Do a homebuilder's capitalized 'soft costs' — labor, interest, permits, services — count in the Tennessee franchise tax minimum property measure, or just the land and materials?

Plain-English summary

The taxpayer is a homebuilder that acquires, develops, and sells real property in Tennessee and other states. On its balance sheet, real property shows up as land (no development plan yet), work in progress (under development), or inventory (finished homes available for sale). The cost of building a home includes both tangible assets (land, materials, supplies) and "soft costs" — labor, permits, architectural/engineering services, and interest on construction debt. Under GAAP, many of those soft costs must be capitalized into the cost of the property and often appear on the same balance-sheet line as the tangible assets. The question: do those capitalized soft costs count in the Tennessee franchise tax minimum measure, or can the builder exclude them as non-tangible items?

The Department ruled they count. This is a Revenue Ruling — advisory and not binding even on the Department.

Two ways to measure the franchise tax. Tennessee's franchise tax is generally based on a person's net worth, but it can't be less than a floor — the minimum measure — which is the actual value of the real or tangible property owned or used in Tennessee (§ 67-4-2108(a)(1)), excluding certain exempt inventory and required capital investments (none of which applied here).

"Utilization" — and why a homebuilder's whole inventory counts. Property under construction that is not being utilized is excluded from the minimum measure, but property under construction is included if it's actually being utilized in the business (§ 67-4-2108(a)(3); Rule 1320-06-01-.18(4)). And the Department's rule is explicit that if the taxpayer is in the business of building and selling real property, ALL of its construction in progress is treated as utilized. So a homebuilder's WIP and inventory go into the minimum measure.

GAAP pulls the soft costs in. Section 67-4-2108(a)(3) requires "property" to be valued in accordance with GAAP, at cost less accumulated depreciation. Under GAAP (FASB ASC 330-10-30-1), the cost of inventory is "the sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location" — i.e., acquisition and production cost, which contemplates capitalizing soft costs into inventory. Because constructing the home (and the soft costs of doing so) enhances the value of the real property, GAAP includes those soft costs in the cost of the home — and therefore so does the franchise tax minimum measure.

No bifurcating out the soft costs. The Department rejected the argument that, because § 67-4-2108(a)(1) refers to "real or tangible personal property," a builder may split inventory into tangible and soft-cost components and exclude the soft costs (since a permit or an engineering fee isn't itself "real or tangible property"). That reading conflicts with GAAP, which controls valuation under (a)(3).

The courts agree — Crown Enterprises. In Crown Enterprises, Inc. v. Woods, 557 S.W.2d 491 (Tenn. 1977), a homebuilder tried to exclude homes under construction from the minimum measure, arguing they weren't "utilized." The Tennessee Supreme Court rejected that — the homes were part of the capital of the business, so they were utilized — and further held that the builder's "miscellaneous overhead" (master plan, equipment depreciation, property taxes, management fees, supervisory wages) had to be included in the minimum measure. Those overhead items closely resemble the soft costs at issue here.

What this means for you

Homebuilders and real-property developers in Tennessee

Your construction in progress and finished-home inventory are "utilized" for the franchise tax minimum measure, and the capitalized soft costs baked into their GAAP cost — labor, permits, design fees, capitalized construction-period interest — are part of the measured value. Don't compute the minimum measure on land-and-materials alone; use the full GAAP cost of your WIP and inventory.

You can't carve out the "intangible" portion of inventory

Splitting inventory into a tangible piece and a soft-cost piece and excluding the latter doesn't work. Valuation follows GAAP under § 67-4-2108(a)(3), and GAAP capitalizes those costs into the inventory's cost. The minimum measure follows the GAAP number.

This is the floor, not the whole tax

Remember the minimum measure is a floor under the net-worth base. If your net worth produces a higher base, that controls; the property measure matters when it would otherwise be the larger (or the only meaningful) number.

Accountants and tax professionals

Franchise tax (net worth): §§ 67-4-2105(a), 67-4-2106(a); persons § 67-4-2004(38). Minimum measure: § 67-4-2108(a)(1) (actual value of real or tangible property owned or used in Tennessee, less listed exclusions); utilization and GAAP valuation: § 67-4-2108(a)(3) (cost less accumulated depreciation; property under construction included if utilized) and § 67-4-2108(a)(2) (utilization; recodified from former § 67-2908); Tenn. Comp. R. & Regs. 1320-06-01-.18(4) (all CIP of a build-and-sell business is utilized — Example 2). GAAP authority: FASB ASC 330-10-30-1 (inventory cost includes expenditures incurred to bring the article to its existing condition and location). Controlling case: Crown Enterprises, Inc. v. Woods, 557 S.W.2d 491 (Tenn. 1977).

