                                       HISTORIC BOARDWALK HALL, LLC, NEW JERSEY SPORTS                                             AND
                                            EXPOSITION AUTHORITY, TAX MATTERS PARTNER,
                                              PETITIONER v. COMMISSIONER OF INTERNAL
                                                       REVENUE, RESPONDENT
                                                        Docket No. 11273–07.                    Filed January 3, 2011.

                                                  New Jersey Sports and Exposition Authority (NJSEA) and
                                               Pitney Bowes (PB) formed Historic Boardwalk Hall, LLC, to
                                               allow PB to invest in the historic rehabilitation of the East
                                               Hall, a popular convention center in Atlantic City, New
                                               Jersey. The East Hall underwent a significant rehabilitation
                                               during the years at issue. On Forms 1065, U.S. Return of
                                               Partnership Income, for 2000, 2001, and 2002, Historic Board-
                                               walk Hall claimed qualified rehabilitation expenditures and
                                               allocated those expenditures to PB, allowing PB to claim his-
                                               toric rehabilitation tax credits pursuant to sec. 47, I.R.C. R
                                               issued an FPAA asserting alternative grounds for denying PB
                                               the claimed rehabilitation tax credits. R’s overarching argu-
                                               ment is that NJSEA sold the rehabilitation tax credits to PB
                                               for a fee. R also argues that the accuracy-related penalty
                                               pursuant to sec. 6662, I.R.C., applies. Held: Historic Board-
                                               walk Hall was not a sham and did not lack economic sub-
                                               stance. Held, further, PB did become a partner in Historic
                                               Boardwalk Hall. Held, further, NJSEA did transfer the bene-
                                               fits and burdens of ownership of the East Hall to Historic
                                               Boardwalk Hall. Held, further, the sec. 6662, I.R.C., penalty
                                               is not applicable.

                                        Kevin M. Flynn and Michael Sardar, for petitioner.
                                        Daniel A. Rosen, Curt M. Rubin, Molly H. Donohue, and
                                      Sashka T. Koleva, for respondent.
                                                                                                                                        1




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                                      2                  136 UNITED STATES TAX COURT REPORTS                                           (1)


                                        GOEKE, Judge: Respondent issued a notice of final partner-
                                      ship administrative adjustment (FPAA) to Historic Boardwalk
                                      Hall, LLC (Historic Boardwalk Hall). The issues for decision
                                      are:
                                        (1) Whether Historic Boardwalk Hall is a sham;
                                        (2) whether Pitney Bowes was a partner in Historic Board-
                                      walk Hall;
                                        (3) whether New Jersey Sports and Exposition Authority
                                      (NJSEA or petitioner) transferred the benefits and burdens of
                                      ownership of the East Hall to Historic Boardwalk Hall; and
                                        (4) whether Historic Boardwalk Hall is liable for section
                                      6662 1 accuracy-related penalties for years 2000, 2001, and
                                      2002.

                                                                          FINDINGS OF FACT

                                         Some of the facts have been stipulated, and the stipula-
                                      tions of fact and the attached exhibits are incorporated
                                      herein by this reference. NJSEA was created by the New
                                      Jersey State Legislature in 1971 and is a State instrumen-
                                      tality. NJSEA was initially formed to build, own, and operate
                                      the Meadowlands Sports Complex in East Rutherford, New
                                      Jersey.
                                         NJSEA’s jurisdiction was expanded by the New Jersey State
                                      Legislature in January 1992 to include the Atlantic City
                                      Convention Center Project. That project authorized NJSEA to
                                      build, own, and operate a new convention center and to own
                                      and operate the East Hall (the East Hall is also known as
                                      Historic Boardwalk Hall).
                                         To carry out the new Convention Center Project, the
                                      Atlantic County Improvement Authority (ACIA) and NJSEA
                                      entered into a lease for the East Hall whereby NJSEA leased
                                      the East Hall for a term of 35 years at a rent of $1 per year.
                                      Shortly thereafter, NJSEA entered into an operating agree-
                                      ment with the Atlantic City Convention Center Authority
                                      (ACCCA). ACCCA was initially formed to promote tourism in
                                      the Atlantic City region, and it would serve as day-to-day
                                      manager of the East Hall.
                                         Later, NJSEA and ACCCA entered into a management agree-
                                      ment with Spectator Management Group (SMG). SMG was
                                        1 All section references are to the Internal Revenue Code (Code), and all Rule references are

                                      to the Tax Court Rules of Practice and Procedure.




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          3


                                      well known for managing, marketing, and developing public
                                      assembly facilities, including convention and special event
                                      centers. NJSEA contracted to have SMG manage the East
                                      Hall because NJSEA felt that a private company would be
                                      able to promote, oversee, and manage the East Hall, the
                                      West Hall (a facility adjacent to the East Hall), and the soon-
                                      to-be constructed convention center. The management agree-
                                      ment stated that SMG would provide operations, marketing,
                                      finance, employee supervision, administrative, and other gen-
                                      eral management services.
                                         SMG managed the East Hall day to day. SMG maintained a
                                      system of accounts for Historic Boardwalk Hall, and Historic
                                      Boardwalk Hall’s annual audited financial statements were
                                      based on this system of accounts. Although SMG’s initial
                                      agreement was for a 3-year term, it has been extended.
                                      1. Overview of the Transaction at Issue
                                        Historic Boardwalk Hall was organized under the laws of
                                      the State of New Jersey as a limited liability company on
                                      June 26, 2000. NJSEA was the sole member of Historic Board-
                                      walk Hall at formation. On September 14, 2000, PB Historic
                                      Renovations, LLC (Pitney Bowes), 2 was admitted as a
                                      member of Historic Boardwalk Hall.
                                        Historic Boardwalk Hall’s purpose was to allow Pitney
                                      Bowes to invest in the rehabilitation of the East Hall.
                                      Because the East Hall was a historic structure, this
                                      rehabilitation project had the potential to earn section 47
                                      historic rehabilitation credits. 3 Historic Boardwalk Hall’s
                                      formation would allow Pitney Bowes, a private party, to earn
                                      these historic rehabilitation credits from the rehabilitation of
                                      a public, governmentally owned, building. Respondent argues
                                      that in substance the transaction was akin to NJSEA’s selling
                                      rehabilitation credits to Pitney Bowes. To that end,
                                      respondent determined alternatively in the FPAA that His-
                                      toric Boardwalk Hall is a sham, that Pitney Bowes was never
                                      a partner in Historic Boardwalk Hall, and that NJSEA never
                                        2 PB Historic Renovations, LLC, was a limited liability company whose sole member during

                                      all relevant periods was Pitney Bowes Credit Corp. During all relevant times, Pitney Bowes
                                      Credit Corp. was a wholly owned subsidiary of Pitney Bowes Corp. For simplicity, we refer to
                                      PB Historic Renovations, LLC, Pitney Bowes Credit Corp., and Pitney Bowes Corp. as Pitney
                                      Bowes.
                                        3 Sec. 47 allows for a Federal tax credit of 20 percent of the qualified rehabilitation expendi-

                                      tures with respect to any certified historic structure.




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                                      4                  136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      transferred ownership of the East Hall to Historic Boardwalk
                                      Hall. A finding for respondent on any of these theories would
                                      prevent the section 47 rehabilitation credits from flowing to
                                      Pitney Bowes; instead they would flow to NJSEA. Petitioner
                                      contends instead that transactions like the one at issue were
                                      promoted and supported by Congress and are not shams.
                                      2. East Hall History
                                         Construction of the East Hall began in 1926 and was com-
                                      pleted in 1929. It is located prominently at the center of the
                                      Atlantic City, New Jersey, Boardwalk and faces the Atlantic
                                      Ocean. The East Hall was a popular event space of
                                      exceptionally large dimensions, featuring an auditorium with
                                      a 130-foot ceiling and over 250,000 square feet of floor space.
                                         After it was completed, the East Hall hosted a number of
                                      public events, including hockey matches, professional football
                                      games, and equestrian shows. The East Hall also hosted
                                      trade shows, conferences, meetings, and musical perform-
                                      ances, including those of the Beatles and the Rolling Stones.
                                      Beginning in 1933, the East Hall hosted the Miss America
                                      pageant.
                                         The East Hall was listed as a National Historic Landmark
                                      by the U.S. Department of the Interior on February 27, 1987.
                                      In January 1992 the New Jersey State Legislature author-
                                      ized NJSEA to undertake construction of the new convention
                                      center and renovation of the East Hall. Once the new conven-
                                      tion center was completed, it was expected to become the pri-
                                      mary location for flat-floor conventions like the ones that had
                                      until that time been held in the East Hall. As a result, the
                                      East Hall would no longer draw those types of events and
                                      would have no use unless renovated.
                                         Once construction began on the new convention center,
                                      representatives of NJSEA and other New Jersey State officials
                                      began to study and make plans for the future of the East
                                      Hall. Because it had become run down, the only way to make
                                      the East Hall usable again was to convert it to a special
                                      events facility that could host concerts, sporting events,
                                      family shows, and other civic events. This conversion would
                                      require that the East Hall be substantially rehabilitated.
                                      State officials in New Jersey decided to rehabilitate the East
                                      Hall and convert it into a mixed-use space.




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          5


                                         Rehabilitation of the East Hall began in December 1998. It
                                      was to be completed in four phases: (1) Construction of scaf-
                                      folding suspended from the auditorium’s ceiling to facilitate
                                      rehabilitation of the ceiling; (2) removal of auditorium ceiling
                                      tiles and abatement of asbestos; (3) reconstruction of the
                                      ceiling using glass-fiber reinforced tiles and high-perform-
                                      ance acoustical perforated aluminum tiles; and (4) construc-
                                      tion of a new permanent arena seating bowl, construction of
                                      support services and patron amenities beneath the seating
                                      bowl, and restoration and historically accurate painting of
                                      the Hall’s interior.
                                         To pay for a portion of the renovation costs, on June 15,
                                      1999, NJSEA issued about $49.5 million of State bonds. In
                                      addition, NJSEA received approximately $22 million from the
                                      New Jersey Casino Reinvestment Development Authority. 4
                                      In the absence of an equity investor, the rehabilitation would
                                      have been funded entirely by the State of New Jersey.
                                      3. Sovereign Capital Resources, LLC
                                         In late 1998, Paul Hoffman (Mr. Hoffman) of Sovereign
                                      Capital Resources, LLC (Sovereign), contacted representatives
                                      of NJSEA. Sovereign was founded by Mr. Hoffman and a
                                      partner in 1995. Mr. Hoffman contacted NJSEA because he
                                      had learned of the East Hall renovation; one of Sovereign’s
                                      business lines was raising equity for historic rehabilitations.
                                      NJSEA engaged the services of Sovereign to act as its finan-
                                      cial adviser in finding an equity investor for the East Hall’s
                                      rehabilitation. Respondent argues that this was not an
                                      investment, but rather Sovereign was facilitating a sale of
                                      the historic tax credits generated by the East Hall rehabilita-
                                      tion.
                                         NJSEA engaged several law firms to review and opine on
                                      certain aspects of the transaction: (1) Wolf, Block, Schorr,
                                      Solis-Cohen, LLP; (2) Gibbons, Del Deo, Dolan, Griffinger &
                                      Vecchione (Gibbons, Del Deo); and (3) Wolf & Sampson, P.C.
                                      NJSEA also engaged the accounting firm of Reznick Fedder &
                                      Silverman, P.C. (Reznick), to provide counsel on the
                                      rehabilitation credit transaction.
                                        4 The New Jersey Casino Reinvestment Development Authority is a State agency created by

                                      the New Jersey State Legislature that uses funds generated from governmental charges imposed
                                      on the casino industry for economic development and community projects throughout the State.
                                      The funds given to NJSEA were in the form of a grant.




