Shea Homes, Inc. v. Commissioner

SHEA HOMES, INC. AND SUBSIDIARIES, ET AL., 1 PETITIONERS
v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket Nos. 29271–09, 1400–10, Filed February 12, 2014.
1401–10.

Corporation C and partnerships S and V develop large,
planned residential communities. They develop the land and
construct homes and common improvements, including amen-
ities. For the years at issue they reported income from their
contracts for the sale of homes using the completed contract
method of accounting. Under their interpretation of this
method of accounting, their contracts are complete when they
meet the use and 95% test pursuant to sec. 1.460–1(c)(3)(A),
Income Tax Regs., and incur 95% of the costs of the develop-
ment. They contend that final completion and acceptance
pursuant to sec. 1.460–1(c)(3)(B), Income Tax Regs., does not
occur (after excluding secondary items, if any, pursuant to sec.
1.460–1(c)(3)(B)(ii), Income Tax Regs.) until the last road is
paved and the final bond is released. R seeks to place C, S,
and V on his interpretation of the completed contract method.
R contends that the subject matter of the contracts of C, S,
and V consists only of the houses and the lots upon which the
houses are built. Under R’s interpretation, the contract for
each home meets the final completion and acceptance test
upon the close of escrow for the sale of each home. R also
alleges that contracts entered into and closed within the same
taxable year are not long-term contracts under I.R.C. sec. 460.
Held: The subject matter of the contracts consists of the home
and the larger development, including amenities and other
common improvements. Held, further, C, S, and V are per-
mitted to report income and losses from sales of homes in
their planned developments using their interpretation of the
completed contract method of accounting.

Gerald A. Kafka, Rita A. Cavanagh, Chad D. Nardiello,
and Sean M. Akins, for petitioners.
Melissa D. Lang, Allan E. Lang, David Rakonitz, and
Nicholas D. Doukas, for respondent.
WHERRY, Judge: These consolidated cases are before the
Court on a petition for redetermination of deficiencies in
income tax respondent determined for petitioner Shea
Homes, Inc., and Subsidiaries’ 2004 and 2005 tax years; a
1 Cases
of the following petitioners are consolidated herewith: Shea
Homes, LP, J F Shea, LP, f.k.a. J F Shea, LLC, Tax Matters Partner, dock-
et No. 1400–10; and Vistancia, LLC, Shea Homes Southwest, Inc., Tax
Matters Partner, docket No. 1401–10.

60

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 61

petition for review of notices of final partnership administra-
tive adjustment respondent issued for the 2004, 2005, and
2006 tax years of Shea Homes, LP; and a petition for review
of notices of final partnership administrative adjustment
respondent issued for the 2004 and 2005 tax years of
Vistancia, LLC.
The ultimate issue for decision in these cases is whether
Shea Homes, Inc., and Subsidiaries, Shea Homes, LP, and
Vistancia, LLC, properly reported income and loss from the
sale of homes in their planned developments using the com-
pleted contract method of accounting provided for in section
460. 2 The resolution of this issue turns on the determination
of whether the home sale contracts include the development
amenities or are limited to the house and the lot on which
it sits.

FINDINGS OF FACT

The parties’ stipulation of facts and the accompanying
exhibits are incorporated herein by this reference.
Petitioners
Petitioner in docket No. 29271–09, Shea Homes, Inc. (SHI),
and Subsidiaries, is an affiliated group of corporations with
the common parent, SHI, organized under the laws of Dela-
ware. At all relevant times SHI maintained its principal
offices in Walnut, California. SHI used the accrual method as
its overall method of accounting for the years at issue.
The partnership in docket No. 1400–10, Shea Homes, Lim-
ited Partnership (SHLP), is a limited partnership organized
under the laws of California. J F Shea, LP, f.k.a. J F Shea,
LLC (JFLP), is the tax matters partner of SHLP. 3 At all rel-
evant times SHLP maintained its principal offices in Walnut,

2 Unless
otherwise indicated, all section references are to the Internal
Revenue Code of 1986 (Code), as amended and in effect for the taxable
year at issue, and all Rule references are to the Tax Court Rules of Prac-
tice and Procedure. All monetary amounts are rounded to the nearest dol-
lar unless otherwise noted.
3 Effective April 1, 2005, JFLP was converted from a Delaware limited

liability company, known as J F Shea, LLC, to its current form as a lim-
ited partnership.

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 62 142 UNITED STATES TAX COURT REPORTS (60)

California. SHLP used the accrual method as its overall
method of accounting for the years at issue.
The partnership in docket No. 1401–10, Vistancia, LLC
(Vistancia), is a limited liability company organized under
the laws of Delaware. Shea Homes Southwest, Inc. (SHSI),
is the tax matters partner of Vistancia. At all relevant times
Vistancia maintained its principal offices in Scottsdale,
Arizona. Vistancia used the accrual method as its overall
method of accounting for the years at issue.
During the tax years at issue, SHI, SHLP, and Vistancia
deferred revenue, costs of sales, and income from the con-
tracted-for sales of homes that closed in escrow as follows:

2002 2003 2004 2005 2006

SHI:
Revenue --- --- $81,066,693 $122,237,525 ---
Cost of
sales --- --- 64,005,169 80,638,808 ---
Income $9,260,993 17,061,524 41,598,717
Vistancia:
Revenue --- --- 92,348,246 310,218,513 ---
Cost of
sales --- --- 66,561,918 212,621,241 ---
Income --- 8,835,716 25,786,328 97,597,272 ---
SHLP:
Revenue --- 289,761,283 563,962,237 944,999,695 $956,921,373
Cost of
sales --- 235,477,059 417,368,568 678,173,038 739,981,843
Income1 $182,000 54,284,224 146,593,669 266,826,659 216,939,529
1 In 2002, SHLP deferred $3,149,537 of income. It then determined that it had erro-
neously deferred $2,967,537 of that amount; and rather than file an amended return
for 2002, it included the $2,967,537 in income on the 2003 return, which respondent
accepted. The remaining $182,000 has apparently not yet been recognized. In addi-
tion, the parties stipulated that the income calculation for the 2006 year contains a
rounding error. The income calculation for the 2005 year also likely contains a round-
ing error.

For the tax years at issue, SHI, SHLP, and Vistancia
deferred some income from the sales of homes in the tax
years the contracts for those sales closed in escrow and then
recognized part of that income for Federal income tax pur-
poses in following years as follows:

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 63

Year Deferred Year Amount
deferred income recognized recognized

SHI 2003 $9,260,993 2007 $9,260,993
2004 17,061,524 2007 17,061,524
2005 41,598,717 2007 41,598,717
Vistancia 2003 8,835,716 2009 8,835,716
2004 25,786,328 2009 25,786,328
2005 1 97,597,272 2009 97,597,272
SHLP 2002 3,149,537 2003 2,967,537
2003 2 54,466,226 2004 35,127,818
2005 18,234,951
2006 1,103,457
2004 3 146,593,669 2005 40,817,288
2006 101,577,422
2007 4,198,958
2005 266,826,659 2006 60,556,813
2007 48,350,567
2008 33,374,188
2009 21,215,992
2006 216,939,529 2007 32,896,005
2008 64,557,454
2009 49,310,872
2010 39,173,387
1 Paragraph 42(c) of the parties’ stipulation of facts reports the
amount deferred as $97,597,272. Paragraph 79 of the stipulation
reports the amount deferred as $97,597,273. This $1 discrepancy
may be the result of rounding.
2 This amount is derived from paragraph 79 of the parties’ stipu-
lation of facts and is in partial conflict with the $54,284,226
amount specified by paragraph 46(c) of the stipulation. This dis-
crepancy is the apparent result of the $182,000 of deferred but not
yet recognized income. See supra p. 62, table note 1.
3 Paragraph 48(c) of the parties’ stipulation of facts reports the
amount deferred as $146,593,669. Paragraph 79 of the stipulation
reports the amount deferred as $146,593,668. The $1 discrepancy
may be the result of rounding.

Deficiencies and Adjustments to Income
Respondent determined the following deficiencies with
respect to the Federal income tax of SHI:

Additional
Year Deficiency amended amount
2004 $5,971,533 $3,241,348
2005 14,559,551 ---

The additional amended amount in the above table rep-
resents the amount respondent asserted in an amendment to
his answer. Respondent asserts that this additional tax due
amount is necessary under section 481(a) to prevent its
permanent exclusion from Federal income taxation because
of respondent’s change in SHI’s method of accounting.

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 64 142 UNITED STATES TAX COURT REPORTS (60)

Respondent also proposed the following adjustments to
partnership income with respect to SHLP and Vistancia:

Adjustments to Additional
Year partnership income items amended amounts

SHLP 2003 $54,284,226 $182,000
2004 111,465,850 ---
2005 266,826,659 ---
2006 216,939,529 ---
Vistancia 2004 25,786,328 8,835,716
2005 97,597,272 ---

Again, the additional amended amounts of taxable income
are the amounts respondent alleges, by way of amended
answer, are necessary under section 481(a). We also note
that the partnership adjustments to the Federal taxable
income of SHLP and Vistancia would have ultimately
resulted in additional taxable income to the partners and
may have resulted in significant additional tax due at the
partner level.
Respondent calculated the above amounts by including in
income amounts SHI, SHLP, and Vistancia deferred using
the completed contract method of accounting as reported on
schedules attached to their tax returns and as supported by
their underlying work papers. These amounts do not reflect
various computational, correlative adjustments. Petitioners,
SHI, JFLP, and SHSI, timely petitioned this Court for
review, and a trial was held in Washington, D.C.
Company Background
The Shea family has been in the home development busi-
ness for more than 40 years. The home development business
was operated through several entities, including SHI, SHLP,
and Vistancia. During the years at issue the Shea family
companies were one of the largest private homebuilders in
the United States.
Business Model
SHI, SHLP, and Vistancia are builders/developers of
planned communities, ranging in size from 100 homes to
more than 1,000 homes in Colorado, California, and Arizona.
During the years at issue they sold homes in 114 develop-
ments. For the purposes of these cases, the parties have

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selected eight representative developments and have agreed
that the Court’s findings of fact based on documents and
information from these sample developments will be control-
ling for all developments. 4
The eight developments are each representative of a divi-
sion. They are: (1) Trilogy at La Quinta; (2) Vistancia; (3)
Parkside at Reunion; (4) Breakers at Pointe Marin; (5) Costa
Azul; (6) Azure; (7) Country Lane; and (8) Sommerset at
Morgan Hill. SHI, SHLP, and Vistancia conducted their
home development business through divisions, organized on
the basis of the geographic locations of their developments,
except in the case of the Active Adults Division,
which was based on the type of development. These divisions
were as follows: (1) Active Adults Division; (2) Arizona Divi-
sion; (3) Colorado Division; (4) Northern California Division;
(5) Southern California Division; (6) San Diego Division; (7)
Inland Empire Division; and (8) Sacramento Division.
SHI, SHLP, and Vistancia pride themselves on providing
their customers with more than just the ‘‘bricks and sticks’’
of a home and emphasize the features and lifestyle of the
community to potential buyers. For example, at the Reunion
at Parkside community they advertised using the themes
‘‘live well, work well, play well’’ and ‘‘the pursuit of happi-
ness’’.
SHI, SHLP, and Vistancia purchased land in various
stages from completely raw to finished lots in developed
communities. Their business involved the analysis and
acquisition of land for development and the construction and
marketing of homes and the design and/or construction of
developments and homes on the land they acquired. The
costs incurred in their home construction business included,
by partial example: (1) acquisition of land; (2) financing; (3)
municipal and other regulatory approvals of entitlements; (4)
construction of infrastructure; (5) construction of amenities;
(6) construction of homes; (7) marketing; (8) bonding; (9) site
supervision and overhead; and (10) taxes. Their primary
source of revenue from the home development business was
from the sale of houses.
4 The agreement is subject to an exception where it is necessary for the

Court to make specific findings pertaining to the adjustments at issue, cor-
relative adjustments, or any other computational findings.

