                              T.C. Memo. 2014-30



                        UNITED STATES TAX COURT



 ROUTE 231, LLC, JOHN D. CARR, TAX MATTERS PARTNER, Petitioner v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 13216-10.                         Filed February 24, 2014.



      William Lee S. Rowe, Timothy L. Jacobs, and Hilary B. Lefko, for

petitioner.

      Timothy B. Heavner, John M. Tkacik, Jr., Warren P. Simonsen, and Mary

Ann Waters, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      KERRIGAN, Judge: On March 17, 2010, respondent issued two notices of

final partnership administrative adjustment (FPAAs) to John D. Carr (petitioner),
                                        -2-

[*2] as tax matters partner of Route 231, LLC (Route 231), one regarding Route

231’s tax year 2005 and the other regarding its tax year 2006. The FPAA for tax

year 2005 proposed an adjustment to ordinary income of $3,816,000, among other

things.1 The FPAA for tax year 2006 did not involve an adjustment to ordinary

income. Petitioner filed a timely petition for readjustment under section 6226

regarding the FPAA for tax year 2005. No petition was filed regarding the FPAA

for tax year 2006.

      Unless otherwise indicated, all section references are to the Internal

Revenue Code (Code) in effect for the year in issue, and all Rule references are to

the Tax Court Rules of Practice and Procedure. We round all monetary amounts

to the nearest dollar.

      After concessions we must decide (1) whether Route 231 engaged in a

disguised sale under section 707 and, if so, (2) whether the proceeds from the

disguised sale were income to Route 231 for tax year 2005.

                              FINDINGS OF FACT

      Some facts have been stipulated and are so found. At the time petitioner

filed the petition, Route 231’s principal place of business was in Virginia. Route

      1
       The FPAA for tax year 2005 also proposed an adjustment to Route 231’s
net farm profit (loss) and an adjustment to noncash charitable contributions.
These adjustments are not in issue.
                                         -3-

[*3] 231 treated itself as a partnership for Federal income tax purposes at all

relevant times.

Virginia Tax Credits

      During 2005 and 2006 Virginia provided an income tax credit to encourage

the preservation and sustainability of its unique natural resources, wildlife

habitats, open spaces, and forested areas. For 2005 this Virginia tax credit was

equal to 50% of the “fair market value” of any land or interest in land in Virginia

donated to a public or private conservation agency eligible to hold such land and

interests therein for conservation or preservation purposes. The credit was

available to individuals and corporations for use on their Virginia income tax

returns. A partner in a passthrough entity that held Virginia tax credits could use

the credits on his or her own Virginia income tax returns either in proportion to his

or her interest in the entity or as set forth in the partnership agreement. Any

taxpayer holding Virginia tax credits could transfer or sell unused but otherwise

allowable credits to another taxpayer for use on his or her Virginia income tax

return. A Virginia tax credit, however, could be claimed by only one taxpayer on

his or her Virginia income tax return.

      The Virginia Department of Taxation (VDT) verified a taxpayer’s right to

claim Virginia tax credits on his or her Virginia income tax return by requiring
                                         -4-

[*4] that the credits be registered, among other things. In order to register the

Virginia tax credits, the donor of a conservation easement was required to submit a

completed Form LPC, Virginia Land Preservation Tax Credit Notification, and

supporting documentation to the VDT. Supporting documentation included (1) a

full copy of the qualified appraisal for the donated property, (2) a copy of the

recorded deed for charitable donation, and (3) an Internal Revenue Service (IRS)

Form 8283, Noncash Charitable Contributions, executed by the donee of the

donated property.

      While not prescribed by Virginia statute or regulation, the VDT required

procedurally that the Virginia taxpayer submit a Form LPC before he or she could

use any allocated or transferred tax credits on a Virginia income tax return.

Likewise, while not prescribed by Virginia statute or regulation, the VDT directed

donors and credit holders to submit the Form LPC and supporting documentation

within 90 days of the origination or transfer of the Virginia tax credits or at least

60 days before filing the annual Virginia income tax return claiming the credits.

      Section IV, Transfer Information, of the Form LPC contained spaces for

information relating to the transfer and the resulting transferee of all or any portion

of the Virginia tax credits, including the name of the transferee and the date of the

transfer. Section V, Declaration, Signature and Notarization, contained a space for
                                         -5-

[*5] the signature of the credit holder and was to be signed and notarized under

the penalties provided by law. Section VI, Credit Allocation Schedule, contained

spaces for information about each person receiving a credit from a passthrough

entity and for the amounts of the credits.

      Once the VDT received the Form LPC and supporting documentation, it

would review the submitted documents for compliance with applicable rules and

procedures. If this preliminary review suggested compliance, the VDT would

provide a tax credit acknowledgment letter. The credit acknowledgment letter

included a “credit transaction number”, the “effective year” for the tax credits--i.e.,

the first year for which they could be claimed--and the “expires tax year” for the

tax credits--i.e., the last year for which they could be claimed. The credit

acknowledgment letter stated: “A copy of this letter must be attached to your

[Virginia income tax] return to claim the credit. You will need the assigned credit

number if you wish to transfer this credit in the future.” If a taxpayer wished to

use his or her Virginia tax credits on a Virginia income tax return, the VDT

required that the taxpayer provide a copy of the credit acknowledgment letter.

      During the 2006 legislative session Virginia made several changes to the

statutory provisions applicable to the Virginia tax credit. These changes applied

only to conveyances of property made on or after January 1, 2007. On November
                                         -6-

[*6] 30, 2007, the Virginia tax commissioner released a summary of the changes

in the form of a ruling. The ruling explained that the VDT would “no longer

simply acknowledg[e] the Credit as has been done in the past” but would have to

“actually issue the Credit” for the Virginia tax credit to be valid.

Route 231

      In 2001 Raymond Humiston, a securities trader from Connecticut, moved

his family to a farming community in Albemarle, Virginia. In the farming

community there were two tracts of property named Castle Hill and Walnut

Mountain. Castle Hill consists of 1,203 acres, including a historic manor home

dating to 1764. Walnut Mountain consists of 345 acres.

      Mr. Humiston met petitioner, a businessman, in 2005. Petitioner owns two

farms and an apartment rental business, and he sits on the boards of several

materials companies. Petitioner and Mr. Humiston decided to acquire Castle Hill

and Walnut Mountain together.

      In May 2005 Mr. Humiston and petitioner formed Route 231, a Virginia

limited liability company. Petitioner and Mr. Humiston signed an initial operating

agreement for Route 231, effective May 3, 2005, in which they agreed to each
                                        -7-

[*7] make an original capital contribution of $2 million.2 The initial operating

agreement stated that petitioner and Mr. Humiston each owned a “percentage

interest” equal to 50% in Route 231. The initial operating agreement further

stated that the purpose of Route 231 was to “own, acquire, manage and operate”

certain real property not described in the initial operating agreement.

      In or around June 2005 Route 231 engaged Conservation Solutions to

provide consulting services regarding Route 231’s potential acquisition of Castle

Hill and Walnut Mountain, the initial management of those properties, the division

of those properties, and the placing of conservation easements on those properties.

At all relevant times Melton McGuire was the principal and owner of

Conservation Solutions. At a meeting on June 3, 2005, Mr. McGuire gave a

presentation to Route 231 about placing a conservation easement on Castle Hill;

the presentation discussed the tax benefits that could be derived from the

easement.

      On June 28, 2005, Route 231 purchased Castle Hill and Walnut Mountain

for $24 million. Route 231 financed the purchase with a loan from BB&T Bank

that was guaranteed personally by petitioner and Mr. Humiston. Walnut Mountain


      2
       Despite this agreement, the record reflects that petitioner and Mr. Humiston
actually made contributions of $2,300,000 each.
                                        -8-

[*8] was subdivided into 24 lots before Route 231 purchased it. On November 30,

2005, Route 231 sold 4 of the 24 lots to an individual for $2,200,000.

Donation of Conservation Easements

      On December 9, 2005, Route 231 obtained an appraisal report valuing a

conservation easement on Castle Hill (Castle Hill easement) at $8,849,240; a

conservation easement on Walnut Mountain (Walnut Mountain easement) at

$5,225,249; and a fee interest in Walnut Mountain subject to the Walnut Mountain

easement (Walnut Mountain fee interest) at $2,072,880. Route 231 obtained the

appraisal report in anticipation of making charitable contributions. The effective

date of the appraisal report was December 2, 2005.

      Effective December 30, 2005, Route 231 made three separate charitable

contributions of property: (1) a deed of gift of the Castle Hill easement to the

Nature Conservancy; (2) a deed of gift of the Walnut Mountain easement to the

Albemarle County Public Recreational Facilities Authority; and (3) a deed of gift

of the Walnut Mountain fee interest to the Nature Conservancy.

Virginia Conservation

      Virginia Conservation is a Virginia limited liability limited partnership that

was interested in acquiring Virginia tax credits. Virginia Conservation acquired

Virginia tax credits via partnership arrangements with landowners who placed
                                         -9-

[*9] conservation easements on property in Virginia. When dealing with other

partnership arrangements with landowners, Virginia Conservation generally

contributed $0.53 for each dollar of Virginia tax credits that the landowner

partnerships would allocate to it. Once Virginia Conservation received these

Virginia tax credits, it would allocate them to individual investors or to

Chesterfield Conservancy, Inc. (Chesterfield Conservancy), a nonstock

corporation that owned an interest in Virginia Conservation. Chesterfield

Conservancy would then sell the credits to other individuals or entities interested

in claiming Virginia tax credits on their Virginia income tax returns.

