Route 231, LLC, John Carr v. Commissioner of IRS

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 14-1983
ROUTE 231, LLC, JOHN D. CARR, TAX MATTERS PARTNER,
Petitioner - Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee.
Appeal from the United States Tax Court.
(Tax Ct. No. 013216-10)
Argued: October 28, 2015 Decided: January 8, 2016
Before AGEE and WYNN, Circuit Judges, and HAMILTON, Senior
Circuit Judge.
Affirmed by published opinion. Judge Agee wrote the opinion, in
which Judge Wynn and Senior Judge Hamilton joined.
ARGUED: Timothy Lee Jacobs, HUNTON & WILLIAMS LLP, Washington,
D.C., for Appellant. Richard Farber, UNITED STATES DEPARTMENT
OF JUSTICE, Washington, D.C., for Appellee. ON BRIEF: William
L.S. Rowe, Richmond, Virginia, Richard E. May, Hilary B. Lefko,
Matthew S. Paolillo, HUNTON & WILLIAMS LLP, Washington, D.C.,
for Appellant. Caroline D. Ciraolo, Acting Assistant Attorney
General, Regina S. Moriarty, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.
AGEE, Circuit Judge:
Route 231, LLC, a Virginia limited liability company,
(“Route 231”) reported capital contributions of $8,416,000 on
its 2005 federal tax return. 1 This number reflected, in relevant
part, $3,816,000 it received from one of its members, Virginia
Conservation Tax Credit FD LLLP (“Virginia Conservation”). Upon
audit, the Commissioner of the Internal Revenue Service issued a
Final Partnership Administrative Adjustment (“FPAA”) indicating
that Route 231 should have reported the $3,816,000 received as
gross income and not a capital contribution. Route 231
challenged the FPAA by petition to the United States Tax Court.
After a trial, the Tax Court determined that the transaction was
a “sale” and reportable as gross income in 2005. Route 231 now
appeals, asserting that the Tax Court erred in finding the
transfer was not a capital contribution or, alternatively, that
any income was not reportable until 2006. For the reasons set
forth below, we disagree with Route 231 and affirm the decision
of the Tax Court.
1
The Internal Revenue Code treats limited liability
companies with two or more members as a partnership unless the
company elects otherwise. See 26 C.F.R. §§ 301.7701-1, 7701-2,
7703-3. Route 231 filed returns consistent with being treated
as a partnership for federal tax purposes.
2
I.
In May 2005, Raymond Humiston and John Carr formed Route
231, a limited liability company (“LLC”) registered in Virginia.
Humiston and Carr each made initial capital contributions of
$2,300,000 and each received a 50% membership interest in the
LLC. Route 231’s initial operating agreement stated its purpose
was “to own, acquire, manage and operate [certain] real
property.” (J.A. 225.) Consistent with that purpose, Route 231
purchased two parcels, known as Castle Hill and Walnut Mountain,
in Albemarle County, Virginia, for approximately $24 million.
Carr and Humiston personally guaranteed the bank loan financing
the purchase.
Carr and Humiston were interested in donating some of Route
231’s property for conservation purposes and retained a
consultant to assist with that process. At that time, Virginia
offered state income tax credits “equal to 50 percent of the
fair market value of any land or interest in land located in
Virginia” donated to a public or private agency eligible to hold
such land and interests therein for conservation or preservation
purposes. Va. Code § 58.1-512 (2005). Through the consultant,
Route 231 discussed the possibility of Virginia Conservation
joining the LLC by contributing money to Route 231 and receiving
a majority of the Virginia tax credits that would be earned as a
result of three proposed conservation donations.
3
These discussions led to Route 231’s first amended
operating agreement, signed December 27, 2005, in which Virginia
Conservation became a member of Route 231 with a 1% membership
interest, with Humiston and Carr’s interests each being reduced
to 49.5%. The amended operating agreement provided that
Virginia Conservation agreed to make an “initial capital
contribution” of $500 plus an additional sum “in an amount equal
to the product of $0.53 for each $1.00 of [the tax credits]
allocated to” it. (J.A. 477, § 2.2.) The first amended
operating agreement anticipated that Route 231 would earn
Virginia tax credits “in the range of $6,700,000 to 7,700,000”
as a result of the proposed conservation donations, and it
provided that while Carr would receive $300,000 of credits,
Virginia Conservation would receive “the balance.” 2 (J.A. 479, §
3.6.)
Two days later, on December 29, 2005, Virginia Conservation
paid $3,816,000 into an escrow account pursuant to three escrow
agreements reflecting the three conservation donations Route 231
2
For tax credits earned during the time in question,
taxpayers could claim up to $100,000 of tax credits on their
state income tax returns as a $1 for $1 credit. If the value of
tax credits earned exceeded this cap, taxpayers were permitted
to carry over the tax credits for use up to five years after the
tax credits were earned. See Va. Code § 58.1-512(C)(1) (2005).
4
intended to make. 3 The escrow agreements provided that the funds
would be released to Route 231 upon written confirmation by
Virginia Conservation that it had received copies of several
documents verifying the conservation donations and Virginia tax
credits. One item listed was the Virginia Department of
Taxation’s transaction number for tracking the conservation
donations and Virginia tax credits.
The next day, December 30, 2005, Route 231 recorded deeds
conveying the following conservation donations of real property:
(1) a deed of gift of an easement on Castle Hill to the Nature
Conservancy, which was valued at $8,849,240; (2) a deed of gift
of an easement on Walnut Mountain to the Albemarle County Public
Recreational Facilities Authority, which was valued at
$5,225,249; and (3) a fee interest in Walnut Mountain (subject
to the above easement) to the Nature Conservancy, which was
valued at $2,072,880.
