The Historic Boardwalk Hall Case in which the Internal Revenue Service challenged the traditional structure used by tax credit investors in the syndication of Federal Historic Tax Credits came to an uncerimonial end with the denial by the United State Supreme Cout of the taxpayer’s writ of certiorari to the high court. As reported in an earlier entry on this blog, the Service has announced its intention to provide guidance, most likely in the form of a Revenue Procedure, which will provide a safe harbor for investors in Federal Historic Tax Credits. It is anticipated that the safe harbor will reflect the position of the Service in the Historic Boardwalk Hall Case and an investor must demonstrate that it is a partner for Federal income tax purposes with downside risk and upside potential as a partner.
In the aftermath of the Third Circuit’s decision in Historic Boardwalk Hall LLC v. Commissioner, the IRS has announced its intention to provide guidance for tax structures where developers work with investors to use Federal Historic Tax Credits to further the development of historic structures. While the Service acknowledges that Congress supports the rehabilitation of historic buildings, the position of the Service is that partnerships with investors must conform to the Service’s historic requirements for tax partnerships. It is anticipated that the guidance from the IRS to come in a revenue procedure that provides a safe harbor similar to what Rev. Proc. 2007-65, 2007-45 offers for the section 45 wind energy production tax credit.. If this is the case, we can expect the Service to require that the investors have real upside and downside as a partner which was the Service’s position articulated in the Historic Boardwalk Hall LLC case.
On Thursday, January 17, 2013 Counsel for Historic Boardwalk Hall and the New Jersey Sports and Exposition Authority filed a Petition for a Writ of Certiorari in the United States Supreme Court seeking reversal of the Third Circuit Opinion in the Historic Boardwalk Hall Case. The Third Circuit in the Historic Boardwalk Hall case had reversed the Tax Court decision and ruled that the Pitney Bowes affiliate was not a true partner in Historic Boardwalk Hall, LLC. As a result, the Third Circuit affirmed the IRS Administrative Adjustment to reallocate all of the Historic Rehabilitation Tax Credits from Pitney Bowes to the tax-exempt New Jersey Sports and Exposition Authority, a political subdivision of the State of New Jersey. The taxpayer in the petition argues that “…this is the first litigated case in the country in which the IRS has made a sweeping challenge to the allocation of federal HRTCs from a partnership to a partner in the very type of rehabilitation project that formed the basis for Congressional enactment of the HRTC statute. In a true sense, this case represents a dramatic legal clash between the Legislative Branch’s clearly stated intent in enacting the HRTC statute to encourage private investment in the restoration of historic properties…”. While petitions for a writ of certiorari are rarely granted by the Supreme Court, the taxpayer advanced several arguments which may form the basis of granting the writ including the resolution of conflicting decisions in the Circuits and a reversing a decision which is inconsistent with the Supreme Court’s holding in Commissioner v. Culbertson.
The Creating American Prosperity through Preservation Act of 2012 is a proposed bill which would expand the rehabilitation tax credit. The Act would increase the Historic Tax Credit from 20 percent to 30 percent of qualified rehabilitation expenditures for smaller projects that cost less than $7.5 million. The Act would also provide additional tax credits for including energy efficiencies in redevelopment projects and would allow for any state historic tax proceeds to be exempt from federal tax. Energy-efficiency is promoted by increasing the amount of the credit by 2 percentage points for every project that increases the building’s energy efficiency by 30 percent. And while historically the historic tax credit’s tax exempt leasing rules make it difficult for nonprofits to access the historic tax credit, the Act would permit nonprofits greater access to the rehabilitation credit.
The petition for rehearing filed by taxpayer in the Historic Boardwalk case was reviewed the Third Circuit Court of Appeals judges who participated in the Historic Boardwalk case and the other available circuit judges of the Third Circuit Court of Appeals. The Third Circuit Court of Appeals noting that no judge who concurred in the Historic Boardwalk decision asked for a rehearing, and a majority of the circuit judges of the circuit in regular service did not vote for rehearing, denied the petition for rehearing by the panel and the Third Circuit Court of Appeals en banc. The only appeal left to the taxpayer in the Historic Boardwalk case is to the United States Supreme Court.
Following the reversal by the Third Circuit Court of Appeals of the Tax Court’s decision in the Historic Boardwalk case, the taxpayer has filed a petition for a rehearing or rehearing en banc of the Historic Boardwalk Hall case. The taxpayer’s brief in support of the petition asserts that the Third Circuit Court of Appeals misapplied the reasoning of the U. S Supreme Court case of Commissioner v. Culbertson. Under Culbertson, a partnership exists if, based on the totality of the facts and circumstances, it is determined that “the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise.” The brief also contends that the Court of Appeals made a fundamental error in treating the historic tax credits as a return of capital. It is not common for cases to be reheard especially when there was no dissent on the panel. If the petition is denied the only appeal remaining is to the United States Supreme Court.
