The Howard Hughes Company, LLC f.k.a. The Howard Hughes Corporation, and Subsidiaries v. Commissioner

THE HOWARD HUGHES COMPANY, LLC, F.K.A. THE HOWARD
HUGHES CORPORATION, AND SUBSIDIARIES, PETITIONER v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
HOWARD HUGHES PROPERTIES, INC., PETITIONER v.
COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT
Docket Nos. 10539–11, 10565–11. Filed June 2, 2014.
Ps are in the residential land development business and
develop land in and adjacent to Las Vegas, Nevada. Ps sell
land to builders and, in some cases, individuals, who construct
and sell houses. Ps generally sell land through bulk sales, pad
sales, finished lot sales, and custom lot sales. In bulk sales,
Ps develop raw land into villages and sell an entire village to
a builder. Ps do not otherwise develop the sold village. In pad
sales, Ps develop villages into parcels and sell the parcels to
builders. Ps do not develop within the sold parcels. In finished
lot sales, Ps develop parcels into lots and sell whole parcels
of finished lots to builders. In custom lot sales, Ps sell indi-
vidual lots to individual purchasers or custom home builders,
who then construct homes. In all instances, Ps do not con-
struct residential dwelling units on the land they sell. During
the years at issue, Ps reported income from purchase and sale
agreements under the completed contract method of
accounting. R alleges Ps’ contracts are not home construction
contracts within the meaning of I.R.C. sec. 460(e). R further
contends the land sale contracts are not long-term construc-
tion contracts and are not eligible for the long-term percent-
age of completion method of accounting under I.R.C. sec. 460.
Held: Ps’ bulk sale and custom lot contracts are long-term
construction contracts. Held, further, Ps’ contracts are not
home construction contracts within the meaning of I.R.C. sec.
460(e), and Ps may not report gain and loss from these con-
tracts using the completed contract method of accounting.
355
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356 142 UNITED STATES TAX COURT REPORTS (355)
Stephen F. Gertzman, Kevin L. Kenworthy, Steven R.
Dixon, Mary W.B. Prosser, and Sat Nam S. Khalsa, for peti-
tioners.
Ronald S. Collins, Jr., Bernard J. Audet, Jr., and John R.
Gilbert, for respondent.
WHERRY, Judge: These cases, consolidated for trial,
briefing, and opinion, are before the Court on petitions for
redetermination of Federal income tax deficiencies.
Respondent determined deficiencies for the 2007 and 2008
tax years of petitioner the Howard Hughes Co., LLC (THHC)
(formerly the Howard Hughes Corp. & Subsidiaries (Old
THHC)), and deficiencies for the 2007 and 2008 tax years for
petitioner Howard Hughes Properties, Inc. (HHPI). The issue
for consideration concerns the proper method of accounting
for income from certain contracts. Respondent alleges that,
with respect to most of petitioners’ contracts, petitioners
must use the percentage of completion method of accounting
instead of the completed contract method of accounting. Peti-
tioners, however, contend that because their contracts qualify
as home construction contracts within the meaning of section
460(e)(6), they properly reported income on the completed
contract method. 1 Respondent further alleges that certain
other contracts are not long-term contracts or construction
contracts and that petitioners cannot account for the gain or
loss from these contracts under section 460.
FINDINGS OF FACT
The parties’ stipulation of facts and supplemental stipula-
tion of facts, both with accompanying exhibits, are incor-
porated herein by this reference. At the time petitioners filed
the petitions, their principal place of business was Dallas,
Texas. Their main business operations, however, are in Las
Vegas, Nevada.
Company Background
When Howard Hughes died in 1976, his portfolio of assets,
owned by Summa Corp., included land which was then out-
1 Unless otherwise noted, all section references are to the Internal Rev-
enue Code of 1986, as amended and in effect for the years at issue, and
all Rule references are to the Tax Court Rules of Practice and Procedure.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 357
side the city of Las Vegas, Nevada. In the 1980s this land
was selected for development. The land was called
Summerlin, which was the maiden name of Mr. Hughes’
paternal grandmother. Summerlin was divided into three
geographic regions: Summerlin North, Summerlin South, and
Summerlin West.
In 1996 the Rouse Co. (Rouse), a publicly traded corpora-
tion based in Columbia, Maryland, acquired the assets of the
Hughes estate, including Howard Hughes Properties LP
(HHPLP), which owned Summerlin. Effective January 1,
1998, Rouse elected to be treated as a real estate investment
trust (REIT) in 1998. As part of this conversion Rouse orga-
nized HHPI, which in turn purchased the undeveloped acre-
age in Summerlin North and South from HHPLP. In
December 1997 HHPLP had distributed Summerlin West to
Old THHC. In 2004 General Growth Properties, Inc. (GGP),
a publicly traded REIT, acquired Rouse by merger. During
the tax years at issue, GGP was the general partner in a lim-
ited partnership, which, through another limited partner-
ship, the Rouse Co. LP, and a limited liability company,
Rouse LLC, owned HHPI and the Hughes Corp., which in
turn owned Old THHC.
In 2009 GGP and its affiliated entities filed for bankruptcy
under chapter 11 of the U.S. Bankruptcy Code. Effective
December 31, 2009, Old THHC converted from a corporation
to a Delaware limited liability company, which is petitioner
THHC in these cases. As part of the plan of reorganization
in 2010 GGP spun off the part of its business that owned
Summerlin. A newly formed entity, the Howard Hughes
Corp., an entity distinct from Old THHC, ended up owning,
as second- and third-tier subsidiaries, HHPI and THHC.
THHC owns Summerlin West, and HHPI owns Summerlin
North and Summerlin South to the extent that these prop-
erties have not yet been sold to third parties.
Summerlin
During the years at issue petitioners were in the residen-
tial land development business. They generated revenue pri-
marily by selling property to builders who would then con-
struct and sell homes. In some cases, they also sold property
to individual buyers who would then construct single-family
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358 142 UNITED STATES TAX COURT REPORTS (355)
residential homes. The land petitioners sold and still sell is
part of a large master-planned community known as
Summerlin.
Summerlin comprises approximately 22,500 acres on the
western rim of the Las Vegas Valley, about nine miles west
of downtown Las Vegas. As of the end of 2010 approximately
100,000 residents lived in 40,000 homes in Summerlin. At
completion, petitioners expect Summerlin to house approxi-
mately 220,000 residents. While Summerlin is largely resi-
dential, it is a fully integrated community, which means it
includes commercial, educational, and recreational facilities.
It contains about 1.7 million square feet of developed retail
space, 3.2 million square feet of developed office space, 3
hotels, and health and medical centers. It has 25 public and
private schools, 5 higher learning institutions, 9 golf courses,
parks, trails, and cultural facilities.
Summerlin North and Summerlin West are, as a result of
annexation, part of the city of Las Vegas, and Summerlin
South is in Clark County, Nevada. The first residential land
sales in Summerlin North took place around 1986, and by
the years at issue HHPI had fully developed Summerlin
North. The first land sales in Summerlin South took place in
1998, and the first land sales in Summerlin West took place
in 2000. Each of these three geographical regions is further
divided into villages, each of which averages about 500 acres.
Villages are further divided into parcels, or neighborhoods,
which contain the individual lots. These cases involve only
petitioners’ sales of land in Summerlin South and Summerlin
West.
Petitioners’ sales generally fell into one of four categories:
pad sales, finished lot sales, custom lot sales, and bulk
sales. 2 In a pad sale, petitioners, after dividing the village
into parcels, constructed all of the infrastructure in the vil-
lage up to a parcel boundary. Petitioners then sold the parcel
to a buyer, who was usually a homebuilder. The builder, with
petitioners’ approval, was responsible for all of the infra-
structure (such as streets and utilities) within the parcel and
subdividing the parcel into lots. In a finished lot sale, peti-
tioners also divided the village into parcels. They then fur-
2 The parties disagree over whether the bulk sales contracts are in sub-
stance different from the pad sales contracts. We resolve this issue infra.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 359
ther constructed any additional needed parcel infrastructure,
divided the parcels into lots, and sold the neighborhoods to
a buyer, usually a homebuilder. In finished lot sales, peti-
tioners constructed all of the infrastructure up to the lot line.
In both the pad sales and the finished lot sales, petitioners
contracted with homebuilders through building development
agreements (BDAs). The BDAs were more than just simple
sales contracts that, for consideration, pass title. We discuss
the parties’ responsibilities infra. In doing so, we do not pur-
port to cover all of the details but simply address some
important aspects of the BDAs.
Custom lot sales were essentially the same as finished lot
sales except that petitioners sold the individual lots. The
buyers of these individual lots were individuals who were
contractually bound to build a residential dwelling unit. 3
The purchase sales contracts required the individuals to
agree that they would occupy the home for at least one year
or, if the home was sold before then to a third party, to pay
additional consideration of 10% of the third-party price.
Finally, in a bulk sale, petitioners sold an entire village to
a purchaser. The purchaser was responsible for subdividing
the village into parcels and lots and for constructing all of
the infrastructure improvements within the village.
Even though the builders were ultimately responsible for
building and selling homes to the end user—the home-
buyer—petitioners marketed to the homebuyers. Petitioners’
marketing strategy embodied the idea of the master-planned
community, and they viewed Summerlin as a brand that
evokes thoughts of an attractive lifestyle and community.
But petitioners did not bear the sole burden of the marketing
cost. In fact, their agreements with the builders required the
builders to pay into an advertising program promoting
Summerlin. The builders paid, upon the close of escrow of a
home sale, a fee equal to 1% of the purchase price.
3 The parties stipulated that the sales in all custom lot contracts were
made to ‘‘an individual purchaser’’. A review of the list of custom lot con-
tracts, however, reveals that some of the buyers appear to be builders (e.g.,
Executive Home Builder, Six Star Construction, Inc., and PMR Homes,
Inc.). This apparent discrepancy may result from the meaning of ‘‘indi-
vidual purchaser’’ but is irrelevant to our ultimate holding. For simplicity,
we will rely on the parties’ stipulation.
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360 142 UNITED STATES TAX COURT REPORTS (355)
We discuss infra the general process THHC and HHPI
undertake in their home development business. Much of the
trial was devoted to the details of the process, and we by no
means purport to address every step. Our intention is not to
discount those important steps not addressed but to provide
a general picture of how the development process worked.