The final value of these conservation donations – and hence
the amount of Virginia tax credits – was slightly lower than
Route 231’s consultant had anticipated. Consequently, Carr
agreed to defer receiving approximately $84,000 of the $300,000
in tax credits he had been promised in the first amended
3
The escrow agreements contain nearly identical language,
with each agreement corresponding to one of Route 231’s proposed
conservation donations.
5
operating agreement so as to allow Virginia Conservation to
receive tax credits equivalent to the formula for the full
amount of money it had paid into escrow.
On January 1, 2006, Humiston, Carr, and Virginia
Conservation executed a second amended operating agreement for
Route 231. The agreement described the three specific
conservation donations the LLC had made and set out the Virginia
tax credits Route 231 had earned as a result of those donations.
It indicated that those credits “have been allocated as follows:
(i) $215,983.00 . . . to Carr and (ii) $7,200,000.00” to
Virginia Conservation. (J.A. 508, § 3.5.)
After execution of the second amended operating agreement,
Route 231 submitted three Virginia Land Preservation Tax Credit
Notification Forms (“Forms LPC”) to the Virginia Department of
Taxation. The forms stated that Route 231 had earned its
Virginia tax credits on December 30, 2005 (the date of the
conservation donations), and that it allocated those credits to
Carr and Virginia Conservation in the amounts reflected in the
second amended operating agreement.
In March 2006, the Virginia Department of Taxation provided
Virginia Conservation and Carr with the transaction numbers for
Route 231’s conservation donations and the tax credits. The
Virginia Department of Taxation’s letter stated that these tax
credits were “effective” in 2005.
6
Soon after Virginia Conservation received these tax credit
transaction numbers, the escrow funds were released to Route
231.
In April 2006, Carr – acting as Route 231’s tax matters
partner – filed Route 231’s 2005 federal Return of Partnership
Income Tax. 4 Schedule M-2 of that form lists total annual
capital contributions received in 2005 in the amount of
$8,416,000, which includes the amounts Humiston and Carr had
provided as capital contributions as well as the $3,816,000
Virginia Conservation paid into escrow. In addition, Schedule
K-1 of Route 231’s tax form lists Virginia Conservation as a
partner that had contributed $3,816,000 in capital “during the
[taxable] year.” (J.A. 120.)
4 While there are substantive legal differences,
particularly for state law purposes, between partnerships and
limited liability companies, they are treated alike as
partnerships for federal income tax purposes. See supra n.1.
For convenience, we refer to partners and partnerships
interchangeably with members and limited liability companies in
our discussion of the federal tax issues in this opinion.
Under the Internal Revenue Code, a partnership is a “pass-
through” entity, meaning that although the partnership prepares
a tax return, the partnership does not pay federal income taxes.
Instead, its taxable income and losses pass through to the
individual partners, who in turn are liable for their
distributive shares of the partnership’s tax items on their own
individual returns. United States v. Woods, 134 S. Ct. 557, 562
(2013).
7
The Internal Revenue Service sent Route 231 an FPAA
indicating, in relevant part, that Route 231 had improperly
characterized the $3,816,000 received as a capital contribution
rather than as income from the sale of the Virginia tax credits
to Virginia Conservation. 5 Route 231 challenged that
determination in a petition for readjustment in the Tax Court.
In a detailed memorandum opinion, the Tax Court upheld the
Commissioner’s determination that the transaction between
Virginia Conservation and Route 231 constituted a “disguised
sale” that occurred in 2005, and it adjusted Route 231’s 2005
tax return to reflect the $3,816,000 as gross income.
At the outset of its opinion, the Tax Court described our
decision in Virginia Historic Tax Credit Fund 2001 LP v.
Commissioner, 639 F.3d 129 (4th Cir. 2011), as “squarely on
point” with the case before it. (Cf. J.A. 1518.) Following
much of the same analysis we applied in Virginia Historic, the
Tax Court first concluded that Route 231’s Virginia tax credits
were “property” so their transfer would fall within the scope of
I.R.C. § 707. Next, the Tax Court determined that under the
applicable tax regulations of § 707, the transaction was a
5
The FPAA made additional adjustments that were resolved by
the parties. While those adjustments were included in the Tax
Court’s final decision reflecting all of the adjustments to
Route 231’s 2005 tax return, they are not at issue in this
appeal.
8
“disguised sale” because the record demonstrated that (1) Route
231 would not have transferred the Virginia tax credits to
Virginia Conservation “but for” the fact that Virginia
Conservation transferred $3,816,000 to it, and (2) Route 231’s
transfer of the Virginia tax credits was not dependent on the
ongoing entrepreneurial risks of Route 231’s operations. In
examining the totality of the facts and circumstances relevant
to this inquiry, the Tax Court observed that the amended
operating agreements set out the timing and amount of the
exchange with “reasonable certainty”; they established Virginia
Conservation’s binding contractual right to the Virginia tax
credits; and they secured Virginia Conservation’s rights by an
indemnification clause. In addition, the Tax Court observed
that Virginia Conservation’s share of the Virginia tax credits
was disproportionately large in comparison to its membership
interest and that it had no obligation to return the credits to
Route 231. As such, the Tax Court held that the transfer
between Route 231 and Virginia Conservation was a disguised sale
and that the $3,816,000 received was thus gross income.
