# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Aa07a9a959210258b ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text 136 T.C. No. 1 UNITED STATES TAX COURT HISTORIC BOARDWALK HALL, LLC, NEW JERSEY SPORTS AND EXPOSITION AUTHORITY, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 11273-07. Filed January 3, 2011. New Jersey Sports and Exposition Authority (NJSEA) and Pitney Bowes (PB) formed Historic Boardwalk Hall, LLC, to allow PB to invest in the historic rehabilitation of the East Hall, a popular convention center in Atlantic City, New Jersey. The East Hall underwent a significant rehabilitation during the years at issue. On Forms 1065, U.S. Return of Partnership Income, for 2000, 2001, and 2002, Historic Boardwalk Hall claimed qualified rehabilitation expenditures and allocated those expenditures to PB, allowing PB to claim historic rehabilitation tax credits pursuant to sec. 47, I.R.C. R issued an FPAA asserting alternative grounds for denying PB the claimed rehabilitation tax credits. R's overarching argument is that NJSEA sold the rehabilitation tax credits to PB for a fee. R also SERVED JAN -3 2011 - 2 - argues that the accuracy-related penalty púrsuant to sec. 6662, IRC, applies Held: istoric- Boardwalk Hall was not a sham and s d d not lack economic substance.Held, further, PB did become a partner in Históric Boardwalk Hall. Held, further, NJSEA did transfer the benefits and urdens of ownership of the East Hall to Historic Boardwalk Hall. Held, further, -the sec. 6662, IRC, penalty is not appl ic able . Kevin M. Flynn and Michael Serdof f Daniel Rosen; Kurt Ruben for petitioner Molly Donough, and Sashka Koleva, for respondent. COEKE, udge: Respondent issued a notice o fina partnership administrative adjustment (FPAA) to Historic Boardwalk Hall LLC (Historic Boardwalk Hall) . The issues for decis on are: (1) Whether Hist oric Boardwalk Hall is a shain; (2) whether Pitney Bowes was a partner in Historic Boardwalk Hall; 3) whether New Jersey Sports and, Exposition Aut hority (NJSE or petitioner) transferred the benefits and burdens of ownership of the East Hall to liistoric Boardwalk Hall and - 3 (4) whether Historic Boardwalk Hall is liable for section 66621 accuracy-related penalties for years 2000, 2001, and 2002. FINDINGS OF FACT Some of the facts have been stipulated, and the stipulations of fact and the attached exhibits are incorporated herein by this reference. NJSEA was created by the New Jersey State Legislature in 1971 and is a State instrumentality. NJSEA was initially formed to build, own, and- operate.the Meadowlands Sports Complex in East Rutherford, New Jersey NJSEA's jurisdiction was expanded by the New Jersey State Legislature in January 1992 to include the Atlantic City Convention Center Project. That project authorized NJSEA to build, own, and operate a new convention center and to own and operate the East Hall (the East Hall is also known as Historic Boardwalk Hall). To carry out the new Convention Center Project, the Atlantic County 'Improvement Authority (ACIA) and NJSEA entered into a lease for the East Hall whereby NJSEA leased the- East Hall for a term of 35 years at a rent of -$1 per year. Shortly thereafter, NJSEA entered into an operating agreement with the Atlantic City Convention Center Authority (ACCCA). * ACCCA was initially formed All section references are to the Internal Revenue Code (Code), and all Rule references are to the Tax Court Rules of Practice and Procedure. to. proinote tourism in the Atlantic City region nd eit would serve" as day-to-dÁy managet of, the*Êast HÉll. Läter NJSEA and ACCCAr entered into a management agreement with Spectator Managementa,Group (SMG) . SMGewas well known for managing, marketing,- and, developing public assembly facilities, includ ng c'onvention andispecial event centers. NJSEAucontracted to have SMG manage the East +Ìall beöause NJSEA felt tihet a private company would ibehable to promote oversee, andemanage the East Hall, the West Hall (a facility adjacept to the. East Hal-l)s and the -soon-to-be cons'tr cted conventiori ce ter The management agreement stated that SMG would piovide opei-ations, marketing, f inance, employee supervision, adininistrat iñe,; :ahd óther .general management services . SMG managed the East Hall day to day .a - . e a SMG maintained saa system of accounts for Historic Boardwalk Háll and Historic Boardwalk Hall's annual auclitedafinancial statements)wer based on this asystem of accounts . NAlthough SMG s initïal agreement pas for a '3-year term, it has Meen extended. 1 1. Overview of the T ansaction lat ]!ssue n * : Historic Boardwalk Hall was orgànized under the laws of the State of New Jersey as aglimitedAiabil-ity companyson/June 26, 2000 . NJSEA was the sole member 6f Historic Boardwalk Hall at formation. On September 14, 2000, PB Historic Renovations, LLC - 5 (Pitney Bowes),2 was admitted as a member of Historic Boardwalk Hall. Historic Boardwalk Hall's purpose was to allow Pitney Bowes to invest in the rehabilitation of the East Hall. Because the East Hall was a historic structure, this rehabilitation project had the potential to earn -section 47 historic rehabilitation credits.3 Historic Boardwalk Hall's formation would allow Pitney Bowes, a private party, to earn these historic rehabilitation credits from the rehabilitation of a public, governmentally owned, building. Respondent argues that in substance the transaction was akin to NJSEA's selling rehabilitation credits to Pitney Bowes. To that end, respondent determined alternatively in the FPAA that Historic Boardwalk Hall is a -sham, that Pitney Bowes was never a partner in Historic Boardwalk Hall, and that NJSEA never transferred ownership of the East Hall to Historic Boardwalk Hall. A finding for respondent on any of these theories would prevent the section 47 rehabilitation credits from flowing to Pitney Bowes; instead they would flow to NJSEA. 2PB Historic Renovations, LLC, was a limited liability company whose sole member during all relevant periods was Pitney Bowes Credit Corp. During all relevant times, Pitney Bowes Credit Corp. was a wholly owned subsidiary of Pitney Bowes Corp. For simplicity, we refer to PB Historic Renovations, LLC, Pitney Bowes Credit Corp., and Pitney Bowes Corp. as Pitney Bowes. 3Sec. 47 allows for a Federal tax credit of 20 percent of the qualified rehabilitation expenditures with respect to any certified historic structure. - 6 - Petitioner contends instead that transactions like the one at issue were promoted and supported by Congress and are not shams. 2. 