DocketNumber： Docket Nos. 10539-11, 10565-11.
Judges： WHERRY
Filed Date： 6/2/2014
Status： Precedential
Modified Date： 10/19/2024
Decisions will be entered for respondent.
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 individual lots to individual purchasers or custom home builders, who then construct homes. In all instances, Ps do not construct 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
*356 WHERRY,
The parties' stipulation of facts and supplemental stipulation of facts, both with accompanying exhibits, are incorporated 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.
When Howard Hughes died in 1976, his portfolio of assets, owned by Summa Corp., included land which was then outside *357 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 corporation based in Columbia, Maryland, acquired*23 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 organized HHPI, which in turn purchased the undeveloped acreage 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 limited partnership, which, through another limited partnership, 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*24 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 properties have not yet been sold to third parties.
During the years at issue petitioners were in the residential land development business. They generated revenue primarily by selling property to builders who would then construct and sell homes. In some cases, they also sold property to individual buyers who would then construct single-family *358 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 approximately 220,000 residents. While Summerlin is largely residential, 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*25 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.*26 then sold the parcel to a buyer, who was usually a homebuilder. The builder, with petitioners' approval, was responsible for all of the infrastructure (such as streets and utilities) within the parcel and subdividing the parcel into lots. In a finished lot sale, petitioners also divided the village into parcels. They then further *359 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, petitioners 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
Custom lot sales were essentially the same as finished lot sales except that petitioners sold*27 the individual lots. The buyers of these individual lots were individuals who were contractually bound to build a residential dwelling unit.*28 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.
*360 We discuss
Petitioners were parties to master development agreements 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*29 agreements and remove any necessity to negotiate development agreements and entitlements village by village.
Las Vegas, pursuant to powers delegated by the State of Nevada by
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*30 occur in phases called villages. The owner has to prepare and submit for city approval a Village Development Plan for each village. A village *361 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 improvements 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 recreational facilities and assume the cost of constructing a sewer interceptor. With respect to traffic and transportation, the LVDA required HHPLP to*31 provide, or at least provide adequate assurance that it would provide, standard improvements in connection with each village. Standard improvements were "mitigation measures and improvements required for intersections and roadways immediately adjacent 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.
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, *362 Clark*32 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 developed 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 envisioned development by phases called villages, and HHPLP agreed to submit a Village Development Plan before beginning development of a village. HHPLP also agreed to submit with the Village Development Plan a traffic study, a drainage 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 nonresidential 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*33 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 systems. 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 facilities 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 *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*34 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 purposes or 30 acres or more for a sports park to be designed and constructed by HHPI, and a community center and outdoor aquatic center to be designed and constructed by HHPI.
Petitioners and their predecessors in interest recorded Master Declarations, which govern use of the land by subsequent owners. These declarations, also known as covenants, conditions, and restrictions (CC&Rs), not only imposed use restrictions and protective covenants, but also created homeowners 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 declarations.
The Master Declarations provided for the establishment of village subassociations through new declarations. The subassociation declarations supplemented*35 the Master Declarations. 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 neighborhood, 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 *364 respective Summerlin West and Summerlin South geographic regions.
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*36 created by the adjacent villages.
Generally, the first step in petitioners' development activities 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 developing 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 immediately*37 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 tentative map, petitioners were required to also submit a final *365 subdivision map. In the case of pad sales, the builders also had to prepare and submit tentative and final maps to further subdivide the pad land into lots. The pad purchase contracts governing pad sales also required the builders to first submit these maps to petitioners for approval.
The final map showed roads and easements that petitioners 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*38 body could require petitioners to enter agreements 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 landscaping. 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 ownership.
Petitioners also used tax-exempt SIDs financing to finance construction of some Summerlin infrastructure improvements. 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*39 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.
Respondent's determinations concern income from 107 BDAs*40 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.*41 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 *367 known as Pulte Group, Inc., occurred in December 2006, just before the 2007 housing market collapse, and neither petitioners nor the purchaser have done any work on this property. In fact, the sale of Village 26 was to occur in two parts, but the purchaser defaulted on the second half of the contract. With bulk sales, petitioners still incurred regional costs that benefit the two villages, such as costs for water lines, regional drainage, and road extensions.
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*42 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 associations 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 construction 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 construction in Summerlin, including construction of the dwelling units.
