Tax Court Reverses Itself on Qualified Appraisals for Façade Easements

UESThe proper standard for a qualified appraisal in the façade easement context has been vigorously contested by the IRS in recent years. In a rare reversal on reconsideration, the Tax Court adopted the Second Circuit Court of Appeals’ view of the necessary elements for a qualified appraisal in the context of these easement deductions. In short, the Court affirmed that the regulatory standard for a qualified appraisal requires only a method of valuation and a basis for valuation.

The decision under reconsideration was Friedberg v. Commissioner , TC Memo. 2011-238. In the reversal the Tax Court observed its practice of following the precedent of the U.S Court of Appeals to which a case may be appealed, first established in Golsen v. Commissioner, 54 T.C. 742 (1970).

In 2002, the taxpayers, Mr. Friedberg and Ms. Moss, purchased a townhouse in Manhattan’s Upper East Side Historic District for $9,400,000. In 2003, the National Architectural Trust (NAT) contacted Mr. Friedberg and asked him to donate a façade easement. Mr. Friedberg agreed and contacted an appraiser, recommended by NAT, who appraised the value of the easement. The appraisal concluded that the total loss of value, including the easement and the value of unused development rights, was $3,775,000. The taxpayers deducted that amount on their 2003 tax return as a charitable donation of a qualified conservation easement. The Commissioner challenged the deduction with a statutory notice of deficiency. The taxpayers filed a petition in the Tax Court.

The Tax Court issued an opinion following cross-motions on summary judgment. One of the questions decided in favor of respondent was that the taxpayers had failed to provide a qualified appraisal under Treas. Reg. §1.170A-13(c)(3)(ii). In reaching that determination, the Court followed its findings in Scheidelman v. Commissioner, T.C. Memo. 2010-151 (Scheidelman I) where it found that

“the mechanical application of a percentage diminution to the fair market value before donation of a façade easement does not constitute a method of valuation as contemplated under section 1.170A-13(c)(3)(ii).”

Though Friedberg and Moss lost on that issue, not all of the argued issues were decided, including whether the appraisal was “qualified” as to the valuation of the unused development rights. The parties continued discovery on that question.

Meanwhile, in Scheidelman v. Commissioner, 682 F.3d 189 (2d Cir. 2012) (Scheidelman II), the Second Circuit vacated the Tax Court on the qualified appraisal standard referenced in the Friedberg opinion. The Court of Appeals held that Huda Scheidelman had obtained a qualified appraisal under the regulations because her appraisal adequately specified the appraiser’s method of, and basis for, determining the easement’s fair market value.

Friedberg and Moss were still hashing out interrogatories and depositions when the Second Circuit decided Ms. Scheidelman’s case. They filed a motion for reconsideration of the Court’s earlier ruling under Tax Court Rule 161. The Tax Court granted the motion.

On reconsideration, the Tax Court found that the appellate opinion “specifically alter[ed] the underlying law” applied in the 2011 Friedberg decision. The Tax Court held that under Scheidelman II

“any evaluation of accuracy is irrelevant for purposes of deciding whether the appraisal is qualified pursuant to section 1.170A-13(c)(3)(ii)(J), Income Tax Regs.”

Accordingly, the Court re-examined the two elements necessary for a qualified appraisal under Treas. Reg. §1.170A-13(c)(3): (1) a method of valuation and (2) a specific basis for the valuation. With regard to the first element, the Court found that Mr. Freidberg’s appraiser provided sufficient information to enable the Commissioner to evaluate his underlying methodology. Thus it included a method of valuation. The Court then considered and found that the appraisal included “some research and analysis” which was enough to establish a specific basis for the appraisal. The legal standard met, the Court reversed its holding in favor of the government and granted summary judgment for the taxpayers on the question of whether they had obtained a qualified appraisal.

The case is hardly over for Friedberg and Moss though. The Court specifically did not opine on the reliability and accuracy of the appraisal, reserving that factual determination for trial. Nonetheless, the Court’s reconsideration reversed its legal ruling in favor of the government and re-established the appraisal as qualified under the regulations. Whether the merits of the appraisal will withstand the scrutiny of a trial remains to be determined.

