With land prices increasing, developers are looking for opportunities to save on development costs, including cost saving tax strategies. Thus, we have seen increasing interest in development strategies that offer tax savings. One strategy is speculative building: Owners of property who self-perform construction avoid sales tax and B&O tax on the self-performed scope. See Blog Article Posted April 9, 2013, titled What Is A Speculative Builder? In addition, the Department of Revenue has provided an explanation of speculative building.
A developer seeking to operate as a speculative builder must be aware of the “tax avoidance” statute, RCW 82.32.655. The statute states the legislature’s intent to require all taxpayers to pay their fair share of taxes and “it is the legislature’ s intent to stop transactions or arrangements that are designed to unfairly avoid taxes.”
In order to prevent use of joint venture entities in which the contractor member would have a di minimus interest in the ownership LLC (previously a 1% interest was the norm), RCW 82.32.655(3)(a) precludes the following:
“Arrangements that are, in form, a joint venture or similar arrangement between a construction contractor and the owner or developer of a construction project but that are, in substance, substantially guaranteed payments for the purchase of construction services characterized by a failure of the parties’ agreement to provide for the contractor to share substantial profits and bear significant risk of loss in the venture;”
In other words, the Department of Revenue will look at substance over form to determine whether use of the speculative builder approach qualifies or represents an impermissible tax avoidance. Reflective of this substance over form analysis, RCW 82.32.655 will look at the following factors to determine whether tax avoidance is appropriate:
The department must deny the tax benefit that would otherwise result from the tax avoidance transaction or arrangement. In determining whether the department must disregard a transaction or arrangement described under subsection (3) of this section, the department may consider:
- Whether an arrangement or transaction changes in a meaningful way, apart from its tax effects, the economic positions of the participants in the arrangement when considered as a whole;
- Whether substantial nontax reasons exist for entering into an arrangement or transaction;
- Whether an arrangement or transaction is a reasonable means of accomplishing a substantial nontax purpose;
- An entities’ relative contributions to the work that generates income;
- The location where work is performed; and
- Other relevant factors
The take-away from the tax avoidance statute is that to be receive tax savings as a speculative builder, there will be more than a superficial analysis of the contract structure. The developer will need to be a registered contractor or have a member that is a construction contractor. If a construction contractor is a member of the owner entity, there can be no guaranteed payments for the construction services and it must share in substantial profits and bear significant risk of loss. It is recommended that legal advice be obtained to identify what will meet the required criteria.