A recent court decision on investor risk for the Atlantic City Boardwalk Hall has called the investment structures of the Federal Historic Tax Credits. Matt Welch describes the problem and potential implications for preservation projects and the credits in part three of our series on State and Federal Historic Rehabilitation Tax Credits.
After a corporation invested in the rehabilitation of the historic Atlantic City Boardwalk Hall in New Jersey in 2000, the IRS disallowed the historic tax credit that the developer passed through to the corporate investor. The IRS’s primary argument was that the investor lacked a significant assumption of risk (or reward) in the project, which, the IRS argued, meant that the corporate investor was not a genuine partner in the project for tax purposes. Ultimately, a tax court ruled in favor of the investor; on appeal earlier this year, however, the Third Circuit Court of Appeals reversed the district tax court’s decision, ruling in favor of the IRS. Indeed, the Court of Appeals agreed that the investor lacked any meaningful stake in the project: the payment to the investor was guaranteed, the investor did not contribute any capital until the developer actually secured the tax credits, and the investor reaped no benefits from any return on the project aside from its guaranteed distribution. The Court’s decision seems to underscore the notion that the IRS expects a corporate investor to join a developer in a rehabilitation project as a legitimate partner, albeit one that may incidentally receive a disproportionate share of the tax benefits resulting from the project, rather than joining the project as a nominal partner that is indirectly purchasing tax credits. In other words, Boardwalk suggests that the partnership between the developer and investor should demonstrate a business purpose (i.e. profit motive) for the investor.