Shea Homes, Inc. v. Comm'r
| Decision Date | 24 August 2016 |
| Docket Number | No. 14–72163, No. 14–72162,No. 14–72161,14–72161 |
| Citation | 834 F.3d 1061 |
| Parties | Shea Homes, Inc. and Subsidiaries, Petitioner–Appellee, v. Commissioner of Internal Revenue, Respondent–Appellant. Shea Homes, LP; JF Shea, LP, FKA JF Shea LLC, Tax Matters Partner, Petitioners–Appellees, v. Commissioner of Internal Revenue, Respondent–Appellant. Vistancia, LLC; Shea Homes Southwest, Inc., Tax Matters Partner, Petitioners–Appellees, v. Commissioner of Internal Revenue, Respondent–Appellant. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Andrew M. Weiner (argued) and Richard Farber, Attorneys, Tax Division; Caroline D. Ciraolo, Assistant Attorney General; Department of Justice, Washington, D.C., for Respondent–Appellant.
Gregory G. Garre (argued), Gerald A. Kafka, Sean M. Akins, and Benjamin W. Snyder, Latham & Watkins LLP, Washington, D.C.; Robert A. Long, Jr. and Kevin King, Covington & Burling LLP, Washington, D.C.; for Petitioners–Appellees.
Before: Ferdinand F. Fernandez, Johnnie B. Rawlinson, and Carlos T. Bea, Circuit Judges.
OPINION
FERNANDEZ
, Circuit Judge:
The Commissioner of Internal Revenue (“Commissioner”) appeals the decisions of the United States Tax Court in these consolidated cases that Shea Homes, Inc. and Subsidiaries (“SHI”) did not have any deficiencies for the tax years under consideration and that Shea Homes, LP (“SHLP”) and Vistancia, LLC (“Vistancia”) had no adjustments to partnership items for their tax years which were under consideration.1 Hereafter, SHI, SHLP and Vistancia are collectively referred to as “the Taxpayers.”2 The decisions flowed from the Tax Court's determination3 that the Taxpayers had used an accounting method4 that clearly reflected their income during the tax years under consideration. We affirm.
The Tax Court found that the Taxpayers are builders and developers of planned communities “ranging in size from 100 homes to more than 1,000 homes in Colorado, California, and Arizona.” Shea Homes , 142 T.C. at 64
. It further determined that:
. Because of the magnitude of those undertakings, the process tends to extend across more than one tax year. See 26 U.S.C. § 460(f)(1) ; 26 C.F.R. §§ 1.460–1(b)(5)–(6), 1.460–3(a).
Although the Internal Revenue Code generally requires that a taxpayer report income in “the taxable year in which [it was] received,” 26 U.S.C. § 451(a)
, it also provides special rules for reporting taxable income from long-term contracts, id. § 460. “A long-term contract generally is any contract for the ... construction of property if the contract is not completed within the contracting year....” 26 C.F.R. § 1.460–1(b)(1) ; see also 26 U.S.C. § 460(f)(1). Typically, taxable income from long-term contracts must “be determined under the percentage of completion method” of accounting. 26 U.S.C. § 460(a). But home construction contracts are exempt from that requirement. Id. § 460(e)(1)(A) ; 26 C.F.R. § 1.460–3(b)(1). Instead, the regulations prescribe several acceptable methods of accounting for home construction contracts (and other contracts exempt from the percentage-of-completion method of accounting), one of which is the completed-contract method (“CCM”) of accounting. 26 C.F.R. § 1.460–4(c)(1) ; see also id. (a).5
The parties agree that the contracts at issue here are long-term home construction contracts. See 26 U.S.C. § 460(e)(1)(A), (6)(A)
. The Taxpayers applied the CCM to report income from their home construction projects. “[A] taxpayer using the CCM to account for a long-term contract must take into account in the contract's completion year, as defined in § 1.460–1(b)(6), the gross contract price and all allocable contract costs incurred by the completion year.” 26 C.F.R. § 1.460–4(d)(1). “The completion year is the taxable year in which a taxpayer completes a contract as described” by the applicable regulation. Id. § 1.460–1(b)(6). That regulation, in turn, provides that:
.6 The date of contract completion should be “determined without regard to whether one or more secondary items have been used or finally completed and accepted.” Id. § 1.460–1(c)(3)(ii).
During the tax years at issue here, the Taxpayers reported their income using the CCM. They applied the 95 percent test to determine the year of contract completion and, hence, the year in which they recognized income from their long-term home construction contracts. The Taxpayers took the position that the subject matter of their home construction contracts included the development in which the home was situated. For each tax year, the Taxpayers would calculate, on a development-by-development basis, whether they had incurred at least 95 percent of the budgeted costs of the development, including the costs of the houses and the common improvements and amenities.
If the incurred costs were equal to or greater than 95% of the budgeted costs, then [the Taxpayers] reported income for that tax year from homes that had closed in escrow up to that date. If the incurred costs did not exceed 95%, then [the Taxpayers] deferred any income from homes that closed in escrow that year.
.7
In 2009, the Commissioner issued a notice of deficiency to SHI for the tax years 2004–2005, and notices of final partnership administrative adjustments to SHLP for 2003–2006 and to Vistancia for 2004–2005. Each notice provided the same explanation for the Commissioner's action: that is, the “amounts can not be deferred under the completed contract method of accounting until the completion of a future common improvement” because “the primary subject matter of the contract” was the home, and “[t]he cost of common improvements and any future obligations are secondary items and do not impact when a contract is completed on the subject matter.” In effect, the Commissioner took the position that for purposes of applying the CCM, the subject matter of a contract for sale of a house in a planned community development was limited to the house and lot alone and that anything else—for example, the common improvements—constituted “secondary items” to be ignored in determining when the contract was completed. See 26 C.F.R. § 1.460–1(c)(3)(ii)
. Thus, in the Commissioner's view, the Taxpayers' home construction contracts were complete, under the final completion test, once a home purchase closed in escrow. That meant that contracts entered into and closed in escrow in a single tax year were not long-term contracts at all, and that income from home construction contracts entered into in one tax year but closed in another tax year had to be recognized for tax purposes once the home purchase closed in escrow, even if the Taxpayers had not yet finished the development or the common improvements and amenities to which the buyer was entitled pursuant to his sale contract with the Taxpayers.
The Taxpayers disagreed and pointed out that the subject matter of their contracts with their buyers went beyond a mere house and lot sale, but included much more; the subject matter included the common improvements and the other requirements needed to create a house within the particularly oriented planned community development that the buyer had bargained for. Therefore, they said, they had properly applied the 95 percent test to determine the date of contract completion, and their method of accounting reflected the subject matter of their home construction contracts and clearly reflected income. The Taxpayers contended that the Commissioner's proposed method—that is, recognizing income upon closing of a home purchase in escrow—did not clearly reflect income.
The Tax Court essentially agreed with the Taxpayers. In a careful and detailed opinion, the Tax Court concluded that on the evidence before it all aspects of the planned community development were understood by the Taxpayers and their buyers to be what was bargained for, and that the documents reflected that understanding. As the Tax Court put it: “[The Taxpayers] and the buyers of their homes understood and believed that the parties had contracted for the entire lifestyle of the development and its amenities.” Shea Homes , 142 T.C. at 95
. Ultimately, it concluded that “[t]he contract does not include the houses and lots other than that which is purchased; but the subject matter of each individual purchased house still includes the development or phase of development and its common improvements and amenities.” Id...
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