'East-Hall History - - , , , Construction of the East Hall began, in,1,926 and was, completed in 1929. It is loca_ted prominently- at the center of the,At+lanti'c City, New Jersey, Boardwalk and faces the Atlantic Ocean.a The East Hall was;a popular event space of exceptionally large ,dimensions,-featuring an auditorium with a 130-foot ceiling and over 250,000 square feet of floor space. After it was completed, the.East Ha_ll hosted ,a-number of public events, including hockey matches, professional football games,p and equestrian shows. The East Hall also hosted trade shows, conferences, meetings, and musi.cal performances, including those sof the Beatles and the Rollling Stones. Beginning in 1933, the East Hall.hosted the.Miss America pageant. The East, Hall was listed as a National Histor.ic Landmark by the U."S. Department of the Interi-or on February 27, 1987. In - January 1992 the New Jersey State Legislature authorized NJSEA to undertake construction of the new convention center and renovation of the East Hall. Once the new convention center was complêted, it'was expected to become the primary locati-on'for flat-floor conventions like the ones that had until that time been ßeld in the East Hall. * As a result,'~the East Hall would no - 7 longer draw those types of events and wouldrhaverno use unless renovated. Once construction began on the new convention center, representatives of NJSEA and other New Jersey State officials began to study and make plans for the future of the East Hall. Because it had become run down, the'only way to make the East Hall usable again was to convert it to a special events facility that could host concerts, sporting events, family shows, and other civic events. This conversion would require thit the East Hall be substantially rehabilitated." State officials-in New Jersey decided to rehabilitate the East Hall and convert it into a mixed-use space. Rehabilitation of the East Hall began in December 1998. was to be completed in four phases: It (1) Construction of scaffolding suspended from the auditorium's ceiling to facilitate rehabilitation of the ceiling; (2) removal of auditorium ceiling tiles and abatement of asbestos; (3) reconstruction of the ceiling using glass-fiber reinforced tiles and high-performance acoustical perforated aluminum tiles; and (4) construction of a new permanent arena seating bowl, construction of support services and patron amenities beneath the seating bowl, and restoration and historically accurate.painting of the Hall's interior. To pay for a ,portion of the renovation. costs, on/Juner15,* 1999, NJSEA issued about $49.5 million of State bonds. In additi.on, NJSEA received approximately $22 million from the New Jersey, Casino Reinvestment Development Authority . In the absence of- an equity investor, the rehabilitation would have been funded, entirely by the State.of New:Jersey. 3. Sovereign Capital Resources , LLC In late 1998, Paul -Hoffman (Mr. Hoffman) of Sovereign Capital Resources, LLC , (Sovereign),, contacted, representatives of NJSEA. , Sovereign was founded by Mr. Hoffman ,and a partner in 1995. Mr. H,offman contacted NJSEA because he had 1 arned of the East Hall renovation; one of Sovereign' s business ilines Was raising, equity for,historicr rehabilitations. NJSEA engaged the services of Sovereign.to act as -its financial advisér in finding an equity investor for the East Hall' s rehabilitatioír. y a Respondent argues that this was not an investment, but rather Sovereign was facilitating a sale of the historic tax credits generated by the East Hall rehabilitation. , NJSEA engaged several law firms sto review and opine on' a 11 certain aspects of the transaction: (1) ; Wol f , BlockdSchorr, 4The New Jersey Casinò Reinvestment 'Developfnent Authority is a State agency created by the New Jersey State Isegislature that uses funds generated from governmental charges imposed on the casino industry for economic development and community projects throughout the State. The funds given to NJSEA were in tihe form of a grant . Solis-Cohen, LLP; Vecchione (2) Gibbons, Del Deo, Dolan, Griffinger & (Gibbons, Del Deo); and (3) Wolf & Sampson, P.C. NJSEA also engaged the accounting firm of Reznick Fedder & Silverman, P.C. (Reznick), to provide counsel on the rehabilitation credit transaction. 4. Confidential Offering Memorandum Sovereign prepared a confidential offering memorandum as part of its services to NJSEA. The memorandum was prepared using information provided to Soverign by NJSEA, Reznick, and others and included financial information for the rehabilitation of the East Hall and for its operation after the rehabilitation was completed. The financial projections in the confidential offering memorandum were based on certain assumptions, most importantly that revenue from the East Hall would increase 3 percent per year. The financials projected that the eventual partnership would have positive net operating income from 2002 through^2009. That net operating income would be zeroed out through lease payments, an increase in a "replacement reserve", the investor member's 3-percent priority distribution, and an incentive management fee, to the extent there was cash to make- those payments. T e confidential offering memorandum a]so, informed prospe tive investors, that-Historic JBoardwalk Halle would hav.e taxable losses for at, least the years 2002 -through 2009. The financial projections attached to the amended and restated operating agreement, discussed moré fully below, are different from those attached to the confidential offerings memora dum. The memorandum was -sent to 19¥ corporations and described Ethe transaction as, a "sale" of tax credits . The memorandum indicated that t e private investor' s equi y investment would bei used to pay, a development fee to NJSEA, with any surplus remaining with Historic Boardwalk Hall. joinin Four corporations showed interest ,in the ti-ansaction, and each submitted a bid detailing how much it would be willing to invest depending on the rehabilitation credits it would earn. ¿Eventtiallye Pit-ney4Bowes' offer was accepted and it was selected to invest in Historic Board alk Hall. 5. Formatifon of Historic Boardwalk Hall Historic Boardwalk Hall, organized on June 26, 2000 elected to bedtreated a,s a, partnership for Fe'deral income tax purposes. NJSEA was dhe sole member at formationrand executed ari operating agreenent for the East Hall, as explained above. When Pitney Bowes joined Historic Boardwalk Hall on September 14, ,2000, NJSEA and Historic Boardwalk Hall signed an amended and restated - 11 - operating agreement (the AREA). The AREA identified NJSEA as managing member and Pitney