                       T.C. Memo. 2009-295



                     UNITED STATES TAX COURT



VIRGINIA HISTORIC TAX CREDIT FUND 2001 LP, VIRGINIA HISTORIC TAX
 CREDIT FUND 2001, LLC, TAX MATTERS PARTNER, ET AL.,1 Petitioner
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 716-08, 870-08,       Filed December 21, 2009.
                 871-08.



          R issued a partnership and its two pass-thru
     partners (lower-tier partnerships) notices of final
     partnership administrative adjustment (FPAAs) for 2001
     and 2002 increasing each of the partnerships’ ordinary
     income for unreported sales of Virginia Historic
     Rehabilitation Tax Credits (State tax credits). In
     doing so, R determined that certain limited partners
     and members (investors) of the partnerships were not
     partners for Federal tax purposes but instead were
     purchasers of State tax credits from the partnerships.
     R determined, in the alternative, that the investors’


     1
      This case is consolidated for trial, briefing, and opinion
with Virginia Historic Tax Credit Fund 2001 SCP, LLC, Virginia
Historic Tax Credit Fund 2001, LLC, Tax Matters Partner, Docket
No. 870-08, and Virginia Historic Tax Credit Fund 2001 SCP, LP,
Virginia Historic Tax Credit Fund 2001, LLC, Tax Matters Partner,
Docket No. 871-08.
                                - 2 -

     contributions of capital and the partnerships’
     allocation of State tax credits to them were disguised
     sales under sec. 707, I.R.C.

          Held: The investors were partners for Federal tax
     purposes rather than purchasers of State tax credits.

          Held, further, the transactions between the
     investors and the partnerships were not disguised sales
     under sec. 707, I.R.C.

          Held, further, the limitations period for
     assessment bars the adjustments for 2001 in the FPAAs.



     David D. Aughtry and Hale E. Sheppard, for petitioner.2

     Mary Ann Waters, Jason M. Kuratnick, Alex Shlivko, Warren P.

Simonsen, Paul T. Butler, and Timothy B. Heavner, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:    These consolidated cases arise from notices

of final partnership administrative adjustment (FPAAs) issued to

Virginia Historic Tax Credit Fund 2001 LP (the source

partnership), Virginia Historic Tax Credit Fund 2001 SCP, LLC

(SCP LLC), and Virginia Historic Tax Credit Fund 2001 SCP, LP

(SCP LP) (collectively, Virginia Historic Funds or partnerships)

for 2001 and 2002.    Respondent took alternative “whipsaw”

positions in the six FPAAs, determining that the partnerships had



     2
      We use “petitioner” for convenience to reflect that the
petitions in these consolidated cases were filed by the
partnerships’ shared tax matters partner.
                               - 3 -

collectively failed to report income of $7,058,503 ($7 million)

from the sale of State tax credits in either 2001 or 2002.3

Respondent also determined that the partnerships were liable for

accuracy-related penalties for negligence and substantial

understatement of income tax under section 6662.4

     After concessions,5 we are left to decide three issues.     The

first issue is whether certain limited partners or members

(investors) were partners of the Virginia Historic Funds for

Federal tax purposes.   We hold that they were.   The second issue

is whether the transactions between the partnerships and the

investors were disguised sales under section 707.   We hold that

the transactions were not disguised sales.   The third issue is

whether the 6-year limitations period under section 6229(c)(2)

for substantial omission of gross income applies.   We hold it




     3
      The parties have stipulated that if respondent prevails on
the merits, the Virginia Historic Tax Credit Fund 2001 LP would
have no adjustment for 2001.
     4
      All section references are to the Internal Revenue Code
(Code) in effect for the years at issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated.
     5
      Respondent has conceded the determinations in the notices
of final partnership administrative adjustment (FPAAs) at issue
disregarding the partnerships under sec. 1.701-2(b), Income Tax
Regs.
                              - 4 -

does not and that the determinations in the FPAAs are therefore

untimely for 2001.6

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulations of fact and settled issues and their

accompanying exhibits are incorporated by this reference.    The

Virginia Historic Funds’ principal place of business was in

Virginia at the time the petitions were filed.

Overview of Tax Credits for Historic Rehabilitation

     The Federal Government has created various tax incentives to

encourage taxpayers to participate in otherwise unprofitable

activities that benefit the public welfare.   For example, section

47(a) allows for a Federal tax credit of 20 percent of the

qualified rehabilitation expenditures with respect to any

certified historic structure (Federal tax credit).    The Federal

tax credit encourages private sector rehabilitation of historic

buildings.

     In addition, Congress has declared that it is a policy of

the Federal Government to give maximum encouragement to

organizations and individuals undertaking preservation by private

means and to assist States in expanding and accelerating their




     6
      Respondent relies only on sec. 6229(c)(2) in arguing that
the FPAAs were timely.
                                 - 5 -

historic preservation programs and activities.     National Historic

Preservation Act of 1966, as amended 16 U.S.C. sec. 470-1 (2006).

The Need for State Tax Credits

     Conventional lenders are often unwilling to finance the

entire cost of a historic rehabilitation project because the cost

often exceeds the fair market value of the structure after

rehabilitation is complete.    The Commonwealth of Virginia is one

of several States that have enacted legislation providing for

historic rehabilitation State income tax credits (State tax

credits) to address this credit gap.     The Virginia Historic

Rehabilitation Credit Program (Virginia Program) was enacted in

1996 and provides State tax credits to individuals and businesses

to encourage the preservation of historic residential and

commercial buildings.   In addition, the Virginia Program helps

the owner or developer of a historic property attract the

necessary capital to fill the gap between costs and conventional

financing.

     State tax credits issued to the owner of historic property

often exceed the owner’s State tax liabilities.     The Virginia

Program includes a partnership allocation provision that allows

owners to use their excess credits to attract capital

contributions from other entities or individuals.     See Va. Code

Ann. sec. 58.1-339.2 (2009).   This allocation provision provides

that State tax credits granted to a partnership are to be
                                - 6 -

allocated among all partners either in proportion to their

ownership interest in the partnership or as the partners mutually

agree.   Id.   Thus, the State allocation provision allows an owner

to allocate a disproportionate share of the State tax credits to

limited partners whose contributions then fill the credit gap.

