Quick answer: For tax, a contractor with average annual gross receipts above $32 million (2026) generally must report long-term contracts on the percentage-of-completion method under IRC section 460, measured strictly by cost-to-cost. Below that, other methods open up — and for residential builders, the 2025 law change reopened them dramatically.

The tax default is percentage of completion, and it is narrower than the book version

Section 460(a) requires taxable income from a long-term contract to be determined under the percentage-of-completion method. A long-term contract, under section 460(f)(1), is any contract for building, installation or construction not completed within the tax year it was entered into. For construction there is no additional carve-out, so a job that starts in November and finishes in March is a long-term contract even though it ran four months.

The measure of progress is not negotiable. Section 460(b)(1)(A) and Reg. section 1.460-4(b)(1) require the completion factor to be computed by comparing allocable contract costs incurred to estimated total allocable contract costs. Cost-to-cost, and nothing else. Under ASC 606 you may use an input or an output method for the books; for tax on a non-exempt contract, you may not.

The small contractor exception, and the number that moves every year

Section 460(e)(1)(B) exempts a construction contract from mandatory percentage of completion if two things are true. You must estimate, when you enter into the contract, that it will be completed within two years of commencement. And you must meet the gross receipts test of section 448(c) for the year the contract is entered into.

That threshold is indexed for inflation, and it is the figure contractors most often quote out of date:

Tax years beginning in 2025: $31,000,000 (Rev. Proc. 2024-40)
Tax years beginning in 2026: $32,000,000 (Rev. Proc. 2025-32)

The $25 million figure people still cite was the amount as enacted in 2017. Indexing began immediately, so 2018 was the only year it actually applied. Note also that for non-corporate taxpayers, section 460(e)(2)(A) and Reg. section 1.460-3(b)(3)(ii) aggregate all trades and businesses of the individual, and partners and S corporation shareholders include a proportionate share — so the test is rarely as simple as looking at one entity’s revenue.

Clear the exception and the options open up. Reg. section 1.460-4(c)(1) permits the completed contract method, the exempt-contract percentage-of-completion method, or any other permissible method under section 446, which is where cash and accrual come in. The exempt-contract method is the flexible one: Reg. section 1.460-4(c)(2) lets you measure progress by any reasonable cost comparison or by work performed, and look-back does not apply to it.

Method selection is a decision you make once and live with for years

Whether you sit above or below the gross receipts threshold, whether a job is expected to close inside two years, and whether a residential contract now qualifies under the 2025 definition all change what you owe and when. A method change is a filing, not an afterthought, and the wrong default can leave cash with the government for a full cycle before anyone notices.

We work through this with contractors before the return, not during it. Call 631-349-1661 or send us the details and we will give you a straight answer.

What changed for residential builders in 2025

This is the part most contractors have not caught up with. The One Big Beautiful Bill Act, Public Law 119-21, enacted 4 July 2025, rewrote the residential side of section 460.

Before, only a home construction contract was excepted: 80% or more of estimated total contract costs attributable to dwelling units in buildings containing four or fewer dwelling units. Apartment and condominium work failed that test and was pushed onto a hybrid 70/30 method.

OBBBA section 70430(a) substituted residential construction contract throughout section 460(e)(1)(A). The new definition at section 460(e)(4)(B) applies the same 80% cost test without the four-or-fewer-units limitation, and the old subsection (e)(4) that forced the 70/30 treatment was struck outright.

The practical effect: multifamily, apartment and condominium contracts can now use the completed contract method or another exempt method for regular tax. Where a residential contract is not a home construction contract, the two-year test in section 460(e)(1)(B) becomes a three-year test. If the tests are not met, section 263A capitalization applies.

Two cautions worth stating plainly. The effective date in section 70430(c) is contracts entered into in taxable years beginning after 4 July 2025 — for a calendar-year contractor that means contracts entered into from 2026, not contracts signed the week the bill passed. And the regulations have not caught up: Reg. section 1.460-3 was last amended in 2021 and still describes only the old home construction contract rule. Where the statute and the regulation disagree right now, the statute governs.