Bowes as investot member of Historic Boardwalk Hall. Pursuant to the terms of the AREA, Pitney Bowes has a 99.9-percent ownership interest in Historic Boardwalk Hall. NJSEA owns the remaining 0.1 percent. Profits, losses, tax credits, and net cashflow are allocated to Historic Boardwalk | Hall's members according to their ownership interests. The AREA stated that Historic Boardwalk Hall was formed to acquire, develop, finance, rehabilitate, own, maintain, operate, license, and sell or otherwise dispose of the East Hall for- use as a special events facility to hold events, including but not limited to, spectator sporting events. The AREA made -clear that the potential rehabilitation tax credits were an integral part of the transaction but did not use the term "sale". It referred to both Pitney Bowes and NJSEA as members of Historic Boardwalk Hall. Article 3.01 of the AREA reiterated the purpose of Historic Boardwalk Hall and also granted Historic Boardwalk Hall the authority to take actions nece-ssary to carry out its purpose. The AREA included an additional set of financial information. The most important difference between these financials and those attached to the confidential offering mémorandum was the inflation factor applied to the East'Hall''s revenues. The financial projections attached to the AREA used a 12 - 3 . 5 -percent inf lator , rather than thes 34. 0 -percent - inf lator in the confidêntial offe'rlng memorandum. .Also, the soperating assumpi-ions underlying the updated financials, assumed higher servioè income, parking revenue,. and rnovelty revenue in the first year o operations Operating expenses for- -the nitial years remained the same . As a result of higher projected fevenues, the. statement of projecged cashflows attached to the AREA showed higher payments to they equity, investor and also payments on the acquisition and constaction loans discussed below. Chese finanéials, h weëer, still cesulted in a staxable net loss 6. Lease and ,Sublease of the East Hall Äsediscussed above, NJSEA leased the East H 11 from ACIA for a 35 ear, term. , On September 14, 2000, NJSEA amended its lease agreegent. to extend the lease termountil Noyember 11,( 2087. On that date, NJSEA and Historic Boardwalk Hall entered ;into two agreenîents. First, NJSEA ass sublessor and Histo ic Boardwalk Hall as suble.ssee entered into a sublease of the East Hall whereby NJSEA subleased the property to Historic Boardwalk Hall. Second, NJSEA and †Iistoric ;Boardwalk Hall entered. into a lease agreements which the parties treated as a sale sand putchase for Federal , S tate , and ,loáal income taxopurposes . Pursuant3to , the lease tagreementy Historic Boardwalk Hall purportedly acquired ownership of Žhe East,Hall. - 13 - Historic Boardwalk Hall paid for the East Hall by an acquisition note in the amount of $53,621,405. The acquisition note was secured by a mortgage on the property. The amount of the acquisition note represented the total expenditures that NJSEA had made through that date in renovating the East Hall. The acquisition note bears interest at 6.09 percent per year and provides for level annual payments of $3,580,840 through the year 2040, to the exten~t Historic Boardwalk Hall has sufficient cash to make the-annual payments. Also on September 14, 2000, NJSEA entered into a construction loan -agreement with Historic Boardwalk Hall to lend amoúnts to the partnership from time to time to pay for the remainder of renovations to the East Hall. At that time, NJSEA agreed to lend $57,215,733 to Historic Boardwalk Hall. NJSEA's obligation to lend to Historic Boardwalk Hall was evidenced by a mortgage note and a second mortgage on the property. 7. Contributions to Historic Boardwalk Hall Pitney Bowes made capital contributions to Historic Boardwalk Hall and also lent funds to the partnership. Pursuant to the AREA, Pitney Bowes was to make four cap'ital contributions totaling $18,195,757. Pitney Bowes made the following contributions to Historic Boardwalk Hall: - 14 Date Amount / 9/14/00 $650 , 000 12/19'/00 3 660 1/17/01 3,400,000 10/30/02 10,467,849 2/12/04 21,173 182 The Dec. 19, 2000, and Jan. 17 2001, 65 apital contributions were together considered Pitney Bowes sécorid caþital contribution, even though the coritribûtion was niadd on t wo s'eparatlê datås. A portion of Pitney Bowes' fourth capital e contribution was paid and is ourrently being held i escrow. Pitney Bowes also nade an investor loan, of. $1 1 nillion to Historic Boardwalk Hall on September, 14, 2000 . - The þrincipal amount of the investor ldan2 was increased to $1 218.000 on or around October 30, 2002. Pitney Bowes wast not required to make the second third, or fou th capital contribution if certain requireme ts in the AREA were not satisfied. The AREA provided that Pitney Bowes' capit 1 contributions 2 ewere to be úsed to pay down t;he principal on,the acquigition note. 7 Pitgey Bowes' capital .contributions were in fact used to ay down the principal on the acquisition note . Shortly thereaf ter, a corresponding draw would be made , on the construction note, and NJSEA would advance those funds to Historic Boardwalk Hall. Ultimately, these offåett'ing draws left - 15 - Historic Boardwalk Hall with cash in the amount of Pitney Bowes' capital contributions, a decreased balanch on the acquisition loan, and an increased balance on the construction loan. These funds were then used by Historic Boardwalk Hall to pay assorted fees related to the transaction and to pay NJSEA a developer's fee for its work managing and overseeing the East Hall's rehabilitation. A portion of Pitney Bowes' second capital contribution was not returned to Historic Boardwalk Hall but rather was used by NJSEA to purchase the guaranteed investment contract (GIC). The GIC is discussed further below. Historic Boardwalk Hall paid NJSEA $14 million as a development fee for its role overseeing the East Hall's rehabilitation. This came mainly from Pitney Bowes' third and fourth capital contributions and was paid pùrsuant to a development agreement between Historic Boardwalk Hall and NJSEA. The development agreement reiterated Historic Boardwalk Hall's purpose and imposed certain obligations on NJSEA as the developer, in exchange for a $14 million development fee. The development agreement obligated NJSEA to obtain all required Government approvals for the rehabilitation and to-oversee the completion of the rehabilitation. This included: (1) Overseeing the contractors who were rehabilitating the East Hall; ensuring that all amenities consistent with the overall (2) - 16 - rehabi itation were pput in place; phase, (3) causing the completion of of the rehabil-itation; and (4) causing the rehabi-1-itation such that it would earn rehabi-litation tax, credits . - The déveio månty ägreement further required NJSEA, to obtain4 certif cation -of ·the rehabilitation from atheeU.S. Department of the Interior and to maintain insurance sover the ehabilitatiòn as set fo th in the AREA. ouid NJSEA's .development,fee o be earned untial the fehabilitation was completed, and it was payable immediately upon completion. 