                                           THE HOWARD HUGHES COMPANY, LLC, F.K.A. THE HOWARD
                                            HUGHES CORPORATION, AND SUBSIDIARIES, PETITIONER v.
                                             COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
                                                HOWARD HUGHES PROPERTIES, INC., PETITIONER v.
                                                    COMMISSIONER OF INTERNAL REVENUE,
                                                               RESPONDENT
                                                Docket Nos. 10539–11, 10565–11.                           Filed June 2, 2014.

                                                   Ps are in the residential land development business and
                                                develop land in and adjacent to Las Vegas, Nevada. Ps sell
                                                land to builders and, in some cases, individuals, who construct
                                                and sell houses. Ps generally sell land through bulk sales, pad
                                                sales, finished lot sales, and custom lot sales. In bulk sales,
                                                Ps develop raw land into villages and sell an entire village to
                                                a builder. Ps do not otherwise develop the sold village. In pad
                                                sales, Ps develop villages into parcels and sell the parcels to
                                                builders. Ps do not develop within the sold parcels. In finished
                                                lot sales, Ps develop parcels into lots and sell whole parcels
                                                of finished lots to builders. In custom lot sales, Ps sell indi-
                                                vidual lots to individual purchasers or custom home builders,
                                                who then construct homes. In all instances, Ps do not con-
                                                struct residential dwelling units on the land they sell. During
                                                the years at issue, Ps reported income from purchase and sale
                                                agreements under the completed contract method of
                                                accounting. R alleges Ps’ contracts are not home construction
                                                contracts within the meaning of I.R.C. sec. 460(e). R further
                                                contends the land sale contracts are not long-term construc-
                                                tion contracts and are not eligible for the long-term percent-
                                                age of completion method of accounting under I.R.C. sec. 460.
                                                Held: Ps’ bulk sale and custom lot contracts are long-term
                                                construction contracts. Held, further, Ps’ contracts are not
                                                home construction contracts within the meaning of I.R.C. sec.
                                                460(e), and Ps may not report gain and loss from these con-
                                                tracts using the completed contract method of accounting.

                                                                                                                                   355




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                                     356                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                        Stephen F. Gertzman, Kevin L. Kenworthy, Steven R.
                                     Dixon, Mary W.B. Prosser, and Sat Nam S. Khalsa, for peti-
                                     tioners.
                                        Ronald S. Collins, Jr., Bernard J. Audet, Jr., and John R.
                                     Gilbert, for respondent.
                                        WHERRY, Judge: These cases, consolidated for trial,
                                     briefing, and opinion, are before the Court on petitions for
                                     redetermination of Federal income tax deficiencies.
                                     Respondent determined deficiencies for the 2007 and 2008
                                     tax years of petitioner the Howard Hughes Co., LLC (THHC)
                                     (formerly the Howard Hughes Corp. & Subsidiaries (Old
                                     THHC)), and deficiencies for the 2007 and 2008 tax years for
                                     petitioner Howard Hughes Properties, Inc. (HHPI). The issue
                                     for consideration concerns the proper method of accounting
                                     for income from certain contracts. Respondent alleges that,
                                     with respect to most of petitioners’ contracts, petitioners
                                     must use the percentage of completion method of accounting
                                     instead of the completed contract method of accounting. Peti-
                                     tioners, however, contend that because their contracts qualify
                                     as home construction contracts within the meaning of section
                                     460(e)(6), they properly reported income on the completed
                                     contract method. 1 Respondent further alleges that certain
                                     other contracts are not long-term contracts or construction
                                     contracts and that petitioners cannot account for the gain or
                                     loss from these contracts under section 460.

                                                                          FINDINGS OF FACT

                                        The parties’ stipulation of facts and supplemental stipula-
                                     tion of facts, both with accompanying exhibits, are incor-
                                     porated herein by this reference. At the time petitioners filed
                                     the petitions, their principal place of business was Dallas,
                                     Texas. Their main business operations, however, are in Las
                                     Vegas, Nevada.
                                     Company Background
                                       When Howard Hughes died in 1976, his portfolio of assets,
                                     owned by Summa Corp., included land which was then out-
                                       1 Unless otherwise noted, all section references are to the Internal Rev-

                                     enue Code of 1986, as amended and in effect for the years at issue, and
                                     all Rule references are to the Tax Court Rules of Practice and Procedure.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    357


                                     side the city of Las Vegas, Nevada. In the 1980s this land
                                     was selected for development. The land was called
                                     Summerlin, which was the maiden name of Mr. Hughes’
                                     paternal grandmother. Summerlin was divided into three
                                     geographic regions: Summerlin North, Summerlin South, and
                                     Summerlin West.
                                        In 1996 the Rouse Co. (Rouse), a publicly traded corpora-
                                     tion based in Columbia, Maryland, acquired the assets of the
                                     Hughes estate, including Howard Hughes Properties LP
                                     (HHPLP), which owned Summerlin. Effective January 1,
                                     1998, Rouse elected to be treated as a real estate investment
                                     trust (REIT) in 1998. As part of this conversion Rouse orga-
                                     nized HHPI, which in turn purchased the undeveloped acre-
                                     age in Summerlin North and South from HHPLP. In
                                     December 1997 HHPLP had distributed Summerlin West to
                                     Old THHC. In 2004 General Growth Properties, Inc. (GGP),
                                     a publicly traded REIT, acquired Rouse by merger. During
                                     the tax years at issue, GGP was the general partner in a lim-
                                     ited partnership, which, through another limited partner-
                                     ship, the Rouse Co. LP, and a limited liability company,
                                     Rouse LLC, owned HHPI and the Hughes Corp., which in
                                     turn owned Old THHC.
                                        In 2009 GGP and its affiliated entities filed for bankruptcy
                                     under chapter 11 of the U.S. Bankruptcy Code. Effective
                                     December 31, 2009, Old THHC converted from a corporation
                                     to a Delaware limited liability company, which is petitioner
                                     THHC in these cases. As part of the plan of reorganization
                                     in 2010 GGP spun off the part of its business that owned
                                     Summerlin. A newly formed entity, the Howard Hughes
                                     Corp., an entity distinct from Old THHC, ended up owning,
                                     as second- and third-tier subsidiaries, HHPI and THHC.
                                     THHC owns Summerlin West, and HHPI owns Summerlin
                                     North and Summerlin South to the extent that these prop-
                                     erties have not yet been sold to third parties.
                                     Summerlin
                                        During the years at issue petitioners were in the residen-
                                     tial land development business. They generated revenue pri-
                                     marily by selling property to builders who would then con-
                                     struct and sell homes. In some cases, they also sold property
                                     to individual buyers who would then construct single-family




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                                     358                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     residential homes. The land petitioners sold and still sell is
                                     part of a large master-planned community known as
                                     Summerlin.
                                        Summerlin comprises approximately 22,500 acres on the
                                     western rim of the Las Vegas Valley, about nine miles west
                                     of downtown Las Vegas. As of the end of 2010 approximately
                                     100,000 residents lived in 40,000 homes in Summerlin. At
                                     completion, petitioners expect Summerlin to house approxi-
                                     mately 220,000 residents. While Summerlin is largely resi-
                                     dential, it is a fully integrated community, which means it
                                     includes commercial, educational, and recreational facilities.
                                     It contains about 1.7 million square feet of developed retail
                                     space, 3.2 million square feet of developed office space, 3
                                     hotels, and health and medical centers. It has 25 public and
                                     private schools, 5 higher learning institutions, 9 golf courses,
                                     parks, trails, and cultural facilities.
                                        Summerlin North and Summerlin West are, as a result of
                                     annexation, part of the city of Las Vegas, and Summerlin
                                     South is in Clark County, Nevada. The first residential land
                                     sales in Summerlin North took place around 1986, and by
                                     the years at issue HHPI had fully developed Summerlin
                                     North. The first land sales in Summerlin South took place in
                                     1998, and the first land sales in Summerlin West took place
                                     in 2000. Each of these three geographical regions is further
                                     divided into villages, each of which averages about 500 acres.
                                     Villages are further divided into parcels, or neighborhoods,
                                     which contain the individual lots. These cases involve only
                                     petitioners’ sales of land in Summerlin South and Summerlin
                                     West.
                                        Petitioners’ sales generally fell into one of four categories:
                                     pad sales, finished lot sales, custom lot sales, and bulk
                                     sales. 2 In a pad sale, petitioners, after dividing the village
                                     into parcels, constructed all of the infrastructure in the vil-
                                     lage up to a parcel boundary. Petitioners then sold the parcel
                                     to a buyer, who was usually a homebuilder. The builder, with
                                     petitioners’ approval, was responsible for all of the infra-
                                     structure (such as streets and utilities) within the parcel and
                                     subdividing the parcel into lots. In a finished lot sale, peti-
                                     tioners also divided the village into parcels. They then fur-
                                       2 The parties disagree over whether the bulk sales contracts are in sub-

                                     stance different from the pad sales contracts. We resolve this issue infra.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    359


                                     ther constructed any additional needed parcel infrastructure,
                                     divided the parcels into lots, and sold the neighborhoods to
                                     a buyer, usually a homebuilder. In finished lot sales, peti-
                                     tioners constructed all of the infrastructure up to the lot line.
                                     In both the pad sales and the finished lot sales, petitioners
                                     contracted with homebuilders through building development
                                     agreements (BDAs). The BDAs were more than just simple
                                     sales contracts that, for consideration, pass title. We discuss
                                     the parties’ responsibilities infra. In doing so, we do not pur-
                                     port to cover all of the details but simply address some
                                     important aspects of the BDAs.
                                        Custom lot sales were essentially the same as finished lot
                                     sales except that petitioners sold the individual lots. The
                                     buyers of these individual lots were individuals who were
                                     contractually bound to build a residential dwelling unit. 3
                                     The purchase sales contracts required the individuals to
                                     agree that they would occupy the home for at least one year
                                     or, if the home was sold before then to a third party, to pay
                                     additional consideration of 10% of the third-party price.
                                     Finally, in a bulk sale, petitioners sold an entire village to
                                     a purchaser. The purchaser was responsible for subdividing
                                     the village into parcels and lots and for constructing all of
                                     the infrastructure improvements within the village.
                                        Even though the builders were ultimately responsible for
                                     building and selling homes to the end user—the home-
                                     buyer—petitioners marketed to the homebuyers. Petitioners’
                                     marketing strategy embodied the idea of the master-planned
                                     community, and they viewed Summerlin as a brand that
                                     evokes thoughts of an attractive lifestyle and community.
                                     But petitioners did not bear the sole burden of the marketing
                                     cost. In fact, their agreements with the builders required the
                                     builders to pay into an advertising program promoting
                                     Summerlin. The builders paid, upon the close of escrow of a
                                     home sale, a fee equal to 1% of the purchase price.
                                       3 The parties stipulated that the sales in all custom lot contracts were

                                     made to ‘‘an individual purchaser’’. A review of the list of custom lot con-
                                     tracts, however, reveals that some of the buyers appear to be builders (e.g.,
                                     Executive Home Builder, Six Star Construction, Inc., and PMR Homes,
                                     Inc.). This apparent discrepancy may result from the meaning of ‘‘indi-
                                     vidual purchaser’’ but is irrelevant to our ultimate holding. For simplicity,
                                     we will rely on the parties’ stipulation.