      In or around June 2005 Virginia Conservation began discussions with Route

231 regarding Virginia tax credits relating to the placement of conservation

easements on Castle Hill and Walnut Mountain.

      In July 2005 Route 231, through Mr. McGuire, and Virginia Conservation

discussed Virginia Conservation’s possible investment in Route 231 and Route

231’s allocation of Virginia tax credits from the Castle Hill easement and the

Walnut Mountain easement to Virginia Conservation. Sometime later in 2005

Virginia Conservation agreed to make a capital contribution to Route 231 based

on the Virginia tax credits Route 231 agreed to allocate to Virginia Conservation.
                                       - 10 -

[*10] The negotiations between Route 231 and Virginia Conservation during 2005

culminated in an amended and restated operating agreement admitting Virginia

Conservation as a member, three escrow agreements, and an option to purchase

agreement. These transaction documents were finalized and executed in

December 2005.

      On December 27, 2005, Virginia Conservation, Mr. Humiston, and

petitioner prepared and executed an amended and restated operating agreement of

Route 231 (first amended operating agreement) which admitted Virginia

Conservation as a partner in Route 231. The first amended operating agreement

included an attachment indicating that Virginia Conservation was deemed to have

made a $500 capital contribution to Route 231 on December 27, 2005. The first

amended operating agreement further stated:

      2.2 Fund Additional Capital Contribution. The Fund [Virginia
      Conservation], in accordance with a separate agreement between the
      parties, shall make an additional capital contribution to the Company
      [Route 231] in an amount equal to the product of $0.53 for each $1.00
      of Virginia Credits allocated to the Fund * * *.

      The first amended operating agreement provided for the allocation of items

of partnership profits and losses and for the distribution of net cashflow from

operations to the members in proportion to their “percentage interests” in Route

231. According to the first amended partnership agreement, petitioner’s
                                      - 11 -

[*11] percentage interest was 49.5%, Mr. Humiston’s percentage interest was

49.5%, and Virginia Conservation’s percentage interest was 1%.

      The first amended operating agreement also provided for the allocation of

Virginia tax credits, stating:

      3.6 Virginia Credits. Notwithstanding any other provision of this
      Agreement, Virginia Credits arising from the donation of the
      Easement and/or Conservation Deed in an amount anticipated to be in
      the range of $6,700,000 to $7,700,000 shall be allocated as follows:
      $300,000 of Virginia Credits to Carr [petitioner] and (ii) the balance
      to the Fund. Any additional Virginia Credits arising from the
      donation of the Easement and/or Conservation Deed shall be
      allocated among the Members [petitioner, Mr. Humiston, and
      Virginia Conservation] * * *.

The first amended operating agreement further stated:

      10.1 Representations and Warranties. The Company, Carr and
      Humiston represent and warrant to the Fund as follows:

            (a) The Virginia Credits will have been duly earned by the
      Company as a result of the Company’s donation of the Easement
      and/or Conservation Deed in accordance with Va. Code § 58.1-512
      on or before December 31, 2005.

             *         *         *       *        *         *        *

            (d) The Company will deliver to the Fund valid Virginia
      Department of Taxation (“VDT”) credit registration number(s) for the
      Virginia Credits.

             *         *         *       *        *         *        *
                                          - 12 -

         [*12] 10.2 Indemnification. If a claim is asserted against the
         Company or the Fund by VDT [Virginia Department of Taxation] or
         IRS that would have the effect of disallowing any or all of the
         Virginia Credits allocated to the Fund, the Company, Carr and
         Humiston shall have the option to defend such claim. Any such
         defense shall be limited solely to the issues of the disallowance of the
         Virginia Credits allocated to the Fund. If the Company, Carr and
         Humiston elect to not defend the claim, or upon a final, non-
         appealable decision resulting in a disallowance of any or all of the
         Virginia Credits allocated to the Fund, the Company, Carr and
         Humiston shall, jointly and severally, be liable to pay to the Fund in
         cash an amount equal to $0.53 for each $1.00 in value of such
         Virginia Credits disallowed.

         On December 27, 2005, Virginia Conservation, Mr. Humiston, and

petitioner also entered into an option to purchase (option agreement). The option

agreement allowed Mr. Humiston and petitioner the option to purchase all, but not

less than all, of Virginia Conservation’s membership interest in Route 231, on or

at any time after January 1, 2010. This option was still exercisable at the time of

trial.

         On December 28, 2005, Route 231 and Virginia Conservation signed three

escrow agreements relating to the Castle Hill easement, the Walnut Mountain

easement, and the Walnut Mountain fee interest. The Castle Hill easement escrow

agreement involved $2,154,015 of escrowed proceeds. The Walnut Mountain

easement escrow agreement involved $1,157,420 of escrowed proceeds. The

Walnut Mountain fee interest escrow agreement involved $504,565 of escrowed
                                        - 13 -

[*13] proceeds. The escrow agreements provided that the escrowed proceeds

would be held in a non-interest-bearing attorney trust account until the following

conditions of the escrow agreements were satisfied:

      A. The Landowner [Route 231] or the Fund [Virginia Conservation]
      has provided to the [trust] Agent:

            (i) the Credit Transaction Number with respect to the Credits
      issued by the Virginia Department of Taxation * * *; and

             (ii) a copy of * * * [the deed of gift] bearing recording
      information or a copy of the original recording receipt therefor with a
      copy of * * * [the deed of gift], which evidences that * * * [the deed
      of gift] has been duly record * * *; and

            (iii) an Owner’s Title Insurance Policy issued by Chicago Title
      Insurance Company * * * issued to the Landowner; and

      B. Agent has (i) provided all items in paragraph (A) above to Wm.
      Tracey Shaw * * * (‘Counsel to the Fund’) and (ii) received written
      instructions from Counsel to the Fund confirming the requirements of
      paragraph (A) above have been satisfied and authorizing the release
      of the Escrowed Proceeds to Landowner * * *.

The escrow agreements further stated:

            Upon receipt of the Credit Transaction Number, the Evidence
      of Recordation of * * * [the deed of gift], the New Owner’s Policy,
      and Disbursement Authorization from Counsel to the Fund, and only
      upon receipt of all of them, Agent shall release the Escrowed
      Proceeds to the Landowner. Until such time as disbursement is made
      pursuant to this Agreement, Agent shall take all reasonable measures
      to ensure the protection of the Escrowed Proceeds.

            *         *         *          *       *         *         *
                                        - 14 -

      [*14] Notwithstanding anything to the contrary herein, and in
      recognition of the fact that the Escrowed Funds may be delivered to
      Agent prior to the recordation of * * * [the deed gift] or the Fund’s
      admission as a member of the limited liability company designated
      above as Landowner, Agent shall immediately return the Escrow
      Proceeds, without deduction, to Fund if either (i) * * * [the deed of
      gift] is not recorded in the said Clerk’s Office on or before December
      31, 2005 or (ii) admission as a 1% member of the Fund is not made
      available to the Fund on or before December 31, 2005.

      On December 29, 2005, Virginia Conservation made two wire transfers,

totaling $3,816,000, to James Skeen, an attorney acting as the escrow agent.

Mr. Skeen prepared Federal income tax returns for Route 231 during the years at

issue. Mr. Skeen and his law firm also represented Conservation Solutions in the

transactions between Route 231 and Virginia Conservation. Mr. Skeen placed the

transfers into an attorney trust account.

      On December 31, 2005, petitioner received a letter from Mr. McGuire. In

the letter Mr. McGuire noted that Virginia Conservation “did not see proof of their

credits until 6:00 pm on December 30” and that the amount of credits Virginia

Conservation received was not sufficient to satisfy the amount of credits it had

expected to receive. According to Mr. McGuire, the final figures were $84,000

short. Mr. McGuire thanked petitioner for “permitting us to transfer some of your

surplus credits” to Virginia Conservation and promised to replace the $84,000 in

Virginia tax credits in 2006.
                                       - 15 -

[*15] On January 1, 2006, Virginia Conservation, Mr. Humiston, and petitioner

executed an amended and restated operating agreement of Route 231 (second

amended operating agreement). Section 2.2 of the second amended operating

agreement stated that Virginia Conservation “in accordance with a separate

agreement between the parties, has made an additional capital contribution to the

Company [Route 231] in an amount equal to * * * $0.53 for each $1.00 of

Virginia Credits allocated to” Virginia Conservation. Section 3.5 of the second

amended operating agreement stated: “Notwithstanding any other provision of

this Agreement, Virginia Credits arising from the donation of the Easement and/or

Conservation Deed have been allocated as follows: (i) $215,983.00 of Virginia

Credits to Carr and (ii) $7,200,000.00 of Virginia Credits” to Virginia

Conservation. Section 10.1(a) of the second amended operating agreement stated:

“The Virginia Credits have been duly earned by the Company as a result of the

Company’s donation of the Easement and/or Conservation Deed in accordance

with Va. Code § 58.1-512 on or before December 31, 2005.”