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 66 142 UNITED STATES TAX COURT REPORTS (60)

We discuss infra the general process SHI, SHLP, and
Vistancia used in their home development business. Much of
the trial was dedicated to the details of the process, and we
by no means list every single step. Our intention is not to
discount those important steps not mentioned but to give a
general idea of how the development process worked.
Land Acquisition
The initial step in the process is to acquire land on which
to build the developments. Divisions of SHI, SHLP, and
Vistancia are responsible for identifying parcels of land as
candidates for development. After identification, the divisions
evaluate multiple factors to ascertain whether that property
constitutes a viable development opportunity. If a division
determines that the land is viable for development, it pre-
pares a Land Committee Report which summarizes the divi-
sion’s evaluation of the factors used to evaluate that parcel.
The Land Committee Report is then sent to the Land Com-
mittee, comprising senior executives, including owners, for
approval.
Design of Developments
The developments are typically designed by architects,
engineers, and consultants engaged by SHI, SHLP, and
Vistancia. The final design for the planned construction of
the developments is presented on a map or plat called a
Tract Map. The Tract Map is submitted for approval to the
county or municipality in which the development will be
located. SHI, SHLP, and Vistancia may be required, before
or after formal submission, to revise the design of the
development using input from the county or municipality.
Performance Bonds
SHI, SHLP, and Vistancia were required by State and
municipal law to post bonds to secure their performance with
respect to the completion of the common improvements in
their developments. 5 The bonds required them to complete
5 A surety bond is a promise to pay a party (the obligee) its loss up to

a certain amount (the bond amount) if a second party (the obligor) fails
to meet one or more obligations. A performance bond is a surety bond
issued by an insurance company or bank (the surety) in favor of an obligee
to guarantee satisfactory completion of a project by an obligor. In the real

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the obligations specified therein before the bonds are exoner-
ated. When performance bonds are required, they are posted
before or concurrent with the approval by and recording with
a governmental authority of a map or plat with respect to the
development. The amount of a performance bond depended
on the State and municipal law and the nature, extent, and
anticipated costs of the common improvements. The costs are
estimated by the obligee with the assistance of experts.
The obligor must purchase the bond by paying a premium
to the surety. The surety prices the performance bond pre-
mium according to the risk associated with the obligor, the
amount of the performance bond, and the term of the
performance bond. If an obligor fails to fulfill the conditions
of the performance bond, then the obligee may file a claim
with the surety by sending the surety a letter detailing the
failure of the obligor to perform under the conditions of the
performance bond. Upon receiving the claim from an obligee,
the surety forwards the claim to the obligor, who is required
to manage the claim process, including all associated costs.
If a surety is required to pay any of the bond amount to the
obligee, the surety is entitled to recover the amount paid
from the obligor and/or any third-party guarantor pursuant
to indemnifications the obligor generally must enter into
with respect to each surety.
The obligee must approve of the completion of the subject
matter before the performance bond will be exonerated.
Obtaining the approval of an obligee may involve negotiation
between the parties as to whether the obligor has satisfied
the terms of the performance bond. For example, municipali-
ties may require an obligor to repave roads, fix curbs, install
fire hydrants, or construct additional infrastructure common
improvements before releasing the obligor. Homeowners
associations may, as examples, require an obligor to repave
nature trails, fix steps in common areas, or improve a club-
house before releasing the obligor from a performance bond.
The obligees identified in the performance bonds of SHI,
SHLP, and Vistancia included the homeowners associations

estate development context, a performance bond is a surety bond issued by
a surety in favor of an obligee to guarantee satisfactory completion of,
among other things, common improvements with respect to a development
constructed by an obligor (the developer).

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 68 142 UNITED STATES TAX COURT REPORTS (60)

formed with respect to their developments as well as the
municipalities and States in which the developments are
situated.
A performance bond may be accompanied by a bond
guaranteeing payment of labor and material costs incurred in
the development. These bonds are referred to as ‘‘labor and
material bonds’’ or ‘‘payment bonds’’. They are surety bonds
that supplement a performance bond for labor and material
costs with respect to the conditions in the performance bond.
The obligor of a labor and material bond may pay an addi-
tional premium to post the bond, or the premium may be
included in the premium price of the associated performance
bond. The amount, premium price, and process for exonera-
tion of a labor and material bond or payment bond is similar
to that used for a performance bond.
SHI, SHLP, and Vistancia posted performance bonds, labor
and material bonds, and additional surety bonds for all eight
representative developments. For Trilogy at La Quinta, SHI
posted 28 bonds ranging in amount from $24,625 to
$3,726,220 with premiums between $163 and $12,000. 6 The
obligees on these bonds were the city of La Quinta, the
County of Riverside, the California State government, and
the Trilogy at La Quinta Maintenance Association. These
bonds were exonerated between January 30, 2007, and
December 21, 2010, with one bond for $2 million still out-
standing as of the date of the trial in these cases. 7
For the Parkside at Reunion development, SHLP posted
six bonds ranging in amount from $23,592 to $3,300,000 with
premiums between $464 and $13,200. The obligees were
Commerce City and the County of Douglas. 8 Two bonds are
6 These
figures and the ones discussed below are from bond reports pro-
vided by petitioners and in evidence as stipulations and/or stipulated ex-
hibits except in the case of Vistancia. The factual and documentary record
concerning the bonds is spotty. The parties included original documents as
to some of the bonds, but in other cases we rely solely on the bond reports.
The parties did not provide a bond report for Vistancia, but they did pro-
vide a number of bond documents.
7 Likewise, the bonds noted infra as outstanding were outstanding as of

the date of the trial.
8 The bond for the benefit of Douglas County is confusing to the Court

as it is presented as used in connection with the Parkside at Reunion de-
velopment, but the Exhibit 187–P listing references Highlands Ranch.
Parkside is in Adams County, whereas Highlands Ranch is in Douglas

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 69

still outstanding. The other four bonds were exonerated
between October 5, 2006, and March 19, 2009.
For Breakers at Pointe Marin, SHLP posted 23 bonds
ranging in amounts from $1,677 to $1,708,400. The bond
report does not list the premiums paid, but other exhibits
reflect a $100 premium per bond for the other earlier
Breakers at Pointe Marin surety bonds of $1,677, $1,845,
$2,348, $2,012, $3,689, and $2,348. The obligee on these
surety bonds was Pointe Marin Association, the develop-
ment’s homeowners association. Exhibits also show perform-
ance bonds ranging from $58,635 to $82,151 with premiums
ranging from $150 to $410. The obligee of these bonds was
also the homeowners association. Obligees for the remaining
bonds listed on the bond report were Novato Sanitary Dis-
trict, North Marin Water District, and the city of Novato.
As to Costa Azul, SHLP posted five bonds. SHLP posted a
performance bond in the amount of $500,000, with a pre-
mium of $2,500. The State of California was the obligee on
this bond. SHLP also posted bonds in the amounts of
$10,950, $9,816, and $7,164 with premiums of $110, $100,
and a premium amount not disclosed by the trial record,
respectively. The fifth bond was for $172,000. The record
again does not reflect the premium, but the obligee was the
County of Orange. These bonds were exonerated as early as
January 9, 2009, and as late as July 19, 2010.
For Azure, SHLP posted 22 bonds. These bonds included a
$300,000 bond with a $1,050 premium. The obligee on this
bond was the State of California. Of the remaining bonds, at
least two were surety bonds for $20,824 and $1,885 issued
with the development’s San Elijo Hills Community Home-
owners Association as the obligee. The premiums for these
bonds were $104 and $100, respectively. The remaining 19
bonds ranged in amount from $1,105 to $98,500. The
exoneration dates on all bonds ranged from January 19,
2005, to July 1, 2008.
With respect to Country Lane, SHLP posted only one bond.
This bond was for $330,657, the obligee was the State of
Arizona, and the exoneration date was November 1, 2004.

County with the County of Arapahoe and/or the City and County of Denver
in between. The explanation may involve utilities such as water or sewage
treatment or an error in the exhibit.

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 70 142 UNITED STATES TAX COURT REPORTS (60)

As for Sommerset at Morgan Hill, the bond report shows
that SHLP posted five bonds. According to the report, these
bonds ranged in amount from $52,750 to $570,800. The
obligee on four of these bonds was the County of Riverside,
and the obligee on the fifth bond was the County of San
Bernardino. The report reflects that three of these bonds
were exonerated on December 7, 2007. The parties also
included an unsigned copy of a surety bond not included in
the bond report reflecting a sixth bond for $300,000 with a
premium of $1,050 and the State of California as the obligee.
Finally, for Vistancia, the parties introduced evidence of
three performance bonds. These bonds were for $134,358,
$346,971, and $235,441 with premiums of $672, $1,735, and
$1,177, respectively. The obligee on the $134,358 bond was
the city of Peoria, Maricopa County, Arizona. The obligee on
the other two was the development’s homeowners associa-
tion.
Budgeting
SHI’s, SHLP’s, and Vistancia’s operating divisions pre-
pared budgets for the direct and indirect costs relating to the
construction of developments. They prepared the budgets on
a development-wide basis by compiling a budget file, referred
to as a Tract-Property Investment Evaluator file (Tract-PIE
file). 9 They used this tool to monitor the anticipated and
actual development costs and the projected and actual rev-
enue from the sale of homes in the development. They also
updated the development’s Tract-PIE file on an annual, semi-
annual, or quarterly basis depending on the needs of the par-
ticular development.
The Tract-PIE data inputs included: incurred costs and
revenue received with respect to the development (actuals);
job cost reports containing estimated unincurred costs (job
cost); 10 sales and marketing forecasts (sales and marketing);
estimated construction costs per home model (direct construc-
9 Tract-PIE is a commercial software tool used to forecast and monitor

the costs and revenue associated with constructing a development.
10 The job cost data input is the estimated, non-home-specific construc-

tion costs, including estimated costs for the purchase of land, design of the
development, construction of infrastructure and amenity common improve-
ments, labor, fees, and property taxes.

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 71

tion template); 11 estimated revenue from the sales of homes
(sale price revenue); and inflation and appreciation assump-
tions (inflation/appreciation). Respondent does not challenge
the accuracy of the construction budgets.
Estimates of revenue from home sales involved projections
of the average price of sold homes, the sales absorption rate,
the construction cycle, and price appreciation, among other
variables. SHI, SHLP, and Vistancia came up with their
anticipated revenue starting with a projection of the number
of houses they intended to build in a development and how
many different floor plans they intended to offer. The divi-
sions estimated, using experience and sometimes the help of
outside consultants, a sale price for each floor plan.
The prices per floor plan were exclusive of any discount or
premium for views, lot size, or other aesthetic draws or draw-
backs. Rather SHI, SHLP, and Vistancia estimated each pre-
mium and discount as a development-wide number; then
they divided that number by the projected number of units
to arrive at an average discount and premium per unit. SHI,
SHLP, and Vistancia used the average price per home, plus
the premium and less the discount, to come up with a gross
revenue figure and, after considering forecasted sales pace,
added on additional revenue for expected future price
increases.
Similarly, SHI, SHLP, and Vistancia generally estimated
costs on a development-wide basis, although some costs are
estimated on a per-unit basis and extrapolated to a develop-
ment-wide basis (e.g., their initial pro forma for Azure esti-
mated a permitting cost of $3,000 per house). But they could
roughly estimate costs on an average per-unit basis by
dividing the total amount of estimated costs by the estimated
number of homes to be sold.
The Land Committee Report discussed supra included an
estimated budget of that development’s revenue and
expenses. SHI, SHLP, and Vistancia also summarized esti-

11 The direct construction template consists of the estimated costs on a

per-square-foot basis to construct each home model sold in that develop-
ment.

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 72 142 UNITED STATES TAX COURT REPORTS (60)

mated costs and revenues on a so-called napkin, 12 which
included information from the Land Committee. On these
reports ‘‘direct expenses’’ represented the actual ‘‘bricks and
sticks’’ costs of home construction in the development. The
parties provided Land Committee Reports and napkins for
only four of the developments.
Construction of Developments
SHI, SHLP, and Vistancia constructed their developments
in a sequence of stages consisting of: grading land; initial
construction of amenity and infrastructure common improve-
ments; construction of homes; and construction and finaliza-
tion of any remaining common improvements. The amount of
time it took to grade the land and initially construct the
amenities and common infrastructure varied with the size,
surface and subsurface condition, and nature of the develop-
ment. The grading process was particularly subject to risk
because often soil conditions under the surface differ from
what was originally anticipated. While SHI, SHLP, and
Vistancia assigned a cost and a time line to the initial
construction phase, that time and cost would vary with
conditions. It took approximately three to five months to con-
struct a single-family detached home and approximately six
to eight months to construct multifamily attached homes. For
large developments, they could perform the construction
stages in phases.
Homeowners Associations
Each development had at least one homeowners associa-
tion. These associations could include homeowners associa-
tions, condominium associations, maintenance associations,
master associations, and community associations. The struc-
ture, activities, and obligations of an association were gov-
erned by, inter alia, (i) the articles of incorporation, (ii)
bylaws, and (iii) covenants, conditions, and restrictions docu-
ments with respect to those associations.

