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Important Tax Credit Decision

September 27, 2012

Participants in tax credit transactions used to help finance real estate development will be interested to know about the recent Historic Boardwalk Hall decision by the Third Circuit Court of Appeals. Although involving federal historic tax credits, the decision has implications for allocation of tax benefits in many other partnership transactions.

The owner of Boardwalk Hall (Owner) decided to raise additional funds through a syndication of federal historic tax credits (FHTCs). A large corporate tax credit investor (Investor) agreed to make a capital contribution to the Owner, in return for a 99.99% membership interest (including a 3% preferred return) in the Owner and an allocation of the FHTCs earned from the Owner’s historic restoration. The Investor was obligated to make its capital contributions based on the achievement of progress milestones, while the project sponsor provided construction completion, operating deficit, environmental and tax credit recapture guarantees.

Based on the combined effect of the downside risk protections and the various guarantees and buyout arrangements, the Third Circuit ruled that the Investor was not a true partner for tax purposes in the Owner. The Court found that the contractual relationships served to effectively shield the Investor from any of the risks or rewards of the Owner’s construction and operation of the Boardwalk Hall project. The result was that the Third Circuit denied the Investor the allocation of the tax credits, overruling the Tax Court which had held in favor of the Owner.

The decision is based on the particular facts of the Boardwalk Hall deal, and these were particularly “bad facts” that set a problematic precedent. In addition, the opinion does not provide any “bright line” factors to use in determining that an investor is a partner for tax purposes. Our firm is closely following developments from this case and the discussions among industry participants considering questions such as:

  • Should the amount of the investor’s initial capital contribution be increased and how early in the project should that investment be made?
  • Should there be some relaxing of the protections provided the investor from the project guarantees, thereby exposing the investor to some downside risk?
  • Should the investor accept some risk in terms of the preconditions for committing additional capital contributions to the venture?
  • Should the owner/developer expand the potential for the investor to participate in the upside appreciation of the project?

The Boardwalk Hall case has far-reaching effects. The impact of the case is being debated within the industry and will affect the availability of capital for future deals, the deal structure and the pricing of capital. The effect of the Boardwalk Hall case is being evaluated with respect to deals currently in progress, deals that have closed and future deals. If you are involved in a tax credit transaction, Counsel should be contacted for advice on what measures, if any, should be taken to respond to this recent development.

If you have any questions regarding this matter or any real estate matter, please feel free to contact any of the attorneys listed here.