In Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F. 3rd 141 (4th Cir. 2011), the Fourth Circuit held that the disproportionate allocation of Virginia state historic tax credit to an entity that owned a small interest in a project partnership constituted a “disguised sale” of the state credits. The purchasers of the credit held their partnership interests for a short period. In Route 231 v. Commissioner TCM 2014-30 (February 24 2004), the Tax Court applied the disguised sale analysis to a disproportionate allocation of Virginia conservation easement credit to an entity that remained a partner in an ongoing business.
Recently, SWF Real Estate LLC v. Commissioner, 2015-63 TCM (April 2, 2015) the Tax Court again treated an allocation of Virginia conservation easement credit to a partner that held a small interest in the project partnership as a disguised sale. While the SWF Real Estate did not break any new ground or establish or emphasize new facts in the disguised sale analysis, it added to the string of decisions that are adverse to state credit investors. The growing list of government litigation successes makes it more likely that the transfer of one and done state investment tax credits enacted by states other than Virginia will be treated as a disguised sale.
The tax treatment of allocations of state low-income housing tax credits which carry entrepreneurial risk over a 15 year recapture period remains an open question. While such allocations are frequently made to an investor holding a disproportionately small interest in the project partnership, a high percentage of the credit flows to the investor outside the two year presumptive sale treatment established in Treasury Regulation Section 1.707-3(c). Moreover, the state LIHTC remains available to the investor only to the extent that (1) the project remains in compliance over the recapture period, (2) the project partnership retains ownership of the project, and (3) the investor remains a partner in the investor partnership. These facts argue strongly in favor of a non-disguised sale treatment of state low income housing tax credits.
We anticipate that the application of the disguised sale analysis to state LIHTC programs will be discussed at the ABA Forum meeting with IRS and Treasury officials the afternoon of May 20, 2015.