Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 75-31

1975-1 C.B. 10

Section 61 -- Gross Income Defined
Sec. 752
Sec. 761
Sec. 7701

IRS Headnote

Financing method for construction of low income housing in New York State. Determination of whether a limited partnership formed under New York State law is to be treated as the owner of the project and whether each partner may include a portion of a loan made by the New York Housing Finance Agency in the basis of his partnership interest.

Full Text

Rev. Rul. 75-31

Based on the facts and circumstances set forth below, advice has been requested whether a limited partnership formed under New York State law is to be treated as the owner of certain land and improvements thereon ("project") for Federal income tax purposes and whether each partner of such partnership may include a portion of a loan made by the New York State Housing Finance Agency ("HFA") in the basis of his partnership interest.

D, a corporation organized under the laws of the State of New York, has a net worth of $10,000x. The primary business of D is the acquisition, development, ownership and/or management of real estate properties.

With regard to the project, D determined that it would be desirable to obtain most of the funds required for acquisition and construction through a loan from HFA and the balance of the required funds by capital contributions made by partners (including D itself) to a limited partnership, X, formed under the New York Uniform Limited Partnership Act in which D is to be the managing general partner.

D organized H, a Limited Profit Housing Company ("LPHC"), with nominal capital to receive the desired financing for the project by means of a loan from HFA. All the stock of H is owned by D. H's only asset is a $100 capital contribution that was made so that it could be organized under New York law. In certain documents described below, H was designated as a general partner of X for certain limited purposes in order to make the HFA loan available to X to develop the project. The HFA loan was made to H.

The reasons for this indirect method of financing, a description of the organizations involved and the provisions of New York law under which the organizations operate are set forth below.

The New York State Division of Housing and Community Renewal ("DHCR") is created under sections 10 and 11 of the New York Public Housing Law and is charged under the New York Private Housing Finance Law ("PHFL") inter alia, with supervision of the development and operation of the project including determining the conditions under which the HFA mortgage loan will be made, monitoring progress of construction and approving requisitions for advances on the HFA loan, specifying the allowable rentals, regulating the owner's profits and distributions and approving all contracts of the owner.

HFA was created by section 43 of the PHFL as "a corporate governmental agency, constituting a public benefit corporation." HFA may make mortgage loans for the purpose of financing certain projects, including low income housing projects of the type herein described. HFA may make loans for such projects only with the approval of the Commissioner of Housing and Community Renewal ("Commissioner of DHCR") who is guided by provisions of Article 2 of the PHFL governing state loans. Under provisions of the PHFL and the rules of DHCR such loans may be made only to a LPHC.

A LPHC is a corporation organized pursuant to Article 2 of the PHFL or the Not-For-Profit Corporation Law of the State of New York and such Article 2, for the purpose of providing, among other things, certain types of low income housing.

Article 2 of the PHFL requires, among other things, that the certificate of incorporation of a LPHC must be approved by DHCR before it is filed with the New York Secretary of State. The certificate of incorporation must state that the LPHC is organized to serve a public purpose, that it shall remain subject to the supervision and control of the Commissioner of DHCR as long as Article 2 of the PHFL remains applicable to any project of the LPHC, and that all real and personal property acquired or created by it shall be deemed to be acquired or created by it to properly effect the purposes of Article 2 of the PHFL. The purposes of Article 2 are stated therein to include encouragement of private investment in companies engaged in providing low income housing which are regulated by law as to rents, profits, dividends, and disposition of their property and encouragement of participation of HFA in financing such housing.

Article 2 of the PHFL also requires that the certificate of incorporation of a LPHC state that in the event the LPHC violates any provision of its certificate of incorporation, of the law, or the loan or mortgage contract, or any order, rule or regulation of the Commissioner of DHCR, the Commissioner of DHCR may remove any or all of the directors of the LPHC and appoint new directors to serve until the violation is cured and the Commissioner of DHCR has received assurances satisfactory to him that violations will not reoccur.