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                                      6                  136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      4. Confidential Offering Memorandum
                                         Sovereign prepared a confidential offering memorandum as
                                      part of its services to NJSEA. The memorandum was prepared
                                      using information provided to Soverign by NJSEA, Reznick,
                                      and others and included financial information for the
                                      rehabilitation of the East Hall and for its operation after the
                                      rehabilitation was completed.
                                         The financial projections in the confidential offering memo-
                                      randum were based on certain assumptions, most impor-
                                      tantly that revenue from the East Hall would increase 3 per-
                                      cent per year. The financials projected that the eventual
                                      partnership would have positive net operating income from
                                      2002 through 2009. That net operating income would be
                                      zeroed out through lease payments, an increase in a ‘‘replace-
                                      ment reserve’’, the investor member’s 3-percent priority dis-
                                      tribution, and an incentive management fee, to the extent
                                      there was cash to make those payments.
                                         The confidential offering memorandum also informed
                                      prospective investors that Historic Boardwalk Hall would
                                      have taxable losses for at least the years 2002 through 2009.
                                         The financial projections attached to the amended and
                                      restated operating agreement, discussed more fully below,
                                      are different from those attached to the confidential offering
                                      memorandum.
                                         The memorandum was sent to 19 corporations and
                                      described the transaction as a ‘‘sale’’ of tax credits. The
                                      memorandum indicated that the private investor’s equity
                                      investment would be used to pay a development fee to NJSEA,
                                      with any surplus remaining with Historic Boardwalk Hall.
                                      Four corporations showed interest in joining the transaction,
                                      and each submitted a bid detailing how much it would be
                                      willing to invest depending on the rehabilitation credits it
                                      would earn. Eventually Pitney Bowes’ offer was accepted and
                                      it was selected to invest in Historic Boardwalk Hall.
                                      5. Formation of Historic Boardwalk Hall
                                        Historic Boardwalk Hall, organized on June 26, 2000,
                                      elected to be treated as a partnership for Federal income tax
                                      purposes. NJSEA was the sole member at formation and
                                      executed an operating agreement for the East Hall, as
                                      explained above. When Pitney Bowes joined Historic Board-




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          7


                                      walk Hall on September 14, 2000, NJSEA and Historic
                                      Boardwalk Hall signed an amended and restated operating
                                      agreement (the AREA). The AREA identified NJSEA as man-
                                      aging member and Pitney Bowes as investor member of His-
                                      toric Boardwalk Hall. Pursuant to the terms of the AREA,
                                      Pitney Bowes has a 99.9-percent ownership interest in His-
                                      toric Boardwalk Hall. NJSEA owns the remaining 0.1 percent.
                                      Profits, losses, tax credits, and net cashflow are allocated to
                                      Historic Boardwalk Hall’s members according to their owner-
                                      ship interests.
                                         The AREA stated that Historic Boardwalk Hall was formed
                                      to acquire, develop, finance, rehabilitate, own, maintain,
                                      operate, license, and sell or otherwise dispose of the East
                                      Hall for use as a special events facility to hold events
                                      including, but not limited to, spectator sporting events. The
                                      AREA made clear that the potential rehabilitation tax credits
                                      were an integral part of the transaction but did not use the
                                      term ‘‘sale’’. It referred to both Pitney Bowes and NJSEA as
                                      members of Historic Boardwalk Hall.
                                         Article 3.01 of the AREA reiterated the purpose of Historic
                                      Boardwalk Hall and also granted Historic Boardwalk Hall
                                      the authority to take actions necessary to carry out its pur-
                                      pose.
                                         The AREA included an additional set of financial informa-
                                      tion. The most important difference between these financials
                                      and those attached to the confidential offering memorandum
                                      was the inflation factor applied to the East Hall’s revenues.
                                      The financial projections attached to the AREA used a 3.5-per-
                                      cent inflator, rather than the 3.0-percent inflator in the con-
                                      fidential offering memorandum. Also, the operating assump-
                                      tions underlying the updated financials assumed higher
                                      service income, parking revenue, and novelty revenue in the
                                      first year of operations. Operating expenses for the initial
                                      years remained the same.
                                         As a result of higher projected revenues, the statement of
                                      projected cashflows attached to the AREA showed higher pay-
                                      ments to the equity investor and also payments on the
                                      acquisition and construction loans discussed below. These
                                      financials, however, still resulted in a taxable net loss.




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                                      8                  136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      6. Lease and Sublease of the East Hall
                                         As discussed above, NJSEA leased the East Hall from ACIA
                                      for a 35-year term. On September 14, 2000, NJSEA amended
                                      its lease agreement to extend the lease term until November
                                      11, 2087. On that date, NJSEA and Historic Boardwalk Hall
                                      entered into two agreements. First, NJSEA as sublessor and
                                      Historic Boardwalk Hall as sublessee entered into a sublease
                                      of the East Hall whereby NJSEA subleased the property to
                                      Historic Boardwalk Hall. Second, NJSEA and Historic Board-
                                      walk Hall entered into a lease agreement which the parties
                                      treated as a sale and purchase for Federal, State, and local
                                      income tax purposes. Pursuant to the lease agreement, His-
                                      toric Boardwalk Hall purportedly acquired ownership of the
                                      East Hall.
                                         Historic Boardwalk Hall paid for the East Hall by an
                                      acquisition note in the amount of $53,621,405. The acquisi-
                                      tion note was secured by a mortgage on the property. The
                                      amount of the acquisition note represented the total expendi-
                                      tures that NJSEA had made through that date in renovating
                                      the East Hall. The acquisition note bears interest at 6.09
                                      percent per year and provides for level annual payments of
                                      $3,580,840 through the year 2040, to the extent Historic
                                      Boardwalk Hall has sufficient cash to make the annual pay-
                                      ments.
                                         Also on September 14, 2000, NJSEA entered into a construc-
                                      tion loan agreement with Historic Boardwalk Hall to lend
                                      amounts to the partnership from time to time to pay for the
                                      remainder of renovations to the East Hall. At that time,
                                      NJSEA agreed to lend $57,215,733 to Historic Boardwalk Hall.
                                      NJSEA’s obligation to lend to Historic Boardwalk Hall was
                                      evidenced by a mortgage note and a second mortgage on the
                                      property.
                                      7. Contributions to Historic Boardwalk Hall
                                         Pitney Bowes made capital contributions to Historic Board-
                                      walk Hall and also lent funds to the partnership. Pursuant
                                      to the AREA, Pitney Bowes was to make four capital contribu-
                                      tions totaling $18,195,757.
                                         Pitney Bowes made the following contributions to Historic
                                      Boardwalk Hall:




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                                  9


                                               Date                                                                             Amount

                                              9/14/00 ......................................................................      $650,000
                                              12/19/00 ....................................................................      3,660,765
                                              1/17/01 1 ....................................................................     3,400,000
                                              10/30/02 ....................................................................    10,467,849
                                              2/12/04 ......................................................................   2 1,173,182


                                                 1 The Dec. 19, 2000, and Jan. 17, 2001, capital contributions
                                              were together considered Pitney Bowes’ second capital contribu-
                                              tion, even though the contribution was made on two separate
                                              dates.
                                                 2 A portion of Pitney Bowes’ fourth capital contribution was
                                              paid and is currently being held in escrow.

                                      Pitney Bowes also made an investor loan of $1.1 million to
                                      Historic Boardwalk Hall on September 14, 2000. The prin-
                                      cipal amount of the investor loan was increased to $1,218,000
                                      on or around October 30, 2002.
                                         Pitney Bowes was not required to make the second, third,
                                      or fourth capital contribution if certain requirements in the
                                      AREA were not satisfied.
                                         The AREA provided that Pitney Bowes’ capital contributions
                                      were to be used to pay down the principal on the acquisition
                                      note. Pitney Bowes’ capital contributions were in fact used to
                                      pay down the principal on the acquisition note. Shortly there-
                                      after, a corresponding draw would be made on the construc-
                                      tion note, and NJSEA would advance those funds to Historic
                                      Boardwalk Hall. Ultimately, these offsetting draws left His-
                                      toric Boardwalk Hall with cash in the amount of Pitney
                                      Bowes’ capital contributions, a decreased balance on the
                                      acquisition loan, and an increased balance on the construc-
                                      tion loan. These funds were then used by Historic Boardwalk
                                      Hall to pay assorted fees related to the transaction and to
                                      pay NJSEA a developer’s fee for its work managing and over-
                                      seeing the East Hall’s rehabilitation.
                                         A portion of Pitney Bowes’ second capital contribution was
                                      not returned to Historic Boardwalk Hall but rather was used
                                      by NJSEA to purchase the guaranteed investment contract
                                      (GIC). The GIC is discussed further below.
                                         Historic Boardwalk Hall paid NJSEA $14 million as a
                                      development fee for its role overseeing the East Hall’s
                                      rehabilitation. This came mainly from Pitney Bowes’ third
                                      and fourth capital contributions and was paid pursuant to a
                                      development agreement between Historic Boardwalk Hall




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                                      10                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      and NJSEA. The development agreement reiterated Historic
                                      Boardwalk Hall’s purpose and imposed certain obligations on
                                      NJSEA as the developer, in exchange for a $14 million
                                      development fee. The development agreement obligated
                                      NJSEA to obtain all required Government approvals for the
                                      rehabilitation and to oversee the completion of the rehabilita-
                                      tion. This included: (1) Overseeing the contractors who were
                                      rehabilitating the East Hall; (2) ensuring that all amenities
                                      consistent with the overall rehabilitation were put in place;
                                      (3) causing the completion of phase 3 of the rehabilitation;
                                      and (4) causing the rehabilitation such that it would earn
                                      rehabilitation tax credits. The development agreement fur-
                                      ther required NJSEA to obtain certification of the rehabilita-
                                      tion from the U.S. Department of the Interior and to main-
                                      tain insurance over the rehabilitation as set forth in the
                                      AREA. NJSEA’s development fee would not be earned until the
                                      rehabilitation was completed, and it was payable imme-
                                      diately upon completion.
                                      8. Distributions From Historic Boardwalk Hall
                                         The AREA provided for the distribution of Historic Board-
                                      walk Hall’s net cashflow. First, if certain title insurance or
                                      environmental insurance proceeds were paid, 100 percent
                                      went to Pitney Bowes. Second, any remaining net cashflow
                                      was used to make interest payments on Pitney Bowes’
                                      investor loan to Historic Boardwalk Hall.
                                         Should there be any remaining net cashflow, 99.9 percent
                                      was to be distributed to Pitney Bowes until Pitney Bowes
                                      had received its 3-percent preferred return. The preferred
                                      return was equal to 3 percent of its adjusted capital contribu-
                                      tion, which was determined at the end of Historic Boardwalk
                                      Hall’s fiscal year.
                                         Next, funds were distributed to Pitney Bowes to cover any
                                      Federal, State, and local income taxes paid on taxable income
                                      allocated to Pitney Bowes. Any remaining net cashflow was
                                      then distributed to NJSEA for current and accrued but unpaid
                                      debt service on the acquisition and construction notes, and
                                      then to NJSEA to repay any operating deficit loans. Lastly,
                                      any remaining net cashflow was paid to Pitney Bowes and
                                      NJSEA in accordance with their membership interests.