Lastly, the Tax Court rejected Route 231’s argument that
the transfer occurred for tax purposes in 2006, instead of 2005,
for three separate and independent reasons. First, for purposes
of federal tax law, the factual circumstances indicate the sale
occurred in 2005; second, because Route 231 used the accrual
9
method of accounting, it had to report the transfer as income in
2005 regardless of when it received Virginia Conservation’s
payment; and, third, Route 231’s statements in its 2005 tax
return constituted binding admissions that the transfer of money
(however characterized) occurred in 2005.
Route 231 noted a timely appeal, and this Court has
jurisdiction pursuant to 26 U.S.C. § 7482(a)(1).
II.
Route 231 reasserts its two arguments on appeal. It
principally contends that the Virginia tax credit transaction
with Virginia Conservation constituted a nontaxable capital
contribution followed by a permissible allocation of partnership
assets to a bona fide partner. In the alternative, Route 231
asserts that even if Virginia Conservation’s payment was part of
a sale of tax credits, then the sale occurred in 2006 and not
2005. If that is so, then because 2006 is a closed tax year as
to Route 231, the IRS could not adjust income the LLC received
in that year. 6
6
At the same time it issued the 2005 FPAA, the Commissioner
issued an FPAA with respect to Route 231’s 2006 tax return.
However, Route 231 did not challenge those adjustments before
the U.S. Tax Court. Accordingly, the limitations period for the
IRS to adjust Route 231’s 2006 return expired one year and 151
days after the date of the FPAA, see I.R.C. § 6229(d), or in
August 2011. Therefore, 2006 is now a closed tax year.
10
In addressing these arguments, we review the decision of
the Tax Court “on the same basis as [a] decision[] in [a] civil
bench trial[] in United States district court[].” Waterman v.
Comm’r, 179 F.3d 124, 126 (4th Cir. 1999). Accordingly, we
review the Tax Court’s legal conclusions de novo and its factual
findings for clear error. Va. Historic, 639 F.3d at 142.
A. Disguised Sale
It comes as no secret that taxpayers often seek to
structure transactions creatively in an effort to minimize the
tax consequences. Id. at 138. In response, Congress has
enacted various statutes that look beyond form to substance in
order to differentiate taxable and nontaxable events. Id. The
characterization of the structure of Route 231’s transaction
with Virginia Conservation – a contribution to partnership
capital or a sale of assets – has significant tax consequences:
“[w]hereas a partnership must report any proceeds received from
the sale of its assets as taxable income, partners’
contributions to capital and a partnership’s distributions to
partners are tax-free.” Id.
Relevant to this case is I.R.C. § 707, which “prevents use
of the partnership provisions to render nontaxable what would in
substance have been a taxable exchange if it had not been ‘run
through’ the partnership.” Id. In such a circumstance, the
transaction between the partner and partnership is treated as if
11
a transaction between third parties regardless of the
partnership format: “[i]f a partner engages in a transaction
with a partnership other than in his capacity as a member of
such partnership, the transaction shall, except as otherwise
provided in this section, be considered as occurring between the
partnership and one who is not a partner.” I.R.C. §
707(a)(1)(A).
Particularly applicable in this case is § 707(a)(2)(B),
which provides:
(B) Treatment of certain property transfers. If--
(i) there is a direct or indirect transfer of
money or other property by a partner to a
partnership,
(ii) there is a related direct or indirect
transfer of money or other property by the
partnership to such partner (or another
partner), and
(iii) the transfers described in clauses (i) and
(ii), when viewed together, are properly
characterized as a sale or exchange of
property,
such transfers shall be treated either as a
transaction described in paragraph (1) . . . .
The treasury regulations further explain when such transactions
are “properly characterized as a sale or exchange of property.”
See 26 C.F.R. § 1.707-3. 7 In general, a partner/partnership
7The regulation describes such “disguised sales” as
transactions in which a partner transfers “property” to the
partnership and the partnership transfers “money or other
consideration to the partner.” 26 C.F.R. § 1.707-3(a)(1).
(Continued)
12
transaction is a sale “if based on all the facts and
circumstances,” “[t]he transfer of money or other consideration
would not have been made but for the transfer of property” and,
when the transfers are not simultaneous, “the subsequent
transfer is not dependent on the entrepreneurial risks of
partnership operation.” § 1.707-3(b)(1).
The regulations additionally provide a non-exclusive list
of ten relevant facts and circumstances “that may tend to prove
the existence of a sale,” including whether “the timing and
amount of a subsequent transfer are determinable with reasonable
certainty at the time of an earlier transfer”; “the transferor
has a legally enforceable right to the subsequent transfer”;
“the partner’s right to receive the transfer of money or other
consideration is secured in any manner”; “the transfer of money
or other consideration by the partnership to the partner is
disproportionately large in relationship to the partner’s
general and continuing interest in partnership profits”; and
“the partner has no obligation to return or repay the money or
other consideration to the partnership[.]” § 1.707-3(b)(2).
The regulations also create a presumption of a sale whenever the
However, we have observed that the regulations specifically
provide that these principles also apply when a partnership
transfers “property” to a partner in exchange for “money or
other consideration.” See Va. Historic, 639 F.3d at 139 (citing
26 C.F.R. § 1.707-6(a)).
13
partner/partnership transfers occur within a two-year period
“unless the facts and circumstances clearly establish that the
transfers do not constitute a sale.” § 1.707-3(c)(1). “This
presumption places a high burden on the partnership to establish
the validity of any suspect partnership transfers.” Va.
Historic, 639 F.3d at 139.
