Inventory and land held for sale

Major components of inventory at December 31, 2012 and 2011 were ($000’s omitted):



	2012		2011
Homes under construction	$	1,116,184	$	1,210,717
Land under development	2,435,378		2,610,501
Raw land	662,484		815,250
	$	4,214,046	$	4,636,468

We capitalize interest cost into inventory during the active development and construction of our communities. Each layer of capitalized interest is amortized over a period that approximates the average life of communities under development. Interest expense is recorded based on the cyclical timing of home closings. During 2012 and 2011, we capitalized all Homebuilding interest costs into inventory because the level of our active inventory exceeded our debt levels. During 2010, we capitalized all Homebuilding interest costs into inventory except $1.5 million that was expensed directly to interest expense due to our debt levels exceeding our active inventory levels for a portion of the year.

Information related to interest capitalized into inventory is as follows ($000’s omitted):



	Years Ended December 31,
	2012			2011			2010
Interest in inventory, beginning of period	$	355,068		$	323,379		$	239,365
Interest capitalized	201,103			221,071			264,932
Interest expensed (a)	(224,291		)	(189,382		)	(180,918		)
Interest in inventory, end of period	$	331,880		$	355,068		$	323,379
Interest incurred (b)	$	201,103		$	221,071		$	266,474


(a)	Interest expensed to Homebuilding cost of revenues for 2012, 2011, and 2010 included $6.5 million, $5.4 million, and $27.6 million, respectively, of capitalized interest related to inventory impairments.


(b)	Homebuilding interest incurred includes interest on senior debt and certain other financing arrangements.

Land valuation adjustments and write-offs

Impairment of inventory

We record valuation adjustments on land inventory and related communities under development when events and circumstances indicate that they may be impaired and when the cash flows estimated to be generated by those assets are less than their carrying amounts. Such indicators include gross margin or sales paces significantly below expectations, construction costs or land development costs significantly in excess of budgeted amounts, significant delays or changes in the planned development for the community, and other known qualitative factors. For communities that are not yet active, an additional consideration includes an evaluation of the probability, timing, and cost of obtaining necessary approvals from local municipalities and any potential concessions that may be necessary in order to obtain such approvals. We also consider potential changes to the product offerings in a community and any alternative strategies for the land, such as the sale of the land either in whole or in parcels. Communities that demonstrate potential impairment indicators are tested for impairment. We compare the expected undiscounted cash flows for these communities to their carrying value. For those communities whose carrying values exceed the expected undiscounted cash flows, we estimate the fair value of the community. Impairment charges are required to be recorded if the fair value of the community's inventory is less than its carrying value.

We determine the fair value of a community's inventory using a combination of market comparable land transactions, where available, and discounted cash flow models. These estimated cash flows are significantly impacted by estimates related to expected average selling prices, expected sales paces, expected land development and construction timelines, and anticipated land development, construction, and overhead costs. The assumptions used in the discounted cash flow models are specific to each community tested for impairment. Due to uncertainties in the estimation process, the significant volatility in demand for new housing, and the long life cycles of many communities, actual results could differ significantly from such estimates. Our determination of fair value also requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with each of the assets and related estimated cash flow streams. The discount rate used in determining each community's fair value depends on the stage of development of the community and other specific factors that increase or decrease the inherent risks associated with the community's cash flow streams. For example, communities that are entitled and near completion will generally be assigned a lower discount rate than communities that are not entitled and consist of multiple phases spanning several years of development and construction activity.

In 2012, we reviewed each of our land positions for potential impairment indicators and performed detailed impairment calculations for 35 communities. As discussed above, determining the fair value of a community's inventory involves a number of variables, many of which are interrelated. The table below summarizes certain quantitative unobservable inputs utilized in determining the fair value of impaired communities during 2012:



Unobservable input	Range
Average selling price ($000s)	$139	-	$626
Sales pace per quarter (units)	1	-	9
Discount rate	12%	-	16%

The table below provides, as of the date indicated, the number of communities for which we recognized impairment charges, the fair value of those communities at such date (net of impairment charges), and the amount of impairment charges recognized ($000’s omitted):



	2012					2011
Quarter Ended	Number of Communities Impaired	Fair Value of Communities Impaired, Net of Impairment Charges		Impairment Charges		Number of Communities Impaired	Fair Value of Communities Impaired, Net of Impairment Charges		Impairment Charges
March 31	4	$	7,468	$	4,514	1	$	483	$	103
June 30	4	16,311		2,796		6	6,665		3,300
September 30	4	6,172		2,263		3	6,416		1,494
December 31	5	11,243		3,864		25	23,766		11,043
				$	13,437				$	15,940

We recorded these valuation adjustments within Homebuilding home sale cost of revenues.

Our evaluations for impairments were based on our best estimates of the future cash flows for our communities. However, if conditions in the homebuilding industry or our local markets worsen in the future or if our strategy related to certain communities changes, we may be required to evaluate our assets for future impairments or write-downs, which could result in future charges that might be significant.

Net realizable value adjustments – land held for sale

Land held for sale is valued at the lower of carrying value or fair value less costs to sell. In determining the fair value of land held for sale, we consider recent offers received, prices for land in recent comparable sales transactions, and other factors. During 2012, 2011, and 2010, we recognized net realizable value adjustments related to land held for sale of $1.5 million, $9.8 million, and $39.1 million, respectively. We record these net realizable value adjustments within Homebuilding land sale cost of revenues. Land held for sale at December 31, 2012 and 2011 was as follows ($000’s omitted):



	2012			2011
Land held for sale, gross	$	135,201		$	190,099
Net realizable value reserves	(44,097		)	(54,792		)
Land held for sale, net	$	91,104		$	135,307

Write-off of deposits and pre-acquisition costs

We wrote off (net of recoveries) deposits and pre-acquisition costs in the amount of $2.3 million, $10.0 million, and $5.6 million, during 2012, 2011, and 2010, respectively. We record these write-offs of deposits and pre-acquisition costs within other expense (income), net.