The Internal Revenue Service has issued a revenue procedure providing a safe harbor to those who invest in renovations of historic commercial buildings, addressing concerns stemming from a 2012 appeals court decision that upset users of historic tax credits, or rehabilitation credits.
Revenue Procedure 2014-12 establishes the requirements under which the Internal Revenue Service will not challenge partnership allocations of rehabilitation credits under Section 47 of the Tax Code by a partnership to its partners. The revenue procedure comes in response to an August 2012 federal appeals court decision involving Historic Boardwalk Hall on the boardwalk in Atlantic City, N.J. The U.S. Court of Appeals for the Third Circuit decided that a tax credit investor was not a bona fide partner because it didn’t have a meaningful stake in the success or failure of the project, reversing an earlier U.S. Tax Court decision. The Third Circuit determined that the investor’s return from the partnership was effectively fixed, and that the investor also had no meaningful downside risk because its investment was guaranteed.
The appeals court ruling had a chilling effect on the historic tax credit industry, and the IRS guidance aims to provide investors with a safe harbor. The revenue procedure establishes the requirements under which the IRS will not challenge partnership allocations of Section 47 rehabilitation credits by a partnership to its partners. The Treasury Department and the IRS intend for the safe harbor to provide partnerships and partners with more predictability regarding the allocation of Section 47 rehabilitation credits to partners of partnerships that rehabilitate certified historic structures and other qualified rehabilitated buildings.
The investor must have, at all times during the period it owns an interest in the partnership, a minimum interest in each material item of partnership income, gain, loss, deduction and credit equal to at least 5 percent of the investor’s percentage interest in each such item for the taxable year for which the investor’s percentage share of that item is the largest (as adjusted for sales, redemptions or dilution of the investor’s interest).
The investor’s partnership interest must constitute a bona fide equity investment with a reasonably anticipated value commensurate with the investor’s overall percentage interest in the partnership, separate from any federal, state and local tax deductions, allowances, credits and other tax attributes to be allocated by the partnership to the investor. An investor’s partnership interest is a bona fide equity investment only if the reasonably anticipated value is contingent upon the partnership’s net income, gain and loss, and is not substantially fixed in amount. Likewise, the investor must not be substantially protected from losses from the partnership’s activities. The investor must participate in the profits from the partnership’s activities in a manner that is not limited to a preferred return that is in the nature of a payment for capital.
The principal must have a minimum 1 percent interest in each material item of partnership income, gain, loss, deduction, and credit at all times during the existence of the partnership.