Construction Contractor Tax Deductions: WIP Accounting, Equipment Write-Offs, and the QBI Deduction

Construction contractors operate under tax rules that differ from most businesses in three fundamental ways. First, income recognition on long-term contracts follows percentage-of-completion accounting under IRC 460, not cash or accrual. Second, job costs are capitalized into each contract under UNICAP rules (IRC 263A) rather than expensed as incurred. Third, the capital-intensive nature of the work (equipment, vehicles, specialty tools) creates large depreciation deductions, now amplified by 100% bonus depreciation made permanent under IRC 168(k). Add the 20% qualified business income deduction under IRC 199A, and the return for a mid-size contractor is meaningfully different from what a generalist CPA typically handles.

When do I use percentage-of-completion?

IRC 460 requires the percentage-of-completion method (PCM) for any long-term contract, defined as a contract for the manufacture, building, installation, or construction of property that is not completed within the taxable year it is entered into (IRC 460(f)(1)). Under PCM, you recognize revenue each year based on the ratio of costs incurred to date divided by total estimated costs. If you have incurred 40% of the estimated costs on a $500,000 contract, you report $200,000 of revenue that year, regardless of how much the customer has paid you.

The rule exists because contractors can manipulate income timing if they defer recognition until project completion. PCM prevents that by matching income to the work performed, but it also means you may owe tax on income you have not yet collected.

Two exemptions matter for smaller contractors. The home construction contract exemption under IRC 460(e)(1)(A) applies to contracts where 80% or more of the estimated costs relate to dwelling units in buildings with four or fewer units. These contracts can use the completed-contract method, which defers all income and costs to the year of completion. The small construction contract exemption under IRC 460(e)(1)(B) applies to contracts the contractor estimates will be completed within two years, if the contractor meets the gross receipts test under IRC 448(c). The 448(c) threshold for 2025 is $31 million in average annual gross receipts over the prior three years, indexed for inflation.

A residential remodeler doing $4 million a year in kitchen and bathroom renovations is almost certainly exempt from PCM on both grounds (home construction + small contractor). A commercial GC doing $50 million in multi-year office buildouts is required to use PCM on every contract that spans more than one year.

What are the UNICAP rules for contractors?

IRC 263A requires taxpayers who produce property to capitalize direct and indirect costs into the cost of that property, rather than deducting them currently. For a contractor, “producing property” means building or installing real or tangible personal property, and the costs that must be capitalized include direct materials, direct labor, and a share of indirect costs: equipment depreciation allocated to jobs, insurance, job-site utilities, storage, and indirect labor (project management, estimating, scheduling).

The practical impact is that a contractor cannot deduct these costs as current-year expenses on the income statement. They are loaded into each job’s work-in-progress balance and reduce income only when the contract’s revenue is recognized (under PCM or completed-contract, whichever applies).

The same IRC 448(c) gross receipts threshold that governs the PCM exemption also governs the UNICAP exemption under IRC 263A(i). A contractor meeting the gross receipts test is exempt from UNICAP entirely and can deduct costs as incurred under normal cash or accrual accounting. This is a significant simplification: instead of tracking indirect cost allocations across active jobs, the contractor deducts everything on the return in the year paid or incurred.

How does 100% bonus depreciation work for contractors?

The One Big Beautiful Bill Act (signed July 4, 2025) made 100% bonus depreciation permanent for qualified property acquired after January 19, 2025, under IRC 168(k). This reverses the TCJA phase-down that had dropped the rate to 80% (2023), 60% (2024), and 40% (2025 pre-OBBBA). Property acquired under a binding contract before January 20, 2025, follows the old phase-down schedule for the year it is placed in service.

For contractors, the qualifying property includes virtually everything they buy: excavators, backhoes, skid steers, dump trucks, work trucks, trailers, generators, compressors, scaffolding, specialty tools, welding equipment, and concrete equipment. All of these have recovery periods of 5, 7, or 15 years under MACRS, well within the 20-year-or-less threshold for bonus depreciation eligibility. Passenger vehicles are subject to the luxury auto limits under IRC 280F, but work trucks and vans over 6,000 pounds GVWR are not.

The deduction is taken in the year the property is “placed in service,” meaning the year it is ready and available for use. An excavator delivered in November and used on a December job is placed in service that year. An excavator delivered in December and sitting in the yard until January is placed in service the following year.

Used equipment qualifies. The TCJA expanded bonus depreciation to used property in 2017 (previously it was new property only), and the OBBBA maintained that expansion. A contractor buying a used backhoe at auction qualifies for the same 100% write-off as a new one, as long as the contractor has not previously used that specific piece of equipment.

What is the QBI deduction for contractors?

The qualified business income deduction under IRC 199A allows non-corporate taxpayers (sole proprietors, partners, S-corp shareholders) to deduct up to 20% of their qualified business income from a pass-through business. Construction is not a specified service trade or business (SSTB), which means the deduction is available regardless of the contractor’s taxable income level (SSTBs lose the deduction above the income threshold).

The limitation for contractors above the income threshold ($191,950 single / $383,900 married filing jointly for 2025, indexed) is the W-2 wage and UBIA cap: the deduction for each business cannot exceed the greater of (a) 50% of W-2 wages paid by the business, or (b) 25% of W-2 wages plus 2.5% of the unadjusted basis immediately after acquisition (UBIA) of qualified property held by the business.

For contractors, this cap favors businesses that employ workers (high W-2 wages) or own significant equipment (high UBIA). A contractor with $500,000 in QBI, $300,000 in W-2 wages, and $400,000 in equipment UBIA: the 50% W-2 test yields $150,000; the 25% W-2 plus 2.5% UBIA test yields $75,000 plus $10,000 = $85,000. The greater is $150,000, so the deduction is the lesser of $100,000 (20% of $500,000 QBI) and $150,000 (the cap). Deduction: $100,000.

