By Nicolle Donald
In a case* between a California homebuilder and the IRS, the U.S. Tax Court has ruled in favor of the builder, lending clout to an accounting method that could help builders and developers defer taxes.
The court ruled that Shea Homes LP could defer payment of taxes on home sales until 95 percent of the homes in its large, gated-community developments were sold. The IRS had argued Shea should pay taxes as it sold each home and not wait until its developments were nearly filled. However, the Tax Court deemed Shea’s use of the “completed contract method” of accounting appropriate, with Judge Robert Wherry commenting that the company “properly used a permissible method of accounting.”
The IRS has frequently challenged companies over the completed contract method. Completed contract accounting allows for deferral of income and expense until the project is 95% complete. The Shea decision will give more clarification to companies that use the method.
It is important to look at the facts and circumstances of this case before jumping into the completed contract method for any home builder or developer. Shea marketed its developments as a whole and not just as the sale of a home. In some cases, the common improvements in the developments were more than a quarter of the costs incurred. This enabled Shea to pull the common improvements into the analysis rather than just looking at the development on a house by house basis. The states involved defined real estate to include allocable common improvements which was another key factor.
Shea’s dispute involved $23.7 million in taxes for 2004 and 2005. The housing developments at the center of the dispute were in Arizona, California and Colorado.
*Shea Homes, Inc and subsidiaries et al v. Commissioner of Internal Revenue; Docket No. 1400-10.