The Escrow Account

      On January 4, 2006, Route 231, via its attorney, George McCallum,

requested that Mr. Skeen deposit the $3,816,000 of escrowed funds in Mr. Skeen’s

attorney trust account to an interest-bearing account. Route 231 expressed
                                       - 16 -

[*16] concern that the VDT would take three or more weeks to provide credit

acknowledgment letters and that significant interest would be lost.

      On January 6, 2006, following Route 231’s request, Mr. Skeen opened an

interest-bearing money market account at BB&T Bank in Route 231’s name (care

of Mr. Skeen, as agent) and under Route 231’s employer identification number.

He transferred the $3,816,000 of escrowed funds in his attorney trust account to

the interest-bearing account. Mr. Skeen was the only signatory on the interest-

bearing account.

      Virginia Conservation did not authorize this transfer and was not notified

about it until after it had occurred. On January 10, 2006, Mr. Skeen asked whether

Virginia Conservation would consent to depositing the escrowed funds into the

interest-bearing account.

      From January 10 through 19, 2006, Mr. Skeen, Route 231 via Mr.

McCallum, and Virginia Conservation via its attorney Wm. Tracey Shaw

exchanged emails addressing their concerns regarding the interest-bearing

account; the risk of loss if the escrowed funds declined in value while in the

account; and whether Route 231 or Virginia Conservation would be entitled to the

interest on the escrowed funds. In particular, Mr. Skeen expressed concern that if

Virginia Conservation owned the escrowed funds while interest was being earned,
                                        - 17 -

[*17] then questions might arise relating to “whether we can show, on the

partnership tax return [for Route 231] that * * * [Virginia Conservation] made its

contribution of capital during 2005.”

      The parties concluded that if the conditions of the escrow were satisfied,

then the interest earned on the escrowed funds would be released to Route 231;

otherwise, the interest earned would be paid to Virginia Conservation. The parties

also concluded that Route 231 would bear the risk of loss for the escrowed funds

and that it would not require Virginia Conservation to make any additional capital

contributions in the event that the escrowed funds in the interest-bearing account

declined in value.

      On January 18, 2006, Virginia Conservation gave Mr. Skeen its approval to

invest the escrowed funds in the interest-bearing account. On January 19, 2006,

Virginia Conservation confirmed that Route 231 would be entitled to keep the

interest earned on the funds in the interest-bearing account in the event that the

conditions of the escrow were satisfied.

LPC Forms for Route 231

      On or before December 21, 2005, Mr. Skeen began working on the Forms

LPC for the three Route 231 donations. On January 20, 2006, Mr. Skeen

submitted three Forms LPC, one for each donation, to the VDT. Mr. Skeen
                                       - 18 -

[*18] enclosed copies of the appraisals with the Forms LPC. The Forms LPC

reported credit values of $4,064,180 for the Castle Hill easement; $2,399,794 for

the Walnut Mountain easement; and $952,009 for the Walnut Mountain fee

interest. On the Form LPC for the Castle Hill easement Mr. Skeen listed Virginia

Conservation under “Credit Holder Information” with Virginia tax credits of

$4,064,180. On the Form LPC for the Walnut Mountain easement Mr. Skeen

listed Virginia Conservation and petitioner under “Credit Holder Information”

with Virginia tax credits of $2,183,811 and $215,983, respectively. On the Form

LPC for the Walnut Mountain fee interest Mr. Skeen listed Virginia Conservation

under “Credit Holder Information” with Virginia tax credits of $952,009. The

VDT received the Forms LPC on January 27, 2006.

      Route 231 received Credit Acknowledgment Letters dated March 27, 2006,

from the VDT with respect to its three donations. These letters listed a credit

transaction number for the Virginia tax credits, an effective year of 2005, and an

expiration tax year of 2010.

      On March 30, 2006, after Virginia Conservation received copies of credit

acknowledgment letters addressed to it regarding the Route 231 donations,

Mr. Skeen released the escrowed funds and accrued interest from the interest-

bearing account.
                                       - 19 -

[*19] Route 231’s Tax Returns

      Route 231 filed a timely Form 1065, U.S. Return of Partnership Income, for

tax year 2005, reporting that it had made noncash charitable contributions of

$14,831,967. Route 231 also reported that it used the accrual method of

accounting. Under Schedule L, Balance Sheet per Books, Route 231 reported cash

of $4,166,236. Under Schedule M-2, Analysis of Partners’ Capital Accounts,

Route 231 reported capital contributed in cash of $8,416,000. Route 231 reported

an aggregate balance in the partners’ capital accounts of -$8,165,136. On a

Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., Route 231

reported $2,300,000 of capital contributed during 2005 and a capital account of

-$5,916,408 for petitioner; $2,300,000 of capital contributed during 2005 and a

capital account of -$5,916,408 for Mr. Humiston; and $3,816,000 of capital

contributed during 2005 and a capital account of $3,667,680 for Virginia

Conservation.

      On April 12, 2006, Route 231 filed a Virginia Form 502, Pass-Through

Entity Return of Income, with the VDT for tax year 2005. On the Form 502 Route

231 reported $7,415,983 under “Land Preservation Tax Credit”. On a Schedule

VK-1, Owners Share of Income and Virginia Modifications and Credits, for

Virginia Conservation filed with the Form 502, Route 231 reported $7,200,000
                                       - 20 -

[*20] under “Land Preservation Tax Credit”. On a Schedule VK-1 for petitioner,

Route 231 reported $215,983 under “Land Preservation Tax Credit.”

      Route 231 also filed timely its Form 1065 for tax year 2006 and reported no

charitable contributions. On a Schedule K-1 for Virginia Conservation filed with

its Form 1065, Route 231 reported that Virginia Conservation’s share of Route

231’s profit, loss, and capital was 1% at the end of 2006. Route 231 reported that

it used the accrual method of accounting.

Use of the Virginia Tax Credits

      Route 231 allocated $215,983 in Virginia tax credits to petitioner, who

claimed them up to the allowable $100,000 annual limitation on his 2005 Virginia

income tax return. Route 231 allocated the remaining $7,200,000 in Virginia tax

credits to Virginia Conservation. Virginia Conservation allocated its Virginia tax

credits to Chesterfield Conservancy.

FPAA for 2005

      On March 17, 2010, respondent issued the FPAA for Route 231’s tax year

2005, determining that Route 231 had incurred, but failed to report, ordinary

income of $3,816,000 from the “[s]ale of Virginia Conservation Easement Tax

Credits”. The FPAA stated that the $3,816,000 Route 231 received from Virginia

Conservation for Virginia tax credits was income to Route 231 because (1) the
                                       - 21 -

[*21] credits were income derived from business under section 61(a)(2); (2) they

were property taxable under section 61(a)(3) as ordinary income and not capital

assets under section 1221; or (3) alternatively, they were property under section

1221 but taxable only as short-term capital gain. In response, petitioner filed the

petition.

Route 231 Today

      Route 231 and petitioner operate a working farm on the Castle Hill

property. Route 231 maintains a winery business, a commercial orchard, and an

event space. Petitioner and Virginia Conservation are still partners in Route 231.

                                     OPINION

I.    Burden of Proof

      Generally, the Commissioner’s adjustments in an FPAA are presumed

correct, and the taxpayer bears the burden of proving those adjustments are

erroneous. Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933); see

also Republic Plaza Props. P’ship v. Commissioner, 107 T.C. 94, 104 (1996)

(“Petitioner bears the burden of proving respondent’s determinations in the FPAA

are erroneous.”); Clovis I v. Commissioner, 88 T.C. 980, 982 (1987) (holding that

an FPAA is the functional equivalent of a notice of deficiency). The burden of

proof may shift to the Commissioner when the Commissioner’s position implicates
                                        - 22 -

[*22] a “new matter” not in the FPAA. See Rule 142(a)(1); Graev v.

Commissioner, 140 T.C. __ , __ (slip op. at 5 n.3) (June 24, 2013). Petitioner

contends that respondent has raised a new matter not in the FPAAs.

      In the FPAA for 2005 respondent determined that Route 231 sold the tax

credits to Virginia Conservation and, therefore, the sale proceeds were includible

as ordinary income under section 61(a)(2) as income derived from a business. In

the alternative, respondent determined that the credits were property taxable under

section 61(a)(3) as gains derived from dealings in property as ordinary income or

as short-term capital gain under section 1222. In the amended answer, however,

respondent stated: “[I]n support of respondent’s determination that petitioner

received taxable proceeds in 2005 from the sale of Virginia state land preservation

credits, respondent alleges that the ‘capital contributions’ from Virginia

Conservation constituted ordinary income from a disguised sale under the

provisions of I.R.C. § 707.” Respondent contends that no new matter was invoked

because “the underlying theory of a sale of credits did not change as a result of

respondent’s contention that the ‘sale’ was a ‘disguised sale’ under I.R.C. § 707”.

      The burden of proof is relevant only when there is equal evidence on both

sides: “In a case where the standard of proof is preponderance of the evidence and

the preponderance of the evidence favors one party, we may decide the case on the
                                       - 23 -

[*23] weight of the evidence and not on an allocation of the burden of proof.”

