WASHINGTON (Reuters) - In a tax fight that could jolt the real estate business, Howard Hughes Corp is challenging the U.S. Internal Revenue Service over a $144.1 million tax bill stemming from land sales at Summerlin, an enormous planned community in southern Nevada.
The dispute centers on an accounting practice - known as the “completed contract method” - that the IRS has scrutinized for years. A Tax Court trial is scheduled for November 5 in Las Vegas.
The IRS contends, according to court records, that Howard Hughes improperly deferred taxes on income from sales of residential lots at Summerlin, which sprawls across 35 square miles on the western fringe of Las Vegas.
The company should pay taxes as it books the lot sales and not wait until the project is nearly finished, the IRS said.
But Howard Hughes says its use of the method is permissible under an IRS exemption for home construction, and that developers pay up-front costs and do not know their ultimate taxable gains until a project is almost finished.
Both the company and the IRS declined to comment.
Dallas-based Howard Hughes is a spinoff from General Growth Properties. Though Howard Hughes is the company in court, General Growth is liable for tax payments if the IRS wins, according to the spinoff agreement.
General Growth declined to comment.
Activist investor William Ackman is chairman of Howard Hughes. Ackman’s hedge fund, Pershing Square Capital Management LP, owned 3.6 million Howard Hughes shares as of June 30.
The IRS said in September 2009 that companies using the completed contract accounting method to defer income from land sales for years, or even a decade or more, could trigger an audit.
The IRS has other Tax Court challenges pending with property developers over the completed contract method, or CCM.
“Taxpayers’ misuse of the CCM is a growing trend within the residential construction industry,” the IRS said in a September 2009 internal memo, one of several posted on the IRS website.
An IRS win in Tax Court could mean property developers would need to pay taxes on a “percentage-of-completion” accounting method, a less-favorable approach for businesses.
The IRS is “taking a pretty hard-line position, saying that you just are not entitled to the completed-contract method,” said David Auclair, principal at accounting firm Grant Thornton.
“This is a big issue for land developers and commercial real estate,” he said.
Homebuilders also use the completed contract method. In July, California-based Shea Homes LP went to trial with the IRS over this issue.
The company could owe up to $61 million in federal and state taxes, Shea said in Securities and Exchange Commission filings.
Wilkes Graham, senior vice president at Compass Point Research & Trading LLC, said a court loss for Howard Hughes and General Growth would not deal a blow to their shareholders.
But, he said, the challenge to the accounting method will be watched by other companies.
“It’s a bigger deal overall,” he said. For companies using the completed contract method, “those entities would be at risk” if the IRS wins, he said.
Howard Hughes got a tax bill in February 2011 for allegedly under-paying taxes in 2007 and 2008 on Summerlin, a project that the company does not expect to sell out until 2039.
Hurt by the recent financial crisis, Summerlin’s acreage sales are starting to recover this year. The development’s land covers an area half the size of the District of Columbia.
As a developer, Howard Hughes builds the infrastructure at Summerlin - roads, sewer and water, electricity. The company makes money when it sells developed properties to home builders.
A Tax Court loss by Howard Hughes would hurt the development industry just as it is starting to recover.
Developers beginning new projects may need to pay taxes sooner, adding an up-front cost for the businesses, said Richard Shavell, a vice chairman at the Associated Builders and Contractors, an industry group. “If the IRS wins, they could cause a lot of uncertainty,” he said.
Reporting by Patrick Temple-West; Editing by Kevin Drawbaugh and Dan Grebler