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          11


                                      9. Environmental Concerns and Analysis
                                         The parties were concerned that the East Hall’s rehabilita-
                                      tion would lead to certain environmental hazards. To that
                                      end, Pitney Bowes retained the law firm of Kelley Drye &
                                      Warran, LLP, to assess Historic Boardwalk Hall and Pitney
                                      Bowes’ potential liability for environmental claims.
                                         In order to determine any potential environmental issues,
                                      Historic Boardwalk Hall obtained reports that evaluated the
                                      East Hall for potential hazards and also provided remedi-
                                      ation plans.
                                         Environmental Partners, Inc., prepared a Phase I Environ-
                                      mental Site Assessment for Pitney Bowes. The report identi-
                                      fied certain environmental hazards, including asbestos, pos-
                                      sibly lead-based paint, underground storage tanks, and other
                                      chemical hazards. The report characterized the East Hall as
                                      an ‘‘unknown risk’’ and concluded that environmental liabil-
                                      ities could not be estimated at that time without more anal-
                                      ysis of the East Hall.
                                         L. Robert Kimball & Associates, Inc., also prepared a haz-
                                      ardous materials assessment (the Kimball report) of the East
                                      Hall, focusing on asbestos, lead-based paint, hazardous mate-
                                      rials storage, drainage, roof deterioration, and certain haz-
                                      ardous chemicals that might be present or become exposed
                                      by the East Hall’s rehabilitation. The Kimball report then
                                      went on to evaluate how potential hazards should be dealt
                                      with and estimated what remediation would cost. The
                                      Kimball report estimated that remediation would cost more
                                      than $3 million.
                                         The AREA contained certain representations by NJSEA to
                                      Pitney Bowes concerning the East Hall and its rehabilitation
                                      with regard to environmental hazards. First, NJSEA war-
                                      ranted to Pitney Bowes that there were no known environ-
                                      mental hazards other than those identified in the en-
                                      vironmental assessments. NJSEA also warranted that if any
                                      new environmental hazards were uncovered, NJSEA would
                                      remediate them in its role as managing member. Second,
                                      NJSEA warranted that should it default in its role to reme-
                                      diate any environmental hazards, it would hold Pitney Bowes
                                      harmless and indemnify it for any costs incurred as a result
                                      of NJSEA’s default. NJSEA also held environmental liability
                                      insurance. Historic Boardwalk Hall was a named insured on




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                                      12                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      the insurance policy, and Pitney Bowes was later added as
                                      an additional insured.
                                      10. Future Transfers of Pitney Bowes’ Interest
                                        NJSEA and Pitney Bowes contemplated Pitney Bowes’ dis-
                                      posing of its membership interest and leaving Historic
                                      Boardwalk Hall. To that end, they negotiated a number of
                                      possible ways to transfer Pitney Bowes’ interest to NJSEA.
                                           A. Pitney Bowes Repurchase Option
                                        The AREA provided two options. First, article 5.03 gave
                                      Pitney Bowes the authority to require NJSEA to purchase
                                      Pitney Bowes’ interest in Historic Boardwalk Hall. If Pitney
                                      Bowes exercised its option under this article, NJSEA would
                                      have to purchase its membership interest for a price equal to:
                                      (1) Pitney Bowes’ capital contributions up to that point plus
                                      15 percent interest; (2) Pitney Bowes’ reasonable third-party
                                      fees and expenses with regard to the transaction; and (3)
                                      $100,000 as a reimbursement for Pitney Bowes’ internal
                                      expenses with regard to the transaction. NJSEA had to make
                                      the $100,000 reimbursement payment only if phase 3 of the
                                      rehabilitation 5 was not placed in service for purposes
                                      of the rehabilitation tax credit by December 31, 2000, or if
                                      the rehabilitation tax credits were less than $650,000 for tax
                                      year 2000 for any reason. Pitney Bowes could exercise its
                                      repurchase option contained in article 5.03 only until
                                      January 15, 2001.
                                           B. NJSEA Management Purchase Option
                                         Article 8.02(a) and (b) of the AREA imposed certain restric-
                                      tions on NJSEA’s authority as managing member. Article
                                      8.02(a) prevented NJSEA from performing any act in violation
                                      of the law, performing any act in violation of any project
                                      documents, doing any act that required Pitney Bowes’ con-
                                      sent, or borrowing or commingling any of Historic Boardwalk
                                      Hall’s funds.
                                         Article 8.02(b) prevented NJSEA from selling, refinancing,
                                      or disposing of Historic Boardwalk Hall’s assets, materially
                                        5 Phase 3 involved the rehabilitation of the East Hall’s ceiling. This included replacing the

                                      ceiling tiles and the lighting system and installing a computer-controlled light system at the
                                      base of each ceiling bay that would allow for the projection of sunsets and other theatrical ef-
                                      fects onto the new ceiling tiles.




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          13


                                      modifying Historic Boardwalk Hall’s insurance plan,
                                      amending any of the main transaction documents, borrowing
                                      any money other than the acquisition or construction loans,
                                      or taking any action that would adversely affect Pitney
                                      Bowes, either as a member or financially.
                                        These prohibitions were not absolute. Both article 8.02(a)
                                      and (b) gave NJSEA the option to purchase Pitney Bowes’
                                      membership interest before taking any of the prohibited
                                      actions. To exercise its options, NJSEA would have to give
                                      written notice of its intent to purchase Pitney Bowes’ interest
                                      and would have to actually purchase the interest within 90
                                      days of providing such notice.
                                        If it exercised its options, NJSEA would have to pay Pitney
                                      Bowes the present value of the projected tax benefits and the
                                      projected cashflow to be distributed to Pitney Bowes.
                                      The projected cashflows were limited to the projected tax
                                      benefits up until the first date that NJSEA could exercise its
                                      purchase option (discussed below), and to the extent that
                                      Pitney Bowes had received any tax benefits or cashflows at
                                      the time NJSEA decided to purchase Pitney Bowes’ in-
                                      terest. Thus, if NJSEA exercised its option under article
                                      8.02(a) or (b), its payment obligation would be based on its
                                      projected obligations from that date until the earliest date it
                                      could have otherwise opted to purchase Pitney Bowes’ mem-
                                      bership interest.
                                            C. Future Purchase Options
                                         Lastly, the parties negotiated two additional agreements
                                      that would allow NJSEA to reacquire Pitney Bowes’ member-
                                      ship interest in Historic Boardwalk Hall. On September 14,
                                      2000, Pitney Bowes and NJSEA entered into two option con-
                                      tracts. These were the ‘‘purchase option agreement’’ and the
                                      ‘‘agreement to compel purchase’’.
                                         The purchase option agreement gave NJSEA the right to
                                      purchase Pitney Bowes’ membership interest in Historic
                                      Boardwalk Hall. NJSEA could execute the purchase option
                                      agreement at any time during a 12-month period beginning
                                      60 months after the entire East Hall was placed in service
                                      for purposes of determining the historic rehabilitation
                                      credits. Thus, from 60 months to 72 months after the East
                                      Hall was placed in service, NJSEA had the option to purchase




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                                      14                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      Pitney Bowes’ interest. The option would expire at the end
                                      of the 12-month period.
                                         If the purchase option agreement was not executed, the
                                      agreement to compel purchase gave Pitney Bowes the right
                                      to require NJSEA to purchase Pitney Bowes’ membership
                                      interest in Historic Boardwalk Hall. Pitney Bowes may exer-
                                      cise this option during a 12-month period beginning 84
                                      months after the East Hall is placed in service for purposes
                                      of determining the historic rehabilitation credits. Like the
                                      purchase option agreement, the agreement to compel pur-
                                      chase was available only for 12 months.
                                         Both options require NJSEA to pay Pitney Bowes the
                                      greater of: (1) 99.9 percent of the fair market value of 100
                                      percent of the membership interests in Historic Boardwalk
                                      Hall; or (2) any accrued and unpaid preferred return.
                                         At the time of trial, none of the options had been exercised,
                                      and Historic Boardwalk Hall continued to operate with
                                      Pitney Bowes and NJSEA as its only members.
                                      11. Guaranteed Investment Contract
                                         In order to secure NJSEA’s payment if NJSEA reacquired
                                      Pitney Bowes’ interest in Historic Boardwalk Hall, the AREA
                                      required NJSEA to purchase a GIC.
                                         As discussed above, Pitney Bowes’ capital contributions
                                      were initially used to pay down the principal on the acquisi-
                                      tion loan. Shortly thereafter, a corresponding draw would be
                                      made on the construction loan, leaving Historic Boardwalk
                                      Hall with the capital contribution. This did not occur with
                                      respect to Pitney Bowes’ entire second capital contribution.
                                      Although the second capital contribution was used to pay
                                      down the acquisition loan, a corresponding draw was not
                                      made on the construction loan. NJSEA, retaining these funds,
                                      used a portion of the capital contribution to fund the pur-
                                      chase of the GIC.
                                         First Union National Bank (First Union) was appointed
                                      escrow agent for both Pitney Bowes and NJSEA. NJSEA depos-
                                      ited about $3.2 million of Pitney Bowes’ second capital con-
                                      tribution with First Union. First Union then entered into a
                                      master repurchase agreement with Transamerica Occidental
                                      Life Insurance Co. The master repurchase agreement was
                                      then pledged as collateral to secure NJSEA’s payment obliga-