Developing Summerlin—Entitlements
Petitioners were parties to master development agree-
ments with Las Vegas, Nevada, and Clark County, Nevada,
that govern the planned development of Summerlin West
and Summerlin South, respectively. These long-term, 30-year
agreements assure petitioners that they will be able to
develop the land in accordance with the agreements and
remove any necessity to negotiate development agreements
and entitlements village by village.
Summerlin West
Las Vegas, pursuant to powers delegated by the State of
Nevada by chapter 278 of the Nevada Revised Statutes,
adopted in April 1992 the City General Plan, which is a
master land use plan. HHPLP and Las Vegas signed a
development agreement (LVDA) in February 1997. The
LVDA was recorded in the Clark County, Nevada, Recorder’s
Office and was approved by the Las Vegas City Council.
Along with approvals and plans referenced within the agree-
ment, the LVDA governed land development in Summerlin
West. Las Vegas also amended its City General Plan to
incorporate the Summerlin West General Development Plan,
which conceptualized future development of Summerlin
West, and rezoned Summerlin West from a rural district to
a planned community district.
The Summerlin West Development Standards, attached to
the LVDA, set minimum requirements for development,
including ‘‘residential densities; building height and setbacks;
signage; landscaping; parking and open space requirements;
as well as procedures for site plan review and for modifying
the Planned Community Program.’’ The LVDA states that
development of Summerlin West will occur in phases called
villages. The owner has to prepare and submit for city
approval a Village Development Plan for each village. A vil-
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 361
lage traffic study and a village drainage study also had to
accompany the village development plan.
Initially, the LVDA permitted 20,250 residential units,
5.85 million square feet of office, retail, or industrial space
uses on 508 acres of land, golf courses featuring up to 90
holes of golf, and related facilities. Other uses described in
the Summerlin West General Development Plan were also
contemplated. The LVDA required HHPLP to maintain
medians but allowed HHPLP to assign that responsibility to
homeowners associations. HHPLP granted the city the right
to construct traffic signals, turn lanes, and similar improve-
ments as necessary. The LVDA also required HHPLP to
donate land to the city and construct a fire station on that
land and to donate up to five acres of land to the city for a
satellite government center. In addition, HHPLP was to
donate land to the city for a public park with sports and rec-
reational facilities and assume the cost of constructing a
sewer interceptor. With respect to traffic and transportation,
the LVDA required HHPLP to provide, or at least provide
adequate assurance that it would provide, standard improve-
ments in connection with each village. Standard improve-
ments were ‘‘mitigation measures and improvements
required for intersections and roadways immediately adja-
cent to the Planned Community.’’ HHPLP also agreed to
dedicate land needed for the right of way to the city for a
major arterial road, the Summerlin Parkway extension.
In November 2003 Old THHC, as the successor in interest
to HHPLP, and the city amended the LVDA to require Old
THHC to allocate a certain minimum amount of recreational
space per 1,000 residents, construct a neighborhood pool, and
design and construct a police substation with a helicopter
landing pad. The amended LVDA also increased the allowed
number of residential units from 20,250 to 30,000. Petitioner
THHC was and is, as successor in interest to Old THHC,
subject to the LVDA as amended.
Summerlin South
Clark County, Nevada, pursuant to the powers delegated
by the State of Nevada, adopted the Clark County Master
Plan in 1983. It and HHPLP also signed and recorded a
development agreement (CCDA) in February 1996 to govern
the development of Summerlin South. Before the CCDA,
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362 142 UNITED STATES TAX COURT REPORTS (355)
Clark County had amended its County Master Plan to
include the Land Use and Development Guide for
Summerlin’s Southern Comprehensive Planned Community
(Land Use and Development Guide). Clark County also
rezoned Summerlin South from a rural district to a planned
community district.
The CCDA provided that Summerlin South would be devel-
oped in accordance with the Summerlin Master Plans, which
consisted of the Land Use and Development Guide, a
Summerlin Master Parks and Public Facilities Plan, a
Summerlin Master Transportation Plan, and a Summerlin
Master Drainage Plan. As with the LVDA, the CCDA envi-
sioned development by phases called villages, and HHPLP
agreed to submit a Village Development Plan before begin-
ning development of a village. HHPLP also agreed to submit
with the Village Development Plan a traffic study, a drain-
age study, and a parks and public facilities plan.
Under the CCDA, Summerlin South could contain up to
18,000 residential dwelling units, 740 acres for nonresiden-
tial private uses, 90 holes of golf and related facilities, 3
hotels/casinos, and other land uses and facilities. The CCDA
obligated HHPLP to construct a fire station, donate up to 5
acres of land for a satellite government center, which may
include the fire station, and dedicate up to 20 acres of land
for a community sports park. The CCDA also obligated
HHPLP to submit the Master Parks and Public Facilities
Plan, which was to generally identify the location and
development timing of parks, trails, and public spaces sys-
tems. HHPLP also was to submit a Master Transportation
Study, provide the necessary improvements to mitigate the
development’s traffic impact, provide village access roads for
each village, and bear all public and private expenses, such
as roadway construction, lighting, drainage, signage, and
landscaping expenses related to Summerlin South’s internal
roadway network. The CCDA further required HHPLP to
prepare a technical drainage study and construct flood facili-
ties which were to be integrated where possible with the
trails and parks systems.
The parties, Clark County and HHPI, as successor in
interest to HHPLP, have amended the CCDA three times,
most recently in July 2005. The most recent amendment
increased the number of permissible residential dwelling
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 363
units to 32,600. In return, HHPI agreed, inter alia, at its
expense to purchase and provide a 100-foot aerial fire truck
with operating equipment; design, construct, and convey a
second fire station; and convey 2.5 acres of land to the county
for a third fire station. In addition, HHPI agreed to convey
25 acres or more of land to the county for recreational pur-
poses or 30 acres or more for a sports park to be designed
and constructed by HHPI, and a community center and out-
door aquatic center to be designed and constructed by HHPI.
Developing Summerlin—Covenant, Conditions, and Restric-
tions
Petitioners and their predecessors in interest recorded
Master Declarations, which govern use of the land by subse-
quent owners. These declarations, also known as covenants,
conditions, and restrictions (CC&Rs), not only imposed use
restrictions and protective covenants, but also created home-
owners associations. The Master Declarations served as the
governing documents for the homeowners associations. The
declarations applied to an initial set of properties within
Summerlin, but allowed petitioners to annex property,
thereby expanding the community subject to the declara-
tions.
The Master Declarations provided for the establishment of
village subassociations through new declarations. The sub-
association declarations supplemented the Master Declara-
tions. These subassociations were responsible for owning and
maintaining certain common elements and/or exclusive
amenities associated with a neighborhood and for enforcing
their own covenants, conditions, and restrictions. A neighbor-
hood, which could include a gated community, consists of
properties which share exclusive amenities or common areas.
The Summerlin South Master Declaration established the
Summerlin South Design Review Committee. This committee
had to approve ‘‘construction, alteration, grading, additions,
excavation, modification, decoration, redecoration or
reconstruction of an Improvement or removal of any tree in
any Phase of Development’’. The Summerlin West Master
Declaration established a similar review process. In both
cases, petitioners retained control over the review process
until such time as they no longer owned an interest in the
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364 142 UNITED STATES TAX COURT REPORTS (355)
respective Summerlin West and Summerlin South geographic
regions.
Developing Summerlin—Villages
Petitioners developed Summerlin in village phases starting
with the villages adjacent to existing development to take
advantage of the infrastructure. Subsequent villages could
likewise take advantage of the additional infrastructure cre-
ated by the adjacent villages.
Generally, the first step in petitioners’ development activi-
ties was to survey the property and create and file a parcel
map. The parcel map broke off a village-size piece for
development and sale by petitioners. Petitioners also had to
grant easements for utilities and drainage and dedicate
public streets. The parcel map reflected these easements and
dedications.
Often, Clark County or Las Vegas imposed obligations on
petitioners with respect to street grading, surfacing, and
alignment and provisions for drainage, water quality and
supply, sewerage, and particular lot designs. Before devel-
oping the land, petitioners prepared and filed a tentative
map. Along with this map, petitioners conducted technical
studies, such as traffic and drainage studies, and established
a village development plan, which is required by the LVDA
and the CCDA and established the specific zoning, uses, and
entitlements within the villages. Normally, the governing
agency required petitioners to design and construct the
improvements on the tentative map as a condition of
approval of the map. But in certain cases, petitioners
requested waivers. For instance, if a road was not imme-
diately necessary, petitioners could request a waiver delaying
construction until it was necessary. In addition, the tentative
maps did not show all of the improvements that petitioners
would construct on the parcels. For instance, they did not
show landscaping, wall, and dry utility improvements.
Petitioners also prepared improvement plans for the
improvements shown on the tentative maps. It took about
nine months to one year to prepare these plans and for the
governing agency to review and approve them.
Once the various governmental bodies approved the ten-
tative map, petitioners were required to also submit a final
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 365
subdivision map. In the case of pad sales, the builders also
had to prepare and submit tentative and final maps to fur-
ther subdivide the pad land into lots. The pad purchase con-
tracts governing pad sales also required the builders to first
submit these maps to petitioners for approval.
The final map showed roads and easements that peti-
tioners intended to dedicate to the public. These easements
included those for wet utilities, such as sewer and water, and
dry utilities, such as electric, telecommunications, and gas.
Absent a Special Improvement District (SID), the approving
governmental body could require petitioners to enter agree-
ments whereby petitioners posted bonds to ensure completion
of the agreed-upon improvements. These improvements may
have included streets, alleys, curbs, gutters, sidewalks,
medians, streetlights, traffic signals, sewer systems, drainage
facilities, open space improvements, trails, parks, and land-
scaping. Petitioners obtained and posted bonds based on the
unit rate times required material as determined by the
agency that requires the bond. The agency commented on
and required modifications to or approved the bond, and it
exonerated petitioners only when the improvements were
fully constructed and inspected and the agency took owner-
ship.
Petitioners also used tax-exempt SIDs financing to finance
construction of some Summerlin infrastructure improve-
ments. In a project financed by SID bonds, petitioners did
not have to post performance bonds. These SID bonds
financed public improvements such as street, water, sewer,
and storm drainage improvements. Petitioners were entitled
to reimbursement from the money raised from the sale of the
SID bonds when they incurred the relevant construction
costs, subject to the approval of the relevant municipal
authority. Special assessments on the property within the
SID covered the scheduled bond payments. SID financing
was not available to cover dry utilities, landscaping, and
walls. Summerlin West and Summerlin South contain seven
SIDs. The total amount of the SID bonds was $183,685,000.
