Taxand USA examines the Shea Homes decision, now that the US Court of Appeals has weighed in.
On 24 August 2016, the US Court of Appeals affirmed the Tax Court decision in Shea Homes Inc. v. Commissioner, 142 T.C. No. 3 (12 Feb 2014). This opinion is one of the few recent significant taxpayer-favourable decisions and its impact could be significant for homebuilders in similar situations.
Shea Homes affirmed the taxpayer’s position that a builder of a master planned community consisting of residences and amenities could consider the entire project development costs for purposes of qualifying to use the completed contract method of accounting and the related timing of income recognition. As a result, the taxpayer was permitted to defer recognising much of its income until the entire project was substantially complete.
The Internal Revenue Service made several arguments to deny the taxpayer’s contention that it was entitled to the deferral, including the suggestion that the method of accounting did not clearly reflect income in the original proceeding. The Commissioner repeated many of the same arguments at appeals and introduced one additional argument, which attempted to limit the scope of the original opinion, that was rejected by the judges on its merits and as a procedural matter.
Homebuilders should carefully analyse how the Shea Homes case may apply to their specific facts and circumstances in order to reap the potential benefits from this potentially favourable development. But homebuilders should also be wary of the fact that the completed contract method could be a double-edged sword if a project operates at an overall loss, since its application could result in a deferral of the losses.