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          15


                                      tion if, under either the purchase option or the agreement to
                                      compel purchase, it was required to purchase Pitney Bowes’
                                      membership interest in Historic Boardwalk Hall.
                                      12. Tax Benefits Guaranty
                                         NJSEA, Pitney Bowes, and Historic Boardwalk Hall foresaw
                                      the possibility that the Internal Revenue Service (IRS) would
                                      challenge the reporting of the East Hall’s rehabilitation. Con-
                                      sequently, the AREA appointed NJSEA as Historic Boardwalk
                                      Hall’s tax matters partner and provided for the appointment
                                      of counsel by NJSEA should the transaction be challenged.
                                      Pitney Bowes had final approval over the appointment of
                                      counsel to represent Historic Boardwalk Hall.
                                         Pitney Bowes and Historic Boardwalk Hall also executed a
                                      ‘‘Tax Benefits Guaranty Agreement’’ by which Historic
                                      Boardwalk Hall guaranteed the projected tax benefits allo-
                                      cable to Pitney Bowes. NJSEA was required to fund any pay-
                                      ments made pursuant to the tax benefits guaranty.
                                         The tax benefits guaranty provides that it was entered into
                                      to induce Pitney Bowes, as investor, to acquire an interest in
                                      Historic Boardwalk Hall. Its ultimate purpose was to require
                                      NJSEA to make Pitney Bowes whole should any part of the
                                      tax benefits be successfully challenged by the IRS.
                                      13. Opinion Letters
                                        NJSEA and Pitney Bowes sought and received opinion let-
                                      ters concerning various aspects of the transaction.
                                        Wolf Block prepared a tax opinion letter (Wolf Block
                                      opinion) analyzing the East Hall transaction. The Wolf Block
                                      opinion analyzed numerous Federal tax issues and concluded
                                      in pertinent part that Historic Boardwalk Hall was properly
                                      classified as a partnership, Historic Boardwalk Hall owned
                                      the East Hall, and the transaction did not violate the eco-
                                      nomic substance or sham transaction doctrines.
                                        The Wolf Block opinion relied on a number of other legal
                                      opinions in reaching those conclusions. These other opinion
                                      letters analyzed various non-tax-related legal questions
                                      raised by the East Hall’s rehabilitation and Pitney Bowes’
                                      investment. Gibbons, Del Deo opined that NJSEA had the
                                      authority to act on behalf of the State of New Jersey, that
                                      Historic Boardwalk Hall was a valid LLC, and that Pitney




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                                      16                  136 UNITED STATES TAX COURT REPORTS                                                  (1)


                                      Bowes became a member of Historic Boardwalk Hall under
                                      State law. Wolf & Samson, P.C., issued a letter concerning
                                      how New Jersey State law and NJSEA’s being financed by
                                      State bonds would affect NJSEA’s obligations under the AREA
                                      to fund any deficits and any additional construction costs.
                                      Madison & Sutro, LLP, provided an opinion letter evaluating
                                      the proper classification of the acquisition note, the construc-
                                      tion note, and Pitney Bowes’ investor loan as debt rather
                                      than equity.
                                      14. Rehabilitation and Operation of the East Hall
                                        Bank accounts were established by SMG as agent for His-
                                      toric Boardwalk Hall. After February of 2001, account state-
                                      ments show regular activity, including both deposits to and
                                      checks written on the account.
                                        NJSEA had entered into contracts with various third parties
                                      regarding certain aspects of the East Hall’s rehabilitation.
                                      These contracts were all assigned to Historic Boardwalk Hall
                                      at or around the time Pitney Bowes became a member in
                                      Historic Boardwalk Hall. These contracts dealt mainly with
                                      contractors who were engaged to perform various pieces of
                                      the rehabilitation of the East Hall.
                                        The renovation of the East Hall and its conversion to a
                                      special events arena was a success. Since its rehabilitation,
                                      the East Hall has held performances by a number of well-
                                      known entertainers, and its revenues in 2000, 2001, and
                                      2002 exceeded those in the Reznick projections. However, the
                                      East Hall has operated at a deficit.
                                      15. Procedural Posture
                                        Historic Boardwalk Hall timely filed Forms 1065, U.S.
                                      Return of Partnership Income, for 2000, 2001, and 2002. The
                                      Forms 1065 showed income, deductions, and ultimately net
                                      losses for all 3 years. The deductions included the costs of
                                      wages for employees who were operating the East Hall. His-
                                      toric Boardwalk Hall claimed the following qualified
                                      rehabilitation expenses:
                                               Year                                                                        Expenditures
                                               2000 ....................................................................   $38,862,877
                                               2001 ....................................................................    68,865,639
                                               2002 ....................................................................     1,271,482




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                                      Schedules K–1, Partner’s Share of Income, Credits, Deduc-
                                      tions, etc., were issued to Pitney Bowes and NJSEA in accord-
                                      ance with their membership interests.
                                         On February 22, 2007, respondent issued the FPAA cov-
                                      ering the 2000, 2001, and 2002 tax years to Historic Board-
                                      walk Hall. The FPAA determined that any items of income or
                                      loss or separately stated items reported on Historic Board-
                                      walk Hall’s Forms 1065 and allocated to Pitney Bowes were
                                      reallocated to NJSEA. The FPAA also determined that under-
                                      payments of tax attributable to those adjustments would be
                                      subject to the section 6662 penalty.
                                         The FPAA contained an ‘‘Explanation of Adjustments’’
                                      which provided alternative arguments in support of the
                                      adjustments made in the FPAA, including that:
                                         (1) Historic Boardwalk Hall was created for the express
                                      purpose of improperly passing along tax benefits to Pitney
                                      Bowes and is a sham;
                                         (2) Pitney Bowes’ stated partnership interest in Historic
                                      Boardwalk Hall was not bona fide because Pitney Bowes had
                                      no meaningful stake in the success or failure of Historic
                                      Boardwalk Hall;
                                         (3) the East Hall was not ‘‘sold’’ to Historic Boardwalk Hall
                                      because the benefits and burdens of ownership did not pass
                                      to Historic Boardwalk Hall. Accordingly, any items of income
                                      or loss or separately stated items attributable to ownership
                                      of the East Hall were disallowed;
                                         (4) respondent pursuant to his authority in the antiabuse
                                      provisions of section 1.701–2(b), Income Tax Regs., had deter-
                                      mined that Historic Boardwalk Hall should be disregarded
                                      for Federal income tax purposes; and
                                         (5) all or part of the underpayments of tax attributable to
                                      the adjustments in the FPAA were attributable to either neg-
                                      ligence, a substantial understatement of income tax, or both.
                                         Petitioner filed its petition in response to the FPAA on May
                                      21, 2007. A trial was held from April 13–16, 2009, in New
                                      York, New York. Respondent submitted an expert report in
                                      support of his position.




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                                      18                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                                                                  OPINION

                                      I. TEFRA in General
                                         Partnerships do not pay Federal income taxes, but they are
                                      required to file annual information returns reporting the
                                      partners’ distributive shares of tax items. Secs. 701, 6031.
                                      The individual partners then report their distributive shares
                                      of the tax items on their Federal income tax returns. Secs.
                                      701–704. A limited liability company with two or more mem-
                                      bers is treated as a partnership unless it elects to be treated
                                      as a corporation. Sec. 301.7701–3(b)(1)(i), Proced. & Admin.
                                      Regs. Historic Boardwalk Hall did not elect to be treated as
                                      a corporation and thus is treated as a partnership for Fed-
                                      eral income tax purposes.
                                         To remove the substantial administrative burden occa-
                                      sioned by duplicative audits and litigation and to provide
                                      consistent treatment of partnership tax items among part-
                                      ners in the same partnership, Congress enacted the unified
                                      audit and litigation procedures of the Tax Equity and Fiscal
                                      Responsibility Act of 1982 (TEFRA), Pub. L. 97–248, sec. 402,
                                      96 Stat. 648. See Randell v. United States, 64 F.3d 101, 103
                                      (2d Cir. 1995); H. Conf. Rept. 97–760, at 599–600 (1982),
                                      1982–2 C.B. 600, 662–663.
                                         Under TEFRA, all partnership items are determined in a
                                      single partnership-level proceeding. Sec. 6226; see also
                                      Randell v. United States, supra at 103. The determination of
                                      partnership items in a partnership-level proceeding is
                                      binding on the partners and may not be challenged in a sub-
                                      sequent partner-level proceeding. See secs. 6230(c)(4),
                                      7422(h). This precludes the Government from relitigating the
                                      same issues with each of the partners.
                                         In partnership-level proceedings such as the case before us,
                                      the Court’s jurisdiction is limited by section 6226(f) to a
                                      redetermination of partnership items and penalties on those
                                      partnership items. Section 6231(a)(3) defines the term ‘‘part-
                                      nership item’’ as any item required to be taken into account
                                      for the partnership’s taxable year under any provision of sub-
                                      title A of the Code to the extent the regulations provide that
                                      such item is more appropriately determined at the partner-
                                      ship level than at the partner level.
                                         The question whether a partnership is a sham is a partner-
                                      ship item more appropriately determined at the partnership




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                                      level. Petaluma FX Partners, LLC v. Commissioner, 131 T.C.
                                      84, 95 (2008), affd. in pertinent part 591 F.3d 649 (D.C. Cir.
                                      2010). Likewise, whether Pitney Bowes was a partner in His-
                                      toric Boardwalk Hall is also a partnership item more appro-
                                      priately determined at the partnership level. See Blonien v.
                                      Commissioner, 118 T.C. 541 (2002). Further, the determina-
                                      tion whether NJSEA contributed the East Hall to Historic
                                      Boardwalk Hall is also a partnership item. Nussdorf v.
                                      Commissioner, 129 T.C. 30, 41–42 (2007). Lastly, respond-
                                      ent’s determination that the transaction should be recast to
                                      carry out the intent of subchapter K is likewise a partnership
                                      item. Neither party disputes our jurisdiction over these
                                      items.
                                      II. Burden of Proof
                                         The Commissioner’s determinations in an FPAA are gen-
                                      erally presumed correct, and a party challenging an FPAA has
                                      the burden of proving that the Commissioner’s determina-
                                      tions are in error. Rule 142(a); Welch v. Helvering, 290 U.S.
                                      111, 115 (1933); Republic Plaza Props. Pship. v. Commis-
                                      sioner, 107 T.C. 94, 104 (1996). The burden of proof on fac-
                                      tual issues that affect a taxpayer’s liability for tax may be
                                      shifted to the Commissioner where the ‘‘taxpayer introduces
                                      credible evidence with respect to * * * such issue.’’ Sec.
                                      7491(a)(1).
                                         Petitioner argues that the burden shifts to respondent
                                      under section 7491(a). Respondent disagrees and argues that
                                      petitioner has not satisfied the requirements of section 7491.
                                      A shift in the burden of persuasion ‘‘has real significance
                                      only in 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 decide this case on the preponderance
                                      of the evidence, and the burden of proof is not a factor in our
                                      analysis. We will address each of respondent’s arguments in
                                      turn.
                                      III. Economic Substance
                                        Respondent first argues that Historic Boardwalk Hall lacks
                                      economic substance. Both parties agree that an appeal in
                                      this case lies in the Court of Appeals for the Third Circuit.
                                      See sec. 7482. The Court of Appeals for the Third Circuit has