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366 142 UNITED STATES TAX COURT REPORTS (355)
Villages at Issue
Respondent’s determinations concern income from 107
BDAs 4 for the sale of land in 9 of petitioners’ villages. Those
villages are: Village 13 (Summerlin Centre), Village 14B (The
Gardens), Village 15B (Siena), Village 16 (The Mesa), Village
18 (The Ridges), Village 19 (Summerlin Centre West), Village
20 (The Vistas), Village 23A/B (The Paseos), and Village 26
(Reverence). All of the villages except Villages 15B, 19, and
26 contained land sold in pad sales. 5 Finished lot sales
occurred in Villages 16, 18, 19, 20, and 23.
Also at issue are 279 custom lot contract sales. All custom
lot contracts involved the sale of lots in Village 18. Of the
custom lot contracts, 94% were entered into and closed in the
same tax year. The remaining custom lot contracts closed in
the tax year following the one in which they were entered
into.
The parties have agreed that Villages 16, 18, 20, and 23
are generally representative of the villages at issue. The par-
ties have also agreed on a BDA that is representative of fin-
ished lot sales (Ladera BDA), a BDA that is representative
of pad sales (Lyon BDA), and two custom lot contracts,
Redhawk and Arrowhead, that are generally representative
of the custom lot contracts at issue.
In addition to the pad sales, the finished lot sales, and the
custom lot contracts, petitioners also sold villages 15B and 26
in bulk sales essentially equivalent to very large pad sales.
Within the boundaries of the property sold in a bulk sale,
petitioners do nothing. Rather, the purchaser is responsible
for all development. With respect to Village 26, known as
Reverence, the first half of the sale to Pulte Homes, Inc., now
4 The
parties provided a stipulated exhibit that purports to be a list of
BDAs at issue. This list of 130 BDAs includes 23 contracts for sales in Vil-
lage 14A. But the parties also stipulated that petitioners recognized the
gain on BDAs involving Village 14A in 2000. Other stipulated exhibits,
such as a map highlighting the villages at issue and the calculations at-
tached to the 30-day letters, also reveal that the contracts for sales of land
in Village 14A are not in issue. We disregard the contracts from Village
14A in arriving at the total number of BDAs at issue.
5 The parties disagreed over whether Villages 18 and 19 contained land
sold in pad sales. This dispute is immaterial to our ultimate holding, but
we find that the weight of the evidence suggests Village 18 contained land
sold in pad sales whereas Village 19 did not.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 367
known as Pulte Group, Inc., occurred in December 2006, just
before the 2007 housing market collapse, and neither peti-
tioners nor the purchaser have done any work on this prop-
erty. In fact, the sale of Village 26 was to occur in two parts,
but the purchaser defaulted on the second half of the con-
tract. With bulk sales, petitioners still incurred regional costs
that benefit the two villages, such as costs for water lines,
regional drainage, and road extensions.
Common Improvements Generally
The BDAs, loan agreements, governmental laws, and other
legal obligations required petitioners to build common
improvements in Summerlin. These improvements included
rough grading, roadways, sidewalks, utility infrastructure
such as water, sewer, gas, electricity, and telephone, storm
water drainage, parks, trails, landscaping, entry features,
signs, and perimeter walls. Upon completion of a common
improvement, petitioners transferred ownership or granted
easements to the respective community association or, where
appropriate, the municipality. Generally, community associa-
tions received some roads, swimming pools, open spaces, and
medians, whereas the municipalities received police stations,
fire stations, other roads, traffic signals, and street lights.
Some of these improvements were necessary for construc-
tion of the dwelling units. The allocable costs attributable to
petitioners’ improvement construction activities exceeded
10% of the various total contract prices. Petitioners designed
all of the common improvements in an effort to make
Summerlin an attractive community. In addition, petitioners
monitored and maintained approval control over all construc-
tion in Summerlin, including construction of the dwelling
units.
Representative Contracts
Finished Lot Sale—Ladera BDA
With respect to the BDAs, the parties stipulated that these
contracts are construction contracts within the meaning of
section 460(e)(4). The Ladera BDA is a purchase and sale
agreement between HHPI and KB Home Nevada, Inc. (KB
Home), for finished lots in Village 16 in a neighborhood
called Ladera. The Ladera BDA called for the land sale to be
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368 142 UNITED STATES TAX COURT REPORTS (355)
completed in three phases. Village 16, known as The Mesa,
consisted of a mix of residential uses including single family
and multifamily units. The style of The Mesa drew its
inspiration from the mountains in the backdrop, and peti-
tioners required builders to use natural building materials,
such as stone, and to include at least two outdoor living
spaces per residence.
In addition to the purchase price, the Ladera BDA entitled
HHPI to certain participation payments as well as payments
tied to power company refunds. HHPI received a lot premium
participation payment equal to 50% of the lot premium less
a credit calculated by reference to any commission paid to an
unrelated broker. HHPI also received a payment equal to the
greater of 3% of the net sale price or HHPI’s percentage
share, 38% of the net sale price less the finished lot costs. 6
The power company refund payments stemmed from the fact
that HHPI paid the Nevada Power Co. to construct electric
feeder lines. As homeowners subscribed to electrical service,
the power company refunded all or part of the costs. HHPI
assigned the rights to the refunds to KB Home but then
required KB Home to make three lump-sum payments equal
to the estimated amount of the refund.
The Ladera BDA required HHPI to develop the parcel into
finished lots. HHPI constructed all of the infrastructure up
to the individual lot lines. Thus, wet and dry utilities were
‘‘stubbed’’ to the lot boundaries. HHPI was also responsible
for the streets and street improvements such as traffic sig-
nals, the driveway depressions, the perimeter and retaining
walls, entry monumentation, and landscaping. HHPI also
graded the parcel, including the lots. And HHPI agreed to
construct a community park with a swimming pool, for which
KB Home paid HHPI a community park fee of $2,000 per
residence.
Improvement plans governed the work HHPI had to per-
form as part of the contract. HHPI, through the engineering
firm G.C. Wallace, Inc. (GCW), created their plans, one for
each phase, for approval by Clark County, the public utili-
ties, and other agencies. The plans governed the curbs, gut-
6 As used in the contracts, net sale price means the gross sale price less
credit for any lot premium and any costs of amenities, such as swimming
pools. Finished lot costs is the purchase price KB Home paid for the lot.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 369
ters, and other paving improvements, street signs,
streetlights, driveway depressions, and wet utilities, such as
sewer mains, manholes, water mains, fire hydrants, and
water and sewer service stubbed to each lot. Another set of
plans prepared by the utility companies governed the dry
utilities, such as telephone and gas. In addition, HHPI was
responsible for any improvement necessary for the issuance
of a building permit or certificate of occupancy and for land-
scaping, design, and construction of perimeter and screen
walls, entry monumentation, and community open space.
On the purchaser’s side, the Ladera BDA obligated KB
Home to build dwelling units subject to a development dec-
laration and a development plan. The BDA also annexed the
property to the Summerlin South Community Association,
making KB Home also subject to the CC&Rs of that associa-
tion. The development declaration, entered at the time of
closing of phase 1, contained a number of additional restric-
tions on KB Home. The declaration allowed KB Home to con-
struct only single-family homes in accordance with a develop-
ment plan. The declaration preserved HHPI’s control over
design of homes and landscaping by requiring that they con-
form to HHPI’s residential design criteria for The Mesa Vil-
lage and to the landscape standards. The design criteria gov-
erned everything from lot grading to home finishes.
The declaration required KB Home to create a develop-
ment plan. The development plan had to describe land-
scaping improvements as well as building improvements.
With respect to the plans for the homes, the declaration
required KB Home to create a concept plan, with floor plans
and sketches of the home exteriors visible from the street,
preliminary and final plot plans, which showed the location
of the home and other improvements on the lot, an architec-
tural materials sample board, which included samples of the
building materials to be used, and a marketing signage plan,
which contained details on all signage.
The development plan was subject to the approval of
HHPI. If HHPI or a governmental agency disproved or
rejected an item as not being in conformity with the develop-
ment plan, KB Home was obligated to correct the defect at
its own cost. In addition to requiring KB Home to construct
single-family homes in a certain manner, the Ladera BDA
also required KB Home to construct sidewalks, driveways,
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370 142 UNITED STATES TAX COURT REPORTS (355)
model homes, interior screen walls, curb scribes, and water
meters.
Pad Sale—Lyon BDA
The second purchase and sale agreement is an example of
a pad sale. This agreement was between Old THHC and Wil-
liam Lyon Homes, Inc. (Lyon), for the sale of Parcel M in Vil-
lage 20. As part of this agreement, THHC transferred fee
simple title to Lyon subject to a number of encumbrances,
including the Summerlin West Master Declaration, a supple-
mental declaration of annexation, a development declaration,
and the Summerlin West Development Agreement. The
agreement limited Lyon to constructing single-family homes.
The agreement also placed substantial restrictions on
Lyon’s use of the property. The supplemental declaration of
annexation subjected Parcel M to the CC&Rs in the
Summerlin West Master Declaration and imposed its own
restrictions, such as those governing satellite dishes and
signs. Similarly, the development declaration required Lyon
to submit a development plan for THHC’s approval before it
could begin any construction. The development declaration
also required improvements to conform to an architectural
concept plan, a preliminary plot plan, an architectural mate-
rials sample board, a final plot plan, a marketing signage
plan, and the Summerlin Design Standards. If any item did
not conform to the development plan or was otherwise defec-
tive, Lyon had to, at its own cost, correct the problem.
The agreement also required Lyon to build entry
monumentation and landscaping, a minipark, and pedestrian
access ways. The parties agreed to share costs of boundary
walls between the property and adjacent parcels if the par-
ties thought such walls were desirable.
THHC, as part of the agreement, agreed to perform all
other obligations, except those inuring solely and specifically
to the subject property or specifically under the LVDA nec-
essary for the purchaser’s project. THHC also agreed to con-
struct the roads bordering the parcel, Vista Run Drive and
Trail View Lane, and associated roads, curbs, gutters, and
street lighting. The agreement further required petitioners to
construct a perimeter boundary wall along the roads bor-
dering the property and to stub the wet and dry utilities to
the parcel.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 371
Custom Lot Contracts
The parties provided two custom lot contracts for the sale
of property in Village 18 to individual purchasers through
custom lot contracts. Each custom lot contract involved the
sale of a lot(s) in one of seven neighborhoods in Village 18,
known as The Ridges. The two representative contracts were
for the sale of a lot in the Arrowhead neighborhood and for
the sale of a lot in the Redhawk neighborhood. These con-
tracts are representative of the other custom lot contracts at
issue in these cases.
