                                      PRECEDENTIAL
UNITED STATES COURT OF APPEALS
           FOR THE THIRD CIRCUIT
                _____________

                    No. 11-1832
                   _____________

       HISTORIC BOARDWALK HALL, LLC,
NEW JERSEY SPORTS AND EXPOSITION AUTHORITY,
           TAX MATTERS PARTNER

                          v.

    COMMISSIONER OF INTERNAL REVENUE,

                                 Appellant
                  _______________

      On Appeal from the United States Tax Court
                    (No. 11273-07)
          Judge: Hon. Joseph Robert Goeke
                  _______________

                       Argued
                    June 25, 2012

Before: SLOVITER, CHAGARES, and JORDAN, Circuit
                    Judges.

               (Filed: August 27, 2012)
                   _______________
Tamara W. Ashford
Arthur T. Catterall [ARGUED]
Richard Farber
Gilbert S. Rothenberg
William J. Wilkins
United States Department of Justice
Tax Division
950 Pennsylvania Avenue, N.W.
P. O. Box 502
Washington, D.C. 20044
      Counsel for Appellant

Robert S. Fink
Kevin M. Flynn [ARGUED]
Kostelanetz & Fink, LLP
7 World Trade Center, 34th Floor
New York, NY 10007
      Counsel for Appellees

Paul W. Edmondson
Elizabeth S. Merritt
William J. Cook
National Trust for Historic Preservation
1785 Massachusetts Ave., N.W.
Washington, D.C. 20036




                              2
David B. Blair
Alan I. Horowitz
John C. Eustice
Miller & Chevalier, Chartered
655 Fifteenth Street, N.W., Suite 900
Washington, D.C. 20005
      Counsel for Amicus National Trust for Historic
      Preservation

A. Duane Webber
Richard M. Lipton
Robert S. Walton
Derek M. Love
Samuel Grilli
Baker & McKenzie LLP
300 East Randolph Drive, Suite 5000
Chicago, IL 60601
      Counsel for Amicus Real Estate Roundtable
                    _______________

                OPINION OF THE COURT
                    _______________




                             3
                     TABLE OF CONTENTS

                                                                             Page

I.   Background .................................................................. 9

     A.       Background of the HRTC Statute ...................... 9

     B.       Factual Background of the East Hall
              Renovation....................................................... 15

              1. NJSEA Background .................................. 15

              2. Commencement of the East Hall
                 Renovation ................................................ 16

              3. Finding a Partner ..................................... 18

                        a) The Proposal from Sovereign
                           Capital Resources .......................... 18

                        b) The Initial and Revised Five-Year
                           Projections ..................................... 20

                        c) Confidential Offering
                           Memorandum ................................. 22

                        d) Selection of Pitney Bowes .............. 23

                        e) Additional Revisions to Financial
                           Projections ..................................... 25

              4. Closing ...................................................... 26

                        a) The HBH Operating Agreement .... 27




                                      4
                          b) Lease Amendment and Sublease .... 32

                          c) Acquisition Loan and Construction
                             Loan ............................................... 33

                          d) Development Agreement ................ 34

                          e) Purchase Option and Option to
                             Compel ........................................... 35

                          f) Tax Benefits Guaranty ................... 36

                5. HBH in Operation..................................... 37

                          a) Construction in Progress ............... 37

                          b) Post-Construction Phase ............... 41

                6. The Tax Returns and IRS Audit ................ 44

      C.        The Tax Court Decision .................................. 46

II.   Discussion .................................................................. 51

      A.        The Test ........................................................... 54

      B.        The Commissioner’s Guideposts ..................... 56

      C.        Application of the Guideposts to HBH ............ 64

                1. Lack of Meaningful Downside Risk .......... 69

                2. Lack of Meaningful Upside Potential ....... 77

                3. HBH’s Reliance on Form over
                   Substance .................................................. 80




                                        5
III.   Conclusion .................................................................. 85




                                         6
JORDAN, Circuit Judge.

       This case involves the availability of federal historic
rehabilitation tax credits (“HRTCs”) in connection with the
restoration of an iconic venue known as the “East Hall” (also
known as “Historic Boardwalk Hall”), located on the
boardwalk in Atlantic City, New Jersey. The New Jersey
Sports and Exposition Authority (“NJSEA”), a state agency
which owned a leasehold interest in the East Hall, was tasked
with restoring it. After learning of the market for HRTCs
among corporate investors, and of the additional revenue
which that market could bring to the state through a
syndicated partnership with one or more investors, NJSEA
created a New Jersey limited liability company, Historic
Boardwalk Hall, LLC (“HBH”), and subsequently sold a
membership interest in HBH1 to a wholly-owned subsidiary

       1
          An LLC “offers the best of both worlds – the limited
liability of a corporation and the favorable tax treatment of a
partnership.” Canterbury Holdings, LLC v. Comm’r, 98
T.C.M. (CCH) 60, 61 n.1 (2009). Generally, an LLC is a
pass-through entity that does not pay federal income tax. See
I.R.C. § 701; Treas. Reg. § 301.7701-3(a). Rather, profits
and losses “pass through” the LLC to its owners, called
members, who pay individual income tax on their allocable
shares of the tax items. See I.R.C. §§ 701-04, 6031.
Although an LLC with just one owner is, for tax purposes,
disregarded as an entity separate from its owner for tax
purposes, an LLC with two or more members is classified as
a partnership for tax purposes unless it elects to be treated as
a corporation. Treas. Reg. § 301.7701-3(b)(1). Once HBH,
as a duly formed New Jersey limited liability company, had




                               7
of Pitney Bowes, Inc. (“PB”).2 Through a series of
agreements, the transactions that were executed to admit PB
as a member of HBH and to transfer ownership of NJSEA‟s
property interest in the East Hall to HBH were designed so
that PB could earn the HRTCs generated from the East Hall
rehabilitation.    The Internal Revenue Service (“IRS”)
determined that HBH was simply a vehicle to impermissibly
transfer HRTCs from NJSEA to PB and that all HRTCs taken
by PB should be reallocated to NJSEA.3 The Tax Court
disagreed, and sustained the allocation of the HRTCs to PB
through its membership interest in HBH. Because we agree
with the IRS‟s contention that PB, in substance, was not a
bona fide partner in HBH, we will reverse the decision of the
Tax Court.

two members, it did not elect to be treated as a corporation
and thus was classified as a partnership for tax purposes for
the tax years in which it had more than one member. Thus, as
the parties do, we refer to HBH as a partnership when
analyzing whether one of its stated members was a bona fide
partner.
      2
         PB‟s membership interest in HBH was through PB
Historic Renovations, LLC, whose sole member was Pitney
Bowes Credit Corp. At all relevant times, Pitney Bowes
Credit Corp. was a wholly-owned subsidiary of PB. For ease
of reference, we will refer to PB Historic Renovations, LLC,
Pitney Bowes Credit Corp., and PB as “PB.”
      3
           The alphabet-soup of acronyms in this case is
perhaps beyond parody, but the acronyms are a more efficient
means of referring to various corporate and state entities, as
well as the tax credits and other concepts, so we reluctantly
fall into the soup.




                              8
I.     Background

       A.       Background of the HRTC Statute

        We begin by describing the history of the HRTC
statute. Under Section 47 of the Internal Revenue Code of
1986, as amended (the “Code” or the “I.R.C.”), a taxpayer is
eligible for a tax credit equal to “20 percent of the qualified
rehabilitation expenditures [“QREs”4] with respect to any
certified historic structure.[5]” I.R.C. § 47(a)(2). HRTCs are
only available to the owner of the property interest. See
generally I.R.C. § 47; see also I.R.S. Publication, Tax Aspects
of Historic Preservation, at 1 (Oct. 2000), available at
http://www.irs.gov/pub/irs-utl/faqrehab.pdf. In other words,
the Code does not permit HRTCs to be sold.

       4
           The Code defines a QRE as:
       [A]ny amount properly chargeable to [a] capital
       account – (i) for property for which
       depreciation is allowable under [I.R.C. §] 168
       and which is – (I) nonresidential real property,
       (II) residential real property, (III) real property
       which has a class life of more than 12.5 years,
       or (IV) an addition or improvement to property
       described in subclause (I), (II), or (III), and (ii)
       in connection with the rehabilitation of a
       qualified rehabilitated building.
I.R.C. § 47(c)(2)(A).
       5
          The Code defines a “certified historic structure” as
“any building (and its structural components) which – (i) is
listed in the National Register, or (ii) is located in a registered
historic district and is certified by the Secretary of the Interior




                                9
        The idea of promoting historic rehabilitation projects
can be traced back to the enactment of the National Historic
Preservation Act of 1966, Pub. L. No. 89-665, 80 Stat. 9156
(1966), wherein Congress emphasized the importance of
preserving “historic properties significant to the Nation‟s
heritage,” 16 U.S.C. § 470(b)(3). Its purpose was to “remedy
the dilemma that „historic properties significant to the
Nation‟s heritage are being lost or substantially altered, often
inadvertently, with increasing frequency.‟” Pye v. United
States, 269 F.3d 459, 470 (4th Cir. 2001) (quoting 16 U.S.C.
§ 470(b)(3)). Among other things, the National Historic
Preservation Act set out a process “which require[d] federal
agencies with the authority to license an undertaking „to take
into account the effect of the undertaking on any … site …
that is … eligible for inclusion in the National Register‟ prior
to issuing the license.” Id. (quoting 16 U.S.C. § 470f). It also
authorized the Secretary of the Interior to “expand and
maintain a National Register of Historic Places.” 16 U.S.C.
§ 470a(a)(1)(A).

       The Tax Reform Act of 1976 furthered the goals of the
1966 legislation by creating new tax incentives for private
sector investment in certified historic buildings. See Tax
Reform Act of 1976, Pub. L. No. 94-455, 90 Stat. 1520
(1976). The pertinent provisions of the 1976 Act indicate that
Congress wanted to encourage the private sector to restore
historic buildings, and, to provide that encouragement, it
established incentives that were similar to the tax incentives
for building new structures. See, e.g., 122 Cong. Rec. 34320

to the Secretary as being of historic significance to the
district.” I.R.C. § 47(c)(3).




                              10
(1976). Specifically, to equalize incentives affecting the
restoration of historic structures and the construction of new
buildings, it included a provision allowing for the
amortization of rehabilitation expenditures over five years, or,
alternatively, an accelerated method of depreciation with
respect to the entire depreciable basis of the rehabilitated
property. See I.R.S. Publication, Rehabilitation Tax Credit, at
1-2 (Feb. 2002), available at http://www.irs.gov/pub/irs-
mssp/rehab.pdf (hereinafter referred to as “IRS- Rehab”).

        The Revenue Act of 1978 went further to incent the
restoration of historic buildings. It made a 10% rehabilitation
credit available in lieu of the five-year amortization period
provided by the 1976 Act. See Revenue Act of 1978, Pub. L.
No. 95-600, 92 Stat. 2763 (1978); see also IRS-Rehab, at 1-2.
In 1981, Congress expanded the rehabilitation credit to three
tiers, so that a taxpayer could qualify for up to a 25% credit
for certain historic rehabilitations. See Economic Recovery
Tax Act of 1981, Pub. L. No. 97-34, 95 Stat. 172 (1981); see
also IRS-Rehab, at 1-2.

        The Tax Reform Act of 1986 made extensive changes
to the tax law, including the removal of many tax benefits that
had been available to real estate investors. See Tax Reform
Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085 (1986); see
also Staff of J. Comm. on Tax‟n, 99th Cong., General
Explanation of the Tax Reform Act of 1986 (Comm. Print.
1987) (hereinafter referred to as “General Explanation of
TRA 86”). The HRTC survived, although it was reduced to
its modern form of a two-tier system with a 20% credit for
QREs incurred in renovating a certified historic structure, and
a 10% credit for QREs incurred in renovating a qualified




                              11
rehabilitated building6 other than a certified historic structure.
See Tax Reform Act of 1986 § 251, 100 Stat. at 2183; see
also I.R.C. § 47. A Congressional report for the 1986 Act
discussed the rationale for keeping the HRTC:



       6
           The Code defines a “qualified rehabilitated building”
as:
       [A]ny building (and its structural components)
       if – (i) such building has been substantially
       rehabilitated, (ii) such building was placed in
       service before the beginning of the
       rehabilitation, (iii) in the case of any building
       other than a certified historic structure, in the
       rehabilitation process – (I) 50 percent or more
       of the existing external walls of such building
       are retained in place as external walls, (II) 75
       percent or more of the existing external walls of
       such building are retained in place as internal or
       external walls, and (III) 75 percent or more of
       the existing internal structural framework of
       such building is retained in place, and (iv)
       depreciation (or amortization in lieu of
       depreciation) is allowable with respect to such
       building.
I.R.C. § 47(c)(1)(A). Additionally, “[i]n the case of a
building other than a certified historic structure, a
building shall not be a qualified rehabilitated building
unless the building was first placed in service before
1936.” Id. § 47(c)(1)(B).




                                12
             In 1981, the Congress restructured and
      increased the tax credit for rehabilitation
      expenditures [because it] was concerned that the
      tax incentives provided to investments in new
      structures (e.g., accelerated cost recovery)
      would have the undesirable effect of reducing
      the relative attractiveness of the prior-law
      incentives to rehabilitate and modernize older
      structures, and might lead investors to neglect
      older structures and relocate their businesses.

             The Congress concluded that the
      incentives granted to rehabilitations in 1981
      remain justified. Such incentives are needed
      because the social and aesthetic values of
      rehabilitating and preserving older structures
      are not necessarily taken into account in
      investors‟ profit projections. A tax incentive is
      needed because market forces might otherwise
      channel investments away from such projects
      because of the extra costs of undertaking
      rehabilitations of older or historic buildings.

General Explanation of TRA 86, at 149.

       Evidently mindful of how the tax incentives it had
offered might be abused, Congress in 2010 codified the
“economic substance doctrine,” which it defined as “the
common law doctrine under which tax benefits … with
respect to a transaction are not allowable if the transaction
does not have economic substance or lacks a business




                             13
purpose.”7 I.R.C. § 7701(o)(5)(A). At the same time,
however, Congress was at pains to emphasize that the HRTC
was preserved. A Congressional report noted:


      If the realization of the tax benefits of a
      transaction is consistent with the Congressional
      purpose or plan that the tax benefits were
      designed by Congress to effectuate, it is not
      intended that such tax benefits be disallowed.
      … Thus, for example, it is not intended that a
      tax credit (e.g., … section 47[, which provides
      for HRTCs,] …) be disallowed in a transaction
      pursuant to which, in form and substance, a

      7
          Specifically, the codification of the economic

substance doctrine provides:

      In the case of any transaction to which the
      economic substance doctrine is relevant, such
      transaction shall be treated as having economic
      substance only if … (A) the transaction changes
      in a meaningful way (apart from Federal
      income tax effects) the taxpayer‟s economic
      position, and (B) the taxpayer has a substantial
      purpose (apart from Federal income tax effects)
      for entering into such transaction.

I.R.C. § 7701(o)(1).        Section 7701(o) applies to all
transactions entered into after March 30, 2010. Thus, the
common-law version of the economic substance doctrine, and
not § 7701(o), applies to the transaction at issue here.




