Gateway Hotel Partners, LLC v. Commissioner of Internal Revenue, 010914 FEDTAX, 19182-07

Docket Nº:19182-07
Opinion Judge:GOEKE, Judge:
Attorney:Dustin M. Covello, Herbert Odell, and Philip Karter, for participants. Dana E. Hundrieser and Lawrence C. Letkewicz, for respondent.
Case Date:January 09, 2014
Court:United States Tax Court

T. C. Memo. 2014-5




No. 19182-07

United States Tax Court

January 9, 2014

Dustin M. Covello, Herbert Odell, and Philip Karter, for participants.

Dana E. Hundrieser and Lawrence C. Letkewicz, for respondent.


GOEKE, Judge:

The issues in this case arise out of the financing and redevelopment of the former Statler and Lennox Hotels, two historic properties in downtown St. Louis, Missouri. Respondent issued a notice of final partnership administrative adjustment (FPAA) for 2002 and 2003 (years at issue) under section 6223(a)1 to Gateway Hotel Partners L.L.C.'s (GHP) former tax matters partner. In the FPAA, respondent made certain adjustments to the income, expense, and deduction items GHP reported on Forms 1065, U.S. Return of Partnership Income, and imposed accuracy-related penalties under section 6662. GHP's former tax matters partner filed on GHP's behalf a petition for redetermination of partnership items.

The parties have settled several issues; however, there remain three issues for decision. The principal issue is whether GHP must recognize $18, 455, 0002 of income from three transfers it made of certain Missouri Historic Preservation Tax Credits (MHTCs) in 2002. The answer turns on whether the transfers represented partnership distributions or taxable sales. We hold that two of the transfers were properly characterized as partnership distributions. However, a portion of the third transfer produced a taxable sale, and we sustain respondent's determination with respect to that portion. The second issue is whether GHP must include in income the return of $3, 088, 000 that it had previously contributed to a fund established in connection with the hotel project. We hold the return is not includible in income. The final issue is whether GHP is liable for the accuracy-related penalty for 2002 on the portion of any underpayment resulting from GHP's purported sale of the MHTCs. We sustain the accuracy-related penalty resulting from the underpayment attributable to the nondistribution portion of the third transfer.


Some of the facts have been stipulated and are so found. The stipulation of facts, the supplemental stipulation of facts, and the attached exhibits are incorporated by this reference.

I. Hotel Project Background

In the late 1990s the City of St. Louis sought to spur the private development of a 1, 000 room hotel project near its downtown convention center. A major aspect of the City's plan was to encourage the rehabilitation of the historic Statler and Lennox Hotels and the construction of complimentary facilities adjacent to the convention center (collectively, hotel project). Financing for the hotel project was expected to come from public sources, including tax increment financing, revenue bonds, HUD grants, Federal and State tax-credit equity, and private funding.

II. Hotel Project Participants

A. Owner

GHP was organized to own, develop, construct, and operate the rehabilitation portion of the hotel project.3 GHP elected partnership treatment for Federal tax purposes, and its principal place of business was in Missouri when the petition was filed. At all relevant times, Washington Avenue Historic Developer (WAHD), a Missouri limited liability company, and Housing Horizons, LLC (HH), a Texas limited liability company, were GHP's members. At all relevant times, GHP's profits and losses were allocated 1% to WAHD and 99% to HH under GHP's amended and restated operating agreement (GHP amended operating agreement).

B. Developer

WAHD was engaged by GHP to perform on its behalf development services in connection with the hotel project. It was responsible for all the day-to-day operations of GHP, including procuring hotel project financing and managing the various aspects of the development and construction of the hotel project. WAHD was GHP's managing member and tax matters partner and held a 30% membership interest in GHP. WAHD elected partnership treatment for Federal tax purposes.

WAHD was majority owned and controlled by Historic Restoration, Inc. (HRI). HRI was WAHD's managing member. HRI was a real estate developer, engaged in adaptive reuse of historic structures, among other real estate activities, and was based in New Orleans, Louisiana. HRI elected S corporation treatment for Federal tax purposes.

C. Investor

HH was a passive investor in the hotel project and held a 70% membership interest in GHP. HH was majority owned and controlled by Kimberly-Clark Corp. (KC), a Delaware corporation. HH and KC (collectively, participating partners) elected to participate in these proceedings pursuant to section 6226(c)(2) and Rule 245(b).