Each contract sold a lot described in final maps recorded
with the Office of the County Recorder of Clark County,
Nevada. The contracts required the purchaser to build a
single-family home on the lot. In addition, the contracts
stated that HHPI must construct or have constructed certain
improvements and the individual lot purchaser is to be solely
responsible for other lot improvements. For instance, section
7 of the Arrowhead contract stated in part:
HHP’s Improvements. HHP has installed roads providing access to the
Lot, together with underground improvements for sanitary sewer,
potable water, telephone, natural gas and electric power. All such utility
improvements have been stubbed out to the Lot. It shall be Purchaser’s
responsibility to activate water service * * * prior to commencing
construction on the Lot. Purchaser is responsible for all utility connec-
tions from the property line to Purchaser’s Home and for making all nec-
essary arrangements with each of the public utilities for service. Pur-
chaser acknowledges that HHP is not improving the Lot and has not
agreed to improve the Lot for Purchaser except as provided in this Sec-
tion 7. Purchaser will be responsible for finish grading and preparation
of the building pad and acknowledges that HHP has not agreed to pro-
vide any grading of the Lot beyond its present condition.
Section 7 of the Redhawk contract was substantially similar,
but it implied that HHPI’s work was not yet completed at the
time of the purchase and sale agreement.
As part of the custom lot contract, HHPI explicitly stated
that it ‘‘made no representations or warranties concerning
zoning * * * or the future development of phases of Arrow-
head, The Ridges or the surrounding area or nearby prop-
erty’’. A similar provision was in the Redhawk contract. The
contracts also contained integration clauses. Paragraph 23 of
the representative contracts stated:
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372 142 UNITED STATES TAX COURT REPORTS (355)
This Agreement constitutes the entire agreement and understanding
between Purchaser and HHP with respect to the purchase of the Lot and
may not be amended, changed, modified or supplemented except by an
instrument in writing signed by both parties. This Agreement super-
sedes and revokes all prior written and oral understandings between
Purchaser and HHP with respect to the Lot.
But the purchasers also initialed a page of the custom lot
contracts that states: ‘‘ALL OF THE DOCUMENTS LISTED
BELOW ARE IMPORTANT TO THE PURCHASE OF THE
LOT, SHOULD BE READ BY THE PURCHASER AND, AT
THE CLOSE OF ESCROW, SHALL BE DEEMED TO HAVE
BEEN READ AND APPROVED BY PURCHASER. * * *
PURCHASER HEREBY ACKNOWLEDGES RECEIPT OF
COPIES’’ of those listed documents. Among the documents
that purchasers acknowledged receipt of and were deemed to
have read are CC&Rs, articles of incorporation, and bylaws
of the Summerlin South Community Association, copies of
the recorded subdivision map for the neighborhood in which
the lot was located, the neighborhood design criteria, and a
public offering statement. 7
The purchasers and the purchased lots were subject to the
various CC&Rs that govern Summerlin South, Village 18,
and the subassociation within Village 18, and they were
contractually required to conform their lot to the relevant
architectural declaration. The architectural declaration
required that all construction on the lot be approved by
HHPI. If HHPI delegated the approval power to a review
committee for The Ridges, then that committee must approve
the declaration. In addition, the CC&Rs for the Village 18
association granted access to homeowners to their lots by
way of one of two circular roadways accessible by two guard
houses and private gates, all of which were to be designed
and constructed by HHPI, including associated landscaping.
These improvements became common elements owned by the
community association as did other elements such as entry
7 The parties did not provide copies of the attachments to the two rep-
resentative custom lot contracts. Rather, they provided the attachments to
a different custom lot contract, which involved the sale of a lot in The
Azure community in Village 18. The parties have stipulated that these at-
tachments are generally representative of the exhibits attached to a con-
tract for the purchase and sale of a custom lot in Village 18.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 373
features, recreational facilities, landscaped medians, and cul-
de-sacs.
The recorded subdivision maps identified the common
areas, including private roads such as Drifting Shadow Way
and Sun Glow Lane, which were granted to the relevant
community association. These maps also showed the location
of storm drain easements and flood control and drainage
channel right-of-ways. The neighborhood design criteria con-
tained maps showing the walls and fences HHPI had to con-
struct. The design criteria also contained a map that showed
a community and fitness center, which the parties stipulated
was available to residents of Village 18. The public offering
statements not only stated that the private roads, guard
houses, and landscaping improvements are to be owned by
the community association, but they also recited that HHPI
was responsible for utility connections to the lots and land-
scaping improvements in common lots.
Tax Reporting
For the years at issue, petitioners used the completed con-
tract method of accounting in computing gain or loss from
their contracts for sale of residential real property in
Summerlin West and South intended for residential
buildings planned to contain four or fewer residential units
per building. 8 Petitioners reported gain from BDAs, custom
lot contracts, and the bulk sale agreements when they
incurred 95% of the estimated costs allocable to each BDA,
custom lot contract, or bulk sale agreement.
Petitioners broke down estimated BDA costs into three cat-
egories: direct village costs, regional costs, and finished lot
costs. Direct village costs consisted of the cost for the
common improvements that benefit only the village that was
the subject matter of the contract. These costs included the
following cost categories: planning; engineering; inspection,
testing, and processing; rough grading; water/sewer storm
drain; street improvements; dry utilities; walls/fencing; land-
scaping; parks; deposits; other; and contingency. Regional
8 For
example, petitioners did not use the completed contract method of
accounting to account for gain or loss from the sale of property upon which
large multiunit apartment and commercial buildings were ultimately to be
built.
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374 142 UNITED STATES TAX COURT REPORTS (355)
costs consisted of common improvements that benefited more
than one village and included the following cost categories:
regional water, regional sewer, regional drainage, regional
roads, regional traffic signals, regional entry features,
regional annual costs, regional other costs, and townwide
arterial costs. Finished lot costs were the costs that benefit
only the neighborhood or parcel in which the finished lots
were located.
Petitioners used the engineering firm GCW to calculate
most cost estimates. For the actual construction cost cat-
egories, the ‘‘hard costs’’, GCW used a market price unit rate
for each improvement, which was based on its experience
with past bids as well as prevailing bond rates. The unit rate
generally reflected labor and materials cost for the relevant
improvement. The unit rate was applied differently to dif-
ferent improvements. For instance, GCW applied the unit
rate based on length for improvements such as curbs, sewer
lines, and sidewalks, on area for improvements such as
paving and some landscaping, and on number of units of a
designated improvements such as street lights and fire
hydrants. ‘‘Soft costs’’, or costs other than the actual
construction costs such as engineering, inspection, testing,
and processing, were calculated as a percentage of the hard
costs.
For regional water costs, GCW allocated the costs to vil-
lages according to the percentage of village acreage in the
relevant water zone. GCW assigned costs to each water zone
for water mains, pump stations, reservoirs, and inlet and
outlet pipes in the water zone. For regional sewer costs,
GCW allocated the cost among villages in proportion to their
acreage. These costs included costs for the sewer systems,
including pipes and mains, paving, manholes, flowmeters,
and traffic controls. Drainage, regional roads, regional entry
features, regional annual, regional other, and townwide arte-
rial costs were all also allocated in proportion to village acre-
age. Traffic signal costs, however, were allocated to the vil-
lage(s) adjacent to the street corners (for example, one-fourth
to each corner at a four-way intersection) of the relevant
signal and then prorated by acreage.
For the finished lot costs, petitioners and GCW used a for-
mula based on historical actual costs. This formula yielded
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 375
an estimated incremental cost of improvements of $40,000
per lot.
Deficiencies
For the tax years at issue, petitioners reported income
from the sale of land within Summerlin using the completed
contract method of accounting. Under petitioners’ methods of
accounting, each BDA, custom lot contract, and bulk sale
agreement was a home construction contract, and they were
not completed within the meaning of section 460 until peti-
tioners incurred 95% of the direct and indirect costs allocable
to the agreement or contract.
Respondent issued notices of deficiency to both petitioners.
As part of his determinations, respondent changed peti-
tioners’ methods of accounting from the completed contract
method of accounting to the percentage of completion method
of accounting. Respondent adjusted petitioners’ income as fol-
lows:
Petitioner 2007 2008 Total
THHC $209,875,725 $19,399,420 $229,275,145
HHPI 156,303,168 37,192,046 193,495,214
The total additional cumulative taxable revenue THHC
would have recognized through its 2008 tax year under the
percentage of completion method of accounting is
$239,897,451. The difference between this number and the
total $229,275,145 adjustment in the notice of deficiency is
due to adjustments for (1) gain recognized in the 2003 tax
year pursuant to a prior audit, (2) overreported gain for non-
exempt development activities, and (3) underreported gain
for nonexempt development activities.
The total additional cumulative taxable revenue HHPI
would have recognized through the 2008 tax year under the
percentage of completion method of accounting is
$231,791,739. The difference between this number and the
total $193,495,214 adjustment in the notice of deficiency is
due to (1) gain recognized in the 2003 tax year pursuant to
a prior audit, (2) overreported gain for nonexempt develop-
ment activities, and (3) overreported gain for exempt develop-
ment activities.
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376 142 UNITED STATES TAX COURT REPORTS (355)
Respondent’s adjustments resulted in his determination of
the following deficiencies:
Petitioner 2007 2008
THHC $73,456,504 $6,789,797
HHPI 50,633,554 13,228,620
Petitioners timely petitioned this Court for redetermination,
and a trial was held in Las Vegas, Nevada.
OPINION
I. Burden of Proof
Generally, the Commissioner’s determination of a tax-
payer’s liability for an income tax deficiency is presumed cor-
rect, and the taxpayer bears the burden of proving that the
determination is improper. See Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933). If a taxpayer’s method
of accounting does not clearly reflect income, section 446(b)
allows the Commissioner to change the taxpayer’s method of
accounting to one that does clearly reflect income. The
Commissioner is granted broad discretion in determining
whether an accounting method clearly reflects income, and
that determination is entitled to more than the usual
presumption of correctness. Commissioner v. Hansen, 360
U.S. 446, 467 (1959); RECO Indus., Inc. v. Commissioner, 83
T.C. 912, 920 (1984). The question of whether a particular
accounting method clearly reflects income is a question of
fact. Sam W. Emerson Co. v. Commissioner, 37 T.C. 1063,
1067 (1962).
