Fourth Circuit: LLC’s transfer of tax credits was “disguised sale”

Transfer of tax credits was "disguised sale"

The U.S. Court of Appeals for the Fourth Circuit today affirmed a memorandum opinion of the U.S. Tax Court, finding that a capital contribution to a limited liability company (LLC) in exchange for the LLC’s state tax credits was actually gross income to the LLC under the “disguised sale” rules of section 707(a).

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The case is: Route 231, LLC v. Commissioner, No. 14-1983 (4th Cir. January 8, 2016).  Read the decision [PDF 81 KB]

Summary

Two individuals formed an LLC to hold real estate, and the LLC in 2005 purchased two parcels of land in Virginia. At that time, the state offered state income tax credits equal to 50% of the fair market value of the land donated to a public or private agency for conservation or preservation purposes. 

The LLC agreed to allow another entity to join the LLC by contributing money to the LLC and then receiving a majority of the Virginia tax credits that would be earned as a result of three proposed conservation donations. Under this arrangement, approximately $3.8 million was deposited by that entity into an escrow account. Once the state issued letters stating that the conservation donations were eligible for the tax credits, the funds in escrow were released to the LLC.

The IRS, on audit, determined that the $3.8 million had been improperly characterized as a capital contribution because it was, in fact, income from the sale of the Virginia tax credits by the LLC to the entity. The LLC challenged the assessment before the Tax Court. The Tax Court upheld the IRS determination that the transaction was a “disguised sale” under the rules of section 707, and thus the $3.8 million was gross income to the LLC.

The Fourth Circuit today affirmed. 

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