Route 231 takes issue with the Tax Court’s reliance on
Virginia Historic in the application of § 707. Its arguments
largely attempt to distinguish its transaction with Virginia
Conservation from what occurred in that case, where a
partnership “reported a series of transactions with investor
partners” as capital contributions rather than as income from
“sales” of state historic rehabilitation tax credits. Id. at
132-33. The Virginia Historic partnership actively sought
investors to contribute “capital” in exchange for a less-than-
one-percent partnership interest and an “allocation” of the
state tax credits. Id. at 133-35. The Commissioner asserted
that the investors were not bona fide partners and that “under
the relevant Code provisions and regulations,” “the transactions
between the investors and the [partnership] should nevertheless
be classified as sales for federal tax purposes[.]” Id. at 137.
We assumed, without deciding, that the investors were bona
fide partners, but found that the Commissioner correctly
classified that series of transactions. Id. After rejecting
14
the partnership’s contention that the tax credits did not
constitute “property” for purposes of the “disguised sales”
rules, we concluded the partnership failed to overcome the
presumption that the exchange was a “sale” based on the
applicable regulatory factors. Id. at 140-46.
In attempting to distinguish Virginia Historic, Route 231
points to its “emphas[is] that [the Court was] not deciding
whether tax credits always constitute ‘property’ in the
abstract. Rather, [the Court was] asked to decide only whether
the transfer of tax credits acquired by a non-developer
partnership to investors in exchange for money constituted ‘a
transfer of property’ for purposes of § 707.” Id. at 141 n.15.
Route 231 contends this language limited Virginia Historic’s
holding to sham partnerships that “ceased to exist as soon as
the credits were transferred” and that the “disguised sale rules
do not apply to a valid partnership with economic substance like
Route 231.” (Opening Br. 26.) Furthermore, Route 231 posits
that because Virginia Conservation remains a bona fide partner
in an ongoing partnership, the transfer of tax credits was
“simply an allocation [of partnership assets] among partners,
and not a sale of property by a sham entity to transitory
investors.” (Opening Br. 27.)
Route 231’s argument misses the mark. We note initially
that Route 231 does not challenge the validity of § 707 or the
15
corresponding regulations. For the most part, Route 231 also
does not challenge the Tax Court’s application of the § 1.707-
3(c) “facts and circumstances” test to the circumstances
surrounding its transaction with Virginia Conservation.
Although Route 231 denies doing so, most of its arguments center
on the premise that as Virginia Conservation is a bona fide
partner in a bona fide partnership, its partner/partnership
transactions are immune from the scope of § 707 and related
provisions. Put another way, Route 231 contends § 707 cannot
apply to the transaction at issue here because the entities
involved are bona fide entities in a genuine contractual
relationship.
The Commissioner does not contest that Route 231 is a valid
entity or that Virginia Conservation is a true partner in it.
Neither did the Tax Court rely on a failure of the bona fides of
the entities in reaching its decision. There was no need to do
so as Route 231’s argument fails under the plain language of §
707, which expressly applies to transactions between a partner
and partnership without qualification whenever a partner
“engages in a transaction with a partnership other than in his
capacity as a member of such partnership.” The bona fides of
Virginia Conservation’s status as a member of Route 231, or that
entity’s status as a valid limited liability company (and valid
partnership for tax purposes) do not matter for this inquiry.
16
In short, the analysis under § 707 goes to the bona fides of a
particular transaction, not to the general status of the
participants to that transaction. Contrary to Route 231’s
repeated assertions, I.R.C. § 707 applies by its plain terms to
designated transactions between otherwise valid ongoing
partnerships and their legitimate partners. 8
Relatedly, in Virginia Historic we expressly did not
analyze whether the partnership itself was legitimate, nor did
we limit § 707’s scope to sham partnerships. Quite the
contrary, the Court expressly assumed the existence of a bona
fide partnership and proceeded directly to analyzing whether the
transaction nonetheless constituted a disguised sale under §
707. Cf. Va. Historic, 639 F.3d at 137. So, too, here: this
case does not turn at all on characteristics of the Route 231
8
To supports its contention that § 707 and the disguised
sale rules apply only when a partnership is illegitimate or a
sham, Route 231 points to Historic Boardwalk Hall, LLC v.
Commissioner, 694 F.3d 425 (3d Cir. 2012). There, the Third
Circuit observed that some of the same principles applicable to
disguised sales also apply in the separate context of
determining whether a bona fide partnership exists. Where those
points overlapped, the court relied in part on our decision in
Virginia Historic. See id. at 454-55. Nothing about the
Commissioner’s position or the analysis in Historic Boardwalk
suggests that the two analyses can only take place together, or
that a bona fide partnership cannot engage in a transaction that
§ 707 recognizes as a disguised sale between a partnership and
its partner. To the extent that its analysis is persuasive
authority, Historic Boardwalk stands for the unremarkable
principle that in certain instances, factors relevant to the one
of these inquiries may overlap with factors relevant to the
other.
17
entity or its members. Instead, as contemplated by § 707(a),
this case turns on the nature of the transaction at issue: the
exchange of Virginia tax credits for money. 9
Turning to the specific circumstances of Virginia
Conservation and Route 231’s transaction, we first determine
whether the Virginia tax credits constitute “property” within
the scope of I.R.C. § 707 (regulating the “transfer of money or
other property”). We agree with the Tax Court’s analysis and
its conclusion that the Virginia tax credits are “property” for
purposes of I.R.C. § 707. The tax credits’ status as “property”
is evidenced by their value as an inducement to Virginia
Conservation to join Route 231. It bears noting that Virginia
Conservation was paying fifty-three cents on the dollar for a
credit worth a full dollar in tax relief from Virginia state
income tax: a transaction of real economic value. Moreover,
Route 231’s ownership of the Virginia tax credits gave rise to
such essential proprietary rights as the right to own or use an
item, to exclude others from ownership, and the right to
9 Nor did Virginia Historic limit § 707(a)’s scope to non-
developer partnerships as Route 231 contends. To be sure, in
examining the transaction at issue in Virginia Historic, we
pointed out that our holding that the tax credits were property
arose in the factual context of a “non-developer partnership,”
and that tax credits may not categorically constitute
“property.” But this language simply recognizes the factual
setting of Virginia Historic and reflects the requisite analysis
of “property” must be made in each case and not taken as a per
se rule.
