On February 24, 2014, the tax court in Route 231, LLC v. Commissioner addressed the recognition of income for transfers of Virginia Land Preservation Tax Credits (“VLPTCs”). At issue was the transfer of VLPTCs from Route 231, LLC (“Route 231”), a federal passthrough entity, to Virginia Conservation, a partner in Route 231. Because the case originates in Virginia, within the jurisdiction of the Fourth Circuit that decided the Virginia Historic case (Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F3d 129 (4th Cir. 2011)), the tax court was required to apply the analysis adopted by the Fourth Circuit in Virginia Historic. Accordingly, the tax court treated the VLPTCs as property and applied the disguised sale analysis of Virginia Historic. The court concluded the transfer of VLPTCs from Route 231 to Virginia Conservation was a disguised sale of state credits, finding that six of the ten facts and circumstances of Section 1.707-3(b)(2) of the Treasury Regulations (governing disguised sales) weighed in favor of disguised sale treatment. As a result, the court concluded that Route 231 should recognize income from the sale of VLPTCs in the year in which the transaction occurred.
The ruling in Route 231 expanded the holding in Virginia Historic. Prior to the Route 231opinion, members of the state historic tax credit industry were mostly concerned with ensuring that partners of partnerships would be respected as partners for federal tax purposes, since in Virginia Historic, the state credits at issue were nontransferable state historic tax credits that were only allocable to owners of or partners in rehabilitated historic tax credit projects. In comparison, VLPTCs can be purchased and sold to non-owner entities. Rather than challenging whether Virginia Conservation was a partner of Route 231, instead the court concluded that the transaction was between a partnership and a partner not acting in its capacity as a partner pursuant to Section 707(a) of the Internal Revenue Code and the Treasury Regulations.
Route 231 is significant for two major reasons. First, the principles of Virginia Historic were applied to a non-historic credit. It is clear that both the IRS and the courts will apply the principles of Virginia Historic to any investment tax credit-style “one and done” state credits. Second, unlike the transient investors in Virginia Historic, the investor remained as a partner and participated in the operation and economic benefits of a winery, event space, farm and orchard owned by Route 231. The fact that the investor was clearly a partner for federal tax purposes and held a long-term economic investment in the property is irrelevant to the disguised sale analysis. Within the Fourth Circuit, taxpayers should anticipate that any “allocated” one and done state credit will be taxable to the project owner unless it is allocated to the same investor that acquires the federal credits.