That $100,000 deduction at a 32% marginal rate saves $32,000 in federal income tax. Contractors who pay subcontractors on 1099 instead of employees miss the W-2 wage component of the cap, which can reduce or eliminate the deduction at higher income levels.

How does worker classification affect contractors?

The distinction between employees (W-2) and independent contractors (1099) is the single most litigated area in construction tax. The IRS uses a common-law test based on behavioral control, financial control, and the type of relationship. The Department of Labor uses the economic reality test. Some states use the ABC test (California AB5, Massachusetts, New Jersey, and others), which presumes worker status unless all three prongs are met: (A) the worker is free from control and direction, (B) the service is outside the usual course of the hiring entity’s business, and (C) the worker has an independently established trade.

Prong B is the problem for construction. If a framing contractor hires individual framers as “independent contractors,” those framers are performing work within the usual course of the framing contractor’s business. Under the ABC test, they fail prong B and are presumed employees. Under the common-law test, the analysis is more nuanced, but the IRS and state agencies look at the same factors: who provides tools, who sets the schedule, who controls the methods, whether the worker serves other clients, and whether the relationship is ongoing.

The tax consequences of misclassification are severe. The employer owes the employee’s share of FICA (7.65%), the employer’s share (7.65%), federal unemployment tax (FUTA), state unemployment tax (SUTA), and penalties under IRC 3509. If the misclassification is intentional, the penalties increase and the employer can face the trust fund recovery penalty on the unpaid withholding.

The QBI impact is the hidden cost: 1099 payments are not W-2 wages, so they do not count toward the 50% W-2 wage limitation on the QBI deduction. A contractor with $1 million in subcontractor payments on 1099 and $200,000 in W-2 wages has a much lower QBI cap than a contractor with $1.2 million in W-2 wages. Converting some of those 1099 relationships to W-2 employment (where the facts support it) increases the QBI deduction, partially offsetting the additional payroll tax cost.

What job costs can I deduct currently?

For contractors exempt from UNICAP (under the gross receipts test), the standard deduction rules apply. Ordinary and necessary business expenses under IRC 162 are deductible in the year paid (cash basis) or incurred (accrual basis). This includes materials consumed, direct labor, subcontractor payments, equipment rental, fuel, insurance premiums, vehicle expenses, professional fees, and office expenses.

Repairs to equipment are deductible currently under the tangible property regulations. Improvements to equipment (making it more efficient, adapting it to a new use, or restoring it after a major breakdown) must be capitalized under the improvement rules. The de minimis safe harbor under Reg 1.263(a)-1(f) allows expensing items costing $2,500 or less ($5,000 for taxpayers with applicable financial statements) per invoice or item, regardless of whether they would otherwise be capitalized.

The home office deduction is available to contractors who maintain a home office used regularly and exclusively for business (the office from which you manage jobs, submit bids, and handle administration). The simplified method allows $5 per square foot up to 300 square feet ($1,500 maximum). The regular method allocates a percentage of home expenses (mortgage interest, property tax, utilities, insurance, depreciation) to the business.

What records should I keep for each job?

Job costing records serve both tax compliance and business management. For tax purposes, each job should have: a signed contract or proposal, a cost estimate or budget, a log of direct costs (materials invoices, labor time sheets or payroll allocation, subcontractor invoices, equipment rental receipts), change orders, progress billings, and the final completion date and total contract price.

For PCM compliance (if applicable), you also need the total estimated cost at the beginning of the year and at year-end, and the actual costs incurred during the year, broken down by direct and indirect categories. These feed the percentage-of-completion calculation on Form 8697 (Interest Computation Under the Look-Back Method for Completed Long-Term Contracts).

For equipment depreciation, maintain a fixed asset register listing each piece of equipment with: description, date acquired, cost, placed-in-service date, depreciation method, recovery period, and annual depreciation amount. Your CPA uses this register to compute the depreciation schedule and any Section 179 or bonus depreciation elections.

What should I do next?

The three decisions that have the largest tax impact for a growing contractor are the accounting method (cash vs accrual, PCM vs completed-contract), the entity structure (sole prop vs S-corp for SE tax savings), and the equipment purchase timing (bonus depreciation in the current year vs deferral). All three are best made before the year ends, not during tax preparation.

• Construction worker classification: 1099 vs W-2, the misclassification risk, ABC test, and VCSP settlement option
• Construction equipment depreciation, Section 179 vs bonus depreciation vs MACRS ordering rules for equipment purchases
• Construction insurance and bonding, surety bonds, workers’ comp, GL, and the tax treatment of premiums
• Trust fund recovery penalty, personal liability when employment taxes go unpaid
• FICA tip credit, another industry-specific employment credit (for restaurant contractors who also operate food service)
• Cost segregation after bonus depreciation, the study that accelerates depreciation on the building itself (relevant for contractors who hold their own shop or warehouse)
• Fix-and-flip tax: dealer classification, when a contractor who also flips houses faces dealer status
• Multi-entity rental LLC bookkeeping, entity separation for contractors who hold investment real estate
• Construction entity structure, LLC vs S-corp election, QBI deduction eligibility, and multi-entity strategies for contractors
• IRS installment agreement, the payment plan structure for contractors who owe after a classification audit
• Trucking Form 2290 heavy vehicle use tax, the annual HVUT filing for trucks at 55,000 lbs or more (relevant for contractors who operate heavy trucks)

This guide is general information, not tax advice for your specific situation. Which points apply, and how, depends on your facts.