12 The napkin is so called because it is a quick pro forma estimate, as

if one were quickly evaluating a project on a napkin.

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 73

Pricing of Homes
SHI, SHLP, and Vistancia charged a single price for their
homes. This is the ‘‘total purchase price’’. They did not
charge separate prices for the home, the lot, improvements
to the lot, infrastructure and amenity common improve-
ments, financing, fees, property taxes, labor and supervision,
architectural and environmental design, bonding, or any
other costs. They could increase the price of a home by
charging a lot/homesite or elevation premium. Such a pre-
mium was an additional charge for a home on a lot with pre-
ferred qualities or a home with aesthetic, architectural, or
design upgrades to the exterior. SHI, SHLP, and Vistancia
could also increase the price of a home for additional options
or upgrades to the home. All of these charges were included
in the total price set forth in the purchase and sale agree-
ment.
Marketing
SHI, SHLP, and Vistancia used multiple forms of mar-
keting including: print (magazines, newspapers, flyers, and
pamphlets); radio; television; the Internet; billboards; and
word of mouth. For a prospective buyer visiting a develop-
ment, their on-site marketing efforts included: driving tours;
guided walking tours of a development’s amenities; models of
amenities that remain under construction; movies; and walk-
throughs of model homes presented in a community style.
SHI, SHLP, and Vistancia started their marketing process
well in advance of the opening of the community. For
example, the Active Adults Division developed a preselling
process called tsunami. This process included focus groups,
lead-generating mailers, and design shows. These design
shows, also known as charrettes, and focus groups invited
potential consumers to contribute to the design of the
community. The consumers would, before the first home was
sold, get a sense of ownership in the community. Often
participants in this presale process would be the first buyers
once the development was opened for sale.
After the presale process, the community was generally
opened for sales. At this point SHI, SHLP, and Vistancia
intended to have finished constructing the community center
and the model gallery. They thereafter continued to advertise

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 74 142 UNITED STATES TAX COURT REPORTS (60)

using the tools discussed above. For example, with respect to
Parkside at Reunion they established a Web site,
reunionco.com; ran newspaper ads; and used billboards. Gen-
erally, this marketing process was geared towards selling the
community and lifestyle, not just the homes.
At Vistancia, the ‘‘marketing trail’’ began when consumers
first drove into the community. Vistancia purposefully
designed the development so that the consumer, to get to the
tour center and sales office, had to drive past all of the major
amenities. They designed the grading of the land to make
sure the water feature for the 18th hole of the golf course
was visible for the entire drive from the gatehouse. They also
oriented waterfalls and other aesthetics towards the con-
sumer to maximize visibility on the drive in. Essentially,
prospective purchasers’ views during their initial drive into
a community was intended to be a silent sales corridor.
The sales staff at Vistancia greeted the consumers by their
names, which had been radioed from the gatehouse to the
tour center. At the tour center, the staff showed the con-
sumers a short video, which emphasized the development’s
friendships, lifestyle, and community. The potential buyers
then toured the clubhouse and the golf club and all of the
various amenities. This tour could take between three and
five hours. Customers then returned to the tour center,
where Vistancia’s sales staff explained the benefits of living
in the community. They began their explanation of the bene-
fits at the macro geographical area and the proximity to La
Quinta and then moved on to the micro level of the Vistancia
community. Finally, the potential customers entered the
model gallery, which consisted of several model homes as
well as cafes and an amphitheater. Vistancia showed the
homes only at the end because the marketing approach and
product encompassed much more than the home, and it tried
to showcase features and amenities to sell ‘‘the dream’’ to set
up the sale of the home.
Financial Data Tracking
SHI, SHLP, and Vistancia used Tract-PIE software to
record, account for, and summarize incurred and budgeted
data with respect to each development. The information
Tract-PIE kept on file for each development included
cashflow receipts and disbursements, income statement, bal-

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 75

ance sheet, internal rate of return, financing data, book
interest allocations, inflation projections, total units, units
closed, and projected unit closings for both incurred and
budgeted data during the duration of the development. The
Tract-PIE software tracked costs by both indirect and direct
costs. SHI, SHLP, and Vistancia updated the budgeted costs
quarterly with information provided by the divisions.
The software allowed a breakdown of direct costs into a
number of categories. The land and acquisitions category rep-
resented costs to purchase the development land. The profit
and participation agreements category represented agree-
ments in which the seller of the development land had the
opportunity to share in the profits of the development. The
forward planning category represented costs associated with
civil engineering, design, and architecture for the develop-
ment. Direct construction costs were the costs incurred in the
vertical construction of the homes, and option deposits and
option costs reflected costs incurred with respect to upgrades
buyers could select. Model upgrade costs were costs with
respect to the model homes. Commitment fees were costs
associated with financing activities. Finally, the sales tax
category represented the Arizona sales tax that jurisdiction
imposed on the sale of a home.
The indirect cost categories included property tax pay-
ments, site development/land development/common area costs
for infrastructure, and amenities within a development. The
category for amenities and golf reflected costs for a develop-
ment’s golf course(s). The permits and fees category recorded
payments to municipal and State jurisdictions to permit con-
structing of the development. A property tax payments cat-
egory reflected payments made for tax on property not yet
conveyed to third parties, either through sale or through
transfer to the homeowners associations or municipalities.
There were also indirect cost categories for rebates/credits,
indirect construction costs, management fees, and miscella-
neous costs. Petitioners received rebates and credits from
their materials suppliers if they met certain purchase quotas.
Indirect construction costs were costs associated with super-
vision, cleanup, architectural review, and other similar
activities with respect to construction. Management fees
were fees paid in developments being built as a joint venture.

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 76 142 UNITED STATES TAX COURT REPORTS (60)

Miscellaneous costs consisted of any other indirect cost not
covered by the other categories.
The Tract-PIE files allowed SHI, SHLP, and Vistancia to
compare the indirect costs to the direct costs. For example,
exhibits and testimony show that for the 2005 tax year, the
indirect costs of Parkside at Reunion were approximately
27% or more of the total budgeted costs. Similar or even
larger percentages applied to other developments such as
Vistancia and Trilogy at La Quinta, where SHI, SHLP, or
Vistancia was responsible for converting raw land into a
development rather than purchasing and developing just a
portion of another developer’s project, where some indirect
costs had already been incurred and were included in land
costs.
To monitor operational performance and income tax
compliance, SHI, SHLP, and Vistancia divided the total
incurred direct and indirect costs by the total budgeted direct
and indirect costs. Their tax department made relevant
adjustments to reflect what it considered to be the require-
ments of section 460, such as capitalization computations
and tax interest analyses. If the incurred costs were equal to
or greater than 95% of the budgeted costs, then they reported
income for that tax year from homes that had closed in
escrow up to that date. If the incurred costs did not exceed
95%, then they deferred any income from homes that closed
in escrow that year.
For Federal income tax purposes during 2002 and 2003,
SHLP compared the total number of homes closed in a
development to the number projected to be closed by the end
of the development. SHI computed the 95% test by com-
paring the development’s total incurred direct and indirect
costs to the development’s total budgeted direct and indirect
costs. For the 2003 and 2004 tax years, Vistancia did not
mathematically determine whether either the 95% test or the
final completion and acceptance test had been met, the rea-
son being that Vistancia estimated there were no cir-
cumstances under which the 95% test would be satisfied
because such a small portion of the homes in the develop-
ment had been completed.
For all tax years after 2003, except as just noted, SHI,
SHLP, and Vistancia used the Tract-PIE software and
related documentation to compare the development’s

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 77

incurred direct and indirect costs to the development’s total
budgeted direct and indirect costs for the purposes of deter-
mining whether to report income for Federal income tax pur-
poses under their interpretation of the completed contract
method of accounting.
Description of the Eight Representative Developments
Trilogy at La Quinta
The Trilogy at La Quinta development was a gated
community with security and landscaping features located in
Riverside County, within the city limits of La Quinta, Cali-
fornia. The Trilogy development was constructed in eight
phases, with 1,238 total lots and residences situated on
approximately 536 acres. Construction began in or about
July 2000. The Trilogy development included a 30,000-
square-foot clubhouse with a ballroom, a center for higher
learning, a studio for creative arts, a cafe, a kitchen, a
catering kitchen, a grand living room, offices, mail offices,
locker rooms, studios, an indoor pool, an outdoor pool,
cabanas, an indoor running track, a fitness center, a medita-
tion garden, and a spa. It also had outdoor walking, running
and bike paths, tennis courts, and outdoor recreation areas.
Vistancia
The Vistancia development was in Peoria, Arizona, and
included three subdivisions: Vistancia Village, Blackstone,
and Trilogy. As originally designed, the plan was to include
18 phases, situated on approximately 7,100 acres. Construc-
tion of the Vistancia development began in or about January
2002. The Vistancia development included a 3.5-mile trail
system, a restaurant, a spa, pools, a basketball gymnasium,
a multipurpose building, a tennis court, parks, open spaces
for wildlife, playgrounds, and a country club.
Parkside at Reunion
The Parkside development was in Commerce City, Colo-
rado. It was a subdivision of a larger development named
Reunion. Construction of the Reunion development began in
or about May 2001 and continued through December 2011 in
four phases, with 1,875 total lots and 1,425 total residences
on approximately 980 acres. The Reunion development

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 78 142 UNITED STATES TAX COURT REPORTS (60)

included a 21,000-square-foot recreation center featuring an
indoor gymnasium, a fitness center, aerobics, meeting, and
locker rooms, an outdoor pool with interactive water features,
a 52-acre central park that includes multiuse athletic fields,
trails, playgrounds, picnic facilities, and an amphitheater, 10
miles of walking, running and biking trails, 8 acres of lakes,
150 acres of parks, and 170 acres of open space.
Breakers at Pointe Marin
The Breakers at Pointe Marin development was in Novato,
California. It was a subdivision of a larger development
called Pointe Marin. The homes in the Breakers at Pointe
Marin were constructed in 10 phases, with 106 total lots
situated on approximately 25 acres, beginning in or about
May 2004. The Pointe Marin development included walking,
running, and bike paths as well as open spaces for wildlife.
Costa Azul
The Costa Azul development was a gated community with
security features located in Newport Beach, California. This
development was a subdivision of a larger development called
Pacific Ridge. It consisted of 42 total lots, situated on
approximately 22 acres. The homes in Costa Azul were con-
structed in eight phases beginning in or about April 2004.
The development included a recreation center, tot lots, a
swimming pool, a spa, locker rooms, a park, and walking,
running, and biking trails and paths, including open spaces
for wildlife.
Azure
The Azure development was in San Marcos, California. It
was a subdivision of a larger development called San Elijo
Hills. The homes in the Azure development were constructed
in four phases beginning in or about November 2003. It con-
tained 92 total lots, situated on approximately 30 acres. The
Azure development included a park, a pet run area, a skating
area, a swimming pool, and a daycare facility.
Country Lane
The Country Lane development was in Gilbert, Arizona. It
was a subdivision of a development called Neely Commons.
The homes in the Country Lane development were con-

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 79

structed in a single phase, with 193 total lots, situated on
approximately 25 acres, beginning in or about July 2002. The
Country Lane development included a park, landscaped
pedestrian areas, a soccer field, a tot lot, ramadas, and a
half-court basketball facility.
Sommerset at Morgan Hill
The Sommerset at Morgan Hill development was in
Temecula, California. It was a subdivision of a larger
development called Morgan Hill. The homes in the
Sommerset at Morgan Hill development were constructed
beginning in or about March 2004 in seven phases with 70
total lots, situated on approximately 17 acres. The develop-
ment included a community center, a clubhouse, tennis
courts, swimming pools, spas, a tot lot, and walking, running,
and biking paths.
Documentation
Purchase and Sale Agreement
SHI, SHLP, and Vistancia entered into sales contracts
with prospective homebuyers. The purchase and sale agree-
ment identified the buyer and the seller. It provided that the
buyer agreed to purchase the property and the seller agreed
to sell the property. When the buyer and the seller entered
into a contract for the purchase of a home, the buyer had to
remit an earnest money deposit. Once the contract had been
executed the parties were obligated to perform. Before the
buyer and seller could close escrow on a home, SHI, SHLP,
and Vistancia were required to either construct all common
improvement areas for the development (or phase) or post a
bond as discussed supra. Therefore, in some instances the
buyers were required to pay the full contract price before all
of the common improvements and amenities promised for
that development were completed.
Before escrow could close, SHI, SHLP, and Vistancia had
to obtain a certificate of occupancy from the local government
having jurisdiction over the home. Once the funds and the
closing documents were in escrow, and in proper order and
duly executed, the deed transferring the property to the
buyer was recorded. An average of four to six months passed
between the time the buyer and the seller entered into the