                               14
      taxpayer makes the type of investment or
      undertakes the type of activity that the credit
      was intended to encourage.

Staff of J. Comm. on Tax‟n, Technical Explanation of the
Revenue Provisions of the “Reconciliation Act of 2010,” as
amended, In Combination with the “Patient Protection and
Affordable Care Act,” at 152 n.344 (Comm. Print 2010)
(emphasis added). In sum, the HRTC statute is a deliberate
decision to skew the neutrality of the tax system to encourage
taxable entities to invest, both in form and substance, in
historic rehabilitation projects.

      B.     Factual Background        of   the   East   Hall
             Renovation

             1.     NJSEA Background

       In 1971, the State of New Jersey formed NJSEA to
build, own, and operate the Meadowlands Sports Complex in
East Rutherford, New Jersey. The State legislature expanded
NJSEA‟s jurisdiction in 1992 to build, own, and operate a
new convention center in Atlantic City and to acquire,
renovate, and operate the East Hall. Completed in 1929, the
East Hall was famous for hosting the annual Miss America
Pageant, and, in 1987, it was added to the National Register
of Historic Places as a National Historic Landmark.

       In October 1992, before renovations on the East Hall
began, NJSEA obtained a 35-year leasehold interest in the
property for $1 per year from the owner, the Atlantic County
Improvement Authority. About a month later, NJSEA
entered into an agreement with the Atlantic City Convention




                             15
Center Authority, the then-operator of the East Hall, to
operate both the East Hall and the new convention center. In
July 1995, NJSEA and the Atlantic City Convention Center
Authority handed over management responsibility for both
the East Hall and the yet-to-be-completed convention center
to a private entity, Spectacor Management Group
(“Spectacor”).

              2.     Commencement of the East Hall
                     Renovation

       Once construction started on the new convention
center in the early 1990s, NJSEA began planning for the
future of the East Hall and decided to convert it into a special
events facility. That conversion was initially anticipated to
cost $78,522,000. Renovations were to be performed in four
phases, with the entire project expected to be completed in
late 2001.

       The renovation project began in December of 1998.
By that time, NJSEA had entered into agreements with the
New Jersey Casino Reinvestment Development Authority8
pursuant to which the Casino Reinvestment Development
Authority agreed to reimburse NJSEA up to $4,146,745 for
certain pre-design expenses and up to $32,574,000 for costs
incurred in the East Hall renovation. In a March 1999

       8
         The Casino Reinvestment Development Authority, as
described by the Tax Court, “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.” (Joint Appendix (“J.A.”) at 11 n.4.)




                               16
document prepared in connection with a separate bond
issuance,9 NJSEA noted that it had received grants from the
Casino Reinvestment Development Authority to pay for the
first phase of the East Hall renovation and that “[f]unding for
the remaining cost of the project … is expected to be obtained
through the issuance by [NJSEA] of Federally Taxable State
Contract Bonds.” (J.A. at 708.) In June 1999, NJSEA issued
$49,915,000 in State Contract Bonds to fund the East Hall
renovation.

       The first two phases of the renovation were completed
prior to the Miss America Pageant held in September 1999,
and Phase 3 began the following month. Through 1999,
NJSEA had entered into rehabilitation contracts for
approximately $38,700,000, and had expended $28,000,000
of that amount. Also at about that time, the estimate of the
total cost of the project increased to $90,600,000. NJSEA‟s
1999 annual report stated that the Casino Reinvestment
Development Authority had agreed to reimburse NJSEA for
“all costs in excess of bond proceeds for the project.” (Id. at
1714.) Thus, by the end of 1999, between the proceeds it had
received from the bond issuance and funds provided – or to
be provided – by the Casino Reinvestment Development
Authority, NJSEA had assurances that the East Hall
rehabilitation project was fully funded.



      9
         The proceeds from that bond issuance by NJSEA,
described as the 1999 Luxury Tax Bonds, were not directly
applied to the East Hall renovation. Rather, the 1999 Luxury
Tax Bonds were issued to effect the refunding of certain
amounts from an earlier bond issuance.




                              17
              3.     Finding a Partner

                     a)     The Proposal from Sovereign
                            Capital Resources

         In August 1998, a few months prior to the beginning of
renovations on the East Hall, Paul Hoffman from Sovereign
Capital Resources (“Sovereign”)10 wrote to NJSEA regarding
a “consulting proposal … for the sale of the historic
rehabilitation tax credits expected to be generated” by the
East Hall rehabilitation. (Id. at 691.) That proposal was
“designed to give [NJSEA representatives] a better
perspective on the structure of the historic tax credit sale, as
well as the [potential] financial benefits (estimated in excess
of $11 million) to the project.” (Id.) As an initial summary,
Hoffman stated that “the best way to view the equity
generated by a sale of the historic tax credits is to think of it
as an $11 million interest only loan that has no term and may
not require any principal repayment.” (Id.) Hoffman noted
that although NJSEA, as a tax-exempt entity, would have no
use for the 20% federal tax credit generated by QREs
incurred in renovating historic structures, there were “entities
that actively invest in [HRTC] properties … and are generally
Fortune 500 corporations with substantial federal income tax
liabilities.” (Id. at 692.) Hoffman explained that because
“[t]he [HRTC] is earned when the building is placed into
service” and “cannot be transferred after the fact,” “the


       10
          Sovereign describes itself as “a boutique consulting
firm that facilitates equity financing and offers financial
advisory services for historic rehabilitation … tax credit
transactions.” (J.A. at 696.)




                               18
corporate investor should be admitted into the partnership that
owns the project as soon as possible.” (Id.)

       Hoffman next sketched out the proposed transactions
that would allow NJSEA to bring an investor interested in
HRTCs into co-ownership of the East Hall and yet provide
for NJSEA to “retain its long-term interests in the [East
Hall].” (Id. at 693.) First, NJSEA would sublease its interest
in the East Hall to a newly created partnership in which
NJSEA would be the general partner and a corporate investor
would be the limited partner. The sublease agreement would
be treated as a sale for tax purposes since the sublease would
extend longer than the useful life of the property under tax
rules. Next, that partnership would allocate 99% of its profit
and loss to the limited partner corporate investor so that such
investor could claim substantially all of the tax credits, but
only be allocated a “small portion” of the cash flow. (Id. at
694.) Finally, after a sufficient waiting period, NJSEA would
be given a purchase option to buy-out the corporate investor‟s
interest. With all that said, however, Hoffman warned that
“[c]orporate purchasers of [HRTCs] rarely accept
construction risk,” and “[t]ypically … provide no more than
10% of their equity to the partnership during the construction
period.” (Id. at 695.) Thus, Hoffman “recommend[ed] that
NJSEA plan to issue enough bonds to meet the construction
financing requirements of the project.” (Id.)

       Hoffman then provided a valuation of the HRTCs. He
estimated that NJSEA could expect an investor to contribute
approximately $0.80 to $0.90 per each dollar of HRTC
allocated to the investor. In valuing the HRTCs, Hoffman
“assume[d] that NJSEA would like to minimize the cash
distribution to the investor and retain long-term ownership of




                              19
[the East Hall].” (Id.) He also listed four “standard
guarantees” that “[i]nvestors in the tax credit industry” would
“require” as part of the transaction: (1) a construction
completion guaranty; (2) an operating deficit guaranty; (3) a
tax indemnity; and (4) an environmental indemnity. (Id. at
696.) Additionally, Hoffman noted that “the investor will
expect that either NJSEA or the State of New Jersey be
obligated to make debt service on the bond issuance if
operating revenue is insufficient to support the debt
payments.” (Id.)

        NJSEA decided to further explore the benefits
described by Sovereign. In March 1999, NJSEA issued a
request for proposal (as supplemented by an addendum on
April 30, 1999, the “RFP”) from “qualified financial advisors
… in connection with a proposed historic rehabilitation tax
credit transaction … relating to the rehabilitation of the East
Hall.” (Id. at 710.) The RFP provided that the selected
candidate would “be required to prepare a Tax Credit offering
Memorandum, market the tax credits to potential investors
and successfully close a partnership agreement with the
proposed tax credit investor.” (Id. at 721.) In June 1999,
after receiving four responses, NJSEA selected Sovereign as
its “[f]inancial [a]rranger” for the “Historic Tax Credit
transaction.” (Id. at 750.)

                     b)     The Initial and Revised Five-Year
                            Projections

       In September 1999, as the second phase of the East
Hall renovation had just been completed, Spectacor, as the
East Hall‟s operator, produced draft five-year financial
projections for the East Hall beginning for the 2002 fiscal




                              20
year.11 Those projections estimated that the East Hall would
incur a net operating loss of approximately $1.7 million for
each of those five years. Sovereign received a copy of the
projections, and, in a memo dated October 1, 1999, responded
that it was “cautious about [Spectacor‟s] figures as they might
prove excessively conservative.”       (Id. at 793.)      In a
December 10, 1999 memo to NJSEA representatives,
Sovereign said that, for the yet-to-be-created partnership
between NJSEA and an HRTC investor to earn the desired
tax credits, the partnership “should be able to reasonably
show that it is a going concern.”12 (Id. at 804.) To that end,
Sovereign suggested that “[t]o improve the operating results,
NJSEA could explore shifting the burden of some of the
operating expenses from the [partnership] to the Land Lessor
(either [the Atlantic County Improvement Authority] or
NJSEA depending upon [how the partnership was
structured]).” (Id.)

       Approximately two months later, Sovereign received
revised estimates prepared by Spectacor. Those pro forma

      11
          Because it was projected that the East Hall
renovation would be completed in late 2001, fiscal year 2002
was anticipated to be the East Hall‟s first full year of
operations.
      12
          A “going concern” is “[a] commercial enterprise
actively engag[ed] in business with the expectation of
indefinite continuance.” Black‟s Law Dictionary 712 (8th ed.
2004). Evidently and understandably, Sovereign viewed year
after year of large losses from the operations of the East Hall
as inconsistent with an ordinary expectation of indefinite
continuance.




                              21
statements projected much smaller net operating losses,
ranging from approximately $396,000 in 2002 to $16,000 in
2006.     Within two weeks, Spectacor made additional
revisions to those projections which resulted in estimated net
operating income for those five years, ranging from
approximately $716,000 in 2002 to $1.24 million in 2006.
About 90% of the remarkable financial turnaround the East
Hall thus was projected to enjoy on paper was due to the
removal of all projected utilities expenses for each of the five
years ($1 million in 2002, indexed for 3% inflation each year
thereafter). When the accountants for the project, Reznick,
Fedder & Silverman (“Reznick”), included those utilities
expenses in their compiled projections one week later,
Sovereign instructed them to “[t]ake [the] $1MM Utility Cost
completely out of Expenses, [because] NJSEA [would] pay at
[the] upper tier and [then] we should have a working
operating model.” (Id. at 954.)

                     c)     Confidential Offering
                            Memorandum

       On March 16, 2000, Sovereign prepared a 174-page
confidential information memorandum (the “Confidential
Memorandum” or the “Memo”) which it sent to 19 potential
investors and which was titled “The Sale of Historic Tax
Credits Generated by the Renovation of the Historic Atlantic
City Boardwalk Convention Hall.” (Id. at 955.) Although the
executive summary in the Confidential Memorandum stated
that the East Hall renovation would cost approximately $107
million, the budget attached to the Memo indicated that the
“total construction costs” of the project were $90,596,088.
(Id. at 1035). Moreover, the Memo stated that “[t]he
rehabilitation [was] being funded entirely by [NJSEA].” (Id.




                              22
at 962). The difference between the $107 million “estimated
… renovation” (id. at 961), and the “total construction costs”
of $90,596,088 was, as the Memo candidly put it, the
“[p]roceeds from the sale of the historic tax credits” (id. at
963). The Memo did not contemplate that those proceeds,
estimated to be approximately $16,354,000, would be applied
to “total construction costs” but rather indicated that the funds
would be used for three things: (1) payment of a $14,000,000
“development fee” to NJSEA; (2) payment of $527,080 in
legal, accounting, and syndication fees related to the tax-
credit transaction; and (3) the establishment of a $1,826,920
working capital reserve.

       The Memo also provided financial projections through
2009. Those projections assumed that the investor would
receive a 3% priority distribution (the “Preferred Return”)
from available cash flow on its $16,354,000 contribution,
which contemporaneous NJSEA executive committee notes
described as “required by tax rules.” (Id. at 1135.) The
financial projections provided for sufficient net operating
income – ranging from $715,867 in 2002 to $880,426 in 2009
– to pay a portion of the Preferred Return on an annual basis
(varying from $465,867 in 2002 to $490,620 in 2009), but
also showed substantial tax losses through 2009 that were
mainly attributable to depreciation deductions.

                     d)     Selection of Pitney Bowes

      Four entities, including PB, responded to the
Confidential Memorandum and submitted offers “regarding
the purchase of the historic tax credits anticipated to be
generated by the renovation” of the East Hall. (Id. at 1143.)
In a May 2000 letter supplementing its offer, PB




                               23
recommended that NJSEA fund the construction costs
through a loan to the partnership, rather than in the form of
capital contributions, so that “the managing member could
obtain a pre-tax profit and therefore the partnership would be
respected as such for US tax purposes.” (Id. at 1145.)

        On July 13, 2000, PB and NJSEA executed a letter of
intent (“LOI”) reflecting their agreement that PB would make
“capital contributions”13 totaling $16.4 million over four
installments in exchange for a 99.9% membership interest in
HBH, which NJSEA had recently formed. The LOI further
indicated that PB would also make an “Investor Loan” of $1.1
million. Consistent with PB‟s earlier recommendation, the
LOI said that NJSEA, as the managing member retaining a
0.1% interest in HBH, would provide approximately $90
million in the form of two loans: (1) a purchase money
obligation that represented the amount of QREs incurred by
NJSEA in the East Hall renovation prior to PB‟s investment
(the “Acquisition Loan”); and (2) a loan to finance the
remainder of the projected QREs (the “Construction Loan”).
According to the LOI, it was anticipated that the project
would qualify for a minimum of $17,602,667 in HRTCs:
$9,379,981 in 2000 and $8,222,686 in 2001. The LOI also
noted that a 3% Preferred Return would be paid to PB.
Although the LOI contemplated that PB would receive 99.9%
of any available cash flow, HBH‟s financial projections from
2000 to 2042 forecasted no cash flow available for
distribution during that time frame. Similarly, while the LOI

       13
         Although we use the term “capital contributions”
because that was the term used by the parties in this context,
we do not attribute any dispositive legal significance to it as
used herein.




