## Facts

- Virginia’s Historic Rehabilitation Tax Credit Program provided transferable state income tax credits (up to 25% of eligible rehabilitation expenses) after state certification of qualifying projects.
- Multiple Funds were organized to acquire Virginia historic rehabilitation credits from developers for cash and a small residual project interest.
- The Funds admitted numerous investor-partners who made cash payments labeled as capital contributions.
- Investors received allocations of Virginia credits in a targeted exchange ratio of about $1 of credit for $0.74 of cash, while the Funds acquired credits from developers for about $0.55 per $1 of credit.
- The price spread yielded net gain at the partnership level; the IRS treated this gain as taxable income.
- Investor economics were structured so that investors’ expected return was primarily the credits, with minimal participation in project profits and losses and limited exposure to entrepreneurial risk.
- On audit of the Funds’ 2001–2002 returns, the IRS recharacterized the transactions as taxable sales of credits rather than partnership contributions and allocations.
- The Tax Court ruled for the Funds, concluding the investors were bona fide partners and the transactions were not disguised sales.
- The Commissioner appealed.

## Issues

1. Whether the Virginia historic rehabilitation tax credits transferred to investor-partners in exchange for cash were “property” for federal tax purposes.
2. Whether the cash-for-credit arrangements, though cast as capital contributions and allocations, were properly treated as taxable sales (disguised sales) under I.R.C. § 707(a)(2)(B) and Treas. Reg. § 1.707-3.

## Decision

- The Fourth Circuit reversed the Tax Court and remanded.
- The court held the Virginia tax credits were property for federal tax purposes.
- The court held the transactions were disguised sales under I.R.C. § 707, producing taxable income to the Funds under I.R.C. § 61.
- The court declined to decide whether the investors were bona fide partners for all purposes, finding the disguised sale analysis dispositive.

## Legal Principles

- Transferable state tax credits with market value and assignability may constitute “property” for federal tax purposes.
- Under I.R.C. § 707(a)(2)(B) and Treas. Reg. § 1.707-3, paired transfers between a partner and a partnership are treated as a sale when, viewed together, they function as an exchange of property for consideration.
- Substance controls over form: labeling a payment as a capital contribution and the receipt as an allocation does not prevent recharacterization when investors pay a near-fixed price for a near-fixed quantity of credits and bear limited entrepreneurial risk.
- Disguised sale treatment can apply even if the parties use a partnership structure and even assuming partner status.

## Conclusion

The Fourth Circuit treated the Funds’ credit syndication model as a taxable sale of transferable Virginia historic tax credits, holding that the credits were property and that cash contributions tied to fixed credit allocations fell within the disguised sale rules of I.R.C. § 707.


Va. Historic Tax Credit Fund 2001 LP v. Comm'r, 639 F.3d 129 (4th Cir. 2011)