18
transfer them as permitted under state law. In addition, as we
explained in greater detail in Virginia Historic, treating the
tax credits as “property” is consistent “with Congress’s intent
to widen [§ 707’s] reach” when that statute was amended in 1984.
See 639 F.3d at 142.
Having determined that the Virginia tax credits constitute
“property,” we turn to whether the transfer of this property
from Route 231 to Virginia Conservation constituted a “sale.”
Because the exchange of tax credits for money occurred within a
two-year period, the presumption that the transaction is a
disguised sale arises unless the “facts and circumstances
clearly establish” otherwise. See 26 C.F.R. § 1.707-3(c)(1).
The regulations provide that transactions of this nature are in
fact sales if, “based on all the facts and circumstances,” (1)
the transfer of money would not have been made without the
transfer of property, and (2) the subsequent transfer was not
dependent on the entrepreneurial risks of the partnership. 26
C.F.R. § 1.707-3(b)(1).
The analysis of these two considerations is based on the
totality of the “facts and circumstances,” including the ten
potentially applicable factors noted earlier. 26 C.F.R. §
1.707-3(b)(2). As the Tax Court noted, among the items that
“tend to prove the existence of a sale” in this case are:
19
• the fixed cash-to-credit ratio for the transaction as
set out in the amended operating agreements, coupled
with Route 231’s agreement to earn those tax credits
by December 31, 2005 (cf. 26 C.F.R. § 1.707-
3(b)(2)(i); Va. Historic, 639 F.3d at 143);
• Virginia Conservation’s contractual right under the
amended operating agreement to all but Carr’s share
of the tax credits Route 231 earned (cf. 26 C.F.R. §
1.707-3(b)(2)(ii); Va. Historic, 639 F.3d at 143);
• Virginia Conservation’s right to be indemnified by
Route 231, Carr, and Humiston should it not receive
all the tax credits for which it provided Route 231
money (cf. 26 C.F.R. § 1.707-3(b)(2)(iii); Va.
Historic, 639 F.3d at 143-44) 10;
• Carr’s agreement to reduce the amount of tax credits
he would receive so that Route 231 could transfer to
Virginia Conservation the full amount of tax credits
for which it had contracted and paid (cf. 26 C.F.R. §
1.707-3(b)(2)(v));
• That Virginia Conservation received a 1% interest in
the LLC and yet received 97% of Route 231’s state tax
credits for the “contribution” of $3,816,000 while
Carr and Humiston each received a 50% (later reduced
10 We reject Route 231’s argument that the amended operating
agreements’ indemnity clause should not serve as proof that
Virginia Conservation’s right to the tax credits or their value
was secured. Route 231 contends that the indemnity clause did
not “fully protect [it] from partnership risks” because Route
231, Carr, and Humiston had minimal available assets should any
one of them have been required to pay Virginia Conservation in
satisfaction of the indemnity obligation. That argument
misunderstands the relevant factor, which is whether “the
partner’s right to receive the transfer of money or other
consideration is secured in any manner[.]” 26 C.F.R. § 1.707-
3(b)(2)(iii). The regulation only asks whether the secured
right exists, not whether there is a risk that the secured party
may not in fact be able to collect on a judgment for breach of
contract at some point in time. Because the indemnity clause
creates a legally enforceable right of indemnity, the Tax Court
appropriately concluded that this factor weighed in favor of a
disguised sale.
20
to 49.5%) interest in the partnership and yet
received 3% and 0% of Route 231’s conservation tax
credits for their “contributions” of $2,300,000 (cf.
26 C.F.R. § 1.707-3(b)(2)(ix); Va. Historic, 639 F.3d
at 144); and
• That Virginia Conservation had no obligation to return
or repay the tax credits to Route 231, but exercised
full ownership rights in them (cf. 26 C.F.R. § 1.707-
3(b)(2)(x); Va. Historic, 639 F.3d at 144).
These facts and circumstances form the basis for our
conclusion that the Tax Court correctly determined that this
transaction was a sale under 26 C.F.R. § 1.707-3(b)(1). Viewing
all the circumstances surrounding this transaction, and in
particular the terms of the amended operating agreements, the
Tax Court did not err in finding that “Route 231 would not have
transferred $7,200,000 of Virginia tax credits to Virginia
Conservation but for the fact that Virginia Conservation had
transferred $3,816,000 to it” and vice versa. J.A. 1526; cf. 26
C.F.R. § 1.707-3(b)(1)(i).
Moreover, Virginia Conservation’s right to the tax credits
did not depend on the entrepreneurial risks of Route 231’s
operations. Cf. 26 C.F.R. § 1.707-3(b)(1)(ii). Arguing to the
contrary, Route 231 points to Virginia Conservation’s assuming
certain entrepreneurial risks as a partner in an ongoing
partnership, but 26 C.F.R. § 1.707-3(b)(1)(ii) focuses on
whether the later of the two transfers depended on the
entrepreneurial risks of Route 231. Here, the plain language of
21
the amended operating agreements created a fixed cash-to-credit
ratio to determine what each party would exchange. They also
contained a specific guarantee that Virginia Conservation would
receive all of the tax credits it paid for and that it would be
entitled to reimbursement in cash for any shortfall. At bottom,
Virginia Conservation’s right to the tax credits depended on
fixed contractual terms, not the entrepreneurial risks of Route
231’s operations.