                              24
mentioned that PB would receive 99.9% of the net proceeds
from a sale of HBH, a pre-closing memo from NJSEA‟s
outside counsel to NJSEA suggested that, “[d]ue to the
structure of the transaction,” the fair market value of PB‟s
interest in HBH would be insignificant. (J.A. at 1162.) Thus,
for its investment of $17.5 million ($16.4 million in capital
contributions and the $1.1 million Investor Loan), PB would
receive, in addition to the 3% Preferred Return, 99.9% of the
approximately $17.6 million worth of HRTCs that would be
generated from the QREs.

                    e)     Additional Revisions to Financial
                           Projections

       Prior to the closing on PB‟s commitment to purchase a
membership interest in HBH, an accountant from Reznick
who was preparing HBH‟s financial projections, sent a memo
to Hoffman indicating that the two proposed loans from
NJSEA to HBH “ha[d] been set up to be paid from available
cash flow” but that “[t]here was not sufficient cash to
amortize this debt.” (Id. at 1160.) To remedy the problem,
Hoffman instructed the accountant to increase the projection
of baseline revenues in 2002 by $1 million by adding a new
revenue source of $750,000 titled “naming rights,” and by
increasing both “parking revenue” and “net concession
revenue” by $125,000 each. Additionally, whereas the initial
projections assumed that baseline revenues and expenses
would both increase by 3% on an annual basis, the revised
projections used at closing assumed that baseline revenues
would increase by 3.5% annually, while maintaining the 3%
estimate for the annual increases in baseline expenses. With
those modifications, Reznick was able to project that, even
after paying PB its 3% Preferred Return, HBH could fully pay




                             25
off the Acquisition Loan by 2040, at which point HBH would
then be able to make principal payments on the Construction
Loan.

       Also prior to closing, by moving certain expenditures
from the “non-eligible” category to the “eligible” category,14
Reznick increased by about $9 million the amount of
projected QREs that the East Hall renovation would generate.
That increase in QREs resulted in an approximately $1.8
million increase in projected HRTCs from $17,602,667 to
$19,412,173. That uptick in HRTCs, in turn, resulted in an
increase in PB‟s anticipated capital contribution from
$16,400,000 to $18,195,797.15

             4.     Closing

       On September 14, 2000,16 NJSEA and PB executed
various documents to implement the negotiated transaction,
and PB made an initial contribution of $650,000 to HBH.

      14
          Reznick apparently used the terms “eligible” and
“non-eligible” construction expenditures to differentiate
between costs that were QREs and those that were not.
      15
          The LOI provided that PB‟s contribution would be
“adjusted … upward by $0.995 per additional $1.00 of
Historic Tax Credit in the event that … the QREs for the
Project after 1999 support[ed] Historic Tax Credits in excess
of the projected Historic Tax Credits.” (J.A. at 1148.)
      16
         Although it is unclear from the record exactly when
Phase 3 of the four-phase rehabilitation project was
completed, the March 2000 Confidential Memorandum
estimated that Phase 3, which began in October 1999, would




                              26
                     a)     The HBH Operating Agreement

        The primary agreement used to admit PB as a member
of HBH and to restate HBH‟s governing provisions was the
amended and restated operating agreement (the “AREA”).
The AREA stated that the purpose of HBH was “to acquire,
develop, finance, rehabilitate, own, maintain, operate, license,
lease, and sell or otherwise dispose of a[n] 87-year
subleasehold interest in the Historic East Hall … for use as a
special events facility.” (Id. at 157.) The AREA provided
that PB would hold a 99.9% ownership interest as the
“Investor Member,” and NJSEA would hold a 0.1%
ownership interest as the “Managing Member.” The AREA
also provided that PB, in addition to its $650,000 initial
contribution, would make three additional capital
contributions totaling $17,545,797 (collectively, with the
initial capital contribution, $18,195,797). Those additional
contributions were contingent upon the completion of certain
project-related events, including verification of the amount of
rehabilitation costs that had been incurred to date that would
be classified as QREs to generate HRTCs. According to
Section 5.01(c)(v) of the AREA, each of the four
contributions were to be used by HBH to pay down the
principal of the Acquisition Loan contemplated by the LOI.
Pursuant to the AREA, NJSEA, in addition to providing HBH

be completed by August 2000. That same memo stated that
NJSEA anticipated that the entire renovation would be
completed by December 2001, and, in fact, the East Hall
reopened in October 2001. Thus, it is likely that Phase 3 of
the renovation was entirely completed by the time NJSEA
and PB executed the various documents effecting PB‟s
investment in HBH.




                              27
with the Acquisition Loan and the Construction Loan, agreed
to pay all “Excess Development Costs” (the “Completion
Guaranty”),17 fund all operating deficits through interest-free
loans to HBH (the “Operating Deficit Guaranty”), and
indemnify PB against any loss incurred by PB as a result of
any liability arising from “Hazardous Materials” relating to
the East Hall,18 including remediation costs (the
“Environmental Guaranty”).

       17
          The AREA defined the term “Excess Development
Costs” as “all expenditures in excess of the proceeds of the
[Acquisition and Construction] Loans and the Capital
Contributions of the Members which are required to complete
rehabilitation of the [East] Hall,” including, but not limited to,
“(1) any interest, taxes, and property insurance premiums not
payable from proceeds of the Loans or Capital Contributions,
and (2) any construction cost overruns and the cost of any
change orders which are not funded from proceeds of the
Loans or Capital Contributions of the Members.” (J.A. at
161.)
       18
          The term “Hazardous Materials” under the AREA
included, among other things, “any „hazardous substance‟,
„pollutant‟ or „contaminant‟ as defined in any applicable
federal statute, law, rule or regulation now or hereafter in
effect … or any amendment thereto or any replacement
thereof or in any statute or regulation relating to the
environment now or hereafter in effect,” and “any hazardous
substance, hazardous waste, residual waste or solid waste, as
those terms are now or hereafter defined in any applicable
state or local law, rule or regulation or in any statute or
regulation relating to the environment now or hereafter in
effect.” (J.A. at 162.)




                               28
        The AREA also set forth a detailed order of priority of
distributions from HBH‟s cash flow. After distributing any
title insurance proceeds or any environmental insurance
proceeds to PB, cash flow was to be distributed as follows:
(1) to PB for certain repayments on its $1.1 million “Investor
Loan” contemplated by the LOI; (2) to PB and NJSEA, in
accordance with their respective membership interests, until
PB received an amount equal to the current and any accrued
and unpaid 3% Preferred Return as mentioned in the LOI; (3)
to PB for an amount equal to the income tax liability
generated by income earned by HBH that was allocated to
PB, if any; (4) to NJSEA for an amount equal to the current
and any accrued and unpaid payments of interest and
principal owed on the Acquisition Loan and the Construction
Loan; (5) to NJSEA in an amount equal to any loans it made
to HBH pursuant to the Operating Deficit Guaranty; and (6)
the balance, if any, to PB and NJSEA, in accordance with
their respective membership interests.

       Additionally, the AREA provided the parties with
certain repurchase rights and obligations.19 In the event that
NJSEA desired to take certain actions that were prohibited
under the AREA or otherwise required it to obtain PB‟s
consent to take such actions, NJSEA could instead – without
the consent of PB – purchase PB‟s interest in HBH. In the
papers submitted to us, the ill-fitting name the parties gave to
this ability of NJSEA to buy out PB without PB‟s consent is

       19
         Those rights and obligations are distinct from the put
and call options set forth in separate agreements which were
executed the same day and which are discussed infra in
Section 1.B.4.e.




                              29
the “Consent Option.” The purchase price under the Consent
Option is not measured by any fair market value of PB‟s
interest, if any such value were even to exist, but rather is
equal to the then-present value of any yet-to-be realized
projected tax benefits and cash distributions due to PB
through the end of the five-year tax credit recapture period.20
In the event that NJSEA committed a material default as
defined by the AREA, PB had the right to compel NJSEA to
purchase its interest (the “Material Default Option”) for that
same price.21



       20
           In this context, the term “tax credit recapture” is
apparently used to convey the concept that a taxpayer is
required to repay to the IRS a portion of a tax credit it had
previously claimed with respect to a property interest because
that property interest did not continue to qualify for the tax
credit for the requisite period of time. Specifically, if the East
Hall were disposed of or “otherwise cease[d] to be [an
HRTC] property with respect to” HBH within five years after
the East Hall was placed into service, any HRTCs allocated to
PB through its membership interest in HBH would be
recaptured by, in effect, increasing PB‟s tax (through its
membership interest in HBH) by the amount of the total
HRTCs taken multiplied by a “recapture percentage,” which
varies based on the holding period of the property. See I.R.C.
§ 50(a). The amount of HRTCs subject to recapture would
decrease by 20% for each of the first five years after the East
Hall was placed in service. See id. § 50(a)(1)(B).
       21
          At the time that the IRS challenged this series of
transactions, neither the Consent Option nor the Material
Default Option had been exercised.




                               30
        To protect PB‟s interest, Section 8.08 of the AREA
mandated that NJSEA obtain a guaranteed investment
contract (the “Guaranteed Investment Contract”).22 The
Guaranteed Investment Contract had to be “reasonably
satisfactory to [PB], in the amount required to secure the
payment of the purchase price” to be paid by NJSEA in the
event that NJSEA exercised the option to purchase PB‟s
interest under another purchase option agreement that NJSEA
had.23 (Id. at 187-88; see supra note 19.) The AREA also
provided that the Guaranteed Investment Contract had to be
obtained on or before the payment of PB‟s second capital
contribution. In a memo dated two days prior to closing,
Sovereign explained to NJSEA that “[t]he [Guaranteed
Investment Contract] should be sized to pay off the Investor
Loan of $1.1 million, accrued but unpaid interest on the
[Investor Loan], and [PB‟s] annual priority distributions.”
(Id. at 1211.)



      22
          A “guaranteed investment contract” is “[a]n
investment contract under which an institutional investor
[here, NJSEA] invests a lump sum … with an insurer that
promises to return the principal (the lump sum) and a certain
amount of interest at the contract‟s end.” Black‟s Law
Dictionary 845 (8th ed. 2004).
      23
           That option, known as the call option, was one of
two vehicles (the other being the Consent Option) that was
available to NJSEA if it wanted to buy out PB‟s interest in
HBH. PB had a corresponding put option which gave it the
right to compel NJSEA to buy out PB‟s interest. As noted
earlier, supra note 19, the put and call options are discussed
infra in Section 1.B.4.e.




                             31
                     b)     Lease Amendment and Sublease

       NJSEA also executed several documents that
purported to transfer ownership of its interest in the East Hall
to HBH. First, NJSEA entered into an amended and restated
agreement with its lessor, Atlantic County Improvement
Authority, to extend the term of NJSEA‟s leasehold interest
in the East Hall from 2027 to 2087.24 After that agreement,


       24
          It appears that the leasehold interest was extended so
that its term was longer than the depreciable basis of the
improvements to be made on the East Hall for tax purposes.
That extension was in accord with Hoffman‟s ultimate plan
for NJSEA to transfer ownership of the East Hall (for tax
purposes) to the newly created partnership, a plan he laid out
in Sovereign‟s consulting proposal to NJSEA (albeit the
actual lease extension was longer than that suggested in that
proposal). (See J.A. at 693 (“Since the useful life of
commercial improvements is 39.5 years, the tax industry
consensus is that the sub-lease should be for a period of 50
years.”). Extending the lease term beyond the useful life of
the improvements was necessary so that when NJSEA entered
into a sublease with HBH in connection with the East Hall,
HBH, as Hoffman put it, could “be recognized as the „owner‟
for tax purposes” (id.), and thus would be eligible to incur
QREs that, in turn, would generate HRTCs. See I.R.C.
§ 47(c)(2)(B)(vi) (“The term „[QRE]‟ does not include …any
expenditure of a lessee of a building if, on the date the
rehabilitation is completed, the remaining term of the lease
(determined without regard to any renewal periods) is less
than the recovery period determined under [I.R.C.
§ 168(c)].”).




                              32
NJSEA and HBH entered into a “Sublease” with NJSEA, as
landlord, and HBH, as tenant. (Id. at 413.)

                    c)     Acquisition      Loan          and
                           Construction Loan

       As contemplated in the LOI, NJSEA provided
financing to HBH in the form of two loans. First, NJSEA and
HBH executed a document setting forth the terms of the
Acquisition Loan, reflecting NJSEA‟s agreement to finance
the entire purchase price that HBH paid to NJSEA for the
subleasehold interest in the East Hall, which amounted to
$53,621,405. That amount was intended to represent the
construction costs that NJSEA had incurred with respect to
the East Hall renovation prior to PB making its investment in
HBH. The Acquisition Loan provided for HBH to repay the
loan in equal annual installments for 39 years, beginning on
April 30, 2002, with an interest rate of 6.09% per year;
however, if HBH did not have sufficient cash available to pay
the annual installments when due, the shortfall would accrue
without interest and be added to the next annual installment.
HBH pledged its subleasehold interest in the East Hall as
security for the Acquisition Loan.

       Second, NJSEA and HBH executed a document setting
forth the terms of the Construction Loan, reflecting NJSEA‟s
agreement to finance the projected remaining construction
costs for renovating the East Hall, to be repaid by HBH in
annual installments for 39 years, beginning on April 30, 2002,
at an annual interest rate of 0.1%. Although the parties only




                             33
anticipated $37,921,036 of additional construction costs,25 the
maximum amount that HBH could withdraw from the
Construction Loan provided by NJSEA was $57,215,733.
That difference, $19,294,697, was nearly identical to the total
investment that PB was to make in HBH ($18,195,797 in
capital contributions and $1,100,000 for the Investor Loan).
See infra Section I.B.5.a. Similar to the Acquisition Loan, the
Construction Loan provided for equal annual installments out
of available cash flow, but, if sufficient cash was not
available, any shortfall would accrue without interest and be
added to the next annual installment. HBH gave NJSEA a
second mortgage on its subleasehold interest in the East Hall
as security for the Construction Loan.

                     d)     Development Agreement

       HBH and NJSEA also entered into a development
agreement in connection with the ongoing rehabilitation of
the East Hall. The agreement stated that HBH had “retained
[NJSEA as the developer] to use its best efforts to perform
certain services with respect to the rehabilitation … of the
[East] Hall … including renovation of the [East] Hall,

       25
          The final projections prepared during the week prior
to closing contemplated $27,421,036 of remaining
construction costs. During that week, Sovereign sent a memo
to PB identifying an additional $10.5 million of “[p]otential
additional expenditure[s]” that included environmental
remediation costs ($3.0 million), tenant improvements ($2.5
million), and an additional rehabilitation contingency ($5.0
million). (J.A. at 1209.) If those expenditures were treated as
QREs, the memo indicated that the transaction would
generate an additional $2.1 million in HRTCs.