8. Dist!ributions FromsHistoric Boardwalk Hall The AREA provided for the distribution of H storic Boardwalk Håll's net cashflow. First, if certain title insurance or environmental insurance sproceeds, were paid, 100 PÅtney Bowes. ercent went to Second, any;remaining net-cashflow was used to make interest payments one Pitney.:Bowes' investor loán to ,Históric Bôardwalk Hall . Should there be any ,remaining neta c ashf low, 99 . 9 percent was tò be distributedato «Pitney Bowese until Pitney Bowes had received its 3-p rcent preferred return. ,The preferred return was equal to 3 percent ,of ;its adjusted capital contributidn, which was detarinined fat the .endsofeHistoric Boardwalk Ha]:1 sofisca year. Nekt, funds, were 'distributed to Pitneyusiness interests-, it will not be disregarded. merely because it was motivated by tax considerations.'" Id. (quot-ing ACM.Pship v. Commissioner, 157 F-3d at 247) . Respondent argues that Historic Boardwalk Hall ism a sham because it lacked; objective economic substance andrthat its partners lacked any business motivation other than transferring historic tax credits from NJSEA to Pitney Bowes. Respondent asks that we look to- t-he individual partners to determine thet economic substance of the transaction. Respondent contends that Historic Boardwalk- Hall lacked objective. economic substance because the parties, in respondent's view, negotiated and executed a transaction in anticipation of a limited number of possible outcomes, none of which would appreciably-affect Pitney Bowes' economic position- otherethan through a reduction of its tax liabilities. Respondent argues that the following are the only, possible outcomes of Historic Boardwalk Hall' s formation, assuming the partiest act in an "economically rational manner" (1) If the East Hall was profitable, NJSEA wóuld be- compelled to exercise its repurchase option immediately after the sectiorra47 recapture. period ended, terminating Pitney Bowes' intereste in Historic Boardwalk Hall. Pitney Bowes woulds receive its 3,percent, annual return until it exited Historic Boardwalk Hall through preferred net cashflow distributions.s - s - 33 - (2) If the East Hall was unprofitable, Pitney Bowes would exercise its put option, compelling NJSEA to purchase its interest in Historic Boardwalk Hall for its 3-percent annual return. In this case, because East Hall is unprofitable and there are no preferred net cashflow distributions, Pitney Bowes receives its payment through the GIC. Respondent contends that the parties knew that Historic Boardwalk Hall would not earn a profit and that the Reznick projections showing a profit were simply window dressing meant to give the transaction an appearance of legitimacy. Respondent further argues that Pitney Bowes would never earn a profit on its investment in Historic Boardwalk Hall. In respondent's view, although Pitney Bowes was entitled to its 3percent return either through preferred distributions or the GIC, Historic Boardwalk Hall still lacked objective business substance because any return would be less than Pitney Bowes could have earned had it invested its capital contributions in other financial instruments. Taking into account the time value of money, respondent argues that Pitney Bowes' investment results in a negative cashflow to Pitney Bowes. Respondent also a gues that other contractual provisions ensure that Historic Boardwalk Hall has no economic' effect on its partners, including the tax benefits guaranty agreement, the operating-deficit guaranty, the completion guaranty, and the fact - 34 - that all. of Historic Boardwalk Hall's debts are.nonrecourse to Pitney, Bowes . Respondent concludes that the -parties econcéic posi ions were all fixed and unaffected by the return from Historic Boardwalk Hall in any circumstance. Moving to the subjective test, respondent argues that Historic Boardwalk Hall served no subjective business purpose because it was intended solely to facilitate NJSEA s sale, of rehabilitation tax credits and other favorable tax attributes to Pitney Bowes.: All of respondent's arguments concerning the economic substance of Historic Boardwalk Hall are made without taking into account the 3-percent return and the rehabilitation creditse Respondent argues that the rehabilitation, credits must be ignored in evaluati.ng, the economic substance of Historic Boardwalk Hall. Respondent points to Friendship Dairies, Inc.av. Commissionera 90 T.,C ,1054 (1988), and argues that investment tax.credits are never to be.taken into account in determining the economic substance of, a transaction. Petitioners first argues that the economic substance doctrine is inapplicable to the Historic Boardwalk Hall transaction båáäuse Congress, in enacting and amending section 47, intended to use section 47 to spur corporations to invest in historic rehabilitation projects that otherwise would not be economically -feasiblea Petitioner further contends that the point of the l --35 credit -wa's to address the reality that most rehabilitation projects had an inherent lack of profitability-athus it would be inappropriate to disregard a transaction for aliack of~ profitability when the purpose of section 47 isato make up for that lack of profitability. Further, petitioner puts forth alternative arguments in support of its position that the Historic Boardwalk Hall transaction has economic substanoe. First, pëtitioner argues e that the rehabislitation tax credits at issue' can be taken into account in determining whether the transaction has economic substance and provided a net economic benefit to Pitney Bowes. Petitioner points to Saaks v. Commissioner, 69 F.3d 982 (9th Cir. 1995) , revg . T . C.' Memo . 1992-596,4 and' argues that - we' must take s the rehabilitation credits into account- in determining ·the profitability of the transaction. Second, petitioner argues that even if wer do not take- the rehabilitation tax credits into account, the Reznick projections show that the Historic Boardwalk Hall has economic substance be'cause 'Pitney Bowes land the-Easti Hall Chad a chance of searning a prof it . Petitioner also asserts the 3-percent return gives the transaction economic significance. In Sacks v..