Tag Archives: Conservation Easement

Reliance on Tax Attorney & Licensed Appraiser Helps Taxpayer Preserve Deductions & Avoid Penalties

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us_tax_courtIn Palmer Ranch v. Commissioner, a TEFRA partnership avoided accuracy-related penalties even though the Tax Court reduced the fair market value of its conservation easement by $3.98 million.

The taxpayer claimed a $23.94 million charitable contribution deduction on its 2006 partnership return. The IRS disallowed $16.97 million of the value under exam. At trial, the parties presented valuation experts who relied upon the comparable sales method to set the before and after value of the property. The taxpayer’s expert valued the land at $307,000 per acre, while the IRS expert came in at at $94,000 per acre. The Tax Court reviewed the four properties used by both experts and compared the property’s then-current use with its highest and best use. The taxpayers’ contended that 360 multifamily dwelling units could be developed on the 82-acre parcel. The IRS disagreed, emphasizing: a failed rezoning history; environmental concerns; limited access to outside roads; and neighborhood opposition. The Court rejected each of these arguments and found that “there is a reasonable probability that [the parcel] could have been successfully rezoned to allow for the development of multifamily dwellings.”

The IRS also argued that the real estate market was softening in 2006. Judge Goeke accepted the idea of a declining real estate market and reduced the taxpayer’s pre-encumbrance appraisal of the land from $25.2 million to $21 million. Using the same “after” value percentage (5% of the unencumbered property) the Court found that the fair market value of the conservation easement was $19.96 million.

Following the framework set forth in the U.S. Supreme Court’s recent decision in United States v. Woods, the Court determined that it had jurisdiction to consider the IRC § 6662 penalties. The Court then accepted the taxpayers’ reasonable cause defense and disallowed the 20% penalty because the taxpayer: retained a tax attorney to advise them on the tax aspects of the easement donation; hired a credible, licensed appraiser, and made a good-faith attempt to determine the easement value.

Read the Tax Court opinion here: Palmer Ranch v. Commissioner, T.C. Memo. 2014-79

Tax Court Rejects Expert Value, Imposes Penalties

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us_Tax_Court_fasces-with-red-ribbonIn what may be the last word on Kaufman v. Commissioner, the Tax Court sustained the IRS’s complete disallowance of charitable deductions claimed for the donation of a façade easement. The case returned to the Tax Court on remand from the First Circuit Court of Appeals to determine the value of the easement and the application of accuracy-related penalties.

The taxpayers’ owned a 150 year-old row house in a designated historic district in Boston, Massachusetts subject to the South End Landmark District Residential Standards (“South End Standards”). In 2003, taxpayers’ entered into an agreement with the NAT to donate a façade easement over the property. The taxpayers 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 the unused development rights, was $220,800. The taxpayers deducted that amount on their 2004 and 2005 tax returns as a charitable donation of a qualified conservation easement. The Commissioner challenged the deductions with a statutory notice of deficiency.

In Kaufman v. Commissioner, 134 T.C. 182 (2010) (Kaufman I), the Tax Court ruled for the IRS in a motion for partial summary judgment. The Court held that the conservation easement failed to satisfy the “in perpetuity” requirements of the Treasury Regulations. The Court then issued a second opinion making additional findings, disallowing other items and imposing penalties on the remaining issues (Kaufman II). The taxpayers’ appealed. The U.S. Court of Appeals for the First Circuit rejected the Tax Court’s ruling that the taxpayers’ mortgage lender agreement undercut the regulation’s “in perpetuity” requirement as a matter of law (Kaufmann III) and remanded for further consideration of the taxpayers’ charitable contribution deductions under the facts.

The primary issue on remand was the proper valuation of the façade easement. The taxpayers’ valuation expert used a sales comparison analysis with data from three comparable properties. Using the before-and-after method, he determined that the value of the property was $1,840,000 before the grant of the easement. The expert used a “method unique to him and not a generally accepted appraisal or valuation method” to determine that the total value of the property was reduced by 12% or $220,800 when encumbered by the façade easement.

The IRS’s expert discredited the taxpayer’s valuation stating that it was “the fruit of an inappropriate valuation methodology employing a wholly unsupported adjustment factor.” Notably, both the IRS expert and the taxpayer’s expert agreed, “neither the preservation agreement nor the preexisting restrictions hamper the potential for developing the property to its highest and best use…as a single family home.”

The Tax Court gave no weight to the taxpayers’ expert because of his close relationship with NAT, his limited experience appraising façade easements, and his use of a “unique” valuation methodology. The Court also conducted its own comparison of the façade easement restrictions and the South End Standards. The Tax Court found that the agreements were “basically duplicative” and there were no significant additional restrictions placed on the property by the façade easement.

The Court held in favor of the IRS finding that the façade easement had no fair market value when conveyed to NAT. The Tax Court also upheld the IRS’s imposition of accuracy-related penalties.