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 80 142 UNITED STATES TAX COURT REPORTS (60)

contract for the purchase of a home and the time when
escrow closed. At closing, SHI, SHLP, and Vistancia had
expended all costs required to construct the dwelling unit
and the improvements to the lot on which it sat.
For the two representative developments in Arizona,
Country Lane and Vistancia, the purchase contracts and the
closing and escrow instructions included a statement dis-
closing the purchaser’s right to receive and read a copy of the
development’s public report before signing the purchase
agreement. The documents also included an initialed and
signed acknowledgment, by the purchaser(s), of the receipt of
a copy of the development’s public report and of the oppor-
tunity to read it. The purchaser(s) also signed a receipt docu-
menting that he/she acknowledged the public report, identi-
fied by a registration number and a date, and the informa-
tion contained therein, which constituted a part of the pur-
chase contract and closing and escrow instruction docu-
mentation.
For the five representative developments in California,
Trilogy at La Quinta, Breakers at Pointe Marin, Costa Azul,
Azure, and Sommerset at Morgan Hill, the purchase con-
tracts and the closing and escrow instructions included Cali-
fornia DRE Form RE614E, Receipt For Public Report Or
California Permit, as evidence of the purchasers’ receipt of
the public report. This document stated:
The Laws and Regulations of the Real Estate Commissioner require that
you as a prospective purchaser * * * be afforded an opportunity to read
the public report * * * for this subdivision before you make any written
offer to purchase * * * a subdivision interest or before any money or
other consideration toward purchase * * * of a subdivision interest is
accepted from you.

The document further admonished prospective purchasers:
‘‘DO NOT SIGN THIS RECEIPT UNTIL YOU HAVE
RECEIVED A COPY OF THE PUBLIC REPORT * * * AND
HAVE READ IT.’’ The document further required the signa-
ture(s) of the purchaser(s) confirming that he/she had read
the public report, identified by registration number and date
of issuance.

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 81

Public Reports
The purpose of a public report is to disclose to a home-
buyer the rights and obligations imposed on or granted to the
homebuyer as well as the seller with respect to a certain
development.
Arizona
In Arizona the public report stated that the Department of
Real Estate requires the developer to provide each purchaser
with a copy of the public report and to obtain a signed
receipt. It noted that the purchase contract is rescindable by
the purchaser if the developer fails to obtain a public report
before offering the subdivided lots for sale or if the developer
fails to provide the purchaser with a copy of the report. The
public report also noted the designation of the portions of the
development that are common areas, specifically stating for
one of the developments that the portions that are common
areas ‘‘ARE TO BE CONVEYED TO THE COUNTY LANE
COMMUNITY ASSOCIATION, IN EACH CASE FOR THE
USE AND ENJOYMENT OF SUCH ASSOCIATION AS
MORE FULLY SET FORTH IN THE DECLARATION OF
COVENANTS, CONDITIONS AND RESTRICTIONS
APPLICABLE TO SUCH ASSOCIATION’’.
The public reports for the two Arizona developments also
cited the locations of the development maps, which identified
the developments’ common areas and improvements. The
reports indicated the dates the developer anticipated comple-
tion of the common area improvements and facilities as well
as providing assurances that the common improvements
would be completed. Specifically, for example, the Country
Lane development reports stated: ‘‘Escrows will not close
until the Town of Gilbert has issued its Occupancy Clearance
and all Subdivision improvements have been completed. A
bond has been secured to assure the completion of the land-
scaping in the common area tracts. A bond for the completion
of the additional landscaped pedestrian areas has been
secured as assurance of their completion.’’
California
The public reports for the five developments in California
stated that a purchaser(s) must acknowledge by signature

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 82 142 UNITED STATES TAX COURT REPORTS (60)

that he/she has received and read the public report for the
development. The public reports stated, under a section titled
‘‘INTEREST TO BE CONVEYED’’, that each purchaser
would receive fee title to a lot, membership in the home-
owners association, and rights to use the common areas. The
public reports also provided the developers’ estimate of when
common areas and improvements would be completed and
stated that escrows would not close until either the common
areas and facilities had been completed or bonds had been
posted. However, four of the five reports also stated that
there was no assurance the project would be completed or
developed as proposed. Therefore, while the public reports
warned the purchasers that there was no assurance that the
project would be completed or developed as proposed, the
phase of the development that the public report discussed
was assured. SHI, SHLP, and Vistancia had to complete or
post bonds ensuring completion of common improvements.
The public reports for the five California developments
included a provision that before closing escrow, the developer
was required to provide the purchaser with copies of the
homeowners association articles of incorporation, including
bylaws and covenants, conditions, and restrictions and that
those documents should be read and included numerous
provisions that substantially affected the purchasers’ rights.
Covenants, Conditions, and Restrictions
The developments were governed by a declaration of cov-
enants, conditions, and restrictions (CC&Rs). The CC&Rs
were reviewed and approved by the State’s department of
real estate and local government agencies where that
development was located and, in California and Colorado,
were recorded. 13
SHI, SHLP, and Vistancia provided each purchaser, at or
before execution of a purchase agreement, with a copy of the
declaration of CC&Rs in connection with the sales of homes
in that development. These CC&Rs provided rights and
restrictions with respect to the use and enjoyment of the pur-
chased property. CC&Rs applied to the purchaser of property
13 California and Colorado require a developer to file the CC&Rs with

the clerk and recorder’s office of the county in which the development was
located.

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 83

within the development and to all future interest holders of
property in the development. The CC&Rs included a legal
description of the land subject to the CC&Rs, including both
residential lots and common areas, and all of the property
within the eight representative developments was held or
conveyed subject to the terms of their respective CC&Rs. The
purchasers of each home affirmed receipt of a copy of the
CC&Rs by signing acknowledgments in the purchase and
sale agreement or other related documents.
The CC&Rs provided the authority for the homeowners
association to administer the CC&Rs and manage the
development, including the authority to assess members and
to own and maintain common improvements. Under the
CC&Rs each homeowner in the development automatically
became a member of the development’s homeowners associa-
tion and remained a member until he/she no longer held an
ownership interest. The CC&Rs also authorized the respec-
tive homeowners associations to enforce collection action,
including filing a lien and the commencement of a foreclosure
action against any member that failed to satisfy an assess-
ment. Both the homeowners associations and their individual
members could enforce the CC&Rs.
For seven of the eight representative developments, the
CC&Rs required SHI, SHLP, and Vistancia to transfer title
to the common improvements to the developments’ respective
homeowners associations. For Parkside at Reunion, the
common improvements were not conveyed to the homeowners
association. Rather, the purchasers obtained a tenancy in
common interest with all other development owners in these
common improvements. The CC&Rs specified this ownership
interest.
Maps and Plats
The public reports referred to the tract maps on file with
the local government. These tract maps represented the final
design for the planned development. Generally, SHI, SHLP,
and Vistancia prepared tentative versions of these maps
first. The tentative map dictated grading, lots, streets, parks,
easements, and other similar features. Often the local
government required some modifications and also attached
conditions and requirements before it would accept a tract
map.

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 84 142 UNITED STATES TAX COURT REPORTS (60)

Approval of a final tract map often resulted in additional
conditions, such as requiring the developer to pay for
grading, curbs, gutters, sidewalk paving, streets, and utili-
ties, which met that jurisdiction’s standards. The local
governments did not just restrict conditions to the areas
within the developments themselves. They could also condi-
tion the approval upon widening arterial roads at the bound-
aries of the developments, the building of schools, or
installing offsite traffic lights. SHI, SHLP, and Vistancia
could negotiate with respect to the scope, standards, and
nature of the conditions to some degree, but the govern-
mental authority retained the ultimate approval control over
the maps. During the entitlement process, SHI, SHLP, and
Vistancia often employed consultants. The governments also
sometimes employed consultants in this process, and on occa-
sion, SHI, SHLP, and Vistancia would cover the cost of these
government consultants.
SHI, SHLP, and Vistancia would also enter into agree-
ments with the local governmental agencies. SHI, SHLP, and
Vistancia had two options. They could build everything
required by the map, or alternatively, they could enter into
a subdivision improvement agreement with the governmental
authority. These agreements required them to post bonds for
improvements not yet built. If all of these steps were satis-
factorily completed, then the governmental authority was
obligated to record the map.
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). But 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

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 85

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 factual ques-
tion. 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.
On brief petitioners renewed pretrial motions to shift the
burden of proof to respondent. Petitioners contend that
respondent’s determinations are excessive and arbitrary and
thus justify the burden shift. See Estate of Mitchell v.
Commissioner, 250 F.3d 696, 702 (9th Cir. 2001), aff ’g in
part, vacating in part and remanding T.C. Memo. 1997–461.
Specifically, petitioners allege, citing Golden State Litho v.
Commissioner, T.C. Memo. 1998–184, that respondent has
not identified the correct method of accounting on which he
seeks to place SHI, SHLP, and Vistancia. We disagree.
Respondent is seeking to place SHI, SHLP, and Vistancia on
his interpretation of the completed contract method, dis-
cussed in more detail below. Thus the burden of proof does
not shift in these cases.
II. Legal Framework
A. Long-Term Contracts Generally
Section 460 governs how taxpayers report income from
long-term contracts. It generally provides that taxpayers who
receive income from long-term contracts must account for
that income through the percentage of completion method.
Sec. 460(a). This method essentially requires a taxpayer to
recognize income and expenses throughout the duration of a
contract. Sec. 460(b); Tutor-Saliba Corp. v. Commissioner,
115 T.C. 1, 4 (2000). But, by an amendment, the statute
excepts, inter alia, home construction contracts. Sec.
460(e)(1)(A), (6)(A) (as amended by the Technical and Mis-

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 86 142 UNITED STATES TAX COURT REPORTS (60)

cellaneous Revenue Act of 1988, Pub. L. No. 100–647, sec.
5041(b)(1), 102 Stat. at 3673).
Section 460(f)(1) defines a long-term contract as ‘‘any con-
tract for the manufacture, building, installation, or construc-
tion of property if such contract is not completed within the
taxable year in which such contract is entered into.’’ The
statute does not define completion, which is to be determined
on a contract-by-contract basis, sec. 1.460–1(f), Income Tax
Regs., but the regulations provide that a contract is com-
pleted when it first meets one of two tests, sec. 1.460–
1(c)(3)(i), Income Tax Regs. These tests are commonly known
as the use and 95% completion test, and the final completion
and acceptance test.
Under the first test, the contract is completed upon ‘‘[u]se
of the subject matter of the contract by the customer for its
intended purpose (other than for testing) and at least 95 per-
cent of the total allocable contract costs attributable to the
subject matter have been incurred by the taxpayer’’. Sec.
1.460–1(c)(3)(i)(A), Income Tax Regs. Under the second test,
the contract is completed upon ‘‘[f]inal completion and accept-
ance of the subject matter of the contract.’’ Sec. 1.460–
1(c)(3)(i)(B), Income Tax Regs. As for this latter test, ‘‘to
determine whether final completion and acceptance of the
subject matter of a contract have occurred, a taxpayer must
consider all relevant facts and circumstances.’’ Sec. 1.460–
1(c)(3)(iv), Income Tax Regs.
A further wrinkle to determining when a taxpayer com-
pletes a contract is the role of secondary items. Taxpayers
are to apply the tests to determine when a contract is com-
pleted under the completed contract method ‘‘without 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 applying the 95% completion test, taxpayers
‘‘must separate the portion of the gross contract price and the
allocable contract costs attributable to the incomplete sec-
ondary item(s) from the completed contract’’. Id.
B. Home Construction Contracts
A taxpayer may account for income from home construction
contracts under the completed contract method. Sec. 460(e).
That is because section 460(e) provides that the percentage

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 87

of completion method will not apply to ‘‘any home construc-
tion contract’’. 14 A ‘‘home construction contract’’ is
any construction contract if 80 percent 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 * * * contained in buildings containing 4 or fewer
dwelling units * * *, and
(ii) improvements to real property directly related to such dwelling
units and located on the site of such dwelling units.
[Sec. 460(e)(6)(A).]