Section 44(9) of the PHFL provides that the power of HFA to make a loan to a LPHC and to secure repayment of the loan by mortgage is subject to the approval of the Commissioner of DHCR. Further, section 27(4) of the PHFL provides that without first having the written consent of the Commissioner of DHCR, a LPHC may not construct any project or contract for the construction, sale, transfer, or assignment of any of its real property (except in the event of a foreclosure sale) or enter into any contract for the operation of the project.

Section 16 of Article 2 of the PHFL provides that, subject to regulations prescribed by the Commissioner of DHCR, a LPHC may be a partner in a partnership formed for the sole purpose of providing the LPHC with capital. A partner in such a partnership may but is not required to own the shares of the LPHC.

The Commissioner of DHCR determined that the arrangement described herein falls within and meets the provisions of the PHFL, including the provisions described above, as well as the regulations of the DHCR. Consistent with said determination, the Commissioner of DHCR approved the certificate of incorporation of H, the LPHC, the certificate of limited partnership and the partnership agreement of the members of X. These approvals were signified in writing at the end of the documents.

All of the equity capital of X was contributed by D and the limited partners; none of the equity capital of X was contributed by H. None of X's capital will be invested in H and none of the limited partners of X has or will have any interest in H. The limited partners have a 99 percent interest in the items of income, gain, loss, deduction and credit of X, and D, in its capacity as general partner, has a one percent interest in such items. H has no interest in any item of income, deduction, gain, loss or credit of X during the existence of X or in any property of X upon its dissolution or liquidation. No amount was or will be paid to H by X or D for any act performed by H on behalf of X.

After X was formed and capitalized by D and the limited partners as described above, the following transactions occurred at the closing of the HFA loan. H executed a building loan contract, a note for the HFA loan and a mortgage on the project to secure repayment thereof ("the loan documents") in its own name, and not as general partner, without otherwise signifying thereon that it was acting on behalf of anyone but itself. H took legal title by deed to the land in its own name and simultaneously therewith H and X executed a Declaration of Interest ("Declaration") that stated (1) H had acquired and would continue to hold title to the land and any improvements thereon as a general partner of and on behalf of X; (2) X has the equitable interest in the project, notwithstanding that H holds legal title to such project; (3) H has no interest, and will never have any interest in the items of income, gain, loss, deduction, credit or capital of X, nor will it have any beneficial interest in any receipts, investment or other property of X; (4) H has no authority to impose personal liability on X or any partner thereof except H with respect to the HFA loan and therefore H executed the loan documents in its own name so that no partner of X other than itself will be liable thereon; (5) no party to the loan documents, or any successor, pledgee or assignee of such party, will have recourse against X or any partners thereof other than H for the amount due under the loan documents; and (6) H became a general partner of X pursuant to, and solely for the purpose of, section 16 of Article 2 of the PHFL.

Further, the Declaration states that all loan proceeds, all income realized in the operation of the project which are subject to the lien of the mortgage, and all DHCR required equity capital of X, will be deposited in accounts in the name of H as general partner of X, but that H will have no equitable interest in such proceeds, income or capital directly or as a partner of X; that subject to limits imposed by Article 2 of the PHFL, the loan documents, and the approval of DHCR, H will, upon direction of X, sell, assign, or otherwise transfer the project property to X's designee; that upon repayment of the HFA loan, H will forthwith convey legal title to such project to X and thereafter dissolve; and that copies of the certificate of incorporation of H, the partnership agreement, the certificate of limited partnership of X and the loan documents are available at the offices of DHCR for public inspection.

The Declaration was approved by DHCR, the approval being signified in writing at the end of the Declaration.