To prevail, the taxpayer must establish that the Commis-
sioner abused his discretion in changing the method of
accounting. Prabel v. Commissioner, 91 T.C. 1101, 1112
(1988), aff ’d, 882 F.2d 820 (3d Cir. 1989). But the Commis-
sioner may not change a taxpayer’s method of accounting
from an incorrect method to another incorrect method. Id.Nor may the Commissioner change a taxpayer’s method of
accounting ‘‘[w]here a taxpayer’s method of accounting is
clearly an acceptable method’’ and clearly reflects income. Id.VerDate Mar 15 2010 13:28 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00022 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\HOWARD~1._LL JAMIE
(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 377
II. Custom Lot Contracts and Bulk Sale Agreements as Long-
Term Contracts
First, we must determine whether petitioners’ contracts
are long-term contracts. The parties stipulated that the
BDAs are long-term construction contracts. The notices of
deficiency determined deficiencies as if all of petitioners’ con-
tracts were long-term contracts. On brief respondent has
departed from that determination and contends that the cus-
tom lot contracts and the bulk sale agreements are not long-
term contracts. Generally, the Court will not allow a party
to raise an issue on brief if consideration of that issue would
surprise and prejudice the opposing party. Chapman Glen
Ltd. v. Commissioner, 140 T.C. 294, 349 (2013). Because we
do not think that petitioners need additional evidence to
respond to the new issue and respondent has not carried the
issue, we address it below. See id. (looking to ‘‘the degree to
which the opposing party is surprised by the new issue and
the opposing party’s need for additional evidence to respond
to the new issue’’ to determine prejudice). As to new issues,
respondent bears the burden of proof. See Rule 142(a)(1).
A. Custom Lot Contracts
Respondent alleges that none of petitioners’ custom lot con-
tracts qualify even for accounting under the percentage of
completion method because they are not long-term contracts.
Initially, respondent contends that many of the contracts
were entered into and closed within the same tax year and
they therefore cannot be considered long term within the
meaning of section 460. Second, respondent contends that
because petitioners did not have a legal obligation to perform
the construction activities contemplated by the contracts, the
contracts are not construction contracts. Petitioners, on the
other hand, first assert that the contracts are complete, for
the purposes of section 460, when they incur at least 95% of
the total allocable contract costs attributable to the contract’s
subject matter. They also contend that their contracts are
construction contracts that impose legal obligations upon
them.
A long-term contract is ‘‘any contract for the manufacture,
building, installation, or construction of property if such con-
tract is not completed within the taxable year in which such
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378 142 UNITED STATES TAX COURT REPORTS (355)
contract is entered into.’’ Sec. 460(f)(1). The relevant regula-
tion provides that the date a contract is completed is the ear-
lier of
(A) Use of the subject matter of the contract by the customer for its
intended purpose (other than for testing) and at least 95 percent of the
total allocable contract costs attributable to the subject matter have been
incurred by the taxpayer; or
(B) Final completion and acceptance of the subject matter of the con-
tract.
[Sec. 1.460–1(c)(3)(i), Income Tax Regs.]
But taxpayers determine the contract completion date ‘‘with-
out regard to whether one or more secondary items have
been used or finally completed and accepted.’’ Sec. 1.460–
1(c)(3)(ii), Income Tax Regs. In addition, the regulation
directs taxpayers to ‘‘consider all relevant facts and cir-
cumstances’’ in determining whether final completion and
acceptance has occurred. Sec. 1.460–1(c)(3)(iv), Income Tax
Regs.
If the subject matter of the custom lot contracts is solely
the sale of the piece of land, then petitioners’ custom lot con-
tracts would be complete upon close of escrow. The custom
lot contracts do indeed provide for the sale of a piece of land,
but they also reference numerous other documents, including
CC&Rs, development plans, and subdivision maps. Under
Nevada law, ‘‘ ‘[w]ritings which are made a part of the con-
tract by annexation or reference will be so construed; but
where the reference to another writing is made for a par-
ticular and specified purpose, such other writing becomes a
part for such specified purpose only.’ ’’ Lincoln Welding
Works, Inc. v. Ramirez, 647 P.2d 381, 383 (Nev. 1982)
(quoting Orleans M. Co. v. Le Champ M. Co., 284 P. 307(Nev. 1930)). However, if the reference ‘‘indicates an
intention to incorporate * * * [the documents] generally,
such reference becomes a part of the contract for all pur-
poses.’’ Id.The custom lot contracts contain a page whereon the pur-
chaser(s) acknowledge receipt of copies of numerous docu-
ments, which are listed on the page. 9 We believe that this
9 As
previously noted, the page reads in part: ‘‘ALL OF THE DOCU-
MENTS LISTED BELOW ARE IMPORTANT TO THE PURCHASE OF
THE LOT, SHOULD BE READ BY THE PURCHASER AND, AT THE
CLOSE OF ESCROW, SHALL BE DEEMED TO HAVE BEEN READ
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 379
sentence incorporates the documents listed, and, because
there is no indication that the reference is for a specific pur-
pose, we incorporate these documents generally.
After reviewing the custom lot contracts, the documents
referenced therein, and the testimony regarding Summerlin
as a master-planned community marketed as such by peti-
tioners, we are convinced that the subject matter of the con-
tracts encompasses more than just the sale of the lot. The
costs incurred for a custom lot contract are not really dif-
ferent from the costs for the finished lot sales. At the time
of trial, petitioners still had to complete a water service line,
traffic signals, landscaping, and construction of a park.
Therefore, we agree that final completion and acceptance
does not necessarily occur at the close of escrow, but rather
occurs when final completion and acceptance of the subject
matter of the contracts, which includes improvements whose
costs are allocable to the custom lot contracts, occurs. Cf.
Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. 60, 104
(2014). Consequently, petitioners are entitled to account for
the gain or loss from these contracts on the appropriate long-
term method of accounting under section 460 to the extent
the contracts are not completed within the taxable year in
which they are entered into.
In so holding, we reject respondent’s contention that the
contracts impose upon petitioners no separate legal obliga-
tion to complete the required improvements. The regulations
provide that a contract is a long-term contract under section
460 ‘‘if the manufacture, building, installation, or construc-
tion of property is necessary for the taxpayer’s contractual
obligations to be fulfilled and if the manufacture, building,
installation, or construction of that property has not been
completed when the parties enter into the contract’’ and the
contract is not completed within the contracting year. Sec.
1.460–1(b)(1) and (2)(i), Income Tax Regs.; see also Foothill
Ranch Co. P’ship v. Commissioner, 110 T.C. 94, 98–99 (1998).
For contracts that provide for the provision of land, the
regulations also contain a de minimis rule, under which if
the allocable costs attributable to construction activities do
not exceed 10% of the total contract price, the contract is not
a construction contract under section 460. Sec. 1.460–
AND APPROVED BY PURCHASER.’’
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380 142 UNITED STATES TAX COURT REPORTS (355)
1(b)(2)(ii), Income Tax Regs. To calculate the allocable costs,
the regulation allows a taxpayer to ‘‘include a proportionate
share of the estimated cost of any common improvement that
benefits the subject matter of the contract if the taxpayer is
contractually obligated, or required by law, to construct the
common improvement.’’ Id. Petitioners’ allocable costs attrib-
utable to construction activities exceed the 10% threshold.
Respondent appears to read this regulation as requiring a
taxpayer to have a legal obligation independent of any other
preexisting duty.
While we agree with respondent that work completed by
petitioners at the time the contracts are entered into cannot
transform a contract into a construction contract under sec-
tion 460, we disagree that the statute and the regulations
necessarily require that all construction activity obligations
be solely enforceable because of the contract. Respondent
believes that section 1.460–1(b)(2)(i), Income Tax Regs., codi-
fies the common law preexisting duty doctrine. Therefore, he
says that because petitioners are already obligated by statute
to complete various improvements, the obligations are not
contractual obligations.
The preexisting duty rule states that ‘‘a promise to do that
which the promisor is already legally obligated to do is
unenforceable.’’ Johnson v. Seacor Marine Corp., 404 F.3d
871, 875 (5th Cir. 2005). Nevada follows the preexisting duty
rule. Cnty. of Clark v. Bonanza No. 1, 615 P.2d 939, 944
(Nev. 1980). The Nevada Common-Interest Ownership Act
requires sellers, such as petitioners, to complete all improve-
ments depicted on any site plan or similar documents except
those labeled ‘‘NEED NOT BE BUILT’’, Nev. Rev. Stat. sec.
116.4119(1) (1991), and provides purchasers with a cause of
action, id. sec. 116.4117 (1997). 10
It is not clear that the preexisting duty rule applies in
these cases. The contracts between petitioners and the pur-
chasers are valid contracts with valid consideration inde-
pendent of the duties with respect to the development.
Second, while the Nevada statute does indeed seem to grant
10 We
note that Nev. Rev. Stat. sec. 116.4117 (1997) has been amended
numerous times since it was enacted in 1991. We refer to the statute as
amended and in effect for the years in which the contracts were entered
into.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 381
purchasers a cause of action if petitioners fail to construct
improvements as shown on site plans or plats, the statute
explicitly provides: ‘‘The civil remedy provided by this section
is in addition to, and not exclusive of, any other available
remedy or penalty.’’ Id. sec. 116.4117(5). Therefore, it is
uncertain whether a Nevada court would apply the pre-
existing duty rule to petitioners’ contracts. See Johnson, 404
F.3d at 875 (‘‘[A]s long as the contracting parties gain some
legally enforceable right as a result of the contract which
they previously did not have, consideration is present[.]’’).
The public policy concerns that underpin the preexisting duty
rule do not seem to be present here. 11
In addition, we do not agree with respondent that section
1.460–1(b)(2), Income Tax Regs., codifies the preexisting duty
rule. The regulation clearly states that ‘‘how the parties
characterize their agreement (e.g., as a contract for the sale
of property) is not relevant’’ in determining the existence of
a section 460 construction contract. Sec. 1.460–1(b)(2)(i),
Income Tax Regs.; see also Koch Indus., Inc. & Subs. v.
United States, 603 F.3d 816, 822 (10th Cir. 2010) (citing the
regulation). As to the allocable costs attributable to common
improvements in the de minimis rule, the regulation does not
require that the obligation be solely contractual. Sec. 1.460–
1(b)(2)(ii), Income Tax Regs. Rather, the regulation allows a
taxpayer to include the allocable costs ‘‘if the taxpayer is
contractually obligated, or required by law, to construct the
common improvement.’’ Id. Nothing in the regulation
requires that the contract be the sole source of the obligation,
and, in fact, it indicates the opposite—that the obligation
may be noncontractual.
