PLR 200033030: partnership transfers terminate some OLPs but avoid low income housing credit recapture

Plain-English summary

A limited partner planned to contribute interests in operating partnerships that owned low income housing projects to a holding limited partnership. The IRS ruled that the contribution would terminate operating partnerships in which the partner held at least 50 percent of the capital and profits, while smaller interests would terminate only if combined transfers reached the statutory threshold within 12 months. The IRS also concluded that the transfer would not cause low income housing credit recapture under section 42 because the represented facts supported analogous change in form and de minimis exceptions. The letter gave no opinion on whether the holding limited partnership was a partnership for federal tax purposes.

Ruling snapshot

• Question: Would contributing the partner's operating partnership interests to a holding partnership terminate the operating partnerships or cause low income housing credit recapture?
• Outcome: Mixed. Some operating partnerships terminate under section 708(b)(1)(B), while the transfer avoids the represented section 42 recapture liability under the cited exceptions.
• Key authorities: IRC §§ 38, 42, 42(j), 47, 50, 351, and 708(b)(1)(B); Treas. Reg. §§ 1.47-1, 1.47-3(f), 1.47-6(a)(2), and 1.708-1(b)(iv); Rev. Rul. 90-60.

Full text (IRS public release)

Internal Revenue Service                        Department of the Treasury

Index Numbers: 708.01-00, 42.10-00              Washington, DC 20224



                                                Person to Contact:

                                                Telephone Number:
Number: 200033030
Release Date: 8/18/2000                         Refer Reply To:
                                                CC:DOM:P&SI:1 PLR-114514-99
                                                Date:
                                                    May 18, 2000



Legend

X     =

Y     =

HLP   =

A     =

D1    =

State =

a%    =

      This responds to the letter dated August 26, 1999, and subsequent
correspondence dated January 24, 2000 and May 4, 2000, submitted on behalf of X
and HLP, requesting rulings under §§ 708 and 42 of the Internal Revenue Code.

                                         FACTS

       X is a limited partner in numerous operating limited partnerships (OLPs) that
own and operate qualified projects that provide low-income rental housing and receive
low-income housing tax credits (“LIHTCS”) under § 42. Section 42(j)(5) does not apply
to the OLPs. Except for five of the OLPs, X has more than a 50 percent interest in the
capital and profits of each of the OLPs.

      X is also a partner in a holding limited partnership (HLP) formed in D1. X is the
general partner and A, an officer of X, is the limited partner.

       For what has been represented to be valid business reasons, including
consolidating and improving the administration of the OLPs, X and HLP plan to
implement a holding company structure. Under this structure, X will contribute its
limited partnership interests in the OLPs to HLP. X’s general partnership interest in
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HLP will be converted into a limited partnership interest, and A will terminate his interest
in HLP. Further, Y, who has significant expertise in the management of investments in
real estate, will contribute property and services to HLP in exchange for a general
partnership interest in HLP.

       X and HLP represent that:

       (1) HLP will be classified as a partnership for federal tax purposes;

      (2) X’s interest in HLP will exceed a% throughout the compliance period (as
defined in § 42(i)(l)) of each OLP; and

       (3) With respect to HLP, § 1.47-1 will not apply to any § 38 property that is
subject to recapture due to its being held by a partnership terminated under
§ 708(b)(1)(B) because HLP will satisfy the “mere change in form” exception under
§ 1.47-3(f).

                                 RULINGS REQUESTED

      In connection with the proposed restructuring described above, X and HLP
request the following rulings:

     (1) The contribution of X’s interests in the OLPs to HLP will not terminate the
OLPs under § 708(b)(1)(B); and

      (2) The contribution of X’s interests in the OLPs to HLP will not cause X to
recapture LIHTCs under § 42(j).

                                  LAW AND ANALYSIS

       Ruling Request #1

       Section 708(a) provides that a partnership continues to exist for federal income
tax purposes until it is terminated. A partnership is terminated if, within a 12-month
period, there is a sale or exchange of 50 percent or more of the total interest in
partnership capital and profits. Section 708(b)(1)(B).