Many historic rehabilitation projects involve a developer

partnership composed of a developer or owner, a State tax credit

partner like the source partnership, and a Federal tax credit

partner, which is often a large national corporation that may not

be doing business in the State.   Generally, Federal tax credits

must be allocated in accordance with a partner’s profits interest

so that the Federal tax credit partner may hold as much as a 98-

percent developer partnership interest.   See sec. 1.704-

1(b)(4)(ii), Income Tax Regs.   The Virginia Program’s allocation

provision allows the State tax credit partner to have a small

ownership percentage in the developer partnership that does not

substantially interfere with the allocation of Federal tax

credits.   The State tax credit partner, however, receives most of

the excess State tax credits.   Developers depend on State tax

credits to attract the capital necessary to cover the credit gap

and provide a viable alternative to demolishing historic

structures that might otherwise be destroyed.
                               - 7 -

Mechanics of the Virginia Program

     Several States have programs similar to the Virginia

Program, but the programs vary from State to State with respect

to eligibility, credit amount, caps, and transferability.    The

Virginia Program provides dollar-for-dollar State income tax

credits against Virginia income tax liability for taxpayers who

meet the Virginia Program’s guidelines.    The Virginia Program was

codified in Va. Code Ann. sec. 58.1-339.2, and the Virginia

Department of Historic Resources (DHR) manages and administers

the Virginia Program with the assistance of the Virginia

Department of Taxation.   A taxpayer must submit an application to

the DHR and comply with the Secretary of the Interior’s

guidelines for rehabilitating historic buildings to receive tax

credits under the Virginia Program.

     The amount of credits granted for a rehabilitation project

depends on the amount of eligible expenses incurred.    Credits

were allowed for up to 25 percent of eligible expenses incurred

during the years at issue.   A party incurring eligible expenses

must submit an application to the DHR to receive a Certification

of Rehabilitation (certificate).    The taxpayer must attach the

certificate to the Virginia tax return on which credits are

claimed.   Generally, credits must be reported in the year in

which the certified rehabilitation project is completed.
                               - 8 -

Projects may also be completed in phases, however, with

qualification of credits at the end of each phase.

     The Virginia Program provides that the credits may be

carried over for 10 years if a taxpayer’s Virginia income tax

liability is less than the amount of credits granted for a given

year.   The credits are not, however, refundable or inheritable.

They are also not transferable with the exception of credits

received while there was a temporary one-time transfer provision

in effect.

     Unlike other State programs, the Virginia Program, as

originally enacted, did not allow for the transfer of State tax

credits.   Some projects were started, however, with the

understanding that the credits would be transferable.   In 1999,

the Virginia Program was amended to provide for a one-time

transfer of credits only for projects certified before the

publication of the final regulations under the Virginia Program

(Program regulations).   The purpose of the one-time transfer

provision was to protect projects that had begun under the

assumption that the credits would be transferable.    All one-time

transfers required approval by the director of the DHR.    The

director, Kathleen Kilpatrick, approved transfers only from the

entity or individual initially earning the credits.   The DHR

operated the Virginia Program for several years without the

benefit of Program regulations.   The one-time transfer provision
                                - 9 -

was not included in the final Program regulations, which were not

published until September 2002.

Daniel Gecker and the Formation of the Virginia Historic Funds

     The Internal Revenue Service (IRS) had issued no direct

guidance regarding the Federal tax treatment of allocated State

tax credits when the Virginia Program was enacted.   Accordingly,

the DHR sought advice from professionals with expertise in the

areas of tax credits and historic rehabilitation in drafting the

Program regulations.   In 1996 the director of the DHR asked

Daniel Gecker to serve on the DHR committee that assisted in

drafting the Program regulations.   Mr. Gecker had represented

clients involved in historic rehabilitation and Federal historic

credits as an attorney for 20 years when the Virginia Program was

enacted.    In addition, Mr. Gecker consulted regularly with other

practitioners across the country including William Machen, a

well-known tax credits practitioner and partner at Holland &

Knight, regarding the Federal tax implications of State tax

credits generally and of the Virginia Program’s allocation

provision specifically.   Mr. Gecker agreed to help draft the

regulations and has continued to provide legal and other advice

to the DHR and its personnel pro bono.   In addition, Mr. Gecker

served as the managing partner of the Richmond office of Kutak

Rock, LLP, one of a few national firms with a tax credits

practice.
                              - 10 -

     Robert Miller and George Brower also provided their

expertise to the DHR.   Mr. Miller had been restoring historic

buildings as a real estate developer for over 30 years when

introduced to the Virginia Program.    Mr. Brower was a senior vice

president of Howard Weil, a division of the investment firm Legg

Mason Wood Walker Inc. (Legg Mason).   Mr. Gecker, Mr. Miller, and

Mr. Brower realized that funding existed for large rehabilitation

projects, yet many smaller projects had difficulty obtaining

financial support.   They discussed ways to increase the Virginia

Program’s reach by pooling capital for smaller projects that did

not have the resources to attract funding.   These discussions

were the springboard for the idea that became the Virginia

Historic Funds.

Overview of the Virginia Historic Funds

     Mr. Gecker, Mr. Miller, and Mr. Brower (the principals)

formed Virginia Historic Tax Credit Fund 2001, LLC (general

partner) in 2001 to provide funding for smaller historical

rehabilitation projects.   The general partner was the tax matters

partner (TMP) and general partner or managing member of the

source partnership and its pass-thru partners, SCP LLC and SCP LP

(lower-tier partnerships).   The purpose of the partnerships was

to acquire interests in a diverse selection of partnerships or

limited liability companies (developer partnerships) that were

involved in the qualified rehabilitation of real property and
                              - 11 -

entitled to State tax credits.    The partnerships could then pool

capital to support both large and small historic rehabilitation

projects.   Some of the resulting State tax credits would then be

allocated to the partnerships and, ultimately, to the investors.

     Mr. Gecker and Mr. Miller each held a 35-percent interest in

the general partner.   Mr. Miller held his interest through his

wholly owned entity BKM, LLC (BKM).    Mr. Brower held the

remaining 30-percent interest.    The principals were actively

involved in the partnerships’ activities.    Mr. Gecker contributed

his legal skills and knowledge of Federal and State tax credits.

Mr. Miller contributed his knowledge of historic rehabilitation

and served as the developer of some of the projects that

generated the credits at issue.    Finally, Mr. Brower was

primarily responsible for communications between the Virginia

Historic Funds and the developer partnerships.

Marketing the Partnerships

     The Virginia Historic Funds actively sought investors

willing to contribute capital to the partnerships during the

years at issue.   The principals approached various accounting and

investment firms to locate interested investors.    These firms

examined the structure of the partnerships and provided advice to

their clients about participating in the partnerships.    Multiple

representatives of these firms stated they discussed the

partnership allocation provision of the Virginia Program with the
                              - 12 -

investors they referred to the partnerships.   In addition, the

accounting firms typically coordinated the execution of their

clients’ agreements with the partnerships and handled their

Virginia and Federal tax planning and reporting.

