the howard hughes company llc f k a the howard hughes corporation and subsidiaries petitioner v commissioner of internal revenue respondent howard hughes properties inc petitioner v commissioner of internal revenue respondent docket nos filed date ps are in the residential land development business and develop land in and adjacent to las vegas nevada ps sell land to builders and in some cases individuals who construct and sell houses ps generally sell land through bulk sales pad sales finished lot sales and custom lot sales in bulk sales ps develop raw land into villages and sell an entire village to a builder ps do not otherwise develop the sold village in pad sales ps develop villages into parcels and sell the parcels to builders ps do not develop within the sold parcels in finished lot sales ps develop parcels into lots and sell whole parcels of finished lots to builders in custom lot sales ps sell indi- vidual lots to individual purchasers or custom home builders who then construct homes in all instances ps do not con- struct residential dwelling units on the land they sell during the years at issue ps reported income from purchase and sale agreements under the completed_contract_method of accounting r alleges ps’ contracts are not home construction contracts within the meaning of sec_460 r further contends the land sale contracts are not long-term construc- tion contracts and are not eligible for the long-term percent- age of completion method_of_accounting under sec_460 held ps’ bulk_sale and custom lot contracts are long-term construction contracts held further ps’ contracts are not home construction contracts within the meaning of sec_460 and ps may not report gain and loss from these con- tracts using the completed_contract_method of accounting verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports stephen f gertzman kevin l kenworthy steven r dixon mary w b prosser and sat nam s khalsa for peti- tioners ronald s collins jr bernard j audet jr and john r gilbert for respondent income of federal wherry judge these cases consolidated for trial briefing and opinion are before the court on petitions for redetermination tax deficiencies respondent determined deficiencies for the and tax years of petitioner the howard hughes co llc thhc formerly the howard hughes corp subsidiaries old thhc and deficiencies for the and tax years for petitioner howard hughes properties inc hhpi the issue for consideration concerns the proper method_of_accounting for income from certain contracts respondent alleges that with respect to most of petitioners’ contracts petitioners must use the percentage_of_completion_method_of_accounting instead of the completed_contract_method of accounting peti- tioners however contend that because their contracts qualify as home construction contracts within the meaning of sec_460 they properly reported income on the completed_contract_method respondent further alleges that certain other contracts are not long-term_contracts or construction contracts and that petitioners cannot account for the gain_or_loss from these contracts under sec_460 findings_of_fact the parties’ stipulation of facts and supplemental stipula- tion of facts both with accompanying exhibits are incor- porated herein by this reference at the time petitioners filed the petitions their principal_place_of_business was dallas texas their main business operations however are in las vegas nevada company background when howard hughes died in his portfolio of assets owned by summa corp included land which was then out- unless otherwise noted all section references are to the internal rev- enue code of as amended and in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner for development the side the city of las vegas nevada in the 1980s this land was selected land was called summerlin which was the maiden name of mr hughes’ paternal grandmother summerlin was divided into three geographic regions summerlin north summerlin south and summerlin west in the rouse co rouse a publicly traded corpora- tion based in columbia maryland acquired the assets of the hughes estate including howard hughes properties lp hhplp which owned summerlin effective date rouse elected to be treated as a real_estate_investment_trust reit in as part of this conversion rouse orga- nized hhpi which in turn purchased the undeveloped acre- age in summerlin north and south from hhplp in date hhplp had distributed summerlin west to old thhc in general growth properties inc ggp a publicly traded reit acquired rouse by merger during the tax years at issue ggp was the general_partner in a lim- ited partnership which through another limited partner- ship the rouse co lp and a limited_liability_company rouse llc owned hhpi and the hughes corp which in turn owned old thhc in ggp and its affiliated entities filed for bankruptcy under chapter of the u s bankruptcy code effective date old thhc converted from a corporation to a delaware limited_liability_company which is petitioner thhc in these cases as part of the plan_of_reorganization in ggp spun off the part of its business that owned summerlin a newly formed entity the howard hughes corp an entity distinct from old thhc ended up owning as second- and third-tier subsidiaries hhpi and thhc thhc owns summerlin west and hhpi owns summerlin north and summerlin south to the extent that these prop- erties have not yet been sold to third parties summerlin during the years at issue petitioners were in the residen- tial land development business they generated revenue pri- marily by selling property to builders who would then con- struct and sell homes in some cases they also sold property to individual buyers who would then construct single-family verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports residential homes the land petitioners sold and still sell is part of a large master-planned community known as summerlin summerlin comprises approximately big_number acres on the western rim of the las vegas valley about nine miles west of downtown las vegas as of the end of approximately big_number residents lived in big_number homes in summerlin at completion petitioners expect summerlin to house approxi- mately big_number residents while summerlin is largely resi- dential it is a fully integrated community which means it includes commercial educational and recreational facilities it contains about million square feet of developed retail_space million square feet of developed office space hotels and health and medical centers it ha sec_25 public and private_schools higher learning institutions golf courses parks trails and cultural facilities summerlin north and summerlin west are as a result of annexation part of the city of las vegas and summerlin south is in clark county nevada the first residential land sales in summerlin north took place around and by the years at issue hhpi had fully developed summerlin north the first land sales in summerlin south took place in and the first land sales in summerlin west took place in each of these three geographical regions is further divided into villages each of which averages about acres villages are further divided into parcels or neighborhoods which contain the individual lots these cases involve only petitioners’ sales of land in summerlin south and summerlin west petitioners’ sales generally fell into one of four categories pad sales finished lot sales custom lot sales and bulk sales in a pad sale petitioners after dividing the village into parcels constructed all of the infrastructure in the vil- lage up to a parcel boundary petitioners then sold the parcel to a buyer who was usually a homebuilder the builder with petitioners’ approval was responsible for all of the infra- structure such as streets and utilities within the parcel and subdividing the parcel into lots in a finished lot sale peti- tioners also divided the village into parcels they then fur- the parties disagree over whether the bulk sales contracts are in sub- stance different from the pad sales contracts we resolve this issue infra verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner ther constructed any additional needed parcel infrastructure divided the parcels into lots and sold the neighborhoods to a buyer usually a homebuilder in finished lot sales peti- tioners constructed all of the infrastructure up to the lot line in both the pad sales and the finished lot sales petitioners contracted with homebuilders through building development agreements bdas the bdas were more than just simple sales contracts that for consideration pass title we discuss the parties’ responsibilities infra in doing so we do not pur- port to cover all of the details but simply address some important aspects of the bdas custom lot sales were essentially the same as finished lot sales except that petitioners sold the individual lots the buyers of these individual lots were individuals who were contractually bound to build a residential dwelling_unit the purchase sales contracts required the individuals to agree that they would occupy the home for at least one year or if the home was sold before then to a third party to pay additional consideration of of the third-party price finally in a bulk_sale petitioners sold an entire village to a purchaser the purchaser was responsible for subdividing the village into parcels and lots and for constructing all of the infrastructure improvements within the village even though the builders were ultimately responsible for building and selling homes to the end user-the home- buyer-petitioners marketed to the homebuyers petitioners’ marketing strategy embodied the idea of the master-planned community and they viewed summerlin as a brand that evokes thoughts of an attractive lifestyle and community but petitioners did not bear the sole burden of the marketing cost in fact their agreements with the builders required the builders to pay into an advertising program promoting summerlin the builders paid upon the close of escrow of a home sale a fee equal to of the purchase_price the parties stipulated that the sales in all custom lot contracts were made to an individual purchaser a review of the list of custom lot con- tracts however reveals that some of the buyers appear to be builders eg executive home builder six star construction inc and pmr homes inc this apparent discrepancy may result from the meaning of indi- vidual purchaser but is irrelevant to our ultimate holding for simplicity we will rely on the parties’ stipulation verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports we discuss infra the general process thhc and hhpi undertake in their home development business much of the trial was devoted to the details of the process and we by no means purport to address every step our intention is not to discount those important steps not addressed but to provide a general picture of how the development process worked developing summerlin-entitlements petitioners were parties to master development agree- ments with las vegas nevada and clark county nevada that govern the planned development of summerlin west and summerlin south respectively these long-term 30-year agreements assure petitioners that they will be able to develop the land in accordance with the agreements and remove any necessity to negotiate development agreements and entitlements village by village summerlin west las vegas