At the closing of the HFA loan, HFA signed and delivered a letter addressed to H and to DHCR ("HFA Letter") stating that HFA was acknowledging receipt of copies of the Declaration, the certificate of incorporation of H, the partnership agreement and the certificate of limited partnership and that HFA was making its mortgage loan subject to the provisions of the Declaration, including that portion which states that no party to the loan documents, or any successor, pledgee or assignee of such party, shall have recourse against the partnership, or any partners thereof, other than H, for any amount due under the loan documents.

Also at the closing of the HFA loan, the attorney for HFA on behalf of HFA; signed and delivered to H and to DHCR a letter addressed to H and to DHCR ("HFA Attorney Letter") which recites that under applicable authority (including Restatement of the Law of Agency 2d sec. 150 Comment c and Huntington Pennysaver Inc. v. Tire Supply Corporation of Long Island, 59 Misc. 2d 268, 298 N.Y.S. 2d 824 (Dist. Ct. Suffolk Co. 1969) discussed below) the legal effect of the HFA Letter and Declaration is that no person other than H is or will be liable for repayment of such loan. The attorney for DHCR, on behalf of DHCR, concurred in writing to the HFA Attorney Letter. In both the HFA Letter and the HFA Attorney Letter, H and DHCR are authorized by HFA to make these two letters available in such manner, for such purposes, and to such persons as shall be necessary to facilitate the closing of the HFA loan and the development of the project. Finally, at closing, the HFA Letter and the HFA Attorney Letter were both attached as exhibits to and were incorporated by reference into the Declaration which stated that the approval of and agreement to the terms of the Declaration by X and H, were in consideration for, in reliance upon, and expressly subject to the provisions of these two letters and the approval by DHCR of the HFA loan and the terms of the Declaration was expressly subject to the provisions of these two letters.

Immediately after the closing of the HFA loan, the deed to the project site, the mortgage securing the HFA loan, a copy of the certificate of limited partnership of X, and the Declaration (to which are attached as exhibits copies of the HFA Letter and the HFA Attorney Letter) were all simultaneously filed in the appropriate records in the office of the local County Clerk and thereby made a matter of public record.

Neither X, nor D, nor any of the limited partners assumed any liability with respect to the repayment of the HFA loan or entered into any other agreement to repay it, guarantee its repayment, or otherwise incur any obligation to repay it.

Consistent with the Declaration described above, the partnership agreement of X provides that H will acquire and hold legal title to the project as general partner of, and on behalf of X which has the equitable interest therein. All HFA mortgage loan advances, partners' contributions of required equity and managing agent remissions of net rentals, are deposited directly in accounts entitled "H as general partner of X." The partnership agreement of X further states, subject to the provisions set forth as 1 and 2 below, that all the powers and rights of the general partners of X are vested in D to the exclusion of H.

1. As required by DHCR, H will execute various documents pertaining to the development and operation of the project including the loan documents, the construction contract, the architect's agreement, the managing agent's agreement, the leases of units in the project, the accountant's agreement, and the attorney's agreement. These documents will be executed by H as general partner of, and on behalf of X, except that the loan documents are to be executed only in H's own name. The partnership agreement recites that the purpose of this exception is to cause neither X nor any partners of X (other than H) to be liable for the repayment of the HFA loan.

2. H, as general partner, will be responsible to DHCR for assuring that X's development, management and operation of the project conform with the requirements of the PHFL, the rules and regulations of the DHCR, and the loan documents. During the period of supervision by DHCR (that is, so long as Article 2 of the PHFL remains applicable), the Commissioner of DHCR can remove and replace any of H's directors (in accordance with previously described provisions in H's certificate of incorporation), and the Commissioner of DHCR can, pursuant to specific and required terms of the partnership agreement, terminate D's right to exercise the rights and powers of the general partners and direct H to exercise them. In such event, such rights and powers must be exercised by H only upon, and in accordance with, the directions of DHCR. Such exercise by H lasts until DHCR determines that such rights and powers may revert to D.