     Several pamphlets and letters were used to market the

Virginia Historic Funds.   Some of the marketing materials

originated with Mr. Brower and were used in communications with

developer partnerships or investors.   Other materials were

prepared by accounting firm Witt Mares & Co., PLC (Witt Mares)

and were given to some of its clients.   The Witt Mares materials

addressed both the State and Federal tax consequences of

investment in the Virginia Historic Funds.   The written

promotional materials distributed by the partnerships emphasize

the dual purpose of investment in the partnerships.   These

materials highlighted the partnerships’ role in the preservation

of Virginia’s architectural heritage and discussed numerous

benefits of rehabilitation to the community at large.   The

materials also addressed the role of State tax credits in funding

historic rehabilitation and the Virginia Program’s partnership

allocation provision.   The marketing materials advise potential

investors that they must invest as partners in the partnerships

to be entitled to State tax credits.   Some of the marketing

materials use the colloquial terms “sell” or “sold” when

discussing the Virginia Program’s complicated allocation
                               - 13 -

provision.    These terms were quoted, stressing that they were

colloquialisms.

Investors

     The investors’ participation in the partnerships is the

focus of this litigation.    The source partnership included 181

investors, while SCP LLC included 93 investors and SCP LP

included eight investors.    Each investor made a contribution of

capital in exchange for a partnership or LLC interest.    The 181

investors in the source partnership collectively contributed

$3,959,962, SCP LP’s eight investors collectively contributed

$1,494,000, and SCP LLC’s 93 investors collectively contributed

$1,541,370.   The lower-tier partnerships contributed all their

capital contributions to the source partnership.    Accordingly,

the total investor contributions to the source partnership were

$6,995,332.

     The partnerships were tiered to reflect the various ways

investors were introduced to the Virginia Historic Funds.    The

investors in SCP LP were largely clients of Legg Mason.

Similarly, the investors in the source partnership and in SCP LLC

were clients of Witt Mares or Biegler & Associates, P.C., another

accounting firm.
                              - 14 -

Structure of the Virginia Historic Funds

     The following graph depicts the structure of the Virginia

Historic Funds.




      Various Developer Partnerships            One-Time Credit
                                                   Transfers




                         Virginia Historic
      181                 Tax Credit Fund
   Investors                  2001 LP




     Virginia Historic                       Virginia Historic
      Tax Credit Fund                         Tax Credit Fund
       2001 SCP, LP                            2001 SCP, LLC


                                                           93
       8                                               Investors
   Investors

                         Virginia Historic
                          Tax Credit Fund
                             2001, LLC




         Mr. Gecker            BKM              Mr. Brower


                            Mr. Miller
                              - 15 -

Partnership Documents

     The investors signed partnership agreements, subscription

agreements, and option agreements (partnership documents) and

wrote checks for their respective capital contributions.       The

partnership agreements contained standard provisions defining the

operation of the partnerships and the relationships of the

parties involved.   The partnership agreements provided that the

partners would share in the partnerships’ profits and losses in

proportion to their respective ownership interests and that the

partners were entitled to distributions upon dissolution in

accordance with positive balances in their respective capital

accounts, all as required by State law.     The subscription

agreements set the investors’ capital contribution and expected

allocation of State tax credits.   Generally, an investor would

contribute 74 cents for every dollar of expected State tax

credit.

     The partnership documents included traditional limited

partnership provisions that limited the investors’ liability for

partnership debts to their individual capital contributions.         The

partnership agreements also included language that limited the

risk to the investors’ capital contributions.     This language

indicated that the investors would receive a part of their

contribution back, less expenses, if the partnerships failed to

pool sufficient State tax credits.     The partnerships balanced
                               - 16 -

this risk by including provisions in its agreements with the

developer partnerships that the developer partnerships would

compensate the Virginia Historic Funds if the developer

partnerships failed to obtain State tax credits or if the credits

were revoked.   Finally, the option agreements provided that the

general partner could purchase an investor’s limited partnership

interest for fair market value after the partnership had

fulfilled its purpose.

Activities of the Virginia Historic Funds in 2001

     The source partnership became a partner in each of several

developer partnerships that earned State tax credits for 2001.

The source partnership also purchased State tax credits earned in

2001 under the one-time transfer provision.    The pooled credits

were not designated for allocation to any one particular

investor.   Instead, the investors were allocated a share of

credits from the pool of credits.    The partnerships allocated the

State tax credits to the investors on their respective Schedules

K-1, Partner’s Share of Income, Credits, Deductions, etc., for

2001.   The investors in the source partnership were allocated

$5,354,302 of pooled credits, the investors in SCP LLC were

allocated $1,972,297 of credits, and the SCP LP investors were

allocated $1,867,500.    The State tax credits were not

transferable when held by the partnerships or the investors.     The
                              - 17 -

investors were eventually bought out after the partnerships

accomplished their purpose.

The Partnerships’ Reporting Position

     The Virginia Historic Funds timely filed Forms 1065, U.S.

Return of Partnership Income, for both 2001 and 2002.     The

partnerships reported the tax credit allocations to their

investors on Schedules K-1 and included the accompanying

certificates.   Similarly, the partnerships reported capital

contributions from their respective investors.   The source

partnership also reported the flow-through contributions from the

lower-tier partnerships.

     In addition, the source partnership reported expenses of

$1,662,815 in 2001 and $1,479,373 in 2002 for “Tax Credit

Acquisition Fees” on its Forms 1065.   The source partnership

incurred these expenses when it acquired tax credits under the

one-time transfer provisions in the Virginia Program.   The source

partnership also deducted $30,000 in 2001 and $58,164 in 2002 for

legal expenses.

Respondent’s Examination of the Virginia Historic Funds

     Respondent launched concurrent examinations for the

partnerships’ 2001 and 2002 taxable years, as well as the 2002

and 2003 taxable years of the 2002 Virginia Historic Funds

(successor entities).   Respondent’s revenue agent met with Mr.

Gecker and other partnership representatives on multiple
                              - 18 -

occasions with respect to each entity.   Mr. Gecker cooperated

with the revenue agent, explaining the operations of the various

entities in detail and describing their relationships with one

another.   The Virginia Historic Funds did not execute extensions

of the period of limitations on assessment for 2001.   They did

execute extensions for 2002, however.

     Respondent issued the source partnership and the lower-tier

partnerships six separate FPAAs for 2001 and 2002 in October

2007.   Respondent determined that the investors were not partners

for Federal tax purposes and that the investors’ capital

contributions to the partnership and receipt of the State tax

credits in return were instead sales of State tax credits.    In

the alternative, respondent determined that, if the investors

were partners, the transactions were disguised sales of State tax

credits.   Respondent also determined that each partnership

recognized unreported income from these sales in the amount of

its investors’ collective capital contributions.   Finally,

respondent determined in each of the respective FPAAs that “the

partnership was formed with a principal purpose to reduce

substantially the present value of the partners’ aggregate tax

liability in a manner that is inconsistent with the intent of

subchapter K.   Accordingly, the partnership should be disregarded

pursuant to Treas. Reg. § 1.701-2(b).”   Respondent omitted the

word “federal” from the phrase “aggregate federal tax liability”
                              - 19 -

reproduced from section 1.701-2(b), Income Tax Regs. (anti-abuse

regulation).   Respondent conceded on the eve of trial that the

anti-abuse regulation does not apply to these partnerships

formed, in part, to reduce the investors’ State tax liabilities.