         Section 1.708-1(b)(iv) provides that if a partnership is terminated by a sale or
exchange of an interest, the following is deemed to occur: The partnership contributes
all of its assets and liabilities to a new partnership in exchange for an interest in the new
partnership; and, immediately thereafter, the terminated partnership distributes its
interests in the new partnership to the purchasing partner and the other remaining
partners in proportion to their respective interests in the terminated partnership in
liquidation of the terminated partnership, either for continuation of the business by the
new partnership or for its dissolution and winding up.
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        Here, the contribution to HLP of X’s interest in an OLP will be treated as a sale
or exchange for purposes of § 708(b)(1)(B). Accordingly, the contribution to HLP of X’s
interests in those OLPs in which X holds an interest equal to or in excess of 50 percent
of the OLP’s total interests in partnership capital and profits will terminate such OLPs
under § 708(b)(1)(B).

       Ruling Request #2

       Section 38(a) provides for a general business credit against tax that includes the
amount of the current year business credit. Section 38(b)(5) provides that the amount
of the current year business credit includes the low-income housing credit determined
under § 42(a).

        Section 42(a) provides that, for purposes of § 38, the amount of the low-income
housing credit determined under § 42 for any taxable year in a 10-year credit period
shall be an amount equal to the applicable percentage of the qualified basis of each
qualified low-income building.

       In the case of any qualified low-income building placed in service by a taxpayer
after 1987, § 42(b) provides, in part, that the term “applicable percentage” means the
appropriate percentage prescribed by the Secretary for the month applicable under
§ 42(b)(2)(A)(i) or (ii). Section 42(b)(2)(B) provides that the percentages prescribed by
the Secretary for any month shall be percentages that will yield over a 10-year period
amounts of credit that have a present value equal to: (i) 70 percent of the qualified
basis of new buildings that are not federally subsidized for the taxable year; and (ii) 30
percent of the qualified basis of existing buildings, and of new buildings that are
federally subsidized for the taxable year.

        Section 42(c) provides that the qualified basis of any qualified low-income
building for any taxable year is an amount equal to the applicable fraction (defined in
§ 42(c)(1)(B)) of the eligible basis of such building. In general, under § 42(d) the
eligible basis of a new building is its adjusted basis as of the close of the first taxable
year of the credit period.

       Section 42(j)(1) provides that if at the close of any taxable year in the compliance
period, the amount of the qualified basis of any building with respect to the taxpayer is
less than the amount of such basis as of the close of the preceding taxable year, the
taxpayer's tax for the taxable year will be increased by the credit recapture amount.
The credit recapture amount is determined under § 42(j)(2) and § 42(j)(3).

       The legislative history to § 42 provides that, generally, any change in ownership
of a low-income building during the compliance period is a recapture event and that all
dispositions of ownership interests in buildings are treated as transfers for purposes of
recapture. See 2 H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess., II-96 and II-102
(1986), 1986-3 (Vol. 4) C.B. 1, 96, 102. Under § 42(j)(6), however, no recapture will be
imposed on a disposition of a low-income building (or an interest therein) if the taxpayer
furnishes to the Secretary a bond, and it is reasonably expected that the building will
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continue to be operated as a qualified low-income building through the end of the
compliance period. A taxpayer may satisfy the bond posting requirement of
§ 42(j)(6) by: (1) completing a portion of Form 8693, Low-Income Housing Credit
Disposition Bond, and having it approved by the Internal Revenue Service; or (2)
following the procedures outlined in Rev. Proc. 99-11 (1992-2 I.R.B. 14) establishing a
Treasury Direct Account.

       Analogous provisions concerning recapture of investment tax credit (ITC)
property provide relevant guidance for determining recapture under § 42(j). Under
§ 50(a)(1), if during any taxable year ITC property is disposed of or otherwise ceases to
be ITC property with respect to the taxpayer before the close of the recapture period,
the tax for such taxable year shall be increased. Currently, there are no regulations
under § 50. However, for property placed in service before January 1, 1991, former
§ 47(a)(1) (and the regulations thereunder) contained a similar ITC recapture rule. The
regulations under former § 47 (which are still effective) mirror the general recapture rule
of former § 47 that a disposition or cessation of ITC property before the close of the
estimated useful life of the property that was taken into account in computing the
taxpayer's qualified investment will result in ITC recapture.

