Homebuilder Loss Claim Crumbles

Defects
The IRS further stated in the CCA memo that "...we are also of the view that the damages in this case are not attributable to a product defect...." To constitute product liability, the damages in question must be attributable to a product defect. Defects, the IRS noted, may be qualitative or may constitute safety defects. For Section 172(f)(4) purposes, the IRS concluded, defect means (only) a safety defect.

Although some of the defects giving rise to the damages at issue might, if left unattended for a sufficient period, ultimately result in the collapse of the structure, none of the defects made the homes "unreasonably dangerous." Therefore, the construction deficiencies did not make the homes defective within the meaning of Section 172(f)(4).

Accordingly, the portion of the NOL sustained by homebuilders attributable to repairing the homes pursuant to the warranties may not be carried back 10 years. That portion of the NOL did not meet the standards for classification as a product liability loss. As a result, in this case, the liability for damages was not on account of damage to or loss of the use of property caused by any defect in any product manufactured by the homebuilder.

Contributor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.

Footnotes
¹ Section 13 of the Worker, Home Ownership, and Business Assistance Act of 2009, Public Law 111-92, amended Section 172(b)(1)(H) to allow taxpayers to carry back an applicable NOL for a period of three, four, or five years. An applicable NOL is the taxpayer's NOL for a taxable year ending after December 31, 2007, and beginning before January 1, 2010. Section 172(b)(1)(H)(iv) limits the amount of an NOL that a taxpayer elects to carry back to the fifth taxable year preceding the taxable year of the loss to 50% of the taxpayer's taxable income for the carryback year. Moreover, Section 172(b)(1)(H) does not apply to any taxpayer (or member of its affiliated group) that received certain benefits (even though repaid) under the Emergency Economic Stabilization Act of 2008.
² See CCA 201006028, November 5, 2009.
³ See Heller v. Cadral Corporation, 406 N.E. 2d 88 (Ill. App. Ct. 1980).
⁴ See Harvard Secured Creditors Liquidation Trust v. I.R.S., 568 F.3d 444 (3rd Cir. 2009). A division of Harvard Industries (HI) manufactured "lock-nuts" for use in commercial and military aircraft. HI sold the lock-nuts to distributors who then sold them to manufacturers for incorporation into the aircraft. It was discovered that certain lock-nuts sold by HI to the distributors were defective. HI's largest customer, H, filed suit against HI based on the sale of defective lock-nuts. The suit was settled; HI paid H $820,000. In addition, HI entered into settlement agreements with several other distributors to which it had sold lock-nuts. In these settlements, HI forgave a total of $3,009,807 in accounts receivable arising from the sale of lock-nuts. At issue was whether the damages HI sustained were product liabilities. The answer was no. The Third Circuit noted that product liabilities encompass liabilities for damages resulting from damage to or loss of the use of property on account of any defect in any product manufactured by the taxpayer. The question, therefore, was whether the distributors' inability to resell the defective product qualifies as damage to or loss of the use of property. The court concluded that such inability did not qualify as damage to or loss of the use of the property. Where the only injury was to the product itself, the resulting loss is essentially the failure of the purchaser to receive the benefit of its bargain — typically the "core concern" of contract law. Citing East River Steamship Corporation with approval, the court concluded that "...a manufacturer...has no duty...under either a negligence or products liability theory to prevent a product from injuring itself...."

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