When to Use Percentage of Completion vs. Completed Contract?

Choosing between the percentage of completion method and the completed contract method for long-term contracts is usually not a free choice. Section 460 of the Internal Revenue Code requires percentage of completion (POC) as the default, and only three categories of contracts qualify for the completed contract method (CCM): small construction contracts under the gross receipts test, home construction contracts, and residential construction contracts. If your contract fits one of those buckets, CCM defers all income until the job is done; if it doesn’t, POC recognizes income year by year as the work progresses, and you don’t have a choice to make.¹

Which Contracts These Rules Cover

A contract is “long-term” for federal tax purposes when it involves building, installing, manufacturing, or constructing property and won’t finish in the same tax year it started.¹ Duration in months doesn’t matter. A job that starts in November and wraps up in February crosses a tax year and counts, even though the actual work spans about three months.

Manufacturing contracts have an additional filter. They fall under Section 460 only if the item is unique (not something the manufacturer normally keeps in finished-goods inventory) or takes more than 12 calendar months to produce.¹ Standard mass-produced goods filled on a purchase order aren’t governed by long-term contract accounting even when the order runs past year-end.

Percentage of Completion Is the Default

Section 460 requires taxpayers to determine income from long-term contracts using POC unless a specific statutory exception applies.² The policy rationale is that income should be taxed as the economic activity happens, not years later when the final invoice clears. So the practical question isn’t “which method do I want?” It’s “do I qualify for CCM?” If not, POC applies.

Who Qualifies for the Completed Contract Method

Three exceptions carve contracts out of mandatory POC. If your contract fits one of them, you can use CCM (or the cash method, or another permissible method) for that contract.

Small Construction Contracts

A non-residential construction contract escapes POC if two things are true when the contract is signed. First, the contractor estimates the project will be completed within two years of its start date. Second, the contractor’s average annual gross receipts for the three preceding tax years don’t exceed the inflation-adjusted threshold under Section 448(c).² Both tests must pass. A large contractor doing a short project doesn’t qualify, and neither does a small contractor doing a long one.

For tax years beginning in 2026, the gross receipts threshold is $32 million.³ The figure adjusts annually for inflation, rounded to the nearest million.

Home Construction Contracts

Home construction contracts are exempt from POC regardless of the contractor’s size or the project’s expected duration. A contract qualifies as home construction if at least 80% of estimated total contract costs relate to building or improving dwelling units in buildings containing four or fewer units, plus directly related site improvements like driveways and landscaping.⁴ Each townhouse or rowhouse counts as its own building, so a row of six townhouses is six one-unit buildings, not one six-unit building.

Apartment complexes, condominium towers, and other buildings with more than four units are outside this exception.

Residential Construction Contracts

Residential construction is a broader category that covers work on dwelling units in any size of building, including apartment buildings, large condo projects, and mixed-use buildings with residential components. The One Big Beautiful Bill Act, signed in July 2025, eliminated the former hybrid rule that had required large contractors to report 70% of these contracts under POC and 30% under CCM. All residential construction contracts are now fully exempt from mandatory POC under Section 460(e)(1)(A).²

One boundary to notice: residential contracts that don’t also meet the small contractor requirements remain subject to the uniform capitalization rules under Section 263A. Exemption from POC doesn’t mean exemption from capitalizing indirect costs.

How the Two Methods Differ in Practice

POC recognizes income as work progresses. The Treasury regulations prescribe the cost-to-cost method as the default: you divide cumulative costs incurred through year-end by total estimated costs to get a completion factor, multiply that factor by the total contract price to get cumulative gross receipts, and subtract prior years’ cumulative receipts to get current-year income.⁵ Both direct costs and certain indirect costs must be allocated to the contract, though the IRS permits a simplified cost allocation method for taxpayers running many concurrent contracts.⁶

Cost estimates on multi-year projects shift. When they do, POC doesn’t reopen prior years. You recalculate the completion factor with updated estimates, and the entire effect hits the current period as a cumulative catch-up adjustment. Every revision to estimated costs ripples through current-year income immediately, so estimating discipline matters.

CCM is mechanically simpler. During the project, all costs sit on the balance sheet as work-in-progress and customer billings sit in a liability account. Nothing hits the income statement until the contract is substantially complete and accepted. At completion, the accumulated costs become cost of goods sold, the total contract price becomes revenue, and the entire profit or loss lands in a single tax year. A three-year project shows zero contract income in years one and two and everything in year three.

