February 15, 2006
Organization: Moss Adams
For tax years beginning in 2005, the Domestic Production Activity Deduction (DPAD) is available to contractors who perform qualifying construction services related to residential and commercial buildings as well as inherently permanent land improvements. Engineering and architectural services can be eligible as well. Here are some common questions regarding this new deduction.
How is DPAD calculated?
DPAD is the lesser of:
• Qualified Production Activities Income (QPAI) or
• Taxable Income Multiplied by a percentage specified by law: 2005-2006 3% 2007-2009 6% 2010-forward 9% The deduction is limited to 50% of W-2 wages paid by the business during the year.
How is QPAI calculated?
QPAI is calculated as follows: Domestic Production Gross Receipts (DPGR) • Less: Cost of goods sold (CGS) allocated to such gross receipts • Less: Direct expenses allocated to such receipts • Less: Ratable portion of other expenses not directly allocable to such receipts Depending on the size of your company, there are special rules that influence how the CGS, direct and other expenses are allocated in the calculation of QPAI.
What is DPGR?
Gross receipts received from: • Construction, erection, or substantial renovation of real estate including infrastructure • Sale of real property constructed by the taxpayer
Substantial renovation is activity involving a major component or substantial structural part of real property that materially increases its value, prolongs the property’s useful life or adapts the property to a different use.
Infrastructure includes roads, power lines, water systems, communications facilities, sewers, sidewalks, cable and wiring.
What gross receipts are excluded from DPGR?
• Hauling trash or debris (unless performed with other qualifying services)
• Grading land or landscaping (unless performed with other qualifying services)
• Purchased materials • Lease or rental of construction property
How are land sale gross receipts determined to exclude from DPGR?
Gross receipts are not dictated by the fair market value of the property, but are made up of the purchase price of the land, other capitalized land costs and a percentage markup. The deemed markup percentages are based on the amount of time the land has been held by the taxpayer:
• 0-5 years 5%
• 6-10 years 10%
• 11-15 years 15%
• >15 years–not eligible for this rule
Where do taxpayers report DPAD?
Form 8903 is used to report how DPAD is calculated for income tax purposes. DPAD is then taken as an additional expense on the corporation’s tax return, or, for passthrough entities, as a deduction against gross income on the individual owner’s tax return. DPAD generally cannot increase a net operating loss (NOL) for any taxpayer. Taxpayer K-1s are required to reflect the pertinent information owners will need to calculate their individual deductions.
We have provided you with some general guidelines regarding DPAD. However, there are special exceptions and additional rules that may apply to your particular entity. Please contact your local Moss Adams office to assist you in utilizing this deduction.