A developer buys a hundred acres, runs in roads and utilities, divides it into lots, and sells them off over several years. A deceptively hard question follows the first closing: how much basis comes out against that first sale? You cannot deduct the whole cost of the land against the first lot, and you cannot wait until the last lot to recover basis. The Code requires allocation — and for the future improvement costs that have not yet been spent, it offers a special election that most developers never claim.

The general rule: equitable apportionment

Reg. §1.61-6(a) states the principle. When part of a larger property is sold, the cost or other basis of the whole is “equitably apportioned” among the parts, and gain or loss is computed on the part sold. For subdivided lots the accepted method is relative value — allocate the aggregate basis across the lots in proportion to their respective fair market values, so that each lot carries its fair share of the land and the common costs, and recovers it as it sells.

One parcel + its common improvements = a single basis poolLot 1Lot 2Lot 3Lot 4Lot 5Lot 6Allocate the pool by RELATIVE VALUE (Reg. §1.61-6); recover each lot’s basis as it sellsGeneral ruleSell Lot 1 in Year 1, before the roads,sewers and amenities are built.Future costs are NOT yet in basis →early gain is overstated.Alternative cost method · Rev. Proc. 92-29Include your estimated share of the futurecommon-improvement costs in the lot’sbasis now → gain matches economics.Needs IRS consent, annual reconciliation,and an extended statute of limitations.
Aggregate basis is allocated across the lots by relative value. The alternative cost method lets a developer pull estimated future common-improvement costs into the basis of lots sold before those costs are incurred.

The problem with common improvements

Roads, sewers, drainage, utilities, and amenities benefit every lot, but they are built over time — often after the earliest lots have already sold. Under ordinary tax-accounting rules a developer cannot add a cost to basis before it is incurred. The result distorts the early closings: a lot sold in year one carries none of the future improvement cost it will ultimately bear, so its reported gain is overstated, while later lots are understated. The economics and the tax diverge precisely when the cash is tightest.

The alternative cost method — Rev. Proc. 92-29

The IRS supplies a fix. Under the alternative cost method of Rev. Proc. 92-29, a developer may — with consent — include in the basis of lots sold the developer’s allocable share of the estimated future common-improvement costs, even though those costs have not yet been incurred, so that gain on each lot reflects the true economic cost of the project. The price of admission is procedural: a written request and consent, an annual statement reconciling estimated costs against costs actually incurred, and consent to extend the period of limitations on the affected returns until the project’s costs are settled. It is an election in substance, and it materially improves the timing of gain recognition across a multi-year project.

Character sidebarLots held for sale to customers are dealer property — ordinary income, not capital gain. The limited safe harbor of §1237 can preserve capital treatment for a qualifying non-dealer who makes only modest subdivisions and substantial improvements, subject to its five-lot and holding-period conditions. Character first, then basis allocation, then timing.

Subdivision tax accounting rewards planning done before the first lot closes, not after. Choosing the allocation method, deciding whether to make the alternative-cost election, and pinning down dealer-versus-investor character are decisions with seven-figure consequences across a project — and they are squarely the structuring work the firm does for its development clients.