October 27, 2014
Article by Mike D'Amario, Tax & Business Services Manager, "IRS Issues Safe Harbor Guidance for Allocating Rehabilitation Tax Credits to Investors," Featured in Bloomberg BNA
By Mike D'Amario, Tax & Business Services Manager
The Internal Revenue Service (IRS) issued guidance explaining the circumstances in which it will not challenge partnership allocations to its partners under §47, rehabilitation tax credits. Rev. Proc. 2014-12, 2014-3 I.R.B. 415, establishes the requirements of a "safe harbor." According to the Rev. Proc., if the partnership follows the guidelines of the safe harbor, the IRS will not challenge the allocations of the §47 credit.
Under §47, the owner of a qualified rehabilitated building is entitled to claim a tax credit of 10% of the qualified rehabilitation expenditures starting in the year in which the property is placed in service. The amount of the credit increases to 20% of the qualified rehabilitation expenditures made with respect to a certified historic structure.
The IRS issued the Rev. Proc. in response to the decision rendered by the Third Circuit Court of Appeals in the case Historic Boardwalk Hall LLC v. Commissioner, 694 F.3d 425 (3d Cir. 2012), rev'g 136 T.C. 1 (2011), in which the Third Circuit reversed the decision by the Tax Court, and held that the sole investor's interest in the LLC was lacking a meaningful stake in either the success or failure of the partnership, and the investor was not a bona fide partner. This ruling resulted in the disallowance of the partnership's allocation of the rehabilitation tax credits.
In this case, the New Jersey Sports and Exposition Authority (NJSEA) had undertaken to restore "Historic Boardwalk Hall," the property in which NJSEA held a leasehold interest. Since the building was a certified historic structure, the tax credits would be 20% of the qualified rehabilitation costs as properly allocated under the partnership agreement and in accordance with applicable tax regulations.
NJSEA formed a New Jersey LLC and sold a 99% interest to an investor member, who was a wholly owned subsidiary of Pitney-Bowes (PB). Through the agreement for PB to invest in Historic Boardwalk Hall, PB would receive 99% of the §47 rehabilitation credits and a preferred return of 3%. Additionally, the structure of the deal was designed to minimize as much risk as possible to PB. This was through various contractual provisions. The provisions were as follows: a construction completion guaranty, operating deficit guaranty, preferred return, and a tax benefit guaranty. Basically, the agreements set in place negated any possible risk for PB, and any cash that was invested into the LLC was essentially certain to be recouped by the rehabilitation tax credits or their cash equivalent.
The IRS audited and reviewed the allocation of the tax credits. The IRS determined that in substance, PB was not a bona fide partner for federal income tax purposes due to the contractual provisions and agreements set in place. This determination led Historic Boardwalk Hall to file a petition with the Tax Court challenging the IRS's position – where Historic Boardwalk Hall succeeded. The IRS Commissioner then appealed to the Third Circuit. The Third Circuit Court of Appeals concluded that PB did not have a meaningful stake in either the success or the failure of Historic Boardwalk Hall, and therefore was not a bona fide partner.