pursuant to powers delegated by the state of nevada by chapter of the nevada revised statutes adopted in date the city general plan which is a master land use plan hhplp and las vegas signed a development agreement lvda in date the lvda was recorded in the clark county nevada recorder’s office and was approved by the las vegas city council along with approvals and plans referenced within the agree- ment the lvda governed land development in summerlin west las vegas also amended its city general plan to incorporate the summerlin west general development plan which conceptualized future development of summerlin west and rezoned summerlin west from a rural district to a planned community district the summerlin west development standards attached to the lvda set minimum requirements for development including residential densities building height and setbacks signage landscaping parking and open space requirements as well as procedures for site plan review and for modifying the planned community program the lvda states that development of summerlin west will occur in phases called villages the owner has to prepare and submit for city approval a village development plan for each village a vil- verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner lage traffic study and a village drainage study also had to accompany the village development plan initially the lvda permitted big_number residential units dollar_figure million square feet of office retail or industrial space uses on acres of land golf courses featuring up to holes of golf and related facilities other uses described in the summerlin west general development plan were also contemplated the lvda required hhplp to maintain medians but allowed hhplp to assign that responsibility to homeowners associations hhplp granted the city the right to construct traffic signals turn lanes and similar improve- ments as necessary the lvda also required hhplp to donate land to the city and construct a fire station on that land and to donate up to five acres of land to the city for a satellite government center in addition hhplp was to donate land to the city for a public park with sports and rec- reational facilities and assume the cost of constructing a sewer interceptor with respect to traffic and transportation the lvda required hhplp to provide or at least provide adequate assurance that it would provide standard improve- ments in connection with each village standard improve- ments were improvements required for intersections and roadways immediately adja- cent to the planned community hhplp also agreed to dedicate land needed for the right of way to the city for a major arterial road the summerlin parkway extension mitigation measures and in date old thhc as the successor_in_interest to hhplp and the city amended the lvda to require old thhc to allocate a certain minimum amount of recreational space per big_number residents construct a neighborhood pool and design and construct a police substation with a helicopter landing pad the amended lvda also increased the allowed number of residential units from big_number to big_number petitioner thhc was and is as successor_in_interest to old thhc subject_to the lvda as amended summerlin south clark county nevada pursuant to the powers delegated by the state of nevada adopted the clark county master_plan in it and hhplp also signed and recorded a development agreement ccda in date to govern the development of summerlin south before the ccda verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports the land use and development guide clark county had amended its county master_plan to include for summerlin’s southern comprehensive planned community land use and development guide clark county also rezoned summerlin south from a rural district to a planned community district the ccda provided that summerlin south would be devel- oped in accordance with the summerlin master plans which consisted of the land use and development guide a summerlin master parks and public facilities plan a summerlin master transportation plan and a summerlin master drainage plan as with the lvda the ccda envi- sioned development by phases called villages and hhplp agreed to submit a village development plan before begin- ning development of a village hhplp also agreed to submit with the village development plan a traffic study a drain- age study and a parks and public facilities plan under the ccda summerlin south could contain up to big_number residential dwelling units acres for nonresiden- tial private uses holes of golf and related facilities hotels casinos and other land uses and facilities the ccda obligated hhplp to construct a fire station donate up to acres of land for a satellite government center which may include the fire station and dedicate up to acres of land for a community sports park the ccda also obligated hhplp to submit the master parks and public facilities plan which was to generally identify the location and development timing of parks trails and public spaces sys- tems hhplp also was to submit a master transportation study provide the necessary improvements to mitigate the development’s traffic impact provide village access roads for each village and bear all public and private expenses such as roadway construction lighting drainage signage and landscaping expenses related to summerlin south’s internal roadway network the ccda further required hhplp to prepare a technical drainage study and construct flood facili- ties which were to be integrated where possible with the trails and parks systems the parties clark county and hhpi as successor_in_interest to hhplp have amended the ccda three times most recently in date the most recent amendment increased the number of permissible residential dwelling verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner units to big_number in return hhpi agreed inter alia at its expense to purchase and provide a 100-foot aerial fire truck with operating equipment design construct and convey a second fire station and convey acres of land to the county for a third fire station in addition hhpi agreed to convey acres or more of land to the county for recreational pur- poses or acres or more for a sports park to be designed and constructed by hhpi and a community center and out- door aquatic center to be designed and constructed by hhpi developing summerlin-covenant conditions and restric- tions petitioners and their predecessors in interest recorded master declarations which govern use of the land by subse- quent owners these declarations also known as covenants conditions and restrictions cc rs not only imposed use restrictions and protective covenants but also created home- owners associations the master declarations served as the governing documents for the homeowners associations the declarations applied to an initial set of properties within summerlin but allowed petitioners to annex property thereby expanding the community subject_to the declara- tions the master declarations provided for the establishment of village subassociations through new declarations the sub- association declarations supplemented the master declara- tions these subassociations were responsible for owning and maintaining certain common elements and or exclusive amenities associated with a neighborhood and for enforcing their own covenants conditions and restrictions a neighbor- hood which could include a gated community consists of properties which share exclusive amenities or common areas the summerlin south master declaration established the summerlin south design review committee this committee had to approve construction alteration grading additions excavation modification or reconstruction of an improvement or removal of any tree in any phase of development the summerlin west master declaration established a similar review process in both cases petitioners retained control_over the review process until such time as they no longer owned an interest in the redecoration decoration verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports respective summerlin west and summerlin south geographic regions developing summerlin-villages petitioners developed summerlin in village phases starting with the villages adjacent to existing development to take advantage of the infrastructure subsequent villages could likewise take advantage of the additional infrastructure cre- ated by the adjacent villages generally the first step in petitioners’ development activi- ties was to survey the property and create and file a parcel map the parcel map broke off a village-size piece for development and sale by petitioners petitioners also had to grant easements for utilities and drainage and dedicate public streets the parcel map reflected these easements and dedications often clark county or las vegas imposed obligations on petitioners with respect to street grading surfacing and alignment and provisions for drainage water quality and supply sewerage and particular lot designs before devel- oping the land petitioners prepared and filed a tentative map along with this map petitioners conducted technical studies such as traffic and drainage studies and established a village development plan which is required by the lvda and the ccda and established the specific zoning uses and entitlements within the villages normally the governing agency required petitioners to design and construct the improvements on the tentative map as a condition of approval of the map but in certain cases petitioners requested waivers for instance if a road was not imme- diately necessary petitioners could request a waiver delaying construction until it was necessary in addition the tentative maps did not show all of the improvements that petitioners would construct on the parcels for instance they did not show landscaping wall and dry utility improvements petitioners also prepared improvement plans for the improvements shown on the tentative maps it took about nine months to one year to prepare these plans and for the governing agency to review and approve them once the various governmental bodies approved the ten- tative map petitioners were required to also submit a final verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner subdivision map in the case of pad sales the builders also had to prepare and submit tentative and final maps to fur- ther subdivide the pad land into lots the pad purchase con- tracts governing pad sales also required the builders to first submit these maps to petitioners for approval the final map showed roads and easements that peti- tioners intended to dedicate to the public these easements included those for wet utilities such as sewer and water and dry utilities such as electric telecommunications and gas absent a special improvement district sid the approving governmental body could require petitioners to enter agree- ments whereby petitioners posted bonds to ensure completion of the agreed-upon improvements these improvements may have included streets alleys curbs gutters sidewalks medians streetlights traffic signals sewer systems drainage facilities open space improvements trails parks and land- scaping petitioners obtained and posted bonds based on the unit rate times required material as determined by the agency that requires the bond the agency commented on and required modifications to or approved the bond and it