The ‘‘activities referred to in paragraph (4)’’ are ‘‘building,
construction, reconstruction, or rehabilitation of, or the
installation of any integral component to, or improvements
of, real property.’’ Sec. 460(e)(4).
As the statute is written and depending on the meaning of
the word ‘‘site’’, taxpayers such as SHI, SHLP, and Vistancia
can have trouble meeting the 80% requirement of section
460(e)(6)(A). This occurs because a significant portion of the
contract costs may be attributable to items not ‘‘located on
the site of such dwelling units’’, such as development infra-
structure. The regulations, however, instruct a taxpayer to
‘‘include[] in the cost of the dwelling units their allocable
share of the cost that the taxpayer reasonably expects to
incur for any common improvements (e.g., sewers, roads,
clubhouses) that benefit the dwelling units and that the tax-
payer is contractually obligated, or required by law, to con-
struct within the tract or tracts of land that contain the
dwelling units.’’ Sec. 1.460–3(b)(2)(iii), Income Tax Regs.
Thus, at least for the purpose of determining whether the
contract qualifies as a home construction contract under sec-
tion 460(e), the taxpayer includes, for the 80% test, costs
attributable to common improvements in the manner dic-
tated by the regulations. Petitioners and respondent dis-
agree, however, as to whether this regulation affects the
tests in section 1.460–1(c)(3)(A) and (B), Income Tax Regs.,
14 Sec. 460(e) also contains an exception for certain other construction

contracts provided that the taxpayer meets a gross receipts test and antici-
pates the contract will be completed within two years of contract com-
mencement. Sec. 460(e)(1)(B). This section also gives a more generous per-
centage of completion method of accounting for residential construction
contracts which are not home construction contracts. Sec. 460(e)(5).

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 88 142 UNITED STATES TAX COURT REPORTS (60)

that determine when the taxpayer completes the contract for
the purposes of deciding whether it is a long-term contract.
III. Analysis
We must decide whether SHI, SHLP, and Vistancia prop-
erly reported their income from the sales of homes in their
developments using the completed contract method.
Respondent contends that only the contracts that closed in
tax years different from the taxable years they were entered
into qualify as long-term contracts. Under respondent’s
interpretation of the completed contract method, SHI, SHLP,
and Vistancia must report income from these long-term con-
tracts for the years in which the contracts closed in escrow.
Respondent takes this position because, in his view, the sub-
ject matter of the contract is the home and the lot upon
which it sits. Consequently, each contract is completed,
within the meaning of section 460, in the year in which
escrow closes. That year is when respondent contends final
completion and acceptance occurs. 15 For the other contracts,
respondent would require SHI, SHLP, and Vistancia to
account for the income under their normal method of
accounting.
Petitioners are of the opinion that the subject matter of the
contracts is broader and encompasses the entire development
or, in some instances of larger developments, the develop-
ment phase of which the home is a part. In support, peti-
tioners contend that a contract comprises all documents pro-
vided to the buyer, any documents expressly referenced
therein or incorporated therein by law, and easements,
restrictions, and other documents recorded as encumbrances
on a home purchaser’s title. Petitioners assert that these
documents collectively set forth the rights and obligations of
the buyer and seller. Therefore, they contend that, other
15 It
has been 25 years since sec. 460(e)(1)(A) and (6)(A) was enacted by
the Technical and Miscellaneous Revenue Act of 1988, Pub. L. No. 100–
647, sec. 5041, 102 Stat. at 3673, and apparently development builders,
such as SHI, SHLP, and Vistancia, may have used this method since 1988.
The earliest tax year at issue in these cases is 2003. That delay in enforce-
ment is immaterial to our consideration as the Commissioner is not bound
by his failure to enforce the law in an earlier year. United States v. Woods,
571 U.S. ll, ll, 134 S. Ct. 557, 567 n.5 (2013); Coors v. Commissioner,
60 T.C. 368, 395 (1973), aff ’d, 519 F.2d 1280 (10th Cir. 1975).

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 89

than secondary items if any, the final completion and accept-
ance does not occur until, as to the phase or the develop-
ment, the final road is paved and the final bond is released.
Under their interpretation, the use and 95% completion test
is met first when SHI, SHLP, and Vistancia incur 95% of the
phase’s or development’s costs. Petitioners contend that
because the 80% test for a home construction contract
includes the allocable share of the costs of common improve-
ments, the 95% test also must include these costs.
Respondent also urges an alternative theory. According to
this theory, if we hold that the subject matter of the con-
tracts is broader than the house and the lot, we must apply
the 95% completion test without regard to the costs attrib-
utable to common improvements because they are secondary
items. Petitioners, however, contend that these common
improvements are part of the primary subject matter of the
contract, not secondary items, and that they may include
such allocable costs in applying the 95% test.
The initial question is what documents are part of the con-
tracts. Under respondent’s interpretation, the subject matter
of the contracts is the lot and the house which the buyer(s)
purchase. To support this contention, respondent points to
the purchase and sale agreement as being the sole contract
document. He urges us to find that State law and the
wording of the contract necessarily restrict the contract to
only this document. Petitioners, however, contend that the
scope of the contracts exceeds the mere ‘‘bricks and sticks’’
and encompasses the development as a whole. In this vein,
petitioners assert that, for the purposes of section 460, the
contract consists of the purchase and sale agreements as well
as all documents referenced or incorporated therein. This
would encompass public reports, CC&Rs, publicly recorded
plats and maps, public resolutions or conditions of approval,
and homeowners association documents.
A. What Constitutes the Contract
1. Integration Clauses
Respondent claims that because each of the respective pur-
chase and sale agreements contains an integration clause,
the purchase and sale agreements constitute the entire con-
tract. Each purchase and sale agreement states that the

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 90 142 UNITED STATES TAX COURT REPORTS (60)

agreement is the sole and entire agreement between the
buyer and the seller. Courts have given integration clauses
significant weight when interpreting contracts. See, e.g.,
Betaco, Inc. v. Cessna Aircraft Co., 103 F.3d 1281, 1283 (7th
Cir. 1996). California caselaw explains that ‘‘ ‘[t]he crucial
issue in determining whether there has been an integration
is whether the parties intended their writing to serve as the
exclusive embodiment of their agreement.’ ’’ Grey v. Am.
Mgmt. Servs., 139 Cal. Rptr. 3d 210, 213 (Ct. App. 2012)
(quoting Masterson v. Sine, 65 Cal. Rptr. 545, 547 (1968)). An
Arizona court explained: ‘‘A completely integrated contract is
a contract adopted by the parties as a complete and exclusive
statement of the terms of the contract.’’ Anderson v. Preferred
Stock Food Mkts., Inc., 854 P.2d 1194, 1197 (Ariz. Ct. App.
1993).
While we agree with respondent that the purchase and
sale agreements do contain integration clauses, we do not
conclude that the purchase and sale agreement alone serves
as the exclusive embodiment of the entire agreement between
the parties. Buyers of homes from SHI, SHLP, and Vistancia
are consciously purchasing more than the ‘‘bricks and sticks’’
of the home. The purchase and sale agreement specifically
includes a checklist ensuring that the purchaser receives the
related documents.
For the two representative developments in Arizona,
Country Lane and Vistancia, the purchase contracts and the
closing and escrow instructions include a statement dis-
closing the purchaser’s right to receive and read a copy of the
development’s public report before signing the purchase
agreement. Included is an attached acknowledgment, sig-
nified by the purchaser’s initials and signature, of the receipt
and opportunity to read a copy of the development’s public
report.
For the five representative developments in California, the
purchase contracts and the closing and escrow instructions
include California DRE Form RE614E as evidence of the pur-
chaser’s receipt of the public report. The document also con-
tains the signature of the purchaser confirming that he/she
has read the public report, identified by registration number
and date of issuance.
At trial petitioners emphasized that it is not just the house
but the lifestyle that SHI, SHLP, and Vistancia advertise

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 91

and sell to their purchasers. For the representative develop-
ments SHI, SHLP, and Vistancia budgeted and incurred
significant indirect costs when compared to the direct costs
of building the homes. Purchasers of homes in their develop-
ments were conscious of the elaborate amenities and would
have understood that the price they paid for a home included
the amenities of the development. If a purchaser did not
want to live in one of the planned developments with its
accompanying amenities, it is likely he or she could have
paid much less for an otherwise comparable dwelling outside
of a development and with no seller-provided amenities. 16
Further evidence that SHI, SHLP, and Vistancia were obli-
gated to their lot purchasers for much more than the pur-
chase and sale agreement sans amenities is the hefty
performance bonds that were required by State and munic-
ipal law in order to secure their performance with respect to
the completion of the common improvements in each develop-
ment. In order for the performance bonds to be exonerated
the obligees had to approve the completion of the amenity
subject matter. Homeowners associations for each of the rep-
resentative developments as well as the municipalities and
States in which the developments were situated were identi-
fied as obligees in the performance bonds. Purchasers auto-
matically became members in the homeowners associations,
and thus each purchaser had certain rights as to enforce-
ment of the bonds vis-a-vis the homeowners association.
SHI, SHLP, and Vistancia were also required by State law
in California and Arizona to provide a purchaser with a copy
of the public report which discloses to the homebuyer the
obligations imposed on the homebuyer as well as SHI, SHLP,
and Vistancia with respect to the development. SHI, SHLP,
and Vistancia were required to obtain a signed acknowledg-
ment from the purchaser that he or she had received the
public report, and in Arizona the public report states that the
purchase contract is rescindable if the developer fails to pro-
vide the purchaser with a copy of the report. The public
16 Indirect costs in, for example, Parkside at Reunion, could amount to

over one-fourth of the total development costs. Other raw land develop-
ments, such as Trilogy at La Quinta and Vistancia, had similarly large in-
direct costs. To believe that the consumer homebuyers did not view the
fruits of these expenditures as an integral aspect of their home purchase
decision strains credibility.

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 92 142 UNITED STATES TAX COURT REPORTS (60)

reports for the two Arizona developments also cite the loca-
tions of the development maps, which identify the develop-
ments’ common areas and improvements. The reports
indicate the dates the developer anticipates completion of the
common area improvements and facilities as well as pro-
viding assurances that the common improvements will be
completed.
The public reports for the five developments in California
state that each purchaser will receive fee title to a lot, mem-
bership in the homeowners association, and right to use of
the common areas. Each report also provides the developer’s
estimate of when common areas and improvements will be
complete and states that either escrows will not close until
completion of the common areas and facilities or bonds have
been posted.
Evidence of the home purchasers’ extra-purchase and sale
agreement obligations are found in the CC&Rs. SHI, SHLP,
and Vistancia provided all purchasers with copies of the dec-
laration of CC&Rs for the developments in connection with
the sales of homes in their developments, which provided the
rights and restrictions with respect to the property pur-
chased. They provided the purchasers with copies of the
CC&Rs at or before the time of execution of the purchase and
sale agreements, and the purchasers affirmed receipt of the
CC&Rs by signing acknowledgments in the purchase and
sale agreements or other related documents.
We disagree with respondent’s conclusion that the integra-
tion clause of the purchase and sale agreements necessarily
excludes these documents. Rather, we agree with petitioners
that in construing the contracts under section 460, these
documents should be and in fact are incorporated into the
construction purchase and sale contracts. Not only are these
documents exchanged or acknowledged during the signing by
the parties, but the purchase and sale agreements reference
these documents.
We concur with respondent that mere reference to another
document does not mandate incorporation of that document
into the contract. See, e.g., United Cal. Bank v. Prudential
Ins. Co. of Am., 681 P.2d 390, 411 (Ariz. Ct. App. 1983). Yet,
the Arizona court of appeals subsequently stated that
‘‘substantially contemporaneous instruments will be read
together to determine the nature of the transaction between

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 93

the parties.’’ Pearll v. Williams, 704 P.2d 1348, 1351 (Ariz.
Ct. App. 1985). While no specific wording is required to incor-
porate another document, the incorporating reference must
be clear and unequivocal and ‘‘must be called to the attention
of the other party, he must consent thereto, and the terms
of the incorporated document must be known or easily avail-
able to the contracting parties’’. United Cal. Bank, 681 P.2d
at 420. Here, the homebuyers acknowledge that they have
received and read the public reports as well as the CC&Rs.
Not only is the reference called to the purchasers’ attention,
but they consent, and the document is provided to them by
SHI, SHLP, or Vistancia. We believe, therefore, that the pur-
chase and sale agreements incorporate the other referenced
documents, such as the public reports, the CC&Rs, the home-
owners association documents, and even the publicly
recorded maps and conditions of approval.
California courts have rules similar to Arizona’s regarding
incorporation by reference. See Avery v. Integrated
Healthcare Holdings, Inc., 159 Cal. Rptr. 3d 444, 457 (Ct.
App. 2013) (‘‘ ‘For the terms of another document to be incor-
porated into the document executed by the parties the ref-
erence must be clear and unequivocal, the reference must be
called to the attention of the other party and he must con-
sent thereto, and the terms of the incorporated document
must be known or easily available to the contracting par-
ties.’ ’’ (quoting Wolschlager v. Fid. Nat’l Tit. Ins. Co., 4 Cal.
Rptr. 3d 179, 184 (Ct. App. 2003))). Thus, we believe simi-
larly that the contracts for sale of homes in California incor-
porated the referenced documents.
In Colorado, a public report is not required. But home-
buyers still acknowledged receipt of homeowners association
documents, which included maps and legal descriptions of
the development, contiguous area reports, which included
maps, and a list of easements. And Colorado courts take a
view similar to those of California and Arizona on incorpora-
tion by reference. See Taubman Cherry Creek Shopping Ctr.,
LLC v. Neiman-Marcus Grp., Inc., 251 P.3d 1091, 1095 (Colo.
App. 2010) (‘‘Pursuant to general contract law, for an incor-
poration by reference to be effective, ‘it must be clear that
the parties to the agreement had knowledge of and assented
to the incorporated terms.’ ’’ (quoting 11 Samuel Williston &
Richard A. Lord, Contracts, sec. 30.25, at 234 (4th ed.