- Commissioner, supra, the Court of Appeals for the Ninth Circuit evaluated the economic substance of a solar - 36 - energyaequipmentesale-leaseback transaction. The Courtsof Appeals found that the transaction had economic substance on the basis of the following factors: (1) The taxpayer's personal obligation to payathe price was genuine; (2) the taxpayer paid fair market value for thesequipment; (3) .the tak benefits would have existed for someone, and were not created out of thin air.by the transaction; (4) the - business of selling solar energy was, genuine; and (5) . the business consequences of a rise or fall in energy prices were: genuinely shifted to the taxpayer. I_d. at 988. GThe Court of Appeals discussed whether the solar energy credits should be taken into account in determining the profitability sof a the transaction. The Commissioner had argued successfully in this Court that any financial analysis of the transalction had to be done without regard to the solar energy credits: On the basis of that argument, we found ÷that the e taxpayer'sytransaction lacked economic substance because itswas cashflow negative unless the tax credits were taken into account and" disallowed the claimed credits . The; Court of Appeals disagreed with that analyáis,asstating that the taxpayer' s investment "did not become as sham just because git,s profitability was based on after-tax instead of pretax projections." Id. at 991. The Court of Appeals went on to 37 - state that "Where a transaction has economic - substance, it does not become a sham merely because it is likely to be unprofitable on a pre-tax basis", id.,a and that "Absences of pre-tax profitability doeenot show 'whether the stransaction had economic sübstance beyond the creation of taxe benefits 'twhere Congress: has purposely used, tax incentives to= change investors'- conduct", id.a(citation omitted) . The- Court; of Appeals rejected. the Commissioner's argument thatethe tax benefits3should be excluded from the economic sanalysis, because. "If the government treats taxadvantaged transactions as shams unless they make economic sense on a pre-tax basis, then it takes away with the executiver hand what it gives with the legislative." Id. at 992. - Ultimately, the Court of Appeals recognized that if the types of transactions that Congress intehded to encourage had -to be profitable on a pretax' basis, then Congress would not have needed to provide incentives -to get taxpayers to invest in them;; in effect, ther Commissione'r was attempting to use the reason Congress created the tax benefits as a ground for denying them. Id. The Court of Appeals' for the Third Circuit has not directly addressed whether investment táx credits are to-be taken into account in determining the economic substance of a transaction. In IRS v. CM Holdings,o Inc., 301 F.3d 96 (3d Cir.¯ 200-1), the 2 taxpayer attempted to rely on the opinion of the Court of Appeals for the Ninth Circuit in Sacks in arguing that2 a corporate-owned - 38 life ainsurance-plan had economic substance because Congress had explicitly sanctioned those types of tax strategies. Howeverá the Courts of Appeals for- the Third Circuit distinguished±Sacks because- the Sacks opinion, in allowing depreciation deductions and investment credits with respect to a sale and leasebacksof solar energy equipment, reasoned that both Federal-and:State legislatures had specifically encouraged investment in solar energyt and thereby "skewed the neutrality of the allow the partners to share and distribute State tax credits. In Luna v. Commissioner, 42 T.C. 1067, 1077-1078 (1964), this Court stated that "while all circumstances are to be considered the essential question is whether the parties - 46 intended tomand did in fact, join together for the present conduct of an undertaking or enterprise", and cited Commissioner v. Culbertson, supra at 742, which stated: e The - question is not whether the servicest or capital - contributed by a partner are of sufficient importance to meet some objective standard * * * but whether, considering all the facts * * * the parties in good faith and acting with a business purpose intended tá "join together in the present conduct of the enterprise . * * * Petitioner argues that Historic Boardwalk Hall is a valid partnership and that Pitney Bowes was a partner ein, that partnership. Petitioner points to the partnership agreement, the parties' actions in negotiating that agreement, and ,the part;i.es' actions, after the agreement was executed. Petit-ioner contends that Pitney Bowes' extensive investigation of all aspects of the transaction and Historic Boardwalk Hall' s business changes made af ter execution all support a conclusion that Pitney Bowes was a partner in Historic Boardwalk Hall. We agree with petitioner. Pitney Bowes and NJSEA, in good faith and acting with a business purpose, intended to join together in the present conduct of a business enterprise ., As we held above, Pitney Bowes and NJSEA joined together in a transaction with economic substance to allow Pitney Bowes yto invest in sthe East Hall rehabilitation. Further, as we found above, the decision to invest provided a net economic benefit to Pitney Bowes through its 3-percent preferred return and .- - 47 - rehabilitation tax credits. Combined with our above holding that Historic Boardwalk Hall had economic substance, it is clear that Pitney Bowes was a partner in Historic Boardwalk Hall. The parties' investigations and documentation both support a finding that the, parties intended to join together in a rehabilitation of the East Hall. Although the confidential - offering memorandum used the term "sale", it was used in the context of describing an investment transaction. The confidential offering memorandum accurately described the substance of the transaction: an investment in the East Hall's rehabilitation. The parties' investigation likewise.suppoirts a.finding- of an effort to join together in rehabilitating the East Hall. The parties investigated potential environmental hazards and attémpted to mitigate them: This included two analyses by consulting firms- and adding Historic BoardwalkiHall and Pitney Bowes as named parties to NJSEA's insurance policies. .NJSEA and Pitney Bowes sought and received a number of opinion letters; evaluating various aspect's of thé transaction. The executed-transaction documents accurately represent the substance of the transaction. The AREA is between Pitney Bowes and NJSEA and provides a detailed description of Historic Boardwalk