We paid to replace a failed subcontractor. How do those costs enter the unfinished contract calculation?
Replacement subcontractor costs can enter the unfinished contract's properly allocable cost pool, but the analysis must also address recoveries and…
By AE Tax Advisors Team · Updated October 28, 2026
Replacement subcontractor costs can enter the unfinished contract's properly allocable cost pool, but the analysis must also address recoveries and remaining completion costs. A loss-making project does not automatically create a separate immediate deduction for every replacement payment. The contract's tax method continues to govern recognition.
A specific business-owner situation
A roofing subcontractor abandons a project. The general contractor hires a replacement at a higher price and pursues the original firm's performance bond. The job forecast now contains both additional costs and a possible recovery.
Illustrative example, not a client result.
What to establish before filing
- Identify the work each payment covers.
- Update estimated total contract costs.
- Analyze the bond claim without netting unsupported estimates.
Which fact changes the answer?
A bond recovery that is enforceable and reasonably expected differs from a speculative lawsuit. The recovery's treatment must be coordinated with the contract-price and cost rules.
A mistake to avoid
Do not count the abandoned subcontractor's unpaid scope and the replacement scope twice in estimated remaining costs.
Records that support the decision
- Subcontracts and replacement bids.
- Bond correspondence.
- Revised project budget.
The decision to document
Create one reconciled job forecast showing incurred costs, unfinished scope and separately supported recoveries.
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Related questions
- Our agreement includes land and construction. Does the whole price use the long-term contract method?
- The project is usable, but punch-list work remains. Is the contract complete for tax?
Sources and editorial context
- Section 460: long-term contracts
- Treasury regulation 1.460-1: contract classification and completion
- Treasury regulation 1.460-5: contract costs
- Treasury regulation 1.460-4: contract revenue and estimates
General educational information prepared with AI assistance. No individual professional review is claimed. Apply the relevant tax-year rules to the actual records. Editorial policy · AI disclosure.