The Supreme Court has declined to review a decision of the Court of Appeals for the Third Circuit that a corporate investor wasn’t a bona fide partner in an LLC and thus wasn’t entitled to claim its share of historic rehabilitation tax credits. The Third Circuit found that the investor had no “meaningful stake” in the LLC’s failure or success, and that the transaction was in substance a prohibited sale of the tax credits.
Historic rehabilitation tax credit (rehabilitation credit) is available for the qualified rehabilitation of a qualified building first placed in service before ’36, and a certified historic structure regardless of when placed in service. The rehabilitation credit for a building is generally 10% (20% for a certified historic structure) of the qualified rehabilitation expenditure.
Rehabilitation credits are available only to the owner of the property interest. According to an IRS publication titled “Tax Aspects of Historic Preservation,” the rehabilitation credit cannot be bought or sold.
East Hall is a government-owned convention center in Atlantic City, New Jersey, that is listed as a National Historic Landmark. In ’92, the New Jersey State Legislature authorized the New Jersey Sports and Exposition Authority (NJSEA) to undertake construction of a new convention center and renovate East Hall.
In late ’98, a representative of Sovereign Capital Resources, LLC, which raises equity for historical rehabilitations, contacted NJSEA and was later hired to find an investor for the East Hall’s rehabilitation. Sovereign sent a confidential offering memorandum to prospective investors, which described the transaction as a “sale” of tax credits (which NJSEA couldn’t use since it was tax-exempt) and provided for a 3% preferred return to the investor.
NJSEA formed Historic Boardwalk Hall, LLC (HBH), on June 26, 2000, and Pitney Bowes (PB) was admitted as a member/investor on Sept. 14, 2000. A letter of intent provided that PB would make $16.4 million in “capital contributions” and also made projections of the anticipated rehabilitation credit amounts. The agreement noted that the rehabilitation credits were an integral part of the deal, but didn’t use the term “sale.”
On Sept. 14, 2000, the 35-year lease was extended until Nov. 11, 2087. HBH and NJSEA entered into two agreements on that date, one of which was a sublease of East Hall from NJSEA to HBH, and the other of which treated the lease as a sale and purchase for tax purposes. Pursuant to the lease agreement, HBH purportedly acquired ownership of East Hall.
HBH ultimately claimed rehabilitation expenses as qualifying rehabilitation credit for years 2000–2002 in the following amounts: $38,862,877 for 2000; $68,856,639 for 2001; and $1,271,482 for 2002.
On Feb. 22, 2007, IRS issued a final partnership administrative adjustment (FPAA) covering those years and reallocated all items of income or loss from PB to NJSEA. IRS argued that the formation and operation of HBH was akin to NJSEA selling rehabilitation credits to PB. In its FPAA, IRS determined alternatively that: (i) HBH was a sham; (ii) PB was never a partner in HBH; and (iii) NJSEA never transferred ownership of the hall to HBH.
The Tax Court ruled in favor of HBH, finding that it wasn’t a sham lacking economic substance. The Tax Court also found that PB faced risks as a result of joining HBH and was a bona fide partner.
The Court of Appeals for the Third Circuit reversed the Tax Court, finding that PB didn’t truly join HBH with the intent of carrying on a business and sharing the profits and losses therefrom, and wasn’t a bona fide partner in HBH.
The Court, looking beyond the form of the transaction and considering its substance, found that PB bore no meaningful risk in joining HBH. Specifically, the various agreements effectively immunized PB against losses while also depriving it of any meaningful upside potential. HBH’s argument that PB was nonetheless a legitimate partner was based on mere formalities that arguably gave an “outward appearance of an arrangement to engage in a common enterprise,” but didn’t demonstrate that PB had a meaningful stake in HBH’s success or failure.
HBH subsequently filed a petition for rehearing en banc , which was denied by the Third Circuit in an order dated Oct. 22, 2012.
Decision now final. The Supreme Court has declined to review this case. Accordingly, the Third Circuit’s decision is now final.
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