United States

Partner's investment in state tax credits ruled a disguised sale


In January 2016, the Fourth Circuit Court of Appeals ruled that a capital contribution to a partnership followed by an immediate allocation of Virginia state tax credits to the partner was a disguised sale of property.

This decision affirmed an earlier Tax Court decision that recharacterized the investor’s intended cash contribution to the partnership as gross income received by the partnership in exchange for the tax credits. This decision is similar to the result in a 2011 Fourth Circuit case  and represents a continuation of the IRS’ recent trend of deeming partnership transactions resulting in the allocation of tax credits to investors to be something other than bona fide partnership investments.

The IRS has provided a safe harbor under which it will not challenge an allocation of federal historic tax credits, and the associated requirements are intended to ensure a partner’s investment is a bona fide investment with the possibility of sharing in future profits or losses in addition to the partner’s tax credit allocation.

In light of this recent court decision and IRS actions, taxpayers should carefully review their structures to ensure tax credit allocations will be respected by the IRS in the event of an audit.