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 94 142 UNITED STATES TAX COURT REPORTS (60)

1999))). We think it clear that the purchase and sale agree-
ments in Colorado also incorporated the referenced docu-
ments.
Respondent, however, also cites Treo @ Kettner Home-
owners Ass’n v. Superior Court, 83 Cal. Rptr. 3d 318 (Ct.
App. 2008), as standing for the proposition that CC&Rs
cannot be considered contracts. But Treo held only that the
‘‘developer-written requirement in an association’s CC&R’s
that all disputes between owners and the developer and dis-
putes between the association and the developer be decided
by a general judicial reference is not a written contract’’
because it violated a constitutional right to a jury trial. Id.
at 326. Further, respondent failed to fully consider the
impact of Pinnacle Museum Tower Ass’n v. Pinnacle Mkt.
Dev. (US), LLC, 282 P.3d 1217 (Cal. 2012).
The California Supreme Court in Pinnacle determined that
CC&Rs referenced in purchase and sale agreements were
binding on the individual purchasers as well as the home-
owners association. Id. at 1235. The court distinguished Treo
as voiding the jury trial waiver in those CC&Rs as unconsti-
tutional, whereas Pinnacle involved an agreement to
arbitrate, which is favored by public policy. Id. at 1231.
Respondent also ignores the multitude of cases in which
California courts have characterized CC&Rs as contracts,
including those between the developer and the homeowners
association. See, e.g., Villa Milano Homeowners Ass’n v. Il
Davorge, 102 Cal. Rptr. 2d 1, 4–5 (Ct. App. 2000) (construing
CC&Rs, to the extent that the purchasers had constructive
notice, as a contract between the parties and citing cases
where CC&Rs have been construed as contracts). 17
17 Arizona
courts have held that CC&Rs are contracts ‘‘ ‘between the sub-
division’s property owners as a whole and the individual lot owners.’ ’’ Hor-
ton v. Mitchell, 29 P.3d 870, 872 (Ariz. Ct. App. 2001) (quoting Ariz. Bilt-
more Estates Ass’n v. Tezak, 868 P.2d 1030, 1031 (Ariz. Ct. App. 1993)).
Respondent cites Horton for the proposition that a CC&R is not a contract
between a homebuilder and a buyer. But we are not aware of any caselaw
in Arizona or Colorado that would prevent an owner or a homeowners as-
sociation from bringing suit against a developer for violating CC&Rs. In
Colorado this may be because Colorado statutes specifically grant home-
owners associations standing to bring construction defect claims on behalf
of individual owners for units and common areas even if the CC&Rs do not
authorize such a suit. See Heritage Village Owners Ass’n, Inc. v. Golden
Heritage Investors, Ltd., 89 P.3d 513, 514–515 (Colo. App. 2004) (citing the

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 95

SHI, SHLP, and Vistancia and the buyers of their homes
understood and believed that the parties had contracted for
the entire lifestyle of the development and its amenities. The
purchase and sale agreement is not the exclusive embodi-
ment of that understanding. Consequently, the integration
clauses do not limit the entire contract to the naked purchase
and sale agreement.
2. State Laws Governing Real Property Sales
Respondent further contends that State laws regarding
real property sales support his position that the contract sub-
ject matter consists only of the house, the lot, and improve-
ments to that lot. For instance, the California Civil Code pro-
vides: ‘‘A real property sales contract may not be transferred
by the fee owner of the real property unless accompanied by
a transfer of the real property which is the subject of the con-
tract, and real property may not be transferred by the fee
owner thereof unless accompanied by an assignment of the
contract’’, Cal. Civ. Code sec. 2985.1 (West 2012), and ‘‘[a]
real property sales contract is an agreement in which one
party agrees to convey title to real property to another party
upon the satisfaction of specified conditions set forth in the
contract’’, id. sec. 2985(a) (West 2012 & Supp. 2014).
Colorado courts have called the real estate the subject
matter of real estate contracts and have noted that when the
contract is signed, equitable title immediately transfers to
the purchaser although naked legal title remains with the
seller. Dwyer v. Dist. Court, Sixth Judicial Dist., 532 P.2d
725, 727 (Colo. 1975). And Arizona statutes define a real
estate sales contract as ‘‘an agreement in which one party
agrees to convey title to real estate to another party upon the
satisfaction of specified conditions set forth in the contract.’’
Ariz. Rev. Stat. sec. 32–2101(49) (2012) (West). Thus,
according to respondent, in Arizona, Colorado, and California
the subject of a real estate contract is the real estate being
transferred.
But in California, the legislature has also defined real
property to include ‘‘[t]hat which is incidental or appurtenant
to land’’. Cal. Civ. Code sec. 658(3) (West 2007). The Colorado

Colorado Common Interest Ownership Act, Colo. Rev. Stat. secs. 38–33.3–
101, et seq.).

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 96 142 UNITED STATES TAX COURT REPORTS (60)

legislature defines real estate to include ‘‘other improvements
and interests that, by custom, usage, or law, pass with a
conveyance of land though not described in the contract of
sale or instrument of conveyance.’’ Colo. Rev. Stat. sec. 38–
33.3–103(25) (2013). And the Arizona legislature also
includes within the definition of real estate ‘‘interests which
by custom, usage or law pass with a conveyance of land
though not described in the contract of sale or instrument of
conveyance.’’ Ariz. Rev. Stat. Ann. sec. 33–1202(19) (2007)
(West). We therefore firmly reject respondent’s contention
that State law definitions of real estate contracts foreclose us
from including the above-referenced documents as an
integral part of the home purchase contracts.
Respondent also advances the statutes of repose from the
three States as supporting his position that the contracts
were completed at the close of escrow. These State statutes
essentially place a time limit on a homebuyer’s right to raise
claims against builders or developers. In Arizona, the statute
of repose begins upon ‘‘substantial completion of the improve-
ment to real property’’. Id. sec. 12–552(A) (2003) (West).
Colorado and California statutes contain similar language.
Cal. Civ. Proc. Code sec. 337.15(a), (g) (West 2006); Colo.
Rev. Stat. sec. 13–80–104(1)(a) (2013). The California statute
defines ‘‘substantial completion’’ to mean the first occurrence
of: ‘‘(1) The date of final inspection by the applicable public
agency. (2) The date of recordation of a valid notice of
completion. (3) The date of use or occupation of the improve-
ment. (4) One year after termination or cessation of work on
the improvement.’’ Cal. Civ. Proc. Code sec. 337.15(g). The
Arizona statute defines the term ‘‘substantial completion’’ as
the date the owner or occupant first uses the improvement,
the improvement is first available for use after completion,
or upon final inspection if required. Ariz. Rev. Stat. Ann. sec.
12–552(E) (2003) (West). The Colorado statute is silent as to
the meaning of substantial completion, but Colorado courts
have indicated it means at least the issuance of a certificate
of occupancy. Shaw Constr., LLC v. United Builder Servs.,
Inc., 296 P.3d 145, 155–156 (Colo. App. 2012).
We conclude that respondent’s emphasis on the statutes of
repose is misplaced. These statutes determine the time from
the date of completion of an improvement which is afforded
to the purchaser to bring suit for construction defects. In

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 97

effect, they operate like a statute of limitation. So, in the
case of homes, the statutes would necessarily run, for
example, from the issuance of a certificate of habitability if
that is the earliest triggering event. But a certificate of occu-
pancy for a particular home would have at most a limited
impact on a homeowners association’s hypothetical cause of
action against SHI, SHLP, or Vistancia for a defect in an
amenity they had constructed.
Respondent also contends that SHI, SHLP, and Vistancia
should not be allowed to hold their homes out as complete for
the purposes of obtaining certificates of occupancy under
State law while simultaneously representing to the Federal
Government that the sales are not complete. Respondent’s
contention lacks merit. The subject matter of the contract is
not limited to the house and the lot, and respondent is com-
paring two different things.
We concur with petitioners that respondent’s interpreta-
tions of the relevant State legal definitions of real estate and
the statutes of repose are too narrow. When viewed in proper
context, the State laws do not necessarily restrict the subject
matter of a real estate contract to just a house and the lot
upon which it sits. Respondent’s analysis is simplistic and
short sighted; it does not acknowledge the complex relation-
ships created by the purchase and sales agreement, espe-
cially SHI’s, SHLP’s, and Vistancia’s obligations that con-
tinue long after the first home is built.
B. Subject Matter of the Contracts
Because we determine that, for the purposes of
ascertaining the proper use of the completed contract method
of accounting as applied to residential home construction,
supra, the contract consisted of more than the purchase and
sale agreement, we must now address the subject matter of
the contract. See sec. 1.460–1(c)(3)(i), Income Tax Regs. In
respondent’s view, the subject matter of the contract consists
solely of the house, the lot, and improvements to the lot.
Under this view, SHI, SHLP, and Vistancia complete their
contracts when escrow closes because at that point the final
completion and acceptance test is met. See sec. 1.460–
1(c)(3)(B), Income Tax Regs. In contrast, petitioners assert
that the subject matter of the contract encompasses the
development in its entirety. Under this view, SHI, SHLP,

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 98 142 UNITED STATES TAX COURT REPORTS (60)

and Vistancia complete their contracts for the purposes of
section 460 when they incur 95% of the allocable costs attrib-
utable to the subject matter of the contract, which is the
development as a whole, and the homebuyers use the subject
matter. See sec. 1.460–1(c)(3)(A), Income Tax Regs. Peti-
tioners contend that the final completion and acceptance test
is met only when the last road is paved and the final bond
is released.
The regulations accompanying section 460 explicitly
acknowledge that the subject matter of a home construction
contract extends beyond the construction of a home. See sec.
1.460–3(b)(2)(iii), Income Tax Regs. When determining
whether a contract qualifies as a home construction contract,
the taxpayer takes into account the total costs of dwelling
units, improvements to the related real property at the site
of the dwelling unit, and the ‘‘allocable share of the cost that
the taxpayer reasonably expects to incur for any common
improvements’’. Id.
Respondent contends that this inclusion is solely for the
purposes of determining whether the taxpayer meets the 80%
test, which determines whether the contract in question is a
home construction contract. Under this theory, a taxpayer
computes the 95% completion test, for which the taxpayer
uses as a part of the denominator only ‘‘total allocable con-
tract costs attributable to the subject matter’’, sec. 1.460–
1(c)(3)(i)(A), Income Tax Regs., without regard to costs allo-
cable to common improvements. But, as petitioners point out,
the regulations also state that, in determining when a con-
tract is begun and completed, ‘‘a taxpayer must consider all
relevant allocable contract costs incurred and activities per-
formed by itself, by related parties on its behalf, and by the
customer, that are incident to or necessary for the long-term
contract.’’ Sec. 1.460–1(c)(1), Income Tax Regs. According to
this interpretation, because the sale price on a home
construction contract includes an allocable share of the cost
of common improvements, sec. 1.460–3(b)(2)(iii), Income Tax
Regs., then the total allocable contract costs must also
include the allocable share of common improvement costs.
Given the divergent positions, the parties ask the Court to
interpret this aspect of the regulations. 18
18 Implicit in the parties’ positions is that the regulation is valid and en-