exonerated petitioners only when the improvements were fully constructed and inspected and the agency took owner- ship petitioners also used tax-exempt sids financing to finance construction of some summerlin infrastructure improve- ments in a project financed by sid bonds petitioners did not have to post performance bonds these sid bonds financed public improvements such as street water sewer and storm drainage improvements petitioners were entitled to reimbursement from the money raised from the sale of the sid bonds when they incurred the relevant construction costs subject_to the approval of the relevant municipal authority special_assessments on the property within the sid covered the scheduled bond payments sid financing was not available to cover dry utilities landscaping and walls summerlin west and summerlin south contain seven sids the total amount of the sid bonds was dollar_figure verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports villages at issue respondent’s determinations concern income from bda sec_4 for the sale of land in of petitioners’ villages those villages are village summerlin centre village 14b the gardens village 15b siena village the mesa village the ridges village summerlin centre west village the vistas village 23a b the paseos and village reverence all of the villages except village sec_15b and contained land sold in pad sales finished lot sales occurred in villages and also at issue are custom lot contract sales all custom lot contracts involved the sale of lots in village of the custom lot contracts were entered into and closed in the same tax_year the remaining custom lot contracts closed in the tax_year following the one in which they were entered into the parties have agreed that villages and are generally representative of the villages at issue the par- ties have also agreed on a bda that is representative of fin- ished lot sales ladera bda a bda that is representative of pad sales lyon bda and two custom lot contracts redhawk and arrowhead that are generally representative of the custom lot contracts at issue in addition to the pad sales the finished lot sales and the custom lot contracts petitioners also sold village sec_15b and sec_26 in bulk sales essentially equivalent to very large pad sales within the boundaries of the property sold in a bulk_sale petitioners do nothing rather the purchaser is responsible for all development with respect to village known as reverence the first half of the sale to pulte homes inc now the parties provided a stipulated exhibit that purports to be a list of bdas at issue this list of bdas include sec_23 contracts for sales in vil- lage 14a but the parties also stipulated that petitioners recognized the gain on bdas involving village 14a in other stipulated exhibits such as a map highlighting the villages at issue and the calculations at- tached to the 30-day letters also reveal that the contracts for sales of land in village 14a are not in issue we disregard the contracts from village 14a in arriving at the total number of bdas at issue the parties disagreed over whether villages and contained land sold in pad sales this dispute is immaterial to our ultimate holding but we find that the weight of the evidence suggests village contained land sold in pad sales whereas village did not verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner known as pulte group inc occurred in date just before the housing market collapse and neither peti- tioners nor the purchaser have done any work on this prop- erty in fact the sale of village was to occur in two parts but the purchaser defaulted on the second half of the con- tract with bulk sales petitioners still incurred regional costs that benefit the two villages such as costs for water lines regional drainage and road extensions common improvements generally the bdas loan agreements governmental laws and other legal obligations required petitioners to build common improvements in summerlin these improvements included rough grading roadways sidewalks utility infrastructure such as water sewer gas electricity and telephone storm water drainage parks trails landscaping entry features signs and perimeter walls upon completion of a common improvement petitioners transferred ownership or granted easements to the respective community association or where appropriate the municipality generally community associa- tions received some roads swimming pools open spaces and medians whereas the municipalities received police stations fire stations other roads traffic signals and street lights some of these improvements were necessary for construc- tion of the dwelling units the allocable_costs attributable to petitioners’ improvement construction activities exceeded of the various total contract prices petitioners designed all of the common improvements in an effort to make summerlin an attractive community in addition petitioners monitored and maintained approval control_over all construc- tion in summerlin including construction of the dwelling units representative contracts finished lot sale-ladera bda with respect to the bdas the parties stipulated that these contracts are construction contracts within the meaning of sec_460 the ladera bda is a purchase and sale agreement between hhpi and kb home nevada inc kb home for finished lots in village in a neighborhood called ladera the ladera bda called for the land sale to be verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports completed in three phases village known as the mesa consisted of a mix of residential uses including single family and multifamily units the style of the mesa drew its inspiration from the mountains in the backdrop and peti- tioners required builders to use natural building materials such as stone and to include at least two outdoor living spaces per residence in addition to the purchase_price the ladera bda entitled hhpi to certain participation payments as well as payments tied to power company refunds hhpi received a lot premium participation payment equal to of the lot premium less a credit calculated by reference to any commission paid to an unrelated broker hhpi also received a payment equal to the greater of of the net sale price or hhpi’s percentage share of the net sale price less the finished lot costs the power company refund payments stemmed from the fact that hhpi paid the nevada power co to construct electric feeder lines as homeowners subscribed to electrical service the power company refunded all or part of the costs hhpi assigned the rights to the refunds to kb home but then required kb home to make three lump-sum payments equal to the estimated amount of the refund the ladera bda required hhpi to develop the parcel into finished lots hhpi constructed all of the infrastructure up to the individual lot lines thus wet and dry utilities were stubbed to the lot boundaries hhpi was also responsible for the streets and street improvements such as traffic sig- nals the driveway depressions the perimeter and retaining walls entry monumentation and landscaping hhpi also graded the parcel including the lots and hhpi agreed to construct a community park with a swimming pool for which kb home paid hhpi a community park fee of dollar_figure per residence improvement plans governed the work hhpi had to per- form as part of the contract hhpi through the engineering firm g c wallace inc gcw created their plans one for each phase for approval by clark county the public utili- ties and other agencies the plans governed the curbs gut- as used in the contracts net sale price means the gross sale price less credit for any lot premium and any costs of amenities such as swimming pools finished lot costs is the purchase_price kb home paid for the lot verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner street improvements ters and other paving signs streetlights driveway depressions and wet utilities such as sewer mains manholes water mains fire hydrants and water and sewer service stubbed to each lot another set of plans prepared by the utility companies governed the dry utilities such as telephone and gas in addition hhpi was responsible for any improvement necessary for the issuance of a building permit or certificate of occupancy and for land- scaping design and construction of perimeter and screen walls entry monumentation and community open space on the purchaser’s side the ladera bda obligated kb home to build dwelling units subject_to a development dec- laration and a development plan the bda also annexed the property to the summerlin south community association making kb home also subject_to the cc rs of that associa- tion the development declaration entered at the time of closing of phase contained a number of additional restric- tions on kb home the declaration allowed kb home to con- struct only single-family homes in accordance with a develop- ment plan the declaration preserved hhpi’s control_over design of homes and landscaping by requiring that they con- form to hhpi’s residential design criteria for the mesa vil- lage and to the landscape standards the design criteria gov- erned everything from lot grading to home finishes the declaration required kb home to create a develop- ment plan the development plan had to describe land- scaping improvements as well as building improvements with respect to the plans for the homes the declaration required kb home to create a concept plan with floor plans and sketches of the home exteriors visible from the street preliminary and final plot plans which showed the location of the home and other improvements on the lot an architec- tural materials sample board which included samples of the building materials to be used and a marketing signage plan which contained details on all signage the development plan was subject_to the approval of hhpi if hhpi or a governmental agency disproved or rejected an item as not being in conformity with the develop- ment plan kb home was obligated to correct the defect at its own cost in addition to requiring kb home to construct single-family homes in a certain manner the ladera bda also required kb home to construct sidewalks driveways verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports model homes interior screen walls curb scribes and water meters pad sale-lyon bda the second purchase and sale agreement is an example of a pad sale this agreement was between old thhc and wil- liam lyon homes inc lyon for the sale of parcel m in vil- lage as part of this agreement thhc transferred fee simple title to lyon subject_to a number of encumbrances including the summerlin west master declaration a supple- mental declaration of annexation a development declaration and the summerlin west development agreement the agreement limited lyon to constructing single-family homes the agreement also placed substantial restrictions on lyon’s use of the property the supplemental declaration of annexation subjected parcel m to the cc rs in the summerlin west master declaration and imposed its own restrictions such as those governing satellite dishes and signs similarly the development declaration required lyon to submit a development plan for thhc’s approval before it could begin any construction the development declaration also required improvements to conform to an architectural concept plan a preliminary plot plan an architectural mate- rials sample board a