III. MHTCs as a Source of Financing

One of the sources of financing HRI planned to use to finance the hotel project was MHTCs it expected to receive from the completion of the hotel project. The MHTC program started in 1998. The MHTC program's purpose is to aid in the redevelopment of historic structures in the State of Missouri. Under the program, any person, firm, partnership, trust, estate, or corporation incurring qualifying costs and expenses for the rehabilitation of eligible property is entitled to MHTCs. The amount of MHTCs available is 25% of the total costs and expenses of the rehabilitation. MHTCs were not earned or issued until the completion of the relevant rehabilitation project. Taxpayers having earned MHTCs could transfer, sell, or assign them.

A taxpayer desiring to receive MHTCs must apply to the Missouri Department of Economic Development (MDED) for such credits through a multistep application procedure. In connection with the hotel project, GHP applied for entrance into the MHTC program. In December 1999 the MDED granted preliminary approval of GHP's application. In December 2002 it granted final approval.

IV. The Bridge Loan Financing

The MHTCs HRI expected to use as a source of financing were not available until completion of the hotel project. To include the MHTCs as a source of funds at the beginning of the hotel project, bridge financing was required. The Missouri Development Finance Board (MDFB) was approached about making a $18, 455, 000 bridge loan to HRI in connection with the hotel project. The MDFB is an agency created by statute as a body corporate and politic. Its mission is to assist infrastructure and economic development projects in Missouri by providing financial support for otherwise unfeasible projects that private lenders are unwilling to finance. The MDFB is self-funded, and the funds that it lends for development projects typically come from the issuance of revenue bonds.

A. Due Diligence

The MDFB undertook due diligence to determine HRI's creditworthiness. In particular, it sent several representatives to HRI's New Orleans, Louisiana, headquarters to review its financial records. Ultimately, the MDFB satisfied itself that HRI had sufficient potential assets in the event of a default on the bridge loan. The MDFB viewed HRI as a more reliable borrower than GHP because GHP was a single-project company whose assets were limited to the hotel project, whereas HRI was not.

B. Authority to Enter into the Bridge Loan Agreement

The MDFB passed a board resolution authorizing its participation in the hotel project and authorizing it to make the bridge loan to HRI. HRI, WAHD, and GHP all executed closing certificates for the hotel project financing containing certain resolutions to enter into the bridge loan agreement. The HRI closing certificate contains a resolution under which HRI resolves to "enter into" the bridge loan agreement on "its own behalf", "on behalf of" WAHD, and "on behalf of" GHP. The WAHD closing certificate contains a resolution under which WAHD resolves to "enter into" the bridge loan agreement "on behalf of" GHP. Finally, the GHP closing certificate contains a resolution under which GHP resolves to "enter into" the bridge loan agreement.

C. The Bridge Loan Agreement

In December 2000 HRI entered into the bridge loan agreement with the MDFB. The bridge loan agreement designated HRI as the "borrower" of the bridge loan. The bridge loan agreement recitals reflect that HRI applied for the bridge loan for the purpose of providing funds to WAHD to make a capital contribution to GHP. The bridge loan agreement reflects that the bridge loan matured in December 2005 or upon the final payment for the purchase of MHTCs under a certain tax credit purchase agreement (discussed infra). It also reflects that the principal amount of the bridge loan bore interest at an annual rate of 9.5%. It further reflects that HRI was required to deposit with the MDFB $3, 285, 000 to prepay two years of interest on the bridge loan.

To induce the MDFB to make the bridge loan, HRI made various nonmonetary representations, covenants, and warranties on behalf of GHP and WAHD. For example, HRI represented and warranted on GHP's and WAHD's behalf that: (1) their assets and interests in the hotel project were free and clear of all liens and encumbrances; (2) they did not have knowledge of pending litigation against them; (3) they would use the bridge loan proceeds only as specified in the bridge loan agreement; (4) they were not in default; (5) they had not incurred any "material" liabilities and had not entered into any "material" transactions; and (6) they did not have knowledge of certain environmental issues concerning the hotel project properties.

HRI executed the bridge loan agreement as the "borrower". On a signature page for acknowledging...

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