     The TMP timely filed petitions for readjustment of

partnership items for the Virginia Historic Funds, and a lengthy

trial was held.

                              OPINION

I.   Introduction

     We must decide whether the partnerships’ allocations of

State tax credits to the investors pursuant to State law must be

treated as sales for Federal tax purposes.   Respondent argues

that the Virginia Historic Funds acted as a retailer between the

developer partnerships and the investors and received $1.5

million7 in gross income for the reselling of State tax credits.

In doing so, respondent challenges the substance of the

investors’ participation in the partnerships using two

alternative arguments.   First respondent argues that the

investors were not partners in the partnerships for Federal tax

purposes and that the substance over form doctrine dictates that

the investors purchased State tax credits rather than investing


     7
      Investors contributed a total of $6,995,332 to the Virginia
Historic Funds, and the partnerships then contributed
$5,131,702.58 to the developer partnerships. Respondent has
allowed $330,986 in costs. Accordingly, respondent alleges a net
partnership gain of $1,532,643.42, less other costs.
                               - 20 -

in a diverse group of developer partnerships to rehabilitate

historic properties.    Alternatively, respondent argues that the

transactions between the investors and the partnerships were

disguised sales under section 707.      We disagree with both of

respondent’s arguments.   Instead, we hold that the substance of

the transactions matched their form.

      We address each of respondent’s alternative arguments in

turn and then address the impact of the relevant limitations

period.   We begin with the burden of proof.

II.   Burden of Proof

      The parties disagree whether the burden of proof shifted to

respondent under section 7491(a).    The Commissioner’s

determinations in an FPAA are generally presumed correct, and a

party challenging an FPAA has the burden of proving that the

Commissioner’s determinations are in error.      Rule 142(a); Welch

v. Helvering, 290 U.S. 111, 115 (1933); Republic Plaza Props.

Pship. v. Commissioner, 107 T.C. 94 (1996).      The burden of proof

shifts to the Commissioner under section 7491(a) with respect to

a factual issue under certain circumstances.      The burden shifts

to the Commissioner if the taxpayer introduces credible evidence

with respect to the issue and meets the other requirements of

section 7491(a).   Sec. 7491(a)(2)(A) and (B).     We find that both

parties have satisfied their respective burdens of production.        A

shift in the burden of persuasion “has real significance only in
                              - 21 -

the rare event of an evidentiary tie.”     Blodgett v. Commissioner,

394 F.3d 1030, 1039 (8th Cir. 2005), affg. T.C. Memo. 2003-212.

We do not find that to be the case here.    We therefore decide

this case on the weight of the evidence.

III. The Investors Were Partners for Federal Tax Purposes

     We now address whether the investors were partners in the

Virginia Historic Funds for Federal tax purposes.    Respondent

admits that the Virginia Historic Funds were valid partnerships

among the principals for Federal tax purposes and no longer

argues that the partnerships should be disregarded under the

anti-abuse regulation or the sham transaction doctrine.8

Respondent argues, however, that the investors were not partners

in these partnerships because the investors did not intend to

join together for any business purpose other than the sale of

State tax credits.   Petitioner counters that the investors were

partners who pooled capital to support a diverse group of

developer partnerships and to share a net economic benefit from

the resulting pool of State tax credits.    We agree with

petitioner after carefully considering the extensive evidence and



     8
      The Court of Appeals for the Fourth Circuit requires that
in order to treat a transaction as a sham a “court must find that
the taxpayer was motivated by no business purposes other than
obtaining tax benefits in entering the transaction, and that the
transaction has no economic substance because no reasonable
possibility of a profit exists.” Rice’s Toyota World, Inc. v.
Commissioner, 752 F.2d 89, 91 (4th Cir. 1985), affg. in part and
revg. in part 81 T.C. 184 (1983).
                                  - 22 -

testimony presented, that the investors were partners for Federal

tax purposes.

       We turn now to the classification of partnerships.      Federal

law controls classification for Federal tax purposes though

status under State law may be relevant.         Estate of Kahn v.

Commissioner, 499 F.2d 1186, 1189 (2d Cir. 1974), affg. Grober v.

Commissioner, T.C. Memo. 1972-240; Luna v. Commissioner, 42 T.C.

1067, 1077 (1964); sec. 301.7701-1(a), Proced. & Admin. Regs.

“Partnership” is broadly defined in the Code,9 and Federal law

recognizes as partnerships a broader range of multiple-party

relationships than does State law.         See secs. 761(a), 7701(a)(2);

sec. 1.761-1, Income Tax Regs.       A “partner” is a member in a

“syndicate, group, pool, joint venture, or other unincorporated

organization” that is classified as a partnership under Federal

law.       See sec. 7701(a)(2).

       Respondent argues that the investors are not partners in

these valid partnerships under the standards announced by the

United States Supreme Court in Commissioner v. Culbertson, 337

U.S. 733, 742-743 (1949) and Commissioner v. Tower, 327 U.S. 280,

286 (1946).       These decisions held that certain family

partnerships were not partnerships for Federal tax purposes


       9
      A partnership is defined as “a syndicate, group, pool,
joint venture, or other unincorporated organization, through or
by means of which any business, financial operation, or venture
is carried on, and which is not, within the meaning of this
title, a trust or estate or a corporation.” Sec. 7701(a)(2).
                               - 23 -

because the partnership form was used to shift income earned by

one family member to another family member.    See Commissioner v.

Culbertson, supra at 742-743; Commissioner v. Tower, supra at

286.    This Court and others have relied on these cases where the

Commissioner challenges a person’s status as a partner for

Federal tax purposes.    We will therefore address respondent’s

argument under these cases and their progeny.

       A.   The Investors’ Intent Under Culbertson and Tower

       In general, a partnership exists when persons “join together

their money, goods, labor, or skill for the purpose of carrying

on a trade, profession, or business and when there is community

of interest in the profits and losses.”    Commissioner v. Tower,

supra at 286.    The existence of the requisite purpose is a

question of fact that ultimately depends on the parties’ intent.

Commissioner v. Culbertson, supra at 742-743; Commissioner v.

Tower, supra at 287.    Thus, to determine whether a partnership

exists, we consider whether, in light of all the facts, the

parties intended to join together in good faith with a valid

business purpose in the present conduct of an enterprise.

Commissioner v. Culbertson, supra at 742; Allum v. Commissioner,

T.C. Memo. 2005-177, affd. 231 Fed. Appx. 550 (9th Cir. 2007).

We weigh several objective factors in an attempt to discern their

true intent.    These factors include the agreement between the

parties, the conduct of the parties in executing its provisions,
                                - 24 -

the parties’ statements, the testimony of disinterested persons,

the relationship of the parties, their respective abilities and

capital contributions, the actual control of income and the

purposes for which the income is used.     Commissioner v.