final plot plan a marketing signage plan and the summerlin design standards if any item did not conform to the development plan or was otherwise defec- tive lyon had to at its own cost correct the problem the agreement also required lyon to build entry monumentation and landscaping a minipark and pedestrian access ways the parties agreed to share costs of boundary walls between the property and adjacent parcels if the par- ties thought such walls were desirable thhc as part of the agreement agreed to perform all other obligations except those inuring solely and specifically to the subject property or specifically under the lvda nec- essary for the purchaser’s project thhc also agreed to con- struct the roads bordering the parcel vista run drive and trail view lane and associated roads curbs gutters and street lighting the agreement further required petitioners to construct a perimeter boundary wall along the roads bor- dering the property and to stub the wet and dry utilities to the parcel verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner custom lot contracts the parties provided two custom lot contracts for the sale of property in village to individual purchasers through custom lot contracts each custom lot contract involved the sale of a lot s in one of seven neighborhoods in village known as the ridges the two representative contracts were for the sale of a lot in the arrowhead neighborhood and for the sale of a lot in the redhawk neighborhood these con- tracts are representative of the other custom lot contracts at issue in these cases each contract sold a lot described in final maps recorded with the office of the county recorder of clark county nevada the contracts required the purchaser to build a single-family home on the lot in addition the contracts stated that hhpi must construct or have constructed certain improvements and the individual lot purchaser is to be solely responsible for other lot improvements for instance section of the arrowhead contract stated in part hhp’s improvements hhp has installed roads providing access to the lot together with underground improvements for sanitary sewer potable water telephone natural_gas and electric power all such utility improvements have been stubbed out to the lot it shall be purchaser’s responsibility to activate water service prior to commencing construction on the lot purchaser is responsible for all utility connec- tions from the property line to purchaser’s home and for making all nec- essary arrangements with each of the public_utilities for service pur- chaser acknowledges that hhp is not improving the lot and has not agreed to improve the lot for purchaser except as provided in this sec- tion purchaser will be responsible for finish grading and preparation of the building pad and acknowledges that hhp has not agreed to pro- vide any grading of the lot beyond its present condition section of the redhawk contract was substantially_similar but it implied that hhpi’s work was not yet completed at the time of the purchase and sale agreement as part of the custom lot contract hhpi explicitly stated that it made no representations or warranties concerning zoning or the future development of phases of arrow- head the ridges or the surrounding area or nearby prop- erty a similar provision was in the redhawk contract the contracts also contained integration clauses paragraph of the representative contracts stated verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports this agreement constitutes the entire agreement and understanding between purchaser and hhp with respect to the purchase of the lot and may not be amended changed modified or supplemented except by an instrument in writing signed by both parties this agreement super- sedes and revokes all prior written and oral understandings between purchaser and hhp with respect to the lot but the purchasers also initialed a page of the custom lot contracts that states all of the documents listed below are important to the purchase of the lot should be read by the purchaser and at the close of escrow shall be deemed to have been read and approved by purchaser purchaser hereby acknowledges receipt of copies of those listed documents among the documents that purchasers acknowledged receipt of and were deemed to have read are cc rs articles of incorporation and bylaws of the summerlin south community association copies of the recorded subdivision map for the neighborhood in which the lot was located the neighborhood design criteria and a public offering statement the purchasers and the purchased lots were subject_to the various cc rs that govern summerlin south village and the subassociation within village and they were contractually required to conform their lot to the relevant architectural declaration the architectural declaration required that all construction on the lot be approved by hhpi if hhpi delegated the approval power to a review committee for the ridges then that committee must approve the declaration in addition the cc rs for the village association granted access to homeowners to their lots by way of one of two circular roadways accessible by two guard houses and private gates all of which were to be designed and constructed by hhpi including associated landscaping these improvements became common elements owned by the community association as did other elements such as entry the parties did not provide copies of the attachments to the two rep- resentative custom lot contracts rather they provided the attachments to a different custom lot contract which involved the sale of a lot in the azure community in village the parties have stipulated that these at- tachments are generally representative of the exhibits attached to a con- tract for the purchase and sale of a custom lot in village verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner features recreational facilities landscaped medians and cul- de-sacs the recorded subdivision maps identified the common areas including private roads such as drifting shadow way and sun glow lane which were granted to the relevant community association these maps also showed the location of storm drain easements and flood control and drainage channel right-of-ways the neighborhood design criteria con- tained maps showing the walls and fences hhpi had to con- struct the design criteria also contained a map that showed a community and fitness center which the parties stipulated was available to residents of village the public offering statements not only stated that the private roads guard houses and landscaping improvements are to be owned by the community association but they also recited that hhpi was responsible for utility connections to the lots and land- scaping improvements in common lots tax reporting for the years at issue petitioners used the completed con- tract method_of_accounting in computing gain_or_loss from their contracts for sale of residential_real_property in summerlin west and south for residential buildings planned to contain four or fewer residential units per building petitioners reported gain from bdas custom lot contracts and the bulk_sale agreements when they incurred of the estimated costs allocable to each bda custom lot contract or bulk_sale agreement intended petitioners broke down estimated bda costs into three cat- egories direct village costs regional costs and finished lot costs direct village costs consisted of the cost for the common improvements that benefit only the village that was the subject matter of the contract these costs included the following cost categories planning engineering inspection testing and processing rough grading water sewer storm drain street improvements dry utilities walls fencing land- scaping parks deposits other and contingency regional for example petitioners did not use the completed_contract_method of accounting to account for gain_or_loss from the sale of property upon which large multiunit apartment and commercial buildings were ultimately to be built verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports costs consisted of common improvements that benefited more than one village and included the following cost categories regional water regional sewer regional drainage regional roads regional traffic signals regional entry features regional annual costs regional other costs and townwide arterial costs finished lot costs were the costs that benefit only the neighborhood or parcel in which the finished lots were located petitioners used the engineering firm gcw to calculate most cost estimates for the actual construction cost cat- egories the hard costs gcw used a market price unit rate for each improvement which was based on its experience with past bids as well as prevailing bond rates the unit rate generally reflected labor and materials cost for the relevant improvement the unit rate was applied differently to dif- ferent improvements for instance gcw applied the unit rate based on length for improvements such as curbs sewer lines and sidewalks on area for improvements such as paving and some landscaping and on number of units of a designated improvements such as street lights and fire hydrants soft costs or costs other than the actual construction costs such as engineering inspection testing and processing were calculated as a percentage of the hard costs for regional water costs gcw allocated the costs to vil- lages according to the percentage of village acreage in the relevant water zone gcw assigned costs to each water zone for water mains pump stations reservoirs and inlet and outlet pipes in the water zone for regional sewer costs gcw allocated the cost among villages in proportion to their acreage these costs included costs for the sewer systems including pipes and mains paving manholes flowmeters and traffic controls drainage regional roads regional entry features regional annual regional other and townwide arte- rial costs were all also allocated in proportion to village acre- age traffic signal costs however were allocated to the vil- lage s adjacent to the street corners for example one-fourth to each corner at a four-way intersection of the relevant signal and then prorated by acreage for the finished lot costs petitioners and gcw used a for- mula based on historical actual costs this formula yielded verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner an estimated incremental_cost of improvements of dollar_figure per lot deficiencies for the tax years at issue petitioners reported income from the sale of land within summerlin using the completed_contract_method of accounting under petitioners’ methods_of_accounting each bda custom lot contract and bulk_sale agreement was a home_construction_contract and they were not completed within the meaning of sec_460 until peti- tioners incurred of the direct and indirect_costs allocable to the agreement or contract respondent issued notices of deficiency to both petitioners as part of his determinations respondent changed peti- tioners’ methods_of_accounting from the completed_contract_method of accounting to the percentage_of_completion_method_of_accounting respondent adjusted petitioners’ income as fol- lows petitioner total thhc hhpi dollar_figure big_number dollar_figure big_number dollar_figure big_number of completion method the total additional cumulative taxable revenue thhc would have recognized through