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 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 total estimated costs. If you have incurred 40% of costs on a $500,000 contract, you report $200,000 that year, regardless of how much the customer has paid.

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, deferring 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 is $31 million for 2025 and $32 million for 2026, measured as average annual gross receipts over the prior three years and 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 contractors who produce property to capitalize direct and indirect costs into each job rather than deducting them currently. Capitalized costs include direct materials, direct labor, and a share of indirect costs (equipment depreciation, insurance, job-site utilities, storage, indirect labor). These load into work-in-progress and reduce income only when revenue is recognized.

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 that test is exempt from UNICAP and can deduct costs as incurred.

• Above the threshold: indirect costs must be allocated to each active job, recognized only when the contract’s revenue is recognized.
• Below the threshold: costs are deducted in the year paid or incurred under normal cash or accrual accounting.

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. For contractors, qualifying property includes virtually everything they buy: excavators, backhoes, dump trucks, trailers, generators, compressors, scaffolding, and specialty tools. Used equipment also qualifies.

• The deduction is taken in the year the property is “placed in service” (ready and available for use).
• All qualifying assets have MACRS recovery periods of 5, 7, or 15 years, well within the 20-year bonus depreciation threshold. Work trucks and vans over 6,000 lbs GVWR are not subject to the IRC 280F luxury auto limits.
• Property acquired under a binding contract before January 20, 2025, follows the old TCJA phase-down schedule for the year placed in service.

What’s the QBI deduction for contractors?

The qualified business income deduction under IRC 199A allows non-corporate taxpayers to deduct up to 20% of qualified business income from a pass-through business. Construction is not a specified service trade or business, so the deduction is available regardless of income level.

Above the income threshold ($201,750 single / $403,500 MFJ for 2026), the deduction is capped at the greater of (a) 50% of W-2 wages or (b) 25% of W-2 wages plus 2.5% of UBIA of qualified property. This cap favors contractors who employ workers (high W-2 wages) or own significant equipment (high UBIA).

• Contractors who pay subcontractors on 1099 instead of W-2 employees miss the wage component, which can reduce or eliminate the deduction at higher income levels.
• A contractor with $500,000 in QBI and $300,000 in W-2 wages: the 50% W-2 test yields $150,000, easily clearing the $100,000 deduction (20% of QBI). At a 32% marginal rate, that saves $32,000 in federal income tax.

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. Some states use the ABC test (California AB5, Massachusetts, New Jersey), which presumes worker status unless all three prongs are met.

• Prong B of the ABC test is the problem for construction: a framing contractor who hires individual framers as “independent contractors” fails because the framers perform work within the usual course of the hiring entity’s business. 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), ordinary and necessary business expenses under IRC 162 are deductible in the year paid (cash basis) or incurred (accrual basis). This includes materials, direct labor, subcontractor payments, equipment rental, fuel, insurance premiums, vehicle expenses, and professional fees.

• Repairs to equipment are deductible currently. Improvements (making equipment more efficient, adapting to a new use, or restoring after a major breakdown) must be capitalized.
• The de minimis safe harbor under Reg 1.263(a)-1(f) allows expensing items costing $2,500 or less ($5,000 with applicable financial statements) per invoice or item.
• The home office deduction is available for a space used regularly and exclusively for business. The simplified method allows $5 per square foot up to 300 sq ft ($1,500 maximum).

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, a cost estimate, a log of direct costs (materials invoices, labor time sheets, subcontractor invoices, equipment rental receipts), change orders, progress billings, and the final completion date and total contract price.

• For PCM compliance, you also need total estimated cost at year-start and year-end, plus actual costs incurred during the year broken down by direct and indirect categories. These feed Form 8697.
• For equipment depreciation, maintain a fixed asset register listing each piece with description, acquisition date, cost, placed-in-service date, depreciation method, recovery period, and annual depreciation amount.

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
• DCAA incurred cost submission, the annual filing that government contractors must submit to reconcile provisional billing rates against actual costs, a parallel to the WIP reconciliation construction contractors run at year-end
• 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)

Related guides:

• Tax Planning for Construction Companies: Completed Contract, Percentage of Completion, and Contractor-Specific Rules

• Tax Benefits of US Manufacturing: Bonus Depreciation, R&D Credits, and State Incentives

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