Again consistent with the Declaration, the partnership agreement and certificate of limited partnership of X recite that H is a general partner pursuant to, and solely for the purposes of section 16 of the PHFL. The partnership agreement and certificate of limited partnership further provide that any reference in the agreement or certificate, direct or indirect, to the status of H as a partner of X refers only to its status as a partner for purposes of section 16 of the PHFL.

Any transfer of a limited partner's interest in X is subject to the prior written approval of DHCR. Furthermore, distributions of cash or proceeds to limited partners are subject to the provisions of the PHFL, the rules and regulations of DHCR, and the loan documents.

H files annually a Form 56, Notice of Fiduciary Relationship, with the Internal Revenue Service which states that it acts for or on behalf of X under authority contained in the Declaration.

Section 752(c) of the Internal Revenue Code of 1954 provides that, for purposes of section 752 of the Code, a liability to which property is subject shall, to the extent of the fair market value of the property, be treated as a liability of the owner of the property.

The specific question to be resolved at this point is whether for Federal income tax purposes, X will be treated as the owner of the project and the improvements thereon subject to the HFA loan indebtedness.

In determining whether X is to be treated as the owner of the project site and the improvements thereon for Federal income tax purposes, it is necessary to determine the capacity in which H holds title to the property, that is, whether it holds as agent on behalf of X or on its own behalf.

In any case in which a purported principal owns a controlling stock interest in its purported corporate agent, whether an agency relationship will be recognized for Federal income tax purposes is determined by reference to more than the presence of the usual incidents of an agency relationship. If a corporation is a true agent, its relations with its principal must not be dependent upon the fact that it is owned in substantial part by the principal. National Carbide Corporation v. Commissioner, 336 U.S. 422 (1949). The significant criteria that must be examined are whether "the so-called 'agent' would have made the agreement if the so-called 'principals' were not its owners, and conversely whether the 'principals' would have undertaken the arrangement if the 'agent' were not their corporate creature." Harrison Property Management Co., Inc. v. United States, 475 F.2d 623, 627 (Ct. Cl. 1973), cert. denied 414 U.S. 1130, reh. denied 415 U.S. 952 (1974). Thus, for a true agency relationship to exist, it must be shown that the principal's control over the corporation's functions in an agent's capacity rests on a relationship independent of any control attributable to stock ownership. In determining whether an agency relationship exists pursuant to that test, the Service has consistently taken the position that all the facts and circumstances must be considered. See Rev. Rul. 54-596, 1954-2 C.B. 51; Rev. Rul. 59-247, 1959-2 C.B. 14.

In the instant case, the Declaration contains a specific acknowledgement by H that it holds record title to the project site and any improvements thereon on behalf of X. This is reiterated in the partnership agreement and the partnership certificate, and is consistent with H's certificate of incorporation. Knowledge of the existence of the agency relationship is not limited to the contracting parties but instead is made a matter of public record since the Declaration is filed in the public land records and since copies of the certificate of incorporation of H, the partnership agreement, the certificate of limited partnership of X and the loan documents are available at the offices of DHCR for public inspection.

Although the foregoing is indicative of an agency relationship, as noted above, the existence of an agency relationship must not be dependent upon the controlling stockholders' ownership of the corporation.

In National Carbide Corporation v. Commissioner, above, the claim of an agency relationship between the parent corporation (the purported principal) and its subsidiaries (the purported agents) was rejected because it rested on the control which the parent exercised over its subsidiaries through and by virtue of its stock ownership of the subsidiaries. The various indicia advanced in support of the claimed agency were equally consistent with and could be explained by the corporation--sole stockholder relationship.

By contrast, the agency relationship in the instant case in respect of the project does not rest upon D's stock ownership of H. H is a party to the arrangement because of the New York statutory scheme that requires DHCR to supervise the development, construction and management of the project through a LPHC, that is, H in this case. This supervision and control of the project by DHCR through H is assured to DHCR through provisions in H's charter required by the New York statutes governing such projects. D is not free to remove these charter provisions by amendment. The control which D has over H through its stock ownership in respect of the project is subject to and limited by these charter provisions, and the statutes, rules and regulations of the State of New York and DHCR. If D, through its stock ownership, exercises control over H in a manner inconsistent with these charter provisions, statutes, rules and regulations, D's control of H may be divested by DHCR.