its tax_year under the percentage is dollar_figure the difference between this number and the total dollar_figure adjustment in the notice_of_deficiency is due to adjustments for gain recognized in the tax_year pursuant to a prior audit overreported gain for non- exempt development activities and underreported gain for nonexempt development activities of accounting of completion method the total additional cumulative taxable revenue hhpi would have recognized through the tax_year under the percentage is dollar_figure the difference between this number and the total dollar_figure adjustment in the notice_of_deficiency is due to gain recognized in the tax_year pursuant to a prior audit overreported gain for nonexempt develop- ment activities and overreported gain for exempt develop- ment activities of accounting verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports respondent’s adjustments resulted in his determination of the following deficiencies petitioner thhc hhpi dollar_figure big_number dollar_figure big_number petitioners timely petitioned this court for redetermination and a trial was held in las vegas nevada i burden_of_proof opinion is 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 improper see rule a 290_us_111 if a taxpayer’s method_of_accounting does not clearly reflect income sec_446 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 360_us_446 83_tc_912 the question of whether a particular accounting_method clearly reflects income is a question of fact 37_tc_1063 to prevail the taxpayer must establish that the commis- sioner abused his discretion in changing the method_of_accounting 91_tc_1101 aff ’d 882_f2d_820 3d cir 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 verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner ii custom lot contracts and bulk_sale agreements as long- term contracts first we must determine whether petitioners’ contracts are long-term_contracts the parties stipulated that the bdas are long-term construction contracts the notices of deficiency determined deficiencies as if all of petitioners’ con- tracts were long-term_contracts on brief respondent has departed from that determination and contends that the cus- tom lot contracts and the bulk_sale agreements are not long- term contracts generally the court will not allow a party to raise an issue on brief if consideration of that issue would surprise and prejudice the opposing party 140_tc_294 because we do not think that petitioners need additional evidence to respond to the new issue and respondent has not carried the issue we address it below see id looking to the degree to which the opposing party is surprised by the new issue and the opposing party’s need for additional evidence to respond to the new issue to determine prejudice as to new issues respondent bears the burden_of_proof see rule a a custom lot contracts respondent alleges that none of petitioners’ custom lot con- tracts qualify even for accounting under the percentage_of_completion_method because they are not long-term_contracts initially respondent contends that many of the contracts were entered into and closed within the same tax_year and they therefore cannot be considered long term within the meaning of sec_460 second respondent contends that because petitioners did not have a legal_obligation to perform the construction activities contemplated by the contracts the contracts are not construction contracts petitioners on the other hand first assert that the contracts are complete for the purposes of sec_460 when they incur at least of the total allocable contract costs attributable to the contract’s subject matter they also contend that their contracts are construction contracts that impose legal obligations upon them a long-term_contract is any contract for the manufacture building installation or construction_of_property if such con- tract is not completed within the taxable_year in which such verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports contract is entered into sec_460 the relevant regula- tion provides that the date a contract is completed is the ear- lier of a use of the subject matter of the contract by the customer for its intended purpose other than for testing and at least percent of the total allocable contract costs attributable to the subject matter have been incurred by the taxpayer or b final completion and acceptance of the subject matter of the con- tract sec_1_460-1 income_tax regs but taxpayers determine the contract completion date with- out regard to whether one or more secondary items have been used or finally completed and accepted sec_1 c ii income_tax regs in addition the regulation directs taxpayers to consider all relevant facts and cir- cumstances in determining whether final completion and acceptance has occurred sec_1_460-1 income_tax regs if the subject matter of the custom lot contracts is solely the sale of the piece of land then petitioners’ custom lot con- tracts would be complete upon close of escrow the custom lot contracts do indeed provide for the sale of a piece of land but they also reference numerous other documents including cc rs development plans and subdivision maps under nevada law ‘ w ritings which are made a part of the con- tract by annexation or reference will be so construed but where the reference to another writing is made for a par- ticular and specified purpose such other writing becomes a part for such specified purpose only ’ lincoln welding works inc v ramirez p 2d nev quoting orleans m co v le champ m co p nev however indicates an intention to incorporate the documents generally such reference becomes a part of the contract for all pur- poses id if the reference the custom lot contracts contain a page whereon the pur- chaser s acknowledge receipt of copies of numerous docu- ments which are listed on the page we believe that this as previously noted the page reads in part all of the docu- ments listed below are important to the purchase of the lot should be read by the purchaser and at the close of escrow shall be deemed to have been read verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner sentence incorporates the documents listed and because there is no indication that the reference is for a specific pur- pose we incorporate these documents generally after reviewing the custom lot contracts the documents referenced therein and the testimony regarding summerlin as a master-planned community marketed as such by peti- tioners we are convinced that the subject matter of the con- tracts encompasses more than just the sale of the lot the costs incurred for a custom lot contract are not really dif- ferent from the costs for the finished lot sales at the time of trial petitioners still had to complete a water service line traffic signals landscaping and construction of a park therefore we agree that final completion and acceptance does not necessarily occur at the close of escrow but rather occurs when final completion and acceptance of the subject matter of the contracts which includes improvements whose costs are allocable to the custom lot contracts occurs cf 142_tc_60 consequently petitioners are entitled to account for the gain_or_loss from these contracts on the appropriate long- term method_of_accounting under sec_460 to the extent the contracts are not completed within the taxable_year in which they are entered into in so holding we reject respondent’s contention that the contracts impose upon petitioners no separate legal obliga- tion to complete the required improvements the regulations provide that a contract is a long-term_contract under sec_460 if the manufacture building installation or construc- tion of property is necessary for the taxpayer’s contractual obligations to be fulfilled and if the manufacture building installation or construction of that property has not been completed when the parties enter into the contract and the contract is not completed within the contracting year sec_1_460-1 and i income_tax regs see also 110_tc_94 for contracts that provide for the provision of land the regulations also contain a de_minimis_rule under which if the allocable_costs attributable to construction activities do not exceed of the total_contract_price the contract is not a construction_contract under sec_460 sec_1 and approved by purchaser verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports b ii income_tax regs to calculate the allocable_costs the regulation allows a taxpayer to include a proportionate share of the estimated cost of any common improvement that benefits the subject matter of the contract if the taxpayer is contractually obligated or required_by_law to construct the common improvement id petitioners’ allocable_costs attrib- utable to construction activities exceed the threshold respondent appears to read this regulation as requiring a taxpayer to have a legal_obligation independent of any other preexisting duty while we agree with respondent that work completed by petitioners at the time the contracts are entered into cannot transform a contract into a construction_contract under sec_460 we disagree that the statute and the regulations necessarily require that all construction activity obligations be solely enforceable because of the contract respondent believes that sec_1_460-1 income_tax regs codi- fies the common_law preexisting duty doctrine therefore he says that because petitioners are already obligated by statute to complete various improvements the obligations are not contractual obligations the preexisting duty rule states that a promise to do that which the promisor is already legally obligated to do is unenforceable 404_f3d_871 5th cir nevada follows the preexisting duty rule cnty of clark v bonanza no p 2d nev the nevada common-interest ownership act requires sellers such as petitioners to complete all improve- ments depicted on any site plan or similar documents except those labeled need not be built nev rev stat sec_116 and provides purchasers with a cause of action id sec_116 it is not clear that the preexisting duty rule applies in these cases the contracts between petitioners and the pur- chasers are valid contracts with valid consideration inde- pendent of the duties with respect to the development second while the nevada statute does indeed seem to grant we note that nev rev stat sec_116 has been amended numerous times since it was enacted in we refer to the statute as amended and in effect for the years in which the contracts were entered into verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner purchasers a cause of action if petitioners fail to construct improvements as shown on site plans or plats the statute explicitly provides the civil remedy provided by this section is in addition to and not exclusive of any other available remedy or penalty id sec_116 therefore it is uncertain whether a nevada court would apply the pre- existing duty rule to petitioners’ contracts see johnson f 3d pincite a s long as the contracting parties gain some legally enforceable right as a result of the contract which they previously did not have consideration is present the public policy concerns that underpin the preexisting duty rule do not seem to be present here in addition we do not agree with respondent that sec_1_460-1 income_tax regs codifies the preexisting duty rule the regulation clearly states that how the