       One exception to the general rule concerning the recapture of ITC property,
§ 1.47-3(f)(1) (reflected now, in part, in § 50(a)(4)), provides that no ITC recapture will
occur in the case of a mere change in form of conducting a trade or business. To
qualify for the § 1.47-3(f)(1) exception, the following requirements must be met: (1) the
ITC property must be retained as ITC property in the same trade or business; (2) the
transferor (or in the case where the transferor is a partnership, the partner) of the ITC
property must retain a substantial interest in the trade or business; (3) substantially all
the assets (whether or not ITC property) necessary to operate the trade or business
must be transferred to the transferee to whom the ITC property is transferred; and (4)
the basis of the ITC property in the hands of the transferee is determined in whole or in
part by reference to the basis of the ITC property in the hands of the transferor.

       Section 1.47-3(f)(2) provides that a transferor is considered as having retained a
substantial interest in a trade or business only if, after the change in form, the
transferor’s retained interest in the trade or business is substantial in relation to the total
interest of all persons or is equal to or greater than the transferor’s interest prior to the
change in form.

        Another exception to the general rule concerning the recapture of ITC property,
§ 1.47-6(a)(2), provides a de minimis rule whereby a partner may dispose up to 33D
percent of its proportionate interests in the general profits of a partnership (or in a
particular item of § 38 property) before ITC recapture applies. In determining the
partner’s proportionate interest in the general profits of a partnership for purposes of
applying this de minimis rule, § 1.47-6(a)(2)(b)(iii) provides an ‘identity of interest’ rule
whereby the partner is considered to own any interest in the partnership that it owns
directly or indirectly (through ownership in other entities provided the other entities’
bases in the interest are determined in whole or in part by reference to the basis of the
interest in the hands of the partner). For example, if A, whose proportionate interest in
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the general profits of partnership X is 20 percent, transfers all of this interest to
Corporation Y in exchange for all of the stock of Y in a § 351 transaction, then A shall
be considered to own a 20 percent interest in partnership X.

        Rev. Rul. 90-60, 1990-2 C.B. 6, adopts a similar de minimis rule for purposes of
§ 42(j) whereby no bond is required to avoid or defer recapture for a disposition by a
partner of its interest in a low income building held through a partnership (other than a
partnership described in § 42(j)(5)(B)) until the partner has disposed of more than 33D
percent of its greatest total interest in the building held through the partnership.

        Here, X intends to transfer its entire interest in each of the OLPs to HLP. This
will result in a transfer of X’s entire interest in the assets (including any § 42 buildings)
owned by the OLPs to HLP. All dispositions of ownership interests in § 42 buildings are
treated as transfers (or a change in ownership) for purposes of recapture and any
change in ownership is a recapture event; thus, X’s proposed transfer of its OLP
interests would, absent an exception, be a disposition and therefore a recapture event.

       Section 42(j)(5) does not apply to the OLPs. For these partnerships, a § 42
recapture event can occur at the partnership level and at the partner level. Applying the
two levels of recapture potential for these partnerships to the proposed transaction, the
following results occur –

       A. Partnership Level Recapture Event

       Where X’s contribution of its interest in each of the OLPs to HLP results in a
§ 708(b)(1)(B) technical termination of the OLP, then each OLP will be deemed to have
contributed all their assets, including all their § 42 building(s), to a new OLP in return for
an interest in the new OLP. Each old OLP’s contribution will be a disposition and a §
42 recapture event. X will be a partner in HLP, and HLP will be a partner in each of the
old OLPs when they terminate. Accordingly, X will be subject to any recapture liability
allocated by HLP to its partners as a result of the old OLPs’ disposition of their § 42
buildings to the new OLPs, unless an exception to § 42 recapture applies.

         X and HLP represent that with respect to HLP, § 1.47-1 will not apply to any
§ 38 property that is subject to recapture due to its being held by a partnership
terminated under § 708(b)(1)(B) because HLP will satisfy the “mere change in form”
exception of § 1.47-3(f). Provided the requirements of § 1.47-3(f) are met, no recapture
liability will result from the disposition of § 38 property by the old OLPs; and HLP, as a
partner in the old OLPs (and X as a partner in the HLP) at the time of the dispositions,
likewise will not be subject to ITC recapture. It is appropriate to analogize the § 1.47-
3(f) exception for ITC recapture to determining recapture under § 42(j). Therefore,
based on the analogous application of § 1.47-3(f), the deemed contribution of the § 42
buildings to the new OLPs under § 708(b)(1)(B) will not be treated as a disposition of
§ 42 property resulting in the recapture of § 42 credits by X.