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                                      20                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      stated that a court is to ‘‘analyze two aspects of a transaction
                                      to determine if it has economic substance: its objective eco-
                                      nomic substance and the subjective business motivation
                                      behind it.’’ IRS v. CM Holdings, Inc., 301 F.3d 96, 102 (3d
                                      Cir. 2002). However, in CM Holdings, Inc. the court went on
                                      to state that these aspects do not constitute discrete prongs
                                      of a ‘‘ ‘rigid two-step analysis’ ’’ but ‘‘ ‘represent related factors
                                      both of which inform the analysis of whether the transaction
                                      had sufficient substance, apart from its tax consequences, to
                                      be respected for tax purposes.’ ’’ Id. (quoting ACM Pship. v.
                                      Commissioner, 157 F.3d 231, 247 (3d Cir. 1998), affg. in part
                                      and revg. in part T.C. Memo. 1997–115). If, however, a trans-
                                      action ‘‘ ‘affects the taxpayer’s net economic position, legal
                                      relations, or non-tax business interests, it will not be dis-
                                      regarded merely because it was motivated by tax consider-
                                      ations.’ ’’ Id.
                                         Respondent argues that Historic Boardwalk Hall is a sham
                                      because it lacked objective economic substance and that its
                                      partners lacked any business motivation other than transfer-
                                      ring historic tax credits from NJSEA to Pitney Bowes.
                                      Respondent asks that we look to the individual partners to
                                      determine the economic substance of the transaction.
                                         Respondent contends that Historic Boardwalk Hall lacked
                                      objective economic substance because the parties, in respond-
                                      ent’s view, negotiated and executed a transaction in anticipa-
                                      tion of a limited number of possible outcomes, none of which
                                      would appreciably affect Pitney Bowes’ economic position
                                      other than through a reduction of its tax liabilities.
                                         Respondent argues that the following are the only possible
                                      outcomes of Historic Boardwalk Hall’s formation, assuming
                                      the parties act in an ‘‘economically rational manner’’.
                                         (1) If the East Hall was profitable, NJSEA would be com-
                                      pelled to exercise its repurchase option immediately after the
                                      section 47 recapture period ended, terminating Pitney Bowes’
                                      interest in Historic Boardwalk Hall. Pitney Bowes would
                                      receive its 3-percent annual return until it exited Historic
                                      Boardwalk Hall through preferred net cashflow distributions.
                                         (2) If the East Hall was unprofitable, Pitney Bowes would
                                      exercise its put option, compelling NJSEA to purchase its
                                      interest in Historic Boardwalk Hall for its 3-percent annual
                                      return. In this case, because East Hall is unprofitable and




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                                      there are no preferred net cashflow distributions, Pitney
                                      Bowes receives its payment through the GIC.
                                         Respondent contends that the parties knew that Historic
                                      Boardwalk Hall would not earn a profit and that the Reznick
                                      projections showing a profit were simply window dressing
                                      meant to give the transaction an appearance of legitimacy.
                                         Respondent further argues that Pitney Bowes would never
                                      earn a profit on its investment in Historic Boardwalk Hall.
                                      In respondent’s view, although Pitney Bowes was entitled to
                                      its 3-percent return either through preferred distributions or
                                      the GIC, Historic Boardwalk Hall still lacked objective busi-
                                      ness substance because any return would be less than Pitney
                                      Bowes could have earned had it invested its capital contribu-
                                      tions in other financial instruments. Taking into account the
                                      time value of money, respondent argues that Pitney Bowes’
                                      investment results in a negative cashflow to Pitney Bowes.
                                         Respondent also argues that other contractual provisions
                                      ensure that Historic Boardwalk Hall has no economic effect
                                      on its partners, including the tax benefits guaranty agree-
                                      ment, the operating deficit guaranty, the completion guar-
                                      anty, and the fact that all of Historic Boardwalk Hall’s debts
                                      are nonrecourse to Pitney Bowes. Respondent concludes that
                                      the parties’ economic positions were all fixed and unaffected
                                      by the return from Historic Boardwalk Hall in any cir-
                                      cumstance.
                                         Moving to the subjective test, respondent argues that His-
                                      toric Boardwalk Hall served no subjective business purpose
                                      because it was intended solely to facilitate NJSEA’s sale of
                                      rehabilitation tax credits and other favorable tax attributes
                                      to Pitney Bowes.
                                         All of respondent’s arguments concerning the economic
                                      substance of Historic Boardwalk Hall are made without
                                      taking into account the 3-percent return and the rehabilita-
                                      tion credits. Respondent argues that the rehabilitation
                                      credits must be ignored in evaluating the economic substance
                                      of Historic Boardwalk Hall. Respondent points to Friendship
                                      Dairies, Inc. v. Commissioner, 90 T.C. 1054 (1988), and
                                      argues that investment tax credits are never to be taken into
                                      account in determining the economic substance of a trans-
                                      action.
                                         Petitioner first argues that the economic substance doc-
                                      trine is inapplicable to the Historic Boardwalk Hall trans-




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                                      22                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      action because Congress, in enacting and amending section
                                      47, intended to use section 47 to spur corporations to invest
                                      in historic rehabilitation projects that otherwise would not be
                                      economically feasible. Petitioner further contends that the
                                      point of the credit was to address the reality that most
                                      rehabilitation projects had an inherent lack of profitability—
                                      thus it would be inappropriate to disregard a transaction for
                                      lack of profitability when the purpose of section 47 is to
                                      make up for that lack of profitability.
                                         Further, petitioner puts forth alternative arguments in
                                      support of its position that the Historic Boardwalk Hall
                                      transaction has economic substance. First, petitioner argues
                                      that the rehabilitation tax credits at issue can be taken into
                                      account in determining whether the transaction has economic
                                      substance and provided a net economic benefit to Pitney
                                      Bowes. Petitioner points to Sacks v. Commissioner, 69 F.3d
                                      982 (9th Cir. 1995), revg. T.C. Memo. 1992–596, and argues
                                      that we must take the rehabilitation credits into account in
                                      determining the profitability of the transaction.
                                         Second, petitioner argues that even if we do not take the
                                      rehabilitation tax credits into account, the Reznick projec-
                                      tions show that the Historic Boardwalk Hall has economic
                                      substance because Pitney Bowes and the East Hall had a
                                      chance of earning a profit.
                                         Petitioner also asserts the 3-percent return gives the trans-
                                      action economic significance.
                                         In Sacks v. Commissioner, supra, the Court of Appeals for
                                      the Ninth Circuit evaluated the economic substance of a
                                      solar energy equipment sale-leaseback transaction. The
                                      Court of Appeals found that the transaction had economic
                                      substance on the basis of the following factors:
                                         (1) The taxpayer’s personal obligation to pay the price was
                                      genuine;
                                         (2) the taxpayer paid fair market value for the equipment;
                                         (3) the tax benefits would have existed for someone and
                                      were not created out of thin air by the transaction;
                                         (4) the business of selling solar energy was genuine; and
                                         (5) the business consequences of a rise or fall in energy
                                      prices were genuinely shifted to the taxpayer.
                                      Id. at 988. The Court of Appeals discussed whether the solar
                                      energy credits should be taken into account in determining




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                                      the profitability of the transaction. The Commissioner had
                                      argued successfully in this Court that any financial analysis
                                      of the transaction had to be done without regard to the solar
                                      energy credits. On the basis of that argument, we found that
                                      the taxpayer’s transaction lacked economic substance
                                      because it was cashflow negative unless the tax credits were
                                      taken into account and disallowed the claimed credits.
                                        The Court of Appeals disagreed with that analysis, stating
                                      that the taxpayer’s investment ‘‘did not become a sham just
                                      because its profitability was based on after-tax instead of
                                      pre-tax projections.’’ Id. at 991. The Court of Appeals went
                                      on to state that ‘‘Where a transaction has economic sub-
                                      stance, it does not become a sham merely because it is likely
                                      to be unprofitable on a pre-tax basis’’, id., and that ‘‘Absence
                                      of pre-tax profitability does not show ‘whether the trans-
                                      action had economic substance beyond the creation of tax
                                      benefits,’ where Congress has purposely used tax incentives
                                      to change investors’ conduct’’, id. (citation omitted). The
                                      Court of Appeals rejected the Commissioner’s argument that
                                      the tax benefits should be excluded from the economic anal-
                                      ysis because ‘‘If the government treats tax-advantaged trans-
                                      actions as shams unless they make economic sense on a pre-
                                      tax basis, then it takes away with the executive hand what
                                      it gives with the legislative.’’ Id. at 992. Ultimately, the
                                      Court of Appeals recognized that if the types of transactions
                                      that Congress intended to encourage had to be profitable on
                                      a pretax basis, then Congress would not have needed to pro-
                                      vide incentives to get taxpayers to invest in them; in effect,
                                      the Commissioner was attempting to use the reason Con-
                                      gress created the tax benefits as a ground for denying them.
                                      Id.
                                        The Court of Appeals for the Third Circuit has not directly
                                      addressed whether investment tax credits are to be taken
                                      into account in determining the economic substance of a
                                      transaction. In IRS v. CM Holdings, Inc., 301 F.3d 96 (3d
                                      Cir. 2001), the taxpayer attempted to rely on the opinion of
                                      the Court of Appeals for the Ninth Circuit in Sacks in
                                      arguing that a corporate-owned life insurance plan had eco-
                                      nomic substance because Congress had explicitly sanctioned
                                      those types of tax strategies. However, the Court of Appeals
                                      for the Third Circuit distinguished Sacks because the Sacks
                                      opinion, in allowing depreciation deductions and investment




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                                      credits with respect to a sale and leaseback of solar energy
                                      equipment, reasoned that both Federal and State legislatures
                                      had specifically encouraged investment in solar energy and
                                      thereby ‘‘skewed the neutrality of the tax system.’’ Id. at 106
                                      (quoting Sacks v. Commissioner, supra at 991).
                                         Respondent argues that Sacks does not control since,
                                      unlike the transaction in Sacks, the East Hall transaction
                                      and Historic Boardwalk Hall are shams because they had no
                                      appreciable effect on the parties’ economic positions.
                                         As an initial matter, we do not agree with respondent that
                                      Pitney Bowes invested in the Historic Boardwalk Hall trans-
                                      action solely to earn rehabilitation tax credits. We believe the
                                      3-percent return and the expected tax credits should be
                                      viewed together. Viewed as a whole, the Historic Boardwalk
                                      Hall and the East Hall transactions did have economic sub-
                                      stance. Pitney Bowes, NJSEA, and Historic Boardwalk Hall
                                      had a legitimate business purpose—to allow Pitney Bowes to
                                      invest in the East Hall’s rehabilitation.
                                         Pitney Bowes invested in the East Hall rehabilitation.
                                      Most of Pitney Bowes’ capital contributions were used to pay
                                      a development fee to NJSEA for its role in managing the
                                      rehabilitation of the East Hall according to the development
                                      agreement between Historic Boardwalk Hall and NJSEA.
                                      Respondent’s contention that Pitney Bowes was unnecessary
                                      to the transaction because NJSEA was going to rehabilitate
                                      the East Hall without a corporate investor overlooks the
                                      impact that Pitney Bowes had on the rehabilitation: no
                                      matter NJSEA’s intentions at the time it decided to rehabili-
                                      tate the East Hall, Pitney Bowes’ investment provided NJSEA
                                      with more money than it otherwise would have had; as a
                                      result, the rehabilitation ultimately cost the State of New
                                      Jersey less. Respondent does not allege that a circular flow
                                      of funds resulted in Pitney Bowes receiving its 3-percent pre-
                                      ferred return on its capital contributions. In addition, Pitney
                                      Bowes received the rehabilitation tax credits.
                                         Historic Boardwalk Hall and the AREA imposed financial
                                      requirements on both Pitney Bowes and NJSEA. Pitney Bowes
                                      was required to make capital contributions, and NJSEA was
                                      required to manage the East Hall’s rehabilitation and assure
                                      its completion. If NJSEA failed in its role as manager and the
                                      rehabilitation did not proceed according to the parties’ plan,
                                      Pitney Bowes would not be required to make additional cap-