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 99

As an initial matter, we must ask what deference, if any,
we should give to respondent’s interpretation of the regula-
tions. Neither party appears to address this issue.
Respondent appears to believe that no such inquiry is nec-
essary because the regulation is clear on its face. While he
concedes that ‘‘[t]he regulations do not define the phrase
‘subject matter of the contract’ ’’, he also contends that we
should give those words their ‘‘ordinary, contemporary
meaning’’, implying that no ambiguity in the regulation
exists.
Petitioners also do not address or raise the issue of
whether and to what extent we should defer to respondent’s
interpretation of the regulations. But, petitioners’ briefs are
replete with references to respondent’s ‘‘litigating position’’,
presumably a reference to precedent in which we have
declined to give deference to litigating positions. See, e.g.,
Garnett v. Commissioner, 132 T.C. 368, 381 (2009) (citing
Gen. Dynamics Corp. & Subs. v. Commissioner, 108 T.C. 107,
120–121 (1997)); see also Stromme v. Commissioner, 138 T.C.
213, 223 n.2 (2012) (Holmes, J., concurring); Pierre v.
Commissioner, 133 T.C. 24, 40–41 (2009) (Cohen, J., concur-
ring), supplemented by T.C. Memo. 2010–106.
Petitioners use the term ‘‘litigating position’’ presumably in
an attempt to distinguish the current set of facts from that
of Auer v. Robbins, 519 U.S. 452, 461 (1997), in which the
Supreme Court deferred to an agency’s interpretation of its
own regulations expressed in an amicus brief requested by
the Court. Generally, courts do not have to defer to such liti-
gating positions that are unsupported by regulations, rulings,
or administrative practice. Bowen v. Georgetown Univ. Hosp.,
488 U.S. 204, 212 (1988). Respondent does not claim that his
titled to deference under Chevron U.S.A. Inc. v. Natural Res. Def. Council,
Inc., 467 U.S. 837 (1984). These positions are understandable in the light
of administrative law governing deference to regulations, Mayo Found. for
Med. Educ. & Research v. United States, 562 U.S. 44 (2011), and the con-
gressional directive to the Secretary to promulgate regulations concerning
accounting for long-term contracts, sec. 460(h); see ADVO, Inc. & Subs. v.
Commissioner, 141 T.C. 298, 322 (2013). But cf. United States v. Home
Concrete & Supply, LLC, 566 U.S. ll, 132 S. Ct. 1836 (2012). Likewise,
as to Administrative Procedure Act requirements, see Dominion Res., Inc.
v. United States, 681 F.3d 1313 (Fed. Cir. 2012), Cohen v. United States,
650 F.3d 717 (D.C. Cir. 2011), and Burks v. United States, 633 F.3d 347
(5th Cir. 2011).

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 100 142 UNITED STATES TAX COURT REPORTS (60)

position in these cases constitutes ‘‘fair and considered judg-
ment on the issue’’ rather than ‘‘a post hoc rationalization for
past agency action’’. Massachusetts v. Sebelius, 638 F.3d 24,
34 (1st Cir. 2011) (citing Chase Bank USA, N.A. v. McCoy,
562 U.S. 195, 209 (2011)). Thus, respondent does not argue
his position is entitled to any special deference, and we
accord it none.
In matters of regulatory construction, the rules of statutory
construction apply. Caltex Oil Venture v. Commissioner, 138
T.C. 18, 34 (2012). The starting point for interpreting a
statute or a regulation is its plain and ordinary meaning
unless such an interpretation ‘‘would produce absurd or
unreasonable results.’’ Union Carbide Corp. v. Commissioner,
110 T.C. 375, 384 (1998). Undefined words take their ‘‘ordi-
nary, contemporary, common meaning.’’ Hewlett-Packard Co.
& Consol. Subs. v. Commissioner, 139 T.C. 255, 264 (2012).
‘‘Subject matter’’ is not defined by the regulations or the
statute. According to respondent the plain meaning of ‘‘sub-
ject matter of the contract’’ means only the house, the lot,
and improvements on that lot. Petitioners, however, contend
that the term ‘‘subject matter of the contract’’ must be
viewed in the light of the regulatory definition of a home
construction contract.
We disagree with the basic premise of respondent’s conten-
tion. ‘‘Subject matter of the contract’’ does not in our view
have the plain meaning he contends. As we concluded above,
SHI’s, SHLP’s, and Vistancia’s contracts each encompass
more than just the house, the lot, and the improvements to
the lot. If we were to ascribe a plain meaning to the term,
then the subject matter of the contracts would include the
common improvements.
Further supporting the view that the regulation is not as
narrow as respondent contends is the context of the regu-
latory scheme generally. In construing the regulation, we do
not just look at the words or phrases in isolation, but rather
we read these words and phrases in their context and with
a view to their place in the overall statutory scheme. FDA v.
Brown & Williamson Tobacco Corp., 529 U.S. 120, 133
(2000). Thus, we look at the contract completion tests in sec-
tion 1.460–1(c)(3), Income Tax Regs., in the context of the
entire section 460 regulatory scheme, including section

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 101

1.460–3, Income Tax Regs., concerning long-term construc-
tion contracts, and, of course, the statute itself. 19
Section 1.460–1(c)(3)(i)(A), Income Tax Regs., states that
the contract is completed upon ‘‘[u]se 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’’. The final completion and accept-
19 The little legislative history that exists supports our conclusions. Be-

fore 1986 taxpayers could account for long-term contracts under what is
known as the completed contract method or the percentage of completion
method. See sec. 446(c) until 1965, then sec. 451 (1954 as amended), and
sec. 1.451–3(a), Income Tax Regs. (1986).
In 1986, Congress began to cut back on the completed contract method,
allowing only 60% of revenue to be deferred under this method. Tax Re-
form Act of 1986, Pub. L. No. 99–514, sec. 804(a), 100 Stat. at 2358. In
1987 this percentage was reduced to 30%. Omnibus Budget Reconciliation
Act of 1987, Pub. L. No. 100–203, sec. 10203, 101 Stat. at 1330–394. In
1988 Congress further scaled back the amount of income that could be de-
ferred under the completed contract method. TAMRA sec. 5041. By 1989
long-term contracts had to be reported under the percentage of completion
method. Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101–239,
sec. 7621(a), 103 Stat. at 2375.
Congress added the exception for home construction contracts from the
percentage of completion method of accounting as an intended relief meas-
ure in 1988 as part of TAMRA. Senator Dennis DeConcini and Representa-
tive Richard T. Schulze each proposed identical amendments to the respec-
tive Senate and House versions of the bill. S. 2694, 100th Cong. (1988)
(text at 134 Cong. Rec. 20862 (Aug. 8, 1988)); H.R. 5151, 100th Cong.
(1988). Both legislators were concerned with the potential recognition of in-
come not yet received by the homebuilders and matching costs with reve-
nues. 134 Cong. Rec. 20722–20723 (Aug. 5, 1988) (Sen. DeConcini); 29962–
29963 (Oct. 12, 1988) (Sen. DeConcini); 134 Cong. Rec. 20202 (Aug. 3,
1988) (Rep. Schulze). They were also reacting to an advance release of an
IRS pronouncement that would apply the percentage of completion method
of accounting to contracts for the construction and sale of a home. See also
Notice 88–66, 1988–1 C.B. 522, 554.
Their proposed amendments were narrower than what ultimately
emerged from conference. They called for an exemption for residential real
property contracts that were estimated to be completed within 12 months
of being entered into. S. 2694; H.R. 5151. Senator DeConcini believed this
12-month rule would prohibit deferral for builders of custom homes. 134
Cong. Rec. 20723. The conference report is silent as to the rationale for the
home construction contract exception as it exists now, but what ultimately
emerged was broader than the earlier proposed 12-month rule. What mat-
ters is the law as written. Shady Grove Orthopedic Assocs., P.A. v. Allstate
Ins. Co., 559 U.S. 393, 403 (2010).

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 102 142 UNITED STATES TAX COURT REPORTS (60)

ance test states simply: ‘‘Final completion and acceptance of
the subject matter of the contract.’’ Sec. 1.460–1(c)(3)(i)(B),
Income Tax Regs. But ‘‘to determine whether final comple-
tion and acceptance of the subject matter of a contract have
occurred, a taxpayer must consider all relevant facts and cir-
cumstances.’’ Sec. 1.460–1(c)(3)(iv)(A), Income Tax Regs. In
one test, the taxpayer looks to allocable costs attributable to
the subject matter of the contract; in the other test, all rel-
evant facts and circumstances inform the subject matter of
the contract. It is clear that, in the context of the language
surrounding the phrase ‘‘subject matter of the contract’’, the
definition is necessarily broader than that advocated by
respondent.
The context of the phrase in relation to the rest of the
regulatory scheme also indicates a broader interpretation. As
stated earlier, section 460 defines ‘‘home construction con-
tract’’ for the purposes of a specific subsection. Sec.
460(e)(6)(A). And, as mentioned, 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’’. Sec. 1.460–3(b)(2)(iii), Income
Tax Regs. While the definition of ‘‘home construction con-
tract’’ in the statute and the regulations does not necessarily
mean that this definition carries over to the use of the term
‘‘contract’’ in the rest of the statute and the regulations, it is
at a minimum instructive.
In addition, the regulations instruct taxpayers to ‘‘consider
all relevant allocable contract costs * * * that are incident to
or necessary for the long-term contract’’, sec. 1.460–1(c)(1),
Income Tax Regs., in determining the contract commence-
ment and completion dates. And ‘‘allocable contract costs’’ is
a defined term. Sec. 1.460–1(b)(3), Income Tax Regs. For the
purposes of home construction contracts, such costs include
‘‘the cost of any activity that is incident to or necessary for
the taxpayer’s performance under a long-term contract.’’ Sec.
1.460–5(d)(1), Income Tax Regs. The regulations expressly
include within the definition of ‘‘allocable contract costs’’
indirect costs such as those related to equipment and facili-
ties, labor, indirect materials and supplies, quality control
and inspection, and certain taxes. Sec. 1.460–5(d)(2)(i),
Income Tax Regs.

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Thus, at the very minimum, the 95% completion test, as
applied here, looks to costs beyond just those associated with
the house, the lot, and improvements to the lot. The facts
and circumstances gloss on the final completion and accept-
ance test also indicates that the subject matter of the con-
tract in these cases is more than just the house, the lot, and
improvements to the lot. Ultimately, this outcome is sup-
ported by our conclusion, supra, that SHI’s, SHLP’s, and
Vistancia’s contracts consist of more than the purchase and
sale agreement alone. When the contract documents are read
together, the subject matter of the contract is quite clearly
more than just the house, the lot, and improvements to the
lot.
Respondent further contends that, under these contracts,
the 95% completion test can never occur before final comple-
tion because the 95% completion test contains a use require-
ment. See sec. 1.460–1(c)(3)(A), Income Tax Regs. Under this
theory, the subject matter is the house and the lot, and the
subject matter is used on the same day the contract is com-
pleted and accepted. Respondent bases his contention on the
erroneous assumption that the subject matter of the contract
is only the house and lot. While the house may be complete
as of the close of escrow and the purchaser may be using the
house at that time, the entire subject matter of the contract
may not yet be completed or used.
The subject matter of the contract includes the house, the
lot, and improvements to the lot as well as the common
improvements in the development. Thus, for the purpose of
the 95% completion test, SHI, SHLP, and Vistancia correctly
tested the total allocable costs associated with the develop-
ment against the costs incurred to date. For purposes of the
final completion and acceptance test, SHI, SHLP, and
Vistancia appropriately decided that, on the basis of the facts
and circumstances, final completion did not occur until the
final bonds were released and the final road paved. 20
20 Sec.
1.460–1(c)(3)(iv)(A), Income Tax Regs., contains a caveat as to the
facts and circumstances component of the completion and acceptance test:
‘‘Nevertheless, a taxpayer may not delay the completion of a contract for
the principal purpose of deferring federal income tax.’’ Respondent does not
suggest that SHI, SHLP, or Vistancia intentionally delayed the completion
of their contracts, either through not paving the final road or not securing
Continued