Hall's -purpose--to rehabilitate and manage the East a Hall. Sinces formationy Historic;Boardwalk -Halls hasacarried out - 48 - its goals. The AREA describes Pitney Bowes and NJSEAzas members e and alsó provides for transfers of their membership interests in later years. The development agreement between Historic Boardwalk Hall contractually obligates NJSEA to.manage the East Hall's rehabilitation and accurately represents the ;substance of the transaction. Since execution of those agreements, the partiesahave carried out their responsibilities under the AREA. NJSEA oversaw the-Easte Hall's -rehabilitation, and Pitney Bowes made its required capital contributions. The East Hall was actually rehabilitated, did reopen to the public, and has been successful. This rehabilitation provided benefits to both Pitney Bowes and NJSEA. Respondent again asks us to ignore the rehabilitation tax. creái.its at issue. Pitney Bowes joined Historic Boardwalk Hall in exchange for its 3-percent preferred return and the rehäbilitation itax credits. The 3-percent preferredereturneand theirehabilitation tax credits provided a net economic benefit to Pitney Bowes. Even if we do ignore the tax credits, Pi-tney Bowes' interest -is not more like debt than equity because Pitney Bowes is not guaranteed to receive a 3-percent return every year. Because the East Hall operated at a loss each year,e Pitney Bowes was not guaranteed the 3-percent return at the end of argiven year because there might not be sufficient cashflow to pay it. - 49 - In accord with the AREA, Pitney Bowes might not receive its preferred return until NJSEA purchased Pitney Bowes' membership interest, if at alla . Taking into account the stated purpose behind Historica Boardwalk Hall' s formation, the parties' investigation of the transaction the transaction documents, and the parties' respective.roles we hold that Historic Boardwalk Hall was a e valid partnership. V. Whether- the sEast Hall Was "Sold"- to Historic Boardwalk Hall Respondent next argues that NJSEA did not transfer the East Hall to Historic Boardwalck Hall for Federal income tax purposes because NJSEA did not transfer the benefits and burdens of ownership. Whether the benefits and burdens of ownership with respect to property have passed to the taxpayer is a question of fact that must be answered from the intentions of the parties as established by the written agreements read in light of the attending facts and circumstances. T.C. 244, 252 (2005), Arevalo v.1Commissioner, 124 affd. 1469 F.3d 436 (5th Cir. McKay Rea-lty e Inc . v . Commiss ioner, a 77 T . C . 1221, 2006); Grodt & 1237 (1981),. We look sto the substance of the agreement and nots just the labels us ed by the part ies .; Arevalo V,. Commiss ioner , supra e at· 252a .The following-factors aré considered:: - (1) Whether legal title passes; (2) how the sparties treat the transaction; (3) whether - 50 - equity was acquired in the property; (4) whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to.make payments; (5), whether the right of possession vested in the purchaser; (6) which party pays the property taxes; e (7) which party bears the risk of loss or damage to the property; and (8) which partyareceives the profits from the operation and- sale of the property. Id. Respondent argues that the burdens of ownership remained. with NJSEA because it bore all of the burdens of the East Hall's operation and rehabilitation, including remaining liable for the East Hall's operating expenses, real estate taxes, workers' compensation, and property and other insurance coverage and for completion-of the East Hall rehabilitation. Respondent contends that NJSEA also remained responsible for any excess development costs, interest, taxes, and the costs of any environmental problems Respondent concurrently argues that NJSEA maintained theabenefits of ownership because it had the authority, ,through its purchase option, to purchase Pitney Bowes' interest in , Históric'Bóardwalk Hall at any time. Respondent points to Sun Oïl Co.» v. Commissioner, (3d Cir. 562 F.2d 258 1977) , revg. T.C. Mem6.31976-40, and argues that under the Court of Appeals for the Third Circuit's authority, a purchase option requires a ,finding that the benefits and burdens were not passed. - 51 - Petistioner argues that the transaction documents clearly show the-parties' intent to sell the East Hall to Historic Boardwalk Hall. Petitioner also argues that NJSEA had a contractual obligation 'to deliver the East Hall to -Histotic Boardwalk Hall, - that Historic Boardwalk" Hall shada an obligation to pay for the East Hall, and tha't Històtic~ Boardwalk Hall had possession of the East Hall. - Some of the factors weigh in'favor of finding a-sale: The parties treated the t¯ransaction as a sale; (1) (2) possession of the East Hall vested in Historic Boardwalk Hall; (3), Historic Boardwalk Hall reported the East Hall's profits and stood to lose its income if the East Hall stopped operating as an event space. Others weigh ägainst petitioner: (1) NJSEA remaine& liable for the East Hall's property taxes (2) because Historic Boardwalk Hall operated" atua loss, NJSEAlwas not guaranteed--toirecëive payments on the acquïsition ,loan each year; (3-) NJSEA could reacquire the East H,all by exercising its òpti~on under article 8.02 of the AREA. We must evaluate whether the.East Hallewas transferred in the context of this specific rehabilitation transaction. We look at all the facts and circumstances surrounding the transaction at issue. The East Háll has been öperatinij asaan event space, and all income and expenses of the East Hall have been reported on - 52 Historic Boardwalk Hall's Forms 1065. Bank accounts were opened in Historic, Boardwalk Hall' s name by SMG as operator sof ,the ~East Hall. Respondent argues that the benefits and burdens were not transferred because NJSEA remained liable for the rehabilitation and the expense of managing the East Hall. Respondent points to statements by NJSEA executives that the East Hall would operate in thes same manner as it had before Historic Boardwalk Hall was formed and argues that these statements support- a conclusion- that the benefits and burdens were not transferred to Historic eBoardwalk- Hall. statements . Respondent misinterprets the context of these They were made in relation to NJSEA' s decision to assignesome of its construction contracts to Historic Boardwa]:k Hall. e The statements appear to have been made to .third parties and swere meant to assuage the concerns of those third parties that theirs contracts and dealings with regard to the East Hal]: would be affected by the contract assignment to Historic Boardwalk Hall. 6 Respondent' s additional argument in the context of the East Hall's ownership .concerns the article 8.02 purchase option. Respondent -points to Sun Oil Co. v. Commissioner, supra, and contends that in the Court of Appeals for the Third Circuit, a purchase- option such as the one in article 8.02 requires a - 53 - finding that the benefits and burdens of- ownership remained with NJSEA. We do not believe that Sun Oil- controls. 