United States

IRS does not acquiesce in Shea Homes holding

TAX ALERT  | 

In an Action on Decision issued April 10, 2017, the IRS indicated it would not acquiesce in the holding of Shea Homes, Inc. and Subs. v. Commissioner, 834 F.3d 1061 (9th Cir. 2016), aff’g 142 T.C. 60 (2014). In Shea Homes, the 9th U.S. Circuit Court of Appeals affirmed the holding that, under the completed contract method of accounting, the taxpayer would recognize income from home construction contracts when it incurred 95 percent of the estimated costs of constructing the entire development. The IRS continues to assert that the completed contract is tested at the individual home level and not at the entire community level.

We previously reported on the Shea Homes decision when the 9th Circuit decided the case in August 2016. Briefly, Shea Homes involved a group of residential real estate development companies recognizing income from their construction contracts under the completed contract method of accounting (CCM). Under the CCM, developers recognize contract income and expense either when they incurred 95 percent of the allocable contract costs or when they completed the subject matter of the contract and it was accepted by the customer, whichever was earlier. The primary issue of the Shea Homes case involved identifying exactly what was the subject matter of the developer’s construction contracts. The Shea Homes developers successfully argued that what their customers bargained for (and therefore the subject matter of their contracts) was not only an individual home, but also the larger community development (infrastructure, amenity facilities, etc.). Through this argument, the developers were able to delay recognizing the income and expense from their construction contracts until the entire residential community was nearly completed.

Generally, the IRS’s nonacquiescence to Shea Homes signifies that the IRS does not agree with the court’s holding and will not follow that decision when addressing the completed contract method for other taxpayers. However, since Shea Homes involves the decision of a circuit court of appeals, the IRS must recognize the precedential impact of the opinion for similar cases that arise within the 9th Circuit. Taxpayers should consult with their tax advisors when relying on Shea Homes.

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