An Issue for Real Estate Developers and Their Tax Advisors to Keep An Eye On

On April 10, 2017, the IRS Chief Counsel’s Office issued an Action on Decision (AOD 2017-3) (here) refusing to acquiesce to the Tax Court’s and 9th Circuit’s decisions in Shea Homes Inc. v. Commissioner, 834 F.3d 1061 (9th Cir. 2016), aff’g 142 T.C. 60 (2014). Because of the potential tax benefits associated with the Shea Homes decision, real estate developers and their tax advisors should keep an eye on any future developments.

The issue in Shea Homes and the AOD was the proper application of the completed contract method of accounting. In holding for the taxpayer, both the Tax Court and 9th Circuit ruled that a contract for the construction and sale of a house in a residential development is completed for purposes of the completed contract method of accounting only after a taxpayer has incurred 95 percent of the estimated costs of constructing the entire development, including the cost of constructing houses that are the subjects of contracts with other buyers. Depending on the circumstances, this can result in a significant tax deferral for a residential real estate developer.

In issuing the AOD that disagreed with the Ninth Circuit’s opinion, the IRS said “although we disagree with the decision of the court, we recognize the precedential effect of the decision to cases appealable in the Ninth Circuit, and therefore will follow it with respect to cases within that circuit, if the opinion cannot be meaningfully distinguished. We do not, however, acquiesce to the opinion and will continue to litigate our position in cases in other circuits.”

Real estate developers and their tax advisors should expect the IRS to continue challenging any tax return position that incorporates the Shea Homes decision. Although the facts were different than Shea Homes, the IRS has already prevailed in Tax Court and the 5th Circuit on a similar issue in The Howard Hughes Company LLC v. Commissioner, No. 14-60915 (5th Cir. 10/27/2015), aff’g 142 T.C. 355(2014).

For any questions on this or any other civil tax or criminal tax-related matter, please feel free to contact me at (214) 749-2456 or jcrouch@meadowscollier.com.