Ninth Circuit Allows Home Developer’s Use Of Completed Contract Method For Entire Development

Affirming the Tax Court, the Court of Appeals for the Ninth Circuit has found that a residential home developer properly used the completed contract method (CCM) of accounting for the entire development, not just individual houses. The taxpayer’s method of accounting was deemed to clearly reflect income.

Take away. Under the CCM, a taxpayer generally does not recognize income from a long-term contract until the contract is complete. The court noted that the CCM method is more favorable to taxpayers because it generally defers the taxation of income relative to the percentage-of-completion method.

Background

Code Sec. 460 requires the use of percentage of completion method for long-term construction contracts. However, there are exceptions, one being home construction contracts, for which taxpayers may use the CCM. Reg. §1.460-1(c)(3)(i) provides that a contract is completed under the CCM at the earlier of (1) when the subject matter of the contract is used by the customer for its intended purpose and the taxpayer has incurred at least 95 percent of the total allocable contract costs attributable to the subject matter or (2) upon final completion and acceptance of the subject matter of the contract.

Court’s analysis

The Ninth Circuit first found that on appeal the IRS took a different approach from the one in the Tax Court. The IRS conceded that the Tax Court correctly held that the subject matter of the home construction contracts included more than just the house and lot purchased. The subject matter of the contract also included the common improvements of the planned community development. While the subject matter of the contract includes the house, lot and common amenities, it did not include the other houses in the community, according to the IRS.

The court found that the developer was selling more than just homes. The communities offered a planned life-style. Until all the work was completed, the taxpayer had an obligation to fulfill the promises regarding the development of which it had induced the buyers to become a part. The court affirmed the Tax Court’s decision that the taxpayer used a permissible method of accounting and that method of accounting clearly reflected income.

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