OPERATING PROPERTIES AND REAL ESTATE HELD FOR DEVELOPMENT OR SALE

Operating properties and REO assets consist primarily of properties acquired as a result of foreclosure or purchase and were initially recorded at the lower of cost or fair value, less estimated costs to sell the property. Our fair value assessment procedures are more fully described in Note 6. At September 30, 2016, we held total operating properties and REO assets of $150.6 million, of which $45.9 million were held for sale, $89.3 million were held as operating properties, and $15.5 million were classified as other real estate owned. At December 31, 2015, we held total operating properties and REO assets of $152.9 million, of which $3.7 million were held for development, $5.3 million were held for sale, $116.2 million were held as operating properties, and $27.7 million were classified as other real estate owned.

A summary of operating properties and REO assets owned as of September 30, 2016 and December 31, 2015, respectively, by method of acquisition, is as follows (dollars in thousands):



	Acquired Through Foreclosure and/or Guarantor Settlement				Acquired Through Purchase and Costs Incurred				Accumulated Depreciation						Total
	2016		2015		2016		2015		2016			2015			2016		2015
Operating Properties, net	$	83,653	$	87,965	$	13,814	$	34,746	$	(8,160	)	$	(6,555	)	$	89,307	$	116,156
Real Estate Held for Sale	21,729		4,919		25,448		427		(1,303		)	—			45,874		5,346
Real Estate Held for Development	—		3,661		—		3		—			—			—		3,664
Other Real Estate Owned	2,101		13,626		13,358		14,075		—			—			15,459		27,701
Total	$	107,483	$	110,171	$	52,620	$	49,251	$	(9,463	)	$	(6,555	)	$	150,640	$	152,867

A roll-forward of REO activity from December 31, 2015 to September 30, 2016 is as follows (dollars in thousands):



	Operating Properties			# of Projects		Held for Development			# of Projects		Held for Sale			# of Projects		Other Real Estate Owned			# of Projects		Total Net Carrying Value
Balance, December 31, 2015	$	116,156		4		$	3,664		2		$	5,346		8		$	27,701		14		$	152,867
Additions:
Capital cost additions	7,842			—		45			—		1			—		115			—		8,003
Reductions:
Cost of properties sold	—			—		—					(2,825		)	(4	)	(281		)	(1	)	(3,106		)
Basis adjustment for TIF receivable and liability forgiveness	—			—		—			—		(4,118		)	—		—			—		(4,118		)
Depreciation and amortization	(3,006		)	—		—			—		—			—		—			—		(3,006		)
Transfers, net	(31,685		)	(2	)	(3,709		)	(2	)	47,470			10		(12,076		)	(6	)	—
Balance, September 30, 2016	$	89,307		2		$	—		—		$	45,874		14		$	15,459		7		$	150,640

During the nine months ended September 30, 2016, we sold six REO assets (or portions thereof) for $3.4 million (net of selling costs), resulting in a total net gain of $0.1 million. During the nine months ended September 30, 2015, we sold twenty REO assets (or portions thereof) for $28.2 million (net of selling costs), resulting in a net gain of $0.1 million.

During the nine months ended September 30, 2016, we reclassified certain REO assets from operating properties, REO held for development and Other REO to REO held for sale due to management’s decision to dispose of such assets and efforts taken to achieve such disposal. In addition, certain liabilities associated with the REO assets were reclassified to notes payable and special assessment obligations for assets held for sale. See Note 7 for further discussion.

In the second quarter of 2015, we were awarded certain real estate assets and equity interests in a number of limited liability companies and limited partnerships with various real estate holdings and related assets in connection with certain enforcement and collection activities. Certain of these entities have been consolidated in the accompanying condensed consolidated financial statements based on our determination of the Company’s controlling financial interest in each such entity.

Based on our analysis, the consolidated entities in which these equity interests were awarded did not meet the definition of a business under GAAP since the only assets of such entities consist of unimproved real estate holdings, and the entities lack inputs and processes necessary to produce outputs. For this and other reasons, the entities did not qualify under the VIE model, and we instead applied the voting interest model to ascertain the need for consolidation. Because the entities do not qualify as businesses, the acquisition of such interests in these entities was deemed to be an asset acquisition, whereby we recorded our proportionate interest of each entity’s total assets and liabilities at fair value at the date of acquisition. Thereafter, any subsequent income or loss is being allocated to controlling and noncontrolling interests based on their respective ownership percentages. The aggregate fair value of our interest in the underlying real estate assets of the consolidated entities, after elimination of intercompany balances, totaled $6.3 million, which is classified in other real estate owned in the accompanying condensed consolidated balance sheets.

REO Development and Operations

Costs related to the development or improvements of the Company’s real estate assets are generally capitalized, and costs relating to operating, holding and maintaining those assets are generally charged to expense. Cash outlays for capitalized development costs totaled $10.7 million during the nine months ended September 30, 2016. Costs related to operating, holding and maintaining our real estate assets were $6.7 million and $19.4 million for the three and nine months ended September 30, 2016, respectively, and $6.0 million and $18.8 million for the three and nine months ended September 30, 2015, respectively.

