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Developer's Payments for Marketing Materials Were Nondeductible Bidding Costs

(Parker Tax Publishing August 2019)

The Tax Court held that a real estate developer's payments to his wholly owned corporation for marketing materials he used in pursuit of development projects, which he reported as deductible business expenses, were bidding costs under Reg. Sec. 1.263A-1(e)(3)(ii)(T) that were not deductible for the years at issue because the taxpayer failed to establish when (if ever) the development contracts on which he was bidding would not be awarded to him. The court also held that the taxpayer's sale of a unit in a condominium project he developed resulted in ordinary income, not capital gain, because the taxpayer held the property primarily for sale to customers in the ordinary course of business. Ashkouri v. Comm'r, T.C. Memo. 2019-95.


Hisham Ashkouri pursued real estate development projects under the name Hisham Ashkouri, Architects. For one of those projects, Ashkouri formed a limited liability company called Cold Spring Green (CSG). Ashkouri was also the sole shareholder and officer of ARCADD, Inc., a domestic corporation that provided architectural and design services.

Ashkouri hired ARCADD to assist him in his pursuit of development projects by preparing what he referred to as marketing materials, such as building designs, brochures, and three dimensional drawings. Ultimately, however, Ashkouri did not end up serving as developer of any of the projects he pursued. A potential project in Libya could not go forward because of hostilities in that country. Other projects in Washington State and Utah proved unsuccessful because of a lack of financing. Ashkouri said that, if any of those projects had resulted in a real estate transaction, he would have had 20 percent ownership.

Ashkouri was the sole member of CSG, which developed a condominium project in Newton, Massachusetts. In September of 2011, CSG sold one of the units, Unit B, for $1,250,622. CSG's sole purpose and function was to acquire, hold, develop, operate, and sell the condo complex of which Unit B was a part. CSG funded its development activities with a construction loan from a bank and entered into at least nine contracts with subcontractors (including ARCADD). It relied on a real estate firm to market the condos for sale to customers.

On his Forms 1040 for 2009 through 2011, Ashkouri included a Schedule C for his proprietorship on which he reported deductible expenses for payments to ARCADD for architectural or contract services. Ashkouri also included with his 2011 return a Form 4797, Sales of Business Property, which reported the net gain from CSG's sale of Unit B as capital gain. In a notice of deficiency, the IRS disallowed Ashkouri's Schedule C deductions on the basis that they were required to be capitalized under Code Sec. 263A and recharacterized his proceeds from the sale of Unit B as ordinary income. Ashkouri challenged the notice in the Tax Court.

Code Sec. 263A requires the capitalization of direct and indirect costs of property produced by the taxpayer or acquired by the taxpayer for resale. Under Reg. Sec. 1.263A-2(a)(1)(ii)(A), a taxpayer is not considered to be producing property unless the taxpayer is considered an owner of the property produced. Marketing costs are not required to be capitalized under Reg. Sec. 1.263A-1(e)(3)(iii)(A), but under Reg. Sec. 1.263A-1(e)(3)(ii)(T), bidding costs (i.e., costs incurred in the solicitation of a contract) must deferred until the contract is awarded. If the taxpayer is awarded the contract, the costs become part of the indirect costs allocated to the contract. If not, the bidding costs are deductible when the contract is awarded to another party, the taxpayer is notified in writing that the contract will not be awarded or rebid, or the taxpayer abandons its bid or proposal, whichever occurs first.

Ashkouri contended that his payments to ARCADD could not be capitalized as they were used for marketing and promotion and that he was not required to capitalize any expenses of pursuing any project that did not result in his acquiring an interest in property. The IRS characterized the costs as architect's fees and contended that the Tax Court has specifically held that such fees must be capitalized if Code Sec. 263A applies.


The Tax Court held that the payments Ashkouri made to ARCADD were bidding costs rather than marketing costs, but found that Ashkouri failed to establish that any of the bidding costs became deductible during the years at issue. The Tax Court also upheld the IRS's characterization of Ashkouri's proceeds from the sale of Unit B as ordinary income.

The court accepted Ashkouri's argument that he was not required under Code Sec. 263A to capitalize his expenses of pursuing any project that did not result in his acquiring an interest in property. However, the court said that finding did not establish that the expenses were immediately deductible. The court found that under Reg. Sec. 1.263A-1(e)(3)(ii)(T), the payments to ARCADD had to be deferred pending the outcome of the bidding process, and concluded that Ashkouri failed to prove that those initially deferred costs became deductible during any of the years at issue. The court noted that Ashkouri was, for the most part, unsuccessful in his pursuit of the various projects in regard to which he claimed to have paid ARCADD for marketing materials. But the court found that Ashkouri did not establish when (if ever) the development contracts he sought were awarded to others, when he received written notice that no contract would be awarded, or when he abandoned his bid or proposal for each project. The court further explained that, even if it accepted that the expenses at issue were not subject to deferral under Reg. Sec. 1.263A-1(e)(3)(ii)(T), it would still conclude that the deductions were properly disallowed because Ashkouri did not adequately substantiate the underlying expenses.

The court rejected the IRS's argument that architect's fees must always be capitalized if Code Sec. 263A applies, finding that the cases cited by the IRS that involved such fees required capitalization of fees paid for plans for development of property owned by the taxpayer. Those cases, in the court's view, did not establish that fees paid for architectural drawings used in the unsuccessful pursuit of development projects must also be capitalized.

With regard to the gain from the sale of Unit B, the court agreed with the IRS that Ashkouri recognized ordinary income rather capital gain. The court noted that Ashkouri failed to challenge the IRS's position that the property was held primary for sale to customers in the ordinary course of Ashkouri's business and thus the gain from the sale of the property was ordinary income. The court inferred Ashkouri's position to be that the property was used in the trade or business under Code Sec. 1231(b) and that its sale therefore resulted in Code Sec. 1231 gain under Code Sec. 1231(a)(3)(A), but the court found that Ashkouri offered no explanation of why Unit B qualified as property used in the trade or business.

For a discussion of the types of costs that must be capitalized under Code Sec. 263A, see Parker Tax ¶242,425. For a discussion of the treatment of business gains and losses under Code Sec. 1231, see Parker Tax ¶112,101.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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