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October 16, 2012

Court Issues "Historic" Decision In Tax Credit Case

On August 27, 2012, the United States Court of Appeals for the Third Circuit rendered a decision in the case of Historic Boardwalk Hall, LLC v. Commissioner.1 The Court's decision had an instant impact on the rehabilitation of historic buildings and the design of the transactions which have been used to finance such rehabilitations in the past.

Section 47 of the Internal Revenue Code allows a taxpayer to claim a dollar-for-dollar tax credit ("Historic Tax Credits") equal to 20% of certain expenditures made to renovate certified historic structures. The IRS has stated its position that the Internal Revenue Code does not permit Historic Tax Credits to be sold for use by taxpayers other than the owner of a certified historic structure.

In the Historic Boardwalk Hall case, the State of New Jersey formed a state agency known as the NJSEA. In 1992, the State legislature authorized the NJSEA to acquire, renovate and operate the East Hall, an historic landmark, which is located on the boardwalk in Atlantic City, New Jersey. Thereafter, the NJSEA created a limited liability company named Historic Boardwalk Hall, LLC (the "Company") and, through the issuance of a confidential offering memorandum, sold a 99.9% membership interest in the Company to a wholly-owned subsidiary of Pitney Bowes, Inc. (the "Investor").

The Company ultimately claimed a substantial amount of Historic Tax Credits on its tax return with respect to the expenditures made to renovate East Hall. In accordance with the membership percentages of the Company, these Historic Tax Credits were allocated 99.9% to the Investor.

Following an audit, the IRS determined that the Company was simply a vehicle to transfer Historic Tax Credits from the NJSEA, the owner of East Hall, to the Investor in violation of the Internal Revenue Code. Accordingly, the IRS re-allocated all of the Historic Tax Credits claimed by the Investor to the NJSEA. The Tax Court disagreed with the IRS' determination2 and the IRS appealed to the Court of Appeals for the Third Circuit.

The Court of Appeals reversed the Tax Court and found that the Investor was not a bona fide partner in the Company. Specifically, the Court concluded that the Investor did not have any meaningful downside risk in the Company, nor any meaningful upside potential in the Company. The Court found that the documents evidencing the Investor's relationship with the Company and the NJSEA in effect guaranteed the Investor would recoup its investment and receive the Historic Tax Credits regardless of the success or failure of the rehabilitation of East Hall and the Company's subsequent operations. In addition, the Court cited the reality that the Company would not have any cash remaining after certain required payments to the NJSEA that would allow the Investor to share in any upside of the Company.

Although the facts in the Historic Boardwalk Hall case were somewhat unusual, in substance the transaction was not atypical for deals of this nature. It now seems clear that the typical structure used for rehabilitation projects to this point will have to be revised to insure that the tax credit investor has the ability to share significantly in the upside potential of the rehabilitation project and has at least some downside risk in the project. The unknown right now is how much upside potential and how much downside risk will be sufficient to insure that the structure of the transaction will pass IRS scrutiny.

If you require further information regarding the information presented in this Legal Alert and its impact on your organization, please contact any of the members of the Tax Practice Area.

1 110 A.F.T.R. 2d 2012-5710.
2 136 T.C. 1 (2011).


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