United States: Fourth Circuit Affirms Tax Court On Disguised Sale By Partnership Of State Tax Credit

In Route 231, LLC, et. al v. Commissioner, No. 14-1983 (4th Cir. 2016), the U.S. Court of Appeals for the Fourth Circuit affirmed on Jan. 8 the Tax Court's decision that the taxpayer (Route 231) should have reported the amount it received from one of its members as gross income from a disguised sale of state tax credits under Section 707(a)(2)(B), rather than as a capital contribution.

Route 231 was formed in May 2005 as a limited liability company that reported as a partnership for U.S. federal income tax purposes. Each of two individual partners, John Carr and Raymond Humiston, contributed $2.3 million for a 50% membership interest. Shortly thereafter, Route 231 purchased land in Virginia. In 2005, the Commonwealth of Virginia offered state income tax credits (tax credits) equal to 50% of the fair market value of land located in Virginia that was donated to a public or private agency for conservation or preservation purposes. Route 231 wished to donate some of its property and hired a consultant to assist with the process.

On Dec. 27, 2005, Route 231 amended its operating agreement to add Virginia Conservation Tax Credit FD LLLP (Virginia Conservation) as a member with a 1% membership interest (with Humiston and Carr's interests each being reduced to 49.5%). The amended operating agreement stated that Virginia Conservation agreed to make an "initial capital contribution" of $500 plus 53 cents for each $1 of the expected tax credits allocated to it. Route 231 anticipated it would earn tax credits in the range of $6.7 million to $7.7 million as a result of the proposed conservation donations. Carr would receive $300,000 in tax credits and Virginia Conservation would receive the remainder.

On Dec. 30, 2005, Route 231 recorded deeds conveying conservation donations related to the properties it had purchased, as well as a fee interest in one of the properties, subject to the conservation easement. The total value of the donations was approximately $16.1 million. In March 2006, the Virginia Department of Taxation informed Route 231 of the final amount of the tax credits generated, indicating the tax credits were effective in 2005. Virginia Conservation's receipt of the tax credit was handled through an escrow to which Virginia Conservation deposited $3,816,000.

Route 231's 2005 partnership tax return indicated that the members had made cash contributions of $8,416,000 to Route 231, which included the $3,816,000 amount that Virginia Conservation had paid into escrow. The IRS examined the partnership and ultimately issued a final partnership administrative adjustment (FPAA) indicating that the $3,816,000 payment was improperly characterized as a capital contribution and was instead a disguised sale of property by Route 231 to Virginia Conservation. The Tax Court upheld the IRS's position that a disguised sale of property had occurred in 2005.

Section 707(a)(2)(B) provides that if a partner to a partnership transfers money or property and subsequently takes a distribution of the money or property, the two transactions, when viewed together, are properly characterized as a sale or exchange. Based on Treas. Reg. Sec. 1.707-3(b)(1), such a combination of transfers constitutes a sale of property by a partner to a partnership if the "transfer of money or other consideration would not have been made but for the transfer of property," and the "subsequent transfer is not dependent on the entrepreneurial risks of partnership operations." A presumption of sale exists if such transfers between a partner and a partnership occur within a two-year period "unless the facts and circumstances clearly establish that the transfers do not constitute a sale" (Treas. Reg. Sec. 1.707-3(c)). Treas. Reg. Sec. 1.707-6 also provides for disguised sales of property by a partnership to a partner.

In its appeal, Route 231 argued that no disguised sale of property had occurred. Route 231 specifically took issue with the Tax Court's reliance on a previous Fourth Circuit case, Virginia Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d 129 (4th Cir. 2011), which concluded under similar facts (though the recipients of the state tax credit there were numerous investors) that a disguised sale of property had occurred. In Virginia Historic, the Fourth Circuit assumed, without deciding, that the investors were bona fide partners, but found that the IRS correctly classified the transactions at issue as disguised sales of property by the partnership. Route 231 contended that Virginia Historic's holding should be limited to sham partnerships and that the "disguised sale rules do not apply to a valid partnership with economic substance like Route 231."

Ultimately, the Fourth Circuit determined that the tax credits in Route 231 constituted property within the scope of the disguised sale regulations and that a sale of such property had occurred under those regulations. Additionally, the Fourth Circuit dismissed Route 231's argument that if a disguised sale of property had, in fact, taken place between Route 231 and Virginia Conservation, the sale would have occurred in 2006, which was a closed year for the taxpayer. The Fourth Circuit stated that Route 231 was bound by the representations it made on its 2005 tax return, where it reported that it had received $3,816,000 from Virginia Conservation. As a result, Route 231 was estopped under the duty of consistency from taking an inconsistent position "in an effort to avoid [tax] liability." Aside from Route 231's duty of consistency, the Fourth Circuit added that the sale occurred in 2005 because Route 231 was on the accrual method of accounting and all the events had occurred to establish that a sale had taken place in 2005.

Route 231 illustrates the need to consider whether a purported distribution of property by a partnership needs to be examined for possible recharacterization as a disguised sale of property by the partnership to a partner who makes a transfer to the partnership that in form is labeled a contribution and that is connected to the distribution.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.