                              34
acquisition of necessary building permits and other approvals,
acquisition of financing for the renovations, and acquisition
of historic housing credits for the renovations.” (Id. at 267.)
The agreement noted that “since December 1998, [NJSEA]
ha[d] been performing certain of [those] services … in
anticipation of the formation of [HBH].” (Id.) The
agreement provided that HBH would pay a $14,000,000
development fee to NJSEA, but that fee was not to be earned
until the rehabilitation was completed. Prior to the execution
of the development agreement, as NJSEA was spending over
$53 million towards the renovation of the East Hall, it did not
pay itself any development fee or otherwise account for such
a fee.

                     e)     Purchase Option and Option to
                            Compel

       Concurrent with the AREA and the sublease
agreement, PB and NJSEA entered into a purchase option
agreement (the “Call Option”) and an agreement to compel
purchase (the “Put Option”). The Call Option provides
NJSEA the right to acquire PB‟s membership interest in
HBH, and the Put Option provides PB the right to require
NJSEA to purchase PB‟s membership interest in HBH.
Under the Call Option, NJSEA had the right to purchase PB‟s
interest in HBH at any time during the 12-month period
beginning 60 months after the East Hall was placed in
service.26 If NJSEA did not exercise the Call Option, then PB


      26
       The 60-month period was likely imposed so that, if
NJSEA did exercise the Call Option, any of the HRTCs that
PB had previously been allocated through its membership




                              35
had the right to exercise the Put Option at any time during the
12-month period beginning 84 months after the East Hall was
placed in service. For both the Put Option and the Call
Option, the purchase price was set at an amount equal to the
greater of (1) 99.9% of the fair market value of 100% of the
membership interests in HBH; or (2) any accrued and unpaid
Preferred Return due to PB. As already noted, supra Section
I.B.4.a, the AREA mandated that NJSEA purchase the
Guaranteed Investment Contract to secure funding of the
purchase price of PB‟s membership interest, should either of
the options be exercised.27

                     f)     Tax Benefits Guaranty

       As contemplated by the Confidential Memorandum,
HBH and PB entered into a tax benefits guaranty agreement
(the “Tax Benefits Guaranty”). Pursuant to that guaranty,
upon a “Final Determination of a Tax Benefits Reduction
Event,”28 HBH agreed to pay to PB an amount equal to the

interest in HBH would not be subject to recapture. See supra
note 20.
      27
         Neither of those options were exercised prior to the
IRS‟s challenge.
      28
          Pursuant to the Tax Benefits Guaranty, a “Tax
Benefits Reduction Event means as of any Final
Determination for any taxable year the amount by which the
Actual Tax Benefits for such year are less than the Projected
Tax Benefits.” (J.A. at 300.) A “Final Determination” was
defined as the earliest to occur of certain non-construction
related events which, “with respect to either [HBH] or [PB],
… result[] in loss of Projected Tax Benefits.” (Id. at 299.)




                              36
sum of (1) any reduction in projected tax benefits, “as revised
by the then applicable Revised Economic Projections,”29 as a
result of an IRS challenge; (2) any additional tax liability
incurred by PB from partnership items allocated to it by HBH
as a result of an IRS challenge; (3) interest and penalties
imposed by the IRS on PB in connection with any IRS
challenge; (4) an amount sufficient to compensate PB for
reasonable third-party legal and administrative expenses
related to such a challenge, up to $75,000; and (5) an amount
sufficient to pay any federal income tax liability owed by PB
on receiving any of the payments listed in (1) through (4).
(Id. at 300.) Although HBH was the named obligor of the
Tax Benefits Guaranty, the agreement provided that “NJSEA
… shall fund any obligations of [HBH] to [PB]” under the
Tax Benefits Guaranty. (Id. at 303.)

              5.     HBH in Operation

                     a)     Construction in Progress

       Pursuant to an Assignment and Assumption
Agreement executed on the day of closing between NJSEA,
as assignor, and HBH, as assignee, various agreements and
contracts – including occupancy agreements, construction
contracts, architectural drawings, permits, and management
and service agreements – were assigned to HBH. HBH


      29
         The “Revised Economic Projections” refer to the
revised projections made by Reznick that “reflect the actual
Tax Credits and federal income tax losses … at the time of
payment of the Second, Third and Fourth Installments.” (Id.
at 300.)




                              37
opened bank accounts in its name, and it deposited revenues
and paid expenses through those accounts.

       As previously indicated, supra Section I.B.4.a, PB‟s
capital contributions were, pursuant to the AREA, supposed
to be used to pay down the Acquisition Loan. Although that
did occur, any decrease in the balance of the Acquisition
Loan was then offset by a corresponding increase in the
amount of the Construction Loan. As the Tax Court
explained:

      Shortly [after PB‟s capital contributions were
      used to pay down the principal on the
      Acquisition Loan], a corresponding draw would
      be made on the [C]onstruction [Loan], and
      NJSEA would advance those funds to [HBH].
      Ultimately, these offsetting draws left [HBH]
      with cash in the amount of [PB‟s] capital
      contributions, a decreased balance on the
      [A]cquisition [L]oan, and an increased balance
      on the [C]onstruction [L]oan. These funds were
      then used by [HBH] to pay assorted fees related
      to the transaction and to pay NJSEA a
      developer‟s fee for its work managing and
      overseeing the East Hall‟s rehabilitation.

(Id. at 17-18.) Also as discussed above, supra Section
I.B.4.c, the parties set the upper limit of the Construction
Loan approximately $19.3 million higher than the anticipated
amount of the total remaining construction costs as of the
closing date, which would allow HBH to use PB‟s
approximately $19.3 million in contributions to pay NJSEA a
development fee and expenses related to the transaction




                            38
without being concerned that it would exceed the maximum
limit on the Construction Loan provided by NJSEA.

       PB made its second capital contribution in two
installments, a $3,660,765 payment in December 2000, and a
$3,400,000 payment the following month. Once those
contributions were received by NJSEA and used to pay down
the principal on the Acquisition Loan, NJSEA, instead of
using the entire capital contribution to fund a corresponding
draw by HBH on the Construction Loan, used $3,332,500 of
that amount to purchase the required Guaranteed Investment
Contract as security for its potential obligation or opportunity
to purchase PB‟s interest in HBH.30

      HBH experienced a net operating loss31 for both
200032 ($990,013) and 2001 ($3,766,639), even though

       30
          As noted, supra Section 1.B.4.a, the AREA required
that NJSEA purchase the Guaranteed Investment Contract in
the amount required to secure the purchase price to be paid by
NJSEA if it exercised its Call Option. However, pursuant to a
pledge and escrow agreement entered into by NJSEA, PB,
and an escrow agent in January 2001, NJSEA also pledged its
interest in the Guaranteed Investment Contract as security for
its potential purchase obligation in the event that PB
exercised its Put Option, subject to NJSEA‟s right to apply
the proceeds of that contract toward payment of the purchase
price if it exercised its Call Option or Consent Option, or if
PB exercised its Material Default Option.
       31
         We use the terms “net operating income” or “net
operating loss” to mean the net income or loss before interest
and depreciation expenses.




                              39
projections had indicated that HBH would generate net
operating income of $500,000 in 2001.33 For the tax years
ending in 2000 and 2001, HBH reported approximately
$107.7 million in QREs, about $10.75 million more QREs
than contemplated in the financial projections attached to the
AREA.34 See supra note 25. As a result, PB‟s required

      32
         HBH‟s statement of operations for 2000 covered the
period June 26, 2000 (date of inception) through December
31, 2000.
      33
           HBH‟s accountants did not make financial
projections for operating revenues and expenses prior to
2001.
      34
          It was possible for HBH to claim QREs that were
incurred prior to its purported acquisition of the East Hall.
See Treas. Reg. § 1.48-12(c)(3)(ii) (“Where [QREs] are
incurred with respect to a building by a persons (or persons)
other than the taxpayer [i.e. NJSEA] and the taxpayer [i.e.
HBH] subsequently acquires the building, … the taxpayer
acquiring the property shall be treated as having incurred the
[QREs] actually incurred by the transferor …, provided that
… [t]he building … acquired by the taxpayer was … not
placed in service … after the [QREs] were incurred and prior
to the date of acquisition, and … [n]o credit with respect to
such [QREs] is claimed by anyone other than the taxpayer
acquiring the property.” ). Additionally, even if “total
construction costs” were only approximately $90.6 million as
projected, it would also have been possible to generate over
$107 million in QREs. See id. § 1.48-12(c)(2) (noting that
QREs could include, among other things, “development
fees,” “legal expenses,” and certain “[c]onstruction period
interest” expenses). In any event, as discussed infra, the IRS




                             40
aggregate capital contribution was increased by
approximately $2 million to $20,198,460 and the Investor
Loan was increased by $118,000 to $1,218,000.35

                    b)     Post-Construction Phase

According to NJSEA‟s 2001 annual report, the “$90 million
renovation”36 of East Hall “was completed on time and on
budget” and reopened “in October 2001.” (Id. at 1757, 1758.)
Approximately a year later, PB made its third – and largest –
capital contribution of $10,467,849. Around the time that
contribution was made, Reznick prepared revised financial
projections. Whereas, at closing, Reznick had forecasted
$1,715,867 of net operating income for 2002, the accountants

has not challenged the amount of the QREs reported by HBH,
but rather the allocation of any HBH partnership items to PB.
      35
          As contemplated by the LOI, see supra note 15, the
AREA provided that “if the 2000 or 2001 Tax Credits which
[HBH] will be entitled to claim with respect to such
rehabilitation are greater than the Projected Tax Credits …
the aggregate amount of [PB‟s] Capital Contribution shall be
increased by $.995 for each $.999 by which the Tax Credits
exceed the Projected Tax Credits.” (J.A. at 178.) It is unclear
from the record why a portion of the required increase in
capital contributions was instead applied to increase the
Investor Loan.
      36
          The “$90 million” figure is at odds with the
statement in the Confidential Memorandum that the
renovation project would cost $107 million. The difference
approximates the sum eventually invested by PB. See supra
Section I.B.3.c.




                              41
now projected a net operating loss of $3,976,023. Ultimately,
after reality finished with the pretense of profitability, HBH‟s
net operating loss for 2002 was $4,280,527. Notwithstanding
the discrepancy between the initial and actual budgets for
2002, Reznick did not alter projections for 2003 and future
years. For years 2003 through 2007,37 Reznick projected an
aggregate net operating income of approximately $9.9
million.     HBH actually experienced an aggregate net
operating loss of over $10.5 million for those five years. In
early 2004, PB made a portion of its fourth and final capital
contribution, paying $1,173,182 of its commitment of
$2,019,846.38

       When Reznick was preparing HBH‟s 2003 audited
financial statements, it “addressed a possible impairment
issue under FASB 144.”39 (Id. at 1638.) FASB 144 requires

       37
          The record does not contain audited financial
statements for HBH beyond 2007.
       38
          After paying that portion of the fourth installment,
PB had made $19,351,796 of its $20,198,460 required capital
contribution. The notes to HBH‟s 2007 audited financial
statements indicate that the $846,664 balance, plus interest,
was still due, and was being reserved pending the outcome of
litigation with the IRS. The Tax Court also said that a
“portion of [PB‟s] fourth capital contribution … is currently
being held in escrow.” (J.A. at 17.)
       39
          FASB is an acronym for the Financial Accounting
Standards Board, an organization that establishes standards
which are officially recognized as authoritative by the SEC
for financial accounting and which govern the preparation of
financial reports by nongovernmental entities. The number




                              42
a write down of an impaired asset to its actual value
“whenever events or changes in circumstances indicate that
its carrying amount may not be recoverable,” such as when
there is “[a] current-period operating or cash flow loss
combined with a history of operating or cash flow losses or a
projection or forecast that demonstrates continuing losses
associated with the use of a long-lived asset.” Statement of
Financial Accounting Standards No. 144, Financial
Accounting      Standards     Board,     9    (Aug.    2001),
http://www.fasb.org/pdf/fas144.pdf) (hereinafter referred to
as “FASB 144”). In a memo to HBH‟s audit file, Reznick
considered a write down of HBH‟s interest in the East Hall
pursuant to FASB 144, “[d]ue to the fact that [HBH] has
experienced substantial operating losses and has not
generated any operating cash flow since its inception.” (J.A.
at 1638.) In the end, however, Reznick was persuaded by the
powers at HBH that HBH was never meant to function as a
self-sustaining venture and that the State of New Jersey was
going to make good on HBH‟s losses. In deciding against a
write down, Reznick explained:


      Per discussions with the client, it was
      determined that [HBH] was not structured to
      provide operating cash flow. Instead, the
      managing member, [NJSEA], agreed to fund all
      operating deficits of [HBH] in order to preserve
      the [East Hall] as a facility to be used by the
      residents of the State of New Jersey. [NJSEA]
      has the ability to fund the deficits as a result of

“144” refers to the number assigned to the particular standard
at issue here.




                              43
       the luxury and other taxes provided by the
       hospitality and entertainment industry in the
       state.

(Id.) “Since there is no ceiling on the amount of funds to be
provided [by NJSEA to HBH] under the [AREA],” Reznick
concluded “there [was] no triggering event which require[d]
[a write down] under FASB 144.” (Id.) That same discussion
and conclusion were included in separate memos to HBH‟s
audit files for 2004 and 2005.40 By the end of 2007, the
operating deficit loan payable to NJSEA was in excess of $28
million.

              6.     The Tax Returns and IRS Audit

       On its 2000 Form 1065,41 HBH reported an ordinary
taxable loss of $1,712,893, and $38,862,877 in QREs.42 On
       40
       The record does not contain Reznick‟s audit files for
HBH beyond 2005.
       41
          As detailed earlier, supra note 1, since HBH was a
duly formed New Jersey limited liability company, had two
members by the end of its 2000 tax year, and did not elect to
be treated as a corporation, it was classified as a partnership
for tax purposes for the tax years at issue here. See Treas.
Reg. § 301.7701-3(b)(1). Partnerships do not pay federal
income taxes, but rather are required to file a Form 1065,
which is an annual information return of the partnership. A
Form 1065 also generates a Schedule K-1 for each partner,
which reports a partner‟s distributive share of tax items. The
individual partners then report their allocable shares of the tax
items on their own federal income tax returns. See I.R.C.
§§ 701-04, 6031.




                               44
its 2001 Form 1065, HBH reported an ordinary taxable loss of
$6,605,142 and $68,865,639 in QREs. On its 2002 Form
1065, HBH reported an ordinary taxable loss of $9,135,373
and $1,271,482 of QREs. In accordance with its membership
interest in HBH, PB was issued a Schedule K-1 allocating
99.9% of the QREs for each of those tax years (collectively
referred to herein as the “Subject Years”).43

        Following an audit of the returns of the Subject Years,
the IRS issued to HBH a notice of final partnership
administrative adjustment (“FPAA”). That FPAA determined
that all separately stated partnership items reported by HBH
on its returns for the Subject Years should be reallocated from
PB to NJSEA. The IRS made that adjustment on various
alternative, but related, grounds, two of which are of
particular importance on appeal: first, the IRS said that HBH
should not be recognized as a partnership for federal income
tax purposes because it was created for the express purpose of
improperly passing along tax benefits to PB and should be
treated as a sham transaction; and, second, it said that PB‟s
claimed partnership interest in HBH was not, based on the

      42
         HBH‟s 2000 Form 1065 stated that it began business
on June 26, 2000.
      43
          While PB was also allocated 99.9% of the ordinary
taxable loss for both 2001 and 2002, it appears it was only
allocated approximately 69% of the ordinary taxable loss for
2000. Although it is unclear from the record, PB could have
only been allocated 99.9% of the loss from the time it joined
as a member in HBH in September 2000, although, as noted
above, it was allocated 99.9% of the QREs for HBH‟s entire
taxable year in 2000.




                              45
totality of the circumstances, a bona fide partnership
participation because PB had no meaningful stake in the
success or failure of HBH.44 The IRS also determined that
accuracy-related penalties applied.