Knudsen v. Commissioner, 131 T.C. 185, 189 (2008). We do not believe that the

burden of proof affects the resolution in this case, since the preponderance of the

evidence resolves this issue no matter which party has the burden. See Graev v.

Commissioner, 140 T.C. at __ (slip op. at 26 n.8); Dagres v. Commissioner, 136

T.C. 263, 279 (2011). Consequently, we need not determine whether respondent

has invoked a new matter not in the FPAAs.3

II.   Evidentiary Issues

      Petitioner raises relevancy objections as to paragraphs 250, 251, 252, 254,

255, 256, 257, 276, and 27 of the stipulation of facts. These paragraphs refer to

subsequent allocations and transfers of the Virginia tax credits. Petitioner also

raised relevancy objections to Exhibits 100-R, 101-R, 102-R, 103-R, 104-R, 105-

R, 107-R, 108-R, 117-R, and 118-R. These exhibits refer to subsequent transfers

of the Virginia tax credits.




      3
       Because respondent did not make any argument at trial or on brief that the
money Route 231 received was income because the credits were income derived
from business under sec. 61(a)(2) and property taxable as ordinary income under
sec. 61(a)(3), or, alternatively, that the credits were property under sec. 1221 and
taxable as short-term capital gain, respondent is deemed to have abandoned those
positions. See Mendes v. Commissioner, 121 T.C. 308, 312-313 (2003) (“If an
argument is not pursued on brief, we may conclude that it has been abandoned.”).
                                         - 24 -

[*24] Rule 401 of the Federal Rules of Evidence defines relevant evidence as

evidence having “any tendency to make a fact more or less probable than it would

be without the evidence; and * * * the fact is of consequence in determining the

action.” The Court of Appeals for the Fourth Circuit has stated that

“transferability, although not essential, is * * * a relevant factor” as to whether tax

credits are property. Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639

F.3d 129, 141 (4th Cir. 2011) (citing Drye v. United States, 528 U.S. 49, 60 n.7

(1999)), rev’g and remanding T.C. Memo. 2009-295. The transfer of Virginia tax

credits to Virginia Conservation and the subsequent transfers to Chesterfield

Conservancy and individual investors are related to whether the Virginia tax

credits in issue constitute property. Thus, the paragraphs in the stipulation of facts

and the exhibits to which petitioner objects are all relevant.

      Petitioner further raises hearsay objections to Exhibits 100-R, 101-R, and

117-R. These exhibits are Forms LPC that Virginia Conservation signed under the

penalties provided by law, notarized, and filed with the VDT. These exhibits are

admissible under the business records exception pursuant to rule 803(6) of the

Federal Rules of Evidence. At trial David Gecker, who owned an interest in

Virginia Conservation, and Beth Llewellyn, the accountant Virginia Conservation

hired to fill out the Forms LPC, testified credibly that (a) the Forms LPC were
                                           - 25 -

[*25] “made at or near the time” the transaction, occurred by Ms. Llewellyn, who

was familiar with Virginia Conservation; (b) the Forms LPC were kept in the

course of Virginia Conservation’s ordinary business; and (c) making Forms LPC

was a regular practice of that activity.

III.   Disguised Sale

       Respondent contends that Route 231 sold Virginia tax credits to Virginia

Conservation in exchange for cash and therefore engaged in a disguised sale under

section 707. Petitioner contends that Virginia Conservation made a capital

contribution of cash and then Route 231 allocated Virginia tax credits to it. In

particular petitioner claims that there was no transfer of property for purposes of

section 707 because (1) the credits were never “property” and (2) the credits were

allocated rather than transferred.

       A.       Statutory Framework

       Partnerships are considered passthrough entities. They are not subject to the

income tax at the entity level. Sec. 701. Rather, “[t]he partnership acts as a

conduit, through which its various items of income and loss flow to the individual

partners”. Laura E. Cunningham & Noël B. Cunningham, The Logic of

Subchapter K: A Conceptual Guide to the Taxation of Partnerships 1 (4th ed.

2011). In determining his or her income tax, each partner must include separately
                                        - 26 -

[*26] his or her distributive share of the partnership’s taxable income or loss,

among other things. Sec. 702(a)(8). As a general rule, a partner’s distributive

share of income, gain, loss, deduction, or credit is determined by the partnership

agreement. Sec. 704(a).

      The Code provides generally that partners may contribute capital to a

partnership tax free and may receive a tax-free return of previously taxed profits

through distributions except to the extent the distribution exceeds adjusted basis.

See secs. 721, 731. These nonrecognition rules, however, do not apply to a

transaction between a partnership and a partner not acting in his or her capacity as

a partner. Sec. 1.721-1(a), Income Tax Regs.; see sec. 707(a)(1). One such

transaction, commonly referred to as a disguised sale, is governed by section 707.

      Section 707(a) provides, in pertinent part:

             SEC. 707(a). Partner Not Acting in Capacity as Partner.--

                    (1) In general.--If a partner engages in a transaction with
             a partnership other than in his capacity as a member of such
             partnership, the transaction shall, except as otherwise provided
             in this section, be considered as occurring between the
             partnership and one who is not a partner.

Section 707(a)(2)(B) provides that a disguised sale occurs (1) when a partner

directly or indirectly transfers money or property to a partnership, (2) when there

is a related direct or indirect transfer of money or other property by the partnership
                                        - 27 -

[*27] to such partner, and (3) when viewed together, the transfers are properly

characterized as a sale or exchange of property. In all cases the substance of the

transaction governs rather than its form. Sec. 1.707-1(a), Income Tax Regs.

      Section 707 applies even if it is determined after the application of the rules

that the purported partner is not a partner. Sec. 1.707-3(a)(3), Income Tax Regs.;

see also sec. 1.707-6(a), Income Tax Regs.4 Therefore, the status of a continuing

partner-partnership relationship does not govern our decision in this case.

      Section 707 “prevents use of the partnership provisions to render nontaxable

what would in substance have been a taxable exchange if it had not been ‘run

through’ the partnership.” Otey v. Commissioner, 70 T.C. 312, 317 (1978), aff’d,

634 F.2d 1046 (6th Cir. 1980). Congress enacted section 707(a)(2)(B) because it

was “concerned that individuals have deferred or avoided tax on sales of property

      4
        Sec. 1.707-3, Income Tax Regs., expressly applies to situations in which
the partner transfers property to the partnership, and the partnership transfers
money or other consideration to the partner--i.e., the opposite of what occurred in
this case. Sec. 1.707-6(a), Income Tax Regs., however, notes that rules similar to
those in sec. 1.707-3, Income Tax Regs., apply to the situation at hand, in which
the partner transfers money to the partnership and the partnership transfers
property to the partner. It is therefore appropriate to apply the rules provided in
sec. 1.707-3, Income Tax Regs., to this case. See also Va. Historic Tax Credit
Fund 2001 LP v. Commissioner, 639 F.3d 129, 139 (4th Cir. 2011) (applying the
rules in sec. 1.707-3(b)(1), Income Tax Regs., to a situation described in sec.
1.707-6(a), Income Tax Regs., in which a partner transferred money to the
partnership in exchange for Virginia rehabilitation historic tax credits), rev’g and
remanding T.C. Memo. 2009-295.
                                        - 28 -

[*28] by characterizing sales as contributions of property followed (or preceded)

by a related tax-free partnership distribution”, especially given that “court

decisions have allowed tax-free treatment in cases which are economically

indistinguishable from sales of property to a partnership.” H.R. Rept. No. 98-432

(Part 2), at 1218 (1984), 1984 U.S.C.C.A.N. 697, 884; see also S. Prt. No. 98-169

(Vol. I), at 225 (1984). Congress “believe[d] that these transactions should be

treated for tax purposes in a manner consistent with their underlying economic

substance.” H.R. Rept. No. 98-432 (Part 2), supra at 1218, 1984 U.S.C.C.A.N. at

884; see also S. Prt. No. 98-169 (Vol. I), supra at 225.

         Section 1.707-3(b)(1), Income Tax Regs., clarifies which partnership

transfers should be characterized properly as a sale or exchange of property under

section 707(a)(2)(B)(iii). Pursuant to section 1.707-3(b)(1), Income Tax Regs., a

disguised sale has occurred only if, on all the facts and circumstances, (1) the

transfer of money or other consideration would not have been made but for the

transfer of property and (2) in cases in which the transfers are not made

simultaneously, the subsequent transfer is not dependent on the entrepreneurial

risks.