Read the full opinion here: Kaufman v. Commissioner, T.C. Memo. 2014-52

North Dakota Conservation Easements Prohibited by State Law

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us_tax_courtIn a case that highlights the potential conflict between state law and the requirements for the deductible donation of a conservation easement, the Tax Court in Wachter v. Commissioner held that a North Dakota conservation easement failed the “in perpetuity” requirement under IRC § 170(h)(2)(C) because North Dakota state law limits the duration of an easement to 99 years.

The taxpayers, comprised of two sets of couples filing joint returns for the tax years in question, owned varying interests in two partnerships, WW Ranch and Wind River, LLC. The partnerships entered into a cooperative agreement with the Commodity Credit Corporation and the American Foundation for Wildlife to sell conservation easements on multiple parcels from 2004 through 2006.

The taxpayers made three cash gifts to the North Dakota Natural Resource Trust (NRT) totaling $485,650 from 2004-2006. On its partnership returns, WW Ranch reported bargain sales of conservation easements as charitable contributions of $349,000 for 2004, $247,550 for 2005, and $162,500 for 2006. The parties obtained two appraisals to each contributed parcel. Each appraisal valued the property according to a different land use, and the taxpayers used the difference in appraised values to determine the value of the conservation easements.

The IRS issued notices of deficiency disallowing the charitable contribution deductions for both the cash payments to NRT and the property contributions. The IRS filed a motion for partial summary judgment.

Under IRC § 170(h)(1) a contribution of real property is a qualified conservation contribution if:

  1. The property is a “qualified property interest”,
  2. The contributee is a “qualified organization”, and
  3. The contribution is “exclusively for conservation purposes.”

The IRS argued that because the North Dakota state law restricts easements to 99 years the conservation easements cannot satisfy the first and third requirements of IRC § 170(h)(1). The parties agreed that the state law here is unique; it is the only state with a statute that provides for a maximum duration that may not be overcome by agreement.

Under IRC 170(h)(2)(c) a “qualified property interest” means “a restriction (granted in perpetuity) on the use which may be made of the real property. The taxpayers argued that the possibility that the land would revert back to them, WW Ranch, or their successors in interest is the same as a remote future event under Treas. Reg. § 1.170A-14(g)(3) that will not prevent the easements from being perpetual.

A remote future event under Treas. Reg. § 1.170A-14(g)(3) if “on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible.” The Tax Court cited its opinion in 885 Inv. Co. v. Commissioner, defining “so remote as to be negligible” as “a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction.”

The Court granted partial summary judgment on the conservation easement issue in favor of the IRS finding that “on the dates of the donations it was not only possible, it was inevitable that AFW would be divested of its interests in the easements by operation of North Dakota law.” The case will continue to trial on the deductibility of cash contributions to NRT.

Read the full opinion here: Wachter v. Commissioner, 142 T.C. No. 7

Tax Court Denies Taxpayers’ Second Attempt to Avoid Penalties

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us_Tax_Court_fasces-with-red-ribbonIn Mountanos v. Commissioner, T.C. Memo 2014-38, the Tax Court denied the taxpayer’s request to consider alternative grounds for disallowing deductions conservation easement conveyance. The taxpayer sought to avoid 40% accuracy-related penalties assessed on the disallowance of the deductions in Mountanos v. Commissioner, T.C. Memo 2013-138 (Mountanos I) (see our Summer 2013 newsletter).

In Mountanos I, the taxpayer claimed a $4.9 million deduction return for conveying a conservation easement to the Golden State Land Conservancy. The IRS challenged the easement on multiple grounds, including valuation. The Tax Court found that the conservation easement had no value because the conveyance had no effect on the “highest and best use” of the property. The Court did not consider the respondent’s alternative arguments and imposed a 40% gross valuation misstatement penalty.

The taxpayer filed a motion seeking reconsideration of the Court’s decision on the 40% penalty. Relying on prior opinions of the court, the taxpayer argued that the Court should consider alternative grounds that the taxpayer fails to concede as the basis for calculating the penalty.

The Tax Court denied the taxpayer’s motion for reconsideration of the penalties because it would allow the taxpayer to “take two bites at the same apple.” Judge Kroupa also questioned the viability of the cases relied upon by the taxpayers in light of the Supreme Court’s decision in United States v. Woods. Woods rejected the taxpayer’s reliance on the “Blue Book” formula in an attempt to avoid the gross valuation misstatement penalty.

Read the full opinion here: Mountanos v. Commissioner, T.C. Memo. 2014-38

Tax Court Reverses Itself on Qualified Appraisals for Façade Easements

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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

Tax Court Reasserts Position on Conservation Easements

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Opining on a motion for reconsideration, the Tax Court has reaffirmed the circumstances under which a conservation easement might be extinguished without violating the regulatory requirement that the donation be made in perpetuity. Asked to account for an intervening change in the law based on First Circuit Court of Appeals’ decision in Kaufman v. Shulman, the Court declined to change its earlier decision in Carpenter v. Commissioner, T.C. Memo. 2012-1.