With respect to the BDAs, the parties stipulated that these contracts are construction contracts within the meaning of
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.*44 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 signals, 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 perform 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 utilities, and other agencies. The plans governed the curbs,*45 gutters, *369 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 landscaping, 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 declaration 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 association. The development declaration, entered at the time of closing of phase 1, contained a number of additional restrictions on KB Home. The declaration allowed KB Home to construct only single-family homes in accordance with a development plan. The declaration preserved HHPI's control over design of homes and landscaping by requiring that*46 they conform to HHPI's residential design criteria for The Mesa Village and to the landscape standards. The design criteria governed everything from lot grading to home finishes.
The declaration required KB Home to create a development plan. The development plan had to describe landscaping 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 architectural 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 development 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, *370 model homes,*47 interior screen walls, curb scribes, and water meters.
The second purchase and sale agreement is an example of a pad sale. This agreement was between Old THHC and William Lyon Homes, Inc. (Lyon), for the sale of Parcel M in Village 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 supplemental 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 materials sample board, a final plot plan, a marketing*48 signage plan, and the Summerlin Design Standards. If any item did not conform to the development plan or was otherwise defective, 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 parties 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 necessary for the purchaser's project. THHC also agreed to construct 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 bordering the property and to stub the wet and dry utilities to the parcel.
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)*49 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 contracts 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:
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 Arrowhead, The Ridges or the surrounding area or nearby property". A similar provision was in the Redhawk contract. The contracts also contained integration clauses. Paragraph 23 of the representative contracts stated: *372 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*51 parties. This Agreement supersedes and revokes all prior written and oral understandings between Purchaser and HHP with respect to the Lot.
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 *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*53 the location of storm drain easements and flood control and drainage channel right-of-ways. The neighborhood design criteria contained maps showing the walls and fences HHPI had to construct. 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 landscaping improvements in common lots.
For the years at issue, petitioners used the completed contract 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.*54 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 categories: 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; landscaping; parks; deposits; other; and contingency. Regional *374 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*55 most cost estimates. For the actual construction cost categories, 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 different 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 villages 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*56 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 arterial costs were all also allocated in proportion to village acreage. Traffic signal costs, however, were allocated to the village(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 formula based on historical actual costs. This formula yielded *375 an estimated incremental cost of improvements of $40,000 per lot.
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
Respondent issued notices of deficiency to both petitioners. As part of his determinations,*57 respondent changed petitioners' methods of accounting from the completed contract method of accounting to the percentage of completion method of accounting. Respondent adjusted petitioners' income as follows
| 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 nonexempt 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 development activities,*58 and (3) overreported gain for exempt development activities.
*376 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.
Generally, the Commissioner's determination of a taxpayer's liability for an income tax deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is improper.
To prevail, the taxpayer must establish that the Commissioner abused his discretion in changing the method of accounting.
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' contracts were long-term contracts. On brief respondent has departed from that determination and contends that the custom 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.
Respondent alleges that none of petitioners' custom lot contracts 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
A long-term contract is "any contract for the manufacture, building, installation, or construction of property if such contract is not completed within the taxable year*61 in which such *378 contract is entered into." (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 contract.
If the subject matter of the custom lot contracts is solely the sale of the piece of land, then petitioners' custom lot contracts 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 contract by annexation*62 or reference will be so construed; but where the reference to another writing is made for a particular and specified purpose, such other writing becomes a part for such specified purpose only.'"
The custom lot contracts contain a page whereon the purchaser(s) acknowledge receipt of copies of numerous documents, which are listed on the page.*379 sentence incorporates the documents listed, and, because there is no indication that the reference is for a specific purpose, 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 petitioners, we are convinced that the subject matter of the contracts encompasses*63 more than just the sale of the lot. The costs incurred for a custom lot contract are not really different 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.
In so holding, we reject respondent's contention that the contracts impose upon petitioners no separate legal obligation to complete the required improvements. The regulations provide that a contract is a long-term contract under
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
While we agree with respondent that work completed by petitioners at the time the contracts are entered into cannot transform a contract*65 into a construction contract under
The preexisting duty rule states that "a promise to do that which the promisor is already legally obligated to do is unenforceable."
Respondent similarly contends that the bulk sale contracts do not qualify as long-term construction contracts under
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
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 contracts.
This section provides an exception to the percentage of completion method of accounting for home construction contracts and an exception for other construction contracts where the taxpayers complete the contract within 24 months and meet a gross receipts test.
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.