      C.     The Tax Court Decision

     NJSEA, in its capacity as the tax matters partner of
HBH,45 filed a timely petition to the United States Tax Court




      44
           The FPAA provided two additional grounds for
reallocating partnership items from PB to NJSEA. It
determined that no sale of the East Hall occurred between
NJSEA and HBH for federal income tax purposes because the
burdens and benefits of ownership of the East Hall interest
did not pass from NJSEA, as the seller, to HBH, as the
purchaser. Although the IRS has appealed the Tax Court‟s
rejection of that argument, see infra note 47, we will not
address that contention in view of our ultimate disposition.
The FPAA also determined that HBH should be disregarded
for federal income tax purposes under the anti-abuse
provisions of Treas. Reg. § 1.701-2(b). The Tax Court also
rejected that determination, and the IRS has not appealed that
aspect of the decision.
      45
          A partnership such as HBH “designates a tax matters
partner to handle tax questions on behalf of the partnership,”
and that “partner is empowered to settle tax disputes on
behalf of the partnership.” Mathia v. Comm’r, 669 F.3d
1080, 1082 n.2 (10th Cir. 2012).




                             46
in response to the FPAA.46 Following a four-day trial in April
2009, the Tax Court issued an opinion in favor of HBH.

        The Tax Court first rejected the Commissioner‟s
argument that HBH is a sham under the economic substance
doctrine. See supra note 7 and accompanying text. As the
Court saw it, “all of [the IRS‟s] arguments concerning the
economic substance of [HBH] [were] made without taking
into account the 3-percent return and the [HRTCs].” (Id. at
37.) The Court disagreed with the IRS‟s assertion that “[PB]
invested in the [HBH] transaction solely to earn [HRTCs].”
(Id. at 41.) Instead, the Court “believe[d] that the 3-percent
return and the expected tax credits should be viewed
together,” and “[v]iewed as a whole, the [HBH] and the East
Hall transactions did have economic substance” because the
parties “had a legitimate business purpose – to allow [PB] to

      46
          “Upon receiving an FPAA, a partnership, via its tax
matters partner, may file a petition in the Tax Court … .
Once an FPAA is sent, the IRS cannot make any assessments
attributable to relevant partnership items during the time the
partnership seeks review … .” Mathia, 669 F.3d at 1082.
Once that petition is filed, a partnership-level administrative
proceeding is commenced, governed by the Tax Equity and
Fiscal Responsibility Act of 1982. Under that Act, all
partnership items are determined in a single-level proceeding
at the partnership level, which is binding on the partners and
may not be challenged in a subsequent partner-level
proceeding.      See I.R.C. §§ 6230(c)(4), 7422(h).       This
streamlined process “remove[s] the substantial administrative
burden occasioned by duplicative audits and litigation and …
provide[s] consistent treatment of partnership tax items
among partners in the same partnership.” (J.A. at 31-32.)




                              47
invest in the East Hall‟s rehabilitation.” (Id.) In support of
that determination, the Tax Court explained:

       Most of [PB‟s] 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      [HBH]       and     NJSEA.     [The
       Commissioner‟s] contention that [PB] was
       unnecessary to the transaction because NJSEA
       was going to rehabilitate the East Hall without a
       corporate investor overlooks the impact that
       [PB] had on the rehabilitation: no matter
       NJSEA‟s intentions at the time it decided to
       rehabilitate the East Hall, [PB‟s] 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. [The Commissioner] does not
       allege that a circular flow of funds resulted in
       [PB] receiving its 3–percent preferred return on
       its capital contributions. In addition, [PB]
       received the rehabilitation tax credits.

(Id. at 41-42.)

       The Tax Court further explained that “[PB] faced risks
as a result of joining [HBH]. First … it faced the risk that the
rehabilitation would not be completed,” and additionally,
“both NJSEA and [PB] faced potential liability for
environmental hazards from the rehabilitation.” (Id. at 43.)
While recognizing that HBH and PB were insured parties
under NJSEA‟s existing environmental insurance policy, the




                              48
Tax Court noted that “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 financially able to do so.” (Id. at 43-44.) In sum, because
“NJSEA had more money for the rehabilitation than it would
have had if [PB] had not invested in [HBH],” and “[b]oth
parties would receive a net economic benefit from the
transaction if the rehabilitation was successful,” the Tax
Court concluded that HBH had “objective economic
substance.” (Id. at 46-47.)

        The Tax Court used similar reasoning to reject the
Commissioner‟s assertion that PB was not a bona fide partner
in HBH. Specifically, the Court rejected the Commissioner‟s
contentions that “(1) [PB] had no meaningful stake in
[HBH‟s] success or failure; and (2) [PB‟s] interest in [HBH]
is more like debt than equity.” (Id. at 47.) After citing to the
totality-of-the-circumstances partnership test laid out in
Commissioner v. Culbertson, 337 U.S. 733 (1949), the Court
determined that “[PB] and NJSEA, in good faith and acting
with a business purpose, intended to join together in the
present conduct of a business enterprise” (J.A. at 49). After
“[t]aking into account the stated purpose behind [HBH‟s]
formation, the parties‟ investigation of the transaction, the
transaction documents, and the parties‟ respective roles,” the
Tax Court held “that [HBH] was a valid partnership.” (Id. at
52.)

       Regarding the formation of a partnership, the Court
said that, because “[PB] and NJSEA joined together in a
transaction with economic substance to allow [PB] to invest
in the East Hall rehabilitation,” and “the decision to invest
provided a net economic benefit to [PB] through its 3-percent




                              49
preferred return and rehabilitation tax credits,” it was “clear
that [PB] was a partner in [HBH].” (Id. at 49-50.) The Court
opined that, since the East Hall operated at a loss, even if one
were to “ignore the [HRTCs], [PB‟s] interest is not more like
debt than equity because [PB] [was] not guaranteed to receive
a 3-percent return every year … [as] there might not be
sufficient cashflow to pay it.” (Id. at 51.)

        The Tax Court also placed significant emphasis on
“the parties‟ investigation and documentation” to “support
[its] finding that the parties intended to join together in a
rehabilitation of the East Hall.” (Id. at 50.) According to the
Court, the Confidential Memorandum “accurately described
the substance of the transaction: an investment in the East
Hall‟s rehabilitation.” (Id.) The Court then cited to the
parties‟ investigation into mitigating potential environmental
hazards, as well as the parties‟ receipt of “a number of
opinion letters evaluating various aspects of the transaction,
to “support[] [its] finding of an effort to join together in the
rehabilitation of the East Hall.” (Id.) The Court decided that
“[t]he     executed     transaction    documents      accurately
represent[ed] the substance of the transaction … to
rehabilitate and manage the East Hall.” (Id.) Also, the Court
found it noteworthy that “the parties … carried out their
responsibilities under the AREA[:] NJSEA oversaw the East
Hall‟s rehabilitation, and [PB] made its required capital
contributions.”47 (Id. at 51.)

       47
          Rejecting a third alternative ground brought by the
IRS, see supra note 44, the Tax Court determined that NJSEA
had transferred the benefits and burdens of its interest in the
East Hall to render HBH the owner of the East Hall for tax
purposes, see supra note 24. To support that conclusion, the




                              50
     Hence, the Tax Court entered a decision in favor of
HBH. This timely appeal by the Commissioner followed.

II.   Discussion48

       The Commissioner49 alleges that the Tax Court erred
by allowing PB, through its membership interest in HBH, to
receive the HRTCs generated by the East Hall renovation. He
characterizes the transaction as an impermissible “indirect
sale of the [HRTCs] to a taxable entity. … by means of a
purported partnership between the seller of the credits,
[NJSEA], and the purchaser, [PB].” (Appellant‟s Opening
Br. at 30.) While the Commissioner raises several arguments

Court observed that (1) “[t]he parties treated the transaction
as a sale”; (2) “possession of the East Hall vested in [HBH]”;
(3) “[HBH] reported the East Hall‟s profits and stood to lose
its income if the East Hall stopped operating as an event
space”; and (4) “[b]ank accounts were opened in [HBH‟s]
name by [Spectacor] as operator of the East Hall.” (J.A. at 54-
55.) Because of our ultimate resolution, we will not
specifically address the Tax Court‟s analysis of that
contention.
      48
          The Tax Court had jurisdiction pursuant to I.R.C.
§§ 6226(f) and 7442, and we have jurisdiction pursuant to
I.R.C. § 7482(a)(1). We exercise de novo review over the
Tax Court‟s ultimate characterization of a transaction, and
review its findings of fact for clear error. Merck & Co., Inc.
v. United States, 652 F.3d 475, 480-81 (3d Cir. 2011).
      49
         The current Commissioner of Internal Revenue is
Douglas Shulman.




                              51
in his effort to reallocate the HRTCs from NJSEA to PB, we
focus primarily on his contention that PB should not be
treated as a bona fide partner in HBH because PB did not
have a meaningful stake in the success or failure of the
partnership.50 We agree that PB was not a bona fide partner
in HBH.

      50
          The Commissioner also contends that HBH was a
sham. Specifically, the Commissioner invokes a “sham-
partnership theory,” which he says is “a variant of the
economic-substance          (sham-transaction)     doctrine.”
(Appellant‟s Opening Br. at 50.) That theory, according to
the Commissioner “focus[es] on (1) whether the formation of
the partnership made sense from an economic standpoint, as
would be the case [under the Culbertson inquiry], and (2)
whether there was otherwise a legitimate business purpose for
the use of the partnership form.” (Id.)
        HBH contends that the IRS‟s sham-partnership theory,
which HBH asserts is “merely a rehash of the factual claims
that [the IRS] made in challenging [PB‟s] status as a partner
in HBH,” is distinct from the sham-transaction doctrine (also
known as the economic substance doctrine) that was litigated
before the Tax Court. Amicus Real Estate Roundtable (the
“Roundtable”) agrees, submitting that the Commissioner‟s
sham-partnership argument “inappropriately blur[s] the line
between the [economic substance doctrine] and the
[substance-over-form doctrine],” the latter of which applies
when the form of a transaction is not the same as its economic
reality. (Roundtable Br. at 7.) The point is well-taken, as the
economic substance doctrine and the substance-over-form
doctrine certainly “are distinct.” Neonatology Assocs., P.A. v.
Comm’r, 299 F.3d 221, 230 n.12 (3d Cir. 2002); see generally
Rogers v. United States, 281 F.3d 1108, 1115-17 (10th Cir.




                              52
2002) (noting differences between the substance-over-form
doctrine and the economic substance doctrine).             The
substance-over-form doctrine “is applicable to instances
where the „substance‟ of a particular transaction produces tax
results inconsistent with the „form‟ embodied in the
underlying documentation, permitting a court to
recharacterize the transaction in accordance with its
substance.” Neonatology Assocs., 299 F.3d at 230 n.12. On
the other hand, the economic substance doctrine “applies
where the economic or business purpose of a transaction is
relatively insignificant in relation to the comparatively large
tax benefits that accrue.” Id.
        As the Roundtable correctly explains, “[t]he fact that
[a] taxpayer might not be viewed as a partner (under the
[substance-over-form doctrine]) or that the transaction should
be characterized as a sale (again, under the [substance-over-
form doctrine]) [does] not mean that the underlying
transaction violated the [economic substance doctrine].”
(Roundtable Br. at 7.) Put another way, even if a transaction
has economic substance, the tax treatment of those engaged in
the transaction is still subject to a substance-over-form
inquiry to determine whether a party was a bona fide partner
in the business engaged in the transaction. See Southgate
Master Fund, L.L.C. ex rel. Montgomery Capital Advisors,
LLC v. United States, 659 F.3d 466, 484 (5th Cir. 2011)
(“The fact that a partnership‟s underlying business activities
had economic substance does not, standing alone, immunize
the partnership from judicial scrutiny [under Culbertson].”);
id. (“If there was not a legitimate, profit-motivated reason to
operate as a partnership, then the partnership will be
disregarded for tax purposes even if it engaged in transactions
that had economic substance.”).




                              53
       A.     The Test

        A partnership exists when, as the Supreme Court said
in Commissioner v. Culbertson, two or more “parties in good
faith and acting with a business purpose intend[] to join
together in the present conduct of the enterprise.” 337 U.S. at
742; see also Comm’r v. Tower, 327 U.S. 280, 286-87 (1946)
(“When the existence of an alleged partnership arrangement
is challenged by outsiders, the question arises whether the
partners really and truly intended to join together for the
purpose of carrying on business and sharing in the profits or
losses or both.”); Southgate Master Fund, L.L.C. ex rel.
Montgomery Capital Advisors v. United States, 659 F.3d 466,
488 (5th Cir. 2011) (“The sine qua non of a partnership is an
intent to join together for the purpose of sharing in the profits
and losses of a genuine business.”).



        At oral argument, the IRS conceded that this case
“lends itself more cleanly to the bona fide partner theory,”
under which we look to the substance of the putative partner‟s
interest over its form. Oral Argument at 11:00, Historic
Boardwalk Hall, LLC v. Comm’r (No. 11-1832), available at
http://www.ca3.uscourts.gov/oralargument/audio/11-
1832Historic%20Boardwalk%20LLC%20v%20Commissione
r%20IRS.wma. Accordingly, we focus our analysis on
whether PB is as a bona fide partner in HBH, and in doing so,
we assume, without deciding, that this transaction had
economic substance. Specifically, we do not opine on the
parties‟ dispute as to whether, under Sacks v. Commissioner,
69 F.3d 982 (9th Cir. 1995), we can consider the HRTCs in
evaluating whether a transaction has economic substance.




                               54
       The Culbertson test is used to analyze the bona fides
of a partnership and to decide whether a party‟s “interest was
a bona fide equity partnership participation.” TIFD III-E, Inc.
v. United States, 459 F.3d 220, 232 (2d Cir. 2006)
(hereinafter “Castle Harbour ”). To determine, under
Culbertson, whether PB was a bona fide partner in HBH, we
must consider the totality of the circumstances,


       considering all the facts – the agreement, the
       conduct of the parties in execution of its
       provisions, their statements, the testimony of
       disinterested persons, the relationship of the
       parties, their respective abilities and capital
       contributions, the actual control of income and
       the purposes for which it is used, and any other
       facts throwing light on their true intent.

337 U.S. at 742. That “test turns on the fair, objective
characterization of the interest in question upon consideration
of all the circumstances.” Castle Harbour, 459 F.2d at 232.

       The Culbertson test “illustrat[es] … the principle that a
transaction must be judged by its substance, rather than its
form, for income tax purposes.” Trousdale v. Comm’r, 219
F.2d 563, 568 (9th Cir. 1955). Even if there are “indicia of an
equity participation in a partnership,” Castle Harbour, 459
F.3d at 231, we should not “accept[] at face value artificial
constructs of the partnership agreement,” id. at 232. Rather,
we must examine those indicia to determine whether they
truly reflect an intent to share in the profits or losses of an
enterprise or, instead, are “either illusory of insignificant.”
Id. at 231. In essence, to be a bona fide partner for tax




                              55
purposes, a party must have a “meaningful stake in the
success or failure” of the enterprise. Id.