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                                     360                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                        We discuss infra the general process THHC and HHPI
                                     undertake in their home development business. Much of the
                                     trial was devoted to the details of the process, and we by no
                                     means purport to address every step. Our intention is not to
                                     discount those important steps not addressed but to provide
                                     a general picture of how the development process worked.
                                     Developing Summerlin—Entitlements
                                       Petitioners were parties to master development agree-
                                     ments with Las Vegas, Nevada, and Clark County, Nevada,
                                     that govern the planned development of Summerlin West
                                     and Summerlin South, respectively. These long-term, 30-year
                                     agreements assure petitioners that they will be able to
                                     develop the land in accordance with the agreements and
                                     remove any necessity to negotiate development agreements
                                     and entitlements village by village.
                                           Summerlin West
                                       Las Vegas, pursuant to powers delegated by the State of
                                     Nevada by chapter 278 of the Nevada Revised Statutes,
                                     adopted in April 1992 the City General Plan, which is a
                                     master land use plan. HHPLP and Las Vegas signed a
                                     development agreement (LVDA) in February 1997. The
                                     LVDA was recorded in the Clark County, Nevada, Recorder’s
                                     Office and was approved by the Las Vegas City Council.
                                     Along with approvals and plans referenced within the agree-
                                     ment, the LVDA governed land development in Summerlin
                                     West. Las Vegas also amended its City General Plan to
                                     incorporate the Summerlin West General Development Plan,
                                     which conceptualized future development of Summerlin
                                     West, and rezoned Summerlin West from a rural district to
                                     a planned community district.
                                       The Summerlin West Development Standards, attached to
                                     the LVDA, set minimum requirements for development,
                                     including ‘‘residential densities; building height and setbacks;
                                     signage; landscaping; parking and open space requirements;
                                     as well as procedures for site plan review and for modifying
                                     the Planned Community Program.’’ The LVDA states that
                                     development of Summerlin West will occur in phases called
                                     villages. The owner has to prepare and submit for city
                                     approval a Village Development Plan for each village. A vil-




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    361


                                     lage traffic study and a village drainage study also had to
                                     accompany the village development plan.
                                       Initially, the LVDA permitted 20,250 residential units,
                                     5.85 million square feet of office, retail, or industrial space
                                     uses on 508 acres of land, golf courses featuring up to 90
                                     holes of golf, and related facilities. Other uses described in
                                     the Summerlin West General Development Plan were also
                                     contemplated. The LVDA required HHPLP to maintain
                                     medians but allowed HHPLP to assign that responsibility to
                                     homeowners associations. HHPLP granted the city the right
                                     to construct traffic signals, turn lanes, and similar improve-
                                     ments as necessary. The LVDA also required HHPLP to
                                     donate land to the city and construct a fire station on that
                                     land and to donate up to five acres of land to the city for a
                                     satellite government center. In addition, HHPLP was to
                                     donate land to the city for a public park with sports and rec-
                                     reational facilities and assume the cost of constructing a
                                     sewer interceptor. With respect to traffic and transportation,
                                     the LVDA required HHPLP to provide, or at least provide
                                     adequate assurance that it would provide, standard improve-
                                     ments in connection with each village. Standard improve-
                                     ments were ‘‘mitigation measures and improvements
                                     required for intersections and roadways immediately adja-
                                     cent to the Planned Community.’’ HHPLP also agreed to
                                     dedicate land needed for the right of way to the city for a
                                     major arterial road, the Summerlin Parkway extension.
                                       In November 2003 Old THHC, as the successor in interest
                                     to HHPLP, and the city amended the LVDA to require Old
                                     THHC to allocate a certain minimum amount of recreational
                                     space per 1,000 residents, construct a neighborhood pool, and
                                     design and construct a police substation with a helicopter
                                     landing pad. The amended LVDA also increased the allowed
                                     number of residential units from 20,250 to 30,000. Petitioner
                                     THHC was and is, as successor in interest to Old THHC,
                                     subject to the LVDA as amended.
                                           Summerlin South
                                       Clark County, Nevada, pursuant to the powers delegated
                                     by the State of Nevada, adopted the Clark County Master
                                     Plan in 1983. It and HHPLP also signed and recorded a
                                     development agreement (CCDA) in February 1996 to govern
                                     the development of Summerlin South. Before the CCDA,




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                                     362                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     Clark County had amended its County Master Plan to
                                     include the Land Use and Development Guide for
                                     Summerlin’s Southern Comprehensive Planned Community
                                     (Land Use and Development Guide). Clark County also
                                     rezoned Summerlin South from a rural district to a planned
                                     community district.
                                        The CCDA provided that Summerlin South would be devel-
                                     oped in accordance with the Summerlin Master Plans, which
                                     consisted of the Land Use and Development Guide, a
                                     Summerlin Master Parks and Public Facilities Plan, a
                                     Summerlin Master Transportation Plan, and a Summerlin
                                     Master Drainage Plan. As with the LVDA, the CCDA envi-
                                     sioned development by phases called villages, and HHPLP
                                     agreed to submit a Village Development Plan before begin-
                                     ning development of a village. HHPLP also agreed to submit
                                     with the Village Development Plan a traffic study, a drain-
                                     age study, and a parks and public facilities plan.
                                        Under the CCDA, Summerlin South could contain up to
                                     18,000 residential dwelling units, 740 acres for nonresiden-
                                     tial private uses, 90 holes of golf and related facilities, 3
                                     hotels/casinos, and other land uses and facilities. The CCDA
                                     obligated HHPLP to construct a fire station, donate up to 5
                                     acres of land for a satellite government center, which may
                                     include the fire station, and dedicate up to 20 acres of land
                                     for a community sports park. The CCDA also obligated
                                     HHPLP to submit the Master Parks and Public Facilities
                                     Plan, which was to generally identify the location and
                                     development timing of parks, trails, and public spaces sys-
                                     tems. HHPLP also was to submit a Master Transportation
                                     Study, provide the necessary improvements to mitigate the
                                     development’s traffic impact, provide village access roads for
                                     each village, and bear all public and private expenses, such
                                     as roadway construction, lighting, drainage, signage, and
                                     landscaping expenses related to Summerlin South’s internal
                                     roadway network. The CCDA further required HHPLP to
                                     prepare a technical drainage study and construct flood facili-
                                     ties which were to be integrated where possible with the
                                     trails and parks systems.
                                        The parties, Clark County and HHPI, as successor in
                                     interest to HHPLP, have amended the CCDA three times,
                                     most recently in July 2005. The most recent amendment
                                     increased the number of permissible residential dwelling




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    363


                                     units to 32,600. In return, HHPI agreed, inter alia, at its
                                     expense to purchase and provide a 100-foot aerial fire truck
                                     with operating equipment; design, construct, and convey a
                                     second fire station; and convey 2.5 acres of land to the county
                                     for a third fire station. In addition, HHPI agreed to convey
                                     25 acres or more of land to the county for recreational pur-
                                     poses or 30 acres or more for a sports park to be designed
                                     and constructed by HHPI, and a community center and out-
                                     door aquatic center to be designed and constructed by HHPI.
                                     Developing Summerlin—Covenant, Conditions, and Restric-
                                     tions
                                        Petitioners and their predecessors in interest recorded
                                     Master Declarations, which govern use of the land by subse-
                                     quent owners. These declarations, also known as covenants,
                                     conditions, and restrictions (CC&Rs), not only imposed use
                                     restrictions and protective covenants, but also created home-
                                     owners associations. The Master Declarations served as the
                                     governing documents for the homeowners associations. The
                                     declarations applied to an initial set of properties within
                                     Summerlin, but allowed petitioners to annex property,
                                     thereby expanding the community subject to the declara-
                                     tions.
                                        The Master Declarations provided for the establishment of
                                     village subassociations through new declarations. The sub-
                                     association declarations supplemented the Master Declara-
                                     tions. These subassociations were responsible for owning and
                                     maintaining certain common elements and/or exclusive
                                     amenities associated with a neighborhood and for enforcing
                                     their own covenants, conditions, and restrictions. A neighbor-
                                     hood, which could include a gated community, consists of
                                     properties which share exclusive amenities or common areas.
                                        The Summerlin South Master Declaration established the
                                     Summerlin South Design Review Committee. This committee
                                     had to approve ‘‘construction, alteration, grading, additions,
                                     excavation, modification, decoration, redecoration or
                                     reconstruction of an Improvement or removal of any tree in
                                     any Phase of Development’’. The Summerlin West Master
                                     Declaration established a similar review process. In both
                                     cases, petitioners retained control over the review process
                                     until such time as they no longer owned an interest in the




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                                     364                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     respective Summerlin West and Summerlin South geographic
                                     regions.
                                     Developing Summerlin—Villages
                                        Petitioners developed Summerlin in village phases starting
                                     with the villages adjacent to existing development to take
                                     advantage of the infrastructure. Subsequent villages could
                                     likewise take advantage of the additional infrastructure cre-
                                     ated by the adjacent villages.
                                        Generally, the first step in petitioners’ development activi-
                                     ties was to survey the property and create and file a parcel
                                     map. The parcel map broke off a village-size piece for
                                     development and sale by petitioners. Petitioners also had to
                                     grant easements for utilities and drainage and dedicate
                                     public streets. The parcel map reflected these easements and
                                     dedications.
                                        Often, Clark County or Las Vegas imposed obligations on
                                     petitioners with respect to street grading, surfacing, and
                                     alignment and provisions for drainage, water quality and
                                     supply, sewerage, and particular lot designs. Before devel-
                                     oping the land, petitioners prepared and filed a tentative
                                     map. Along with this map, petitioners conducted technical
                                     studies, such as traffic and drainage studies, and established
                                     a village development plan, which is required by the LVDA
                                     and the CCDA and established the specific zoning, uses, and
                                     entitlements within the villages. Normally, the governing
                                     agency required petitioners to design and construct the
                                     improvements on the tentative map as a condition of
                                     approval of the map. But in certain cases, petitioners
                                     requested waivers. For instance, if a road was not imme-
                                     diately necessary, petitioners could request a waiver delaying
                                     construction until it was necessary. In addition, the tentative
                                     maps did not show all of the improvements that petitioners
                                     would construct on the parcels. For instance, they did not
                                     show landscaping, wall, and dry utility improvements.
                                        Petitioners also prepared improvement plans for the
                                     improvements shown on the tentative maps. It took about
                                     nine months to one year to prepare these plans and for the
                                     governing agency to review and approve them.
                                        Once the various governmental bodies approved the ten-
                                     tative map, petitioners were required to also submit a final




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    365


                                     subdivision map. In the case of pad sales, the builders also
                                     had to prepare and submit tentative and final maps to fur-
                                     ther subdivide the pad land into lots. The pad purchase con-
                                     tracts governing pad sales also required the builders to first
                                     submit these maps to petitioners for approval.
                                        The final map showed roads and easements that peti-
                                     tioners intended to dedicate to the public. These easements
                                     included those for wet utilities, such as sewer and water, and
                                     dry utilities, such as electric, telecommunications, and gas.
                                     Absent a Special Improvement District (SID), the approving
                                     governmental body could require petitioners to enter agree-
                                     ments whereby petitioners posted bonds to ensure completion
                                     of the agreed-upon improvements. These improvements may
                                     have included streets, alleys, curbs, gutters, sidewalks,
                                     medians, streetlights, traffic signals, sewer systems, drainage
                                     facilities, open space improvements, trails, parks, and land-
                                     scaping. Petitioners obtained and posted bonds based on the
                                     unit rate times required material as determined by the
                                     agency that requires the bond. The agency commented on
                                     and required modifications to or approved the bond, and it
                                     exonerated petitioners only when the improvements were
                                     fully constructed and inspected and the agency took owner-
                                     ship.
                                        Petitioners also used tax-exempt SIDs financing to finance
                                     construction of some Summerlin infrastructure improve-
                                     ments. In a project financed by SID bonds, petitioners did
                                     not have to post performance bonds. These SID bonds
                                     financed public improvements such as street, water, sewer,
                                     and storm drainage improvements. Petitioners were entitled
                                     to reimbursement from the money raised from the sale of the
                                     SID bonds when they incurred the relevant construction
                                     costs, subject to the approval of the relevant municipal
                                     authority. Special assessments on the property within the
                                     SID covered the scheduled bond payments. SID financing
                                     was not available to cover dry utilities, landscaping, and
                                     walls. Summerlin West and Summerlin South contain seven
                                     SIDs. The total amount of the SID bonds was $183,685,000.




