A real estate project is considered substantially completed and held available for occupancy upon completion of tenant improvements by the developer, but no later than one year from cessation of major construction activity. Once a real estate project is substantially completed and held available for occupancy, a rental project changes from non-operating to operating, with the following consequences:
- Rental revenues and operating costs are recognized as they accrue
- Carrying costs (such as taxes and insurance) are expensed when incurred
- Interest capitalization ceases
- Depreciation commences
- Amortization of deferred rental costs commences
Paragraph 23 of FASB Statement 67 states:
If portions of a rental project are substantially completed and occupied by tenants or held available for occupancy, and other portions have not yet reached that stage, the substantially completed portions should be accounted for as a separate project. Costs incurred shall be allocated between the portions under construction and the portions substantially completed and held available for occupancy.
Judgment must be used to determine what constitutes a project and, once identified, when that project is substantially completed and ready for its intended use. For example: a company may identify separate buildings in an office complex as separate projects. However, an individual rental project, such as an office building, is considered one real estate project in its entirety, and that rental project is evaluated in its entirety of whether it is substantially complete.
The FASB considered and rejected a phase – in of depreciation and other operating costs based on a percentage – of – occupancy method over the period of lease – up of a building. 78 As such, depreciation commences for an office building held for rental in its entirety, rather than on a floor-by-floor basis. Similarly, costs incurred for property taxes and insurance relate to the building and land as a whole and, therefore, capitalization of those costs should cease when the building is substantially complete and ready for its intended use, rather than being phased in over time.
Costs Incurred Subsequent To Project Completion
For properties that are developed for a company’s own use or rental operations, costs will be incurred subsequent to the completion of the project. Questions of how to account for costs incurred subsequent to a property ’ s completion are encountered not only by real estate companies, but by all companies owning real estate.
The accounting treatment of such costs will depend on the type of costs incurred and the reason for their incurrence. Costs incurred may be start–up costs within the scope of SOP 98 – 5, Reporting on the Costs of Start – Up Activities; they may constitute normal maintenance expenses; or they may stem from renovations, remodeling, or refurbishing activities.
Normal repair and maintenance costs are commonly expensed as incurred. Questions remain, however, with respect to other costs incurred. If a company replaces the roof of a building, for example, should that new roof be capitalized?
If so, is it appropriate or necessary to write off the estimated net book value of the existing roof?
Aside from a general rule that expenditures that extend the life of the property or increase its value are capitalized and that normal recurring repair and maintenance expenditures are expensed, very little guidance exists with respect to the accounting treatment of costs incurred subsequent to project completion.
The proposed SOP, Accounting for Certain Costs and Activities Relating to Property, Plant, and Equipment, offers guidance with respect to costs incurred during the “in service stage”; however, that proposed SOP was not cleared by the FASB. Additionally, the proposed SOP introduces the concept of components, which is generally not followed in U.S. Generally Accepted Accounting Principles (GAAP).