       B.     The Commissioner’s Guideposts

        The Commissioner points us to two cases he calls
“recent guideposts” bearing on the bona fide equity partner
inquiry. (Appellant‟s Opening Br. at 34.) First, he cites to
the decision of the United States Court of Appeals for the
Second Circuit in Castle Harbour, 459 F.3d 220. The Castle
Harbour court relied on Culbertson in disregarding the
claimed partnership status of two foreign banks. Those banks
had allegedly formed a partnership, known as Castle Harbour,
LLC, with TIFD III-E, Inc. (“TIFD”), a subsidiary of General
Electric Capital Corporation, with an intent to allocate certain
income away from TIFD, an entity subject to United States
income taxes, to the two foreign banks, which were not
subject to such taxes. Id. at 223. Relying on the sham-
transaction doctrine, the district court had rejected the IRS‟s
contention that the foreign banks‟ interest was not a bona fide
equity partnership participation “because, in addition to the
strong and obvious tax motivations, the [partnership] had
some additional non-tax motivation to raise equity capital.”
Id. at 231. In reversing the district court, the Second Circuit
stated that it “[did] not mean to imply that it was error to
consider the sham test, as the IRS purported to rely in part on
that test. The error was in failing to test the banks‟ interest
also under Culbertson after finding that the [partnership‟s]
characterization survived the sham test.” Id. The Second
Circuit focused primarily on the Culbertson inquiry, and
specifically on the IRS‟s contention that the foreign banks
“should not be treated as equity partners in the Castle




                              56
Harbour partnership because they had no meaningful stake in
the success or failure of the partnership.” Id. at 224.

       Applying the bona fide partner theory as embodied in
Culbertson‟s totality-of-the-circumstances test, the Castle
Harbour court held that the banks‟ purported partnership
interest was, in substance, “overwhelmingly in the nature of a
secured lender‟s interest, which would neither be harmed by
poor performance of the partnership nor significantly
enhanced by extraordinary profits.” Id. at 231. Although it
acknowledged that the banks‟ interest “was not totally devoid
of indicia of an equity participation in a partnership,” the
Court said that those indicia “were either illusory or
insignificant in the overall context of the banks‟ investment,”
and, thus, “[t]he IRS appropriately rejected the equity
characterization.” Id.

       The Castle Harbour court observed that “consider[ing]
whether an interest has the prevailing character of debt or
equity can be helpful in analyzing whether, for tax purposes,
the interest should be deemed a bona fide equity
participation.” Id. at 232. In differentiating between debt and
equity, it counseled that “the significant factor … [is] whether
the funds were advanced with reasonable expectation of
repayment regardless of the success of the venture or were
placed at the risk of the business.” Id. (citation and internal
quotation marks omitted). Thus, in determining whether the
banks‟ interest was a bona fide equity participation, the
Second Circuit focused both on the banks‟ lack of downside
risk and lack of upside potential in the partnership. It agreed
with the “district court[‟s] recogni[tion] that the banks ran no
meaningful risk of being paid anything less than the
reimbursement of their investment at the [agreed-upon rate]




                              57
of return.” Id. at 233. In support of that finding, the Court
noted that:


       [TIFD] was required … to keep … high-grade
       commercial paper or cash, in an amount equal
       to 110% of the current value of the [amount that
       the banks would receive upon dissolution of the
       partnership.] The partnership, in addition, was
       obliged for the banks‟ protection to maintain
       $300 million worth of casualty-loss insurance.
       Finally, and most importantly, [General Electric
       Capital Corporation] – a large and very stable
       corporation – gave the banks its personal
       guaranty, which effectively secured the
       partnership‟s obligations to the banks.

Id. at 228.

        Regarding upside potential, however, the Second
Circuit disagreed with the district court‟s conclusion that the
banks had a “meaningful and unlimited share of the upside
potential.” Id. at 233. That conclusion could not be credited
because it “depended on the fictions projected by the
partnership agreement, rather than on assessment of the
practical realities.” Id. at 234. Indeed, the Second Circuit
stated that “[t]he realistic possibility of upside potential – not
the absence of formal caps – is what governs this analysis.”
Id.    In reality, “the banks enjoyed only a narrowly
circumscribed ability to participate in profits in excess of” the
repayment of its investment, id., because TIFD had the power
to either effectively restrict the banks‟ share of profits at 1%
above an agreed-upon return of $2.85 million, or to buy out
their interest at any time at a “negligible cost” of




                               58
approximately $150,000, id. at 226, 235. The return on the
banks‟ initial investment of $117.5 million was thus limited
to $2.85 million plus 1% – “a relatively insignificant
incremental return over the projected eight-year life of the
partnership,” id. at 235. In sum, “look[ing] not so much at
the labels used by the partnership but at true facts and
circumstances,” as Culbertson directs, the Castle Harbour
court was “compel[led] [to] conclu[de] that the … banks‟
interest was, for tax purposes, not a bona fide equity
participation.” Id. at 241.

       The second, more recent, precedent that the
Commissioner directs us to as a “guidepost” is Virginia
Historic Tax Credit Fund 2001 LP v. Commissioner, 639 F.3d
129 (4th Cir. 2011) (hereinafter “Virginia Historic”). There,
the United States Court of Appeals for the Fourth Circuit held
that certain transactions between a partnership and its partners
which sought to qualify for tax credits under the
Commonwealth of Virginia‟s Historic Rehabilitation Credit
Program (the “Virginia Program”)51 were, in substance, sales
of those credits which resulted in taxable income to the
partnership. Id. at 132. In Virginia Historic, certain
investment funds (the “Funds”) were structured “as

       51
          The Virginia Program, much like the federal HRTC
statute, was enacted to encourage investment in renovating
historic properties. Virginia Historic, 639 F.3d at 132.
Similar to federal HRTCs, the credits under the Virginia
Program could be applied to reduce a taxpayer‟s Virginia
income tax liability, dollar-for-dollar, up to 25% of eligible
expenses incurred in rehabilitating the property. Id. Also like
federal HRTCs, credits under the Virginia program could not
be sold or transferred to another party. Id. at 132-33.




                              59
partnerships that investors could join by contributing capital.”
Id. at 133. Through four linked partnership entities with one
“source partnership” entity (the “Source Partnership”), “[t]he
Funds would use [the] capital [provided by investors] to
partner with historic property developers [“Operating
Partnerships”] renovating smaller projects, in exchange for
state tax credits.” Id. The confidential offering memorandum
given to potential investors provided that, “[f]or every $.74-
$.80 contributed by an investor, [one of the] Fund[s] would
provide the investor with $1 in tax credits. If such credits
could not be obtained, the partnership agreement promised a
refund of capital to the investor, net of expenses.” Id. at 134
(citation and internal quotation marks omitted). Additionally,
“the partnership agreement stated that the Funds would invest
only in completed projects, thereby eliminating a significant
area of risk” to the investors. Id. “[T]he Funds reported the
money paid to Operating Partnerships in exchange for tax
credits as partnership expenses and reported the investors‟
contributions to the Funds as nontaxable contributions to
capital.” Id. at 135.

        The IRS “challenged [the Funds‟] characterization of
investors‟ funding as „contributions to capital‟” because the
IRS believed that the investors were, in substance, purchasers
of state income tax credits, and thus the money that the Funds
received from the investors should have been reported as
taxable income. Id. At trial, the Commissioner supported his
position with two theories. First, he relied on the substance-
over-form doctrine, saying that the investors were not bona
fide partners in the Funds but were instead purchasers; and,
second, he said that the transactions between the investors
and the partnerships were “disguised sales” under I.R.C.




                              60
§ 707.52 Id. at 136. The Tax Court rejected both of those
assertions, and found that the investors were partners in the
Funds for federal tax purposes. Id. at 136-37.

       The Fourth Circuit reversed the Tax Court.
“Assuming, without deciding, that a „bona fide‟ partnership
existed,” the Virginia Historic court found that “the
Commissioner properly characterized the transactions at issue
as „sales‟” under the disguised-sale rules. Id. at 137. The
Fourth Circuit first turned to the regulations that provide
guidance in determining whether a disguised sale has
occurred. See id. at 137-39 (citing to, inter alia, Treas. Reg.
§§ 1.707-3, 1.707-6(a)). Specifically, it explained that a
transaction should be reclassified as a sale if, based on all the
facts and circumstances, (1) a partner would not have
transferred money to the partnership but for the transfer of
property – the receipt of tax credits – to the partner; and (2)

       52
            Under I.R.C. § 707(a)(2)(A),
       [i]f (i) a partner performs services for a
       partnership or transfers property to a
       partnership, (ii) there is a related direct or
       indirect allocation and distribution to such
       partner, and (iii) the performance of such
       services (or such transfer) and the allocation
       and distribution, when viewed together, are
       properly characterized as a transaction
       occurring between the partnership and a partner
       acting other than in his capacity as a member of
       the partnership, such allocation and distribution
       shall be treated as a transaction [between the
       partnership and one who is not a partner].




                                61
the latter transfer – the receipt of tax credits – “is not
dependent on the entrepreneurial risks of partnership
operations.” Id. at 145 (quoting Treas. Reg. § 1.707-3(b)(1)).
The Fourth Circuit concluded that the risks cited by the Tax
Court – such as the “risk that developers would not complete
their projects on time because of construction, zoning, or
management issues,” “risk … [of] liability for improper
construction,” and “risk of mismanagement or fraud at the
developer partnership level” – “appear[ed] both speculative
and circumscribed.”       Id.    While the Fourth Circuit
acknowledged that “there was … no guarantee that resources
would remain available in the source partnership to make the
promised refunds,” it determined “that the Funds were
structured in such a way as to render the possibility of
insolvency remote.” Id.

       In holding “that there was no true entrepreneurial risk
faced by investors” in the transactions at issue, the Virginia
Historic court pointed to several different factors:


      First, investors were promised what was, in
      essence, a fixed rate of return on investment
      rather than any share in partnership profits tied
      to their partnership interests. … Second, the
      Funds assigned each investor an approximate
      .01% partnership interest and explicitly told
      investors to expect no allocations of material
      amounts of … partnership items of income,
      gain, loss or deduction. Third, investors were
      secured against losing their contributions by the
      promise of a refund from the Funds if tax
      credits could not be delivered or were revoked.




                             62
       And fourth, the Funds hedged against the
       possibility of insolvency by promising investors
       that contributions would be made only to
       completed projects and by requiring the
       Operating Partnerships to promise refunds, in
       some cases backed by guarantors, if promised
       credits could not be delivered.

Id. (internal citations and quotation marks omitted). In sum,
the Fourth Circuit deemed “persuasive the Commissioner‟s
contention that the only risk … was that faced by any advance
purchaser who pays for an item with a promise of later
delivery. It [was] not 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
145-46 (citing Tower, 327 U.S. at 287; Staff of J. Comm. on
Tax‟n, 98th Cong., 2d Sess., General Explanation of the
Revenue Provisions of the Deficit Reduction Act of 1984, at
226 (“To the extent that a partner‟s profit from a transaction
is assured without regard to the success or failure of the joint
undertaking, there is not the requisite joint profit motive.”
(alteration in original))). Accordingly, it agreed with the
Commissioner that the Funds should have reported the money
received from the investors as taxable income. Id. at 146.

        The Fourth Circuit concluded its opinion with an
important note regarding its awareness of the legislative
policy of providing tax credits to spur private investment in
historic rehabilitation projects:


             We reach this conclusion mindful of the
       fact that it is “the policy of the Federal
       Government” to “assist State and local




                              63
       governments … to expand and accelerate their
       historic preservation programs and activities.”
       16 U.S.C. § 470-1(6). And we find no fault in
       the Tax Court‟s conclusion that both the Funds
       and the Funds‟ investors engaged in the
       challenged transactions with the partial goal of
       aiding Virginia‟s historic rehabilitation efforts.
       But Virginia‟s Historic Rehabilitation Program
       is not under attack here.

Id. at 146 n.20.

       C.     Application of the Guideposts to HBH

        The Commissioner asserts that Castle Harbour and
Virginia Historic “provide a highly pertinent frame of
reference for analyzing the instant case.” (Appellant‟s
Opening Br. at 40.) According to the Commissioner, “[m]any
of the same factors upon which the [Castle Harbour court]
relied in finding that the purported bank partners … were, in
substance, lenders to the GE entity also support the
conclusion that [PB] was, in substance, not a partner in HBH
but, instead, was a purchaser of tax credits from HBH.”53
(Id.) That is so, says the Commissioner, because, as
confirmed by the Virginia Historic court‟s reliance on the

       53
           The Commissioner acknowledges that “[a]lthough
certain aspects of [PB‟s] cash investment in HBH were debt-
like (e.g., its 3-percent preferred return), this case does not fit
neatly within the debt-equity dichotomy, since [PB]
recovered its „principal,‟ i.e. its purported capital
contributions to HBH, in the form of tax credits rather than
cash.” (Appellant‟s Opening Br. at 40 n.14.)




                                64
“entrepreneurial risks of partnership operations,” Treas. Reg.
§ 1.707-3(b)(1), “the distinction between an equity
contribution to a partnership … and a transfer of funds to a
partnership as payment of the sales price of partnership
property [, i.e., tax credits,]… is the same as the principal
distinction between equity and debt” (Appellant‟s Opening
Br. at 40-41). The key point is that the “recovery of an equity
investment in a partnership is dependent on the
entrepreneurial risks of partnership operations, whereas
recovery of a loan to a partnership – or receipt of an asset
purchased from a partnership – is not.” (Id. at 41.) In other
words, “an equity investor in a partnership (i.e., a bona fide
partner) has a meaningful stake in the success or failure of the
enterprise, whereas a lender to, or purchaser from, the
partnership does not.” (Id.) In sum, the Commissioner
argues that, just as the banks in Castle Harbour had no
meaningful stake in their respective partnerships, and the
“investors” in Virginia Historic were more like purchasers
than participants in a business venture, “it is clear from the
record in this case that [PB] had no meaningful stake in the
success or failure of HBH.” (Id.)

        In response, HBH asserts that “[t]here are a plethora of
errors in the IRS‟s tortured effort … to apply Castle Harbour
and Virginia Historic … to the facts of the present case.”
(Appellee‟s Br. at 38.) First, HBH argues that it is
“abundantly apparent” that Castle Harbour “is completely
inapposite” to it because the actual provisions in Castle
Harbour‟s partnership agreement that minimized the banks‟
downside risk and upside potential were more limiting than
the provisions in the AREA. (Appellee‟s Br. at 35.) HBH
contends that, unlike the partnership agreement in Castle
Harbour, “[PB] has no rights under the AREA to compel




                              65
HBH to repay all or any part of its capital contribution,” PB‟s
3% Preferred Return was “not guaranteed,” and “NJSEA has
no … right to divest [PB] of its interest in any income or
gains from the East Hall.” (Id.)

        As to Virginia Historic, HBH argues that it “has no
application whatsoever” here. (Id. at 38.) It reasons that the
decision in that case “assumed that valid partnerships existed
as a necessary condition to applying I.R.C. § 707(b)‟s
disguised sale rules” (id. at 36), and that the case was
“analyzed … solely under the disguised sale regime” – which
is not at issue in the FPAA sent to HBH (id. at 38).

