Howard Hughes Co. v. Comm'r

• Decision Date: 27 October 2015
• Docket Number: No. 14–60915.,14–60915.
• Citation: 805 F.3d 175
• Parties: HOWARD HUGHES COMPANY, L.L.C., formerly known as Howard Hughes Corporation and Subsidiaries, Petitioner–Appellant v. COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee. Howard Hughes Properties, Incorporated, Petitioner–Appellant v. Commissioner of Internal Revenue, Respondent–Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

805 F.3d 175

HOWARD HUGHES COMPANY, L.L.C., formerly known as Howard Hughes Corporation and Subsidiaries, Petitioner–Appellant

v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

Howard Hughes Properties, Incorporated, Petitioner–Appellant

v.Commissioner of Internal Revenue, Respondent–Appellee.

No. 14–60915.

United States Court of Appeals, Fifth Circuit.

Oct. 27, 2015.

Kevin Lee Kenworthy, Esq. (argued), Steven R. Dixon, Stephen F. Gertzman, Alan I. Horowitz, Sat Nam Singh Khalsa, Miller & Chevalier Chartered, Washington, DC, for Petitioner–Appellant.

Andrew M. Weiner (argued), Kathryn Keneally, Teresa Ellen McLaughlin, U.S. Department of Justice, Washington, DC, Ronald S. Collins, Jr.William J. Wilkins, Internal Revenue Service, Washington, DC, for Respondent–Appellee.

Appeals from a Decision of the United States Tax Court.

Before KING, DENNIS, and OWEN, Circuit Judges.

Opinion

KING, Circuit Judge:

Petitioners–Appellants used the completed contract method of accounting in computing their gains from sales of property under long-term construction contracts. The Internal Revenue Service challenged the method of accounting, arguing that the contracts at issue do not qualify as home construction contracts and that Petitioners–Appellants should therefore have used the percentage of completion method in computing their gains. The Tax Court sided with the Internal Revenue Service. We AFFIRM.

I. FACTUAL AND PROCEDURAL BACKGROUND

Petitioners The Howard Hughes Company, LLC (THHC) and Howard Hughes Properties, Inc. (HHPI) are subsidiaries of the Howard Hughes Corp., an entity involved in selling and developing commercial and residential real estate. Among the real estate holdings originally owned by Howard Hughes Corp. is a 22,500-acre plot of land west of downtown Las Vegas, Nevada, known as Summerlin. In the 1980s this land was selected for development and was divided into three geographic regions: Summerlin North, Summerlin South, and Summerlin West.¹ Each of the Summerlin geographical regions was further divided into villages, which were then divided into parcels or neighborhoods containing individual lots. Petitioners intended to develop Summerlin as a large master-planned residential community. To secure the rights to develop Summerlin, Petitioners reached master development agreements (MDAs) with the City of Las Vegas and Clark County, which required Petitioners to submit village development plans for municipal approval.

Petitioners generated revenue from their holdings in Summerlin by selling property within the community to commercial builders or individual buyers who would then construct homes on the property. The first land sales in Summerlin North took place approximately in 1986, in Summerlin South in 1998, and in Summerlin West in 2000.² Petitioners' sales generally fell into one of four categories: pad sales, finished lot sales, custom lot sales, or bulk sales. In a pad sale, Petitioners would construct all the infrastructure in a village up to a parcel boundary and then sell a parcel to a homebuilder who would be responsible for any subdivision of the parcel, infrastructure in the parcel, and any construction therein. In a finished lot sale, Petitioners divided the parcels into lots, constructed the village and parcel infrastructure up to the individual lot lines, and then sold neighborhoods to buyers. For both pad sales and finished lots sales, Petitioners reached building development agreements (BDAs) that required the buyers–builders to do further development work on the property. In custom lot sales, Petitioners sold individual lots to buyers who were contractually bound to build residential dwelling units. And in bulk sales, Petitioners sold entire villages to buyers who would then subdivide the villages into parcels and be responsible for all of the infrastructure improvements within the villages.

Under the land sale contracts and MDAs, Petitioners were obligated to construct infrastructure and other common improvements in Summerlin. The MDAs Petitioners signed with municipal authorities required the construction of parks, roadways, fire stations, flooding facilities, and other infrastructure. And the BDAs required Petitioners to construct roads and utility infrastructure such as water and sewer systems up to the line of the lots sold to homebuilders, who would then assume responsibility for completing the infrastructure on their lots.³ Important to this case, Petitioners did not build homes, perform any home construction work, or make improvements within the boundaries of any lots in Summerlin.

