Friday, June 3, 2011

Credits for Rehab of Historic Structures

Tweet

To encourage private investment in the renovation of historic structures, income tax credits have been made available at both the state and federal levels.  Partnerships have been the preferred vehicle for taking advantage of these credits.  However, in at least two cases, the IRS has challenged the use of a partnership to obtain income tax credits for the renovation of historic structures.  The IRS position has been that the investors should not be respected as partners and that the credits were, in fact, sold.

In Va. Hist. Tax Credit Fund 2001 LLC v. Comr., investors made capital contributions to certain funds which then partnered with historic property developers.  The funds’ subscription agreements promised the investors a precise number of state tax credits based on the amount of money contributed to the funds.  Most investors owned only a .01% interest in the funds, and were to expect no material allocation of partnership income, gain, deduction, or loss.  The funds promised the investors that capital contributions would be refunded if sufficient credits could not be obtained or were revoked, and this promise was mirrored in the funds’ agreements with the developers.  Further, the funds promised not to make any significant investment until the projects were already guaranteed to qualify for the credits.  After the investors claimed the credits on their state income tax returns, the general partner of the fund purchased the interests of the investors for a nominal amount. 

Another case, Historic Boardwalk Hall v. Comr., involved partnership allocations of federal income tax credits.  A public entity formed a limited liability company and contributed a long-term lease on a convention center that was to be rehabilitated.  The public entity became a .1% managing member upon the admission of a private corporation as a 99.9% investor owner.  The managing member took draws against the investor member’s capital contributions for obtaining government approvals, insurance, and overseeing the project’s completion.  The partnership agreement provided that the managing member would indemnify the investor for any costs associated with environmental hazards and IRS challenges, and provided several possible options to transfer the investor member’s interest to the managing member. 

In both cases, the Tax Court ruled against the IRS.  The Tax Court found a business purpose for the investors participation in the law-profitability venture because they expected the tax credits to yield a considerable economic benefit net of costs and risks associated with the partnerships’ operations.  And, the Tax Court found significant that the purpose of the sort of credits at issue: to encourage taxpayers to participate in what would otherwise be an unprofitable activity. 

On appeal of Va. Hist. Tax Credit Fund 2001 LLC v. Comr., the Fourth Circuit reversed the Tax Court, finding that the investors were not partners and that there had been a “disguised sale” of the state income tax credits.  While acknowledging that state law provided for an allocation of credits as the partners mutually agree, the appellate court ruled that the investors faced insufficient risk to rebut a regulatory presumption of a disguised sale.  The court agreed with the IRS that the investors’ capital contributions should have been reported as income.   

These cases, and others like them, seem to pose unique problems of business, economic policy, and federalism. 

Any thoughts?

-- Ryan Prillaman, Editor, Federal Tax Law
 

All BNA publications are subscription-based and require an account. If you are a subscriber to the BNA publication and signed-in, you will automatically have access to the story. If you are not a subscriber, you will need to sign-up for a trial subscription.