B. Bulk Sale Contracts
Respondent similarly contends that the bulk sale contracts
do not qualify as long-term construction contracts under sec-
tion 460. Specifically, respondent alleges that petitioners
have not established that they were obligated to construct
anything under these contracts. Respondent bases this posi-
11 In fact, the Nevada Common-Interest Ownership Act appears to en-
able parties other than those in contractual privity with the developer to
have standing to institute a lawsuit. See Nev. Rev. Stat. sec. 116.4117(2)
(allowing suit to be brought by a unit’s owner, not just the original pur-
chaser of the land from the developer).
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382 142 UNITED STATES TAX COURT REPORTS (355)
tion on his belief that the terms of the bulk sale contracts are
unknown and that petitioners failed to carry their burden of
proving that the contracts are entitled to a long-term con-
tract method of accounting.
We disagree that the bulk sale contracts are substantially
different from the pad sale BDAs. The parties stipulated that
the pad sale BDAs are construction contracts. The bulk sale
agreements are merely pad sale BDAs on a larger scale. The
record supports this conclusion. We heard credible testimony
from the vice president of finance for petitioners that the
bulk sale contracts were BDAs and that petitioners were
obligated to build the same types of common improvements
that benefited the property sold, such as regional water lines,
traffic signals, and detention basins. Thus, we hold that
these contracts too are construction contracts that may be
accounted for under section 460 as long-term contracts to the
extent consistent with this Opinion.
III. Completed Contract Method of Accounting
Because the Court has concluded that all of petitioners’
contracts are long-term construction contracts, we turn to the
question of whether the contracts are home construction con-
tracts. Section 460(a) provides generally that taxpayers must
determine taxable income from long-term contracts under the
percentage of completion method of accounting. Under this
method of accounting, taxpayers generally recognize gain or
loss throughout the duration of the contract. See sec. 1.460–
4(b), Income Tax Regs. (rules concerning percentage of
completion method). But in some instances taxpayers may
account for income from certain construction contracts under
other methods of accounting such as the completed contract
method. Sec. 460(e).
This section provides an exception to the percentage of
completion method of accounting for home construction con-
tracts and an exception for other construction contracts
where the taxpayers complete the contract within 24 months
and meet a gross receipts test. Sec. 460(e)(1)(A) and (B). The
parties have stipulated that most of petitioners’ contracts are
construction contracts as defined in section 460(e)(4). Peti-
tioners do not contend that they qualify for the second excep-
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 383
tion, so the question before us is whether petitioners’ con-
tracts qualify as home construction contracts.
Deferral of income tax, like exemptions and deductions, is
a matter of legislative grace, and exceptions to the normal
income recognition rules must be strictly construed. See, e.g.,
Bingler v. Johnson, 394 U.S. 741, 752 (1969) (‘‘[E]xemptions
from taxation are to be construed narrowly[.]’’); Estate of Bell
v. Commissioner, 928 F.2d 901, 903 (9th Cir. 1991) (‘‘The
deferral [of estate tax payment] benefits of section 6166 are
a ‘matter of legislative grace’ that is similar to the benefits
conferred by other statutory provisions dealing with deduc-
tions, exemptions and exclusions from tax. Thus, a strict and
narrow construction should be applied to the deferral benefit
provisions[.]’’), aff ’g 92 T.C. 714 (1989).
The parties disagree over whether contracts such as peti-
tioners’, where the seller does not build the house or any
improvements on the lot, qualify as home construction con-
tracts. Section 460(e)(6) defines a home construction contract
as follows:
(A) HOME CONSTRUCTION CONTRACT.—The term ‘‘home construction
contract’’ means any construction contract if 80 percent or more of the
estimated total contract costs (as of the close of the taxable year in
which the contract was entered into) are reasonably expected to be
attributable to activities referred to in paragraph (4) with respect to—
(i) dwelling units (as defined in section 168(e)(2)(A)(ii)) contained in
buildings containing 4 or fewer dwelling units (as so defined), and
(ii) improvements to real property directly related to such dwelling
units and located on the site of such dwelling units.
For purposes of clause (i), each townhouse or rowhouse shall be treated
as a separate building.
We refer to this definition as the 80% test. Paragraph (4)
referred to by section 460(e)(6)(A) provides: ‘‘For purposes of
this subsection, the term ‘construction contract’ means any
contract for the building, construction, reconstruction, or
rehabilitation of, or the installation of any integral compo-
nent to, or improvements of, real property.’’ Sec. 460(e)(4).
The statute defines dwelling unit by cross-reference as ‘‘a
house or apartment used to provide living accommodations in
a building or structure, but does not include a unit in a hotel,
motel, or other establishment more than one-half of the units
in which are used on a transient basis’’. Sec.
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384 142 UNITED STATES TAX COURT REPORTS (355)
168(e)(2)(A)(ii). 12 The parties do not dispute that pursuant to
the contracts, agreements, and government development
rules, the structures to be ultimately built upon the land
petitioners sell in the contracts at issue are dwelling units.
Importantly, however, petitioners did not build homes on
the land they sold, nor did qualifying dwelling units exist on
the sold land at the time of the sales. Petitioners have not
established that at the time of each sale qualifying dwelling
units would ever be built on the sold land. The bulk sale
agreement for Village 26 is especially troubling as no
construction had yet occurred years later and, because the
purchaser-builder defaulted on the contract, THHC still
owned half of the village. As far as we know, no qualifying
dwelling units will ever be built on these lands, 13 and
12 The relevant regulation largely follows the statute. It defines home
construction contracts as follows:
(i) In general.—A long-term construction contract is a home construc-
tion contract if a taxpayer (including a subcontractor working for a gen-
eral contractor) reasonably expects to attribute 80 percent or more of the
estimated total allocable contract costs (including the cost of land, mate-
rials, and services), determined as of the close of the contracting year,
to the construction of—
(A) Dwelling units, as defined in section 168(e)(2)(A)(ii)(I), contained in
buildings containing 4 or fewer dwelling units (including buildings with
4 or fewer dwelling units that also have commercial units); and
(B) Improvements to real property directly related to, and located at
the site of, the dwelling units.
(ii) Townhouses and rowhouses.—Each townhouse or rowhouse is a
separate building.
(iii) Common improvements.—A taxpayer includes in the cost of the
dwelling units their allocable share of the cost that the taxpayer reason-
ably expects to incur for any common improvements (e.g., sewers, roads,
clubhouses) that benefit the dwelling units and that the taxpayer is con-
tractually obligated, or required by law, to construct within the tract or
tracts of land that contain the dwelling units.
[Sec. 1.460–3(b)(2), Income Tax Regs.]
13 We note that in a case of an insolvent builder, a bankruptcy court may
direct the trustee of the bankruptcy estate to petition the local government
for rezoning. See In re Lloyd, 37 F.3d 271, 274 (7th Cir. 1994) (affirming
the bankruptcy court’s direction to the trustee to seek to rezone property
from agricultural to residential to allow the debtor a homestead exemp-
tion). We also note that the Summerlin West and the Summerlin South de-
velopment agreements with Las Vegas and Clark County have been
amended from time to time by the parties. Thus, contractual promises or
obligations of third parties alone are, at least in this factual context, insuf-
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 385
deferral of income from contracts that might not ever result
in qualifying dwelling units seems entirely inappropriate
under these circumstances. Cf. Shea Homes, Inc. & Subs. v.
Commissioner, 142 T.C. at 105–106 (permitting deferral of
income from contracts where the completed qualifying
dwelling units were, themselves, included in the property
being sold and giving rise to the asserted taxable income).
Petitioners close the contracts and receive revenue without
needing to build a single home. In Shea Homes, the tax-
payers closed their contracts only after a certificate of occu-
pancy had been issued and simultaneously with the pur-
chasers’ taking possession of their house. Id. at 79. Peti-
tioners are under no contractual obligation to build homes as
their contracts are merely for the sale of land, developed to
varying degrees, to builders or individual customers who may
eventually build homes on that land.
In respondent’s mind, the definitions foreclose petitioners
from using the completed contract method of accounting.
Only the section 460(e)(4) costs directly associated with
building the actual house or improvements thereto qualify for
purposes of meeting the 80% test. Petitioners assert that
construction activity costs count in meeting the 80% test
even though they do not build the four walls or roof of a
dwelling unit. Under their interpretation, the ‘‘allocable
costs’’ include the costs of required infrastructure and
common improvements attributable to the dwelling units.
Even if true, this point, without more, would not be deter-
minative of their right to use section 460(e).
The starting point for interpreting a statute or a regulation
is its plain and ordinary meaning unless such an interpreta-
tion ‘‘would produce absurd or unreasonable results’’. Union
Carbide Corp. v. Commissioner, 110 T.C. 375, 384 (1998).
Undefined words take their ‘‘ordinary, contemporary,
ficient to ensure that qualifying dwelling units will in fact be constructed
on the sold land. When it comes to yet-to-be completed common improve-
ments, presumably bonds are posted, whereas the purchasers of the land
do not post or purchase bonds promising construction of homes. We cannot
therefore conclude that governmental zoning and entitlement agreements
and land sale contracts alone are enough to meet petitioners’ evidentiary
burden of establishing that the qualifying dwelling units requirement of
sec. 460(e)(6)(A) is or will be met.
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386 142 UNITED STATES TAX COURT REPORTS (355)
common meaning’’. Hewlett-Packard Co. & Consol. Subs. v.
Commissioner, 139 T.C. 255, 264 (2012).
A. Costs Attributable to Dwelling Units
Section 460(e)(6) defines a home construction contract, as
of the end of the taxable year when the contract was entered
into, by reference to the estimated total contract costs attrib-
utable to construction activity ‘‘with respect to’’ (i) dwelling
units and (ii) improvements to real property directly related
to the units and located on the site of the dwelling units. The
regulations clarify that the allocable contract costs to be
included in the 80% test must be attributable to the
construction of the units and the improvements thereto. Sec.
1.460–3(b)(2)(i), Income Tax Regs. 14
What does the statute mean when it says ‘‘attributable to’’
construction activities ‘‘with respect to’’ dwelling units and
improvements directly related to real property? Sec.
460(e)(6)(A). Respondent asserts that only costs incurred in
the actual construction of the dwelling units or their related
real property improvements count. Respondent contends that
the home construction contract exception requires the tax-
payer to build dwelling units or to build improvements to
real property directly related to and located on the site of
such dwelling units.