The advantage of CCM is cash flow. Tax on contract income waits until the project risk is behind you. For contractors with multiple overlapping projects whose completions don’t all cluster in one year, CCM can also smooth taxable income across years.

CCM has one anti-abuse limit worth knowing. If at any point during the project you determine that total estimated costs will exceed the contract price, the expected loss must be recognized immediately. You can’t defer a known losing contract to the completion year.

The Hidden Cost of POC: Look-Back Interest

Because POC relies on estimates and estimates are always somewhat wrong, Section 460(b)(2) settles up at the end. Once a contract is complete, you recompute what income would have been reported in each prior year using actual final costs and price instead of estimates. If your estimates deferred income, you owe interest to the IRS. If your estimates accelerated income, the IRS owes you interest.⁷

You don’t amend prior returns. The calculation is hypothetical, and the interest is reported on Form 8697 in the year of completion.⁸

Look-back doesn’t apply to every contract. It’s waived if the gross contract price at completion is $1 million or less (or under 1% of the taxpayer’s average annual gross receipts for the three prior years, whichever is lower) and the contract was completed within two years.¹ For larger, longer POC contracts, the interest computation is a real ongoing compliance cost that a contractor weighing which method to use should factor in.

The AMT Wrinkle for CCM Users

Qualifying for CCM under the regular tax rules doesn’t automatically mean you can use it for the alternative minimum tax. Section 56(a)(3) generally requires POC when computing alternative minimum taxable income on long-term contracts entered into after March 1, 1986. For contracts that qualify as exempt construction contracts under Section 460(e)(1), the simplified cost allocation procedures apply to the AMT calculation.⁹

That historically forced CCM users into dual tracking: one set of numbers for regular tax, another for AMT. The 2025 legislation eased this by exempting residential construction contracts from the AMT’s POC requirement.⁹ Contractors on qualifying residential projects can now use the same method for regular tax and AMT.

Switching Methods When Your Situation Changes

If your business crosses the $32 million gross receipts threshold in either direction, your eligibility for CCM on non-residential small construction contracts changes with it. A voluntary change in accounting method requires filing Form 3115.¹⁰

Changes triggered specifically by the gross receipts test get favorable treatment. The statute treats them as taxpayer-initiated changes made with IRS consent, applied on a cut-off basis.² Contracts entered before the change year keep their original method; new contracts use the new one. There’s no Section 481(a) adjustment sweeping income from old contracts into the transition year. Changes made for other reasons follow the general Form 3115 rules, and a 481(a) adjustment may be required.

Cost of Using the Wrong Method

Using CCM on contracts that don’t qualify for an exception is an underpayment of tax, because income that should have been recognized under POC was deferred. The IRS can assess a 20% accuracy-related penalty on the resulting underpayment if it determines the taxpayer was negligent or disregarded the rules, with interest running on both the underpayment and the penalty until paid.¹¹ The IRS may waive the penalty for reasonable cause and good faith, but a construction company that routinely runs multi-year jobs will have a hard time selling unfamiliarity with Section 460 as reasonable. Confirming eligibility for CCM at the start of each contract is the cheap path.

1
Office of the Law Revision Counsel. 26 U.S. Code 460 – Special Rules for Long-Term Contracts
2
Office of the Law Revision Counsel. 26 USC 460 – Special Rules for Long-Term Contracts
3
Internal Revenue Service. Rev. Proc. 2025-32
4
Legal Information Institute. 26 USC 460(e)(5) – Home Construction Contract
5
eCFR. 26 CFR 1.460-4 – Methods of Accounting for Long-Term Contracts
6
eCFR. 26 CFR 1.460-5 – Cost Allocation Rules
7
Internal Revenue Service. Examination and Closing Procedures Form 8697, Look-Back Interest
8
Internal Revenue Service. Instructions for Form 8697 (Rev. December 2025)
9
Office of the Law Revision Counsel. 26 U.S. Code 56 – Adjustments in Computing Alternative Minimum Taxable Income
10
Internal Revenue Service. About Form 3115, Application for Change in Accounting Method
11
Internal Revenue Service. Accuracy-Related Penalty