parties characterize their agreement eg as a contract for the sale of property is not relevant in determining the existence of a sec_460 construction_contract sec_1_460-1 income_tax regs see also 603_f3d_816 10th cir citing the regulation as to the allocable_costs attributable to common improvements in the de_minimis_rule the regulation does not require that the obligation be solely contractual sec_1 b ii income_tax regs rather the regulation allows a taxpayer to include the allocable_costs if the taxpayer is contractually obligated or required_by_law to construct the common in the regulation requires that the contract be the sole source of the obligation and in fact it indicates the opposite-that the obligation may be noncontractual improvement id nothing b bulk_sale contracts respondent similarly contends that the bulk_sale contracts do not qualify as long-term construction contracts under sec_460 specifically respondent alleges that petitioners have not established that they were obligated to construct anything under these contracts respondent bases this posi- in fact the nevada common-interest ownership act appears to en- able parties other than those in contractual privity with the developer to have standing to institute a lawsuit see nev rev stat sec_116 allowing suit to be brought by a unit’s owner not just the original pur- chaser of the land from the developer verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports tion on his belief that the terms of the bulk_sale contracts are unknown and that petitioners failed to carry their burden of proving that the contracts are entitled to a long-term con- tract method_of_accounting we disagree that the bulk_sale contracts are substantially different from the pad sale bdas the parties stipulated that the pad sale bdas are construction contracts the bulk_sale agreements are merely pad sale bdas on a larger scale the record supports this conclusion we heard credible testimony from the vice president of finance for petitioners that the bulk_sale contracts were bdas and that petitioners were obligated to build the same types of common improvements that benefited the property sold such as regional water lines traffic signals and detention basins thus we hold that these contracts too are construction contracts that may be accounted for under sec_460 as long-term_contracts to the extent consistent with this opinion iii completed_contract_method of accounting because the court has concluded that all of petitioners’ contracts are long-term construction contracts we turn to the question of whether the contracts are home construction con- tracts sec_460 provides generally that taxpayers must determine taxable_income from long-term_contracts under the percentage_of_completion_method_of_accounting under this method_of_accounting taxpayers generally recognize gain_or_loss throughout the duration of the contract see sec_1 b income_tax regs rules concerning percentage_of_completion_method but in some instances taxpayers may account for income from certain construction contracts under other methods_of_accounting such as the completed_contract_method sec_460 this section provides an exception to the percentage_of_completion_method_of_accounting for home construction con- tracts and an exception for other construction contracts where the taxpayers complete the contract within months and meet a gross_receipts_test sec_460 and b the parties have stipulated that most of petitioners’ contracts are construction contracts as defined in sec_460 peti- tioners do not contend that they qualify for the second excep- verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner tion so the question before us is whether petitioners’ con- tracts qualify as home construction contracts deferral of income_tax like exemptions and deductions is a matter of legislative grace and exceptions to the normal income_recognition rules must be strictly construed see eg 394_us_741 e xemptions from taxation are to be construed narrowly 928_f2d_901 9th cir the deferral of estate_tax payment benefits of sec_6166 are a ‘matter of legislative grace’ that is similar to the benefits conferred by other statutory provisions dealing with deduc- tions exemptions and exclusions from tax thus a strict and narrow construction should be applied to the deferral benefit provisions aff ’g 92_tc_714 the parties disagree over whether contracts such as peti- tioners’ where the seller does not build the house or any improvements on the lot qualify as home construction con- tracts sec_460 defines a home_construction_contract as follows a home_construction_contract -the term home_construction_contract means any construction_contract if percent or more of the estimated total contract costs as of the close of the taxable_year in which the contract was entered into are reasonably expected to be attributable to activities referred to in paragraph with respect to- i dwelling units as defined in sec_168 contained in buildings containing or fewer dwelling units as so defined and ii improvements to real_property directly related to such dwelling units and located on the site of such dwelling units for purposes of clause i each townhouse or rowhouse shall be treated as a separate building we refer to this definition as the test paragraph referred to by sec_460 provides for purposes of this subsection the term ‘construction contract’ means any contract for the building construction reconstruction or rehabilitation of or the installation of any integral compo- nent to or improvements of real_property sec_460 the statute defines dwelling_unit by cross-reference as a house or apartment used to provide living accommodations in a building or structure but does not include a unit in a hotel motel or other establishment more than one-half of the units in which are used transient_basis sec on a verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports e a ii the parties do not dispute that pursuant to the contracts agreements and government development rules the structures to be ultimately built upon the land petitioners sell in the contracts at issue are dwelling units importantly however petitioners did not build homes on the land they sold nor did qualifying dwelling units exist on the sold land at the time of the sales petitioners have not established that at the time of each sale qualifying dwelling units would ever be built on the sold land the bulk_sale agreement for village is especially troubling as no construction had yet occurred years later and because the purchaser-builder defaulted on the contract thhc still owned half of the village as far as we know no qualifying dwelling units will ever be built on these lands and the relevant regulation largely follows the statute it defines home construction contracts as follows i in general -a long-term construction_contract is a home construc- tion contract if a taxpayer including a subcontractor working for a gen- eral contractor reasonably expects to attribute percent or more of the estimated total allocable contract costs including the cost of land mate- rials and services determined as of the close of the contracting year to the construction of- a dwelling units as defined in sec_168 contained in buildings containing or fewer dwelling units including buildings with or fewer dwelling units that also have commercial units and b improvements to real_property directly related to and located at the site of the dwelling units ii townhouses and rowhouses -each townhouse or rowhouse is a separate building iii common improvements -a taxpayer includes in the cost of the dwelling units their allocable share of the cost that the taxpayer reason- ably expects to incur for any common improvements eg sewers roads clubhouses that benefit the dwelling units and that the taxpayer is con- tractually obligated or required_by_law to construct within the tract or tracts of land that contain the dwelling units sec_1_460-3 income_tax regs we note that in a case of an insolvent builder a bankruptcy court may direct the trustee of the bankruptcy_estate to petition the local_government for rezoning see 37_f3d_271 7th cir affirming the bankruptcy court’s direction to the trustee to seek to rezone property from agricultural to residential to allow the debtor a homestead exemp- tion we also note that the summerlin west and the summerlin south de- velopment agreements with las vegas and clark county have been amended from time to time by the parties thus contractual promises or obligations of third parties alone are at least in this factual context insuf- verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner deferral of income from contracts that might not ever result in qualifying dwelling units seems entirely inappropriate under these circumstances cf shea homes inc subs v commissioner t c pincite permitting deferral of income from contracts where the completed qualifying dwelling units were themselves included in the property being sold and giving rise to the asserted taxable_income petitioners close the contracts and receive revenue without needing to build a single home in shea homes the tax- payers closed their contracts only after a certificate of occu- pancy had been issued and simultaneously with the pur- chasers’ taking possession of their house id pincite peti- tioners are under no contractual obligation to build homes as their contracts are merely for the sale of land developed to varying degrees to builders or individual customers who may eventually build homes on that land in respondent’s mind the definitions foreclose petitioners from using the completed_contract_method of accounting only the sec_460 costs directly associated with building the actual house or improvements thereto qualify for purposes of meeting the test petitioners assert that construction activity costs count in meeting the test even though they do not build the four walls or roof of a dwelling_unit under their interpretation the allocable_costs include the costs of required infrastructure and common improvements attributable to the dwelling units even if true this point without more would not be deter- minative of their right to use sec_460 the starting point for interpreting a statute or a regulation is its plain and ordinary meaning unless such an interpreta- tion would produce absurd or unreasonable results 110_tc_375 undefined words ordinary contemporary their take ficient to ensure that qualifying dwelling units will in fact be constructed on the sold land when it comes to yet-to-be completed common improve- ments presumably bonds are posted whereas the purchasers of the land do not post or purchase bonds promising construction of homes we cannot therefore conclude that governmental zoning and entitlement agreements and land sale contracts alone are enough to meet petitioners’ evidentiary burden of establishing that the qualifying dwelling units requirement of sec_460 is or will be met verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports common meaning 139_tc_255 a costs attributable to dwelling units sec_460 defines a home_construction_contract as of the end of the taxable_year when the contract was entered into by reference to the estimated total contract costs attrib- utable to construction activity with respect to i dwelling units and ii improvements to real_property directly related to the units and located on the