For these reasons, our review of the record leads us to the
firm belief that Route 231 failed to rebut the presumption that
the transaction between Route 231 and Virginia Conservation was
a sale. Cf. 26 C.F.R. § 1.707-3(c) (creating a presumption that
transfers made within two years are presumed to be a sale
“unless the facts and circumstances clearly establish”
otherwise). Accordingly, we hold that the Tax Court did not err
in agreeing with the Commissioner that the money Route 231
received from Virginia Conservation was “income” for federal tax
purposes.
B. Applicable Tax Year
Route 231 contends that even if the funds it received from
Virginia Conservation should have been reported as “income,”
that income was reportable in 2006 rather than 2005. If Route
231 is correct, then the determination that the Virginia tax
credit transfer constituted “income” would have no impact on it
22
because the IRS did not seek an adjustment of Route 231’s 2006
tax return on that ground and any change to that tax year is now
barred by the statute of limitations. See I.R.C. § 6229
(articulating the limitations period for making assessments).
As we discuss below, we find none of Route 231’s arguments
on the applicable tax year to be meritorious. The Tax Court
correctly determined that the tax credit sale occurred in 2005
for federal tax purposes. 11
1.
As an initial matter, Route 231 remains bound by its
affirmative representation on its 2005 federal tax form that it
received $3,816,000 from Virginia Conservation in 2005. That
factual representation to the Commissioner sets the parameters
of the legal dispute between the Commissioner and Route 231:
given that this transaction occurred, how does the Internal
Revenue Code characterize it?
We have previously recognized with approval the Fifth
Circuit’s decision in Wichita Coca Cola Bottling Co. v. United
States, 152 F.2d 6 (5th Cir. 1945), where the court recognized
that a “duty of consistency in tax accounting” does not require
11 Route 231 also raises evidentiary challenges to some of
the exhibits the Tax Court relied upon in concluding the sale
occurred in 2005. Because other independent evidence fully
supports the Tax Court’s conclusion, it is unnecessary to
address those arguments. See 28 U.S.C. § 2111.
23
a “willful misrepresentation” to be proven, nor does it require
“all the elements of a technical estoppel. It arises rather
from the duty of disclosure which the law puts on the taxpayer,
along with the duty of handling his accounting so it will fairly
subject his income to taxation.” Id. at 8, relied on favorably
in Interlochen Co. v. Comm’r, 232 F.2d 873, 877-78 (4th Cir.
1956). Thus, in Wichita Coca Cola Bottling Co., the Fifth
Circuit concluded that if a taxpayer mistakenly “represented a
transaction as to defer taxation on it to a later year he ought
not, when the time for taxation under his view of it comes, to
be allowed to assert the tax ought to have been levied in the
former year if it is then too late so to levy it.” 152 F.2d at
8.
The same basic principle applies here. Through its 2005
tax return, Route 231 represented to the IRS that the events
constituting the transaction occurred in 2005. Upon proof that
the reported tax credit transaction is properly characterized as
a disguised sale and thus taxable as income, Route 231 cannot
then be allowed to assert the transaction occurred in a
different year than it represented, given that it is too late to
require Route 231 to report it as income in the later year,
2006.
The bottom-line principle remains constant: A taxpayer may
be barred from taking one factual position in a tax return and
24
then taking an inconsistent position later in a court proceeding
in an effort to avoid liability based on the altered tax
consequences of the original position. E.g., Janis v. Comm’r,
461 F.3d 1080, 1085 (9th Cir. 2006) (“‘[T]he duty of consistency
not only reflects basic fairness, but also shows a proper regard
for the administration of justice and the dignity of the law.
The law should not be such a[n] idiot that it cannot prevent a
taxpayer from changing the historical facts from year to year in
order to escape a fair share of the burdens of maintaining our
government. Our tax system depends upon self assessment and
honesty, rather than upon hiding of the pea or forgetful
[equivocation].’” (quoting Estate of Ashman v. Comm’r, 231 F.3d
541, 544 (9th Cir. 2000))); Alamo Nat’l Bank v. Comm’r, 95 F.2d
622, 623 (5th Cir. 1938) (“It is no more right to allow a party
to blow hot and cold as suits his interests in tax matters than
in other relationships. Whether it be called estoppel, or a
duty of consistency, or the fixing of a fact by agreement, the
fact fixed for one year ought to remain fixed in all its
consequences, unless a more just general settlement is proposed
and can be effected.”). Accordingly, the Tax Court did not err
in concluding Route 231 remained bound by its original factual
25
representation that the transfer of funds from Virginia
Conservation occurred in 2005. 12
2.
Quite apart from the equitable consistency consideration,
we also conclude that the record demonstrates the sale of
Virginia tax credits in fact occurred in 2005. In particular,
the record supports the Tax Court’s determination that Route 231
transferred to Virginia Conservation before January 1, 2006 the
12Route 231 urges that the duty of consistency should not
apply because, among other things, the IRS could have, and yet
did not, challenge Route 231’s 2006 return in light of its
position with respect to Route 231’s 2005 return. As such, it
contends the Commissioner is responsible for its inability to
adjust the 2006 return. In addition, it contends the
Commissioner’s position in this case is inconsistent with its
position in Virginia Historic, where adjustments were proposed
to two years of tax returns based on the argument that the
challenged transactions constituted sales and where the
Commissioner agreed that any adjustments should be made to the
second year’s returns.