         Section 1.707-3(b)(2), Income Tax Regs., provides a nonexhaustive list of

10 facts and circumstances that “may tend to prove the existence of a sale” under
                                        - 29 -

[*29] section 1.707-3(b)(1), Income Tax Regs. The following six facts and

circumstances are relevant in this case:

             (i) That the timing and amount of a subsequent transfer are
      determinable with reasonable certainty at the time of an earlier
      transfer;

            (ii) That the transferor has a legally enforceable right to the
      subsequent transfer;

             (iii) That the partner’s right to receive the transfer of money or
      other consideration is secured in any manner, taking into account the
      period during which it is secured;

      *         *         *         *            *      *         *

             (v) That any person has loaned or has agreed to loan the
      partnership the money or other consideration required to enable the
      partnership to make the transfer, taking into account whether any
      such lending obligation is subject to contingencies related to the
      results of partnership operations;

      *         *         *         *            *      *         *

            (ix) That the transfer of money or other consideration by the
      partnership to the partner is disproportionately large in relationship to
      the partner’s general and continuing interest in partnership profits;
      and

           (x) That the partner has no obligation to return or repay the
      money or other consideration to the partnership * * *.[5]

      5
      The additional factors in sec. 1.707-3(b)(2)(iv), (vi), (vii), and (viii),
Income Tax Regs., include (iv) whether any person made or was legally obligated
to make a contribution to the partnership so that it could complete the transfer; (vi)
                                                                  (continued...)
                                         - 30 -

[*30] Sec. 1.707-3(b)(2), Income Tax Regs. The weight we give to each factor

depends on the particular case. Id.

      Finally, section 1.707-3(c)(1), Income Tax Regs., provides that transfers

made between a partnership and a partner within a two-year period are “presumed

to be a sale of the property to the partnership unless the facts and circumstances

clearly establish that the transfers do not constitute a sale.” We consider the facts

and circumstances in this case to determine whether the transfers are presumed to

be a sale.




      5
         (...continued)
whether the partnership incurred or was obligated to incur debt to acquire the
money or the consideration to complete the transfer; (vii) the amount of liquid
partnership assets that were expected to be available to make the transfer; and
(viii) whether the transfers were structured “to effect an exchange of the burdens
and benefits of ownership of property.” These factors are not relevant in this case.
See also Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at 139
(noting that factors (iv), (vi), (vii), and (viii) were not relevant in that case).
Factor (iv) is irrelevant because petitioner lent Route 231 the extra Virginia tax
credits it needed to complete the transfer. Factor (vi) is irrelevant because Route
231 did not need to incur debt to obtain the Virginia tax credits necessary to make
the transfer; rather, Route 231 needed only to submit the Forms LPC. Factor (vii)
is irrelevant because Route 231 was not engaged in a business at the time of the
transfers. Finally, factor (viii) is irrelevant because the transfer of the Virginia tax
credits was a one-time transfer and did not implicate general partnership
distributions, allocations, or control of partnership operations.
                                        - 31 -

[*31] B.     Va. Historic Tax Credit Fund 2001 LP v. Commissioner

      Respondent’s claim that Route 231 and Virginia Conservation engaged in a

disguised sale relies on the reasoning and holding of the Court of Appeals for the

Fourth Circuit in Va. Historic Tax Credit Fund 2001 LP (Va. Historic). We follow

a decision of the Court of Appeals to which an appeal from our disposition of a

case lies so long as that decision is squarely on point and reversal upon appeal is

inevitable. See Golsen v. Commissioner, 54 T.C. 742 (1970), aff’d, 445 F.2d 985

(10th Cir. 1971); see also Lardas v. Commissioner, 99 T.C. 490, 494-495 (1992).

The case at hand is appealable to the Court of Appeals for the Fourth Circuit. For

the reasons discussed below, we find that Va. Historic is squarely on point.

      The facts in Va. Historic are similar to those in this case. Three individuals

set up a web of partnerships (funds) in order to pass Virginia historic rehabilitation

tax credits to investors. One fund was the “source partnership” that partnered with

historic developers. The source partnership fund became a 0.01% limited partner

in selected historic property development partnerships and provided capital to

those partnerships in exchange for Virginia historic rehabilitation tax credits. The

source partnership fund invested only in completed historic rehabilitation projects.

The funds solicited investors who were willing to contribute capital in exchange

for the allocation of Virginia historic rehabilitation tax credits. The funds
                                        - 32 -

[*32] promised that each investor would receive $1 in Virginia historic

rehabilitation tax credits for every $0.74 to $0.80 contributed. The funds also

promised that each investor would receive a very small partnership interest in the

funds, although the funds cautioned that the investors should not expect to receive

any material amounts of partnership income or loss. If the promised tax credits

could not be obtained, the funds agreed to refund the investor’s capital, net of

expenses.

      The Commissioner determined, among other things, that the transactions

between the investors and the funds were disguised sales under section 707. The

Court of Appeals agreed with the Commissioner.

      As a preliminary matter, the Court of Appeals rejected the funds’ argument

that no transfer of property had occurred between the funds and their investors.

The Court of Appeals also rejected the funds’ argument that the credits were not

transferred but rather allocated to the investors because the investors were acting

in their capacity as partners.

      The Court of Appeals then examined whether the funds engaged in a

disguised sale under section 707, considering the presumption of sale under

section 1.707-3(c), Income Tax Regs., in the light of the factors enumerated in
                                        - 33 -

[*33] section 1.707-3(b)(i)-(iii), (ix), and (x), Income Tax Regs.6 Va. Historic Tax

Credit Fund 2001 LP v. Commissioner, 639 F.3d at 143. The Court of Appeals

concluded its discussion by examining the requirements in section 1.707-3(b)(1),

Income Tax Regs. The Court of Appeals noted that the “but for” test was

satisfied, finding that the only risk the investors faced was that of an “advance

purchaser who pays for an item with a promise of later delivery.” Va. Historic Tax

Credit Fund 2001 LP v. Commissioner, 639 F.3d at 145.

      There are some factual differences between Va. Historic and the case at

hand. The Virginia tax credits in Va. Historic were nontransferable historic

rehabilitation tax credits provided to Virginia taxpayers who rehabilitated a

historic property, whereas the transferable Virginia tax credits in this case are

provided to Virginia taxpayers who donate land interests for conservation or

preservation purposes. The Virginia historic rehabilitation tax credits were

allowed for up to 25% of eligible expenses, whereas the Virginia tax credits in this

case are allowed for up to 50% of the fair market value of the donated land or

interest in land. This distinction may contribute to the difference between the


      6
        The Court of Appeals did not analyze the other five factors enumerated in
sec. 1.707-3(b), Income Tax Regs., on the ground that they were not relevant in
the context of Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d
at 144 n.19.
                                        - 34 -

[*34] dollar-to-tax-credit contribution ratios used in the two cases. The investors

in Va. Historic contributed $0.74 to $0.80 for every $1 of tax credits they received,

while Virginia Conservation contributed $0.53 for every $1 of tax credits it

received.

      The partnership structures in Va. Historic and the case at hand are also

different. Va. Historic involved a complex web of partnerships with hundreds of

investors, most of whom received a 0.01% partnership interest in the funds, while

Route 231 is a stand-alone partnership with three partners, including Virginia

Conservation, which received a 1% interest in Route 231. Unlike the investors in

Va. Historic, who were partners in the funds for approximately five or six months,

Virginia Conservation is still a partner in Route 231. Moreover, the

Commissioner argued in Va. Historic that the investors were not valid partners,

whereas respondent does not question whether Virginia Conservation was a valid

partner.

      In an attempt to distinguish it from the funds in Va. Historic, petitioner

stresses that Route 231 was a valid partnership, writing: “Unlike Virginia

Historic, this was not a case of ‘grab the tax credits and run’.” Petitioner’s claim

is misguided. Respondent does not challenge that Route 231 was a valid

partnership.
                                          - 35 -

[*35] These differences, however, do not detract from the compelling similarities

between Va. Historic and the case at hand. When we consider the controlling facts

in this case, we find that Va. Historic is squarely on point with respect to

determining whether Route 231 engaged in a disguised sale. The investors in Va.

Historic contributed money to the funds’ capital account; in return the funds gave

them a small partnership interest and promised to provide them with a fixed

amount of Virginia historic rehabilitation tax credits. In this case Virginia

Conservation contributed money to Route 231; in return Route 231 gave Virginia

Conservation a 1% partnership interest and promised to provide a fixed ratio of

money to Virginia tax credits. Moreover, the Court of Appeals decided many of

the same types of issues implicated in this case: (1) whether contributions were

disguised sales under section 707, taking into account the requirements in section

1.707-3(b)(1) and (2), Income Tax Regs., and the presumption of sale provided by

section 1.707-3(c), Income Tax Regs.; (2) whether Virginia tax credits constituted

property for purposes of section 707; and (3) whether Virginia tax credits were

transferred or “allocated” for purposes of section 707. Because of these

similarities, under the Golsen rule we follow the decision of the Court of Appeals

for the Fourth Circuit in Va. Historic.
                                        - 36 -

[*36] C.     Analysis

      All relevant actions regarding the transfers between Route 231 and Virginia

Conservation took place well within a two-year period. Therefore, we presume

that the transfers were a sale. See sec. 1.707-3(b)(2), Income Tax Regs.

             1.    Whether There Was a Valid Transfer of Property

      Neither party disputes that Virginia Conservation transferred money to

Route 231 for purposes of section 707(a)(2)(B)(i). Petitioner, however, claims

that Route 231 did not transfer property to Virginia Conservation for purposes of

section 707(a)(2)(B)(ii) because the Virginia tax credits “retained their character

as potential reduction of taxes”.

