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Decided: January 8, 2016

The Fourth Circuit affirmed the decision of the Tax Court

This case stemmed from Route 231’s filing of its federal tax return in 2005, and the Commissioner of the IRS issued a Final Partnership Administrative adjustment (“FPAA”) stating that one of its transactions from its member Virginia Conservation Tax Credit FD LLLP (“Virginia Conservation”) should have been listed as gross income and not as a capital contribution. Route 231 challenged this determination, and the Tax Court found that the transaction was a “sale” and should have been listed as gross income. Route 231 appealed.

The Fourth Circuit first looked at Route 231’s argument that the “Virginia tax credit transaction with Virignia Conservation constituted a nontaxable capital contribution followed by a permissible allocation of partnership assets to a bona fide partner.” In making its determination, the Court first looked at whether the transaction was a “disguised sale,” and listed seeral relevant factors to look at when amking this determination. The Court also noted that there was a presumption of a sale created in regulation § 1.707-3(b)(2) when the partner/partnership transfers occurred within a two-year period, unless the facts and circumstances established otherwise, a presmption that placed a high burden on a partnership to disprove that a sale had occurred. Although Route 231 attempted to distinguish the previous Virginia Historic from this case and say that because Virginia Conservation is a bona fide partner, the partner/partnership transactions are immune from the scope of § 707.  However, the Court says this argument misses the point, because the analysis under § 707 looks at the nature of the transaction itself and not the nature of the participants in the transaction. In looking at the transaction, the Court first determined whether the Virginia tax credits are property within the scope of § 707, and agree with the Tax Court that they are. It next looked at whether the transfer of the property was a “sale,” and because the exchange of tax credits for money occurred within a two-year period, the sale presumption applied. The Court listed the Tax Court’s list of factors that showed the transaction was a “sale,” and agreed with the Tax Court that those factors point to the conclusion that the transaction was a “sale,” and therefore should have been listed as “income.”  

Furthermore, the Court agreed with the Tax Court that the tax year in which the income should have been reported was 2005, not 2006 as Route 231 contended. First, the Court noted that Route 231 listed on its 2005 tax form that it received the money from the sale in 2005. Under the principles of the tax code, the Court firmly stated that a “taxpayer may be barred from taking one factual position in a tax return and then taking an inconsistent position later in a court proceeding in an effort to avoid liability based on the altered tax consequences of the original position.” Additionally, the Court found that Virginia Conservation had “legal title in, an equity interest in, and the right to possess the tax credits as soon as Route 231 earned them,” according to the terms of the agreement between them. Finally, the Court said that Route 231’s use of the accrual method of accounting showed that the sale occurred in 2005. For these reasons, the Fourth Circuit affirmed the finding of the Tax Court.

Full opinion

Jennie Rischbieter