The Third Circuit Court of Appeals determined in Historic Boardwalk Hall v. Commissioner, 694 F.3d 425 (3d Cir. 2012) that an investor in a partnership that rehabilitated an historic structure did not have a meaningful stake in either the success or failure of the partnership and, therefore, was not treated as a partner of the partnership for federal income tax purposes. As a result of that determination, the court upheld the disallowance by the Internal Revenue Service (the IRS) of the allocation to the investor of rehabilitation/historic credits (HTCs) available to the partnership under Section 47 of the Internal Revenue Code (the Code). The decision in Historic Boardwalk had a chilling effect on investor comfort with obtaining HTCs from partnership investments, significantly decreasing equity financing for the rehabilitation of historic structures. Extensive subsequent discussions between the IRS and the HTC community ensued in an attempt to get some comfort on the characteristics of transactions that the IRS would not challenge.
Revenue Procedure 2014-12, released by the IRS on December 30, 2013 is the IRS response to the fallout fromHistoric Boardwalk, establishing a safe harbor pursuant to which the IRS has agreed to not challenge HTCs allocated by a partnership that complies with all of the requirements of the safe harbor. Such safe harbor is similar in some respects to the safe harbor established by Rev. Proc. 2007-65 for the allocation of renewable energy production tax credits authorized by Section 45 of the Code. This Bulletin summarizes the safe harbor and offers insights into the application of the requirements set forth in Rev. Proc. 2014-12.
Scope and Effective Date of the Safe Harbor
Rev. Proc. 2014-12 specifies that the IRS will not challenge a partnership’s allocation of HTCs if the partnership and its partners comply with the requirements set forth in Section 4 of the Rev. Proc. (a Safe Harbor Compliant Partnership). The amount and/or availability of HTCs to a Safe Harbor Compliant Partnership remain subject to challenge by the IRS for other reasons, including particular expenditures not being properly capitalized into the basis of a building, all or a portion of the historic building constituting tax-exempt use property, or the partnership not being properly treated for federal income tax purposes as the owner of the historic building.
The safe harbor applies to HTCs available to both a partnership that owns the historic building (a Developer Partnership) and a partnership that leases the historic building from the Developer Partnership (a Master Tenant Partnership). In a Developer Partnership transaction the HTCs are allocated to the partners of the Developer Partnership. In a Master Tenant Partnership structure an election is made to treat, solely for HTC purposes, the Master Tenant Partnership as having purchased the building from the Developer Partnership and thereby permit the HTCs that would otherwise be available to the Developer Partnership to “pass through” to the Master Tenant Partnership and be allocated to its partners. Rev. Proc. 2014-12 also explicitly authorizes the use of a common structuring technique in Master Tenant Partnership structures whereby the Master Tenant Partnership not only leases the historic building from the Developer Partnership, but also acquires an interest in the Developer Partnership in return for a capital contribution consisting of a substantial portion of the Investor’s capital contribution to the Master Tenant Partnership, permitting the use of such funds to rehabilitate the historic building and permitting the Investor to share in a portion of the depreciation deductions available to the Developer Partnership.
The safe harbor does not apply to allocations of any federal credits other than HTCs, and the IRS explicitly reserves the right to challenge the allocation of state credits as a sale of intangible property for federal income tax purposes (as was done in Virginia Historic Tax Credit Fund v. Commissioner, 639 F.3d 129 (4th Cir. 2011)).
Rev. Proc. 2014-12 is effective for any allocation of HTCs made on or after December 30, 2013. For any transactions that closed prior to December 30, 2013 where the rehabilitation expenditures have not yet been placed in service, consideration should be given to revisiting the transaction documents to evaluate the desirability of modifying them, prior to the PIS Date, to comply with the requirements of the safe harbor. For rehabilitations that have already been placed in service, however, there will be no benefit obtained by modifying the transaction documents to become a Safe Harbor Compliant Partnership. In that regard it is important to remember that the requirements of the safe harbor do not establish substantive tax rules, and no inference is to be drawn as to the validity of allocations of HTCs by a partnership that is not a Safe Harbor Compliant Partnership.