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                                     366                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     Villages at Issue
                                        Respondent’s determinations concern income from 107
                                     BDAs 4 for the sale of land in 9 of petitioners’ villages. Those
                                     villages are: Village 13 (Summerlin Centre), Village 14B (The
                                     Gardens), Village 15B (Siena), Village 16 (The Mesa), Village
                                     18 (The Ridges), Village 19 (Summerlin Centre West), Village
                                     20 (The Vistas), Village 23A/B (The Paseos), and Village 26
                                     (Reverence). All of the villages except Villages 15B, 19, and
                                     26 contained land sold in pad sales. 5 Finished lot sales
                                     occurred in Villages 16, 18, 19, 20, and 23.
                                        Also at issue are 279 custom lot contract sales. All custom
                                     lot contracts involved the sale of lots in Village 18. Of the
                                     custom lot contracts, 94% were entered into and closed in the
                                     same tax year. The remaining custom lot contracts closed in
                                     the tax year following the one in which they were entered
                                     into.
                                        The parties have agreed that Villages 16, 18, 20, and 23
                                     are generally representative of the villages at issue. The par-
                                     ties have also agreed on a BDA that is representative of fin-
                                     ished lot sales (Ladera BDA), a BDA that is representative
                                     of pad sales (Lyon BDA), and two custom lot contracts,
                                     Redhawk and Arrowhead, that are generally representative
                                     of the custom lot contracts at issue.
                                        In addition to the pad sales, the finished lot sales, and the
                                     custom lot contracts, petitioners also sold villages 15B and 26
                                     in bulk sales essentially equivalent to very large pad sales.
                                     Within the boundaries of the property sold in a bulk sale,
                                     petitioners do nothing. Rather, the purchaser is responsible
                                     for all development. With respect to Village 26, known as
                                     Reverence, the first half of the sale to Pulte Homes, Inc., now
                                           4 The
                                              parties provided a stipulated exhibit that purports to be a list of
                                     BDAs at issue. This list of 130 BDAs includes 23 contracts for sales in Vil-
                                     lage 14A. But the parties also stipulated that petitioners recognized the
                                     gain on BDAs involving Village 14A in 2000. Other stipulated exhibits,
                                     such as a map highlighting the villages at issue and the calculations at-
                                     tached to the 30-day letters, also reveal that the contracts for sales of land
                                     in Village 14A are not in issue. We disregard the contracts from Village
                                     14A in arriving at the total number of BDAs at issue.
                                       5 The parties disagreed over whether Villages 18 and 19 contained land

                                     sold in pad sales. This dispute is immaterial to our ultimate holding, but
                                     we find that the weight of the evidence suggests Village 18 contained land
                                     sold in pad sales whereas Village 19 did not.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    367


                                     known as Pulte Group, Inc., occurred in December 2006, just
                                     before the 2007 housing market collapse, and neither peti-
                                     tioners nor the purchaser have done any work on this prop-
                                     erty. In fact, the sale of Village 26 was to occur in two parts,
                                     but the purchaser defaulted on the second half of the con-
                                     tract. With bulk sales, petitioners still incurred regional costs
                                     that benefit the two villages, such as costs for water lines,
                                     regional drainage, and road extensions.
                                     Common Improvements Generally
                                        The BDAs, loan agreements, governmental laws, and other
                                     legal obligations required petitioners to build common
                                     improvements in Summerlin. These improvements included
                                     rough grading, roadways, sidewalks, utility infrastructure
                                     such as water, sewer, gas, electricity, and telephone, storm
                                     water drainage, parks, trails, landscaping, entry features,
                                     signs, and perimeter walls. Upon completion of a common
                                     improvement, petitioners transferred ownership or granted
                                     easements to the respective community association or, where
                                     appropriate, the municipality. Generally, community associa-
                                     tions received some roads, swimming pools, open spaces, and
                                     medians, whereas the municipalities received police stations,
                                     fire stations, other roads, traffic signals, and street lights.
                                        Some of these improvements were necessary for construc-
                                     tion of the dwelling units. The allocable costs attributable to
                                     petitioners’ improvement construction activities exceeded
                                     10% of the various total contract prices. Petitioners designed
                                     all of the common improvements in an effort to make
                                     Summerlin an attractive community. In addition, petitioners
                                     monitored and maintained approval control over all construc-
                                     tion in Summerlin, including construction of the dwelling
                                     units.
                                     Representative Contracts
                                           Finished Lot Sale—Ladera BDA
                                       With respect to the BDAs, the parties stipulated that these
                                     contracts are construction contracts within the meaning of
                                     section 460(e)(4). The Ladera BDA is a purchase and sale
                                     agreement between HHPI and KB Home Nevada, Inc. (KB
                                     Home), for finished lots in Village 16 in a neighborhood
                                     called Ladera. The Ladera BDA called for the land sale to be




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                                     368                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     completed in three phases. Village 16, known as The Mesa,
                                     consisted of a mix of residential uses including single family
                                     and multifamily units. The style of The Mesa drew its
                                     inspiration from the mountains in the backdrop, and peti-
                                     tioners required builders to use natural building materials,
                                     such as stone, and to include at least two outdoor living
                                     spaces per residence.
                                        In addition to the purchase price, the Ladera BDA entitled
                                     HHPI to certain participation payments as well as payments
                                     tied to power company refunds. HHPI received a lot premium
                                     participation payment equal to 50% of the lot premium less
                                     a credit calculated by reference to any commission paid to an
                                     unrelated broker. HHPI also received a payment equal to the
                                     greater of 3% of the net sale price or HHPI’s percentage
                                     share, 38% of the net sale price less the finished lot costs. 6
                                     The power company refund payments stemmed from the fact
                                     that HHPI paid the Nevada Power Co. to construct electric
                                     feeder lines. As homeowners subscribed to electrical service,
                                     the power company refunded all or part of the costs. HHPI
                                     assigned the rights to the refunds to KB Home but then
                                     required KB Home to make three lump-sum payments equal
                                     to the estimated amount of the refund.
                                        The Ladera BDA required HHPI to develop the parcel into
                                     finished lots. HHPI constructed all of the infrastructure up
                                     to the individual lot lines. Thus, wet and dry utilities were
                                     ‘‘stubbed’’ to the lot boundaries. HHPI was also responsible
                                     for the streets and street improvements such as traffic sig-
                                     nals, the driveway depressions, the perimeter and retaining
                                     walls, entry monumentation, and landscaping. HHPI also
                                     graded the parcel, including the lots. And HHPI agreed to
                                     construct a community park with a swimming pool, for which
                                     KB Home paid HHPI a community park fee of $2,000 per
                                     residence.
                                        Improvement plans governed the work HHPI had to per-
                                     form as part of the contract. HHPI, through the engineering
                                     firm G.C. Wallace, Inc. (GCW), created their plans, one for
                                     each phase, for approval by Clark County, the public utili-
                                     ties, and other agencies. The plans governed the curbs, gut-
                                       6 As used in the contracts, net sale price means the gross sale price less

                                     credit for any lot premium and any costs of amenities, such as swimming
                                     pools. Finished lot costs is the purchase price KB Home paid for the lot.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    369


                                     ters, and other paving improvements, street signs,
                                     streetlights, driveway depressions, and wet utilities, such as
                                     sewer mains, manholes, water mains, fire hydrants, and
                                     water and sewer service stubbed to each lot. Another set of
                                     plans prepared by the utility companies governed the dry
                                     utilities, such as telephone and gas. In addition, HHPI was
                                     responsible for any improvement necessary for the issuance
                                     of a building permit or certificate of occupancy and for land-
                                     scaping, design, and construction of perimeter and screen
                                     walls, entry monumentation, and community open space.
                                        On the purchaser’s side, the Ladera BDA obligated KB
                                     Home to build dwelling units subject to a development dec-
                                     laration and a development plan. The BDA also annexed the
                                     property to the Summerlin South Community Association,
                                     making KB Home also subject to the CC&Rs of that associa-
                                     tion. The development declaration, entered at the time of
                                     closing of phase 1, contained a number of additional restric-
                                     tions on KB Home. The declaration allowed KB Home to con-
                                     struct only single-family homes in accordance with a develop-
                                     ment plan. The declaration preserved HHPI’s control over
                                     design of homes and landscaping by requiring that they con-
                                     form to HHPI’s residential design criteria for The Mesa Vil-
                                     lage and to the landscape standards. The design criteria gov-
                                     erned everything from lot grading to home finishes.
                                        The declaration required KB Home to create a develop-
                                     ment plan. The development plan had to describe land-
                                     scaping improvements as well as building improvements.
                                     With respect to the plans for the homes, the declaration
                                     required KB Home to create a concept plan, with floor plans
                                     and sketches of the home exteriors visible from the street,
                                     preliminary and final plot plans, which showed the location
                                     of the home and other improvements on the lot, an architec-
                                     tural materials sample board, which included samples of the
                                     building materials to be used, and a marketing signage plan,
                                     which contained details on all signage.
                                        The development plan was subject to the approval of
                                     HHPI. If HHPI or a governmental agency disproved or
                                     rejected an item as not being in conformity with the develop-
                                     ment plan, KB Home was obligated to correct the defect at
                                     its own cost. In addition to requiring KB Home to construct
                                     single-family homes in a certain manner, the Ladera BDA
                                     also required KB Home to construct sidewalks, driveways,




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                                     370                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     model homes, interior screen walls, curb scribes, and water
                                     meters.
                                           Pad Sale—Lyon BDA
                                        The second purchase and sale agreement is an example of
                                     a pad sale. This agreement was between Old THHC and Wil-
                                     liam Lyon Homes, Inc. (Lyon), for the sale of Parcel M in Vil-
                                     lage 20. As part of this agreement, THHC transferred fee
                                     simple title to Lyon subject to a number of encumbrances,
                                     including the Summerlin West Master Declaration, a supple-
                                     mental declaration of annexation, a development declaration,
                                     and the Summerlin West Development Agreement. The
                                     agreement limited Lyon to constructing single-family homes.
                                        The agreement also placed substantial restrictions on
                                     Lyon’s use of the property. The supplemental declaration of
                                     annexation subjected Parcel M to the CC&Rs in the
                                     Summerlin West Master Declaration and imposed its own
                                     restrictions, such as those governing satellite dishes and
                                     signs. Similarly, the development declaration required Lyon
                                     to submit a development plan for THHC’s approval before it
                                     could begin any construction. The development declaration
                                     also required improvements to conform to an architectural
                                     concept plan, a preliminary plot plan, an architectural mate-
                                     rials sample board, a final plot plan, a marketing signage
                                     plan, and the Summerlin Design Standards. If any item did
                                     not conform to the development plan or was otherwise defec-
                                     tive, Lyon had to, at its own cost, correct the problem.
                                        The agreement also required Lyon to build entry
                                     monumentation and landscaping, a minipark, and pedestrian
                                     access ways. The parties agreed to share costs of boundary
                                     walls between the property and adjacent parcels if the par-
                                     ties thought such walls were desirable.
                                        THHC, as part of the agreement, agreed to perform all
                                     other obligations, except those inuring solely and specifically
                                     to the subject property or specifically under the LVDA nec-
                                     essary for the purchaser’s project. THHC also agreed to con-
                                     struct the roads bordering the parcel, Vista Run Drive and
                                     Trail View Lane, and associated roads, curbs, gutters, and
                                     street lighting. The agreement further required petitioners to
                                     construct a perimeter boundary wall along the roads bor-
                                     dering the property and to stub the wet and dry utilities to
                                     the parcel.




