Land developer, IRS head for U.S. Tax Court on accounting fight


* Real estate companies monitoring outcome of case

* IRS taking 'hard line' on accounting issue-lawyer

* "Completed contract method" allows income tax deferral

By Patrick Temple-West

WASHINGTON, Oct 11 (Reuters) - In a tax fight that couldjolt the real estate business, Howard Hughes Corp ischallenging the U.S. Internal Revenue Service over a $144.1million tax bill stemming from land sales at Summerlin, anenormous planned community in southern Nevada.

The dispute centers on an accounting practice - known as the"completed contract method" - that the IRS has scrutinized foryears. A Tax Court trial is scheduled for Nov. 5 in Las Vegas.

The IRS contends, according to court records, that HowardHughes improperly deferred taxes on income from sales ofresidential lots at Summerlin, which sprawls across 35 squaremiles on the western fringe of Las Vegas.

The company should pay taxes as it books the lot sales andnot wait until the project is nearly finished, the IRS said.

But Howard Hughes says its use of the method is permissibleunder an IRS exemption for home construction, and thatdevelopers pay up-front costs and do not know their ultimatetaxable gains until a project is almost finished.

Both the company and the IRS declined to comment.

Dallas-based Howard Hughes is a spinoff from General GrowthProperties . Though Howard Hughes is the company incourt, General Growth is liable for tax payments if the IRSwins, according to the spinoff agreement.

General Growth declined to comment.

Activist investor William Ackman is chairman of HowardHughes. Ackman's hedge fund, Pershing Square Capital ManagementLP, owned 3.6 million Howard Hughes shares as of June 30.

The IRS said in September 2009 that companies using thecompleted contract a ccounting method to defer income from landsales for years, or even a decade or more, could trigger anaudit.

The IRS has other Tax Court challenges pending with propertydevelopers over the completed contract method, o r CCM.

"Taxpayers' misuse of the CCM is a growing trend within theresidential construction industry," the IRS said in a September2009 i n ternal memo, one of several posted on the IRS website.


An IRS win in Tax Court could mean property developers wouldneed to pay taxes on a "percentage-of-completion" accountingmethod, a less-favorable approach for businesses.

The IRS is "taking a pretty hard-line position, saying thatyou just are not entitled to the completed-contract method,"said David Auclair, principal at accounting firm Grant Thornton.

"This is a big issue for land developers and commercial realestate," he said.

Homebuilders also use the completed contract method. InJuly, California-based Shea Homes LP went to trialwith the IRS over this issue.

The company could owe up to $61 million in federal and statetaxes, Shea said in Securities and Exchange Commission filings.

Wilkes Graham, senior vice president at Compass PointResearch & Trading LLC, said a court loss for Howard Hughes andGeneral Growth would not deal a blow to their shareholders.

But, he said, the challenge to the accounting method will bewatched by other companies.

"It's a bigger deal overall," he said. For companies usingthe completed contract method, "those entities would be at risk"if the IRS wins, he said.

Howard Hughes got a tax bill in February 2011 for allegedlyunder-paying taxes in 2007 and 2008 on Summerlin, a project thatthe company does not expect to sell out until 2039.

Hurt by the recent financial crisis , Summerlin's acreagesales are starting to recover this year. The development's landcovers an area half the size of the District of Columbia.

As a developer, Howard Hughes builds the infrastructure atSummerlin - roads, sewer and water, electricity. The companymakes money when it sells developed properties to home builders.

A Tax Court loss by Howard Hughes would hurt the developmentindustry just as it is starting to recover.

Developers beginning new projects may need to pay taxessooner, adding an up-front cost for the businesses, said RichardShavell, a vice chairman at the Associated Builders andContractors, an industry group. "If the IRS wins, they couldcause a lot of uncertainty," he said.

(Reporting by Patrick Temple-West; Editing by Kevin Drawbaughand Dan Grebler)