Petitioners claim the statute contemplates a broader defi-
nition of home construction costs. Under their interpretation,
they believe that their costs benefit dwelling units and real
property improvements related to and located on the site of
such dwelling units. Because the costs benefit dwelling units,
petitioners contend that the costs are therefore attributable
to the dwelling units and that these costs should count
towards meeting the 80% test. Under petitioners’ view,
because all of their development costs are attributable to
construction activity with respect to dwelling units and real
property improvements related to and located on the site of
14 Petitioners do not challenge the regulations, and accordingly we give
them their due deference. See sec. 460(h); Mayo Found. for Med. Educ. &
Research v. United States, 562 U.S. 44, 55–56 (2011) (applying to regula-
tions the test announced in Chevron, U.S.A. Inc. v. Natural Res. Def. Coun-
cil, Inc., 467 U.S. 837, 842–843 (1984)); cf. Shea Homes, Inc. & Subs. v.
Commissioner, 142 T.C.60, 98 n.18 (2014).
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 387
those dwelling units, section 460(e) is applicable even though
they do not construct the dwelling units.
Petitioners assert that because the costs are allocable to
the contracts and because the costs benefit the property sold
to the homebuilders and ultimately to individual buyers, the
costs are attributable to construction activities with respect
to the dwelling units or real property improvements. This
conclusion follows, according to petitioners, because the
statute does not confine the availability of the completed con-
tract method of accounting to those taxpayers who build the
dwelling units’ ‘‘sticks and bricks’’ and/or real property
improvements related to and located on the dwelling units’
lots.
Petitioners’ interpretation of the statute would make any
construction cost tangentially related to a dwelling unit or
real property improvement related to and located on the site
of the dwelling unit a cost to be counted in determining
whether a contract is a home construction contract. Without
petitioners’ development work, the pads and lots would be
mere patches of land in a desert. Petitioners’ work may
indeed be necessary for the ultimate home to feasibly be built
and occupied.
But these correlations do not mean that those costs are
necessarily incurred ‘‘with respect to’’ qualifying dwelling
units. ‘‘With respect to’’ implies a stronger proximate causa-
tion than petitioners’ interpretation permits. The preposi-
tional phrase ‘‘with respect to’’ can mean ‘‘as regards: insofar
as concerns: with reference to’’. Webster’s Third New Inter-
national Dictionary 1934 (2002). So the construction activi-
ties that count towards meeting the 80% test are defined by
reference to the dwelling unit. The phrase does not imply a
correlation as loose as proposed by petitioners, nor does it
encompass real property improvement activities that are
merely related to land which at some indeterminate future
time may perhaps become the site of a qualified dwelling
unit(s). Consequently, petitioners have failed to establish
that such construction costs are incurred with respect to
qualifying dwelling units.
At most the statute is ambiguous, and we look to section
1.460–3(b)(2)(i), Income Tax Regs., which clarifies the
statute. ‘‘Attribute’’ as used in the regulation means ‘‘to
explain as caused or brought about by: regard as occurring
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388 142 UNITED STATES TAX COURT REPORTS (355)
in consequence of or on account of ’’. Webster’s Third New
International Dictionary 142. The word implies causation,
and as used in the regulation, the plain meaning of
‘‘attribute to’’ is ‘‘caused by’’. 15 None of these costs, in our
view, are attributable to the construction of the dwelling
units, because petitioners do not intend to build such units
and neither the units nor the real property improvements
related to and located on the site of the dwelling units have
yet been built. The regulation is reasonable, and we conclude
it forecloses petitioners’ interpretation. See Chevron U.S.A.,
Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842–843
(1984).
Congress added the exception for home construction con-
tracts in 1988. Technical and Miscellaneous Revenue Act of
1988 (TAMRA), Pub. L. No. 100–647, sec. 5041, 102 Stat. at
3673. Senator Dennis DeConcini and Representative Richard
T. Schulze were concerned that homebuilders would have to
recognize income not yet received and that costs would no
longer match revenues. 134 Cong. Rec. 20722–20723 (Aug. 5,
1988) (Sen. DeConcini); 134 Cong. Rec. 29962–29963 (Oct.
12, 1988) (Sen. DeConcini); 134 Cong. Rec. 20202 (Aug. 3,
1988) (Rep. Schulze). While the conference report is ulti-
mately silent as to why the exception was added in its final
form, it is clear that the intended beneficiaries of this relief
measure were taxpayers involved in ‘‘the building, construc-
tion, reconstruction, or rehabilitation of ’’ a home and not
land developers who do not build homes, even if essential
development work paves the way for, and thus facilitates,
home construction. TAMRA sec. 5041. 16
15 Cf. Lawinger v. Commissioner, 103 T.C. 428, 435 (1994) (discussing
the definition of ‘‘attributable to’’ in the context of sec. 117(m) of the Inter-
nal Revenue Code of 1954 and sec. 108(g)(2)(B) of the Internal Revenue
Code of 1986).
16 The Congressional Record reveals that Chairman Rostenkowski of the
House Ways and Means Committee, when moving to suspend the rules so
that the House could adopt the Conference Committee Report on H.R.
4333, stated that the conference report exempted ‘‘single family home-
builders from the provision’’ that restricted the completed contract method
of accounting. 134 Cong. Rec. 33112 (Oct. 21, 1988). Likewise, Representa-
tive Archer, the ranking House conference committee member, stated in
support of the conference report: ‘‘I was particularly pleased that we
changed the ‘completed contract method of accounting’ provisions under
current law to exempt single family residential construction—thereby
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 389
That Congress changed the wording of section 460(e)(4)
from ‘‘reasonably expected to be attributable to the building,
construction, reconstruction, or rehabilitation of ’’ to ‘‘reason-
ably expected to be attributable to activities referred to in
paragraph (4)’’ only confirms our view. Omnibus Budget Rec-
onciliation Act of 1989, Pub. L. No. 101–239, sec.
7815(e)(1)(A) and (B), 103 Stat. at 2419. This change added
‘‘the installation of any integral component to, or improve-
ments of, real property’’ to the list of construction activity.
Id. The purpose of this change was to ensure that costs
incurred in installing integral components such as heating or
air conditioning systems were qualifying costs. H.R. Rept.
No. 101–247, at 1411 (1989), 1989 U.S.C.C.A.N. 1906, 2881;
Staff of J. Comm. on Taxation, Description of Technical
Corrections Proposed to the Technical and Miscellaneous
Revenue Act of 1988, The Revenue Act of 1987, and Certain
Other Pension-Related Tax Legislation 4 (J. Comm. Print
1989). 17 Congress intended to extend this relief provision
only to taxpayers who have some direct dwelling construction
costs, as defined in section 460(e)(4).
In summary, the terms ‘‘with respect to’’, sec. 460(e)(6)(A),
or ‘‘attribute * * * to’’, sec. 1.460–3(b)(2)(i), Income Tax
Regs., do not qualify contracts as home construction con-
tracts when petitioners do not construct the home, prove that
a qualifying dwelling unit was built, or, in the case of pad
and bulk sales, even develop the immediate neighborhood.
We do not agree with petitioners’ assertion that the term
‘‘dwelling units’’ encompasses more than the home. Peti-
tioners urge us not to confine ‘‘dwelling unit’’ to the structure
built on the lot and would instead have that term encompass
all the relevant infrastructure that makes the unit suitable
for habitation. The regulations clarify this point by providing
a separate relief provision for such common improvements.
Sec. 1.460–3(b)(2)(B)(iii), Income Tax Regs. We recognize the
potential tension with our Opinion in Shea Homes, and we
address such concerns infra.
reducing the cost of homes.’’ Id.
17 We cite the Joint Committee on Taxation’s report for its persuasive
merit. See United States v. Woods, 571 U.S. ll, ll, 134 S. Ct. 557, 568
(2013).
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390 142 UNITED STATES TAX COURT REPORTS (355)
B. Section 406(e)(6)(A)(ii) Real Property Improvements
We disagree with petitioners that the statute allows their
construction activity costs to qualify because they are related
to and located on the site of the dwelling units. ‘‘Site’’,
according to petitioners, means Summerlin, not the indi-
vidual lot on which a house is later built. Petitioners reason
that because the statute uses the plural of dwelling unit—‘‘on
the site of such dwelling units’’—but does not use the plural
of ‘‘site’’, then the statute necessarily envisions a develop-
ment, like Summerlin, containing multiple dwelling units
and requires that a site be more than the lot upon which the
dwelling unit is built. Be that as it may, this argument is not
controlling here because it ignores the fact that the statute
allows a construction contract for a building with four or
fewer dwelling units to still be considered a home construc-
tion contract. Sec. 460(e)(6)(A)(i). Such a building would nec-
essarily consist of dwelling units (plural), but would sit on a
single site.
Petitioners read the preposition ‘‘on’’ in the phrase ‘‘on the
site’’ to connote proximity. Indeed, ‘‘on’’ can be used to
indicate contiguity. Webster’s Third New International Dic-
tionary 1574 (‘‘location closely adjoining something’’). But
‘‘on’’ is also used ‘‘to indicate position over and in contact
with that which supports from beneath’’. Id. By using the
phrase ‘‘at the site’’ in the regulations, respondent did not
necessarily interpret ‘‘on’’ to indicate proximity rather than
the narrower usage. While ‘‘at’’ can be used ‘‘to indicate pres-
ence in, on, or near’’, id. at 136, we do not think that in
choosing the word ‘‘at’’, as opposed to a phrase like ‘‘on or
nearby’’, the regulation intended to interpret ‘‘on the site’’
broadly.
Even if we were to view the statute as ambiguous in its
use of ‘‘on the site of ’’, the Secretary has resolved any ambi-
guity through regulatory gap-filling. And we are required to
defer to an agency’s permissible interpretation of an ambig-
uous statute. Chevron U.S.A., Inc., 467 U.S. at 842–843.
The Secretary believed that the statutory phrase might
prevent taxpayers from counting the costs of common
improvements towards the 80% test, and as a result many
large homebuilders might be unable to qualify for the com-
pleted contract method of accounting for home construction
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 391
contracts. He rightly ameliorated this problem by adopting
section 1.460–3(b)(2)(B)(iii), Income Tax Regs., which allows
taxpayers to count such costs as part of the cost of building
dwelling units for the purposes of the 80% test. The regula-
tion reflects a permissible—inescapable in our minds—
construction of the statute, and we defer to that construction.