The parties disagree over whether contracts such as petitioners', where the seller does not build the house or any improvements on the lot, qualify as home construction contracts. (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 (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
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*73 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,*74 and *385 deferral of income from contracts that might not ever result in qualifying dwelling units seem entirely inappropriate under these circumstances.
In respondent's mind, the definitions foreclose petitioners from using the completed contract method of accounting. Only the
The starting point for interpreting a statute or a regulation is its plain and ordinary meaning unless such an interpretation "would produce absurd or unreasonable results".
Petitioners claim the statute contemplates a broader definition 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'*77 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 *387 those 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 contract 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*78 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 causation than petitioners' interpretation permits. The prepositional phrase "with respect to" can mean "as regards: insofar as concerns: with reference to". Webster's Third New International Dictionary 1934 (2002). So the construction activities 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
Congress added the exception for home construction contracts in 1988. Technical and Miscellaneous Revenue Act of 1988 (TAMRA),
In summary, the terms "with respect to",
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 individual 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*83 necessarily envisions a development, 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 construction contract.
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 Dictionary 1574 ("location closely adjoining something"). But "on" is also used "to indicate position over and in contact with that which supports from beneath".
Even if we were to view the statute as ambiguous in its use of "on the site of", the Secretary has resolved any ambiguity through regulatory gap-filling. And we are required to defer to an agency's permissible interpretation of an ambiguous statute.
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 completed contract method of accounting for home construction *391 contracts. He rightly ameliorated this problem by adopting
The costs petitioners incur are, if anything, common improvement costs as defined in
*392 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 allocable 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' contracts and agreements do not qualify as home construction contracts.*88 *89 Recently, we held that availability to homebuilders *393 of*87 the completed contract method of accounting is "generously broad and reflects a deliberate choice by Congress that home construction contracts should be treated differently", but only as to homebuilders.
In
In reaching this conclusion, we looked in part at the definition of home construction contract to inform our understanding of the regulation's use of "subject matter" of the contract. We concluded that
But at no point in
Our Opinion today draws a bright line. A taxpayer's contract can qualify as a home construction contract only if the taxpayer builds, constructs, reconstructs, rehabilitates,*91 or installs integral components to dwelling units or real property 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 benefit a home that may or may not be built, to use the completed 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
*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 construction contract. For instance, a subcontractor who does the electrical work inside the home may have a home construction contract. Petitioners attempt to characterize their relationship with the homebuilders as a general contract or subcontractor relationship. In an interesting and innovative twist, petitioners try to characterize themselves as the subcontractor in the relationship, as if the builders are subcontracting out all of*93 this infrastructure and extra-home development work to petitioners. But this is not the relationship the parties have chosen.
Petitioners' contracts are not home construction contracts within the meaning of
The Court has considered all of the parties' contentions, arguments, requests, and statements. To the extent not discussed herein, the Court concludes that they are moot, irrelevant, or without merit.
1. Unless otherwise noted, all section references are to the Internal Revenue 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.↩
2. The parties disagree over whether the bulk sales contracts are in substance different from the pad sales contracts. We resolve this issue
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 contracts, 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 "individual purchaser" but is irrelevant to our ultimate holding. For simplicity, we will rely on the parties' stipulation.↩
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 Village 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 attached 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.↩
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.↩
7. The parties did not provide copies of the attachments to the two representative 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 attachments are generally representative of the exhibits attached to a contract for the purchase and sale of a custom lot in Village 18.
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.
9. As previously noted, the page reads in part: "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."↩
10. We note that
11. In fact, the Nevada Common-Interest Ownership Act appears to enable parties other than those in contractual privity with the developer to have standing to institute a lawsuit.
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 (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 reasonably expects to incur for any common improvements (e.g., sewers, roads, clubhouses) that benefit the dwelling units and that the taxpayer is contractually obligated, or required by law, to construct within the tract or tracts of land that contain the dwelling units.
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.
14. Petitioners do not challenge the regulations, and accordingly we give them their due deference.
15.
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 homebuilders from the provision" that restricted the completed contract method of accounting. 134 Cong. Rec. 33112 (Oct. 21, 1988). Likewise, Representative 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 reducing the cost of homes."
17. We cite the Joint Committee on Taxation's report for its persuasive merit.
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
19. We also do not think that respondent's current position is inconsistent with the Internal Revenue Service (IRS) material petitioners cite. For instance, 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
We recognize that the proposed regulations, which would redesignate
20. The regulations caution that "taxpayers may not delay the completion of a contract for the principal purpose of deferring federal income tax."
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