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                                     (355)               HOWARD HUGHES CO., LLC v. COMMISSIONER                                    371


                                     Custom Lot Contracts
                                       The parties provided two custom lot contracts for the sale
                                     of property in Village 18 to individual purchasers through
                                     custom lot contracts. Each custom lot contract involved the
                                     sale of a lot(s) in one of seven neighborhoods in Village 18,
                                     known as The Ridges. The two representative contracts were
                                     for the sale of a lot in the Arrowhead neighborhood and for
                                     the sale of a lot in the Redhawk neighborhood. These con-
                                     tracts are representative of the other custom lot contracts at
                                     issue in these cases.
                                       Each contract sold a lot described in final maps recorded
                                     with the Office of the County Recorder of Clark County,
                                     Nevada. The contracts required the purchaser to build a
                                     single-family home on the lot. In addition, the contracts
                                     stated that HHPI must construct or have constructed certain
                                     improvements and the individual lot purchaser is to be solely
                                     responsible for other lot improvements. For instance, section
                                     7 of the Arrowhead contract stated in part:
                                           HHP’s Improvements. HHP has installed roads providing access to the
                                           Lot, together with underground improvements for sanitary sewer,
                                           potable water, telephone, natural gas and electric power. All such utility
                                           improvements have been stubbed out to the Lot. It shall be Purchaser’s
                                           responsibility to activate water service * * * prior to commencing
                                           construction on the Lot. Purchaser is responsible for all utility connec-
                                           tions from the property line to Purchaser’s Home and for making all nec-
                                           essary arrangements with each of the public utilities for service. Pur-
                                           chaser acknowledges that HHP is not improving the Lot and has not
                                           agreed to improve the Lot for Purchaser except as provided in this Sec-
                                           tion 7. Purchaser will be responsible for finish grading and preparation
                                           of the building pad and acknowledges that HHP has not agreed to pro-
                                           vide any grading of the Lot beyond its present condition.

                                     Section 7 of the Redhawk contract was substantially similar,
                                     but it implied that HHPI’s work was not yet completed at the
                                     time of the purchase and sale agreement.
                                       As part of the custom lot contract, HHPI explicitly stated
                                     that it ‘‘made no representations or warranties concerning
                                     zoning * * * or the future development of phases of Arrow-
                                     head, The Ridges or the surrounding area or nearby prop-
                                     erty’’. A similar provision was in the Redhawk contract. The
                                     contracts also contained integration clauses. Paragraph 23 of
                                     the representative contracts stated:




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                                     372                 142 UNITED STATES TAX COURT REPORTS                                    (355)

                                           This Agreement constitutes the entire agreement and understanding
                                           between Purchaser and HHP with respect to the purchase of the Lot and
                                           may not be amended, changed, modified or supplemented except by an
                                           instrument in writing signed by both parties. This Agreement super-
                                           sedes and revokes all prior written and oral understandings between
                                           Purchaser and HHP with respect to the Lot.

                                     But the purchasers also initialed a page of the custom lot
                                     contracts that states: ‘‘ALL OF THE DOCUMENTS LISTED
                                     BELOW ARE IMPORTANT TO THE PURCHASE OF THE
                                     LOT, SHOULD BE READ BY THE PURCHASER AND, AT
                                     THE CLOSE OF ESCROW, SHALL BE DEEMED TO HAVE
                                     BEEN READ AND APPROVED BY PURCHASER. * * *
                                     PURCHASER HEREBY ACKNOWLEDGES RECEIPT OF
                                     COPIES’’ of those listed documents. Among the documents
                                     that purchasers acknowledged receipt of and were deemed to
                                     have read are CC&Rs, articles of incorporation, and bylaws
                                     of the Summerlin South Community Association, copies of
                                     the recorded subdivision map for the neighborhood in which
                                     the lot was located, the neighborhood design criteria, and a
                                     public offering statement. 7
                                       The purchasers and the purchased lots were subject to the
                                     various CC&Rs that govern Summerlin South, Village 18,
                                     and the subassociation within Village 18, and they were
                                     contractually required to conform their lot to the relevant
                                     architectural declaration. The architectural declaration
                                     required that all construction on the lot be approved by
                                     HHPI. If HHPI delegated the approval power to a review
                                     committee for The Ridges, then that committee must approve
                                     the declaration. In addition, the CC&Rs for the Village 18
                                     association granted access to homeowners to their lots by
                                     way of one of two circular roadways accessible by two guard
                                     houses and private gates, all of which were to be designed
                                     and constructed by HHPI, including associated landscaping.
                                     These improvements became common elements owned by the
                                     community association as did other elements such as entry
                                       7 The parties did not provide copies of the attachments to the two rep-

                                     resentative custom lot contracts. Rather, they provided the attachments to
                                     a different custom lot contract, which involved the sale of a lot in The
                                     Azure community in Village 18. The parties have stipulated that these at-
                                     tachments are generally representative of the exhibits attached to a con-
                                     tract for the purchase and sale of a custom lot in Village 18.




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                                     (355)               HOWARD HUGHES CO., LLC v. COMMISSIONER                                    373


                                     features, recreational facilities, landscaped medians, and cul-
                                     de-sacs.
                                       The recorded subdivision maps identified the common
                                     areas, including private roads such as Drifting Shadow Way
                                     and Sun Glow Lane, which were granted to the relevant
                                     community association. These maps also showed the location
                                     of storm drain easements and flood control and drainage
                                     channel right-of-ways. The neighborhood design criteria con-
                                     tained maps showing the walls and fences HHPI had to con-
                                     struct. The design criteria also contained a map that showed
                                     a community and fitness center, which the parties stipulated
                                     was available to residents of Village 18. The public offering
                                     statements not only stated that the private roads, guard
                                     houses, and landscaping improvements are to be owned by
                                     the community association, but they also recited that HHPI
                                     was responsible for utility connections to the lots and land-
                                     scaping improvements in common lots.
                                     Tax Reporting
                                        For the years at issue, petitioners used the completed con-
                                     tract method of accounting in computing gain or loss from
                                     their contracts for sale of residential real property in
                                     Summerlin West and South intended for residential
                                     buildings planned to contain four or fewer residential units
                                     per building. 8 Petitioners reported gain from BDAs, custom
                                     lot contracts, and the bulk sale agreements when they
                                     incurred 95% of the estimated costs allocable to each BDA,
                                     custom lot contract, or bulk sale agreement.
                                        Petitioners broke down estimated BDA costs into three cat-
                                     egories: direct village costs, regional costs, and finished lot
                                     costs. Direct village costs consisted of the cost for the
                                     common improvements that benefit only the village that was
                                     the subject matter of the contract. These costs included the
                                     following cost categories: planning; engineering; inspection,
                                     testing, and processing; rough grading; water/sewer storm
                                     drain; street improvements; dry utilities; walls/fencing; land-
                                     scaping; parks; deposits; other; and contingency. Regional
                                           8 For
                                            example, petitioners did not use the completed contract method of
                                     accounting to account for gain or loss from the sale of property upon which
                                     large multiunit apartment and commercial buildings were ultimately to be
                                     built.




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                                     374                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     costs consisted of common improvements that benefited more
                                     than one village and included the following cost categories:
                                     regional water, regional sewer, regional drainage, regional
                                     roads, regional traffic signals, regional entry features,
                                     regional annual costs, regional other costs, and townwide
                                     arterial costs. Finished lot costs were the costs that benefit
                                     only the neighborhood or parcel in which the finished lots
                                     were located.
                                        Petitioners used the engineering firm GCW to calculate
                                     most cost estimates. For the actual construction cost cat-
                                     egories, the ‘‘hard costs’’, GCW used a market price unit rate
                                     for each improvement, which was based on its experience
                                     with past bids as well as prevailing bond rates. The unit rate
                                     generally reflected labor and materials cost for the relevant
                                     improvement. The unit rate was applied differently to dif-
                                     ferent improvements. For instance, GCW applied the unit
                                     rate based on length for improvements such as curbs, sewer
                                     lines, and sidewalks, on area for improvements such as
                                     paving and some landscaping, and on number of units of a
                                     designated improvements such as street lights and fire
                                     hydrants. ‘‘Soft costs’’, or costs other than the actual
                                     construction costs such as engineering, inspection, testing,
                                     and processing, were calculated as a percentage of the hard
                                     costs.
                                        For regional water costs, GCW allocated the costs to vil-
                                     lages according to the percentage of village acreage in the
                                     relevant water zone. GCW assigned costs to each water zone
                                     for water mains, pump stations, reservoirs, and inlet and
                                     outlet pipes in the water zone. For regional sewer costs,
                                     GCW allocated the cost among villages in proportion to their
                                     acreage. These costs included costs for the sewer systems,
                                     including pipes and mains, paving, manholes, flowmeters,
                                     and traffic controls. Drainage, regional roads, regional entry
                                     features, regional annual, regional other, and townwide arte-
                                     rial costs were all also allocated in proportion to village acre-
                                     age. Traffic signal costs, however, were allocated to the vil-
                                     lage(s) adjacent to the street corners (for example, one-fourth
                                     to each corner at a four-way intersection) of the relevant
                                     signal and then prorated by acreage.
                                        For the finished lot costs, petitioners and GCW used a for-
                                     mula based on historical actual costs. This formula yielded




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                     375


                                     an estimated incremental cost of improvements of $40,000
                                     per lot.
                                     Deficiencies
                                        For the tax years at issue, petitioners reported income
                                     from the sale of land within Summerlin using the completed
                                     contract method of accounting. Under petitioners’ methods of
                                     accounting, each BDA, custom lot contract, and bulk sale
                                     agreement was a home construction contract, and they were
                                     not completed within the meaning of section 460 until peti-
                                     tioners incurred 95% of the direct and indirect costs allocable
                                     to the agreement or contract.
                                        Respondent issued notices of deficiency to both petitioners.
                                     As part of his determinations, respondent changed peti-
                                     tioners’ methods of accounting from the completed contract
                                     method of accounting to the percentage of completion method
                                     of accounting. Respondent adjusted petitioners’ income as fol-
                                     lows:

                                              Petitioner                   2007                       2008               Total

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

                                     The total additional cumulative taxable revenue THHC
                                     would have recognized through its 2008 tax year under the
                                     percentage of completion method of accounting is
                                     $239,897,451. The difference between this number and the
                                     total $229,275,145 adjustment in the notice of deficiency is
                                     due to adjustments for (1) gain recognized in the 2003 tax
                                     year pursuant to a prior audit, (2) overreported gain for non-
                                     exempt development activities, and (3) underreported gain
                                     for nonexempt development activities.
                                       The total additional cumulative taxable revenue HHPI
                                     would have recognized through the 2008 tax year under the
                                     percentage of completion method of accounting is
                                     $231,791,739. The difference between this number and the
                                     total $193,495,214 adjustment in the notice of deficiency is
                                     due to (1) gain recognized in the 2003 tax year pursuant to
                                     a prior audit, (2) overreported gain for nonexempt develop-
                                     ment activities, and (3) overreported gain for exempt develop-
                                     ment activities.




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                                     376                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                       Respondent’s adjustments resulted in his determination of
                                     the following deficiencies:

                                                    Petitioner                        2007                         2008

                                                        THHC                      $73,456,504                   $6,789,797
                                                        HHPI                       50,633,554                   13,228,620

                                     Petitioners timely petitioned this Court for redetermination,
                                     and a trial was held in Las Vegas, Nevada.