Common questions

Q: Do my capitalized soft costs (labor, permits, design fees, construction interest) count in the franchise tax minimum measure?
A: Yes. For a homebuilder, the minimum measure includes the full GAAP cost of utilized work-in-progress and inventory, and GAAP capitalizes those soft costs into the cost of the property.

Q: Can I exclude the soft costs because they aren't "real or tangible property" on their own?
A: No. The Department rejected that bifurcation. Property is valued under GAAP per § 67-4-2108(a)(3), and GAAP includes the soft costs in the inventory's cost.

Q: Is my construction in progress "utilized" if the homes aren't sold yet?
A: Yes, if you're in the business of building and selling real property. Rule 1320-06-01-.18(4) treats all such construction in progress as utilized, and Crown Enterprises held homes under construction are part of the business's capital.

Q: Does this apply to every business with construction in progress?
A: The "all CIP is utilized" treatment is keyed to being in the business of building and selling (or renting) real property. Other businesses' construction in progress is included only to the extent it's actually utilized.

Q: Can I rely on this ruling?
A: Not as binding. This is a Revenue Ruling — advisory only and not binding even on the Department, and not on other taxpayers. Confirm your own facts with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):
- § 67-4-2108(a)(1) (franchise tax minimum measure: no less than the actual value of real or tangible property owned or used in Tennessee, less exempt inventory and exempt required capital investments)
- § 67-4-2108(a)(3) (property valued per GAAP at cost less accumulated depreciation; property under construction included only if utilized); § 67-4-2108(a)(2) (utilization; recodified from former § 67-2908)
- §§ 67-4-2105(a), 67-4-2106(a) (franchise tax on net worth); § 67-4-2004(38) ("persons" include corporations, LLCs, partnerships)

Regulation and accounting standard:
- Tenn. Comp. R. & Regs. 1320-06-01-.18(4) (all construction in progress of a build-and-sell business is utilized; Example 2)
- FASB Accounting Standards Codification 330-10-30-1 (inventory cost = expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location)

Case law:
- Crown Enterprises, Inc. v. Woods, 557 S.W.2d 491 (Tenn. 1977) (homes under construction are part of the business's capital and thus "utilized"; "miscellaneous overhead" included in the minimum measure)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/20-12fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 20-12
Revenue rulings are not binding on the Department. This ruling is based on the particular facts
and circumstances presented and is an interpretation of the law at a specific point in time. The
law may have changed since this ruling was issued, possibly rendering it obsolete. The
presentation of this ruling in a redacted form is provided solely for informational purposes and
is not intended as a statement of Departmental policy. Taxpayers should consult with a tax
professional before relying on any aspect of this ruling.
SUBJECT
The inclusion of capitalized costs in the Tennessee franchise tax minimum measure.
SCOPE
Revenue Rulings are statements regarding the substantive application of law and statements of
procedure that affect the rights and duties of taxpayers and other members of the public. Revenue
Rulings are advisory in nature and are not binding on the Department.
FACTS
The Taxpayer is a homebuilder operating in Tennessee and other states. In Tennessee, the Taxpayer
acquires, develops, and sells real property. Presentation of the real property on the Taxpayer’s
balance sheet varies depending upon its stage of development. Real property with no immediate plan
for development is presented as land. Real property under development is presented as work in
progress. When the construction of a home is completed and it is available for sale, it is presented as
inventory.
Costs incurred to construct a home include the cost of the tangible assets employed in the
construction (land, materials, and supplies), as well as certain “soft costs” such as labor, permits, and
architectural/engineering services that contribute to the construction of the home. Additionally, the
Taxpayer will incur debt, a portion of which is used to finance the cost of construction. Pursuant to
generally accepted accounting principles (“GAAP”), many of these soft costs are required to be
capitalized, and they are often presented on the Taxpayer’s balance sheet in the same line item in
which the tangible assets are reported.

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RULING
Does the minimum measure of the Tennessee franchise tax under TENN. CODE ANN. § 67-4-2108 (2013)
include costs of labor, interest, permits, services, and other non-tangible items that are capitalized
and presented on the Taxpayer’s balance sheet as components of its inventory and/or work in
progress?
Ruling: Yes. The Taxpayer is a homebuilder and as such is considered to be utilizing its
inventory and work in progress for purposes of the franchise tax minimum measure under
TENN. CODE ANN. § 67-4-2108 (2013). Therefore, the Taxpayer’s capitalized costs are a part of
the value of its real and tangible personal property and are included in the franchise tax
minimum measure.
ANALYSIS
Tennessee imposes a franchise tax at the rate of $0.25 per $100, or major fraction thereof, on the net
worth of a person doing business in Tennessee, pursuant to TENN. CODE ANN. §§ 67-4-2105(a) (Supp.
2019) and -2106(a) (2013). Persons subject to the Tennessee franchise tax include, but are not limited
to, entities such as corporations, limited liability companies, and partnerships. 1
TENN. CODE ANN. § 67-4-2108(a)(1) (2013) provides that the minimum measure of the franchise tax shall
in no case be less than the actual value of the real or tangible property owned or used in Tennessee,
excluding exempt inventory and exempt required capital investments. 2 Property that is under
construction and not being utilized, in whole or in part, is also excluded from the minimum measure. 3
However, the value of property under construction is to be included in the minimum measure if there
is actual utilization of the property in whole or in part. 4 Actual utilization of the construction in
progress depends upon whether the construction in progress is utilized in the particular business
conducted by the taxpayer. 5 Importantly, if the taxpayer is in the business of building and selling real
property, all of the construction in progress is treated as being utilized for purposes of the franchise
tax minimum measure. 6