This argument overlooks key factual differences between
this case and Virginia Historic. There, the partnership engaged
in multiple transactions with partners that occurred “between
November 2001 and April 2002.” 639 F.3d at 135. The
Commissioner challenged the partnership’s tax returns for both
2001 and 2002 because the transactions at issue occurred in both
tax years. Furthermore, the Commissioner stipulated that any
adjustments for all of the transactions should apply to the
partnership’s 2002 tax returns. Id. at 136. That stipulation
has no bearing on the Commissioner’s position in this case and
even less on the appropriate analysis. Here, in contrast, the
Commissioner only challenged one transaction. The Commissioner
appropriately challenged Route 231’s characterization of that
transaction for the tax year where Route 231 reported the
transaction as having occurred. Far from being inconsistent
positions, the Commissioner has taken its position based on the
facts of the cases before it.
26
tax credits that it had earned because of the December 30
conservation donation.
Under the then-applicable Virginia statute, Va. Code §
58.1-512 (2005), Route 231 earned tax credits as a matter of law
as soon as it made a qualifying conservation donation. The
statute set out – among other things – the value of the tax
credits (“50% of the fair market value”), what type of donation
qualified, and how the fair market value of the donation was to
be substantiated. See Va. Code § 58.1-512 (2005). As the Tax
Court observed, this statutory language was later amended to add
language requiring taxpayers to “apply for a credit” that would
then be “issued” by the Virginia Department of Taxation. Va.
Code § 58.1-512(D)-(E) (2007). But that amended language was
not the law of Virginia in 2005.
Based on the applicable Virginia statutory language, Route
231 earned the tax credits by making the statutorily compliant
donation on December 30, 2005. Notably, Route 231 does not
contend that it had failed to meet any of the Virginia statutory
requirements, and it only speculates that the Virginia
Department of Taxation might have decreased the anticipated
number of earned tax credits despite having satisfied those
requirements. The point remains, under the applicable state
27
statutes, Route 231 earned – and therefore owned – tax credits
as of the time of its donation, which occurred in 2005. 13
The record also shows that Route 231 transferred all but
Carr’s share of those tax credits to Virginia Conservation in
2005. Under 26 C.F.R. § 1.707-3(a)(2), a
sale is considered to take place on the date that,
under general principles of Federal tax law, the
partnership is considered the owner of the property.
If the transfer . . . from the partnership to the
partner occurs after the transfer . . . . to the
partnership[,] the partner and the partnership are
treated as if, on the date of the sale, the
partnership transferred to the partner an obligation
to transfer to the partner[.]
As noted earlier, a corollary principle applies when the
transfer from the partner occurs after the transfer from the
partnership. See 26 C.F.R. § 1.707-6(a).
Under federal tax law, an entity “owns” property when it
possesses the benefits and burdens of ownership. The Tax Court
appropriately applied a multi-factor analysis to determine
whether Route 231 owned the tax credits in 2005. The relevant
13
Route 231’s argument that while it might have been able
to use the tax credits immediately, it could not transfer the
credits without registering them misreads the applicable
Virginia statute. Va. Code § 58.1-513(C) (2005) allowed the
transfer of “unused but otherwise allowable credit for use by
another taxpayer on Virginia income tax returns” without
reservation. While that statute required taxpayers to file a
notification of the transfer with the Virginia Department of
Taxation, nothing in the statute required that the notification
occur prior to the transfer of tax credits. See Va. Code §
58.1-513(C) (2005).
28
factors in that analysis include: whether legal title passed;
how the parties treated the transaction; whether an equity
interest in the property was acquired; whether the contract
created a present obligation on the seller to execute and
deliver a deed and a present obligation on the purchaser to make
payments; whether the right of possession was vested in the
purchasers; which party bore the risk of loss or damage to the
property; and which party received profits from the operation
and sale of the property. Calloway v. Comm’r, 691 F.3d 1315,
1327-28 (11th Cir. 2012); Arevalo v. Comm’r, 469 F.3d 436, 439
(5th Cir. 2006); Crooks v. Comm’r, 453 F.3d 653, 656 (6th Cir.
2006); Upham v. Comm’r, 923 F.2d 1328, 1334 (8th Cir. 1991). No
one of these factors controls, as the determination of ownership
is based on all the facts and circumstances of a particular
case, and some factors may be “ill-suited or irrelevant” to a
particular case. Calloway, 691 F.3d at 1327.
Under the totality of the relevant circumstances here, the
Tax Court correctly determined that the sale occurred in 2005.
We already discussed Route 231’s representation on its 2005
federal tax forms, but that is just one of several instances
where Route 231 treated or represented the transfer as occurring
in 2005. Route 231’s Forms LPC represented to the Virginia
Department of Taxation that the tax credits had been transferred
to Virginia Conservation in December 2005. In addition, the
29
first amended operating agreement (signed on December 28)
created a present contractual obligation for Route 231 to convey
to Virginia Conservation all but $300,000 of any tax credits
Route 231 earned from a conservation donation before December
31, 2005. Thus, as soon as Route 231 earned the tax credits by
recording the statutory-compliant conservation donation on
December 30, 2005, Virginia Conservation had the legal right to
those credits.