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          25


                                      ital contributions. This would have left NJSEA responsible for
                                      a larger portion of the East Hall’s rehabilitation.
                                         Respondent points to the parties’ use of the term ‘‘sale of
                                      tax credits’’ and argues that the term ‘‘development fee’’ and
                                      the payment of a development fee by Historic Boardwalk
                                      Hall to NJSEA is merely meant to disguise evidence showing
                                      the true nature of the transaction to be a sale of tax credits.
                                      We must look to the substance of the transaction, rather
                                      than the terms used by the parties. The regulations clearly
                                      indicate that a development fee is a qualified rehabilitation
                                      expense. Sec. 1.48–12(c)(2), Income Tax Regs. The opinion
                                      letters obtained by NJSEA and Pitney Bowes all discuss
                                      whether a development fee is the type of rehabilitation
                                      expense that is eligible to earn rehabilitation tax credits, and
                                      whether the amount of the development fee at issue was
                                      reasonable in this type of rehabilitation. Respondent does not
                                      argue that any portion of the rehabilitation credits claimed
                                      is inappropriate or attempt to disallow any of Historic Board-
                                      walk Hall’s claimed credits on the ground that the develop-
                                      ment fee was not a qualified rehabilitation expense.
                                         Pitney Bowes faced risks as a result of joining Historic
                                      Boardwalk Hall. First, and most importantly to its goals, it
                                      faced the risk that the rehabilitation would not be completed.
                                         In addition, both NJSEA and Pitney Bowes faced potential
                                      liability for environmental hazards from the rehabilitation.
                                      Although Historic Boardwalk Hall and Pitney Bowes were
                                      added as named insured parties to NJSEA’s environmental
                                      insurance, there was no guaranty that: (1) The insurance
                                      payout would cover any potential liability; and (2) if NJSEA
                                      was required to make up any difference, it would be finan-
                                      cially able to do so.
                                         Overall, respondent’s argument that certain agreements
                                      prevented the East Hall transaction from affecting the part-
                                      ners’ economic positions is incorrect. These side agreements
                                      and guaranties must be looked at in context: they were nec-
                                      essary to attract an equity investor. These provisions are
                                      meant to protect Pitney Bowes from any unforeseen cir-
                                      cumstances that could arise as a result of problems with the
                                      rehabilitation. Respondent does not argue that the comple-
                                      tion guaranty is a sham or is not a legitimate agreement
                                      between the parties. Instead, respondent argues that because
                                      Pitney Bowes’ investment is limited to its capital contribu-




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                                      26                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      tions and because Pitney Bowes cannot be held responsible
                                      for additional funds to complete the East Hall rehabilitation,
                                      the East Hall transaction as a whole lacks economic sub-
                                      stance. However, those agreements show that the East Hall
                                      and Historic Boardwalk Hall did in fact affect the parties’
                                      economic positions—the agreements were meant to prevent
                                      the transaction from having a larger impact than the parties
                                      had bargained for.
                                         This is not a transaction in which the parties had com-
                                      peting interests that would work against the partnership’s
                                      stated purpose. NJSEA and Pitney Bowes had a common goal:
                                      the rehabilitation of the East Hall. NJSEA needed the
                                      rehabilitation to be successful in order to make the East Hall
                                      an attractive site for concerts and events after the construc-
                                      tion of the new convention center. Pitney Bowes needed the
                                      rehabilitation to be successful so it would earn rehabilitation
                                      credits and its 3-percent return. Both would receive a net
                                      economic benefit if the rehabilitation was successful.
                                         The legislative history of section 47 indicates that one of
                                      its purposes is to encourage taxpayers to participate in what
                                      would otherwise be an unprofitable activity. Congress
                                      enacted the rehabilitation tax credit in order to spur private
                                      investment in unprofitable historic rehabilitations. As
                                      respondent notes, the East Hall has operated at a deficit.
                                      Without the rehabilitation tax credit, Pitney Bowes would
                                      not have invested in its rehabilitation, because it could not
                                      otherwise earn a sufficient net economic benefit on its invest-
                                      ment. The purpose of the credit is directed at just this
                                      problem: because the East Hall operates at a deficit, its oper-
                                      ations alone would not provide an adequate economic benefit
                                      that would attract a private investor. Further, if not for the
                                      rehabilitation tax credit, NJSEA would not have had access to
                                      the nearly $14 million paid to it as a development fee for its
                                      efforts in rehabilitating the East Hall. Considering that the
                                      cost of the rehabilitation was about $100 million, Pitney
                                      Bowes contributed about 15 percent of the cost of the
                                      rehabilitation.
                                         Respondent attempts to read Friendship Dairies, Inc. v.
                                      Commissioner, 90 T.C. 1054 (1988), as holding that the
                                      investment tax credit is never taken into account in consid-
                                      ering the economic substance of a transaction. Friendship
                                      Dairies does not make such a broad holding. Although we




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          27


                                      held in that case that the investment tax credits at issue
                                      could not be taken into account in evaluating the economic
                                      substance of that transaction, we did not explicitly hold that
                                      investment credits are never taken into account when
                                      applying the economic substance doctrine. We stated that
                                        ‘‘We acknowledge that many such tax-motivated transactions are
                                      congressionally approved and encouraged. * * * The determination
                                      whether a transaction is one Congress intended to encourage will require
                                      a broad view of the relevant statutory framework and some investigation
                                      into legislative history. The issue of congressional intent is raised only
                                      upon a threshold determination that a particular transaction was entered
                                      into primarily for tax reasons.’’ [Id. at 1064 (quoting Fox v. Commissioner,
                                      82 T.C. 1001, 1021 (1984)).]

                                         In Friendship Dairies, we disregarded a sale-leaseback
                                      transaction which had no chance of profitability. This case is
                                      distinguishable on its facts.
                                         Ultimately, NJSEA had more money for the rehabilitation
                                      than it would have had if Pitney Bowes had not invested in
                                      Historic Boardwalk Hall. Both parties would receive a net
                                      economic benefit from the transaction if the rehabilitation
                                      was successful. Pitney Bowes would earn a net economic ben-
                                      efit as a result of its entering into the East Hall’s rehabilita-
                                      tion, while NJSEA would see higher revenues from other
                                      Atlantic City properties if the East Hall was a successful loss
                                      leader and began attracting large crowds after the rehabilita-
                                      tion was completed.
                                         The rehabilitation of the East Hall was a success. Historic
                                      Boardwalk Hall has been operating and continues to operate
                                      day to day, with the East Hall being used as a convention
                                      facility. In conclusion, Historic Boardwalk Hall had objective
                                      economic substance.
                                      IV. Whether Pitney Bowes Was a Partner in Historic Board-
                                          walk Hall
                                         Respondent next argues that Pitney Bowes was not a
                                      partner in Historic Boardwalk Hall. Respondent contends
                                      that Pitney Bowes’ partnership interest should be dis-
                                      regarded because: (1) Pitney Bowes had no meaningful stake
                                      in Historic Boardwalk Hall’s success or failure; and (2)
                                      Pitney Bowes’ interest in Historic Boardwalk Hall is more
                                      like debt than equity. Ultimately, respondent’s two argu-




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                                      28                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      ments both center on the fact that Pitney Bowes’ return was
                                      limited to 3 percent.
                                        Section 761(a) defines ‘‘Partnership’’ as follows:
                                         SEC. 761(a). PARTNERSHIP.—For purposes of this subtitle, the term
                                      ‘‘partnership’’ includes 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 [subtitle], a corporation or a trust or estate. * * *

                                         Both petitioner and respondent point to Commissioner v.
                                      Culbertson, 337 U.S. 733 (1949), in support of their argu-
                                      ments. In Culbertson, the Supreme Court had to determine
                                      whether a valid partnership was formed. The Supreme Court
                                      listed several objective factors that influence the determina-
                                      tion of whether a partnership is valid, including: (1) The
                                      agreement between the parties; (2) the conduct of the parties
                                      in executing its provisions; (3) the parties’ statements; (4) the
                                      testimony of disinterested persons; (5) the relationship of the
                                      parties; (6) their respective abilities and capital contribu-
                                      tions; (7) the actual control of income; and (8) the purposes
                                      for which the income is used. Id. at 742; see also Va. Historic
                                      Tax Credit Fund 2001 LP v. Commissioner, T.C. Memo.
                                      2009–295. In Va. Historic Tax Credit Fund, we applied the
                                      Culbertson factors and upheld a partnership which was
                                      formed to allow the partners to share and distribute State
                                      tax credits.
                                         In Luna v. Commissioner, 42 T.C. 1067, 1077–1078 (1964),
                                      this Court stated that ‘‘while all circumstances are to be
                                      considered, the essential question is whether the parties
                                      intended to, and did in fact, join together for the present con-
                                      duct of an undertaking or enterprise’’, and cited Commis-
                                      sioner v. Culbertson, supra at 742, which stated:
                                        The question is not whether the services or capital contributed by a
                                      partner are of sufficient importance to meet some objective standard * * *
                                      but whether, considering all the facts * * * the parties in good faith and
                                      acting with a business purpose intended to join together in the present
                                      conduct of the enterprise. * * *

                                      Petitioner argues that Historic Boardwalk Hall is a valid
                                      partnership and that Pitney Bowes was a partner in
                                      that partnership. Petitioner points to the partnership agree-
                                      ment, the parties’ actions in negotiating that agreement, and
                                      the parties’ actions after the agreement was executed. Peti-