        Overall, HBH characterizes Castle Harbour and
Virginia Historic as “pure misdirections which lead to an
analytical dead end” (id. at 32), and emphasizes that “[t]he
question … Culbertson asks is simply whether the parties
intended to conduct a business together and share in the
profits and losses therefrom” (id. at 39). We have no quarrel
with how HBH frames the Culbertson inquiry. But what
HBH fails to recognize is that resolving whether a purported
partner had a “meaningful stake in the success or failure of
the partnership,” Castle Harbour, 459 F.3d at 224, goes to the
core of the ultimate determination of whether the parties
“„intended to join together in the present conduct of the
enterprise,‟” id. at 232 (quoting Culbertson, 337 U.S. at 742).
Castle Harbour‟s analysis that concluded that the banks‟
“indicia of an equity participation in a partnership” was only
“illusory or insignificant,” id. at 231, and Virginia Historic‟s
determination that the limited partner investors did not face
the “entrepreneurial risks of partnership operations,” 639 F.3d
at 145 (citation and internal quotation marks omitted), are
both highly relevant to the question of whether HBH was a




                              66
partnership in which PB had a true interest in profit and
loss,54 and the answer to that question turns on an assessment

      54
          We reject, moreover, any suggestion that the
disguised-sale rules and the bona fide-partner theory apply in
mutually exclusive contexts. Virginia Historic did not
“assume[] that valid partnerships existed as a necessary
condition” prior to applying the disguised-sale rules.
(Appellee‟s Br. at 36.) Rather, as the Virginia Historic court
observed, “[t]he Department of the Treasury specifically
contemplates that its regulations regarding disguised sales can
be applied before it is determined whether a valid partnership
exists.” 639 F.3d at 137 n.9 (citing Treas. Reg. § 1.707-3).
       More importantly, HBH simply ignores why many of
the principles espoused in Virginia Historic are applicable
here. It is true that the challenged transaction here does not
involve state tax credits and that the IRS has not invoked the
disguised-sale rules, but distinguishing the case on those
grounds fails to address the real issue. Virginia Historic is
telling because the disguised-sale analysis in that case
“touches on the same risk-reward analysis that lies at the
heart of the bona fide-partner determination.” (Appellant‟s
Reply Br. at 9.) Under the disguised-sale regulations, a
transfer of “property … by a partner to a partnership” and a
“transfer of money or other consideration … by the
partnership to the partner” will be classified as a disguised
sale if, based on the facts and circumstances, “(i) [t]he
transfer of money or other consideration would not have been
made but for the transfer of property; and (ii) [i]n cases in
which the transfers are not made simultaneously, the
subsequent transfer is not dependent on the entrepreneurial
risks of partnership operations.” Treas. Reg. § 1.707-3(b)(1).




                              67
       Thus, the disguised-sale analysis includes an
examination of “whether the benefit running from the
partnership to the person allegedly acting in the capacity of a
partner is „dependent upon the entrepreneurial risks of
partnership operations.‟”        (Appellant‟s Reply Br. at 9
(quoting Treas. Reg. § 1.707-3(b)(1)(ii)).)                  That
entrepreneurial risk issue also arises in the bona fide-partner
analysis, which focuses on whether the partner has a
meaningful stake in the profits and losses of the enterprise.
Moreover, many of the facts and circumstances laid out in the
pertinent treasury regulations that “tend to prove the existence
of a [disguised] sale,” Treas. Reg. § 1.707-3(b)(2), are also
relevant to the bona fide-partner analysis here. See, e.g., id.
§ 1.707-3(b)(2)(i) (“That the timing and amount of a
subsequent transfer [i.e., the HRTCs] are determinable with
reasonable certainty at the time of an earlier transfer [i.e.,
PB‟s capital contributions];”); id. § 1.707-3(b)(2)(iii) (“That
the partner‟s [i.e., PB‟s] right to receive the transfer of money
or other consideration [i.e., the HRTCs] is secured in any
manner, taking into account the period during which it is
secured;”); id. § 1.707-3(b)(2)(iv) (“That any person [i.e.,
NJSEA] has made or is legally obligated to make
contributions [e.g., the Tax Benefits Guaranty] to the
partnership in order to permit the partnership to make the
transfer of money or other consideration [i.e., the HRTCs];”);
id. § 1.707-3(b)(2)(v) (“That any person [i.e., NJSEA] has
loaned or has agreed to loan the partnership the money or
other consideration [e.g., Completion Guaranty, Operating
Deficit Guaranty] 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;”). Although we are not suggesting




                               68
of risk participation.      We are persuaded by the
Commissioner‟s argument that PB, like the purported bank
partners in Castle Harbour, did not have any meaningful
downside risk or any meaningful upside potential in HBH.

              1.     Lack of Meaningful Downside Risk

PB had no meaningful downside risk because it was, for all
intents and purposes, certain to recoup the contributions it had
made to HBH and to receive the primary benefit it sought–
the HRTCs or their cash equivalent. First, any risk that PB
would not receive HRTCs in an amount that was at least
equivalent to installments it had made to-date (i.e., the
“Investment Risk”) was non-existent. That is so because,
under the AREA, PB was not required to make an installment
contribution to HBH until NJSEA had verified that it had
achieved a certain level of progress with the East Hall
renovation that would generate enough cumulative HRTCs to
at least equal the sum of the installment which was then to be
contributed and all prior capital contributions that had been
made by PB. (See J.A. at 176, 242 (first installment of
$650,000 due at closing was paid when NJSEA had already
incurred over $53 million of QREs which would generate
over $10 million in HRTCs); id. at 176-77 (second
installment, projected to be $7,092,588, was not due until,
among other events, a projection of the HRTCs for 2000
(which were estimated at closing to be $7,789,284) based on

that a disguised-sale determination and a bona fide-partner
inquiry are interchangeable, the analysis pertinent to each
look to whether the putative partner is subject to meaningful
risks of partnership operations before that partner receives the
benefits which may flow from that enterprise.




                              69
a “determination of the actual rehabilitation costs of [HBH]
that qualify for Tax Credits in 2000”); id. at 177 (third
installment, projected to be $8,523,630, was not due until the
later of, among other events, (1) “evidence of Substantial
Completion of Phase 4 … .”; and (2) a projection of the
HRTCs for 2001 (which were estimated at closing to be
$11,622,889) based on a “determination of the actual
rehabilitation costs of [HBH] that qualify for Tax Credits in
2001”); id. (fourth installment, projected to be $1,929,580,
was not due until, among other events, PB received a “K-1 for
2001 evidencing the actual Tax Credits for 2001,” a tax
document that would not have been available until after the
estimated completion date of the entire project).) While PB
did not have the contractual right to “compel HBH to repay
all or any part of its capital contribution” (Appellee‟s Br. at
35), PB had an even more secure deal. Even before PB made
an installment contribution, it knew it would receive at least
that amount in return.

         Second, once an installment contribution had been
made, the Tax Benefits Guaranty eliminated any risk that, due
to a successful IRS challenge in disallowing any HRTCs, PB
would not receive at least the cash equivalent of the
bargained-for tax credits (i.e., the “Audit Risk”). The Tax
Benefits Guaranty obligated NJSEA55 to pay PB not only the
amount of tax credit disallowed, but also any penalties and
interest, as well as up to $75,000 in legal and administrative
expenses incurred in connection with such a challenge, and

      55
         Although HBH was the named obligor under the
Tax Benefits Guaranty, the agreement provided that “NJSEA
… shall fund any obligations of [HBH] to [PB]” under the
Tax Benefits Guaranty. (J.A. at 303.)




                              70
the amount necessary to pay any tax due on those
reimbursements. Cf. Virginia Historic, 639 F.3d at 145
(noting the fact that “investors were secured against losing
their contributions by the promise of a refund from the Funds
if tax credits could not be delivered or were revoked”
“point[ed] to the conclusion that there was no true
entrepreneurial risk faced by investors”).

       Third, any risk that PB would not receive all of its
bargained-for tax credits (or cash equivalent through the Tax
Benefits Guaranty) due to a failure of any part of the
rehabilitation to be successfully completed (i.e., the “Project
Risk”) was also effectively eliminated because the project
was already fully funded before PB entered into any
agreement to provide contributions to HBH. (See J.A. at 962
(statement in the Confidential Memorandum that “[t]he
rehabilitation is being funded entirely by [NJSEA]”); id. at
1134 (notes from a NJSEA executive committee meeting in
March 2000 indicating that “[t]he bulk of the Investor‟s
equity is generally contributed to the company after the
project is placed into service and the tax credit is earned, the
balance when stabilization is achieved”); id. at 1714 (notes to
NJSEA‟s 1999 annual report stating that the Casino
Reinvestment Development Authority had “agreed to
reimburse [NJSEA] [for] … all costs in excess of bond
proceeds for the project”).) That funding, moreover, included
coverage for any excess development costs.56 In other words,

       56
           PB had no exposure to the risk of excess
construction costs, as the Completion Guaranty in the AREA
provided that NJSEA was obligated to pay all such costs.
Additionally, even after the renovation was completed, PB
need not worry about any operating deficits that HBH would




                              71
PB‟s contributions were not at all necessary for the East Hall
project to be completed. Cf. Virginia Historic, 639 F.3d at
145 (noting that the fact that “the Funds hedged against the
possibility of insolvency by promising investors that
contributions would be made only to completed projects”
“point[ed] to the conclusion that there was not true
entrepreneurial risk faced by investors”). Furthermore,
HBH‟s own accountants came to the conclusion that the
source of the project‟s funds – NJSEA (backed by the Casino
Reinvestment Development Authority) – was more than
capable of covering any excess development costs incurred
by the project, as well as any operating deficits of HBH, and
NJSEA had promised that coverage through the Completion
Guaranty and the Operating Deficit Guaranty, respectively, in
the AREA. (See J.A. at 1638 (memo to audit file noting that,
because “[NJSEA] has the ability to fund the [operating]
deficits as a result of the luxury and other taxes provided by
the hospitality and entertainment industry in the state,” and
“there is no ceiling on the amount of funds to be provided [by
NJSEA to HBH],” “no triggering event [had occurred] which
require[d] [a write down] under FASB 144”).) Cf. Virginia
Historic, 639 F.3d at 145 (noting that although “[i]t [was] true
… there was … no guarantee that resources would remain
available in the source partnership to make the promised
refunds … it [was] also true that the Funds were structured in
such a way as to render the possibility of insolvency
remote”).) Thus, although the Tax Court determined that PB

incur, as NJSEA promised to cover any such deficits through
the Operating Deficit Guaranty. Furthermore, as detailed
infra note 58, PB ran no real risk of incurring any
environmental liability in connection with the East Hall
renovation.




                              72
“faced the risk that the rehabilitation would not be
completed” (J.A. at 43), the record belies that conclusion.
Because NJSEA had deep pockets, and, as succinctly stated
by Reznick, “there [was] no ceiling on the amount of funds to
be provided [by NJSEA to HBH]” (id. at 1638), PB was not
subject to any legally significant risk that the renovations
would falter.57

       In short, PB bore no meaningful risk in joining HBH,
as it would have had it acquired a bona-fide partnership
interest. See ASA Investerings P’ship v. Comm’r, 201 F.3d
505, 514 (D.C. Cir. 2000) (noting that the Tax Court did not
err “by carving out an exception for de minimis risks” when
assessing whether the parties assumed risk for the purpose of
determining whether a partnership was valid for tax purposes,
and determining that the decision not to consider de minimis
risk was “consistent with the Supreme Court‟s view … that a
transaction will be disregarded if it did „not appreciably affect
[taxpayer‟s] beneficial interest except to reduce his tax‟”

       57
           Although the question of the existence of a risk is a
factual issue we would review for clear error, there was
certainly no error in acknowledging that there were risks
associated with the rehabilitation. The relevant question,
here, however, is not the factual one of whether there was
risk; it is the purely the legal question of how the parties
agreed to divide that risk, or, in other words, whether a party
to the transactions bore any legally significant risk under the
governing documents. That question – whether PB was
subject to any legally meaningful risk in connection with the
East Hall rehabilitation – depends on the AREA and related
documents and hence is a question of law that we review de
novo.




                               73
(alteration in original) (quoting Knetsch v. United States, 364
U.S. 361, 366 (1960))).58

       PB‟s effective elimination of Investment Risk, Audit
Risk, and Project Risk is evidenced by the “agreement … of
the parties.” Culbertson, 337 U.S. at 742. PB and NJSEA, in
substance, did not join together in HBH‟s stated business
purpose – to rehabilitate and operate the East Hall. Rather,
the parties‟ focus from the very beginning was to effect a sale
and purchase of HRTCs. (See J.A. at 691 (Sovereign‟s
“consulting proposal … for the sale of historic rehabilitation
tax credits expected to be generated” by the East Hall
renovation); id. at 955 (Confidential Memorandum entitled
“The Sale of Historic Tax Credits Generated by the
Renovation of the Historic Atlantic City Boardwalk
Convention Hall”); id. at 1143 (cover letter from Sovereign to
NJSEA providing NJSEA “with four original investment
offers from institutions that have responded to the

       58
           The Tax Court thought that “[PB] faced potential
liability for environmental hazards from the rehabilitation.”
(J.A. at 43.) Specifically, it theorized that PB could be on the
hook for environmental liability (1) if environmental
insurance proceeds did not cover any such potential liability,
and (2) NJSEA was unable to cover that difference. In
reality, however, PB was not subject to any real risk of
environmental liability because of the Environmental
Guaranty and the fact that PB had a priority distribution right
to any environmental insurance proceeds that HBH received
(HBH‟s counsel at oral argument indicated that HBH carried
a $25 million policy). Moreover, PB received a legal opinion
that it would not be subject to any environmental liability
associated with the East Hall renovation.




                              74
[Confidential] Memorandum regarding the purchase of the
historic tax credits expected to be generated by” the East Hall
renovation).)59

       That conclusion is not undermined by PB‟s receipt of a
secondary benefit – the 3% Preferred Return on its
contributions to HBH. Although, in form, PB was “not
guaranteed” that return on an annual basis if HBH did not
generate sufficient cash flow (Appellee‟s Br. at 35), in
substance, PB had the ability to ensure that it would
eventually receive it. If PB exercised its Put Option (or
NJSEA exercised its Call Option), the purchase price to be
paid by NJSEA was effectively measured by PB‟s accrued
and unpaid Preferred Return. See infra note 63 and
accompanying text. And to guarantee that there would be
sufficient cash to cover that purchase price, NJSEA was
required to purchase the Guaranteed Investment Contract in
the event that NJSEA exercised its Call Option.60 Cf.
Virginia Historic, 639 F.3d at 145 (noting the fact that
“investors were promised what was, in essence, a fixed rate of

       59
         Although we do not “[p]ermit[] a taxpayer to control
the economic destiny of a transaction with labels” when
conducting a substance-over-form inquiry, Schering-Plough,
Corp. v. United States, 651 F. Supp. 2d 219, 242 (D.N.J.
2009), the labels chosen are indicative of what the parties
were trying to accomplish and thus those labels “throw[] light
on [the parties‟] true intent,” Culbertson, 337 U.S. at 742.
       60
          As noted supra in Section I.B.4.a, the Guaranteed
Investment Contract was “sized to pay off” the accrued but
unpaid Preferred Return, as well as the outstanding balance
on the Investor Loan with accrued interest. (J.A. at 1211.)