                                                                                  OPINION

                                     I. Burden of Proof
                                       Generally, the Commissioner’s determination of a tax-
                                     payer’s liability for an income tax deficiency is presumed cor-
                                     rect, and the taxpayer bears the burden of proving that the
                                     determination is improper. See Rule 142(a); Welch v.
                                     Helvering, 290 U.S. 111, 115 (1933). If a taxpayer’s method
                                     of accounting does not clearly reflect income, section 446(b)
                                     allows the Commissioner to change the taxpayer’s method of
                                     accounting to one that does clearly reflect income. The
                                     Commissioner is granted broad discretion in determining
                                     whether an accounting method clearly reflects income, and
                                     that determination is entitled to more than the usual
                                     presumption of correctness. Commissioner v. Hansen, 360
                                     U.S. 446, 467 (1959); RECO Indus., Inc. v. Commissioner, 83
                                     T.C. 912, 920 (1984). The question of whether a particular
                                     accounting method clearly reflects income is a question of
                                     fact. Sam W. Emerson Co. v. Commissioner, 37 T.C. 1063,
                                     1067 (1962).
                                       To prevail, the taxpayer must establish that the Commis-
                                     sioner abused his discretion in changing the method of
                                     accounting. Prabel v. Commissioner, 91 T.C. 1101, 1112
                                     (1988), aff ’d, 882 F.2d 820 (3d Cir. 1989). But the Commis-
                                     sioner may not change a taxpayer’s method of accounting
                                     from an incorrect method to another incorrect method. Id.
                                     Nor may the Commissioner change a taxpayer’s method of
                                     accounting ‘‘[w]here a taxpayer’s method of accounting is
                                     clearly an acceptable method’’ and clearly reflects income. Id.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    377


                                     II. Custom Lot Contracts and Bulk Sale Agreements as Long-
                                         Term Contracts
                                       First, we must determine whether petitioners’ contracts
                                     are long-term contracts. The parties stipulated that the
                                     BDAs are long-term construction contracts. The notices of
                                     deficiency determined deficiencies as if all of petitioners’ con-
                                     tracts were long-term contracts. On brief respondent has
                                     departed from that determination and contends that the cus-
                                     tom lot contracts and the bulk sale agreements are not long-
                                     term contracts. Generally, the Court will not allow a party
                                     to raise an issue on brief if consideration of that issue would
                                     surprise and prejudice the opposing party. Chapman Glen
                                     Ltd. v. Commissioner, 140 T.C. 294, 349 (2013). Because we
                                     do not think that petitioners need additional evidence to
                                     respond to the new issue and respondent has not carried the
                                     issue, we address it below. See id. (looking to ‘‘the degree to
                                     which the opposing party is surprised by the new issue and
                                     the opposing party’s need for additional evidence to respond
                                     to the new issue’’ to determine prejudice). As to new issues,
                                     respondent bears the burden of proof. See Rule 142(a)(1).
                                           A. Custom Lot Contracts
                                       Respondent alleges that none of petitioners’ custom lot con-
                                     tracts qualify even for accounting under the percentage of
                                     completion method because they are not long-term contracts.
                                     Initially, respondent contends that many of the contracts
                                     were entered into and closed within the same tax year and
                                     they therefore cannot be considered long term within the
                                     meaning of section 460. Second, respondent contends that
                                     because petitioners did not have a legal obligation to perform
                                     the construction activities contemplated by the contracts, the
                                     contracts are not construction contracts. Petitioners, on the
                                     other hand, first assert that the contracts are complete, for
                                     the purposes of section 460, when they incur at least 95% of
                                     the total allocable contract costs attributable to the contract’s
                                     subject matter. They also contend that their contracts are
                                     construction contracts that impose legal obligations upon
                                     them.
                                       A long-term contract is ‘‘any contract for the manufacture,
                                     building, installation, or construction of property if such con-
                                     tract is not completed within the taxable year in which such




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                                     378                  142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     contract is entered into.’’ Sec. 460(f)(1). The relevant regula-
                                     tion provides that the date a contract is completed is the ear-
                                     lier of
                                             (A) Use of the subject matter of the contract by the customer for its
                                           intended purpose (other than for testing) and at least 95 percent of the
                                           total allocable contract costs attributable to the subject matter have been
                                           incurred by the taxpayer; or
                                             (B) Final completion and acceptance of the subject matter of the con-
                                           tract.
                                             [Sec. 1.460–1(c)(3)(i), Income Tax Regs.]

                                     But taxpayers determine the contract completion date ‘‘with-
                                     out regard to whether one or more secondary items have
                                     been used or finally completed and accepted.’’ Sec. 1.460–
                                     1(c)(3)(ii), Income Tax Regs. In addition, the regulation
                                     directs taxpayers to ‘‘consider all relevant facts and cir-
                                     cumstances’’ in determining whether final completion and
                                     acceptance has occurred. Sec. 1.460–1(c)(3)(iv), Income Tax
                                     Regs.
                                        If the subject matter of the custom lot contracts is solely
                                     the sale of the piece of land, then petitioners’ custom lot con-
                                     tracts would be complete upon close of escrow. The custom
                                     lot contracts do indeed provide for the sale of a piece of land,
                                     but they also reference numerous other documents, including
                                     CC&Rs, development plans, and subdivision maps. Under
                                     Nevada law, ‘‘ ‘[w]ritings which are made a part of the con-
                                     tract by annexation or reference will be so construed; but
                                     where the reference to another writing is made for a par-
                                     ticular and specified purpose, such other writing becomes a
                                     part for such specified purpose only.’ ’’ Lincoln Welding
                                     Works, Inc. v. Ramirez, 647 P.2d 381, 383 (Nev. 1982)
                                     (quoting Orleans M. Co. v. Le Champ M. Co., 284 P. 307
                                     (Nev. 1930)). However, if the reference ‘‘indicates an
                                     intention to incorporate * * * [the documents] generally,
                                     such reference becomes a part of the contract for all pur-
                                     poses.’’ Id.
                                        The custom lot contracts contain a page whereon the pur-
                                     chaser(s) acknowledge receipt of copies of numerous docu-
                                     ments, which are listed on the page. 9 We believe that this
                                           9 As
                                          previously noted, the page reads in part: ‘‘ALL OF THE DOCU-
                                     MENTS LISTED BELOW ARE IMPORTANT TO THE PURCHASE OF
                                     THE LOT, SHOULD BE READ BY THE PURCHASER AND, AT THE
                                     CLOSE OF ESCROW, SHALL BE DEEMED TO HAVE BEEN READ




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    379


                                     sentence incorporates the documents listed, and, because
                                     there is no indication that the reference is for a specific pur-
                                     pose, we incorporate these documents generally.
                                        After reviewing the custom lot contracts, the documents
                                     referenced therein, and the testimony regarding Summerlin
                                     as a master-planned community marketed as such by peti-
                                     tioners, we are convinced that the subject matter of the con-
                                     tracts encompasses more than just the sale of the lot. The
                                     costs incurred for a custom lot contract are not really dif-
                                     ferent from the costs for the finished lot sales. At the time
                                     of trial, petitioners still had to complete a water service line,
                                     traffic signals, landscaping, and construction of a park.
                                     Therefore, we agree that final completion and acceptance
                                     does not necessarily occur at the close of escrow, but rather
                                     occurs when final completion and acceptance of the subject
                                     matter of the contracts, which includes improvements whose
                                     costs are allocable to the custom lot contracts, occurs. Cf.
                                     Shea Homes, Inc. & Subs. v. Commissioner, 142 T.C. 60, 104
                                     (2014). Consequently, petitioners are entitled to account for
                                     the gain or loss from these contracts on the appropriate long-
                                     term method of accounting under section 460 to the extent
                                     the contracts are not completed within the taxable year in
                                     which they are entered into.
                                        In so holding, we reject respondent’s contention that the
                                     contracts impose upon petitioners no separate legal obliga-
                                     tion to complete the required improvements. The regulations
                                     provide that a contract is a long-term contract under section
                                     460 ‘‘if the manufacture, building, installation, or construc-
                                     tion of property is necessary for the taxpayer’s contractual
                                     obligations to be fulfilled and if the manufacture, building,
                                     installation, or construction of that property has not been
                                     completed when the parties enter into the contract’’ and the
                                     contract is not completed within the contracting year. Sec.
                                     1.460–1(b)(1) and (2)(i), Income Tax Regs.; see also Foothill
                                     Ranch Co. P’ship v. Commissioner, 110 T.C. 94, 98–99 (1998).
                                        For contracts that provide for the provision of land, the
                                     regulations also contain a de minimis rule, under which if
                                     the allocable costs attributable to construction activities do
                                     not exceed 10% of the total contract price, the contract is not
                                     a construction contract under section 460. Sec. 1.460–
                                     AND APPROVED BY PURCHASER.’’




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                                     380                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     1(b)(2)(ii), Income Tax Regs. To calculate the allocable costs,
                                     the regulation allows a taxpayer to ‘‘include a proportionate
                                     share of the estimated cost of any common improvement that
                                     benefits the subject matter of the contract if the taxpayer is
                                     contractually obligated, or required by law, to construct the
                                     common improvement.’’ Id. Petitioners’ allocable costs attrib-
                                     utable to construction activities exceed the 10% threshold.
                                     Respondent appears to read this regulation as requiring a
                                     taxpayer to have a legal obligation independent of any other
                                     preexisting duty.
                                        While we agree with respondent that work completed by
                                     petitioners at the time the contracts are entered into cannot
                                     transform a contract into a construction contract under sec-
                                     tion 460, we disagree that the statute and the regulations
                                     necessarily require that all construction activity obligations
                                     be solely enforceable because of the contract. Respondent
                                     believes that section 1.460–1(b)(2)(i), Income Tax Regs., codi-
                                     fies the common law preexisting duty doctrine. Therefore, he
                                     says that because petitioners are already obligated by statute
                                     to complete various improvements, the obligations are not
                                     contractual obligations.
                                        The preexisting duty rule states that ‘‘a promise to do that
                                     which the promisor is already legally obligated to do is
                                     unenforceable.’’ Johnson v. Seacor Marine Corp., 404 F.3d
                                     871, 875 (5th Cir. 2005). Nevada follows the preexisting duty
                                     rule. Cnty. of Clark v. Bonanza No. 1, 615 P.2d 939, 944
                                     (Nev. 1980). The Nevada Common-Interest Ownership Act
                                     requires sellers, such as petitioners, to complete all improve-
                                     ments depicted on any site plan or similar documents except
                                     those labeled ‘‘NEED NOT BE BUILT’’, Nev. Rev. Stat. sec.
                                     116.4119(1) (1991), and provides purchasers with a cause of
                                     action, id. sec. 116.4117 (1997). 10
                                        It is not clear that the preexisting duty rule applies in
                                     these cases. The contracts between petitioners and the pur-
                                     chasers are valid contracts with valid consideration inde-
                                     pendent of the duties with respect to the development.
                                     Second, while the Nevada statute does indeed seem to grant
                                           10 We
                                            note that Nev. Rev. Stat. sec. 116.4117 (1997) has been amended
                                     numerous times since it was enacted in 1991. We refer to the statute as
                                     amended and in effect for the years in which the contracts were entered
                                     into.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    381


                                     purchasers a cause of action if petitioners fail to construct
                                     improvements as shown on site plans or plats, the statute
                                     explicitly provides: ‘‘The civil remedy provided by this section
                                     is in addition to, and not exclusive of, any other available
                                     remedy or penalty.’’ Id. sec. 116.4117(5). Therefore, it is
                                     uncertain whether a Nevada court would apply the pre-
                                     existing duty rule to petitioners’ contracts. See Johnson, 404
                                     F.3d at 875 (‘‘[A]s long as the contracting parties gain some
                                     legally enforceable right as a result of the contract which
                                     they previously did not have, consideration is present[.]’’).
                                     The public policy concerns that underpin the preexisting duty
                                     rule do not seem to be present here. 11
                                       In addition, we do not agree with respondent that section
                                     1.460–1(b)(2), Income Tax Regs., codifies the preexisting duty
                                     rule. The regulation clearly states that ‘‘how the parties
                                     characterize their agreement (e.g., as a contract for the sale
                                     of property) is not relevant’’ in determining the existence of
                                     a section 460 construction contract. Sec. 1.460–1(b)(2)(i),
                                     Income Tax Regs.; see also Koch Indus., Inc. & Subs. v.
                                     United States, 603 F.3d 816, 822 (10th Cir. 2010) (citing the
                                     regulation). As to the allocable costs attributable to common
                                     improvements in the de minimis rule, the regulation does not
                                     require that the obligation be solely contractual. Sec. 1.460–
                                     1(b)(2)(ii), Income Tax Regs. Rather, the regulation allows a
                                     taxpayer to include the allocable costs ‘‘if the taxpayer is
                                     contractually obligated, or required by law, to construct the
                                     common improvement.’’ Id. Nothing in the regulation
                                     requires that the contract be the sole source of the obligation,
                                     and, in fact, it indicates the opposite—that the obligation
                                     may be noncontractual.
                                           B. Bulk Sale Contracts
                                        Respondent similarly contends that the bulk sale contracts
                                     do not qualify as long-term construction contracts under sec-
                                     tion 460. Specifically, respondent alleges that petitioners
                                     have not established that they were obligated to construct
                                     anything under these contracts. Respondent bases this posi-
                                       11 In fact, the Nevada Common-Interest Ownership Act appears to en-

                                     able parties other than those in contractual privity with the developer to
                                     have standing to institute a lawsuit. See Nev. Rev. Stat. sec. 116.4117(2)
                                     (allowing suit to be brought by a unit’s owner, not just the original pur-
                                     chaser of the land from the developer).