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                                      tioner contends that Pitney Bowes’ extensive investigation of
                                      all aspects of the transaction and Historic Boardwalk Hall’s
                                      business changes made after execution all support a conclu-
                                      sion that Pitney Bowes was a partner in Historic Boardwalk
                                      Hall.
                                         We agree with petitioner. Pitney Bowes and NJSEA, in good
                                      faith and acting with a business purpose, intended to join
                                      together in the present conduct of a business enterprise. As
                                      we held above, Pitney Bowes and NJSEA joined together in a
                                      transaction with economic substance to allow Pitney Bowes
                                      to invest in the East Hall rehabilitation. Further, as we
                                      found above, the decision to invest provided a net economic
                                      benefit to Pitney Bowes through its 3-percent preferred
                                      return and rehabilitation tax credits. Combined with our
                                      above holding that Historic Boardwalk Hall had economic
                                      substance, it is clear that Pitney Bowes was a partner in His-
                                      toric Boardwalk Hall.
                                         The parties’ investigations and documentation both sup-
                                      port a finding that the parties intended to join together in a
                                      rehabilitation of the East Hall. Although the confidential
                                      offering memorandum used the term ‘‘sale’’, it was used in
                                      the context of describing an investment transaction. The con-
                                      fidential offering memorandum accurately described the sub-
                                      stance of the transaction: an investment in the East Hall’s
                                      rehabilitation.
                                         The parties’ investigation likewise supports a finding of an
                                      effort to join together in rehabilitating the East Hall. The
                                      parties investigated potential environmental hazards and
                                      attempted to mitigate them. This included two analyses by
                                      consulting firms and adding Historic Boardwalk Hall and
                                      Pitney Bowes as named parties to NJSEA’s insurance policies.
                                      NJSEA and Pitney Bowes sought and received a number of
                                      opinion letters evaluating various aspects of the transaction.
                                         The executed transaction documents accurately represent
                                      the substance of the transaction. The AREA is between Pitney
                                      Bowes and NJSEA and provides a detailed description of His-
                                      toric Boardwalk Hall’s purpose—to rehabilitate and manage
                                      the East Hall. Since formation, Historic Boardwalk Hall has
                                      carried out its goals. The AREA describes Pitney Bowes and
                                      NJSEA as members and also provides for transfers of their
                                      membership interests in later years. The development agree-
                                      ment between Historic Boardwalk Hall contractually obli-




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                                      30                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      gates NJSEA to manage the East Hall’s rehabilitation and
                                      accurately represents the substance of the transaction.
                                        Since execution of those agreements, the parties have car-
                                      ried out their responsibilities under the AREA. NJSEA oversaw
                                      the East Hall’s rehabilitation, and Pitney Bowes made its
                                      required capital contributions. The East Hall was actually
                                      rehabilitated, did reopen to the public, and has been success-
                                      ful. This rehabilitation provided benefits to both Pitney
                                      Bowes and NJSEA.
                                        Respondent again asks us to ignore the rehabilitation tax
                                      credits at issue. Pitney Bowes joined Historic Boardwalk Hall
                                      in exchange for its 3-percent preferred return and the
                                      rehabilitation tax credits. The 3-percent preferred return and
                                      the rehabilitation tax credits provided a net economic benefit
                                      to Pitney Bowes. Even if we do ignore the tax credits, Pitney
                                      Bowes’ interest is not more like debt than equity because
                                      Pitney Bowes is not guaranteed to receive a 3-percent return
                                      every year. Because the East Hall operated at a loss each
                                      year, Pitney Bowes was not guaranteed the 3-percent return
                                      at the end of a given year because there might not be suffi-
                                      cient cashflow to pay it. In accord with the AREA, Pitney
                                      Bowes might not receive its preferred return until NJSEA pur-
                                      chased Pitney Bowes’ membership interest, if at all.
                                        Taking into account the stated purpose behind Historic
                                      Boardwalk Hall’s formation, the parties’ investigation of the
                                      transaction, the transaction documents, and the parties’
                                      respective roles, we hold that Historic Boardwalk Hall was a
                                      valid partnership.
                                      V. Whether the East Hall Was ‘‘Sold’’ to Historic Boardwalk
                                         Hall
                                         Respondent next argues that NJSEA did not transfer the
                                      East Hall to Historic Boardwalk Hall for Federal income tax
                                      purposes because NJSEA did not transfer the benefits and
                                      burdens of ownership.
                                         Whether the benefits and burdens of ownership with
                                      respect to property have passed to the taxpayer is a question
                                      of fact that must be answered from the intentions of the par-
                                      ties as established by the written agreements read in light
                                      of the attending facts and circumstances. Arevalo v. Commis-
                                      sioner, 124 T.C. 244, 252 (2005), affd. 469 F.3d 436 (5th Cir.




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                                      2006); Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C.
                                      1221, 1237 (1981). We look to the substance of the agreement
                                      and not just the labels used by the parties. Arevalo v.
                                      Commissioner, supra at 252. The following factors are consid-
                                      ered: (1) Whether legal title passes; (2) how the parties treat
                                      the transaction; (3) whether equity was acquired in the prop-
                                      erty; (4) whether the contract creates a present obligation on
                                      the seller to execute and deliver a deed and a present obliga-
                                      tion on the purchaser to make payments; (5) whether the
                                      right of possession vested in the purchaser; (6) which party
                                      pays the property taxes; (7) which party bears the risk of loss
                                      or damage to the property; and (8) which party receives the
                                      profits from the operation and sale of the property. Id.
                                         Respondent argues that the burdens of ownership
                                      remained with NJSEA because it bore all of the burdens of the
                                      East Hall’s operation and rehabilitation, including remaining
                                      liable for the East Hall’s operating expenses, real estate
                                      taxes, workers’ compensation, and property and other insur-
                                      ance coverage and for completion of the East Hall rehabilita-
                                      tion. Respondent contends that NJSEA also remained respon-
                                      sible for any excess development costs, interest, taxes, and
                                      the costs of any environmental problems. Respondent concur-
                                      rently argues that NJSEA maintained the benefits of owner-
                                      ship because it had the authority, through its purchase
                                      option, to purchase Pitney Bowes’ interest in Historic Board-
                                      walk Hall at any time. Respondent points to Sun Oil Co. v.
                                      Commissioner, 562 F.2d 258 (3d Cir. 1977), revg. T.C. Memo.
                                      1976–40, and argues that under the Court of Appeals for the
                                      Third Circuit’s authority, a purchase option requires a
                                      finding that the benefits and burdens were not passed.
                                         Petitioner argues that the transaction documents clearly
                                      show the parties’ intent to sell the East Hall to Historic
                                      Boardwalk Hall. Petitioner also argues that NJSEA had a
                                      contractual obligation to deliver the East Hall to Historic
                                      Boardwalk Hall, that Historic Boardwalk Hall had an obliga-
                                      tion to pay for the East Hall, and that Historic Boardwalk
                                      Hall had possession of the East Hall.
                                         Some of the factors weigh in favor of finding a sale: (1) The
                                      parties treated the transaction as a sale; (2) possession of the
                                      East Hall vested in Historic Boardwalk Hall; (3) Historic
                                      Boardwalk Hall reported the East Hall’s profits and stood to
                                      lose its income if the East Hall stopped operating as an event




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                                      32                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      space. Others weigh against petitioner: (1) NJSEA remained
                                      liable for the East Hall’s property taxes (2) because Historic
                                      Boardwalk Hall operated at a loss, NJSEA was not guaranteed
                                      to receive payments on the acquisition loan each year; (3)
                                      NJSEA could reacquire the East Hall by exercising its option
                                      under article 8.02 of the AREA.
                                         We must evaluate whether the East Hall was transferred
                                      in the context of this specific rehabilitation transaction. We
                                      look at all the facts and circumstances surrounding the
                                      transaction at issue.
                                         The East Hall has been operating as an event space, and
                                      all income and expenses of the East Hall have been reported
                                      on Historic Boardwalk Hall’s Forms 1065. Bank accounts
                                      were opened in Historic Boardwalk Hall’s name by SMG as
                                      operator of the East Hall.
                                         Respondent argues that the benefits and burdens were not
                                      transferred because NJSEA remained liable for the rehabilita-
                                      tion and the expense of managing the East Hall. Respondent
                                      points to statements by NJSEA executives that the East Hall
                                      would operate in the same manner as it had before Historic
                                      Boardwalk Hall was formed and argues that these state-
                                      ments support a conclusion that the benefits and burdens
                                      were not transferred to Historic Boardwalk Hall. Respondent
                                      misinterprets the context of these statements. They were
                                      made in relation to NJSEA’s decision to assign some of its
                                      construction contracts to Historic Boardwalk Hall. The state-
                                      ments appear to have been made to third parties and were
                                      meant to assuage the concerns of those third parties that
                                      their contracts and dealings with regard to the East Hall
                                      would be affected by the contract assignment to Historic
                                      Boardwalk Hall.
                                         Respondent’s additional argument in the context of the
                                      East Hall’s ownership concerns the article 8.02 purchase
                                      option. Respondent points to Sun Oil Co. v. Commissioner,
                                      supra, and contends that in the Court of Appeals for the
                                      Third Circuit, a purchase option such as the one in article
                                      8.02 requires a finding that the benefits and burdens of
                                      ownership remained with NJSEA. We do not believe that Sun
                                      Oil controls.
                                         In that case, Sunray DX Oil Co. (Sunray) sold 320 parcels
                                      of land to a tax-exempt trust. Sunray then leased those par-
                                      cels back. The Commissioner challenged Sunray’s deductions




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                                      for lease payments. This Court found in favor of the tax-
                                      payer, but the Court of Appeals for the Third Circuit
                                      reversed our decision.
                                         The Court of Appeals focused on Sunray’s ability to recover
                                      the land ‘‘sold’’ to the tax-exempt trust. Sunray had a
                                      number of options if it decided it wanted to recover a specific
                                      piece of land. First, it could simply swap another piece of
                                      land for that land, without the trust’s being able to reject it.
                                      Second, Sunray could make an offer to repurchase a specific
                                      piece of land. Lastly, Sunray had a right of repurchasing the
                                      land for an amount equal to the present value of rent pay-
                                      ments due 60 years in the future, which would be an almost
                                      negligible value.
                                         The Court of Appeals focused on how these provisions did
                                      not truly transfer any rights to the trust. The Court of
                                      Appeals observed that because Sunray could, without any
                                      restrictions, swap any piece of land for one subject to the
                                      sale-leaseback at issue, the offer provisions in the contracts
                                      were rendered moot. Further, the Court of Appeals held that
                                      because Sunray could always repurchase the land for an
                                      almost negligible amount by its repurchase options, it could
                                      always recover the land without paying the trust fair market
                                      value. The Court of Appeals stated: ‘‘The options to
                                      repurchase provide Sunray with a built in latch-string by
                                      which it could spring legal title to the properties whenever
                                      it served its convenience without obligating Sunray to pay
                                      fair market value.’’ Sun Oil Co. v. Commissioner, 562 F.2d at
                                      268.
                                         As an initial matter, we note that Sun Oil is distinguish-
                                      able on its facts. That case dealt with a sale-leaseback trans-
                                      action entered into to generate artificial rent deductions.
                                      Further, we do not believe that the presence of a purchase
                                      option prevents our finding that the benefits and burdens of
                                      ownership of the East Hall were transferred to Historic
                                      Boardwalk Hall in the context of the rehabilitation tax
                                      credit.
                                         A purpose of Historic Boardwalk Hall was to allow Pitney
                                      Bowes to invest in the rehabilitation of the East Hall and
                                      earn rehabilitation tax credits. The purchase option agree-
                                      ment gave NJSEA the right to purchase Pitney Bowes’ mem-
                                      bership interest in Historic Boardwalk Hall at any time
                                      during a 12-month period beginning 60 months after the