                              75
return on investment rather than any share in partnership
profits tied to their partnership interests” “point[ed] to the
conclusion that there was not true entrepreneurial risk faced
by investors”). Thus, the Tax Court‟s finding that PB “might
not receive its preferred return … at all” unless NJSEA
exercised its Call Option (J.A. at 51-52), was clearly
erroneous because it ignored the reality that PB could assure
its return by unilaterally exercising its Put Option.61

        HBH, of course, attacks the Commissioner‟s assertion
that PB lacked downside risk, claiming that “the IRS‟s theory
that a valid partnership cannot exist unless an investor-partner
shares in all of the risks and costs of the partnership has no
basis in partnership or tax law,” and “is contrary to the
standard economic terms of innumerable real estate
investment partnerships in the United States for every type of
real estate project.” (Appellee‟s Br. at 44.) HBH also asserts
that many of the negotiated provisions – such as the
Completion Guaranty, Operating Deficit Guaranty, and the
Preferred Return – are “typical in a real estate investment
partnership.” (Id. at 45.) The Commissioner has not claimed,
however, and we do not suggest, that a limited partner is
prohibited from capping its risk at the amount it invests in a
partnership. Such a cap, in and of itself, would not jeopardize
its partner status for tax purposes. We also recognize that a
limited partner‟s status as a bona fide equity participant will

       61
         It is true, of course, that PB could not exercise its
Put Option until seven years from the date that the East Hall
was placed in service. However, PB would have no interest
in exercising that option within the first five years anyway
because the HRTCs that PB received would be subject to
recapture during that period. See supra note 20.




                              76
not be stripped away merely because it has successfully
negotiated measures that minimize its risk of losing a portion
of its investment in an enterprise. Here, however, the parties
agreed to shield PB‟s “investment” from any meaningful risk.
PB was assured of receiving the value of the HRTCs and its
Preferred Return regardless of the success or failure of the
rehabilitation of the East Hall and HBH‟s subsequent
operations. And that lack of meaningful risk weighs heavily
in determining whether PB is a bona fide partner in HBH. Cf.
Virginia Historic, 639 F.3d at 145-46 (explaining that
“entrepreneurial risks of partnership operations” involves
placing “money into a venture with the hope that it might
grow in amount but with the knowledge that it may well
shrink”); Castle Harbour, 459 F.3d at 232 (noting that
“Congress appears to have intended that „the significant
factor‟ in differentiating between [debt and equity] be
whether „the funds were advanced with reasonable
expectations of repayment regardless of the success of the
venture or were placed at the risk of the business‟” (quoting
Gilbert v. Comm’r, 248 F.2d 399, 406 (2d Cir. 1957))).

              2.     Lack of Meaningful Upside Potential

        PB‟s avoidance of all meaningful downside risk in
HBH was accompanied by a dearth of any meaningful upside
potential. “Whether [a putative partner] is free to, and does,
enjoy the fruits of the partnership is strongly indicative of the
reality of his participation in the enterprise.” Culbertson, 337
U.S. at 747. PB, in substance, was not free to enjoy the fruits
of HBH. Like the foreign banks‟ illusory 98% interest in
Castle Harbour, PB‟s 99.9% interest in HBH‟s residual cash
flow gave a false impression that it had a chance to share in
potential profits of HBH. In reality, PB would only benefit




                               77
from its 99.9% interest in residual cash flow after payments to
it on its Investor Loan and Preferred Return and the following
payments to NJSEA: (1) annual installment payment on the
Acquisition Loan ($3,580,840 annual payment for 39 years
plus arrears); (2) annual installment payment on the
Construction Loan;62 and (3) payment in full of the operating
deficit loan (in excess of $28 million as of 2007). Even
HBH‟s own rosy financial projections from 2000 to 2042,
which (at least through 2007) had proven fantastically
inaccurate, forecasted no residual cash flow available for
distribution. Thus, although in form PB had the potential to
receive the fair market value of its interest (assuming such
value was greater than its accrued but unpaid Preferred
Return) if either NJSEA exercised its Call Option or PB
exercised its Put Option, in reality, PB could never expect to
share in any upside.63 Cf. Castle Harbour, 459 F.3d at 234

       62
          The Construction Loan called for annual interest-
only payments until April 30, 2002, and thereafter, called for
annual installments of principal and interest that would fully
pay off the amount of the principal as then had been advanced
by April 30, 2040. Under the original principal amount of
$57,215,733 with an interest rate of 0.1% over a 39-year
period, and assuming no arrearage in the payment of principal
and interest, the annual installment of principal and interest
would be approximately $1.5 million.
       63
         To put it mildly, the parties and their advisors were
imaginative in creating financial projections to make it appear
that HBH would be a profit-making enterprise. For example,
after Sovereign said that it was “cautious about [Spectacor‟s
projections of net losses for HBH since] they might prove
excessively conservative” (J.A. at 793), and suggested that
NJSEA “could explore shifting the burden of some of




                              78
[HBH‟s] operating expenses … to improve results” (id. at
804), Spectacor made two sets of revisions to HBH‟s five-
year draft projections that turned an annual average $1.7
million net operating loss to annual net operating gains
ranging from $716,000 to $1.24 million by removing HBH‟s
projected utilities expenses for each of the five years.
Similarly, when an accountant from Reznick informed
Hoffman that the two proposed loans from NJSEA to HBH
“ha[d] been set up to be paid from available cash flow” but
that “[t]here was not sufficient cash to amortize this debt” (id.
at 1160), Hoffman instructed that accountant to remedy that
issue by increasing the projection of baseline revenues in
2002 by $1 million by adding a new revenue source of
$750,000 titled “naming rights,” and by increasing both
“parking revenue” and “net concession revenue” by $125,000
each (id. at 1196). Overall, although Reznick projected near
closing that HBH would generate an aggregate net operating
income of approximately $9.9 million for 2003 through 2007,
HBH actually experienced an aggregate net operating loss of
over $10.5 million for those five years.
        Despite the smoke and mirrors of the financial
projections, the parties‟ behind-the-scenes statements reveal
that they never anticipated that the fair market value of PB‟s
interest would exceed PB‟s accrued but unpaid Preferred
Return. (See id. at 1162 (pre-closing memo from NJSEA‟s
outside counsel to NJSEA that “[d]ue to the structure of the
transaction,” the fair market value would not come into play
in determining the amount that PB would be owed if NJSEA
exercised its Call Option).) That admission is hardly
surprising because the substance of the transaction indicated
that this was not a profit-generating enterprise. Cf. Virginia
Historic, 639 F.3d at 145 (noting that the fact that “the Funds




                               79
(“The realistic possibility of upside potential – not the
absence of formal caps – is what governs [the bona fide
equity participation] analysis.”). Even if there were an
upside, however, NJSEA could exercise its Consent Option,
and cut PB out by paying a purchase price unrelated to any
fair market value.64 See supra Section I.B.4.a. In sum, “the
structure of the … transaction ensured that [PB] would never
receive any [economic benefits from HBH].” Southgate
Master Fund, 659 F.3d at 486-87. And “[i]n light of
Culbertson‟s identification of „the actual control of income
and the purposes for which it [was] used‟ as a metric of a
partnership‟s legitimacy, the terms of the [AREA and the
structure of the various options] constitute compelling
evidence” that PB was not a bona fide partner in HBH. Id. at
486 (quoting Culbertson, 337 U.S. at 742).

              3.     HBH’s Reliance on Form over Substance

      After attempting to downplay PB‟s lack of any
meaningful stake in the success or failure of the enterprise,
HBH presses us to consider certain evidence that it believes
“overwhelmingly proves that [PB] is a partner in HBH” under


… explicitly told investors to expect no allocation of material
amounts of … partnership items of income, gain, loss, or
deduction” “point[ed] to the conclusion that there was no true
entrepreneurial risk faced by investors” (citation and internal
quotation marks omitted)).
       64
           Thus, contrary to HBH‟s assertion, NJSEA
effectively did have the “right to divest [PB] of its interest in
any income or gains from the East Hall.” (Appellee‟s Br. at
35.)




                               80
the Culbertson totality-of-the-circumstances test. (Appellee‟s
Br. at 38.) That “overwhelming” evidence includes: (1) that
HBH was duly organized as an LLC under New Jersey law
and, as the AREA provides, “was formed to acquire, develop,
finance, rehabilitate, maintain, operate, license, and sell or
otherwise to dispose of the East Hall” (id. at 40; see J.A. at
157); (2) PB‟s “net economic benefit” from the HRTCs and
the 3% Preferred Return (Appellee‟s Br. at 41); (3) PB‟s
representatives‟ “vigorous[] negotiat[ion] [of] the terms of the
AREA” (id. at 41); (4) “the nature and thoroughness” of PB‟s
“comprehensive due diligence investigation in connection
with its investment in HBH” (id. at 42); (5) PB‟s “substantial
financial investment in HBH” (id.); (6) various business
agreements that had been entered into between NJSEA and
certain third parties that were all assigned to, and assumed by,
HBH (id. at 43); (7) bank and payroll accounts that were
opened in HBH‟s name and insurance agreements that were
amended to identify HBH as an owner and include PB as an
additional insured; and (8) the fact that, following closing,
“NJSEA kept in constant communication with [PB] regarding
the renovations to the East Hall, and the business operations
of the Hall” (id.).

       Much of that evidence may give an “outward
appearance of an arrangement to engage in a common
enterprise.” Culbertson, 337 U.S. at 752 (Frankfurter, J.,
concurring). But “the sharp eyes of the law” require more
from parties than just putting on the “habiliments of a
partnership whenever it advantages them to be treated as
partners underneath.” Id. Indeed, Culbertson requires that a
partner “really and truly intend[] to … shar[e] in the profits
and losses” of the enterprise, id. at 741 (majority opinion)
(emphasis added) (citation and internal quotation marks




                              81
omitted), or, in other words, have a “meaningful stake in the
success or failure” of the enterprise, Castle Harbour, 459
F.3d at 231. Looking past the outward appearance, HBH‟s
cited evidence does not demonstrate such a meaningful stake.

       First, the recitation of partnership formalities – that
HBH was duly organized, that it had a stated purpose under
the AREA, that it opened bank and payroll accounts, and that
it assumed various obligation – misses the point. We are
prepared to accept for purposes of argument that there was
economic substance to HBH. The question is whether PB had
a meaningful stake in that enterprise. See Castle Harbour,
459 F.3d at 232 (“The IRS‟s challenge to the taxpayer‟s
characterization is not foreclosed merely because the taxpayer
can point to the existence of some business purpose or
objective reality in addition to its tax-avoidance objective.”);
Southgate Master Fund, 659 F.3d at 484 (“The fact that a
partnership‟s underlying business activities had economic
substance does not, standing alone, immunize the partnership
from judicial scrutiny [under Culbertson]. The parties‟
selection of the partnership form must have been driven by a
genuine business purpose.” (internal footnote omitted)). To
answer that, we must “look beyond the superficial formalities
of a transaction to determine the proper tax treatment.”
Edwards v. Your Credit, Inc., 148 F.3d 427, 436 (5th Cir.
1998) (citation and internal quotation marks omitted).

       Second, evidence that PB received a “net economic
benefit” from HBH and made a “substantial financial
investment in HBH” can only support a finding that PB is a
bona fide partner if there was a meaningful intent to share in
the profits and the losses of that investment. The structure of
PB‟s “investment,” however, shows clearly that there was no




                              82
such intent. Recovery of each of the contributions that made
up the “substantial financial investment” was assured by the
provisions of the AREA and the Tax Benefits Guaranty.
And, as the Commissioner rightly notes, PB‟s net after-tax
economic benefit from the transaction – in the form of the
HRTCs (or the cash equivalent via the Tax Benefits
Guaranty) and the effectively guaranteed Preferred Return –
“merely demonstrates [PB‟s] intent to make an economically
rational use of its money on an after-tax basis.” (Appellant‟s
Reply Br. at 13.) Indeed, both parties in a transaction such as
this one will always think they are going to receive a net
economic benefit; otherwise, the transaction would never
occur. If in fact that was the test, there would be a green-light
for every tax-structured transaction that calls itself a
“partnership.”

        Third, the fact that NJSEA “kept in constant
communication” regarding the East Hall is hardly surprising.
As discussed earlier, supra Section II.C.1, each installment
contribution from PB was contingent upon NJSEA verifying
that a certain amount of work had been completed on the East
Hall so that PB was assured it would not be contributing more
money than it would be guaranteed to receive in HRTCs or
their cash equivalent. The mere fact that a party receives
regular updates on a project does not transform it into a bona
fide partner for tax purposes.

       Fourth, looking past the form of the transaction to its
substance, neither PB‟s “vigorous[] negotiat[ion]” nor its
“comprehensive due diligence investigation” is, in this
context, indicative of an intent to be a bona fide partner in
HBH. We do not doubt that PB spent a significant amount of
time conducting a thorough investigation and negotiating




                               83
favorable terms. And we acknowledge that one of the factors
cited by Culbertson is “the conduct of the parties in execution
of its provisions.” 337 U.S. at 742. But the record reflects
that those efforts were made so that PB would not be subject
to any real risks that would stand in the way of its receiving
the value of the HRTCs; not, as HBH asserts, “to form a true
business relationship.” (Appellee‟s Br. at 41.) We do not
believe that courts are compelled to respect a taxpayer‟s
characterization of a transaction for tax purposes based on
how document-intensive the transaction becomes. Recruiting
teams of lawyers, accountants, and tax consultants does not
mean that a partnership, with all its tax credit gold, can be
conjured from a zero-risk investment of the sort PB made
here.

       In the end, the evidence HBH cites focuses only on
form, not substance.          From the moment Sovereign
approached NJSEA, the substance of any transaction with a
corporate investor was calculated to be a “sale of … historic
rehabilitation tax credits.” (J.A. at 691.) Cf. Castle Harbour,
459 F.3d at 236 (finding that the banks‟ interest “was more in
the nature of window dressing designed to give ostensible
support to the characterization of equity participation … than
a meaningful stake in the profits of the venture”). And in the
end, that is what the substance turned out to be.

       Like the Virginia Historic court, we reach our
conclusion mindful of Congress‟s goal of encouraging
rehabilitation of historic buildings. See 639 F.3d at 146 n.20.
We have not ignored the predictions of HBH and amici that,
if we reallocate the HRTCs away from PB, we may
jeopardize the viability of future historic rehabilitation
projects. Those forecasts, however, distort the real dispute.




                              84
The HRTC statute “is not under attack here.” Id. It is the
prohibited sale of tax credits, not the tax credit provision
itself, that the IRS has challenged. Where the line lies
between a defensible distribution of risk and reward in a
partnership on the one hand and a form-over-substance
violation of the tax laws on the other is not for us to say in the
abstract. But, “[w]here, as here, we confront taxpayers who
have taken a circuitous route to reach an end more easily
accessible by a straightforward path, we look to the substance
over form.” Southgate Master Fund, 659 F.3d at 491
(citation and internal quotation marks omitted). And, after
looking to the substance of the interests at play in this case,
we conclude that, because PB lacked a meaningful stake in
either the success or failure of HBH, it was not a bona fide
partner
        .
III. Conclusion

       For the foregoing reasons, we will reverse the Tax
Court‟s January 3, 2011 decision, and remand the case for
further proceedings consistent with this opinion.




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