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improvements; and (3) the county would incrementally issue FRC
permits to construct housing units as FRC fulfilled its
obligation to construct the aforementioned buildings and
improvements.
In May of 1988, FRC executed separate agreements, with Lyon
Communities, Inc. (Lyon), and P.B. Partners (Partners), to sell
each of them a large parcel of the Whiting Ranch. Lyon and
Partners entered into their respective agreements with the
intention to develop each of their parcels. To ensure that the
county would issue the construction permits necessary for such
development, each sales agreement provided that FRC would fulfill
its construction obligations to the county. The sales agreements
also imposed on FRC construction obligations that were unrelated
to its obligations to the county (e.g., the construction of
affordable housing units). In addition, the sales agreements
provided that Lyon and Partners would perform some of the
construction required pursuant to FRC's obligations to the
county.
By the end of FRC's 1988 tax year, FRC had not completed its
construction obligations. On its 1988 Form 1065 (U.S.
Partnership Return of Income), which was filed on October 16,
1989, FRC used the percentage of completion method of accounting
(PCM) to calculate the income attributable to its property
transactions with Lyon and Partners. On September 28, 1995,
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