2012 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

8-27-2012

Historic Boardwalk Hall v. Commissioner of

Internal Reven

Precedential or Non-Precedential: Precedential

Docket No. 11-1832

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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)

_______________
2

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
3

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

_______________
4

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
5

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
6

III. Conclusion..................................................................85
7

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 HBH1to 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 
8

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.
9

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 
10

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).
11

(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/irsmssp/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 
12

rehabilitated building6other 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).
13

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 
14

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.
15

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 
16

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.)
17

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.
18

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.)
19

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 
20

[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 
21

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.
22

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.
23

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 taxcredit 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 
24

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. 
25

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 
26

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 
27

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. 
28

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.)
29

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.
30

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.
31

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.
32

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)].”). 
33

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 
34

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.
35

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 
36

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.)
37

sum of (1) any reduction in projected tax benefits, “as revised 

by the then applicable Revised Economic Projections,”29as 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.)
38

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 
39

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.
40

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 
41

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.
42

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 
43

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.
44

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.
45

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.
46

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).
47

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.)
48

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 
49

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 
50

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 
51

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.
52

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 “shampartnership 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. 
53

 

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-overform 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.”). 
54

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.
55

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
56

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 shamtransaction 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 
57

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] 
58

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 
59

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.
60

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 substanceover-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. 
61

§ 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].
62

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. 
63

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 
64

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 debtlike (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.)
65

“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 
66

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 
67

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).
68

 

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 
69

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.
70

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.)
71

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 
72

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.
73

“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.
74

(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. 
75

[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.)
76

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.
77

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 
78

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 interestonly 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 
79

 

[HBH‟s] operating expenses ... to improve results” (id. at 

804), Spectacor made two sets of revisions to HBH‟s fiveyear 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 
80

(“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.)
81

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 
82

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 
83

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 
84

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. 
85

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.