Culbertson, supra at 742.    None of these factors alone is

determinative, however.     Luna v. Commissioner, supra at 1077.

Accordingly, we weigh the objective factors to determine the

investors’ intent.

            1.   The Agreement Between the Parties

     The investors executed multiple documents, each of which

reflects their intent to become partners in the Virginia Historic

Funds.   Each investor signed both a partnership agreement and a

subscription agreement.   Each document designated them partners.

These agreements reflect each individual investor’s capital

contribution, the percentage of the partnership owned, and the

amount of State tax credits that would be allocated to the

investor when the certificates were approved.    These agreements

indicate the partnerships’ purpose to help rehabilitate historic

property and to receive State tax credits in return.    Each

partnership agreement specifically provided that an investor

would have an interest in the profits, losses, and net cash

receipts of the partnership in proportion to his or her ownership

interest.    Each partnership agreement also provided that assets

remaining after satisfying the partnerships’ liabilities shall be
                                - 25 -

distributed to the partners in accordance with positive balances

in their respective capital accounts upon dissolution.     These

rights were enforceable under State law.

     In addition, the investors were told that they must either

individually own historic real property or partner with an entity

that does to reap the benefit of State tax credits.     The

marketing materials the investors received described how their

State encouraged its citizens to participate in the Virginia

Program through the partnership form.     They also received advice

from accounting or investment firms that their involvement would

be as partners.    We do not ignore these facts.   Most of the

investors desired to support historic rehabilitation.     All of

them hoped to reap a net economic reward by using the credits

while also limiting their risks in an appropriate manner.      The

Virginia Historic Funds offered the investors interests in an

entity that was not only a partner in a diversified group of

developer partnerships but was also managed by an expert on the

Virginia Program.     We therefore find that the agreements between

the investors and the partnerships indicate that the investors

intended to be partners.

          2.      Conduct of the Parties in Execution of the
                  Agreement

     The investors contributed capital to the partnerships upon

execution of the partnership documents.     The partners received

Schedules K-1 from their respective partnerships allocating their
                              - 26 -

shares of credits from the partnership pool as well as their

shares of other partnership items.     They applied the credits to

their individual Virginia income tax liabilities for 2001.    In

addition, the investors accepted checks pursuant to the option

agreements in 2002 that liquidated their partnership interests

after their respective partnerships met their purposes.     Further,

the investors filed Federal tax returns for 2002 consistently

reporting their partner status and the sale of their partnership

interests under penalty of perjury.    These returns were

consistent with the partnership returns and the Schedules K-1.

All these facts indicate the general partner and investors

intended to be partners and behaved as such.

     The investors also had certain rights pursuant to the

partnership agreements, subscription agreements, and option

agreements that were enforceable under Virginia law.    Merely

because they failed to exercise these rights did not negate these

rights.   The investors’ continued participation in the successor

partnerships indicates that many of the investors’ purposes in

joining the partnerships were achieved.    We find that the conduct

of the investors was consistent with their agreement with the

partnerships.

          3.    The Parties’ Statements

     Several investors testified at trial, and all of them

confirmed that they were partners in the Virginia Historic Fund
                               - 27 -

in 2001.    Respondent argues, however, that collectively the

investors did not understand that their agreements with the

partnerships made them partners.    We cannot say whether the

investors fully understood the legal relationship between

partners in a partnership or whether they simply based their

decision to participate in the partnerships on their accountants’

advice and the descriptions of the partnerships that they

provided.   We find, however, that the investors’ statements and

conduct are consistent with their agreement to pool their capital

with that of other investors both to facilitate the

rehabilitation of historic structures, and to receive State tax

credits under the Virginia Program.     Specifically, the investors

contributed significant capital to the partnerships, received

net economic benefits for their participation, accepted checks in

return for the purchase of their partnership interests, and

reported both their partner status and the sale of their limited

partnership interests on their individual Federal returns for

2002.

     Respondent suggests that one partner’s testimony that he

thought he was making a charitable contribution for historic

rehabilitation undermines the partners’ collective intent.      We

find instead that it highlights the investors’ dual intent to

contribute to the preservation of Virginia structures and receive

State tax incentives in return.    In fact, most of the investors
                                - 28 -

who testified at trial discussed the “feel good” aspect of

participating in the partnerships.

     Finally, no investor has denied being a partner in the

Virginia Historic Funds from the outset of this litigation eight

years ago.    We find this compelling given respondent’s

allegations that the partnerships failed to report $7 million for

2001 and 2002 and his many negative allegations concerning the

principals.    We find that the parties’ representations during the

years at issue and their testimony at trial support a finding

that the investors intended to be partners.

          4.     Testimony of Disinterested Persons

     Representatives of the accounting and investment firms

testified they explained the Virginia Program and the use of the

partnership form to their customers who subsequently became

investors in the Virginia Historic Funds.    These professionals

often introduced the investors to the partnerships and were

responsible for filing the investors’ returns, which were all

filed consistently with the investors as partners.    These

professionals were in the best position to know what role the

investors played in the partnerships.    We find compelling that

there were no witnesses or testimony from investors to contradict

the professionals’ testimony.    In addition, the director of the

DHR and Mr. Leith-Tetrault, the president of the National Trust
                              - 29 -

Community Investment Corporation,10 both testified that the

investors were critical partners in the success of the developer

partnerships and the Virginia Program.   We find the testimony of

disinterested witnesses to be in the partnerships’ favor.

          5.   Relationship of the Parties and Their Respective
               Abilities and Capital Contributions

     Respondent argues that the only relationship between the

investors and the partnerships is that of buyer and seller.    We

find, however, that the parties intended to pool resources and

share the results of investment.   Each party contributed

something of value.   The investors contributed capital, while the

principals contributed both capital and services.   See

Commissioner v. Tower, 327 U.S. at 287-288.   The principals also

initially bore the risk of loss associated with the costs of

marketing the opportunity to invest in the Virginia Program

through the Virginia Historic Funds.   The investors relied upon

the principals’ expertise in the Virginia Program and the

principals’ selection of viable rehabilitation projects.    The

principals relied upon the investors’ capital contributions and

loyalty to make the rehabilitation projects viable.   In summary,

the partnerships were successful in rehabilitating a diversified

group of structures primarily because the principals made good



     10
      The National Trust Community Investment Corporation is a
wholly owned subsidiary of the National Trust for Historic
Preservation.
                                - 30 -

business decisions and the investors provided a large pool of

capital.

