During a recent discussion about representing developers, fellow attorney Greg Rhodes reported to our Tax Group that real estate developers were delivered a significant victory in a recent U.S. Tax Court case involving a California homebuilder. The case, Shea v. Commissioner, 142 T.C. 3 (2/12/2014), which involves the relatively unsexy (even in the tax world) concept of “accounting methods,” should be appealing to developers wishing to defer significant amounts of taxes.
Handing a defeat to the Internal Revenue Service, the court ruled that Shea Homes LP could use the “completed contract” method of accounting. This allowed Shea to defer payment of taxes on home sales until 95-percent of the homes and amenities in its large, gated-community developments were sold. The outcome resulted in Shea deferring roughly $900 million of income.
Of course, every case is specific to its facts, and Shea had some “good” facts. Key to Shea’s success was establishing that the completed contract method of accounting applied to its development activities. Establishing that the completed contract method of accounting was applicable turned on Shea persuading the court that its residential sales contracts were intimately tied to its completion of the entire development, including amenities. In essence, good and thoughtful planning helped Shea establish that homebuyers in the development were purchasing a set of amenities in addition to a home.
Developers large and small should be aware of the Shea decision and the planning opportunities and pitfalls it highlights. What is obvious from reading the Shea decision is that the taxpayer put significant time, effort and planning into setting the battlefield for its fight with the IRS. The planning paid dividends.