A TAX EQUITY TRANSACTION with some aggressive features was upheld by the US Tax Court in early January.

The New Jersey Sports and Exposition Authority, or NJSEA, took on renovation of a sport arena and exhibition hall in Atlantic City called the East Hall that was originally built in the late 1920’s and that, starting in 1933, was the site of the annual Miss America pageant. The renovation work began in 1999. The state issued $49.5 million in bonds and used another $22 million from the New Jersey Casino Reinvestment Development Authority to fund the work.

Since East Hall is listed as a national historic landmark by the US government, the work qualified potentially for rehabilitation tax credits for 20% of the cost. The tax credits are claimed in the year the renovation work is completed. The state was not in a position to use the tax credits, so it essentially bartered them for capital to help fund the project in a tax equity transaction. NJSEA leased East Hall from the Atlantic County Improvement Authority for 87 years at $1 a year. NJSEA then subleased East Hall to a partnership that was managed by NJSEA, but owned 99.9% by Pitney Bowes. The partnership paid $53.6 million for the property up front by giving NJSEA an “acquisition note” that bore interest at 6.09% and provided for level annual payments over 40 years. The payments were to be made on the note only to the extent the partnership had cash flow to make them. The parties reported the transaction as a sale of East Hall to the partnership for income tax purposes.

Pitney Bowes made capital contributions to the partnership of $39.4 million over four years. The partnership used the money to pay down the “acquisition note.” As each payment was made on the acquisition note, NJSEA returned the amount to the partnership as a “construction loan,” with the exception of $3.2 million from the second capital contribution. The partnership used the money to pay assorted fees plus a $14 million developer fee to NJSEA that stepped up the basis in the project for purposes of the tax credits.

The partnership allocated 99.9% of income and loss to Pitney Bowes. It had a more complicated arrangement for sharing cash. Pitney Bowes received cash first equal 3% of its declining capital account balance