      The Court of Appeals for the Fourth Circuit directly addressed this issue in

Va. Historic. The Court of Appeals explained that the determination of whether

something is property is a hybrid Federal and State law question. Referring to the

common idiom of property as a “bundle of sticks”, the Court of Appeals noted that

State law determines which sticks are in a taxpayer’s bundle of sticks, while

Federal tax law determines whether those sticks qualify as “property” for tax law

purposes. Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at

140 (citing United States v. Craft, 535 U.S. 274, 278-279 (2002)). The Court of

Appeals determined that the Virginia historic rehabilitation tax credits were
                                        - 37 -

[*37] property for the purposes of being transferable under section 707 because

they were “both ‘valuable’ and imbued with ‘some of the most essential property

rights’.” Id. at 141 (quoting Craft, 535 U.S. at 283). The Court of Appeals noted

that the funds used the credits to induce contributions of money and that the funds

exercised proprietary control over the credits because they could “exclude others

from utilizing the credits and were free to keep or pass along the credits to partners

as they saw fit.” Id.

      Like the funds in Va. Historic, Route 231 used the promise of Virginia tax

credits to induce Virginia Conservation to make a contribution of money. Route

231 likewise exercised proprietary control over the Virginia tax credits once it

received them. The Virginia tax credits were both valuable and imbued with

essential property rights. They are property for purposes of section 707. See also

Tempel v. Commissioner, 136 T.C. 341, 354 (2011) (finding that Colorado tax

credits created “cognizable property rights in those credits for the recipients of

those credits”).

      Petitioner further claims that the Virginia tax credits were “allocated and not

transferred as part of a distribution to Virginia Conservation.” The Court of

Appeals rejected the same type of claim in Va. Historic, concluding:
                                        - 38 -

      [*38] [T]his argument is tautological: the test developed in I.R.C. §
      707 and Treas. Reg. § 1.707-3 is designed to evaluate whether
      partners are acting in their partnership capacity when “allocating”
      property. Thus, the only way we can determine whether the Funds
      and their investors were acting in their capacity as partners during
      these transactions is to consider the “facts and circumstances” of the
      transactions as instructed by I.R.C. § 707 and Treas. Reg. § 1.707-3.

Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at 140 n.13.

Consequently, we find that Route 231 transferred property to Virginia

Conservation for purposes of section 707(a)(2)(B)(ii).

             2.    Section 1.707-3(b)(1), Income Tax Regs.

      To determine whether the transfers between Route 231 and Virginia

Conservation are properly characterized as a sale or exchange of property pursuant

to section 707(a)(2)(B)(iii), we must determine (i) whether Route 231 would not

have transferred $7,200,000 in Virginia tax credits to Virginia Conservation but

for the fact that Virginia Conservation transferred $3,816,000 to it; and (ii) if we

do not consider the transfers simultaneous, whether Route 231’s transfer was not

dependent on its entrepreneurial risks. See sec. 1.707-3(b)(1), Income Tax Regs.

We note that petitioner’s contention that Route 231 is a valid partnership, though

undisputed, has no bearing on our analysis of a disguised sale. Likewise, the

validity of a partner-partnership relationship does not matter for purposes of

section 707. See sec. 1.707-3(a)(3), Income Tax Regs.
                                        - 39 -

[*39]               a.     The “But for” Test

        The parties expressly linked the amount of Virginia tax credits that Virginia

Conservation received to the amount of money it transferred to Route 231. Under

the terms of the first amended operating agreement Virginia Conservation

promised to make a contribution equal to $0.53 for each $1 of Virginia tax credit

allocated, and Route 231 agreed to allocate between $6,700,000 and $7,700,000 of

Virginia tax credits to Virginia Conservation. Route 231 further promised

Virginia Conservation the lion’s share of the Virginia tax credits, allocating

$300,000 to petitioner, who held a 49.5% interest in Route 231, and the remaining

tax credits to Virginia Conservation, which held only a 1% interest in Route 231.

        Route 231 would not have transferred $7,200,000 of Virginia tax credits to

Virginia Conservation but for the fact that Virginia Conservation had transferred

$3,816,000 to it. We note that Route 231, petitioner, and Mr. Humiston promised

to indemnify Virginia Conservation fully for any Virginia tax credits disallowed

by the VDT or the IRS. Petitioner also guaranteed implicitly that Virginia

Conservation would receive the number of credits it expected to receive: When

the final figures showed that Virginia Conservation was short $84,000 of Virginia

tax credits, petitioner transferred $84,000 of his Virginia tax credits to make up the

difference.
                                        - 40 -

[*40] We thus find that the “but for” test in section 1.707-3(b)(1)(i), Income Tax

Regs., was satisfied. This finding is consistent with the finding in Va. Historic.

As in the case at hand, the funds in Va. Historic promised (1) to provide each

investor $1 in Virginia tax credits for every $0.74 to $0.80 contributed and (2) to

refund the investor if the credits could not be obtained. The Court of Appeals

found that there was “no dispute” that the “but for” test was satisfied. Va. Historic

Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at 145.

                    b.    Entrepreneurial Risks

      Respondent contends that the transfers of cash and credits occurred

simultaneously. Regardless of whether the transfers were simultaneous, we find

that the transfer of credits did not depend on any entrepreneurial risks of Route

231’s operations. Entrepreneurial risk is the “risk of the entrepreneur who puts

money into a venture with the hope that it might grow in amount but with the

knowledge that it may well shrink.” Id. at 145-146 (citing Commissioner v.

Tower, 327 U.S. 280, 287 (1946)).

      The amount of credits Virginia Conservation received was based entirely on

a fixed rate of return ($1 of Virginia tax credit for every $0.53 contributed) rather

than on a share of partnership profits tied to Route 231’s operations. Indeed, there

is no indication in the record that Virginia Conservation even considered Route
                                        - 41 -

[*41] 231’s operations before it agreed to contribute a substantial amount of

money. Moreover, Virginia Conservation was shielded from losing its

contribution because of the indemnity clause and because petitioner provided

$84,000 of Virginia tax credits to Virginia Conservation so that it would not

receive fewer credits than it had anticipated.

      Thus, the transfer of credits did not depend on any entrepreneurial risks.

This finding is also consistent with the finding in Va. Historic, in which the Court

of Appeals held that the investors did not face any true entrepreneurial risk

because (1) there was a fixed rate of return on investment instead of any share in

partnership profits tied to the investor’s partnership interests and (2) the investors

were secured against losing their contributions because the funds promised a

refund if the credits could not be delivered or were revoked, among other things.

Id. at 145.

              3.    Facts and Circumstances Test

      The facts and circumstances test in section 1.707-3(b)(2), Income Tax

Regs., confirms that the transfers between Route 231 and Virginia Conservation

were a disguised sale under section 707(a)(2)(B).

      The first relevant factor is whether the timing and amount of the sale were

determinable with reasonable certainty at the time of Virginia Conservation’s
                                        - 42 -

[*42] transfer. See sec. 1.707-3(b)(2)(i), Income Tax Regs. Virginia

Conservation transferred $3,816,000 to Route 231 via an escrow agent, with the

understanding that it would receive $1 of Virginia tax credits for every $0.53 it

transferred. Route 231 further promised that Virginia tax credits would be earned

on or before December 31, 2005. This factor weighs in favor of a disguised sale.

See Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at 143.

      The second relevant factor is whether Virginia Conservation had a legally

enforceable right to receive the Virginia tax credits. See sec. 1.707-3(b)(2)(ii),

Income Tax Regs. Under the first amended operating agreement Route 231

promised to provide between $6,700,000 and $7,700,000 of Virginia tax credits.

Route 231, petitioner, and Mr. Humiston also promised to refund the amount of

any tax credits disallowed by the VDT or the IRS. The second amended operating

agreement further states that Route 231 allocated $7,200,000 of Virginia tax

credits to Virginia Conservation. Had Route 231 failed to deliver the tax credits,

Virginia Conservation could have pursued a breach of contract claim against it.

See Va. Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at 143.

This factor weighs in favor of a disguised sale.

      The third relevant factor is whether Virginia Conservation’s right to receive

the tax credits was secured in any manner. See sec. 1.707-3(b)(2)(iii), Income Tax
                                        - 43 -

[*43] Regs. We note that the Court of Appeals in Va. Historic defined “secured”

broadly, holding that the investors’ rights were secured because, among other

things, the funds promised to refund investor capital if sufficient credits could not

be obtained or were revoked. Va. Historic Tax Credit Fund 2001 LP v.

Commissioner, 639 F.3d at 143. In the first amended operating agreement Route

231 committed to providing a certain amount of tax credits within a particular

range to Virginia Conservation. Route 231 further committed to earning the

Virginia tax credits on or before December 31, 2005. Route 231, petitioner, and

Mr. Humiston also guaranteed that Virginia Conservation would receive a refund

if the tax credits were disallowed. See id. Finally, we note that when it seemed

that Virginia Conservation would receive fewer tax credits than anticipated,

petitioner gave some of his Virginia tax credits to Virginia Conservation to make

up the difference. The guaranty and petitioner’s accommodation both show that

Virginia Conservation’s right to receive the tax credits was secured. This factor

weighs in favor of a disguised sale.