See id. 18
The costs petitioners incur are, if anything, common
improvement costs as defined in section 1.460–3(b)(2)(iii),
Income Tax Regs. The regulations make clear that taxpayers
may include the allocable share of these common improve-
ment costs in the cost of the dwelling units. Id. But we agree
with respondent that the taxpayer must at some point incur
some construction cost with respect to the dwelling unit to
include these costs in the dwelling unit cost. We do not
believe that section 1.460–3(b)(2)(i) and (iii), Income Tax
Regs., allows a taxpayer with zero direct construction costs
with respect to dwelling units to simply add common
improvement costs for the purposes of the 80% test. Rather,
the regulation states that the taxpayer may ‘‘include’’ such
costs. Sec. 1.460–3(b)(2)(iii), Income Tax Regs. The regulation
allows the taxpayer to include only the share of the common
improvement costs allocable to the dwelling unit. Id. If the
taxpayer does not construct or intend to construct qualified
dwelling units, there is no allocable share of common
improvement costs.
18 In
addition, the legislative history supports our interpretation of ‘‘site’’
as limited to the site of the home. The conference committee report states:
[A] contract is a home construction contract if 80 percent or more of the
estimated total costs to be incurred under the contract are reasonably
expected to be attributable to the building, construction, reconstruction,
or rehabilitation of, or improvements to real property directly related to
and located on the site of, dwelling units in a building with four or fewer
dwelling units. * * * [H.R. Conf. Rept. No. 100–1104 (Vol. II), at 118
(1988), 1988–3 C.B. 473, 608; emphasis added.]
This sentence clearly shows that Congress used ‘‘dwelling units’’ in the
plural as opposed to the singular in sec. 460(e)(6)(A)(ii) because a construc-
tion contract for a building with four or fewer dwelling units could qualify
as a home construction contract. Congress did not intend the plural to ex-
pand the definition of ‘‘site’’ from the geographic limitations of the imme-
diate lot to the geographic boundaries, and even beyond, of the whole de-
velopment.
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392 142 UNITED STATES TAX COURT REPORTS (355)
Petitioners have no dwelling unit costs in which to include
the common improvement costs. The costs petitioners incur
are not the actual homes’ structural, physical construction
costs. Nor are they costs for improvements ‘‘located on’’ or
‘‘located at’’ the site of the homes. Therefore, petitioners may
not include these costs in testing whether 80% of their allo-
cable contract costs are attributable to the dwelling units and
real property improvements directly related to and located on
the site of the yet to be constructed dwelling units.
After reviewing the plain and ordinary meaning of the
statute and the regulation, we conclude that petitioners’ con-
tracts and agreements do not qualify as home construction
contracts. 19 Recently, we held that availability to home-
19 We
also do not think that respondent’s current position is inconsistent
with the Internal Revenue Service (IRS) material petitioners cite. For in-
stance, the IRS Non-Docketed Service Advice Review they referenced does
not say that a home construction contract need not involve the building of
a home. 2003 IRS Non-Docketed Service Advice Review 20006 (Jan. 18,
2003). Rather this document states that the activities enumerated by sec.
460(e)(4) encompass more than just building a house, such as rehabili-
tating a home or installing integral components. Id. As mentioned supra,
when Congress changed sec. 460(e)(6) to reference para. (4), thereby in-
cluding ‘‘the installation of any integral component to, or improvement of,
real property’’ in the qualifying costs of sec. 460(e)(6), it intended to allow
taxpayers who build components such as air conditioning and heating sys-
tems to potentially qualify their construction contracts as home construc-
tion contracts. Omnibus Budget Reconciliation Act of 1989, Pub. L. No.
101–239, sec. 7815(e)(1)(A), 103 Stat. at 2419; H.R. Rept. No. 101–247, at
1411 (1989), 1989 U.S.C.C.A.N. 1906, 2881. For an explication of the IRS’
current position, see Tech. Adv. Mem. 200552012 (Dec. 30, 2005), indi-
cating that the IRS believes the home construction exception is only avail-
able to the party who actually builds or produces a dwelling unit. Con-
sequently, a land developer who did not build any dwelling unit(s) could
not qualify.
We recognize that the proposed regulations, which would redesignate
sec. 1.460–3(b)(2)(iii), Income Tax Regs., as sec. 1.460–3(b)(2)(iv), if adopt-
ed, would expand the scope of the qualifying costs. Proposed Income Tax
Regs., 73 Fed. Reg. 45182 (Aug. 4, 2008). These regulations would modify
the definition of ‘‘improvements to real property directly related to, and lo-
cated on the site of, the dwelling units’’ by including costs of common im-
provements within that definition even if the contract does not provide for
the construction of any dwelling unit(s). Id. Not only does the preamble to
the proposed regulations explicitly caution taxpayers not to rely on these
regulations, id. at 45181, but by negative inference they add credence to
our view that petitioners’ position is unsupported by the wording of the
current statute and regulation.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 393
builders of the completed contract method of accounting is
‘‘generously broad and reflects a deliberate choice by Con-
gress that home construction contracts should be treated dif-
ferently’’, but only as to homebuilders. Shea Homes, Inc. &
Subs. v. Commissioner, 142 T.C. at 107–108. As for other
construction contracts, ‘‘[t]he completed contract method of
accounting is a narrow exception to the legislated rule that
most long-term contracts must now be accounted for under
the percentage of completion method of accounting’’, which
should be strictly construed. Id. at 107. Petitioners were not
homebuilders, and their contracts were not home construc-
tion contracts. Petitioners cannot account for gain or loss
from these contracts using the completed contract method of
accounting.
C. Shea Homes
In Shea Homes, we held that the subject matter of the
home construction contracts of the taxpayers, developers who
both developed land and built homes, included the home, the
lot on which the home sat, and the common improvements
and amenities. Therefore, we held that in testing contract
completion, the taxpayers were entitled to apply the use and
95% completion test by using the contract costs, after
including the allocable share of the costs of the common
improvements and amenities of the development or develop-
ment phase which included the dwelling unit(s).
In reaching this conclusion, we looked in part at the defini-
tion of home construction contract to inform our under-
standing of the regulation’s use of ‘‘subject matter’’ of the
contract. We concluded that section 460(e)(6)(A) defined a
home construction contract, and that ‘‘the regulations expand
this definition to allow taxpayers to include ‘the allocable
share of the cost that the taxpayer reasonably expects to
incur for any common improvement.’ ’’ Shea Homes, Inc. &
Subs. v. Commissioner, 142 T.C. at 102 (quoting section
1.460–3(b)(2)(iii), Income Tax Regs.). We believed that the
fact that the regulations expanded the universe of costs to be
considered when deciding whether a contract qualified as a
home construction contract was ‘‘at minimum instructive’’
when deciding when that contract is subsequently completed.
But at no point in Shea Homes did we say that a home
construction contract could consist solely of common improve-
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394 142 UNITED STATES TAX COURT REPORTS (355)
ment costs. The starting point in Shea Homes was that the
taxpayers’ contracts were for the construction of qualifying
dwelling units. Those taxpayers developed land and built
homes, and so when testing whether their contracts were
home construction contracts, they were permitted by the
regulations to add to the costs of the dwelling units they con-
structed their common improvement costs. And, when testing
the contract completion date, they looked to when they
incurred 95% of the costs of the subject matter of the con-
tract.
Our Opinion today draws a bright line. A taxpayer’s con-
tract can qualify as a home construction contract only if the
taxpayer builds, constructs, reconstructs, rehabilitates, or
installs integral components to dwelling units or real prop-
erty improvements directly related to and located on the site
of such dwelling units. It is not enough for the taxpayer to
merely pave the road leading to the home, though that may
be necessary to the ultimate sale and use of a home. If we
allow taxpayers who have construction costs that merely ben-
efit a home that may or may not be built, to use the com-
pleted contract method of accounting, then there is no telling
how attenuated the costs may be and how long deferral of
income may last. We cautioned in a footnote in Shea Homes,
Inc. & Subs. v. Commissioner, 142 T.C. at 109 n.24, that
there is a temporal component to the home construction con-
tract exception and contract completion. 20 We think it con-
sistent with congressional intent that a line should be drawn
here so as to exclude petitioners’ contracts, when we cannot
conclude that qualifying dwelling units will ever be built.
20 The regulations caution that ‘‘taxpayers may not delay the completion
of a contract for the principal purpose of deferring federal income tax.’’ Sec.
1.460–1(c)(3)(iv)(A), Income Tax Regs. In these cases, petitioners would
often build infrastructure as needed. For instance, the costs of a road or
a water line that is anticipated to benefit a village may upon request, see
supra p. 364, not be incurred for many years. This may lead to a situation
where the contract completion date could be substantially delayed. We do
not suggest that developers intentionally build ghost towns by building out
infrastructure in excess of demand, but we suggest that such costs would
not necessarily be a proper part of a home construction contract. This is
especially important for contracts qualifying for the completed contract
method of accounting where such a delay coupled with just-in-time, as-
needed improvements construction indeterminately defer recognition of in-
come.
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(355) HOWARD HUGHES CO., LLC v. COMMISSIONER 395
Of course, the contract does not necessarily have to be for
the actual sale of a home. The regulations make clear that
a subcontractor’s contract may qualify as a home construc-
tion contract. For instance, a subcontractor who does the
electrical work inside the home may have a home construc-
tion contract. Petitioners attempt to characterize their rela-
tionship with the homebuilders as a general contract or sub-
contractor relationship. In an interesting and innovative
twist, petitioners try to characterize themselves as the sub-
contractor in the relationship, as if the builders are subcon-
tracting out all of this infrastructure and extra-home
development work to petitioners. But this is not the relation-
ship the parties have chosen. See Commissioner v. Nat’l
Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974)
(‘‘[W]hile a taxpayer is free to organize his affairs as he so
chooses, nevertheless, once having done so, he must accept
the tax consequences of his choice, whether contemplated or
not, and may not enjoy the benefit of some other route he
might have chosen to follow but did not.’’ (Citations
omitted.)).
IV. Conclusion
Petitioners’ contracts are not home construction contracts
within the meaning of section 460(e). Petitioners may not
account for these contracts using the completed contract
method of accounting. The custom lot contracts and the bulk
sale agreements are, however, long-term construction con-
tracts for which petitioners, if those contracts are entered
into in a year before their completion, may use a permissible
method of accounting for long-term contracts, such as the
percentage of completion method.
The Court has considered all of the parties’ contentions,
arguments, requests, and statements. To the extent not dis-
cussed herein, the Court concludes that they are moot, irrele-
vant, or without merit.
Decisions will be entered for respondent.
f
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