       B. Partner Level Recapture Event
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        Generally, X, as a partner in partnerships to which § 42(j)(5) does not apply, is
subject to recapture for any disposition of its interest in § 42 property held through
these partnerships. However, X may (if applicable) avail itself of the 33D percent de
minimis exception of Rev. Rul. 90-60. By assigning its entire interest in each of the
OLPs to HLP, X will appear to have disposed of more than 33D percent of its greatest
total interest in the § 42 buildings held through the OLPs. However, because the 33D
percent de minimis rule of Rev. Rul. 90-60 is intended to reflect the 33D percent de
minimis rule of § 1.47-6(a)(2), any rule(s) clarifying how the 33D percent de minimis
rule of § 1.47-6(a)(2) is determined should also apply for purposes of § 42. This
includes the identity of interest rule of § 1.47-6(a)(2)(b)(iii) which provides that in
determining a partner’s proportionate interest in the general profits of a partnership the
partner shall be considered to own any interest in the partnership that it owns directly or
indirectly (through ownership in other entities provided the other entities’ bases in the
interest are determined in whole or in part by reference to the basis of the interest in the
hands of the partner). Here, X’s proportionate interest in the § 42 buildings will not
(after applying the rule of § 1.47-6(a)(2)(b)(iii)) have decreased by more than 33D
percent. Accordingly, under the above facts, X may rely on the 33D percent de minimis
exception provided in Rev. Rul. 90-60 to avoid the recapture liability that would
otherwise result from the contribution (disposition) to HLP of it’s interest in the § 42
buildings held through the OLPs.

                                     CONCLUSIONS

       Based solely on the facts submitted and representations made, we conclude as
follows:

        (1) The contribution to HLP of X’s interests in those OLPs in which X holds an
interest equal to or in excess of 50 percent of the OLP’s total interests in partnership
capital and profits will terminate such OLPs under § 708(b)(1)(B). The contribution to
HLP of X’s interests in those OLPs in which X holds an interest that is less than 50
percent of the OLP’s total interests in capital and profits will not terminate such OLPs
under § 708(b)(1)(B) unless the contribution, taken together with all other transfers of
interests in the OLP during 12 consecutive months results in 50 percent or more of the
total interest in capital and profits of the OLP being transferred within a 12-month
period; and

        (2) The contribution of X’s total interest in each of the OLPs to HLP results in
potential partnership level recapture liability to X because X will be a partner in HLP
who, in turn, will be a partner in the OLPs when the OLPs technically terminate.
However, X is not subject to § 42(j) recapture because it is represented that HLP may
avail itself of the § 1.47-3(f) exception to ITC recapture (and, by analogy, § 42(j)
recapture). To the extent that there is not a technical termination of an OLP under
§ 708(b)(1)(B), there will not be a partnership level recapture event. Further, the
contribution of X’s total interest in each of the OLPs to HLP will result in no partner
level recapture because, applying the identity of interest rule of § 1.47-6(a)(2)(b)(iii) to
dispositions of § 42 property, X will not dispose of more than 33D percent of its greatest
total interest in the § 42 buildings held by the OLPs. Therefore, X may rely on the de
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minimis exception provided in Rev. Rul. 90-60 to avoid recapture liability.

       Except as specifically set forth above, no opinion is expressed concerning the
federal tax consequences of the facts described above under any other provision of the
Code. Specifically, no opinion is expressed or implied as to whether HLP is a
partnership for federal tax purposes.

       This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)
provides that it may not be used or cited as precedent.

       Pursuant to the Power of Attorney on file with this office, a copy of this ruling is
being sent to your authorized representatives.

                                                  Sincerely,
                                                  Signed/David R. Haglund
                                                  Senior Technician Reviewer, Branch 1
                                                  Office of the Assistant Chief Counsel
                                                  (Passthroughs and Special Industries)
Enclosures (2)
      Copy of this letter
      Copy for § 6110 purposes