For the tax years at issue (2007 and 2008), Petitioners used the “completed contract method” of accounting in computing gain for tax purposes from their long-term contracts for the sale of residential property in Summerlin West and South. By using this method, Petitioners deferred reporting income on a contract for the sale of land until the contract was “complete,” i.e., until the year in which Petitioners' incurred costs reached 95% of their estimated contract costs.⁴ See Treas. Reg. § 1.460–1(c)(3)(A). This is in contrast to the general method of reporting income for tax purposes under long-term contracts, the “percentage of completion” method. The percentage of completion method requires a taxpayer to recognize gain or loss annually in proportion to the progress the taxpayer has made during the year toward completing the contract, determined by comparing costs allocated and incurred before the end of the year to the estimated contract costs.⁵ Petitioners claimed that they were entitled to use the completed contract method because their contracts were “home construction contracts” under I.R.C. § 460(e)(1).

Respondent, the Commissioner of Internal Revenue (the Commissioner), disagreed with Petitioners' method of accounting and issued notices of deficiency for the 2007 and 2008 tax years, changing the method of accounting as the Commissioner is authorized to do under I.R.C. § 446(b). The Commissioner asserted that Petitioners were required to use the percentage of completion method to report gains or losses under their contracts. As a result of this change in the method of accounting, the Commissioner increased Petitioners' taxable income for 2007 and 2008 as follows:

Petitioner	2007	2008	Total
THHC	$209,875,725	$19,399,420	$229,275,145
	HHPI	$156,303,168	$37,192,046	$193,495,214

Petitioners challenged the deficiencies⁶ in the United States Tax Court. The Tax Court held that Petitioners' contracts were long-term contracts within I.R.C. § 460 but were not “home construction contracts” under I.R.C. § 460(e)(6)(A) that would permit the use of the completed contract method. Howard Hughes Co., LLC v. Comm'r, 2014 WL 10077466, at *14–25 (T.C. June 2, 2014).

Interpreting the “home construction contracts” exception in I.R.C. § 460(e)(6)(A) and its accompanying regulations, the Tax Court based its reasoning on three points. First, provisions of the Internal Revenue Code permitting the deferral of income (such as § 460(e)(6)(A) ) are to be “strictly construed.” Id. at *18. Second, Petitioners' costs do not come within subsection (i) of § 460(e)(6)(A), which requires that costs be incurred “with respect to” dwelling units. According to the Tax Court, Petitioners did not engage in any activities “attributable to the construction of the dwelling units” because they did not intend to build dwelling units and their costs did not have a sufficient causal nexus to the construction of dwelling units. Id. at *21. The lack of any home construction activity on the part of Petitioners was particularly important to the Tax Court. Apart from the statutory text, the court pointed to the legislative history of the Technical and Miscellaneous Revenue Act of 1988 (TAMRA), which gave birth to § 460(e)(6)(A) and which suggested that the home construction contract exception to the use of the percentage of completion method was specifically directed toward taxpayers involved in building homes.Id. at *21–22.

Third, Petitioners' costs did not come within subsection (ii) of § 460(e)(6)(A) as the costs were not incurred for improvements “on the site of such dwelling units,” a phrase which the court interpreted to mean “the individual lot.” Id. The Tax Court also rejected Petitioners' arguments that their common improvement costs came within subsection (ii) because of a regulation that counted common improvement costs towards home constructions costs.⁷ According to the court, the regulation required the taxpayer to “at some point incur some construction cost with respect to the dwelling unit to include these costs in the dwelling unit cost,” but “[Petitioners] ha[d] no dwelling unit costs in which to include the common improvement costs.” Id. at *23.⁸ The court concluded its opinion by “draw[ing] a bright line,” under which a “contract [could] qualify as a home construction contract only if the taxpayer builds, constructs, reconstructs, rehabilitates, or installs integral components to dwelling units or real property improvements directly related to and located on the site of such dwelling units.” Id. at *25. It held that this rule was necessary to keep costs that were attenuated to home construction from being the basis for the completed contract method of accounting. Id.

The Tax Court issued its consolidated decision on June 2, 2014, and entered decisions finally disposing of Petitioners' claims on September 15, 2014. Petitioners then timely appealed the decision of the Tax Court. We have jurisdiction under I.R.C. § 7482(a)(1).

II. STANDARD OF REVIEW

“In reviewing Tax Court decisions, we apply the same standard as applied to district court determinations.” Rodriguez v. Comm'r, 722 F.3d 306, 308 (5th Cir.2013). Because this case presents a question of statutory interpretation, an issue of law, “the proper standard of review is de novo. ” BMC Software, Inc. v. Comm'r, 780 F.3d 669, 674 (5th Cir.2015).

III. THE HOME CONSTRUCTION CONTRACTS EXCEPTION

The case before us...