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 Topics
Related Articles
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions