The Fourth Circuit Court of Appeals ruled against the taxpayers in Virginia Historic Tax Credit Fund 2001 LLP v. Commissioner (docket no. 10-1333), reversing the Tax Court. As noted in Tax Matters coverage (April 2011, page 52) of the Tax Court’s holding in Historic Boardwalk Hall LLC v. Commissioner, 136 TC no. 1, in both that case and this one, the Tax Court allowed an investor or investors as partners to acquire a historic tax credit. In doing so, the Tax Court analyzed the partnership status of investors in projects yielding federal (Historic Boardwalk Hall) and state (the instant case) historic rehabilitation credits under the criteria of Commissioner v. Culbertson, 337 U.S. 733 (1949). In both cases, it found the investors assumed entrepreneurial risk. In Virginia Historic Tax Credit Fund, the Tax Court then rejected the IRS’ arguments that the transactions were disguised sales under IRC § 707 rather than, as the funds claimed, contributions to capital.
The Fourth Circuit focused on the disguised sale rules, applying Treas. Reg. § 1.707-3. Under them, a transfer of property by a partner to a partnership in exchange for money or other consideration is a sale of property if, considering all the facts and circumstances, the transfer of money or other consideration would not have taken place but for the transfer of property (Treas. Reg. § 1.707-3(b)). A transfer of money or other consideration that occurs within two years of the transfer of property is presumed to be a sale (Treas. Reg. § 1.707-3(c)).
Extrapolating the definitions of property for the purposes of federal tax liens in U.S. v. Craft, 535 U.S. 274 (2002), and Drye v. U.S., 528 U.S. 49 (1999), into this context, the Fourth Circuit held that the tax credits were property within the meaning of section 707. Those factors include the right to use the property, to receive income produced by it and to exclude others from it. They also include the breadth of control the taxpayer could exercise over the property and whether a right is valuable. Another relevant factor, the court said, is transferability. The tax credits carried such property rights, the Fourth Circuit said. They were valuable, and the funds were given control over them that included their exclusive use and distribution. Although Virginia is not among states that allow historic tax credits exceeding a developer’s tax liability to be sold or transferred directly, the court said, their allocation in exchange for a contribution to a partnership—as in this case—constituted a property right, and to hold otherwise would elevate form over substance “in precisely the manner we are advised to guard against.”
Having determined that the credits were property, the court looked at whether the facts indicated that the presumption in Treas. Reg. § 1.707-3(c) should not be applied. In deciding this question, the court considered those facts in light of the factors enumerated in Treas. Reg. § 1.707-3(b). The court found that the factor analysis strongly indicated that the transaction was a sale. It further found that the entrepreneurial risk, which was the basis of the Tax Court’s holding, was very small or nonexistent. Therefore, the court held that the Treas. Reg. § 1.707-3(c) presumption applied, and the transfers of the credits were sales.
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