Read the opinion here:
Friedberg v. Commissioner, TC Memo. 2013-224

DOMA Doomed by Estate Tax Refund Claim

us-supreme-courtThe United States Supreme Court has struck down the Defense of Marriage Act (DOMA) as an unconstitutional violation of the “equal liberty” protections of the 5th Amendment.

The dispute in U.S. v. Windsor began when Edie Windsor filed a claim for refund of estate taxes paid after the death of her same-sex spouse, Thea Spyer. Though the court makes little mention of the $353,053 refund claim in its historic opinion, the high court’s ruling affirmed the Second Circuit Court of Appeals’ decision to award the refund.

Read the entire opinion here:
U.S. v. Windsor, Docket No. 12-307 (U.S.S.C. June 26, 2013)

Today: Supreme Court to Hear Arguments in DOMA Tax Case

Seal_of_the_United_States_Supreme_Court.svgToday, the United States Supreme Court will hear arguments about the Constitutional rights of homosexual couples courtesy of the Internal Revenue Code.

The Court may rule on a variety of grounds in United States v. Windsor including standing (was the couple’s marriage recognized under New York law) and the proper Constitutional standard (does Intermediate Scrutiny apply to homosexuals) but the case started with a tax return.

Edie Windsor and Thea Spyer were New York residents and a couple for over 40 years. In 2007, they were married in Canada where same-sex marriage was legal. Upon Thea’s death, Edie filed a federal estate tax return, Form 706. Thea’s estate paid $363,053 in federal estate taxes because she was not eligible for the unlimited marital deduction under IRC §2056(a) – a benefit routinely applied to married couples of different sexes. Edie filed a claim for refund of the estate taxes paid. When that claim for refund was denied she filed suit in federal district court.

The refund denial was reversed by the U.S. District Court for the Southern District of New York and the Second Circuit Court of Appeals. Read opinions published in those cases here and here.

Whether not the Supreme Court issues a sweeping or narrow opinion on the rights of homosexuals, there is little question that the tax code touches everyone. After all, that’s where this case started.

Second Circuit: Co-Op Owner Is Entitled to Casualty Loss

circseal2The Second Circuit Court of Appeals has reversed the Tax Court’s decision that a New York City co-op owner, Ms. Alphonso, could not deduct casualty losses that occurred on grounds owned in common with other cooperative shareholders.

The Tax Court held that Ms. Alphonso could not take a deduction for a casualty loss because she did not hold a property interest in the damaged property. The damage in question occurred when a retaining wall along the common property of the cooperative apartment building collapsed. The co-op shareholders contributed to the necessary repairs and clean-up. Ms. Alphonso took a deduction of about $23,000 for her share of the repairs, claiming that it qualified as a casualty loss under under IRC §165(c)(3).

The Tax Court did not address the merits of the casualty loss claim. Rather, the Court ruled as a matter of law that Ms. Alphonso did not hold a “sufficient” property interest in the common area of the apartment building to qualify for the deduction.

The Second Circuit vacated the Tax Court holding that although Ms. Alphonso’s interest in the damaged common area was not exclusive with respect to her fellow tenant shareholders it was still a property right. Thus, the “property” element of section 165(c)(3) was satisfied. The Second Circuit remanded the case to the Tax Court for further proceedings on whether the claimed damages qualified as a casualty loss.

Read the Second Circuit’s opinion here:
Alphonso v. Commissioner, No. 11-2364 (2d Cir. Feb. 6, 2013)

Read the Tax Court opinion here.

Second Circuit: DOMA Unconstitutional In Estate Tax Case

The Second Circuit Court of Appeals has affirmed the ruling of the U.S. District Court for the Southern District of New York that Clause 3 of the Defense of Marriage Act (DOMA) is unconstitutional.

The case originated with a refund claim for overpaid estate taxes. Edie Windsor and Thea Spyer were a married homosexual couple from New York. Upon Thea’s death, Edie paid $363,053 in federal estate taxes because she was not eligible for the unlimited marital deduction under IRC Section 2056(a) – a benefit routinely applied to married couples of different sexes. When Edie’s claim for refund of the estate taxes was denied she filed a refund action in U.S. District Court.