The Company commenced a capital improvement program at its hotels and restaurants in Sedona, Arizona during the second quarter of 2015 which was substantially completed during the second quarter of 2016. We have incurred total project costs of $11.2 million through September 30, 2016, of which $5.0 million was incurred during the nine months ended September 30, 2016.

As further described in Note 5, the Company and Titan formed Southwest JV for the purpose of holding and developing certain real property in Apple Valley, Minnesota for a planned multi-family residential housing and retail development to be known as Parkside Village (the “Apple Valley Project”). The first phase of the Apple Valley Project consists of a 196-unit multi-family residential housing development known as Gabella. IMH Gabella commenced leasing operations with respect to Gabella’s first 98 units (“Phase I”) in the fourth quarter of 2015 and for the remaining 98 units (“Phase II”) during the first quarter of 2016.

In connection with the development of Gabella, the City of Apple Valley Economic Development Authority (“EDA”) provided various incentives to IMH Gabella help defray the cost of development, the receipt of which were subject to various completion milestones and other requirements. During the three months ended September 30, 2016, IMH Gabella met the development requirements and were granted 1) a Tax Increment Financing (TIF) note receivable in the amount of $2.7 million (the “TIF Note”) which is included in tax increment financing receivable, assets held for sale in the accompanying condensed consolidated balance sheet, 2) the recognition of contingently refundable TIF advances previously provided by the EDA in the amount of $0.6 million, and 3) the forgiveness of certain debt and related accrued interest due to the EDA with a balance totaling $0.8 million previously recorded by IMH Gabella. The TIF Note bears annual interest at 5% and is to be collected over time through the refund of a portion of property taxes collected by Dakota County in excess of the annual pre-development property tax amount. The TIF Note, TIF advances and forgiveness of debt totaled $4.1 million, and were treated as a reduction in the cost basis of Gabella, as they are effectively reducing the taxable base of the improved property. The TIF note receivable is classified as held for sale since it is anticipated that it will be sold in connection with the sale of Gabella.

The completion of Gabella and the subsequent issuance of the final certificate of occupancy during the second quarter of 2016 triggers Titan’s right under the Development Services Agreement (“DSA”) to receive an amount equal to 10% of the profit on any sale of Gabella since the project was completed both ahead of schedule and under-budget. Titan also has certain buy-out rights based on certain occupancy specifications and the passage of time, neither of which has occurred as of September 30, 2016. For the nine months ended September 30, 2016, the Company has recorded the estimated fair value of its contingent profits-payment obligation to Titan of $0.7 million in the accompanying condensed consolidated balance sheet as an increase in the asset basis with an offsetting increase to noncontrolling interests. During the second quarter of 2016, we reclassified Gabella to REO held for sale as a result of management’s decision and actions to market that asset for sale and as of September 30, 2016, Gabella remains classified as REO held for sale. As a condition to sell the Gabella project, we are required to obtain 1) the consent of the EDA, from which the project received various business subsidies to help defray the cost of development of the project under a Development Assistance Agreement and related agreements, and 2) the buyer’s consent to assume any ongoing obligations under these agreements. We are seeking such consent from the EDA in connection with the anticipated sale of Gabella and do not expect such consent to be reasonably withheld. See Note 7 for further discussion.

We continue to evaluate our use and disposition options with respect to our REO assets. REO assets that are classified as held for sale or as other real estate owned are measured at the lower of carrying amount or fair value, less estimated cost to sell, and are subject to fair value analysis on not less than a quarterly basis. REO assets that are classified as held for development or as operating properties are considered “held and used” and are evaluated for impairment when circumstances indicate that the carrying amount exceeds the sum of the un-discounted net cash flows expected to result from the development or operation and eventual disposition of the asset.

Reclassification of Assets from Operating Properties to Real Estate Held for Sale

In the second quarter of 2016, we reclassified our golf course and restaurant operation in Bullhead City, Arizona and Gabella to REO held for sale as a result of management’s decision and actions to dispose of such assets in order to provide capital for the Company and undertake certain initiatives. These operations are actively being marketed to sell, and remain classified as REO held for sale as of September 30, 2016.

Similarly, during the nine months ended September 30, 2015, we entered into an agreement to sell our commercial office building and related assets that were included in our Commercial and Residential Real Estate Leasing Operations segment, but were reclassified to our Mortgage and REO - Legacy Portfolio and Other Operations segment in the third quarter of 2014. The sales transaction closed in the third quarter of 2015.

As of September 30, 2016, Gabella’s assets represented 16.9% of the Company’s total assets. As such, Gabella qualified as an individually significant component of the Company. Our commercial and residential leasing operations, which for all periods prior to September 30, 2016 were presented in the Commercial and Residential Real Estate Leasing Operations segment, but have since been reclassified to our Mortgage and REO - Legacy Portfolio and Other Operations segment, contributed pretax income of $0.1 million for the three months ended September 30, 2016 and $0.6 million in pretax losses for nine months ended September 30, 2016, and $0.1 million and $0.2 million in pretax losses for the three and nine months ended September 30, 2015, respectively.

Based on management’s analysis, the sales of these business operations do not require separate discontinued operations financial statement presentation since the disposition of these assets represent neither a strategic shift for the Company, nor did they have a major effect on our operations and financial results.