The Tax Court has ruled in Shea Homes Inc. et al. v. Commissioner (142 T.C. No. 3) that planned community developers can use the completed contract method to recognize income.
The taxpayers who brought the case built and developed planned communities in various states. The contracts at issue were long-term contracts that qualified under Section 460 as home construction contracts. The taxpayers elected to use the completed contract method to recognize taxable income under the contracts. At issue was when the contracts were completed under the test in the Section 460 regulations that provides that completion occurs upon “[u]se of the subject matter of the contract by the customer for its intended purpose (other than for testing), and at least 95% of the total allocable contract costs attributable to the subject matter have been incurred by the taxpayer.”
The IRS took the position that the subject matter of the contract was each individual home in the development and that each such contract was completed upon the sale of the home. The taxpayers took the position that the subject matter of the contracts was broader and encompassed the entire development, or in some cases even larger developments, and the completion and sale of the home was only a part of the development phase. Under such an interpretation, the costs of the contract included all common improvements associated with the development. After applying the applicable provisions of state law, the Tax Court found that the method of accounting used by the taxpayers clearly reflects income and that that IRS was not permitted to change their method of accounting even to a method that more clearly reflects income.
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