The trial court held that DOMA denied Ms. Windsor equal protection under the law as guaranteed by the 5th Amendment to United States Constitution. The three judge appellate panel agreed. It added that “homosexuals have suffered a history of discrimination” and thus the proper legal standard for determining Constitutional protections is intermediate scrutiny. The court held that DOMA could not meet that standard and thus Edie’s 5th Amendment right to equal protection under the law was violated when the provisions of the Internal Revenue Code applied differently to her than to other surviving spouses.

Read the opinion here:
Windsor v. U.S., No. 12-2335 (2d Cir. Oct. 12, 2012)

Second Circuit: Exxon Mobil Entitled to Retrospective Interest Netting

The Second Circuit Court of Appeals has affirmed the decision of the Tax Court holding that Exxon Mobil is entitled to net interest for periods of overlapping underpayments and overpayments even where the statute of limitations for one “leg” of the overlapping periods has expired.

Congratulations to the taxpayer’s lead counsel and fellow blogger, Alan Horowitz, and our friend on the brief, Kevin Kenworthy.

Read the entire opinion here:
Exxon Mobil v. Commissioner, No. 11-2814 (2d Cir. August 8, 2012)

Second Circuit Vacates Tax Court in Façade Easement Case

Second Circuit Court of Appeals The Second Circuit Court of Appeals vacated and remanded the U.S. Tax Court’s finding that Ms. Huda Scheidelman failed to obtain a qualified appraisal for the 2004 façade easement donation over her New York City home.

In March of 2003, Ms. Scheidelman and her husband completed a façade conservation easement application and made a fully refundable $1,000 deposit to the National Architectural Trust (“NAT”). The taxpayers waited to pursue the donation until 2004, so that they could save enough money to pay for the appraisal.  In April of 2004, the taxpayers hired an appraiser from a list of appraisers provided by NAT.

The appraiser’s report used the sales comparison approach to determine that the estimated market value of the property was $1,015,000.  Looking at historical comparisons of attached row homes in New York City, the appraiser determined that the façade easement value is about 11% to 11.5% of the total value of the property.  Using these estimates the appraiser found that the value of the façade conservation easement would be estimated at $115,000 or 11.33% of the fee simple value of the property.

After receiving the appraisal, NAT notified Ms. Scheidelman that all of the trust’s easement owners must make a cash contribution toward operating costs equivalent to 10% of the cash value of their easement. Ms. Scheidelman wrote NAT a check for $9,275. NAT accepted the appraisal and the City of New York recorded the conservation deed of easement for the property. The taxpayers attached Form 8283 to their 2004 tax return reporting a $115,000 gift to charity. They carried over $63,083 of the reported contribution to their 2005 and 2006 tax returns.

The IRS conducted an examination of Ms. Scheidelman and disallowed her cash contribution to NAT and the deductions for her conservation easement in all three years. The IRS issued a notice of deficiency and Ms. Scheidelman filed a petition with the United States Tax Court. In Scheidelman v. Commissioner the Tax Court ruled that she did not obtain a “qualified appraisal” under Treas. Reg. § 1.170A-13(c)(3) because it did not use a sufficient method and basis of valuation. The Tax Court also disallowed a deduction for a cash contribution to NAT.

On appeal, the Second Circuit considered the Tax Court’s interpretation of Treas. Reg.  § 1.170A-13(c)(3), qualified appraisals. The appellate panel focused on the Tax Court’s interpretation of Treas. Reg. §§ 1.170A-13(c)(3)(ii)(J)&(K), requiring that a qualified appraisal specify both a method and a basis of valuation. 

The Court of Appeals disagreed with the Tax Court’s conclusion that the appraiser did not provide a proper method of valuation under Treas. Reg. § 1.170A-13(c)(3)(ii)(J). The court held that the appraiser’s use of the “before and after” method and his reliance on a published IRS article proposing an acceptable discount range for facade easements was appropriate.