As further support for our conclusion, the language used in
Route 231’s second amended agreement (signed January 1, 2006)
recited the salient sale events as having occurred in the past,
not as prospective acts. For example, that agreement refers to
Virginia Conservation as having “made” its contribution, Route
231 as having “duly earned” the tax credits, and those credits
having “been allocated” to Carr and Virginia Conservation,
respectively. (J.A. 504, 508, 517.) Lastly, in additional
correspondence between Route 231, Virginia Conservation, and the
escrow agent, Route 231 specifically recognized the potential
tax consequences of the transaction occurring in 2005 versus
2006, and maintained that it occurred in 2005. Consistent with
that view, when a concern arose as to who bore the risk of loss
and owned any interest earned while the funds were held in
escrow, Route 231 and Virginia Conservation agreed that Route
231 bore that risk and would also be entitled to any interest
30
earned. During those discussions, Route 231 affirmed that
Virginia Conservation’s payment of the funds into escrow (in
December 2005) “satisfied [its] contractual obligation to
contribute to the capital of Route 231.” (J.A. 608.)
To recap, Virginia Conservation had legal title, an equity
interest in, and the right to possess the tax credits as soon as
Route 231 earned them in 2005; Route 231, Virginia Conservation,
and other parties to the transaction all intended for the
transaction to occur, and treated the transaction as having
occurred, in 2005 throughout the negotiations up until the
Commissioner challenged how Route 231 characterized the transfer
on its federal tax return; and the first amended operating
agreement gave rise to a present obligation on the part of Route
231 to transfer the tax credits earned in 2005, while the second
amended operating agreement documented that this obligation had
been satisfied. All of these circumstances demonstrate that the
sale occurred in 2005.
Route 231 argues that this analysis ignores the language of
the escrow agreements and the fact that Virginia Conservation
did not authorize release of the funds from escrow until March
2006, after it confirmed receiving various documents related to
the conservation donation and the Virginia tax credit
transaction numbers. To the contrary, the above analysis takes
the totality of circumstances into consideration rather than
31
focusing on the escrow agreements apart from the whole. This
conclusion also finds support in the language of the escrow
agreements, which provide that only two events automatically
required the escrow agent to return the funds to Virginia
Conservation and thus cancelled the sale: failure to record the
charitable donations “on or before December 31, 2005” or failure
to admit Virginia Conservation as a Route 231 partner “on or
before December 31, 2005.” (J.A. 532, 536, 540.) Both those
events were known and satisfied before the end of 2005, so the
escrow agreements’ contingency could not have occurred in 2006.
The remaining acts Route 231 points to as showing a sale of
tax credits did not occur in 2005 – that it provide Virginia
Conservation copies of certain documents relating to the
conservation donation and the tax credits, and that Virginia
Conservation provide written confirmation of receiving them –
are of no consequence. These acts are ministerial, not
substantive. The escrow agreements only speak to Route 231
providing copies of documents and are not directly contingent on
the outcome of the Virginia Department of Taxation’s review
process. Providing copies is a quintessential ministerial task.
See Black’s Law Dictionary 1011 (defining “ministerial” as “[o]f
or relating to an act that involves obedience to instructions or
laws instead of discretion, judgment, or skill”); see also Ray
v. United States, 301 U.S. 158, 163 (1937). In the unlikely
32
event that the Virginia Department of Taxation reduced the
amount of tax credits Virginia Conservation would receive, the
amended operating agreements (not the escrow agreements)
directed how Virginia Conservation would be compensated.
Moreover, it would have no bearing on the fact that Route 231
sold a portion of its earned tax credits to Virginia
Conservation in 2005. That is to say, it would not impact the
fact of the sale.
Based on the totality of the evidence, the sale of tax
credits for money occurred in 2005, and all that remained in
2006 were ministerial formalities.
3.
Route 231’s argument fails for a third reason: it uses the
accrual method of accounting, and under the principles
applicable to the accrual method, the sale occurred in 2005.
Gross income must be “included in the gross income for the
taxable year in which received by the taxpayer, unless, under
the method of accounting used in computing taxable income, such
amount is to be properly accounted for as of a different
period.” I.R.C. § 451(a). “Under an accrual method of
accounting, income is includible in gross income when all the
events have occurred which fix the right to receive such income
and the amount thereof can be determined with reasonable
accuracy.” 26 C.F.R. § 1.451-1(a). Generally speaking, this
33
means that “income . . . is taxable in the year the income is
accrued, or earned, even if it is not received in that year.”
IES Indus., Inc. v. United States, 253 F.3d 350, 357 (8th Cir.
2001). Although we do not have any published authority
elaborating on what “all the events” means for purposes of
applying this regulation, the Tax Court adopted a reasonable
interpretation that other cases have used: (1) the required
performance takes place, (2) the payment is due, or (3) the
payment is made, whichever comes first. Johnson v. Comm’r, 108
T.C. 448, 459 (1997), rev’d in part on other grounds, 184 F.3d
786 (8th Cir. 1999).
Here, Route 231 earned Virginia Conservation’s $3,816,000
payment with reasonable certainty in 2005 when it made the
conservation donations that gave rise to the Virginia tax
credits. Under the terms of the amended operating agreements,
that act was sufficient to obligate Route 231 to transfer all
but Carr’s share of the tax credits to Virginia Conservation.
And, in turn, that occurrence was sufficient to obligate
Virginia Conservation to pay Route 231 the pre-determined cash-
to-credit ratio for the tax credits. Consequently, by December
31, 2005, “all the events [had] occurred which fix[ed] the right
to receive [Virginia Conservation’s money] and the amount
thereof c[ould] be determined with reasonable accuracy.” Cf. 26
C.F.R. § 1.451-1(a). Accordingly, the Tax Court correctly
34
determined that under the accrual method of accounting, Route
231 was obligated to report the $3,816,000 in income from
Virginia Conservation on its 2005 federal tax forms.
III.
For the reasons set out above, we affirm the Tax Court’s
decision adjusting Route 231’s 2005 Return of Partnership Income
federal tax form to reflect, in relevant part, income of
$3,816,000.
AFFIRMED
35