In Historic Boardwalk Hall, LLC v. Commissioner (HBH), Third Circuit, 11-1832 (2012), the Third Circuit Court of Appeals decided that a rehabilitation tax credit investor was not a bona fide partner in Historic Boardwalk Hall, LLC, which owned Atlantic City’s Historic Boardwalk Hall, an “iconic venue” and home to the Miss America beauty pageant. The court found that the investor “lacked a meaningful stake in the success or failure” of the project owner and, consequently, was not entitled to any rehabilitation tax credits attributable to the renovation of Historic Boardwalk Hall.

HBH involved the redevelopment of Historic Boardwalk Hall by the New Jersey Sports and Exposition Authority (NJSEA), a New Jersey state agency. To defray project costs, NJSEA solicited bids from federal rehabilitation tax credit investors. Pitney Bowes, Inc., was the winning bidder. Historic Boardwalk Hall, LLC, was formed to be the tax owner of the building and to complete the renovation of Historic Boardwalk Hall.

In HBH, the starting point for the court’s analysis is the test laid out in Commissioner v. Culbertson, 337 U.S. 733 (1949), that “a partnership exists when two or more parties in good faith and acting with a business purpose intend to join together in the present conduct of the enterprise.” The Third Circuit added that this analysis must be made based on “totality of circumstances,” considering all the facts. The court boiled down the Culbertson test to this–“to be a bona fide partner for tax purposes, a party must have a ‘meaningful stake in the success or failure’ of the enterprise.” The court noted that the test must be based on the substance of a transaction rather than its form.

In applying the nebulous Culbertson test, the court stressed three factors. First, the court concluded that Pitney Bowes lacked a “meaningful downside risk” as a result of several deal features, including guaranties from or backed by a New Jersey state agency that in the court’s view protected the tax credit investor from construction risk, operating risk, environmental risk, and tax risk.

Second, the court found that the tax credit investor lacked a meaningful upside potential in the transaction. While the taxpayer was assured of receiving its projected rehabilitation tax credit and a 3 percent preferred return on its investment, Pitney Bowes lacked a realistic prospect of receiving benefits in excess of the projected benefits.Moreover, four separate put-and-call options suggested that Pitney Bowes would exit its position in Historic Boardwalk Hall, LLC, shortly after the expiration of the five-year credit recapture period or even sooner.

Third, the court found that although the form of the transaction supported the position that Pitney Bowes was a partner, in substance the company lacked a “meaningful stake in [the] enterprise.”

HBH analysis likely applies to LIHTC transactions

Although HBH arose in connection with the federal rehabilitation tax credit, the general principles should apply to a federal low-income housing tax credit (LIHTC) transaction. The language and analysis of HBH suggests that it applies not only to the federal rehabilitation tax credit, but also to the LIHTC. While rehabilitation tax credit transactions are subject to the requirement under Code Sec. 183 that the taxpayer engage in the activity for profit, the LIHTC is exempt from this requirement in the case of a building with respect to which LIHTCs are allowed. See Treasury Reg. Sec. 1.42-4(a). But notwithstanding this exception, LIHTC transactions are still subject to “other provisions of the Code or principles of tax law,” expressly including sham or economic substance analysis and ownership analysis. See Treasury Reg. Sec. 1.42-4(a). The essential question in HBH, of whether an investor is a partner in a partnership, would apply to LIHTC transactions.

The LIHTC is subject to a 15-year recapture period while the rehabilitation tax credit has only a five-year recapture period. Some have suggested that the lengthy recapture period for the LIHTC puts it outside the bounds of the HBH analysis. While the length of “totality of circumstances” analysis, it is likely not dispositive in itself. In Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011), the court addressed whether a taxpayer faced entrepreneurial risk attributable to the risk of recapture of Virginia historic tax credits. The Third Circuit, however, said the recapture risk was “speculative and circumscribed” and held that the taxpayer had engaged in a disguised sale of Virginia historic tax credits. Although the presence of recapture risk is a good fact for purposes of the “totality of circumstances” analysis, it is likely not dispositive.

Where to draw the line?

In HBH, the Third Circuit candidly acknowledged that its decision provides limited guidance to parties planning on structuring a tax credit transaction. The court said:

The [federal rehabilitation tax credit] statute “is not under attack here.” ... It is the prohibited sale of tax credits, not the tax credit provision itself, that the IRS has challenged. Where the line lies between a defensible distribution of risk and reward in a partnership on the one hand and a form-over-substance violation of the tax laws on the other is not for us to say in the abstract.

Significantly, the court endorses the view of the IRS that there is a prohibition on the sale of tax credits. While this prohibition is not expressly stated in Internal Revenue Code Sec. 47 (rehabilitation tax credit) or Sec. 42 (LIHTC), the IRS’ view is based on the position that the rehabilitation tax credit and the LIHTC can only be allowed to a project owner and then allocated among the partners of the owner.

HBH requires developers, investors, counsel, and other participants in the LIHTC industry to decide how to structure a transaction so that it will be on the right side of the line. Will the typical LIHTC transaction in which an institutional investor acquires an interest from a developer in an operating partnership that owns an LIHTC project be on the safe side of the line?

In these transactions, the LIHTC investor will typically have invested a substantial portion of its equity prior to completion and certainly prior to the end of the 10-year period over which it is allowed LIHTCs. The LIHTC investor usually has substantial exposure to the economic performance of the project and compliance with LIHTC legal requirements. Moreover, while broad LIHTC guaranties are common, the guarantors are rarely investment grade credits or the equivalent of a state agency with taxing power.

The history of the LIHTC industry involves numerous occasions of LIHTC investors experiencing losses or providing additional equity to avoid losses. Moreover, even in those transactions in which the upside potential from a transaction is minimal because of rental restrictions, the exemption of the LIHTC from the profit tax motive suggests that the LIHTC investor still can be a partner. Under a Culbertson “totality of circumstances” analysis, it is very likely that the LIHTC investor will be a partner.

For many basic LIHTC transactions, the impact of HBH will not involve more than a discussion of the decision in the tax opinion. But for some LIHTC deals, HBH will require a thorough analysis of the deal structure to determine if there is a risk that the transaction could be recharacterized as an impermissible sale of the LIHTC. Transactions most likely to have exposure to HBH risk are those where the LIHTC investor has complete protection from downside risk and little realistic prospect for a return beyond the projected LIHTC.

Paradoxically, an effort by an investor to eliminate all practical risk from a transaction may increase tax risk. Sales of interests in LIHTC funds backed by high credit quality guarantors, cash collateral, cash equivalents, or guaranteed investment contracts warrant care special care in structuring to avoid crossing the line on converting a partnership interest into an impermissible sale of LIHTCs.


Participants in the LIHTC industry are well aware that they are implementing a congressional program with the socially laudable goal of providing high-quality, newly constructed, and renovated affordable housing. HBH is an important reminder that the LIHTC must be used in a manner consistent with general tax principles that apply to all taxpayers.

Wayne Hykan is a partner in the Real Estate Department at Ballard Spahr, LLP. He focuses his practice on real estate and finance transactions, especially those involving affordable housing, mixed-use development, and community development.