3 In that case, Sunray DX Oil Co..(Sunray)- sold 320 parcels of land to'a tax-exempt trust. back. Sunray then leased those parcels The Commissioner challenged Sunray's. dëductions for lease payments. This Court found in favor of the taxpayer, but the Court of Appeals for the Third Circuit reversed our decision. The Court of Appeals focused on Suhray's ability to-recover the land "sold" to the tax-exempt trust. Sunray had:a number of options if it decided it wanted to recover a specific piece of land. First, it could simply swap another piece of land".for that land, without the trust's being able to reject it. Second, Sunray could make an offer- to repurchase a specific piece of land. Lastly, Sunray had a right of repurchasing the lands for an amount equal, to the present value of rent payments due 60 years -in the future, which would be an almost negligible value. The Court sof Appeals focused on how these provisions did.not truly transfer any rights to the trust. The Court of Appeals, observed that because Sunray could, without any restrictions, swap anyapiece of land for one subject* to the sale-leaseback at issue, the offer provisions in the contracts were rendered moot. Further, the Courtsof Appeals held that because Sunray could always repurchase the land for an almost- negligible amount by its repurchase options,,it ~could always recover the land without - 54 - paying the trust fair market value. The Court of Appeals stated: "The options to repurchase provide Sunray with a built in latchstring by which it could spring legal title to the properties whenever it served its convenience without obligating Sunray to pay fair market value." Sun Oil Co. v. Commissioner, 562 F.2d at 268. As an initial matter, we note that Sun Oil is distinguishable on its facts. That case dealt with a sale- leaseback. transaction entered into to generate artificial rent deductions . Further, we do not believe that the presence of a purchase option prevents our finding that the benefits and burdens of ownership of the East Hall were transferred sto Historic Boardwalk Hall in the context of the reha.bilitation tax credit. A purpose of Historic Boardwalk Hall was to allow Pitney Bowes to invest in the rehabilitation of the East Hall and= earn ,rehabilitation tax credits. The purchase option agreement gave NJSEA the right to purchase Pitney Bowes' membership interest in Historic: Boardwalk Hall at any time during a 12-month period beginning 60 months after the entire East Hall was placed in service for purposes of determining the historic rehabi+litation credits . The rehabilitation credits of Pitney Bowes would have been subject to recapture had it disposed of its partnership interest. within 60 months after the renovated East Hall was - 55 - placed in service. Regs. See sec. 50; sec. 1.47-6(a) (1), Income Tax The statute demonstrates an anticipation of repurchase and creates a disincentive. Congress established a means to police early dispositions and created a deterrent to a premature buyout. For these reasons, NJSEA's purchase option was not contrary to -the purpose of the rehabilitation tax credit. - In conclusion, we find that NJSEA transferred the benefits and burdens of ownership of the East Hall--to Historic Boardwalk Hall. VI. Respondent's Recasting of- the Transaction Respondent alternatively determined in the FPAA that it-was necessary- to redàst the East Hall transaction to "achieve tax results that are consistent with the" intent of subchapter K." Section 1 701-2(b), Income Tax Regs.," gives the Commissioner the authority to recastotransactions foreFederal income tax purposes if a partnership is formed or availed of in connection with a transaction a principal purpose of which is to reduce substantially the present value of the partners' aggregate Federal income tax liability in a manner that is inconsistent with subchapter K. Section 1.701-2(a), Income Tax Regs., provides that the following requirements are implicit in the intent of subchapter K: (1) The partnership -must be bona fide and each partnership transaction or series of related transactions * * * must be entered into for a a substantial business purpose; - 56 - (2) The form of each partnership transaction must be respected under substance over form principles; (3) * * * the tax consequences under subchapter K to;each partner of partnership operations and of transactions between the partner and the partnership must accurately reflect the partners' economic agreement and clearly reflect the partner's income * * * Requirement (3), however, contains an exception in certain situations. Some statutory and regulatory requirements imposed on partnerships by subchapter K may cause tax results that do not accurately reflect the partners' economic agreement or clearly reflect the partners' income, thus violating requirement, (3) above. Section 1.701-2(a) (3), Income Tax Regs., provides that if a transaction satisfies requirements (1) and (2), requirement (3) will be treated as satisfied to the extent that the application of such a provision to the transaction and the ultimate tax results, taking into account all the relevant facts and circumstances, are clearly contemplated by that provision. The determination of whether a transaction involving a partnership ought to be recast is made with consideration given to.ther statutory provision giving rise to the tax benefits and all pertinent facts and circumstances. Section 1.701-2(c) Income Tax -Regs., provides a nonexclusive list of factors to be considered, including whether: (1) The present value of the partners' aggregate Federal tax liability is substantially less than had the partners owned the partnership's assets and conducted the partnership's activities directly; - 57 - (2) The present value of the partners' aggregate Federal tax liability is substantially less than would be the case if purportedly separate transactions that are designed to reach a particular result are integrated'and treated as steps in a~single transaction * * *(3) One or more partners who are necessary to achieve the claimed tax results either have a nominal interest in the