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                                      34                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      entire East Hall was placed in service for purposes of deter-
                                      mining the historic rehabilitation credits. The rehabilitation
                                      credits of Pitney Bowes would have been subject to recapture
                                      had it disposed of its partnership interest within 60 months
                                      after the renovated East Hall was placed in service. See sec.
                                      50; sec. 1.47–6(a)(1), Income Tax Regs. The statute dem-
                                      onstrates an anticipation of repurchase and creates a dis-
                                      incentive. Congress established a means to police early dis-
                                      positions and created a deterrent to a premature buyout. For
                                      these reasons, NJSEA’s purchase option was not contrary to
                                      the purpose of the rehabilitation tax credit.
                                        In conclusion, we find that NJSEA transferred the benefits
                                      and burdens of ownership of the East Hall to Historic Board-
                                      walk Hall.
                                      VI. Respondent’s Recasting of the Transaction
                                        Respondent alternatively determined in the FPAA that it
                                      was necessary to recast the East Hall transaction to ‘‘achieve
                                      tax results that are consistent with the intent of subchapter
                                      K.’’ Section 1.701–2(b), Income Tax Regs., gives the Commis-
                                      sioner the authority to recast transactions for Federal income
                                      tax purposes if a partnership is formed or availed of in
                                      connection with a transaction a principal purpose of which is
                                      to reduce substantially the present value of the partners’
                                      aggregate Federal income tax liability in a manner that is
                                      inconsistent with subchapter K. Section 1.701–2(a), Income
                                      Tax Regs., provides that the following requirements are
                                      implicit in the intent of subchapter K:
                                         (1) The partnership must be bona fide and each partnership transaction
                                      or series of related transactions * * * must be entered into for a substan-
                                      tial business purpose;
                                         (2) The form of each partnership transaction must be respected under
                                      substance over form principles;
                                         (3) * * * the tax consequences under subchapter K to each partner of
                                      partnership operations and of transactions between the partner and the
                                      partnership must accurately reflect the partners’ economic agreement and
                                      clearly reflect the partner’s income * * *

                                         Requirement (3), however, contains an exception in certain
                                      situations. Some statutory and regulatory requirements
                                      imposed on partnerships by subchapter K may cause tax
                                      results that do not accurately reflect the partners’ economic
                                      agreement or clearly reflect the partners’ income, thus vio-




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          35


                                      lating requirement (3) above. Section 1.701–2(a)(3), Income
                                      Tax Regs., provides that if a transaction satisfies require-
                                      ments (1) and (2), requirement (3) will be treated as satisfied
                                      to the extent that the application of such a provision to the
                                      transaction and the ultimate tax results, taking into account
                                      all the relevant facts and circumstances, are clearly con-
                                      templated by that provision.
                                        The determination of whether a transaction involving a
                                      partnership ought to be recast is made with consideration
                                      given to the statutory provision giving rise to the tax benefits
                                      and all pertinent facts and circumstances. Section 1.701–2(c),
                                      Income Tax Regs., provides a nonexclusive list of factors to
                                      be considered, including whether:
                                         (1) The present value of the partners’ aggregate Federal tax liability is
                                      substantially less than had the partners owned the partnership’s assets
                                      and conducted the partnership’s activities directly;
                                         (2) The present value of the partners’ aggregate Federal tax liability is
                                      substantially less than would be the case if purportedly separate trans-
                                      actions that are designed to reach a particular result are integrated and
                                      treated as steps in a single transaction * * *;
                                         (3) One or more partners who are necessary to achieve the claimed tax
                                      results either have a nominal interest in the partnership, are substantially
                                      protected from any risk of loss from the partnership’s activities * * *, or
                                      have little or no participation in the profits from the partnership’s activi-
                                      ties other than a preferred return that is in the nature of a payment for
                                      the use of capital;
                                         (4) Substantially all of the partners * * * are related (directly or
                                      indirectly) to one another;
                                         (5) Partnership items are allocated in compliance with the literal lan-
                                      guage of §§ 1.704–1 and 1.704–2, but with results that are inconsistent
                                      with the purpose of section 704(b) and those regulations * * * ;
                                         (6) The benefits and burdens of ownership of property nominally contrib-
                                      uted to the partnership are in substantial part retained (directly or
                                      indirectly) by the contributing partner (or a related party); or
                                         (7) The benefits and burdens of ownership of partnership property are
                                      in substantial part shifted (directly or indirectly) to the distributee partner
                                      before or after the property is actually distributed to the distributee
                                      partner (or a related party).

                                        Respondent argues that his decision to recast the East Hall
                                      transaction was correct because Historic Boardwalk Hall’s
                                      principal purpose was to substantially reduce the present
                                      value of Pitney Bowes’ aggregate tax liability in a manner
                                      inconsistent with the purpose of subchapter K.




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                                      36                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                         Petitioner, however, contends that the East Hall trans-
                                      action is wholly consistent with the purpose of subchapter K
                                      and further argues that the East Hall transaction is analo-
                                      gous to examples of the proper use of partnerships in section
                                      1.701–2, Income Tax Regs. Section 1.701–2(d), Income Tax
                                      Regs., lists various factual situations involving the use of a
                                      partnership and evaluates whether that use is or is not con-
                                      sistent with the intent of subchapter K.
                                         Section 1.701–2(d), Example (6), Income Tax Regs.,
                                      involves the formation of a partnership by A and B, two
                                      high-bracket taxpayers, and X, a corporation with net oper-
                                      ating loss carryforwards. A, B, and X form partnership PRS
                                      to own and operate a building that qualifies for section 42
                                      low-income-housing credits. PRS is financed with cash con-
                                      tributions by A and B and nonrecourse indebtedness, and the
                                      partnership agreement provides for special allocations of
                                      income and deductions, including depreciation, to A and B
                                      equally. This allocation is consistent with the allocation of
                                      other economically substantial partnership items attributable
                                      to the building. The section 42 low-income-housing credits
                                      are also allocated according to the partnership agreement.
                                      The partners and partnership comply with all applicable
                                      partnership regulations in their management and reporting
                                      of the partnership. These include sections 1.704–1(b)(2)(ii)
                                      and (iii), 1.704–2(e), and 1.752–3, Income Tax Regs.
                                         The ultimate result reached by the Commissioner is that
                                      individuals A and B are allowed to deduct their distributive
                                      shares of PRS’ losses against their nonpartnership income and
                                      to apply the low-income-housing credits against their tax
                                      liabilities. Example (6) goes on to indicate that this allocation
                                      may not accurately reflect the partners’ economic agreement
                                      or clearly reflect income. However, because the provisions
                                      that lead to this result, sections 1.704–1(b)(2)(ii) and (iii),
                                      1.704–2(e), and 1.752–3, Income Tax Regs., clearly con-
                                      templated this result, then requirement (3), discussed above,
                                      is treated as having been satisfied.
                                         The use of PRS results in partners A and B’s aggregate
                                      Federal income tax liability being lower than if A and B had
                                      owned the building directly. This result flows from A and B’s
                                      being able to use corporation X’s otherwise allocable credits.
                                      Example 6 concludes that, even though the use of partner-
                                      ship PRS leads to this result, the PRS transaction is not incon-




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                                      (1)         HISTORIC BOARDWALK HALL, LLC v. COMMISSIONER                                          37


                                      sistent with the intent of subchapter K. As a result, the
                                      Commissioner cannot invoke section 1.701–2(b), Income Tax
                                      Regs., to recast the transaction.
                                         Respondent disputes petitioner’s reliance on Example (6)
                                      and argues that it is inapplicable. Respondent contends that
                                      Example (6) concerns a general partnership, unlike Pitney
                                      Bowes, NJSEA, and Historic Boardwalk Hall, where all part-
                                      ners have personal liability, none of the entities is tax
                                      exempt, section 42 does not require a profit motive, and the
                                      taxpayers are at risk if the building declines in value.
                                         Respondent argues that Historic Boardwalk Hall violated
                                      section 1.701–2(a)(1), Income Tax Regs., because there was
                                      no substantial business purpose for its formation.
                                      Respondent points to certain factors listed in section 1.701–
                                      2(c), Income Tax Regs., and concludes that section
                                      1.701–2(a)(1), Income Tax Regs., has been violated. These
                                      factors include Pitney Bowes’ aggregate tax liability’s being
                                      lower as a result of Historic Boardwalk Hall’s creation; thus,
                                      Pitney Bowes is substantially protected from any risk of loss
                                      and has little or no participation in the partnership’s profits
                                      other than its preferred return. Respondent does not argue
                                      a breach of requirement (1) or (2) of section 1.701–2(a),
                                      Income Tax Regs.
                                         We have previously rejected respondent’s contentions in
                                      the context of his other arguments. We agree with petitioner
                                      that respondent’s decision to recharacterize the East Hall
                                      transaction pursuant to section 1.701–2(b), Income Tax
                                      Regs., was inappropriate. NJSEA and Pitney Bowes had the
                                      legitimate business purpose, as discussed above, of allowing
                                      Pitney Bowes to invest in the East Hall’s rehabilitation. The
                                      use of a partnership was necessary to allow a for-profit cor-
                                      poration to invest in the rehabilitation of a government-
                                      owned building. Although Pitney Bowes’ aggregate tax
                                      liability was reduced as a result of this transaction, Congress
                                      intended to use the rehabilitation tax credit to draw private
                                      investments into public rehabilitations.
                                         Further, the regulations clearly contemplate a situation in
                                      which a partnership is used to transfer valuable tax
                                      attributes from an entity that cannot use them—corporation
                                      X—to individuals who can—taxpayers A and B. See sec.
                                      1.701–2(d), Example (6), Income Tax Regs.




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                                      38                 136 UNITED STATES TAX COURT REPORTS                                           (1)


                                      VII. Section 6662 Accuracy-Related Penalty
                                        Respondent determined in the FPAA that Historic Board-
                                      walk Hall should be liable for the accuracy-related penalty
                                      pursuant to section 6662. Because we find respondent’s other
                                      determinations to be incorrect, the section 6662 penalty is
                                      inapplicable.
                                      VIII. Conclusion
                                        Respondent’s determinations in the                            FPAA    were incorrect. To
                                      reflect the foregoing,
                                                                          An appropriate decision will be entered.

                                                                               f




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