KB Home Pins Hopes on Future Tax Benefits

Hit hard by the housing downturn, the homebuilder is sowing deferred-tax-asset seeds that it may reap in the future.

KB Home took a page from the tax management book of Hovnanian Enterprises when it reported a big write-off that included a $514.32 million valuation allowance. The allowance is related to its deferred tax assets (DTAs) and is reflected as a charge to fourth quarter income tax expense as of November 30, according to a regulatory filing by the company.

Last month, Hovnanian took a similar charge, creating a $216 million valuation allowance. At the time, Lehman Brothers tax guru Robert Willens told CFO.com that the maneuver had been “deft” in setting up a future tax benefit in the same period that it incurred a big loss. To be sure, under FAS 109,Accounting for Income Taxes, companies are permitted to create a tax deduction via a current accounting charge that can be used to offset future earnings.

But to take advantage of a FAS 109 allowance, companies must meet tough criteria. They include establishing that management is more than 50 percent sure that the company will be able to generate income during the carry-forward period when the losses will be netted. A related international standard, IAS 12, says something slightly different: DTAs are not recognized unless it is probable that the asset would be realized.

As it has done to other homebuilders, the recent downturn has hit KB Home hard. The company reported a loss from continuing operations before income taxes of $399 million for its fiscal fourth quarter, which ended November 30, 2007. It also took non-cash charges of $403.4 million associated with inventory and joint venture impairments and the abandonment of certain land option contracts.

The company blamed the impairment and abandonment charges on slowing sales rates, downward pressure on home prices, and sinking gross margins caused by a drop in the fair value of inventory positions, according to KB Home’s president and chief executive officer, Jeffrey Mezger. The market situation “prompted us to reassess our strategy concerning certain projects,” he added.

One way to handle the market uncertainty, said Mezger, is to use the inventory impairments incurred during the housing downturn to produce “substantial” deferred tax assets. “To the extent that we generate sufficient taxable income in the future to utilize the tax benefits of the related deferred tax assets, we expect to see a reduction in our effective tax rate as the valuation allowance is reversed,” added the CEO.

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