The Wall Street Journal-20080206-Lennar-s --36-800 Million Tax Refund

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Lennar's $800 Million Tax Refund

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Lennar Corp. has found a way to salvage something from the huge losses it incurred by overpaying for land during the housing boom.

Late last year, the Miami-based home builder sold a big swath of land -- about 11,000 home sites -- for $525 million to a partnership that it formed with Morgan Stanley. At first glance, the deal seemed terrible for Lennar, which had the land valued on its books at about $1.3 billion.

But the deal's structure allowed Lennar to recognize a big loss that it applied against taxes paid the previous two years. The result: Lennar is expecting a tax refund of more than $800 million, according to the company's annual results filed in late January.

As an added bonus, because of the way Lennar and Morgan Stanley structured their partnership, Lennar still effectively owns 20% of the land, according to the company. It also has a 50% voting interest in the partnership, meaning it will have a say in how the land is developed.

That means Lennar gets the tax loss, but still holds an interest in the land on its books. "That's the holy grail," said Robert Willens, president of tax and accounting advisory firm Robert Willens LLC. "The accounting is saying that they're not really selling it, whereas the taxes are more formal in the way they look at it."

Now, those benefits could prove a boon to other hard-hit home builders if the Senate has its way with the economic-stimulus package moving through Congress. In its version of the legislation, which the chamber is due to vote on in coming days, companies would be allowed to apply losses against taxes paid in the previous five years, as opposed to the current two-year period.

That would allow home builders to offload land for a loss and then apply to the Internal Revenue Service for refunds based on what they paid in taxes possibly going as far back as 2002, or in some cases 2001. The longer look-back period could take some pressure off the builders and housing markets.

"It gives them more time," says Ivy Zelman, chief executive of Zelman & Associates, a housing-research firm. "They could possibly be more patient and sell less land at today's fire-sale prices."

For cash-strapped home builders that have seen various funding avenues closed due to the credit crisis, tax refunds also could be a new source of much-needed, short-term funding. D.R. Horton, for example, paid about $2.14 billion in cash taxes between 2002 and 2005, according to estimates by Bear Stearns. Pulte Homes paid about $1.7 billion during this period, while Lennar paid about $1.6 billion. Together with Centex and NVR, these home builders combined paid nearly $8 billion in cash taxes during this period, according to Bear Stearns.

"It gives you an incentive to create a taxable loss in 2008 if you can carry it back five years and recoup the taxes paid," says Christopher Senyek, an accounting and tax-policy analyst at Bear Stearns.

Yet, the extension is far from a sure thing. A competing stimulus package put forward by the House, and favored by the Bush administration, doesn't include such a provision.

That said, Congress passed a similar five-year extension during the 2002 downturn. And home builders are supporting the Senate's effort.

But even if the extension passes, home builders may have trouble using it fully. To generate the losses that could be turned into tax refunds, companies will have to sell a lot of land in a very depressed market. Such a sales rush could further batter prices. Plus, buyers are pretty scarce, while home builders may prove reluctant to sell at fire-sale prices.

That is why some may look to Lennar's deal as a possible guide for transactions of their own. By creating the partnership at the heart of the deal, Lennar in some ways was selling to itself. That meant it didn't flood the market. In addition, the company retained some of the potential upside given its 20% ownership interest in the partnership. Lennar also will receive fees for building homes on the land and providing other services.

Lennar's ownership stake and voting interest seem to fall below thresholds in tax law that would bar the company from using any losses resulting from the sale as a deduction, said Joel Scharfstein, an attorney specializing in partnerships at Fried, Frank, Harris, Shriver & Jacobson LLP. He added this means the structure would likely withstand government scrutiny.

A spokesman for Lennar declined to comment, as did a Morgan Stanley spokeswoman.

Still, there is always a chance that the IRS will challenge the deal. One possible vulnerability is an option that Lennar has to repurchase some of the land. Whether the IRS agrees that this isn't an obligation, as Lennar says, will depend on the exact terms of the option. "If they're economically compelled to buy it back, that's where the weakness would be," Mr. Willens said.

In its annual results, Lennar said that it "has no obligation to exercise these options." A spokesman for the IRS said the agency doesn't comment on specific companies or transactions.

But if the deal, and Lennar's big refund, pass muster with the tax man, others are likely to follow suit. "Favorable tax treatment from the IRS on land sales as Lennar's press release implies could be a boost to all home builders," Goldman Sachs said in a recent research note.

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Michael Corkery contributed to this article.