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 104 142 UNITED STATES TAX COURT REPORTS (60)

In addition, respondent contends that in effect what SHI,
SHLP, and Vistancia have done is the same as aggregating
the different home purchase contracts. As respondent cor-
rectly points out, taxpayers are to apply the completion tests
of the regulations on a contract-by-contract basis. See sec.
1.460–1(c)(3)(i), Income Tax Regs. The statute and the regu-
lations do allow taxpayers to aggregate contracts, but only in
certain situations, for the purposes of section 460. Sec.
460(f)(3); sec. 1.460–1(e), Income Tax Regs. According to
respondent, not only do the aggregation rules not apply in
these cases but SHI, SHLP, and Vistancia did not file the
requisite statement with their Federal income tax returns as
required by the regulations. See sec. 1.460–1(e)(4), Income
Tax Regs. But SHI, SHLP, and Vistancia did not aggregate
contracts. Rather, they tested completion dates of individual
contracts using their conception of the subject matter of
those contracts.
To summarize, we agree with petitioners that the contracts
consist of more than just the purchase and sale agreements
and that the subject matter of the contracts includes the
costs of common improvements for the purpose of testing
their completion date. Therefore, the contracts will generally
meet the 95% completion test before they meet the final
completion and acceptance test. Under the completed con-
tract method of accounting, SHI, SHLP, and Vistancia are
entitled to defer income from their contracts until 95% of the
total contract costs, allocable to the subject matter of the con-
tract, is incurred or the development or phase of the develop-
ment, as the case may be, is completed and accepted.
C. Secondary Items
Respondent asks that if we agree with petitioners’ reading
of ‘‘subject matter of the contract’’ then we find that the costs
not directly associated with the houses, the lots, and
improvements to the lots constitute secondary items under
section 1.460–1(c)(3)(ii), Income Tax Regs. Respondent con-
tends that because SHI, SHLP, and Vistancia and the home-
buyers treated the common improvements contemplated in
the contract as secondary items ‘‘subordinate in importance

the release of the final bond. We mention this caveat only for the sake of
completeness.

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 105

to the house’’, the regulations forbid them from taking those
items into account in determining the contract completion
date. Petitioners, on the other hand, maintain that these
common improvements are not secondary items and that the
parties to each contract did not treat or consider the items
as secondary items in the contracts but rather integral
aspects of the homes’ purchase and sale.
Section 1.460–1(c)(3)(ii), Income Tax Regs., provides:
(ii) Secondary items. The date a contract accounted for using the CCM
[completed contract method] is completed is determined without regard
to whether one or more secondary items have been used or finally com-
pleted and accepted. If any secondary items are incomplete at the end
of the taxable year in which the primary subject matter of a contract is
completed, the taxpayer must separate the portion of the gross contract
price and the allocable contract costs attributable to the incomplete sec-
ondary item(s) from the completed contract and account for them using
a permissible method of accounting. A permissible method of accounting
includes a long-term contract method of accounting only if a separate
contract for the secondary item(s) would be a long-term contract, as
defined in paragraph (b)(1) of this section.

The regulations do not define ‘‘secondary items’’, and ordi-
narily we would resort to the tools of regulatory analysis dis-
cussed above. But respondent and petitioners are essentially
in agreement as to the meaning of this phrase. In their
briefs, they both urge us to read secondary items as items
that the contracting parties intend to be secondary. We
concur that the questions of what is a secondary item in a
contract and what is the primary subject matter of a contract
are questions to be answered by reference to the facts and
intent of the contracting parties.
Here again, the parties’ disagreement over the nature of
the contracts becomes paramount. Respondent’s interpreta-
tion of the contracts as being merely about the house, the lot,
and the improvements to the lot necessarily informs his
belief that the common improvements must be secondary
items. Similarly, petitioners’ view of the contracts as being
about the lifestyle including access to the planned commu-
nity, the amenities, and the infrastructure, necessarily
informs their belief that the common improvements are part
of the primary subject matter of the contract.
We agree with petitioners. As discussed at length, the
contractual documents consist of more than just the purchase
and sale agreement. When the contract documents are exam-

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 106 142 UNITED STATES TAX COURT REPORTS (60)

ined together, it becomes readily apparent that the primary
subject matter of the contracts includes the house, the lot,
improvements to the lot, and common improvements to the
development. As a factual matter, we find the amenities to
be of great importance to and a crucial aspect of SHI’s,
SHLP’s, and Vistancia’s sales effort, obtaining of govern-
mental approval of the development, and the buyers’ pur-
chase decision, and thus the amenities are an essential ele-
ment of the home purchase and sale contract.
D. Conclusion
We have found that the contract documents consist of
much more than just the purchase and sale agreement. This
conclusion leads us to hold that SHI, SHLP, and Vistancia
appropriately included the costs of common improvements in
determining the contract completion date. Furthermore, the
nature of the business and the contract documents also lead
us to conclude that the common improvements are not sec-
ondary items and do not have to be accounted for separately.
IV. Clear Reflection of Income
We have determined that SHI, SHLP, and Vistancia prop-
erly used a permissible method of accounting. Yet the ques-
tion remains whether that method of accounting clearly
reflects income. See sec. 446(b). The Commissioner has wide
discretion in determining whether a method of accounting
clearly reflects income. Thor Power Tool Co. v. Commissioner,
439 U.S. 522, 532 (1979). If, however, SHI’s, SHLP’s, and
Vistancia’s method of accounting clearly reflects income, then
respondent cannot be permitted to change their method of
accounting even to a method that more clearly reflects
income. Photo-Sonics, Inc. v. Commissioner, 357 F.2d 656,
658 n.1 (9th Cir. 1966), aff ’g 42 T.C. 926 (1964); Keith v.
Commissioner, 115 T.C. 605, 617 (2000). Whether a method
of accounting clearly reflects income is a question of fact.
Peninsula Steel Prods. v. Commissioner, 78 T.C. 1029, 1045
(1982).
SHI, SHLP, and Vistancia expended a great deal of capital
early on in the construction of their developments. The land
acquisition costs alone were a large percentage of the total
development cost. On top of that, they incurred upfront costs

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 107

such as grading the land, installing sewer, water, gas, elec-
tric, and other utilities, and constructing roads, not to men-
tion the entitlement costs and bond costs. Many of these
costs were incurred before the first home was constructed, let
alone sold. Once they began selling homes, it was some time
before revenue from those sales exceeded the already
incurred project costs. They were contractually or legally
required to complete the items associated with these costs.
Because their projects were longer projects, and given the
nature of the home construction industry, costs are difficult
to predict, and they could not accurately determine their
profit until the development was nearly completed.
The 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 comple-
tion method of accounting. But the clearly articulated excep-
tion for homebuilders is, as to them, generously broad and
reflects a deliberate choice by Congress that home construc-
tion contracts should be treated differently and accorded the
more generous deferral of the completed contract method.
SHI’s, SHLP’s, and Vistancia’s use of the completed contract
method was specifically contemplated by Congress and is a
permissible, congressionally sanctioned clear reflection of
income.
We note that SHLP admittedly applied the 95% completion
test in 2002 and 2003 by comparing the number of homes
closed in escrow in the development to the number of homes
projected to be built in the development. This calculation was
an incorrect application of the completed contract method of
accounting. But the 2002 tax year is not in issue, and the
parties introduced evidence showing that for SHLP’s long-
term contracts in 2003, the 95% completion test had not yet
been met. Thus, the completed contract method of accounting
as properly applied renders the same result as the result
which was reported for the 2003 tax year, and it clearly
reflects the income of SHLP for that 2003 tax year.
Respondent points out that Trilogy at La Quinta and
Vistancia were divided into phases for purposes of testing
contract completion, but other developments were not simi-
larly divided. Respondent appears to be implying that such
a discrepancy in the application of the 95% completion test
demonstrates that SHI’s, SHLP’s, and Vistancia’s use of the

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 108 142 UNITED STATES TAX COURT REPORTS (60)

completed contract method does not clearly reflect income.
For instance, the entire Costa Azul development, as indicated
by the public report, was to consist of 17 phases, which at
first glance seems like a lot. But a closer look at the public
report reveals that the projected total number of homes in
Costa Azul was 83, and each phase was to be rather small.
For instance, phase 10 consisted of four residential lots.
Trilogy, on the other hand, was to consist of 23 phases with
a projected 1,365 residences on 1,203 residential lots. The
ninth phase was to consist of 48 residential lots.
In addition, for the purposes of these cases, the parties
stipulated that the Costa Azul development as contemplated
by SHLP was only a small, relatively short-term buildout
aspect of that overall development. In effect, it was equiva-
lent to a phase of the overall development. The Costa Azul
development, as initially proposed to the Land Committee,
was a short-term, 37-home development, and, as stipulated
by the parties, Costa Azul was developed in eight phases
with 42 total lots. 21 While Costa Azul as presented in this
case differs from Costa Azul as presented in the public
report, SHLP’s use of the completed contract method of
accounting clearly reflected income. There is no material evi-
dence in the record, and we discern none, that SHLP
attempted to manipulate or to delay its Costa Azul project or
contracts to obtain a longer deferral period. 22
Respondent also contends that petitioners’ interpretation of
the subject matter of the contract ‘‘creates the nonsensical
situation of the subject matter of each individual contract for
the sale of a house being the entire development and, thus,
including the subject matter of every other past, present, and
future house.’’ He goes on to state that a purchaser of one
21 The record is unclear why the number of lots as stipulated differs from

the number of homes projected in the Land Committee report. Perhaps
some houses were constructed on multiple lots, or some lots were used as
common areas. What is clear is that the project as originally contemplated
in the public report did not fully materialize when the real estate market
turned and SHLP did not purchase the remaining lots.
22 The appropriate scope of each contract as it involves common or exclu-

sive off-lot amenities is a factual question. Respondent has not shown that
SHI’s, SHLP’s, or Vistancia’s choices of development or phase as the scope
for purposes of the 95% test as it involves off-lot amenities were improper
or unreasonable as to any of the eight representative developments.

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 (60) SHEA HOMES, INC. & SUBS. v. COMMISSIONER 109

home has no claim to any unsold or previously sold lots and
homes. Certainly this latter statement is correct. The con-
tract does not include the houses and lots other than that
which is purchased; but the subject matter of each individual
purchased house still includes the development or phase of
the development and its common improvements and amen-
ities. Thus, while there are commonalities in the subject mat-
ters of the contracts, such as the amenities and other
common improvements, the subject matters as to the indi-
vidual house and lot are not identical. 23
For these reasons, we conclude that respondent may not
change SHI’s, SHLP’s, and Vistancia’s method of accounting
even if his proposed method more clearly reflects income. See
Prabel v. Commissioner, 91 T.C. at 1112.
V. Conclusion
SHI, SHLP, and Vistancia are permitted to report income
and loss from the sales of homes in their planned develop-
ments using the completed contract method of accounting as
consistent with this Opinion. 24
23 Furthermore,
we reject the characterization that what SHI, SHLP,
and Vistancia have done, and what we approve of, is in substance an ag-
gregation of contracts. Contracting parties have a right to their own con-
tract for the purposes of State law, and it is this contract that we test in
determining the subject matter of the contract. In the case of much larger,
decades-long developments, the meeting of the minds between the pur-
chaser and the seller would be much less likely to include an amenity or
common improvement with a completion date unreasonably far in the fu-
ture. Here, the subject matter of SHI’s, SHLP’s, and Vistancia’s contracts
includes the development. In a different case, under different facts, similar
treatment of an unreasonably long-term development may in essence be an
aggregation.
24 We are cognizant that our Opinion today could lead taxpayers to be-

lieve that large developments may qualify for extremely long, almost un-
limited deferral periods. We would caution those taxpayers that a deter-
mination of the subject matter of the contract is based on all the facts and
circumstances. If Vistancia, for example, attempted to apply the contract
completion tests by looking at all contemplated phases, it is unlikely that
the subject matter as contemplated by the contracting parties could be
stretched that far. Further, sec. 1.460–1(c)(3)(iv)(A), Income Tax Regs.,
may prohibit taxpayers from inserting language in their contracts that
would unreasonably delay completion until such a super development is
completed.

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 110 142 UNITED STATES TAX COURT REPORTS (60)

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 meritless,
moot, or irrelevant.
Decisions will be entered for petitioners.

f

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