     Respondent also argues that the investors did not intend to

be partners because they failed to share in the profits and

losses of the partnerships.    The partners were free to allocate

the risks and rewards of partnership operation.      The partnership

agreements executed between the partnerships and the investors

together created a shared economic interest in the profits and

losses of the venture.   See Commissioner v. Tower, 327 U.S. 280

(1946).    The investors owned approximately a 1-percent interest

in their respective partnerships and were entitled to 1 percent

of the related profits and losses.       Respondent cites no authority

nor do we find any that an equal sharing of profit and loss is a

prerequisite to the existence of a partnership.      The principals

informed the investors that the partnerships would generate

negligible profits and losses.    This is not surprising in the

area of historic rehabilitation where tax credits are granted by

both State and Federal governments to offset the industry’s lack

of profitability.

     We find the relationship of the parties and their respective

abilities a strong factor that the investors intended to become

partners in the partnerships.
                              - 31 -

          6.   Control of Income and Purposes for Which It Was
               Used

     Respondent determined that the partnerships collectively

failed to report $7 million in partnership income.    Respondent

admits, however, that the amount at issue is actually the 19

cents per credit (19 cents) that the source partnership did not

contribute to the developer partnerships.    Respondent argues that

the relationships between the investors and the partnerships must

be disregarded because the source partnership kept that 19 cents

rather than distributing it as profits.    The 19 cents is profit

only under respondent’s credit-sale theory.    The partnerships did

not report the contributions as income or the 19 cents as profit

to be distributed to their partners because they maintain that

they did not sell credits to the investors.    Mr. Gecker’s

conversations with Mr. Machen and other tax credit practitioners

support this reporting position, especially given the lack of any

guidance on the issue from the IRS.    Instead, we find that the

partnerships used this 19 cents to cover the partnerships’

expenses and to protect against the various risks the

partnerships faced.   One investor stated that the 19 cents

obviously reflected costs associated with the partnerships.

After costs, anything left of the 19 cents remained in the source

partnership or its successors until it was either used in a

successor entity, distributed in part to the general partner, or

exhausted during the course of this litigation.    We consider this
                              - 32 -

factor neutral as the alleged partnership income exists only

under respondent’s credit-sale theory.

     After examining all of the objective facts in the record, we

find that the investors intended to become partners in the

Virginia Historic Funds to pool their capital in a diversified

group of developer partnerships for the purpose of earning State

tax credits.

     B.   The Partners Business Purpose and the Form of the
          Transactions

     With this understanding of the investors’ intent, we now

turn to respondent’s argument that even if the investors intended

to be partners, the investors were not partners because they

lacked a valid business purpose and the substance of the

transactions did not match their form.   The form of a transaction

will not be given effect where it has no business purpose and

operates simply as a device to conceal the true character of a

transaction.   See Gregory v. Helvering, 293 U.S. 465, 469-470

(1935).

          1.    Business Purpose

     We now turn to whether the pooling of capital for the

purposes of supporting the developer partnerships and earning

State tax credits is a valid business purpose.   Respondent argues

that the investors’ profit interests were illusory because they

did not share in the partnerships’ profits.   He further argues

that the only economic value was in the investors’ rights to
                                - 33 -

credits and the related State income tax savings.    Respondent

therefore argues that the investors’ contributions lacked

business purpose because they were not made in anticipation of

receiving profits from the partnerships.    We disagree.

     First, there were no partnership profits except under

respondent’s credit-sale theory.    We have found that the alleged

partnership profits were contributions that remained in the

source partnership to cover the costs and risks associated with

the partnerships’ operations.    We therefore find that the 19

cents does not represent profits that were required to be

distributed to the investors.

     Second, each investor was entitled under the partnership

agreements to a share of any profits generated by the

partnerships had there been any.    The parties agree, however,

that the partnerships did not expect to make a profit in the

literal sense, but instead offered a net economic gain to

investors based on their reduced State income tax.    Virginia

enacted the Virginia Program, in large part, because investment

in historic preservation generally would not otherwise be made

due to low profitability.   The investors understood that the same

lack of profitability that required State legislative action

would result in little to no profit to the developer partnerships

and the Virginia Historic Funds.    Their participation in the
                               - 34 -

Virginia Program despite this understanding should not, in

itself, bar a finding of business purpose.

     Third, the investors reaped a considerable net economic

benefit from State income tax savings.    Respondent cites several

cases where courts have found that a partnership lacked business

purpose because it did not have a nontax business purpose.11

Respondent ignores, however, that in every case the taxes

involved were Federal taxes.    The omission of the word “Federal”

from the anti-abuse regulation in the FPAA illustrates a critical

distinction.   The investors became partners in the Virginia

Historic Funds to earn State tax credits to offset State income

tax liabilities.   State law provided for partnership allocations

of State tax credits to increase funding for historic

rehabilitation while creating minimal interference with the

developers’ allocations of Federal tax credits.   The investors

were not allocated Federal tax credits.   The investors did not

participate in the Virginia Historic Funds for a Federal tax

benefit.   Generally the investors experienced a Federal tax

detriment, and any positive Federal tax consequences were

incidental.    The purpose of reducing non-Federal taxes has been

recognized in the context of section 355 as a valid business


     11
      Respondent cites Boca Investerings Pship. v. United
States, 314 F.3d 625, 630 (D.C. Cir. 2003), ASA Investerings
Pship. v. Commissioner, 201 F.3d 505, 513 (D.C. Cir. 2000), affg.
T.C. Memo. 1998-305, and Saba Pship. v. Commissioner, T.C. Memo.
2003-31.
                                - 35 -

purpose as long as the reduction of non-Federal taxes is greater

than the reduction of Federal taxes.12    See sec. 1.355-2(b)(2),

Income Tax Regs.; T.D. 8238, 1989-1 C.B. 92, 93.     The parties

agree that the investors’ State tax savings far outweighed any

incidental Federal tax savings.    In addition, the Commissioner

has recognized that endeavors involving tax incentives should be

held to a different profit-motive standard.      See Rev. Rul. 79-

300, 1979-2 C.B. 112 (partnerships involved in low-income housing

credits not subject to normal profit-motive standard under

section 183).     Accordingly, we conclude that the investors had a

business purpose for participating in a low-profitability venture

because they expected a considerable net economic benefit from

State tax savings and any Federal tax consequences were

incidental.

            2.    Substance Over Form Doctrine

     We now address respondent’s argument that the substance over

form doctrine dictates that the investors purchased State tax

credits rather than contributing capital to the partnerships as

partners.     We examine the true nature of a transaction rather

than mere formalisms, which exist solely to alter Federal tax


     12
      A purpose of reducing non-Federal taxes is not a corporate
business purpose if (i) the transaction will effect a reduction
in both Federal and non-Federal taxes because of similarities
between Federal tax law and the tax law of the other jurisdiction
and (ii) the reduction of Federal taxes is greater than or
substantially coextensive with the reduction of non-Federal
taxes. Sec. 1.355-2(b)(2), Income Tax Regs.
                               - 36 -

liabilities, to determine whether the substance over form

doctrine applies.   See Frank Lyon Co. v. United States, 435 U.S.

561, 572-573 (1978); Commissioner v. Court Holding Co., 324 U.S.