partnership, are substantially protected from any risk of loss from the partnership's activities * * *, or have little or no participation in the profits from the partnership's activities other than a preferred return that is in the nature of a payment for the use of capital; (4) Substantially all of the partners * * * are related (directly or indirectly) to one another; (5) Partnership items are allocated in compliance with the literal language of §§ 1.704-1 and 1.704-2, but with results that are inconsistent with the purpose of section 704(b)" and those regulations * * * ; (6) " Ther benefits andt burdens of ownership of property nominally contributed to the partnership are in"substantial part retained. (directly orsindirectly) by the contributing partner (or a related party); or (7) The benefits and burdens of ownership of partnership prop'erty -are in substantial part shifted (directly or indirectly) to the distributee partner before or after the property is actually distributed"to a the distributee partner (or a related party). Respondent argues that his decision to recast the East Hall transaction was correct because Historic Boardwalk Hall's principal purpose was to substantially reduce the present value of Pitney Bowes' aggregate tax liability in a manner inconsistent with the purpose of subchapter K. Petitioner, however, contends that the East Hall transaction is wholly consistent with the purpose of subchapter K and further - 58 - argues that the East Hall transaction is analogous to examples of the proper use of partnerships in section 1.701-2, Income Tax Regse Section 1.701-2(d), Income Tax Regs., lists various factual situations involving the use of a partnership and evaluates whether that use is or is not consistent with the intent of subchapter K. Section 1.701-2(d), Example (6), Income Tax Regs., involves the formation of a partnership by A and B, two high-bracket taxpayers, and X, a corporation with net-operating loss carryforwards. A, B, and X form partnership PRS to own and operate a building that qualifies for section 42 low-income housing credits. PRS is financed with cash contributions by A and B and nonrecourse indebtedness, and the partnership agreement provides for special allocations of income and deductions, including depreciation, to A and B equally. This allocation is consistent with the allocation of other economically substantial partnership items attributable to the building. The section 42 low-income housing credits are also allocated according to the partnership agreement. The partners and partnership comply with all applicable partnership regulations in their management and reporting of the partnership. These include sections 1.704- 1(b) (2) (ii)-(iii), 1.704-2(e), and 1.752-3, Income Tax Regs. The ultimate result reached by the Commissioner is that individuals A and B are allowed to deduct their distributive - 59 shares of PRS' losses against their nonpartnership income and to apply the low-income housing credits against their tax liabilities. Example (6) goes on to indicate that this allocation may not accurately reflectithe partners! economic, agreement or clearly reflect income. However,2because- the provisions that lead to' this result, sections 1.704-1(b) (2) (ii") (iii), 1.704-2(ë), and 1.75223, Income Tax Regs., clearly contemplated this result, then requirement (3), discussed above, is treated as having been satisfied. The use of PRS results in partners A and B's aggregate Federal income'tax liability being lower than if A and B had owned the building directly. This result flows from A and B's, being able to use corporation X's otherwise allocable credits. Example 6 concludes that, even though the use of partnership PRS leads eto this result, 'the PRS transaction ~is not inconsistent wi-th the intent of subchapter K. As a result, the Commissioner cannot invoke section 1.701-2(b), Income' Tax Regs., to recast the transaction. Respondent disputes:petitioner's reliance on Example (6) and argues that it is inapplicable. Respondent contends that Example (6) concerns a general partnership, unlike Pitney Bowes, NJSEA, and Historic Boardwalk Hall, where all partners have personal liability, none of the entities is tax exempt, section 42-does - 60 not require a profit motive, and the taxpayers aretat risk if thes building declines in value. Respondent argues that Historic Boardwalk Hall violated section,1r701-2(a)(1), Income Tax Regs., because there was nog substantial business purpose for its formation. Respondent points to certain factors listed in section 1.701-2(c), Income Tax Regs., and concludes that section 1.701-2(a) (1), Income Tax Regs;., has been violated. These factors include Pitney Bowes' aggregate tax liability's being lower as a result of Historic Boardwa-lk Hall's creation; thus, Pitney Bowes is substantially protected from any risk of loss and has little or no participation in the partnership's profits other than its preferred return. Respondent does not argue a breach of requirement (1) or (2) of section 1.701-2(a), Income Tax Regs: We have previously rejected respondent's contentions in,the context of his other arguments. We agree with petitioner that respondent's decision to recharacterize the East Hall transaction pursuant to section 1.701-2 (b), Income Tax Regs., was inappropriate.. as NJSEA and Pitney Bowes had the legitimate business purpose, as discussed above, of allowing Pitney Bowes to invest in.the East Hall's rehabilitation. The use of a partnership was necessary to allow a for-profit corporation,to invest in the rehabilitation of a government-owned building. Although Pitney Bowes' aggregate tax liability was reduced as a - 61 - result of this transaction, Congress intended to use the rehabilitation tax credit to draw private investments into public rehabilitations Further, the regulations clearly contemplate a situation in which a partnership is used to transfer valuable tax attributes from an entity that cannot use them--corporation X--to individuals who can--taxpayers A and B. Example (_6_) , VII. See sec. 1.701-2(d), Income Tax Regs. Section 6_6_62 Accuracy-Related Penalty Respondent determined in the FPAA that Historic Boardwalk Hall should be liable for the accuracy-related penalty pursuant to section 6662. Because we find respondent's other determinations to be incorrect, the section 6662 penalty is inapplic able . VIII. Conclusi-oD Respondent ' s determinations in the FPAA were incorrect . To reflect the foregoing, An appropriate decision will be entered. --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3Aa07a9a959210258b. Public record. Not legal advice.