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Ninth Circuit Opens the Door, IRS Slams It Shut (an update to IRS: "Shea It Ain't So!" The Ninth Circuit Opens the Door for Real Estate Developer to Defer Income Tax)



On April 7, 2017, the IRS issued Action on Decision 2017-03, confirming that the IRS would not follow the Ninth Circuit's ruling in Shea Homes, Inc. v. Commissioner, 834 F.3d 1061 (9th Cir. 2016). The Ninth Circuit's decision in Shea Homes was widely perceived as a significant, albeit narrow, win for taxpayers engaged in real estate development. More on the ruling in Shea Homes can be found from a recent blog post here.

The action on decision effectively places taxpayers on notice that even though the IRS did not appeal the result of the case, the IRS does not agree with the Ninth Circuit's decision and therefore will not follow the holding in that case when resolving cases involving similar facts.

In January the IRS announced its intention to implement a targeted audit campaign covering 13 specific tax issues, including the choice of accounting method used by real estate developers. Recent statements by IRS spokespersons indicate that the full scope of the new compliance program has yet to be determined, but this action on decision is some indication that the IRS does not intend to back off the issue. In fact, the IRS is considering discontinuing the use of "soft letters" notifying the taxpayer of a potential compliance issue with respect to this targeted audit campaign, placing additional pressure on taxpayers to voluntarily come into compliance before coming under scrutiny in the audit process.

As a result, taxpayers should be wary of using the accounting methods approved in Shea Homes, and should do so only if prepared to defend their transactions in litigation.

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