331, 334 (1945).    If the substance of a transaction accords with

its form, then the form will be upheld and given effect for

Federal tax purposes.

     Respondent argues for the first time on brief that the

substance of the investors’ contributions matches their form only

if the investors, through the Virginia Funds, were partners in

rehabilitation activity with the developer partnerships.13    Only

then, he contends, would the investors be treated as members in

the entity that originally qualified for the State tax credits.

Respondent’s argument is misplaced.

     As a general rule, we will not consider issues raised for

the first time on brief where surprise and prejudice are found to

exist.    See Sundstrand Corp. & Subs. v. Commissioner, 96 T.C.

226, 346-347 (1991); Seligman v. Commissioner, 84 T.C. 191, 198



     13
      We have no jurisdiction to make a determination of whether
the investors were indirect partners in the developer
partnerships. The determination of whether someone is a partner
is a partnership item when it affects the distributive shares of
the other partners. See Blonien v. Commissioner, 118 T.C. 541
(2002). Respondent did not issue FPAAs to the developer
partnerships. Accordingly, the partners of the developer
partnerships have long been established as reported on the
partnerships’ returns. We therefore have no jurisdiction to
redetermine the investors’ status as indirect partners in the
developer partnerships. See Sente Inv. Club Pship. v.
Commissioner, 95 T.C. 243, 248 (1990).
                               - 37 -

(1985), affd. 796 F.2d 116 (5th Cir. 1986).     Respondent

determined in the FPAA that the investors were not partners in

the Virginia Historic Funds.   Throughout the lengthy discovery

process and the trial on the merits, the parties’ arguments

focused on whether the investors were partners in these

partnerships.   We find that respondent’s attempt to change the

focus to the developer partnerships creates surprise and

prejudice to the partnerships.

     We now turn to the substance of the transactions between the

investors and the Virginia Historic Funds.     The Supreme Court has

held that we should honor the parties’ relationships where there

is a genuine multiple-party transaction with economic substance

that is compelled or encouraged by regulatory or business

realities, is imbued with Federal tax-independent considerations,

and is not shaped solely by Federal tax avoidance.     See Frank

Lyon Co. v. United States, supra at 583-584; Estate of Hicks v.

Commissioner, T.C. Memo. 2007-182.      Congress encourages State

historic rehabilitation programs and supports individuals

involved in these programs.    National Historic Preservation Act

of 1966, as amended 16 U.S.C. sec. 470-1.     The Virginia Program’s

base-broadening allocation provision encourages capital

contributions to cover the credit gap between cost and available

financing.   This allocation provision allows State investors to

contribute capital to historic rehabilitation projects without
                               - 38 -

interfering with the allocations of Federal tax credits.    The

investors became partners in the Virginia Historic Funds because

they were required to join an entity to participate in the

Virginia Program, which does not provide for freely transferable

credits.   Further, the tiered structure of the partnerships was

not undertaken for Federal tax avoidance reasons.    Developer

testimony established that the developer partnerships were not

equipped to deal with hundreds of partners at the developer-

partnership level.   Instead, the developer partnerships benefited

from working with the principals, who were knowledgeable about

historic rehabilitation and the Virginia Program.    The investors

also benefited by having the principals choose successful

rehabilitation projects.    Further, the investors’ partnership

interests created rights and responsibilities between the parties

under State law and allowed the investors to participate in the

risks and rewards of the partnerships.    We find that the form of

the transactions was not a mere formality undertaken for purposes

of Federal tax avoidance.    Instead, this form was compelled by

realities of public policy programs, generally, and the Virginia

Program, specifically.

     Respondent ignores these realities and argues that the

amounts of the contributions, the timing of the transactions, and

the investors’ lack of risk suggest that the transactions were in

substance sales.   Respondent argues that the entire amount of an
                               - 39 -

investor’s contribution went to the purchase of his or her

allocated State tax credits.   We find instead that the

contributions were pooled to facilitate investment in the

developer partnerships, to purchase additional credits under the

one-time transfer provision to meet the needs of the

partnerships, to cover the expenses of the partnerships, to

insure against the risks of the partnerships, and to provide

capital for successor entities in which many of the investors

participated year after year and for other rehabilitation

projects.   These pooled capital contributions were critical to

the success of both the Virginia Historic Funds and the developer

partnerships.

     Respondent also argues that the timing of the contributions,

the allocations, and the investors’ departure from the

partnerships suggest that the transactions are sales.     Again we

disagree.   The parties have stipulated that the investors

remained in the partnerships until after the partnerships had

fulfilled their purpose.   Their capital contributions funded the

developer partnerships, the developer partnerships completed the

projects and received certification from the DHR, and the State

tax credits were allocated to the investors.   The capital

contributions were generally made late in 2001.    The

contributions then belonged to the partnerships.    The State tax

credits were allocated to the partners on the Schedules K-1 on
                               - 40 -

April 15, 2002.    In addition, the capital contributions were not

made in exchange for credits that had already been allocated to

the partnerships.    Instead, the pooled capital contributions made

it possible for the partnerships to contribute capital to the

developer partnerships and to purchase credits under the one-time

transfer provision.

     Respondent further argues that the investors bore no risk

because the Virginia Historic Funds attempted to limit those

risks in its agreements with the developer partnerships and the

investors.    Again, we disagree.   We find that the investors bore

sufficient risk.    The investors bore risks associated with the

partnerships’ public incentive nature as well as the general

risks faced by partners in most partnerships.    For example, the

partners faced the risk that developers would not complete their

projects on time because of construction, zoning, or management

issues.    They also faced the risk that the DHR would not be

satisfied with the rehabilitation and the developers would not

receive the credits.    Finally, they faced the risk that the DHR

would revoke the credits and recapture them in later years.

Accordingly, the partners risked their anticipated net economic

benefit.    The investors received assurance that their

contributions would be refunded if, and only if, the anticipated

credits could not be had or were revoked.    There was no

guarantee, however, that the resources would remain available in
                              - 41 -

the source partnership to do so.   Further, the investors were

unlikely to recover against the principals if those resources

were exhausted.   The general partner is a limited liability

company whose members are not personally liable for the debts or

actions of the entity.   See Hagan v. Adams Prop. Associates, 482

S.E.2d 805 (Va. 1997); see also Gowin v. Granite Depot, LLC, 634

S.E.2d 714 (Va. 2006).

     The investors also faced risks from the partnerships’

ownership interests in the developer partnerships.    These risks

ranged from liability for improper construction to the risk of

mismanagement or fraud at the developer partnership level.     The

developer partnerships faced continuing duties as a consequence

of receiving the credits.   The Virginia Historic Funds obtained

many of the State tax credits granted to these partnerships, and

any threatened revocation of the credits could have created

additional expenses to be borne by the Funds as the developer

partnerships might not have been willing to perform the duties

necessary to maintain the credits.     Further, the investors faced

the risks of fraud by another investor, retroactive changes in

the law, and litigation in general.    Any of these risks

threatened the partnerships’ pooled capital and ability to

fulfill their purpose.