site of the dwelling units the regulations clarify that the allocable contract costs to be included in the test must be attributable to the construction of the units and the improvements thereto sec_1_460-3 income_tax regs what does the statute mean when it says attributable to construction activities with respect to dwelling units and improvements directly related to real_property sec_460 respondent asserts that only costs incurred in the actual construction of the dwelling units or their related real_property improvements count respondent contends that the home_construction_contract exception requires the tax- payer to build dwelling units or to build improvements to real_property directly related to and located on the site of such dwelling units petitioners claim the statute contemplates a broader defi- nition of home construction costs under their interpretation they believe that their costs benefit dwelling units and real_property improvements related to and located on the site of such dwelling units because the costs benefit dwelling units petitioners contend that the costs are therefore attributable to the dwelling units and that these costs should count towards meeting the test under petitioners’ view because all of their development costs are attributable to construction activity with respect to dwelling units and real_property improvements related to and located on the site of petitioners do not challenge the regulations and accordingly we give them their due deference see sec_460 562_us_44 applying to regula- tions the test announced in 467_us_837 cf shea homes inc subs v commissioner t c ndollar_figure verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner those dwelling units sec_460 is applicable even though they do not construct the dwelling units petitioners assert that because the costs are allocable to the contracts and because the costs benefit the property sold to the homebuilders and ultimately to individual buyers the costs are attributable to construction activities with respect to the dwelling units or real_property improvements this conclusion follows according to petitioners because the statute does not confine the availability of the completed con- tract method_of_accounting to those taxpayers who build the dwelling units’ sticks and bricks and or real_property improvements related to and located on the dwelling units’ lots petitioners’ interpretation of the statute would make any construction cost tangentially related to a dwelling_unit or real_property improvement related to and located on the site of the dwelling_unit a cost to be counted in determining whether a contract is a home_construction_contract without petitioners’ development work the pads and lots would be mere patches of land in a desert petitioners’ work may indeed be necessary for the ultimate home to feasibly be built and occupied but these correlations do not mean that those costs are necessarily incurred with respect to qualifying dwelling units with respect to implies a stronger proximate causa- tion than petitioners’ interpretation permits the preposi- tional phrase with respect to can mean as regards insofar as concerns with reference to webster’s third new inter- national dictionary so the construction activi- ties that count towards meeting the test are defined by reference to the dwelling_unit the phrase does not imply a correlation as loose as proposed by petitioners nor does it encompass real_property improvement activities that are merely related to land which at some indeterminate future time may perhaps become the site of a qualified_dwelling unit s consequently petitioners have failed to establish that such construction costs are incurred with respect to qualifying dwelling units at most the statute is ambiguous and we look to sec_1_460-3 income_tax regs which clarifies the statute attribute as used in the regulation means to explain as caused or brought about by regard as occurring verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports in consequence of or on account of webster’s third new international dictionary the word implies causation and as used in the regulation the plain meaning of attribute to is caused by none of these costs in our view are attributable to the construction of the dwelling units because petitioners do not intend to build such units and neither the units nor the real_property improvements related to and located on the site of the dwelling units have yet been built the regulation is reasonable and we conclude it forecloses petitioners’ interpretation see 467_us_837 congress added the exception for home construction con- tracts in technical_and_miscellaneous_revenue_act_of_1988 tamra pub_l_no sec_5041 sec_102 stat pincite senator dennis deconcini and representative richard t schulze were concerned that homebuilders would have to recognize income not yet received and that costs would no longer match revenues cong rec date sen deconcini cong rec date sen deconcini cong rec date rep schulze while the conference_report is ulti- mately silent as to why the exception was added in its final form it is clear that the intended beneficiaries of this relief measure were taxpayers involved in the building construc- tion reconstruction or rehabilitation of a home and not land developers who do not build homes even if essential development work paves the way for and thus facilitates home construction tamra sec_5041 cf 103_tc_428 discussing the definition of attributable to in the context of sec_117 of the inter- nal revenue code of and sec_108 of the internal_revenue_code_of_1986 the congressional record reveals that chairman rostenkowski of the house ways_and_means_committee when moving to suspend the rules so that the house could adopt the conference committee report on h_r stated that the conference_report exempted single family home- builders from the provision that restricted the completed_contract_method of accounting cong rec date likewise representa- tive archer the ranking house conference committee member stated in support of the conference_report i was particularly pleased that we changed the ‘completed contract method of accounting’ provisions under current law to exempt single family residential construction-thereby verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner that congress changed the wording of sec_460 from reasonably expected to be attributable to the building construction reconstruction or rehabilitation of to reason- ably expected to be attributable to activities referred to in paragraph only confirms our view omnibus budget rec- onciliation act of pub_l_no sec e a and b stat pincite this change added the installation of any integral component to or improve- ments of real_property to the list of construction activity id the purpose of this change was to ensure that costs incurred in installing integral components such as heating or air conditioning systems were qualifying costs h_r rept no pincite u s c c a n staff of j comm on taxation description of technical corrections proposed to the technical_and_miscellaneous_revenue_act_of_1988 the revenue_act_of_1987 and certain other pension-related tax legislation j comm print congress intended to extend this relief provision only to taxpayers who have some direct dwelling construction costs as defined in sec_460 in summary the terms with respect to sec_460 or attribute to sec_1_460-3 income_tax regs do not qualify contracts as home construction con- tracts when petitioners do not construct the home prove that a qualifying dwelling_unit was built or in the case of pad and bulk sales even develop the immediate neighborhood we do not agree with petitioners’ assertion that the term dwelling units encompasses more than the home peti- tioners urge us not to confine dwelling_unit to the structure built on the lot and would instead have that term encompass all the relevant infrastructure that makes the unit suitable for habitation the regulations clarify this point by providing a separate relief provision for such common improvements sec_1_460-3 income_tax regs we recognize the potential tension with our opinion in shea homes and we address such concerns infra reducing the cost of homes id we cite the joint_committee on taxation’s report for its persuasive merit see united_states v woods u s ll ll 134_sct_557 verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports b sec_406 real_property improvements we disagree with petitioners that the statute allows their construction activity costs to qualify because they are related to and located on the site of the dwelling units site according to petitioners means summerlin not the indi- vidual lot on which a house is later built petitioners reason that because the statute uses the plural of dwelling unit- on the site of such dwelling units -but does not use the plural of site then the statute necessarily envisions a develop- ment like summerlin containing multiple dwelling units and requires that a site be more than the lot upon which the dwelling_unit is built be that as it may this argument is not controlling here because it ignores the fact that the statute allows a construction_contract for a building with four or fewer dwelling units to still be considered a home construc- tion contract sec_460 such a building would nec- essarily consist of dwelling units plural but would sit on a single site petitioners read the preposition on in the phrase on the site to connote proximity indeed on can be used to indicate contiguity webster’s third new international dic- tionary location closely adjoining something but on is also used to indicate position over and in contact with that which supports from beneath id by using the phrase at the site in the regulations respondent did not necessarily interpret on to indicate proximity rather than the narrower usage while at can be used to indicate pres- ence in on or near id pincite we do not think that in choosing the word at as opposed to a phrase like on or nearby the regulation intended to interpret on the site broadly even if we were to view the statute as ambiguous in its use of on the site of the secretary has resolved any ambi- guity through regulatory gap-filling and we are required to defer to an agency’s permissible interpretation of an ambig- uous statute chevron u s a inc u s pincite the secretary believed that the statutory phrase might prevent taxpayers from counting the costs of common improvements towards the test and as a result many large homebuilders might be unable to qualify for the com- pleted contract method_of_accounting for home construction verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner contracts he rightly ameliorated this problem by adopting sec_1_460-3 income_tax regs which allows taxpayers to count such costs as part of the cost of building dwelling units for the purposes of the test the regula- tion reflects a permissible-inescapable in our minds- construction of the statute and we defer to that construction see id the costs petitioners incur are if anything common improvement costs as defined in sec_1_460-3 income_tax regs the regulations make clear that taxpayers may include the allocable share of these common improve- ment costs in the cost of the dwelling units id but we agree with respondent that the taxpayer must at some point incur some construction cost with respect to the dwelling_unit to