      The fourth relevant factor is whether any person lent or agreed to lend

Route 231 money or other consideration required to enable Route 231 to make the

transfer. See sec. 1.707-3(b)(2)(v), Income Tax Regs. On December 31, 2005,

Mr. McGuire, who was providing consulting services to Route 231, informed
                                        - 44 -

[*44] petitioner that Virginia Conservation did not receive enough tax credits to

satisfy the number of credits. He thanked petitioner for “permitting us” to transfer

$84,000 of his credits to Virginia Conservation and promised that petitioner would

receive the $84,000 of credits in 2006. Petitioner thus lent the tax credits to Route

231 that it needed to complete the transfer of the promised Virginia tax credits to

Virginia Conservation. This factor weighs in favor of a disguised sale.

      The fifth relevant factor is whether the amount of Virginia tax credits is

disproportionately large in relationship to Virginia Conservation’s general and

continuing interest in Route 231’s profits. See sec. 1.707-3(b)(2)(ix), Income Tax

Regs. When it received the Virginia tax credits, Virginia Conservation held a 1%

interest in partnership profits and losses and distribution of net cashflow, whereas

petitioner and Mr. Humiston each held a 49.5% interest. Yet Virginia

Conservation received approximately 97% of the Virginia tax credits. The size of

the transfer of credits was tied to the amount of money Virginia Conservation

contributed. This factor weighs in favor of a disguised sale. See Va. Historic Tax

Credit Fund 2001 LP v. Commissioner, 639 F.3d at 144.

      The final relevant factor is whether Virginia Conservation has any

obligation to return or repay the Virginia tax credits to Route 231. See sec. 1.707-

3(b)(2)(x), Income Tax Regs. After receiving the tax credits, Virginia
                                       - 45 -

[*45] Conservation could use them for its own benefit; it had no further

obligations to Route 231. This factor weighs in favor of a disguised sale. See Va.

Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d at 144.

      In sum, the facts and circumstances test confirms that Virginia Conservation

and Route 231 engaged in a disguised sale under section 707(a).

IV.   Disguised Sale as Income for 2005

      Because we concluded that the transaction between Route 231 and Virginia

Conservation regarding the Virginia tax credits is a disguised sale under section

707, we must decide whether the income from the sale was reportable for tax year

2005 or tax year 2006. Respondent contends that because the sale occurred in

2005 and the payment was received in 2005, the proceeds of the disguised sale

were reportable as income for 2005. Petitioner contends that because Route 231

did not receive payment until 2006, the proceeds would have been reportable as

income for 2006.

      A.    Earning Virginia Tax Credits

      Petitioner claims that Route 231 could not have sold the Virginia tax credits

in 2005 because it did not register the credits with the VDT until 2006. We

disagree.
                                        - 46 -

[*46] In 2005 a taxpayer was not required to apply to the VDT in order to receive

a Virginia tax credit. See Va. Code Ann. sec. 58.1-512 (West 2005). In 2005 Va.

Code Ann. sec. 58.1-512 (Va. sec. 58.1-512) provided that a taxpayer could

receive a Virginia tax credit for land preservation if (1) the taxpayer made a

qualified donation of land or an interest in land; (2) a qualified appraisal prepared

by a qualified appraiser substantiated the fair market value of the donation; (3) the

qualified appraisal was signed by the qualified appraiser, who had to be licensed

in Virginia, and a copy of the appraisal was submitted to the VDT; (4) the

qualified donation was made to the Commonwealth of Virginia, an instrumentality

thereof, or a qualified charitable organization; and (5) the preservation or similar

use and purpose of such property was assured in perpetuity. Thus, a taxpayer

earned and held a Virginia tax credit when he or she satisfied the statutory

requirements for the credits. The VDT merely acknowledged and registered the

credits to create an accounting track record.

      In 2006, however, Virginia changed the statutory requirements applicable to

the Virginia tax credits for conveyances made on or after January 1, 2007. Among

other things, Virginia expressly required a taxpayer to “apply for a credit after

completing the donation by submitting a form or forms prescribed by the

Department [the VDT]” before he or she would be issued Virginia tax credits for
                                         - 47 -

[*47] donations made on or after January 1, 2007. Va. Code Ann. sec. 58.1-

512(D)(1) (West 2007). Thus, the VDT began to actively issue the credits only

with respect to conveyances made in 2007.

      There is no dispute that Route 231 met the requirements of Va. sec. 58.1-

512 as prescribed in 2005. On December 30, 2005, the instruments conveying the

easements and fee simple interest were recorded with the Clerk’s Office of the

Circuit Court for Albemarle County. The credit acknowledgment letters from the

VDT, dated March 27, 2006, listed the effective year for the credits as 2005.

      At trial, Cathy Early, an employee of the VDT and lead analyst of the tax

credit program, testified that although the VDT received Route 231’s Forms LPC

and copies of the qualified appraisals on January 27, 2006, the effective date for

Route 231’s Virginia tax credits was tax year 2005. She explained that the

effective date of a tax credit “was driven * * * by the date that the donation was

recorded, and * * * [in this case] the donation was recorded December 30, 2005”.

Ms. Early further testified that even if a Form LPC was received after a Virginia

tax return was filed, the taxpayer could still be entitled to a Virginia tax credit on

that Virginia tax return.

      Furthermore, Va. Code Ann. sec. 58.1-513(C) (West 2005) restricted

taxpayers from transferring Virginia tax credits unless the taxpayer was holding
                                        - 48 -

[*48] the credits at the time of transfer. We note that the Virginia tax

commissioner likewise has ruled that “any credit transferred during a taxable year

may be claimed as a credit on the tax return of the transferee in the taxable year

that the transfer of the credit occurs.” Rulings of the Va. Tax Comm’r, Pub.

Document 03-13 (Mar. 4, 2003).

      Because Route 231 possessed the Virginia tax credits in 2005, Route 231

was able to transfer the credits to Virginia Conservation and petitioner on

December 30, 2005. Petitioner reported $215,983 in Virginia tax credits on his

2005 Virginia Income Tax Return. Virginia Conservation allocated its Virginia

tax credits to Chesterfield Conservancy in 2005. At trial, Daniel Gecker, who

owned an interest in Virginia Conservation, testified that Chesterfield

Conservancy sold those Virginia tax credits arising to individual investors to be

claimed on 2005 returns. None of these transfers could have occurred if Route

231 had not acquired and possessed the Virginia tax credits in 2005.

      B.     Date of the Disguised Sale

      A disguised sale is considered to take place on the date that, under general

principles of Federal tax law, the partnership is considered the owner of the

property. Sec. 1.707-3(a)(2), Income Tax Regs.; see also United States v. Irvine,

511 U.S. 224, 238-239 (1994). If the transfer of money or other consideration
                                         - 49 -

[*49] from the partnership to the partner occurs after the transfer of property to the

partnership, the partner and partnership are treated as if, on the date of the sale, the

partnership transferred to the partner an obligation to transfer to the partner money

or other consideration. Sec. 1.707-3(a)(2), Income Tax Regs. A similar rule

applies when the transfer of property from the partnership to the partner occurs

after the transfer of money to the partnership. See sec. 1.707-6(a), Income Tax

Regs.

        Section 61(a) provides generally that gross income means all income from

whatever source derived. Section 61(a)(3) provides that gross income includes

gains derived from dealing in property. See also sec. 1.61-6, Income Tax Regs.

Section 1001(a) provides that the gains from the sale or other disposition of

property shall be the excess of the amount realized over the adjusted basis. Unless

otherwise provided, the entire amount of the gain or loss on the sale of the

property is recognized. Sec. 1001(c).

        State law determines and governs the nature of property rights, while

Federal law determines the appropriate Federal tax treatment of those rights. See

Keith v. Commissioner, 115 T.C. 605, 611 (2000). “The term ‘sale’ is given its

ordinary meaning for Federal income tax purposes and is generally defined as a

transfer of property for money or a promise to pay.” Grodt & McKay Realty, Inc.
                                        - 50 -

[*50] v. Commissioner, 77 T.C. 1221, 1237 (1981) (citing Commissioner v.

Brown, 380 U.S. 563, 570-571 (1965)). A sale occurs for Federal income tax

purposes when there has been a transfer of the benefits and burdens of ownership;

this is a question of fact that must be ascertained from the intention of the parties

as evidenced by a written agreement read in the light of the attending facts and

circumstances. Id.

      The Court has considered the following factors in determining whether a

transfer of the benefits and burdens of ownership has occurred: (1) whether legal

title passed; (2) how the parties treated the transaction; (3) whether an equity

interest in the property was acquired; (4) whether the contract created a present

obligation on the seller to execute and deliver a deed and present obligation on the

purchaser to make payments; (5) whether the right of possession was vested in the

purchasers; (6) which party paid the property tax; (7) which party bore the risk of

loss or damage to the property; and (8) which party received the profits from the

operation and sale the property. Calloway v. Commissioner, 135 T.C. 26, 33-34

(2010), aff’d, 691 F.3d 1315 (11th Cir. 2012). In the case of certain intangible

assets we have focused on whether there was a transfer of substantial rights of

value. Bailey v. Commissioner, 90 T.C. 558, 607 (1988), aff’d in part, vacated in

part, 912 F.2d 44 (2d Cir. 1990).
                                        - 51 -

[*51] The first relevant factor is whether legal title passed in 2005. As discussed

above, Virginia law in 2005 required a taxpayer to hold a tax credit before

transferring it. The record reflects that Virginia Conservation transferred the

Virginia tax credits it received from Route 231 to Chesterfield Conservancy in

2005, and Chesterfield Conservancy transferred the credits to other individuals

and entities in 2005. Legal title passed from Route 231 to Virginia Conservation

in 2005.