In the aftermath of the Historic Boardwalk case, the Historic tax credit investment community is struggling with a partnership investment structure which will not be challenged by the Service. Conceptually one may only need to look to Rev. Proc. 2007-65 in which the Service set forth a safe harbor for investors in partnerships owning qualified energy facilities. The positions advanced by the Service in its appeal of the Tax Court decision in the Historic Boardwalk case mirrored many of the safe harbor requirements of the Rev. Proc. 2007-65. As a result, to follow the safe harbor of Rev. Proc. 2007-65 one would conclude at a minimum future historic tax credit partnership agreements should: (1) provide both cash flow and tax credits to the investor; (2) no longer be structured as “pay as you go” transactions; (3) no longer have tax credit indemnities in favor of the investor; and (4) no longer have an investor “put” to the developer for nominal consideration. To sum up, developers and investors looking for guidance after the Historic Boardwalk Case may find comfort in the “safe harbor” of Rev. Proc. 2007-65
In the aftermath of the Third Circuit Court of Appeal’s decision in the Historic Boardwalk Case, investors, accountants, attorneys, and developers have been analyzing and discussing the ramifications of this case for the Historic Tax Credit industry. Several historic tax credit investors have indicated that they are on hold for future historic tax credit investments and many tax counsels to historic tax credit investors have indicated challenges to their ability to issue tax benefit legal opinions to their clients. Some of the preliminary pronouncements from the Historic Tax Credit industry are that future deals will need to generate real cash flow which will not be paid for by investors, non-profit deals will be challenging because of the real lack of upside potential, and for tax opinions to be issued deals may need to be structured to follow the safe harbor provided by the Internal Revenue Service in Revenue Procedure 2007-65 which addressed the partnership flip with the wind production tax credit. In a nutshell, it may be a period of time before the historic tax credit syndication market opens again and when it does it may look a lot different than before the Historic Boardwalk Case.
Dealing a blow to the Historic Tax Credit syndication industry, the Third Circuit Court of Appeals on August 27th reversed the Tax Court decision in the Historic Boardwalk Case. In siding with the Internal Revenue Service, the Court of Appeals examined a partnership structure commonly used in the syndication of federal Historic Tax Credits and ruled that the tax credit investor was not partner in the entity generating the Historic Tax Credits. The Court of Appeals concluded that the tax credit investor “did not have any meaningful downside risk or any meaning upside potential in HBH [the entity generating the historic tax credits].” Citing a tax credit recapture guaranty in favor of the tax credit investor to protect its capital contributions and a guaranteed investment contract in favor of the tax credit investor to guaranty its 3% preferred return, the Court of Appeals determined there was no downside risk to the tax credit investor. In a similar vein, the Court of Appeals concluded that the consideration contained in the put and call agreements for the sale of the tax credit investor’s partnership interest had no bearing to the economic reality of the transaction. While the Internal Revenue Service appealed the Tax Court decision on several grounds, the Court of Appeals assumed for purposes of its opinion that the transaction had economic substance and based its decision on one issue – whether the tax credit investor was a partner. Although the Court of Appeals acknowledged sensitivity that “… we may jeopardize the viability of future historic rehabilitation projects,” the Court found that “[w]here we confront taxpayers who have taken a circuitous route to reach an end more easily accessible by a straightforward path we look to substance over form” and the Court concluded that the tax credit investor was not a bona fide partner.
On June 30, Pennsylvania became the 30th state in the Country to have a state historic tax credit with the passage of the Pennsylvania Historic Preservation Incentive Act. The Act will provide a 25% state tax credit for the rehabilitation of qualified income-producing buildings that also use the federal historic tax credit. The State tax credit will be equal to 25% of the “qualified expenditures” (as defined under Section 47(c)(2) of the Internal Revenue Code) incurred by the taxpayer. In order to qualify projects must be commercial in nature. To qualify as a historic structure, the building must be listed in the National Register of Historic Places or be part of a historic district listed in the National Register. The “qualified rehabilitation plan” itself must also be approved by the Pennsylvania Historical and Museum Commission, as reviewed against the Secretary of the Interior’s Standards and Guidelines of Rehabilitation. The Pennsylvania historic tax credit program is limited to $3,000,000 annually with an individual project cap of $500,000. The Pennsylvania Historical and Museum Commission and the Department of Economic Development will develop the program guidelines. The credit goes into effect July 1, 2012 but the first tax credits will not be issued until after July 1, 2013.