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                                     382                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     tion on his belief that the terms of the bulk sale contracts are
                                     unknown and that petitioners failed to carry their burden of
                                     proving that the contracts are entitled to a long-term con-
                                     tract method of accounting.
                                        We disagree that the bulk sale contracts are substantially
                                     different from the pad sale BDAs. The parties stipulated that
                                     the pad sale BDAs are construction contracts. The bulk sale
                                     agreements are merely pad sale BDAs on a larger scale. The
                                     record supports this conclusion. We heard credible testimony
                                     from the vice president of finance for petitioners that the
                                     bulk sale contracts were BDAs and that petitioners were
                                     obligated to build the same types of common improvements
                                     that benefited the property sold, such as regional water lines,
                                     traffic signals, and detention basins. Thus, we hold that
                                     these contracts too are construction contracts that may be
                                     accounted for under section 460 as long-term contracts to the
                                     extent consistent with this Opinion.
                                     III. Completed Contract Method of Accounting
                                        Because the Court has concluded that all of petitioners’
                                     contracts are long-term construction contracts, we turn to the
                                     question of whether the contracts are home construction con-
                                     tracts. Section 460(a) provides generally that taxpayers must
                                     determine taxable income from long-term contracts under the
                                     percentage of completion method of accounting. Under this
                                     method of accounting, taxpayers generally recognize gain or
                                     loss throughout the duration of the contract. See sec. 1.460–
                                     4(b), Income Tax Regs. (rules concerning percentage of
                                     completion method). But in some instances taxpayers may
                                     account for income from certain construction contracts under
                                     other methods of accounting such as the completed contract
                                     method. Sec. 460(e).
                                        This section provides an exception to the percentage of
                                     completion method of accounting for home construction con-
                                     tracts and an exception for other construction contracts
                                     where the taxpayers complete the contract within 24 months
                                     and meet a gross receipts test. Sec. 460(e)(1)(A) and (B). The
                                     parties have stipulated that most of petitioners’ contracts are
                                     construction contracts as defined in section 460(e)(4). Peti-
                                     tioners do not contend that they qualify for the second excep-




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                                     (355)               HOWARD HUGHES CO., LLC v. COMMISSIONER                                    383


                                     tion, so the question before us is whether petitioners’ con-
                                     tracts qualify as home construction contracts.
                                        Deferral of income tax, like exemptions and deductions, is
                                     a matter of legislative grace, and exceptions to the normal
                                     income recognition rules must be strictly construed. See, e.g.,
                                     Bingler v. Johnson, 394 U.S. 741, 752 (1969) (‘‘[E]xemptions
                                     from taxation are to be construed narrowly[.]’’); Estate of Bell
                                     v. Commissioner, 928 F.2d 901, 903 (9th Cir. 1991) (‘‘The
                                     deferral [of estate tax payment] benefits of section 6166 are
                                     a ‘matter of legislative grace’ that is similar to the benefits
                                     conferred by other statutory provisions dealing with deduc-
                                     tions, exemptions and exclusions from tax. Thus, a strict and
                                     narrow construction should be applied to the deferral benefit
                                     provisions[.]’’), aff ’g 92 T.C. 714 (1989).
                                        The parties disagree over whether contracts such as peti-
                                     tioners’, where the seller does not build the house or any
                                     improvements on the lot, qualify as home construction con-
                                     tracts. Section 460(e)(6) defines a home construction contract
                                     as follows:
                                             (A) HOME CONSTRUCTION CONTRACT.—The term ‘‘home construction
                                           contract’’ means any construction contract if 80 percent 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
                                             buildings containing 4 or fewer dwelling units (as so defined), and
                                                (ii) improvements to real property directly related to such dwelling
                                             units and located on the site of such dwelling units.
                                           For purposes of clause (i), each townhouse or rowhouse shall be treated
                                           as a separate building.
                                       We refer to this definition as the 80% test. Paragraph (4)
                                     referred to by section 460(e)(6)(A) provides: ‘‘For purposes of
                                     this subsection, the term ‘construction contract’ means any
                                     contract for the building, construction, reconstruction, or
                                     rehabilitation of, or the installation of any integral compo-
                                     nent to, or improvements of, real property.’’ Sec. 460(e)(4).
                                     The statute defines dwelling unit by cross-reference as ‘‘a
                                     house or apartment used to provide living accommodations in
                                     a building or structure, but does not include a unit in a hotel,
                                     motel, or other establishment more than one-half of the units
                                     in which are used on a transient basis’’. Sec.




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                                     384                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     168(e)(2)(A)(ii). 12 The parties do not dispute that pursuant to
                                     the contracts, agreements, and government development
                                     rules, the structures to be ultimately built upon the land
                                     petitioners sell in the contracts at issue are dwelling units.
                                       Importantly, however, petitioners did not build homes on
                                     the land they sold, nor did qualifying dwelling units exist on
                                     the sold land at the time of the sales. Petitioners have not
                                     established that at the time of each sale qualifying dwelling
                                     units would ever be built on the sold land. The bulk sale
                                     agreement for Village 26 is especially troubling as no
                                     construction had yet occurred years later and, because the
                                     purchaser-builder defaulted on the contract, THHC still
                                     owned half of the village. As far as we know, no qualifying
                                     dwelling units will ever be built on these lands, 13 and
                                       12 The relevant regulation largely follows the statute. It defines home

                                     construction contracts as follows:
                                           (i) In general.—A long-term construction contract is a home construc-
                                        tion contract if a taxpayer (including a subcontractor working for a gen-
                                        eral contractor) reasonably expects to attribute 80 percent or more of the
                                        estimated total allocable contract costs (including the cost of land, mate-
                                        rials, and services), determined as of the close of the contracting year,
                                        to the construction of—
                                           (A) Dwelling units, as defined in section 168(e)(2)(A)(ii)(I), contained in
                                        buildings containing 4 or fewer dwelling units (including buildings with
                                        4 or fewer dwelling units that also have commercial units); and
                                           (B) Improvements to real property directly related to, and located at
                                        the site of, the dwelling units.
                                           (ii) Townhouses and rowhouses.—Each townhouse or rowhouse is a
                                        separate building.
                                           (iii) Common improvements.—A taxpayer includes in the cost of the
                                        dwelling units their allocable share of the cost that the taxpayer reason-
                                        ably expects to incur for any common improvements (e.g., sewers, roads,
                                        clubhouses) that benefit the dwelling units and that the taxpayer is con-
                                        tractually obligated, or required by law, to construct within the tract or
                                        tracts of land that contain the dwelling units.
                                           [Sec. 1.460–3(b)(2), Income Tax Regs.]
                                        13 We note that in a case of an insolvent builder, a bankruptcy court may

                                     direct the trustee of the bankruptcy estate to petition the local government
                                     for rezoning. See In re Lloyd, 37 F.3d 271, 274 (7th Cir. 1994) (affirming
                                     the bankruptcy court’s direction to the trustee to seek to rezone property
                                     from agricultural to residential to allow the debtor a homestead exemp-
                                     tion). We also note that the Summerlin West and the Summerlin South de-
                                     velopment agreements with Las Vegas and Clark County have been
                                     amended from time to time by the parties. Thus, contractual promises or
                                     obligations of third parties alone are, at least in this factual context, insuf-




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    385


                                     deferral of income from contracts that might not ever result
                                     in qualifying dwelling units seems entirely inappropriate
                                     under these circumstances. Cf. Shea Homes, Inc. & Subs. v.
                                     Commissioner, 142 T.C. at 105–106 (permitting deferral of
                                     income from contracts where the completed qualifying
                                     dwelling units were, themselves, included in the property
                                     being sold and giving rise to the asserted taxable income).
                                     Petitioners close the contracts and receive revenue without
                                     needing to build a single home. In Shea Homes, the tax-
                                     payers closed their contracts only after a certificate of occu-
                                     pancy had been issued and simultaneously with the pur-
                                     chasers’ taking possession of their house. Id. at 79. Peti-
                                     tioners are under no contractual obligation to build homes as
                                     their contracts are merely for the sale of land, developed to
                                     varying degrees, to builders or individual customers who may
                                     eventually build homes on that land.
                                        In respondent’s mind, the definitions foreclose petitioners
                                     from using the completed contract method of accounting.
                                     Only the section 460(e)(4) costs directly associated with
                                     building the actual house or improvements thereto qualify for
                                     purposes of meeting the 80% test. Petitioners assert that
                                     construction activity costs count in meeting the 80% test
                                     even though they do not build the four walls or roof of a
                                     dwelling unit. Under their interpretation, the ‘‘allocable
                                     costs’’ include the costs of required infrastructure and
                                     common improvements attributable to the dwelling units.
                                     Even if true, this point, without more, would not be deter-
                                     minative of their right to use section 460(e).
                                        The starting point for interpreting a statute or a regulation
                                     is its plain and ordinary meaning unless such an interpreta-
                                     tion ‘‘would produce absurd or unreasonable results’’. Union
                                     Carbide Corp. v. Commissioner, 110 T.C. 375, 384 (1998).
                                     Undefined words take their ‘‘ordinary, contemporary,

                                     ficient to ensure that qualifying dwelling units will in fact be constructed
                                     on the sold land. When it comes to yet-to-be completed common improve-
                                     ments, presumably bonds are posted, whereas the purchasers of the land
                                     do not post or purchase bonds promising construction of homes. We cannot
                                     therefore conclude that governmental zoning and entitlement agreements
                                     and land sale contracts alone are enough to meet petitioners’ evidentiary
                                     burden of establishing that the qualifying dwelling units requirement of
                                     sec. 460(e)(6)(A) is or will be met.




