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April 29, 2012 The Tax Lawyer

Virginia Historic Tax Credit Fund 2001 LP v. Commissioner: Virginia Is for Partners?

Vol. 64, No. 4 - Summer 2011

James W. Hahn


    In Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, the Service disputed the tax treatment of certain transactions between a partnership and its investors. The Virginia Funds were able to receive historic rehabilitation state tax credits for 55 cents on the dollar from developer partnerships. The Virginia Funds then allocated the tax credits to their 282 investors at 74 cents on the dollar. The Service argued that this 19-cent spread, which was worth roughly $1.53 million, was taxable income under section 61 because the transactions were ales. The Virginia Funds, on the other hand, argued that the 19-cent spread constituted nontaxable capital contributions under section 721 because the investors were bona fide partners.

    The Tax Court ruled in favor of the Virginia Funds, holding that the investors were partners for federal tax purposes, the substance of the transactions matched their form, and the transactions between the partnership and its investors were not disguised sales of tax credits. The Fourth Circuit reversed, holding that the Virginia Funds had generated taxable income because the credits were property under federal law and the transactions were disguised sales under section 707.

    This Note argues that the Fourth Circuit came to the correct result but should have held that the investors were not partners under the substance-over-form doctrine. The investors had no real ownership stake in the Virginia Funds, making them analogous to traditional buyers with limited entrepreneurial risks. In substance, the Virginia Funds were selling tax credits since there was no community of interest in the profits and losses between the investors and the promoters. Thus, the $1.53 million should have been includible in gross income because the investors were not bona fide partners. This reasoning would arguably be more workable in practice for tax practitioners. Part II provides background concerning historic rehabilitation programs, along with the underlying partnership law and subsequent tax consequences. Part III outlines the facts of Virginia Historic Tax Credit Fund, describing both the Tax Court and Fourth Circuit opinions. Part IV scrutinizes the two opinions through the lens of the substance-over-form doctrine. Part V concludes that the Fourth Circuit came to the correct result, but should have come to its conclusion by reasoning that the investors were not partners; not through characterizing the allocation of tax credits from the Virginia Funds to investors as disguised sales.

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