Accordingly, it is concluded that the agency relationship between X and H expressed in the Declaration, partnership agreement, certificate of partnership, and other documents approved by DHCR, does not rest upon the corporation--stockholder relationship between H and D, and should be recognized as existing independently of that relationship by reason of the unique facts and circumstances described herein. Cf., Carver v. United States, 412 F.2d 233 (Ct. Cl. 1969). Therefore, the agency will be recognized for Federal income tax purposes.

When a partnership is the owner of property and no partner of the partnership is personally liable for repayment of the liability to which the property is subject, all the partners of the partnership, including its limited partners, shall be considered as sharing such liability under section 752(c) of the Code in the same ratio as they share partnership profits. See section 1.752-1(e) of the Income Tax Regulations.

The second question to be resolved is whether any partner of X is personally liable for the repayment of the loan to HFA.

H has no interest and will never have an interest in any item of income, gain, loss, deduction, credit or capital of X, nor will it have any beneficial interest in the receipts, investments or other property of X during the operation or upon the liquidation of X. Therefore, under these circumstances H will not be considered a partner of X for Federal income tax purposes. See Hubert M. Luna, 42 T.C. 1067 (1964). Since H is not considered a partner for Federal income tax purposes, the personal obligation of H to repay the loan to HFA is of no consequence in determining whether any partner of X is personally liable for repayment of the liability to which the project is subject.

No party other than H signed the note; therefore, if the note is considered negotiable, only H may be held liable thereon. See N.Y. Uniform Commercial Code sec. 3-401(1). Furthermore, whether or not the note is negotiable, an agreement that an agent enters into in his own name on behalf of a disclosed principal can contain a provision in which a third party agrees not to look to the principal for payment. In such a case the principal will not be liable for repayment of the underlying obligation. Restatement of the Law of Agency 2d sec. 150 Comment c. This rule and its result has been recognized in Huntington Pennysaver, Inc. v. Tire Supply Corporation of Long Island, 59 Misc. 2d 268, 298 N.Y.S. 2d 824 (Dist. Ct. Suffolk Co. 1969).

At the closing of the HFA loan, HFA signed and delivered the HFA Letter and the HFA Attorney Letter, which were filed of record as noted above. As recognized in the HFA Attorney Letter, the legal effect of the HFA Letter under New York law is substantially the same as that cited in the above authorities, that is, the creditor, HFA, agrees that the disclosed principal, X, is not liable for repayment of the loan. Therefore, in the instant case, no person other than H is liable for repayment of the loan. Thus, whether or not the note is considered negotiable, neither X nor D could be held liable on the underlying obligation. Since X, the partnership, cannot be held personally liable, D, the only general partner recognized as such for Federal income tax purposes, may not be held personally liable as a partner.

Thus, since no person who is considered a partner of X for Federal income tax purposes is personally liable for the obligation to HFA under the laws of New York governing the arrangement, D and the limited partners share the liability for the HFA loan in the ratio in which they share partnership profits under section 752(c) of the Code and section 1.752-1(e) of the regulations so long as D retains its power to manage the project of X, and H has not been caused to assume such responsibility by DHCR.

This Revenue Ruling does not deal with the requirements for an organization to be classified as a partnership for Federal income tax purposes. See section 301.7701-2 of the Procedure and Administration Regulations. See also Rev. Proc. 72-13, 1972-1 C.B. 735 and Rev. Proc. 74-17, 1974-1 C.B. 438, in connection with obtaining advance rulings regarding the classification of limited partnerships. Furthermore, the conclusions contained in this Revenue Ruling are not changed if D were an individual.