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Fifth Circuit Affirms Tax Court’s Ruling on Method of Accounting for Land Development Contracts


This article was distributed as part of CohnReznick's National Tax Update - December 2015 newsletter.


The Fifth Circuit upheld the U.S. Tax Court’s ruling that a taxpayer’s bulk sale agreements and custom lot contracts were not home construction contracts within the meaning of IRC §460(e), and therefore, the taxpayer could not account for these contracts using the completed contract method of accounting.


The taxpayer, Howard Hughes Company, LLC, is in the residential land development business. The taxpayer sells land to builders who construct and sell houses. The taxpayers generally sell land through bulk sales, pad sales, finished lot sales, and custom lot sales. The taxpayers do not construct residential dwelling units on the land they sell. For the years at issue (2007 and 2008), the taxpayer accounted and reported its income under the completed contract method of accounting and argued that their costs were directly related to dwelling units. By using this method, the taxpayer was able to defer reporting income on a contract for the sale of land until the contract was “complete” i.e., until the year the taxpayer’s incurred costs reached 95% of their estimated contract costs.

The IRS challenged this treatment and issued notices of deficiency. The IRS changed the taxpayer’s method of accounting from the completed contract method of accounting to the percentage of completion method of accounting.

IRC §460(a) requires taxpayers with long-term contracts to determine their taxable income under the percentage completion method of accounting.  Under the percentage of completion method of accounting, taxpayers generally recognize gain or loss throughout the duration of the contract. While IRC §460 generally prohibits the use of the completed contract method, there are exceptions, one of which is an exception for home construction contracts. The completed contract method of accounting allows a taxpayer to defer taxes until the entire development project is substantially completed.

The Fifth Circuit agreed with the Tax Court’s determination that the taxpayer’s contracts were long-term contracts but none were home construction contracts under IRC §460(e). The home construction contract exception to the use of the percentage of completion method was specifically directed toward taxpayers involved in building homes. IRC §460(e)(6)(A) defines a home construction contract as:

Any construction contract if 80% or more of the estimated total contract costs (as of the close of the taxable year in which the contract was entered into) are reasonably expected to be attributable to activities referred to in paragraph (4) with respect to –

(i) dwelling units (as defined in section 168(e)(2)(A)(ii) contained in building containing 4 or fewer dwelling units (as to defined), and
(ii) improvements to real property directly related to such dwelling units and located on the site of such dwelling units.

The Tax Court found that a contract can 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. It is not enough for the taxpayer to merely pave the road leading to the home, though that may be necessary to the ultimate sale and use of a home.

The Fifth Circuit affirmed the Tax Court’s reasoning and decision.

What Does CohnReznick Think?
Any similarly situated taxpayers using the completed contract method of accounting should consider filing a Form 3115 (request to change accounting method) in order to change to the percentage completion method and avoid IRS scrutiny on the issue.


For more information, please contact Richard Shevak, Director, at or 862-245-5029.

Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.

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