     Limited partners, by definition, are protected from many

partnership risks under State law.     Partnerships may find further
                               - 42 -

assurances necessary to attract limited partners.     These

assurances do not necessarily erase entrepreneurial risk

entirely.    Sharing, managing, and even insuring against capital

risks often simply reflect good business practices.     It is

important that the investors shared their risks with one another.

For example, the investors shared the risk of losing their

expected net economic gain.    Had one project failed, the partners

would have shared in the shortage pro rata.     The investors also

shared the risks of an inadequate pool of State tax credits and

the possibility of the credits being retroactively revoked.     This

shared risk sets the investors apart from simple purchasers.

     Considering all the facts and circumstances, we conclude

that the investors intended to join together in the Virginia

Historic Funds as partners to participate in the enterprise of

pooling their capital to invest in developer partnerships and

receive State tax credits in return.     We further conclude that

their participation in the partnerships had a valid business

purpose.    Finally, we conclude that the form of the investors’

contributions to the partnerships and the resulting allocations

of credits reflect their substance.     Accordingly, we hold that

the investors were partners in the Virginia Historic Funds for

Federal tax purposes.
                                    - 43 -

IV.   Disguised Sales Under Section 707

      We have examined the substance of the investors’

participation in the Virginia Historic Funds and held that the

investors were partners in those funds for Federal tax purposes.

We must now address respondent’s alternative argument that the

investors’ capital contributions to the partnerships coupled with

the allocations of State tax credits were disguised sales under

section 707(a)(2)(B).      Respondent argues that these transactions

were disguised sales between the partnerships and their

respective partners.      We disagree.

      A transaction is treated as a disguised sale between a

partner and a partnership when the partner transfers money or

other property to the partnership, the partnership transfers

money or other property14 to such partner in return, and these

transfers when viewed together are properly characterized as a

sale.      See sec. 707(a)(2)(B).    Such transactions are presumed

sales when they occur within two years of one another.        See sec.

1.707-3(c)(1), Income Tax Regs.        In all cases, however, the

substance of the transaction will govern rather than its form.

Sec. 1.707-1(a), Income Tax Regs.        Therefore, transfers of money

or property by a partner to a partnership as contributions, or

transfers of money or property by a partnership to a partner as


      14
      We specifically do not address whether the State tax
credits are property for purposes of sec. 707 as it is not
essential to our holding.
                                - 44 -

distributions, are not transactions included within the

provisions of section 707(a).    Id.

     We have found that the investors made capital contributions

to the Virginia Historic Funds in furtherance of their purpose to

invest in developer partnerships involved in historic

rehabilitations and to receive State tax credits.    We have

further found that the partnerships were able to participate in

the developer partnerships because of the investors’ pooled

capital.    Finally, we found that the partnerships allocated the

resulting pooled credits to the investors as agreed in the

partnership and subscription agreements consistent with the

allocation provisions of the Virginia Program.   The substance of

these transactions reflects valid contributions and allocations

rather than sales.

     In addition, there is no disguised sale when the

transactions are not simultaneous and the subsequent transfer is

subject to the entrepreneurial risks of the partnership’s

operations.   See sec. 1.707-3(b)(1), Income Tax Regs.   The

investors contributed capital at various times during the years

at issue.   The State tax credits were allocated to the partners

when the partnerships attached the certificates to their

respective Schedules K-1.15   We therefore find that the transfers


     15
      The State tax credits remained inchoate until an
individual investor used them to reduce his or her State income
                                                   (continued...)
                               - 45 -

were not simultaneous.    The investors were promised certain

amounts of credits in the subscription agreements, but there was

no guarantee that the partnerships would pool sufficient credits.

This risk, as well as the other risks addressed in our discussion

of business purpose, represent the risks of the enterprise.

Accordingly, we conclude that the transactions are not disguised

sales.    We further hold that the partnerships did not have $7

million in unreported income from these transactions in either of

the years at issue.

V.   Adjustments Barred by the Statute of Limitations

     We now turn to whether the adjustments in the FPAA are time

barred under the statute of limitations.    The Code does not

provide a period of limitations within which an FPAA must be

issued.    See Curr-Spec Partners, L.P. v. Commissioner, 579 F.3d

391 (5th Cir. 2009), affg. T.C. Memo. 2007-289; Rhone-Poulenc

Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. 533,

534-535 (2000).    Any partnership item adjustments made in an FPAA

will be time barred at the partner level if the Commissioner does

not issue the FPAA within the applicable period of limitations

for assessing tax attributable to partnership items.    Curr-Spec

Partners, L.P. v. Commissioner, supra at 398-399; Rhone-Poulenc

Surfactants & Specialties, L.P. v. Commissioner, supra at 535.



     15
      (...continued)
tax liability in 2001 or later years.
                              - 46 -

     The limitations period is generally three years for the

assessment of tax attributable to a partnership item.16    Sec.

6229(a).   This limitations period remains open at least for three

years after the date the partnership return was filed or three

years after the last day, disregarding extensions, for filing the

partnership return, whichever is later.   Id.   The limitations

period is extended to six years if a partnership improperly omits

an amount from gross income that exceeds 25 percent of the gross

income reported on its return.   Sec. 6229(c)(2).

     The parties agree that the determinations in the FPAA are

barred for 2001 under the 3-year limitations period.    Respondent

argues, however, that the 6-year limitations period under section

6229(c)(2) applies because the partnerships omitted at least 25

percent of gross income from their partnership returns.     We

disagree because we have found that the partnerships properly

reported the flow-through allocation of the State tax credits to

the investors as partners.   Further, the capital contributions

were not proceeds from the sale of State tax credits.     By

definition, therefore, the partnerships did not recognize

unreported income from the sale of State tax credits in 2001.     We

therefore conclude that the 6-year limitations period does not

apply and respondent is barred from adjusting the Virginia


     16
      Respondent does not argue that there is a partner or
investor for whom the limitations period of sec. 6501 remains
open.
                                  - 47 -

Historic Funds’ partnership items for 2001 or assessing tax

attributable to these partnership items at the individual partner

level.17

VI.   Conclusion

      In summary, we have found that the investors were partners

in the Virginia Historic Funds for Federal tax purposes in 2001,

that their transactions with the partnerships were not sales of

State tax credits under the substance over form doctrine or under

section 707, and that the statute of limitations bars the

adjustments in the FPAAs for 2001 and any assessment of tax

related to the partnership items at the partner level.      In

reaching these holdings, we have considered all arguments made,

and, to the extent not mentioned, we conclude that they are moot,

irrelevant, or without merit.

      To reflect the foregoing and the concessions of the parties,


                                            Decisions will be entered

                                       for petitioner.




      17
           The partnerships extended the limitations period for 2002.