      The second relevant factor is how the parties treated the transaction. The

record reflects that the parties intended for the transaction to occur in 2005, and

that they treated the transaction as having occurred in 2005. The escrow

agreements, executed on December 28, 2005, stated that Mr. Skeen should

immediately return the escrow proceeds, without deduction, to Virginia

Conservation if either (i) the deeds of gift were not recorded in the said Clerk’s

Office on or before December 31, 2005, or (ii) Virginia Conservation was not

admitted as a 1% partner in Route 231 on or before December 31, 2005. The first

amended operating agreement stated specifically that the credits were for calendar

year 2005. On its Schedule K-1 for Virginia Conservation, Route 231 reported

that Virginia Conservation contributed capital of $3,816,000 in the 2005 tax year.
                                        - 52 -

[*52] Moreover, Chesterfield Conservancy and the individuals to which it

ultimately sold the credits acted as though the transfer occurred in 2005.

       The third relevant factor is whether an equity interest in the property was

acquired. Virginia Conservation held an equity interest in the Virginia tax credits

in 2005 because it could pass or keep the credits as it saw fit starting in 2005 (as

evidenced by the fact that it passed the credits to Chesterfield Conservancy in

2005) and because it could exclude Route 231 from otherwise using the tax

credits.

       The fourth relevant factor is whether the seller had a present obligation to

execute and deliver a deed and the purchaser had a present obligation to make

payments. The transaction between Route 231 and Virginia Conservation was

structured as a partnership allocation, and Virginia Conservation was to receive

the Virginia tax credits in 2005. The terms of the escrow provided that if the

deeds of gift were not recorded on or before December 31, 2005, or if Virginia

Conservation was not made a partner in 2005, the total payment was to be returned

to Virginia Conservation. If Route 231 performed its part of the agreement, then it

would keep the amount Virginia Conservation paid and the interest earned on the

payment. Under the first amended operating agreement, Virginia Conservation

agreed to pay $0.53 for each $1 of Virginia tax credits it received, and it
                                        - 53 -

[*53] anticipated to receive between $6,700,000 and $7,700,000 of Virginia tax

credits. Route 231 had a present obligation to execute and deliver the deeds, and

Virginia Conservation had a present obligation to make a payment.

      The fifth relevant factor is whether the right of possession was vested in the

purchasers. As discussed above, for any donation of land made before January 1,

2007, Virginia tax credits existed under Virginia law before they were

acknowledged and registered by the VDT. Moreover, Virginia Conservation

represented on its Forms LPC that the right of possession in the tax credits was

vested in it in 2005 and that it transferred the credits to Chesterfield Conservancy.

The right of possession was vested in Virginia Conservation in 2005.

      The sixth relevant factor is which party bore the risk of loss or damage to

the property. The property in the instant case is intangible property. Therefore,

we consider who bore the loss if there had been a decrease in economic value. See

Calloway v. Commissioner, 135 T.C. at 36 (finding that the taxpayer bore no risk

of loss in the event that the value of the stock at issue decreased). Once Virginia

Conservation received the Virginia tax credits, it transferred them to Chesterfield

Conservancy. As discussed above, Virginia Conservation represented that this

transfer occurred in 2005. If Virginia Conservation had not transferred the

Virginia tax credits immediately, it would have borne the risk that the value should
                                        - 54 -

[*54] decline. Likewise, Virginia Conservation would have benefited from a

profit if the value of the credits increased. Route 231 and the other partners,

however, were obligated to refund Virginia Conservation’s payment in the event

that the VDT or the IRS disallowed the Virginia tax credits. In that sense, Route

231 and the other partners bore the risk of loss. This factor is neutral.

      In the light of the above, we conclude that Route 231 sold the Virginia tax

credits to Virginia Conservation in 2005.

      C.     Income From the Disguised Sale Reportable for 2005

      In the alternative, even if Route 231 had not completed the disguised sale in

2005, Route 231 nonetheless would have been required to report the income from

the sale for tax year 2005 because it is an accrual method taxpayer.

      Generally, a taxpayer is required to include gains, profits, and income in

gross income for the taxable year in which he or she actually or constructively

received them, unless they are otherwise includible for a different year in

accordance with the taxpayer’s method of accounting. Sec. 451(a); sec. 1.451-

1(a), Income Tax Regs. A taxpayer like Route 231 that uses the accrual method of

accounting includes an item of gain, profit, or income in its gross income for the

taxable year in which (1) all events have occurred that fix its right to receive
                                        - 55 -

[*55] income and (2) the amount can be determined with reasonable accuracy.

Secs. 1.451-1(a), 1.446-1(c)(1)(ii), Income Tax Regs.

        The parties do not dispute that the amount of Virginia Conservation’s

payment could be determined with reasonable accuracy. Petitioner contends that

the “all events” test was not met until 2006.

              1.    The “All Events” Test

        All events have occurred that fix the taxpayer’s right to receive income

when (1) the required performance takes place, (2) the payment is due, or (3) the

payment is made, whichever comes first. Johnson v. Commissioner, 108 T.C. 448,

459 (1997), aff’d in part, rev’d in part on other grounds,184 F.3d 786 (8th Cir.

1999).

        Petitioner contends that Route 231 “did not actually receive the $3,816,000

capital contribution from Virginia Conservation in 2005” because there was a

bona fide escrow and conditions of this escrow were not satisfied until March 30,

2006.

        The escrow agreements were executed on December 28, 2005. Virginia

Conservation made two wire transfers totaling $3,816,000 to Mr. Skeen’s non-

interest-bearing attorney trust account on December 29, 2005. The amount of the
                                         - 56 -

[*56] transfers represented $0.53 for every $1 of Virginia tax credits that would

be allocated to Virginia Conservation.

      The escrow agreements state specifically that Mr. Skeen would immediately

return the escrow proceeds to Virginia Conservation if (i) the deeds of gift were

not recorded in the Clerk’s Office on or before December 31, 2005, or (ii) Virginia

Conservation was not made a 1% partner in Route 231 on or before December 31,

2005. The actions described above occurred on or before December 31, 2005.

Route 231 knew at the close of 2005 that the escrow funds would not be returned

to Virginia Conservation. Therefore, all events necessary to fix Route 231’s right

to receive income from Virginia Conservation occurred in 2005.7

      Consequently, we find that Route 231 would have been required to report

the payment from Virginia Conservation for tax year 2005 as an accrual method

taxpayer regardless of whether the sale actually took place in 2005.




      7
        The escrow agreements also stated that Route 231 would provide to
Virginia Conservation the credit transaction number, the evidence of recordation
of the deed of gift, the new owner’s policy, and disbursement authorization from
Virginia Conservation’s counsel. These acts were ministerial and not conditions
precedent, and we need not determine whether Route 231 properly performed
them.
                                       - 57 -

[*57] 2.    Route 231’s Admission

      We further note that Route 231 admitted that the contribution from Virginia

Conservation occurred in 2005 under the accrual method of accounting. Route

231 reported on its 2005 Form 1065 that it received $3,816,000 from Virginia

Conservation. It also reported on the Schedule K-1 for Virginia Conservation for

its 2005 Form 1065 that Virginia Conservation contributed capital in the total

amount of $3,816,000. Petitioner likewise states in his petition: “In 2005,

Virginia Conservation contributed $3,816,000 in cash to Route 231”.

      We have held repeatedly that statements made in a tax return signed by a

taxpayer are binding and treated as admissions. Mendes v. Commissioner, 121

T.C. 308, 312 (2003) (citing Waring v. Commissioner, 412 F.2d 800, 801 (3d Cir.

1969), aff’g T.C. Memo. 1968-126, Lare v. Commissioner, 62 T.C. 739, 750

(1974), aff’d without published opinion, 521 F.2d 1399 (3d Cir. 1975), and

Kaltrieder v. Commissioner, 28 T.C. 121, 125-126 (1957), aff’d, 255 F.2d 833 (3d

Cir. 1958)). A taxpayer “cannot * * * disavow * * * [his or her tax] returns

without cogent proof that they are incorrect.” Crigler v. Commissioner, T.C.

Memo. 2003-93, slip op. at 13, aff’d per curiam, 85 Fed. Appx. 328 (4th Cir.

2004).
                                       - 58 -

[*58] Petitioner has not shown why the statements on Route 231’s 2005 Federal

income tax returns are incorrect. Therefore, Route 231 admitted that the disguised

sale, which it characterized erroneously as a capital contribution, occurred in 2005

for purposes of the accrual method of accounting.

V.    Conclusion

      We hold that the transactions in issue between Route 231 and Virginia

Conservation amounted to a disguised sale under section 707(a) and that the

disguised sale took place in 2005. Any contentions we have not addressed are

irrelevant, moot, or meritless.

      To reflect the foregoing,


                                                Decision will be entered

                                       under Rule 155.