include these costs in the dwelling_unit cost we do not believe that sec_1_460-3 and iii income_tax regs allows a taxpayer with zero direct construction costs with respect to dwelling units to simply add common improvement costs for the purposes of the test rather the regulation states that the taxpayer may include such costs sec_1_460-3 income_tax regs the regulation allows the taxpayer to include only the share of the common improvement costs allocable to the dwelling_unit id if the taxpayer does not construct or intend to construct qualified_dwelling units there is no allocable share of common improvement costs in addition the legislative_history supports our interpretation of site as limited to the site of the home the conference committee report states a contract is a home_construction_contract if percent or more of the estimated total costs to be incurred under the contract are reasonably expected to be attributable to the building construction reconstruction or rehabilitation of or improvements to real_property directly related to and located on the site of dwelling units in a building with four or fewer dwelling units h_r conf rept no vol ii pincite 1988_3_cb_473 emphasis added this sentence clearly shows that congress used dwelling units in the plural as opposed to the singular in sec_460 because a construc- tion contract for a building with four or fewer dwelling units could qualify as a home_construction_contract congress did not intend the plural to ex- pand the definition of site from the geographic limitations of the imme- diate lot to the geographic boundaries and even beyond of the whole de- velopment verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports petitioners have no dwelling_unit costs in which to include the common improvement costs the costs petitioners incur are not the actual homes’ structural physical construction costs nor are they costs for improvements located on or located at the site of the homes therefore petitioners may not include these costs in testing whether of their allo- cable contract costs are attributable to the dwelling units and real_property improvements directly related to and located on the site of the yet to be constructed dwelling units after reviewing the plain and ordinary meaning of the statute and the regulation we conclude that petitioners’ con- tracts and agreements do not qualify as home construction contracts recently we held that availability to home- we also do not think that respondent’s current position is inconsistent with the internal_revenue_service irs material petitioners cite for in- stance the irs non-docketed service advice review they referenced does not say that a home_construction_contract need not involve the building of a home irs non-docketed service advice review date rather this document states that the activities enumerated by sec_460 encompass more than just building a house such as rehabili- tating a home or installing integral components id as mentioned supra when congress changed sec_460 to reference para thereby in- cluding the installation of any integral component to or improvement of real_property in the qualifying costs of sec_460 it intended to allow taxpayers who build components such as air conditioning and heating sys- tems to potentially qualify their construction contracts as home construc- tion contracts omnibus budget reconciliation act of pub_l_no sec e a stat pincite h_r rept no pincite u s c c a n for an explication of the irs’ current position see tech adv mem date indi- cating that the irs believes the home construction exception is only avail- able to the party who actually builds or produces a dwelling_unit con- sequently a land developer who did not build any dwelling_unit s could not qualify we recognize that the proposed_regulations which would redesignate sec_1_460-3 income_tax regs as sec_1_460-3 if adopt- ed would expand the scope of the qualifying costs proposed income_tax regs fed reg date these regulations would modify the definition of improvements to real_property directly related to and lo- cated on the site of the dwelling units by including costs of common im- provements within that definition even if the contract does not provide for the construction of any dwelling_unit s id not only does the preamble to the proposed_regulations explicitly caution taxpayers not to rely on these regulations id pincite1 but by negative inference they add credence to our view that petitioners’ position is unsupported by the wording of the current statute and regulation verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner builders of the completed_contract_method of accounting is generously broad and reflects a deliberate choice by con- gress that home construction contracts should be treated dif- ferently but only as to homebuilders shea homes inc subs v commissioner t c pincite as for other construction contracts t he completed_contract_method of accounting is a narrow exception to the legislated rule that most long-term_contracts must now be accounted for under the percentage_of_completion_method_of_accounting which should be strictly construed id pincite petitioners were not homebuilders and their contracts were not home construc- tion contracts petitioners cannot account for gain_or_loss from these contracts using the completed_contract_method of accounting c shea homes in shea homes we held that the subject matter of the home construction contracts of the taxpayers developers who both developed land and built homes included the home the lot on which the home sat and the common improvements and amenities therefore we held that in testing contract completion the taxpayers were entitled to apply the use and completion test by using the contract costs after including the allocable share of the costs of the common improvements and amenities of the development or develop- ment phase which included the dwelling_unit s in reaching this conclusion we looked in part at the defini- tion of home_construction_contract to inform our under- standing of the regulation’s use of subject matter of the contract we concluded that sec_460 defined a home_construction_contract and that the regulations expand this definition to allow taxpayers to include ‘the allocable share of the cost that the taxpayer reasonably expects to incur for any common improvement ’ shea homes inc subs v commissioner t c pincite quoting sec_1_460-3 income_tax regs we believed that the fact that the regulations expanded the universe of costs to be considered when deciding whether a contract qualified as a home_construction_contract was at minimum instructive when deciding when that contract is subsequently completed but at no point in shea homes did we say that a home_construction_contract could consist solely of common improve- verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie united_states tax_court reports ment costs the starting point in shea homes was that the taxpayers’ contracts were for the construction of qualifying dwelling units those taxpayers developed land and built homes and so when testing whether their contracts were home construction contracts they were permitted by the regulations to add to the costs of the dwelling units they con- structed their common improvement costs and when testing the contract completion date they looked to when they incurred of the costs of the subject matter of the con- tract our opinion today draws a bright line a taxpayer’s con- tract can qualify as a home_construction_contract only if the taxpayer builds constructs reconstructs rehabilitates or installs integral components to dwelling units or real prop- erty improvements directly related to and located on the site of such dwelling units it is not enough for the taxpayer to merely pave the road leading to the home though that may be necessary to the ultimate sale and use of a home if we allow taxpayers who have construction costs that merely ben- efit a home that may or may not be built to use the com- pleted contract method_of_accounting then there is no telling how attenuated the costs may be and how long deferral of income may last we cautioned in a footnote in shea homes inc subs v commissioner t c pincite n that there is a temporal component to the home construction con- tract exception and contract completion we think it con- sistent with congressional intent that a line should be drawn here so as to exclude petitioners’ contracts when we cannot conclude that qualifying dwelling units will ever be built the regulations caution that taxpayers may not delay the completion of a contract for the principal purpose of deferring federal_income_tax sec_1_460-1 income_tax regs in these cases petitioners would often build infrastructure as needed for instance the costs of a road or a water line that is anticipated to benefit a village may upon request see supra p not be incurred for many years this may lead to a situation where the contract completion date could be substantially delayed we do not suggest that developers intentionally build ghost towns by building out infrastructure in excess of demand but we suggest that such costs would not necessarily be a proper part of a home_construction_contract this is especially important for contracts qualifying for the completed_contract_method of accounting where such a delay coupled with just-in-time as- needed improvements construction indeterminately defer recognition of in- come verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie howard hughes co llc v commissioner of course the contract does not necessarily have to be for the actual sale of a home the regulations make clear that a subcontractor’s contract may qualify as a home construc- tion contract for instance a subcontractor who does the electrical work inside the home may have a home construc- tion contract petitioners attempt to characterize their rela- tionship with the homebuilders as a general contract or sub- contractor relationship in an interesting and innovative twist petitioners try to characterize themselves as the sub- contractor in the relationship as if the builders are subcon- tracting out all of this infrastructure and extra-home development work to petitioners but this is not the relation- ship the parties have chosen see 417_us_134 w hile a taxpayer is free to organize his affairs as he so chooses nevertheless once having done so he must accept the tax consequences of his choice whether contemplated or not and may not enjoy the benefit of some other route he might have chosen to follow but did not citations omitted iv conclusion petitioners’ contracts are not home construction contracts within the meaning of sec_460 petitioners may not account for these contracts using the completed_contract_method of accounting the custom lot contracts and the bulk_sale agreements are however long-term construction con- tracts for which petitioners if those contracts are entered into in a year before their completion may use a permissible method_of_accounting for long-term_contracts such as the percentage_of_completion_method the court has considered all of the parties’ contentions arguments requests and statements to the extent not dis- cussed herein the court concludes that they are moot irrele- vant or without merit decisions will be entered for respondent f verdate mar apr jkt po frm fmt sfmt v files boundv wit bv864a howard _ll jamie