1

TENN. CODE ANN. § 67-4-2004(38) (Supp. 2019).

2

Note that these exclusions do not apply in the Taxpayer’s case.

3

TENN. CODE ANN. § 67-4-2108(a)(3).

4

TENN. COMP. R. & REGS. 1320-06-01-.18(4) (2016). (“Rule 18(4)”). Rule 18(4) includes the following example:
Example 2: A corporation is in the business of building and selling homes and the construction in progress
will ultimately be for sale or rental. All of the construction in progress is utilized in conducting the business
of home building.

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Id.

6

Id.

2

TENN. CODE ANN. § 67-4-2108(a)(3), requires that “property” be valued in accordance with generally
accepted accounting principles (“GAAP”), at cost less accumulated depreciation. The FASB Accounting
Standards Codification provides, “The primary basis of accounting for inventories is cost, which has
been defined generally as the price paid or consideration given to acquire an asset. As applied to
inventories, cost means in principle the sum of the applicable expenditures and charges directly or
indirectly incurred in bringing an article to its existing condition and location. It is understood to mean
acquisition and production cost, and its determination involves many considerations.” 7 Thus, GAAP
contemplates the capitalization of soft costs to inventory.
The process of assembling and constructing homes, and the associated costs of these activities,
including the soft costs, enhance the value of the real property itself. Accordingly, these soft costs are
expenditures and charges incurred to bring the home to its existing condition. In accordance with
GAAP, these soft costs should be included in the cost of the home.
One could argue that the reference to “real or tangible personal property” in TENN. CODE ANN. § 67-42108(a)(1) allows a taxpayer to bifurcate inventory into tangible and soft cost components and to
exclude the latter from the taxpayer’s minimum measure simply because such costs do not constitute
real or tangible personal property. However, this alternative interpretation of the statute would be
inconsistent with GAAP and has been addressed by the courts.
The Tennessee Supreme Court decision in Crown Enterprises, Inc. v. Woods, 8 supports the inclusion of
capitalized soft costs in the Taxpayer’s franchise tax minimum measure. In Crown Enterprises, Inc., a
company in the business of constructing and selling homes attempted to exclude the value of homes
under construction from the minimum measure, arguing that they were not actually “utilized” under
TENN. CODE ANN. § 67-2908 (1976). 9 The Court rejected that argument, holding that because the homes
were part of the capital of the company’s business, it was utilizing them within the meaning of the
statute. 10
The company had excluded certain expenditures from the minimum measure such as “miscellaneous
overhead,” which included the cost of the master plan, depreciation of equipment, property taxes,
management fees, and supervisory wages. 11 The Court, however, disagreed with the company’s
exclusion of these expenditures and determined the “miscellaneous overhead” items should be
included in the minimum measure. 12 This case is informative here because the “miscellaneous
overhead” that the Court concluded should be included in the minimum measure included items that
are very similar to the Taxpayer’s soft costs.

FASB Accounting Standards Codification at ASC 330-10-30-1, available at https://asc.fasb.org/home (last visited October 15,
2020).
7

8

557 S.W.2d 491(Tenn. 1977).

9

Id. at 492. TENN. CODE ANN. § 67-2908 (1976) has been recodified as TENN. CODE ANN. § 67-4-2108(a)(2) (2013).

10

Id.

11

Id. at 492 n.1.

12

Id. at 493-94.

3

Although TENN. CODE ANN. § 67-4-2108(a)(1) states the minimum measure “shall in no case be less than
the actual value of the real or tangible property owned or used in Tennessee” (allowing for certain
listed exclusions), and soft costs on a standalone basis are not generally characterized real or tangible
property, GAAP requires that soft costs be included in the value of such property under TENN. CODE
ANN. § 67-4-2108(a)(3). Thus, the Taxpayer’s soft costs are included in the value of the Taxpayer’s real
or tangible property for purposes of the Tennessee franchise tax minimum measure.

APPROVED:

David Gerregano
Commissioner of Revenue

DATE:

11/18/2020

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