The Fourth Circuit recently confirmed another Tax Court decision finding that the allocation of state tax credits should be treated as a disguised sale for federal income tax purposes. Route 231, LLC v. Comm’r. The result was unsurprising given the numerous other recent cases finding a disguised sale for single-year state tax credits. However there are a couple of results worth noting:
- The Fourth Circuit went out of its way to define the tax credits as property for the purposes of I.R.C. sec. 707 (the code section that defines a disguised sale). Stating that the status of the credits as property is “evidenced by their value as an inducement to Virginia Conservation [the investor] to join Route 231 [the partnership]…Virginia Conservation was paying fifty-three cents on the dollar…a transaction of real economic value…” Additionally the court indicated that this was consistent with its previous ruling in Virginia Historic Tax Credit Fund 2001 LP V. Commissioner in that treating tax credits as property is consistent with Congresses intent to widen section 707’s reach.
- In addition to defining tax credits as property the court stated that Route 231, LLC would be “bound by its affirmative representation on its 2005 federal tax form” and that that representation set the parameters of the legal dispute. Therefore the transactions reported would be considered to have happened in the year they were reported on the tax form. The court continued to go through the record to further demonstrate that the transactions had indeed happened in the year reported; continually going back to the fact that Route 231, LLC had represented that the transactions had happened in 2005.
This case highlights the continuing need for partnerships and limited liability companies allocating tax credits to investor partners/members to carefully structure their agreements in order to minimize the risk the transaction will be deemed a disguised sale if possible. Otherwise, mounting case law indicates that taxpayers may need to plan for the disguised sale treatment and its income tax consequences
 Route 231, LLC v. Comm’r, 2016 U.S. App. LEXIS 256
 Id. at 20
 Virginia Historic Tax Credit Fund 2001 LP V. Commissioner, 639 F.3d 129
 Route 231 at 21
 Id. at 26