Your books and your tax return are not supposed to agree

Contractors are often unsettled to find their WIP schedule and their return showing different income. That divergence is expected, and the IRS has said so structurally. Rev. Proc. 2018-29, which gave taxpayers automatic method-change procedures to conform tax to the new ASC 606 book standard, expressly excludes income from long-term contracts subject to section 460 except for contracts exempt from percentage of completion. A section 460 contractor cannot conform tax to book revenue.

The cost pools differ too, and not marginally:

Selling, marketing and bidding costs. Section 460(c)(4) excludes marketing, selling, advertising and unsuccessful bid and proposal costs from allocable contract costs. ASC 340-40 does the opposite, capitalizing incremental costs of obtaining a contract when they are recoverable.
Production-period interest. Section 460(c)(3) and Reg. section 1.460-5(b)(2)(v) require interest to be capitalized into contract costs for designated property, on a section 460-specific production period. GAAP does not push interest into the cost-to-cost numerator that way.
Depreciation. Section 460(c)(6) requires the completion factor to be computed as if bonus depreciation under section 168(k) had not been enacted, for qualified property with a recovery period of seven years or less. OBBBA made that rule permanent by striking its sunset.

Every one of those differences moves the completion factor, which moves reported income, which moves the tax. They are the reason a contractor can look profitable on the books and owe something quite different.

The look-back method: interest on being wrong

Percentage of completion relies on estimates. Section 460(b)(2) trues them up. Once a contract is complete, income is reallocated across the prior years using actual price and actual costs, a hypothetical over- or underpayment is computed for each year, and interest runs on it at the section 6621 rate, compounded daily. It is reported on Form 8697.

There are two ways out. The small contract exception in section 460(b)(3)(B) applies where the gross contract price at completion is no more than the lesser of $1,000,000 or 1% of average annual gross receipts for the three preceding years, and the contract is completed within two years of commencement. Separately, section 460(b)(6) provides an elective de minimis exception where cumulative reported income stays within 10% of cumulative look-back income.

One caution: the December 2025 Form 8697 instructions contain a note describing a three-year small contract rule that the statute does not support — section 460(b)(3)(B)(ii) still reads two years. Do not plan around the instruction.

Frequently asked questions

What is the gross receipts limit for the small contractor exception?

$31 million for tax years beginning in 2025 and $32 million for tax years beginning in 2026, under the section 448(c) test. It is indexed annually, and for individuals and pass-through owners all trades and businesses are aggregated before the test is applied.

Can an apartment builder use the completed contract method now?

For contracts entered into in taxable years beginning after 4 July 2025, yes, subject to the 80% residential cost test and a three-year completion expectation. Before OBBBA, multifamily work generally could not, and was pushed onto a hybrid method instead.

Does percentage of completion for tax use the same numbers as my WIP schedule?

Usually not. Tax requires cost-to-cost with its own definition of allocable contract costs, which excludes selling and bidding costs, requires certain interest to be capitalized, and ignores bonus depreciation. Book and tax completion factors routinely differ.

What is Form 8697 for?

It computes interest under the look-back method on completed long-term contracts reported on percentage of completion. It is not an income tax computation; it charges or refunds interest on the timing error between your estimates and actual results.

Where this becomes worth a conversation

Method selection is a live decision, not a historical one. Whether you are above or below the gross receipts threshold, whether a job is expected to finish inside two years, whether a residential contract now qualifies under the new definition, and whether a method change is worth filing all move real cash. Getting the answer requires someone who has the contracts and the books in front of them.

This page is general information about the tax rules, not advice on your specific contracts or situation. If you want it looked at properly, our construction accounting and CPA services for contractors and our tax planning work are built around exactly these decisions. The book side of the same question is covered in our guide to overbilling, underbilling and billings in excess of costs.

Equipment is where this bites hardest in practice: the completion factor has to ignore bonus depreciation on short-life property, so the machine cost charged to a contract for tax is not the same number as the book rate. The internal equipment rate build-up worksheet shows where the two part company.

Talk to an accountant who works in your industry

Precision Accounting & Consulting works with contractors, law firms, medical practices and property owners across the country. If something on this page raised a question about your own contracts, send it over and we will give you a straight answer.