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                                     386                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     common meaning’’. Hewlett-Packard Co. & Consol. Subs. v.
                                     Commissioner, 139 T.C. 255, 264 (2012).
                                           A. Costs Attributable to Dwelling Units
                                       Section 460(e)(6) defines a home construction contract, as
                                     of the end of the taxable year when the contract was entered
                                     into, by reference to the estimated total contract costs attrib-
                                     utable to construction activity ‘‘with respect to’’ (i) dwelling
                                     units and (ii) improvements to real property directly related
                                     to the units and located on the site of the dwelling units. The
                                     regulations clarify that the allocable contract costs to be
                                     included in the 80% test must be attributable to the
                                     construction of the units and the improvements thereto. Sec.
                                     1.460–3(b)(2)(i), Income Tax Regs. 14
                                       What does the statute mean when it says ‘‘attributable to’’
                                     construction activities ‘‘with respect to’’ dwelling units and
                                     improvements directly related to real property? Sec.
                                     460(e)(6)(A). Respondent asserts that only costs incurred in
                                     the actual construction of the dwelling units or their related
                                     real property improvements count. Respondent contends that
                                     the home construction contract exception requires the tax-
                                     payer to build dwelling units or to build improvements to
                                     real property directly related to and located on the site of
                                     such dwelling units.
                                       Petitioners claim the statute contemplates a broader defi-
                                     nition of home construction costs. Under their interpretation,
                                     they believe that their costs benefit dwelling units and real
                                     property improvements related to and located on the site of
                                     such dwelling units. Because the costs benefit dwelling units,
                                     petitioners contend that the costs are therefore attributable
                                     to the dwelling units and that these costs should count
                                     towards meeting the 80% test. Under petitioners’ view,
                                     because all of their development costs are attributable to
                                     construction activity with respect to dwelling units and real
                                     property improvements related to and located on the site of
                                        14 Petitioners do not challenge the regulations, and accordingly we give

                                     them their due deference. See sec. 460(h); Mayo Found. for Med. Educ. &
                                     Research v. United States, 562 U.S. 44, 55–56 (2011) (applying to regula-
                                     tions the test announced in Chevron, U.S.A. Inc. v. Natural Res. Def. Coun-
                                     cil, Inc., 467 U.S. 837, 842–843 (1984)); cf. Shea Homes, Inc. & Subs. v.
                                     Commissioner, 142 T.C.60, 98 n.18 (2014).




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    387


                                     those dwelling units, section 460(e) is applicable even though
                                     they do not construct the dwelling units.
                                        Petitioners assert that because the costs are allocable to
                                     the contracts and because the costs benefit the property sold
                                     to the homebuilders and ultimately to individual buyers, the
                                     costs are attributable to construction activities with respect
                                     to the dwelling units or real property improvements. This
                                     conclusion follows, according to petitioners, because the
                                     statute does not confine the availability of the completed con-
                                     tract method of accounting to those taxpayers who build the
                                     dwelling units’ ‘‘sticks and bricks’’ and/or real property
                                     improvements related to and located on the dwelling units’
                                     lots.
                                        Petitioners’ interpretation of the statute would make any
                                     construction cost tangentially related to a dwelling unit or
                                     real property improvement related to and located on the site
                                     of the dwelling unit a cost to be counted in determining
                                     whether a contract is a home construction contract. Without
                                     petitioners’ development work, the pads and lots would be
                                     mere patches of land in a desert. Petitioners’ work may
                                     indeed be necessary for the ultimate home to feasibly be built
                                     and occupied.
                                        But these correlations do not mean that those costs are
                                     necessarily incurred ‘‘with respect to’’ qualifying dwelling
                                     units. ‘‘With respect to’’ implies a stronger proximate causa-
                                     tion than petitioners’ interpretation permits. The preposi-
                                     tional phrase ‘‘with respect to’’ can mean ‘‘as regards: insofar
                                     as concerns: with reference to’’. Webster’s Third New Inter-
                                     national Dictionary 1934 (2002). So the construction activi-
                                     ties that count towards meeting the 80% test are defined by
                                     reference to the dwelling unit. The phrase does not imply a
                                     correlation as loose as proposed by petitioners, nor does it
                                     encompass real property improvement activities that are
                                     merely related to land which at some indeterminate future
                                     time may perhaps become the site of a qualified dwelling
                                     unit(s). Consequently, petitioners have failed to establish
                                     that such construction costs are incurred with respect to
                                     qualifying dwelling units.
                                        At most the statute is ambiguous, and we look to section
                                     1.460–3(b)(2)(i), Income Tax Regs., which clarifies the
                                     statute. ‘‘Attribute’’ as used in the regulation means ‘‘to
                                     explain as caused or brought about by: regard as occurring




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                                     388                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     in consequence of or on account of ’’. Webster’s Third New
                                     International Dictionary 142. The word implies causation,
                                     and as used in the regulation, the plain meaning of
                                     ‘‘attribute to’’ is ‘‘caused by’’. 15 None of these costs, in our
                                     view, are attributable to the construction of the dwelling
                                     units, because petitioners do not intend to build such units
                                     and neither the units nor the real property improvements
                                     related to and located on the site of the dwelling units have
                                     yet been built. The regulation is reasonable, and we conclude
                                     it forecloses petitioners’ interpretation. See Chevron U.S.A.,
                                     Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842–843
                                     (1984).
                                        Congress added the exception for home construction con-
                                     tracts in 1988. Technical and Miscellaneous Revenue Act of
                                     1988 (TAMRA), Pub. L. No. 100–647, sec. 5041, 102 Stat. at
                                     3673. Senator Dennis DeConcini and Representative Richard
                                     T. Schulze were concerned that homebuilders would have to
                                     recognize income not yet received and that costs would no
                                     longer match revenues. 134 Cong. Rec. 20722–20723 (Aug. 5,
                                     1988) (Sen. DeConcini); 134 Cong. Rec. 29962–29963 (Oct.
                                     12, 1988) (Sen. DeConcini); 134 Cong. Rec. 20202 (Aug. 3,
                                     1988) (Rep. Schulze). While the conference report is ulti-
                                     mately silent as to why the exception was added in its final
                                     form, it is clear that the intended beneficiaries of this relief
                                     measure were taxpayers involved in ‘‘the building, construc-
                                     tion, reconstruction, or rehabilitation of ’’ a home and not
                                     land developers who do not build homes, even if essential
                                     development work paves the way for, and thus facilitates,
                                     home construction. TAMRA sec. 5041. 16
                                        15 Cf. Lawinger v. Commissioner, 103 T.C. 428, 435 (1994) (discussing

                                     the definition of ‘‘attributable to’’ in the context of sec. 117(m) of the Inter-
                                     nal Revenue Code of 1954 and sec. 108(g)(2)(B) of the Internal Revenue
                                     Code of 1986).
                                        16 The Congressional Record reveals that Chairman Rostenkowski of the

                                     House Ways and Means Committee, when moving to suspend the rules so
                                     that the House could adopt the Conference Committee Report on H.R.
                                     4333, stated that the conference report exempted ‘‘single family home-
                                     builders from the provision’’ that restricted the completed contract method
                                     of accounting. 134 Cong. Rec. 33112 (Oct. 21, 1988). Likewise, Representa-
                                     tive Archer, the ranking House conference committee member, stated in
                                     support of the conference report: ‘‘I was particularly pleased that we
                                     changed the ‘completed contract method of accounting’ provisions under
                                     current law to exempt single family residential construction—thereby




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    389


                                        That Congress changed the wording of section 460(e)(4)
                                     from ‘‘reasonably expected to be attributable to the building,
                                     construction, reconstruction, or rehabilitation of ’’ to ‘‘reason-
                                     ably expected to be attributable to activities referred to in
                                     paragraph (4)’’ only confirms our view. Omnibus Budget Rec-
                                     onciliation Act of 1989, Pub. L. No. 101–239, sec.
                                     7815(e)(1)(A) and (B), 103 Stat. at 2419. This change added
                                     ‘‘the installation of any integral component to, or improve-
                                     ments of, real property’’ to the list of construction activity.
                                     Id. The purpose of this change was to ensure that costs
                                     incurred in installing integral components such as heating or
                                     air conditioning systems were qualifying costs. H.R. Rept.
                                     No. 101–247, at 1411 (1989), 1989 U.S.C.C.A.N. 1906, 2881;
                                     Staff of J. Comm. on Taxation, Description of Technical
                                     Corrections Proposed to the Technical and Miscellaneous
                                     Revenue Act of 1988, The Revenue Act of 1987, and Certain
                                     Other Pension-Related Tax Legislation 4 (J. Comm. Print
                                     1989). 17 Congress intended to extend this relief provision
                                     only to taxpayers who have some direct dwelling construction
                                     costs, as defined in section 460(e)(4).
                                        In summary, the terms ‘‘with respect to’’, sec. 460(e)(6)(A),
                                     or ‘‘attribute * * * to’’, sec. 1.460–3(b)(2)(i), Income Tax
                                     Regs., do not qualify contracts as home construction con-
                                     tracts when petitioners do not construct the home, prove that
                                     a qualifying dwelling unit was built, or, in the case of pad
                                     and bulk sales, even develop the immediate neighborhood.
                                     We do not agree with petitioners’ assertion that the term
                                     ‘‘dwelling units’’ encompasses more than the home. Peti-
                                     tioners urge us not to confine ‘‘dwelling unit’’ to the structure
                                     built on the lot and would instead have that term encompass
                                     all the relevant infrastructure that makes the unit suitable
                                     for habitation. The regulations clarify this point by providing
                                     a separate relief provision for such common improvements.
                                     Sec. 1.460–3(b)(2)(B)(iii), Income Tax Regs. We recognize the
                                     potential tension with our Opinion in Shea Homes, and we
                                     address such concerns infra.


                                     reducing the cost of homes.’’ Id.
                                       17 We cite the Joint Committee on Taxation’s report for its persuasive

                                     merit. See United States v. Woods, 571 U.S. ll, ll, 134 S. Ct. 557, 568
                                     (2013).




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                                     390                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                           B. Section 406(e)(6)(A)(ii) Real Property Improvements
                                        We disagree with petitioners that the statute allows their
                                     construction activity costs to qualify because they are related
                                     to and located on the site of the dwelling units. ‘‘Site’’,
                                     according to petitioners, means Summerlin, not the indi-
                                     vidual lot on which a house is later built. Petitioners reason
                                     that because the statute uses the plural of dwelling unit—‘‘on
                                     the site of such dwelling units’’—but does not use the plural
                                     of ‘‘site’’, then the statute necessarily envisions a develop-
                                     ment, like Summerlin, containing multiple dwelling units
                                     and requires that a site be more than the lot upon which the
                                     dwelling unit is built. Be that as it may, this argument is not
                                     controlling here because it ignores the fact that the statute
                                     allows a construction contract for a building with four or
                                     fewer dwelling units to still be considered a home construc-
                                     tion contract. Sec. 460(e)(6)(A)(i). Such a building would nec-
                                     essarily consist of dwelling units (plural), but would sit on a
                                     single site.
                                        Petitioners read the preposition ‘‘on’’ in the phrase ‘‘on the
                                     site’’ to connote proximity. Indeed, ‘‘on’’ can be used to
                                     indicate contiguity. Webster’s Third New International Dic-
                                     tionary 1574 (‘‘location closely adjoining something’’). But
                                     ‘‘on’’ is also used ‘‘to indicate position over and in contact
                                     with that which supports from beneath’’. Id. By using the
                                     phrase ‘‘at the site’’ in the regulations, respondent did not
                                     necessarily interpret ‘‘on’’ to indicate proximity rather than
                                     the narrower usage. While ‘‘at’’ can be used ‘‘to indicate pres-
                                     ence in, on, or near’’, id. at 136, we do not think that in
                                     choosing the word ‘‘at’’, as opposed to a phrase like ‘‘on or
                                     nearby’’, the regulation intended to interpret ‘‘on the site’’
                                     broadly.
                                        Even if we were to view the statute as ambiguous in its
                                     use of ‘‘on the site of ’’, the Secretary has resolved any ambi-
                                     guity through regulatory gap-filling. And we are required to
                                     defer to an agency’s permissible interpretation of an ambig-
                                     uous statute. Chevron U.S.A., Inc., 467 U.S. at 842–843.
                                        The Secretary believed that the statutory phrase might
                                     prevent taxpayers from counting the costs of common
                                     improvements towards the 80% test, and as a result many
                                     large homebuilders might be unable to qualify for the com-
                                     pleted contract method of accounting for home construction




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                                     (355)               HOWARD HUGHES CO., LLC v. COMMISSIONER                                    391


                                     contracts. He rightly ameliorated this problem by adopting
                                     section 1.460–3(b)(2)(B)(iii), Income Tax Regs., which allows
                                     taxpayers to count such costs as part of the cost of building
                                     dwelling units for the purposes of the 80% test. The regula-
                                     tion reflects a permissible—inescapable in our minds—
                                     construction of the statute, and we defer to that construction.
                                     See id. 18
                                        The costs petitioners incur are, if anything, common
                                     improvement costs as defined in section 1.460–3(b)(2)(iii),
                                     Income Tax Regs. The regulations make clear that taxpayers
                                     may include the allocable share of these common improve-
                                     ment costs in the cost of the dwelling units. Id. But we agree
                                     with respondent that the taxpayer must at some point incur
                                     some construction cost with respect to the dwelling unit to
                                     include these costs in the dwelling unit cost. We do not
                                     believe that section 1.460–3(b)(2)(i) and (iii), Income Tax
                                     Regs., allows a taxpayer with zero direct construction costs
                                     with respect to dwelling units to simply add common
                                     improvement costs for the purposes of the 80% test. Rather,
                                     the regulation states that the taxpayer may ‘‘include’’ such
                                     costs. Sec. 1.460–3(b)(2)(iii), Income Tax Regs. The regulation
                                     allows the taxpayer to include only the share of the common
                                     improvement costs allocable to the dwelling unit. Id. If the
                                     taxpayer does not construct or intend to construct qualified
                                     dwelling units, there is no allocable share of common
                                     improvement costs.
                                           18 In
                                            addition, the legislative history supports our interpretation of ‘‘site’’
                                     as limited to the site of the home. The conference committee report states:
                                           [A] contract is a home construction contract if 80 percent or more of the
                                           estimated total costs to be incurred under the contract are reasonably
                                           expected to be attributable to the building, construction, reconstruction,
                                           or rehabilitation of, or improvements to real property directly related to
                                           and located on the site of, dwelling units in a building with four or fewer
                                           dwelling units. * * * [H.R. Conf. Rept. No. 100–1104 (Vol. II), at 118
                                           (1988), 1988–3 C.B. 473, 608; emphasis added.]

