Note 11 - Income Taxes

Income taxes have been provided using the liability method under ASC 740. The liability method is used in accounting for income taxes where deferred income tax assets and liabilities are determined based on differences between financial reporting and tax basis of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse.

The components of income tax expense for the years ended December 31, 2016, 2015 and 2014 are as follows (in thousands):


	For the Years Ended December 31,
	2016		2015		2014
Current:
Federal	$	542	$	253	$	—
State		364		183		—
Total current		906		436		—

Deferred:
Federal		(93,383)		—		—
State		(17,044)		—		—
Total deferred		(110,427)		—		—
Total income tax expense (benefit)	$	(109,521)	$	436	$	—

Deferred income taxes reflect the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred income tax assets and liabilities as of December 31, 2016 and 2015 are as follows (in thousands):


	December 31,
	2016		2015
Deferred income tax assets:
Net operating loss carryforward and credits	$	47,529	$	56,768
Impairment charges		48,311		53,103
Other inventory valuation adjustments		13,819		15,338
Land development reserves		5,270		5,321
Other reserves and accruals		5,028		4,745
Executive incentive compensation		2,352		2,112
Total deferred income tax assets		122,309		137,387
Valuation allowance for deferred tax assets		—		(124,525)
Net deferred income tax assets		122,309		12,862

Deferred income tax liabilities:
Deferred gain		(6,246)		(7,094)
State taxes		(2,800)		(3,139)
Depreciation		(1,222)		(1,772)
Goodwill		(1,013)		—
Capitalized expenses		(771)		(857)
Total deferred income tax liabilities		(12,052)		(12,862)
Net deferred income tax assets	$	110,257	$	—

As of December 31, 2016, our gross federal and state NOL carryforwards were approximately $106.5 million and $264.9 million, respectively. Federal NOL carryforwards may be used to offset future taxable income for 20 years and begin to expire in 2030. State NOL carryforwards may be used to offset future taxable income for a period of time ranging from 5 to 20 years, depending on the state, and begin to expire in 2016.

We evaluate our deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. The realization of the deferred tax assets ultimately depends upon the existence of sufficient taxable income in future periods. We established a full valuation allowance against our deferred tax assets beginning in 2009 and regularly analyzed all available positive and negative evidence in determining the continuing need for a valuation allowance with respect to our deferred tax assets. This evaluation considered, among other factors, historical operating results, our three-year cumulative profit or loss position, forecasts of future profitability, and the duration of statutory carryforward periods.

From 2007 to 2014, we generated significant deferred tax assets primarily from asset impairments and reduced operational profitability. As of June 30, 2016 and December 31, 2015, we had net deferred tax assets of $121.2 million and $124.5 million, respectively. The December 31, 2015 net deferred tax asset was offset by a valuation allowance of $124.5 million. During the first quarter of 2016, we recognized a decrease of $0.6 million in the valuation allowance generated from the pre-tax income for the period. During the second quarter of 2016, we evaluated both positive and negative evidence and determined it was “more likely than not” that our federal deferred tax assets and our state deferred tax assets will be realized. Accordingly, we reversed $112.9 million during the second quarter of 2016. When a change in valuation allowance is recognized in an interim period, a portion of the valuation allowance to be reversed must be allocated to the remaining interim periods. The remaining valuation allowance of $11.0 million was reversed in the third and fourth quarters of 2016. These reversals are reflected in our income tax benefit in the accompanying consolidated statements of operations and comprehensive income (loss). There is no remaining valuation allowance as of December 31, 2016.

The principal positive evidence that led to the reversal of the valuation allowance during the second quarter of 2016 includes the following:

Achievement and sustained growth of our three-year cumulative pre-tax profit. During the fourth quarter of 2015, we emerged from our three-year cumulative pre-tax loss position, producing a nominal cumulative pre-tax profit. This cumulative pre-tax profit increased to $20.1 million by the quarter ended June 30, 2016.

Pre-tax income in six of the last eight quarters, including four consecutive quarters of pre-tax income through June 30, 2016. Beginning with the quarter ended September 30, 2015, we reported pre-tax income consistently through the quarter ended June 30, 2016. The pre-tax income in the four consecutive quarter period totaled $30.0 million.

Significant pre-tax income through 2016. The pre-tax income reported for the three months ended March 31, 2016 and June 30, 2016 of $0.9 million and $7.3 million, respectively, and the increased backlog of sold homes closed in the second half of 2016 supported the expected increased level of profitability for the full year.

Continued improvements in 2016 over recent years in other key operating metrics, including revenue growth and selling, general and administrative expense (“SG&A”) margin, with relatively consistent gross margins. Homebuilding revenue has increased from $115 million for the year ended December 31, 2013 to $499 million for the year ended December 31, 2015. SG&A as a percentage of homebuilding revenue has decreased from 30.9% to 16.0% in that same time period, while gross margins have remained between 18% and 20%. In addition, SG&A as a percentage of homebuilding revenue decreased to 15.1% for the six months ended June 30, 2016.

Evidence that conditions in the U.S. economy, and specifically the U.S. housing industry, continue to be favorable and our belief that conditions will continue to be favorable over the long-term. The pace of construction remains higher than a year ago as the real estate sector increasingly reflects the stronger job market. Approved building permits for new residential construction continued to rise in 2016.

Any interest or penalties assessed have been minimal and immaterial to our financial results. In the event we are assessed any interest or penalties in the future, we plan to include them in our consolidated statements of operations and comprehensive income (loss) as income tax expense.

No additional income tax benefits were generated from the exercise of share-based compensation during 2016, 2015 and 2014.

A reconciliation of income tax expense (benefit) to the expected income tax expense (benefit) at the federal statutory rate of 35% for each of the years ended December 31, 2016, 2015 and 2014 is as follows (in thousands):


	For the Years Ended December 31,
	2016		2015		2014
Income tax expense (benefit) computed at statutory rate	$	13,155	$	4,320	$	(522)
State income tax expense, net of federal benefit		1,201		1,452		823
Change in valuation allowance on deferred tax assets		(124,525)		(5,336)		(370)
Change in state rate		688		—		—
Other		(40)		—		69
Income tax expense (benefit)	$	(109,521)	$	436	$	—

We file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. We are subject to U.S. federal income tax examination for calendar tax years ending 2013 through 2015. Additionally, we are subject to various state income tax examinations for the 2012 through 2015 calendar tax years.