Reviewing the basis of valuation requirement under Treas. Reg. § 1.170A-13(c)(3)(ii)(K), the Second Circuit found that the appraiser’s approach was “nearly identical” to the method used in Simmons v. Commissioner. The court noted the similarities between the two cases and held that the appraisal provided by Ms. Scheidelman gave the IRS “sufficient information to evaluate the claimed deduction,” thus satisfying Treas. Reg. § 1.170A-13(c)(3)(ii)(K).

The Second Circuit also held that Ms. Scheidelman’s $9,275 cash donation was a deductible charitable contribution because NAT did not give her any goods or services, any benefit, or anything of value in return for her donation. The Court noted that although Scheidelman hoped to obtain a charitable deduction for her gifts, it was not a quid pro quo because the facade easement deduction would not come directly from the receipt of the cash gift. 

The case was remanded to the Tax Court for further findings on the value of the easement consistent with the findings of the Court of Appeals.

Read the entire opinion here:
Scheidelman v. Commissioner, 682 F.3d 189 (2nd Cir., June 15, 2012).

Altria Settles 14 Years of SILO/LILO Transactions for $500 Million

On May 22, Altria announced that it executed a closing agreement with the Internal Revenue Service settling the federal income tax treatment of fourteen years of leveraged lease transactions (commonly known as lease-in/lease-out (LILO) and sale-in/lease-out (SILO) transactions) entered into by Altria’s wholly-owned subsidiary, Philip Morris Capital Corporation.

Altria had defied the IRS challenges to these transactions in a number of pending cases. In October 2006, Altria filed a complaint in the United States District Court for the Southern District of New York to claim refunds related to its LILO and SILO transactions for 1996 and 1997. In July 2009, following an eleven day trial, a jury returned a unanimous verdict in favor of the IRS. Altria filed motions for judgment as a matter of law or, in the alternative, for a new trial. On March 17, 2010, the court denied Altria’s post-trial motions and, on April 19, 2010, entered final judgment in favor of the IRS.

Altria appealed the final judgment to the United State Court of Appeals for the Second Circuit. In an opinion released on September 27, 2011, the Second Circuit affirmed the District Court’s ruling, and the jury’s findings, against Altria. Altria had a similar tax refund claim pending in the Southern District of New York for the same transactions applicable to the 1998 and 1999 tax years.

According to the press release issued by Altria, the settlement included the 1996 through 1999 tax years and tax years through 2003, in all of which the IRS had disallowed the tax benefits claimed from these transactions. The settlement also covered the tax years 2004 through 2009 for which Altria claimed tax benefits generated by the LILO and SILO transactions but which the IRS was expected to disallow. Altria did not claim tax benefits pertaining to the LILO and SILO transactions in the 2010 and 2011 tax years and, under the terms of the settlement agreement, will not claim such benefits in future tax years.

Altria expects to pay approximately $450 million in federal income taxes and related estimated interest with respect to the 2000 through 2010 tax years. The payment is net of federal income taxes that Altria paid on gains associated with the sales of assets leased in the LILO and SILO transactions from January 1, 2008 through December 31, 2011. Of the $500 million, Altria also expects to pay approximately $50 million of state taxes and related estimated interest. The tax component of these payments represents an acceleration of federal and state income taxes that Altria would have otherwise paid over the lease terms of the LILO and SILO transactions. Pursuant to the settlement agreement, the IRS will not assess penalties against Altria for the LILO and SILO transactions in any tax year, open or closed, through the 2010.

Read the Altria Group, Inc. press release here:
Altria PMCC Press Release May 22, 2012

Read the Second Circuit’s Opinion here:
Altria Group v. US, No 10-2404 (2d Cir. 2011)

2nd Circuit: Entire Transferred Interest in Home Not Included in Estate

In a decision that prompted a 20 page dissent, the Second Circuit reverses the Tax Court on the application of Section 2036 to the transfer of a 49% interest in a home that the donor continued to occupy.

Estate of Stewart v. Commissioner, Docket 07-5370-ag (2d Cir. August 9, 2010)

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