                                     This sentence clearly shows that Congress used ‘‘dwelling units’’ in the
                                     plural as opposed to the singular in sec. 460(e)(6)(A)(ii) because a construc-
                                     tion contract for a building with four or fewer dwelling units could qualify
                                     as a home construction contract. Congress did not intend the plural to ex-
                                     pand the definition of ‘‘site’’ from the geographic limitations of the imme-
                                     diate lot to the geographic boundaries, and even beyond, of the whole de-
                                     velopment.




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                                     392                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                         Petitioners have no dwelling unit costs in which to include
                                     the common improvement costs. The costs petitioners incur
                                     are not the actual homes’ structural, physical construction
                                     costs. Nor are they costs for improvements ‘‘located on’’ or
                                     ‘‘located at’’ the site of the homes. Therefore, petitioners may
                                     not include these costs in testing whether 80% of their allo-
                                     cable contract costs are attributable to the dwelling units and
                                     real property improvements directly related to and located on
                                     the site of the yet to be constructed dwelling units.
                                         After reviewing the plain and ordinary meaning of the
                                     statute and the regulation, we conclude that petitioners’ con-
                                     tracts and agreements do not qualify as home construction
                                     contracts. 19 Recently, we held that availability to home-
                                           19 We
                                              also do not think that respondent’s current position is inconsistent
                                     with the Internal Revenue Service (IRS) material petitioners cite. For in-
                                     stance, the IRS Non-Docketed Service Advice Review they referenced does
                                     not say that a home construction contract need not involve the building of
                                     a home. 2003 IRS Non-Docketed Service Advice Review 20006 (Jan. 18,
                                     2003). Rather this document states that the activities enumerated by sec.
                                     460(e)(4) encompass more than just building a house, such as rehabili-
                                     tating a home or installing integral components. Id. As mentioned supra,
                                     when Congress changed sec. 460(e)(6) to reference para. (4), thereby in-
                                     cluding ‘‘the installation of any integral component to, or improvement of,
                                     real property’’ in the qualifying costs of sec. 460(e)(6), it intended to allow
                                     taxpayers who build components such as air conditioning and heating sys-
                                     tems to potentially qualify their construction contracts as home construc-
                                     tion contracts. Omnibus Budget Reconciliation Act of 1989, Pub. L. No.
                                     101–239, sec. 7815(e)(1)(A), 103 Stat. at 2419; H.R. Rept. No. 101–247, at
                                     1411 (1989), 1989 U.S.C.C.A.N. 1906, 2881. For an explication of the IRS’
                                     current position, see Tech. Adv. Mem. 200552012 (Dec. 30, 2005), indi-
                                     cating that the IRS believes the home construction exception is only avail-
                                     able to the party who actually builds or produces a dwelling unit. Con-
                                     sequently, a land developer who did not build any dwelling unit(s) could
                                     not qualify.
                                        We recognize that the proposed regulations, which would redesignate
                                     sec. 1.460–3(b)(2)(iii), Income Tax Regs., as sec. 1.460–3(b)(2)(iv), if adopt-
                                     ed, would expand the scope of the qualifying costs. Proposed Income Tax
                                     Regs., 73 Fed. Reg. 45182 (Aug. 4, 2008). These regulations would modify
                                     the definition of ‘‘improvements to real property directly related to, and lo-
                                     cated on the site of, the dwelling units’’ by including costs of common im-
                                     provements within that definition even if the contract does not provide for
                                     the construction of any dwelling unit(s). Id. Not only does the preamble to
                                     the proposed regulations explicitly caution taxpayers not to rely on these
                                     regulations, id. at 45181, but by negative inference they add credence to
                                     our view that petitioners’ position is unsupported by the wording of the
                                     current statute and regulation.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    393


                                     builders of the completed contract method of accounting is
                                     ‘‘generously broad and reflects a deliberate choice by Con-
                                     gress that home construction contracts should be treated dif-
                                     ferently’’, but only as to homebuilders. Shea Homes, Inc. &
                                     Subs. v. Commissioner, 142 T.C. at 107–108. As for other
                                     construction contracts, ‘‘[t]he completed contract method of
                                     accounting is a narrow exception to the legislated rule that
                                     most long-term contracts must now be accounted for under
                                     the percentage of completion method of accounting’’, which
                                     should be strictly construed. Id. at 107. Petitioners were not
                                     homebuilders, and their contracts were not home construc-
                                     tion contracts. Petitioners cannot account for gain or loss
                                     from these contracts using the completed contract method of
                                     accounting.
                                           C. Shea Homes
                                        In Shea Homes, we held that the subject matter of the
                                     home construction contracts of the taxpayers, developers who
                                     both developed land and built homes, included the home, the
                                     lot on which the home sat, and the common improvements
                                     and amenities. Therefore, we held that in testing contract
                                     completion, the taxpayers were entitled to apply the use and
                                     95% completion test by using the contract costs, after
                                     including the allocable share of the costs of the common
                                     improvements and amenities of the development or develop-
                                     ment phase which included the dwelling unit(s).
                                        In reaching this conclusion, we looked in part at the defini-
                                     tion of home construction contract to inform our under-
                                     standing of the regulation’s use of ‘‘subject matter’’ of the
                                     contract. We concluded that section 460(e)(6)(A) defined a
                                     home construction contract, and that ‘‘the regulations expand
                                     this definition to allow taxpayers to include ‘the allocable
                                     share of the cost that the taxpayer reasonably expects to
                                     incur for any common improvement.’ ’’ Shea Homes, Inc. &
                                     Subs. v. Commissioner, 142 T.C. at 102 (quoting section
                                     1.460–3(b)(2)(iii), Income Tax Regs.). We believed that the
                                     fact that the regulations expanded the universe of costs to be
                                     considered when deciding whether a contract qualified as a
                                     home construction contract was ‘‘at minimum instructive’’
                                     when deciding when that contract is subsequently completed.
                                        But at no point in Shea Homes did we say that a home
                                     construction contract could consist solely of common improve-




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                                     394                 142 UNITED STATES TAX COURT REPORTS                                    (355)


                                     ment costs. The starting point in Shea Homes was that the
                                     taxpayers’ contracts were for the construction of qualifying
                                     dwelling units. Those taxpayers developed land and built
                                     homes, and so when testing whether their contracts were
                                     home construction contracts, they were permitted by the
                                     regulations to add to the costs of the dwelling units they con-
                                     structed their common improvement costs. And, when testing
                                     the contract completion date, they looked to when they
                                     incurred 95% of the costs of the subject matter of the con-
                                     tract.
                                        Our Opinion today draws a bright line. A taxpayer’s con-
                                     tract can qualify as a home construction contract only if the
                                     taxpayer builds, constructs, reconstructs, rehabilitates, or
                                     installs integral components to dwelling units or real prop-
                                     erty 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. If we
                                     allow taxpayers who have construction costs that merely ben-
                                     efit a home that may or may not be built, to use the com-
                                     pleted contract method of accounting, then there is no telling
                                     how attenuated the costs may be and how long deferral of
                                     income may last. We cautioned in a footnote in Shea Homes,
                                     Inc. & Subs. v. Commissioner, 142 T.C. at 109 n.24, that
                                     there is a temporal component to the home construction con-
                                     tract exception and contract completion. 20 We think it con-
                                     sistent with congressional intent that a line should be drawn
                                     here so as to exclude petitioners’ contracts, when we cannot
                                     conclude that qualifying dwelling units will ever be built.
                                        20 The regulations caution that ‘‘taxpayers may not delay the completion

                                     of a contract for the principal purpose of deferring federal income tax.’’ Sec.
                                     1.460–1(c)(3)(iv)(A), Income Tax Regs. In these cases, petitioners would
                                     often build infrastructure as needed. For instance, the costs of a road or
                                     a water line that is anticipated to benefit a village may upon request, see
                                     supra p. 364, not be incurred for many years. This may lead to a situation
                                     where the contract completion date could be substantially delayed. We do
                                     not suggest that developers intentionally build ghost towns by building out
                                     infrastructure in excess of demand, but we suggest that such costs would
                                     not necessarily be a proper part of a home construction contract. This is
                                     especially important for contracts qualifying for the completed contract
                                     method of accounting where such a delay coupled with just-in-time, as-
                                     needed improvements construction indeterminately defer recognition of in-
                                     come.




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                                     (355)              HOWARD HUGHES CO., LLC v. COMMISSIONER                                    395


                                         Of course, the contract does not necessarily have to be for
                                     the actual sale of a home. The regulations make clear that
                                     a subcontractor’s contract may qualify as a home construc-
                                     tion contract. For instance, a subcontractor who does the
                                     electrical work inside the home may have a home construc-
                                     tion contract. Petitioners attempt to characterize their rela-
                                     tionship with the homebuilders as a general contract or sub-
                                     contractor relationship. In an interesting and innovative
                                     twist, petitioners try to characterize themselves as the sub-
                                     contractor in the relationship, as if the builders are subcon-
                                     tracting out all of this infrastructure and extra-home
                                     development work to petitioners. But this is not the relation-
                                     ship the parties have chosen. See Commissioner v. Nat’l
                                     Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974)
                                     (‘‘[W]hile a taxpayer is free to organize his affairs as he so
                                     chooses, nevertheless, once having done so, he must accept
                                     the tax consequences of his choice, whether contemplated or
                                     not, and may not enjoy the benefit of some other route he
                                     might have chosen to follow but did not.’’ (Citations
                                     omitted.)).
                                     IV. Conclusion
                                       Petitioners’ contracts are not home construction contracts
                                     within the meaning of section 460(e). Petitioners may not
                                     account for these contracts using the completed contract
                                     method of accounting. The custom lot contracts and the bulk
                                     sale agreements are, however, long-term construction con-
                                     tracts for which petitioners, if those contracts are entered
                                     into in a year before their completion, may use a permissible
                                     method of accounting for long-term contracts, such as the
                                     percentage of completion method.
                                       The Court has considered all of the parties’ contentions,
                                     arguments, requests, and statements. To the extent not dis-
                                     cussed herein, the Court concludes that they are moot, irrele-
                                     vant, or without merit.
                                                                         Decisions will be entered for respondent.

                                                                               f




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