retail land sales in the next piece.