Ninth Circuit upholds homebuilder's use of completed-contract method.

Author:Carlton, Brandon

In Shea Homes, Inc., No. 14-72161 (9th Cir. 8/24/16), aff'g 142 T.C. 60 (2014), the Ninth Circuit affirmed the Tax Court's decision that a homebuilder in a master planned community development could apply the percentage-of-completion method for income deferred under the completed-contract accounting method, based on completion of the entire development rather than on the sale of each individual home.


Shea Homes Inc. (SHI) and its subsidiaries formed an affiliated group of corporations that, through several entities, built and sold homes in master planned community developments ranging in size from 100 to more than 1,000 homes in Arizona, California, and Colorado. SHI's business model focused on emphasizing the features and lifestyle of the community to potential buyers. The total purchase price included the home, the lot on which the home was constructed, improvements to the lot, infrastructure and amenity common improvements, financing, fees, property taxes, labor and supervision, architectural and environmental design, bonding, and other costs.

SHI entered into individual purchase-and-sale agreements with all buyers. Before closing escrow on a home, SHI was required to either construct all common improvement areas for the development (or phase) or post a bond securing SHI's performance; the amount of the bond varied by municipality. Both the purchase contracts and the closing and escrow instructions included a requirement that the purchasers receive and acknowledge receipt and understanding of the development s public report and the information it contained, which constituted part of the purchase contract. The public report disclosed to a homebuyer the rights and obligations imposed on or granted to the homebuyer as well as the seller with respect to a certain development. Prior to signing the purchase agreement, each buyer also received a copy of the declaration of the covenants, conditions, and restrictions that applied to that particular development. Typically, four to six months lapsed between execution of the purchase agreement and the closing of escrow.

SHI accounted for the income from the sale of homes using the completed-contract method, based on completion of the entire development, rather than on the sale of each individual home. The IRS disagreed with this method and determined deficiencies and adjustments. The Tax Court looked at eight representative developments out of 114 total developments from the years at issue.

Law and Taxpayer and IRS Analyses

Sec. 460(f)(1) defines a long-term contract as "any contract for the manufacture, building, installation, or construction of property if such contract is not completed within the taxable year in which such contract is entered into." Sec. 460(a) generally requires income from any long-term contract to be reported using the percentage-of-completion...

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