Fourth Circuit Affirms Route 231 Conservation Credit Ruling

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Jan. 8 — The Fourth Circuit affirmed a U.S. Tax Court decision finding that more than $3.8 million contributed to Route 231 LLC should be treated as ordinary income from a disguised sale of Virginia conservation tax credits (Route 231, LLC v. Commissioner, 2016 BL 4437, 4th Cir., No. 14-01983, 1/8/16).

U.S. Court of Appeals for the Fourth Circuit Judge G. Steven Agee ruled in a Jan. 8 opinion that the Tax Court correctly held that the transfer of Virginia tax credits between Route 231 and Virginia Conservation constituted a disguised sale of property under tax code Section 707, and that the amounts received were reportable as gross income in the 2005 tax year (37 DTR K-3, 2/25/14).

Route 231 made two arguments on appeal from the Tax Court including the assertion that the Virginia tax credit transaction constituted a nontaxable capital contribution followed by a permissible allocation of partnership assets to a bona fide partner. The partnership further argued that even if Virginia Conservation's payment was part of a sale of tax credits, the sale occurred in 2006 and not 2005.

Section Validity

According to the opinion, Route 231 didn't challenge the validity of tax code Section 707, but argued that the section couldn't be applied to the transaction at issue because the entities involved were “bona fide entities in a genuine contractual relationship.”

“The Commissioner does not contest that Route 231 is a valid entity or that Virginia Conservation is a true partner in it,” the opinion said, adding that Route 231's argument fails under the plain language of the section.

The language “expressly applies to transactions between a partner and partnership without qualification whenever a partner ‘engages in a transaction with a partnership other than in his capacity as a member of such partnership,' ” Agee said.

Agee ruled further that the court hadn't expressly analyzed whether a partnership was legitimate in prior cases dealing with the scope of Section 707.

Turning Point

According to Agee, the case turned on the nature of the transaction at issue, which was the exchange of Virginia tax credits for money, and he ultimately found that the totality of the facts and circumstances formed the court's opinion that “the Tax Court correctly determined that this transaction was a sale.”

“At bottom, Virginia Conservation's right to the tax credits depended on fixed contractual terms, not the entrepreneurial risks of Route 231's operations,” the opinion said.

Regarding the year that the sale took place, the court found none of Route 231's arguments on the applicable tax year to be meritorious, pointing out that on its 2005 tax return Route 231 had represented to the Internal Revenue Service that the events constituting the transaction occurred in 2005.

According to the court's opinion, “A taxpayer may be barred from taking one factual position in a tax return and then taking an inconsistent position later in a court proceeding in an effort to avoid liability based on the altered tax consequences of the original position.”

Ignored Agreements

Route 231 argued that the court's analysis ignored the language of escrow agreements that didn't authorize release of the funds from escrow until March 2006. However, Agee ruled that the totality of the relevant circumstances pointed to the Tax Court correctly determining that the sale occurred in 2005.

Circuit Judge James A. Wynn Jr. and Senior Circuit Judge Clyde H. Hamilton joined in Agee's opinion.

Timothy Lee Jacobs of Hunton & Williams LLP in Washington represented Route 231. Richard Farber of the Department of Justice represented the commissioner.

To contact the reporter on this story: Matthew Beddingfield in Washington at
To contact the editor responsible for this story: Cheryl Saenz at

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