In the matter under reconsideration, the parties reserved the right to extinguish the conservation easement by mutual agreement. Under those circumstances, the donee organization would have received its proportionate share of the proceeds following removal of the easement. The taxpayers argued that these circumstances met the in perpetuity “safe harbor” under Treas. Reg. Sec. 1.170A- 14(g)(6)(i) for terminated conservation easements.

The Court disagreed and emphasized that “extinguishment by judicial proceedings is necessary” to satisfy the regulation and that a proportionate share reserved for the donee organization is not an adequate substitute for guaranteeing the donation in perpetuity. The Court also reminded the taxpayers that in cases appealable to Federal Courts of Appeals that had not ruled on the issue – as was the case here – the First Circuit’s decision is not binding on the Tax Court.

Read the entire opinion here:
Carpenter v. Commissioner, T.C. Memo. 2013-172

Government Denied Summary Judgment in Conservation Easement Case

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white-cloud-wilderness-idahoThe U.S. District Court for the District of Idaho recently rejected the government’s pre-trial motion for summary judgment on the validity of a conservation easement donation, setting the stage for a trial on the facts of the transaction.

The District Court’s order and decision provides another ray of hope for Alan Pesky’s efforts to preserve his charitable contribution deduction for the conservation easement donation he made in 2002. Mr. Pesky has already been through a series of pre-trial motions. While this decision should have him headed for trial on the merits of the tax deductions for his donation, as we note below, the government has lobbed yet another missive over the transom.

The facts of the Pesky case are complicated but not necessarily unusual among high-net worth individuals with substantial real estate holdings who find themselves approached about a conservation easement donation. In stark summary, Alan Pesky was approached by The Nature Conservancy (TNC) to acquire a parcel over which a conservation easement ultimately was granted to TNC. The acquisition involved a series of negotiations and collateral agreements which may or may not prove to be relevant in sustaining the deduction.

When the donation was complete, Mr. Pesky deducted a portion of the conservation easement donation on his 2002 tax return and carried forward the remainder on his 2003 and 2004 returns. The government has challenged the charitable deductions for all three years but had to assert fraud for the 2002 tax year because it failed to issue a notice of deficiency within the three-year statute of limitations. The government made additional assertions of fraud which were addressed in this order (and elsewhere).

This case is a fine example of the Government’s recent approach to conservation easement litigation. The government wants to win early dismissal of these cases on pre-trials motions without allowing an examination of the facts and is willing to renew and recycle arguments that have failed before and been flat out rejected in other Federal circuits.

The government moved for summary judgment based on three primary arguments. The first argument was that the conservation easement was part of a larger quid pro quo transaction between the taxpayers and TNC.  This argument has been considered in this context by the Tax Court in at least one reported decision but under substantially different facts than these.  Considering the factors that might influence a jury on this question, the U.S. District Court ruled that a genuine issue of material fact remained for consideration at trial and denied the government’s motion.

The government’s second argument was that there was no contemporaneous written acknowledgement of goods and services received. Though the government conceded the existence of such an acknowledgment, its argument was an extension of the quid pro quo position, i.e., that there was no charitable intent. The court also rejected the argument based on the potential for a genuine issue of material fact.  One might argue though that the taxpayer should prevail based on the substantial compliance doctrine adopted in Simmons v. Commissioner, T.C. Memo 2009-208 aff’d. 646 F.3d 6 (D.C. Cir. 2011).

Finally, the government argued that donation should fail because the Pesky’s property appraisal did not meet the standard for a qualified appraisal standard in the regulations. Again, the District Court leaned on potential for a genuine issue of material facts to deny the government’s motion.  Given the minimum threshold standard for a qualified appraisal set forth by the Second Circuit Court of Appeals in Scheidelman v. Commissioner, 682 F.3d 189 (2d Cir. 2012), the taxpayers should also prevail on this issue.

In all events, the court rejected all three of the government’s arguments.  The persistence of the government, however, should not be denied. Despite the court’s rejection of their positions just last Monday, the government had already filed a motion for reconsideration of the order on Friday requesting that the court take yet another look at these well-worn arguments.  The Pesky’s might yet have their day in court, but not before they cross a few more hurdles the government intends to through in the way.

Read the Order Denying the Government’s Motion for Summary Judgement here:
Pesky Order 7.8.13

Read the Government’s Motion for Reconsideration here:
Pesky Motion for Reconsideration 7.12.13

Tax Court: Side Letter Invalidates Facade Easement Donation

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tread_HDIn a division opinion that reflects the increasingly technical aspects of defending conservation easement cases, the Tax Court has disallowed deductions for the contribution of cash and a façade easement to a qualified organization.  The charitable contributions were disallowed because the donee issued a “side letter” promising to refund cash contributions and rescind the easement over the donor’s property if the donation was “disallowed” by the Internal Revenue Service.

The taxpayers donated a façade easement over their home in the Treadwell Farms Historic District on the Upper East Side of Manhattan. They obtained a qualified appraisal and took deductions based on their cash contributions and the value of the donated easement. The entire transaction was covered by the side letter. The IRS disallowed the deductions for the cash and easement donations and imposed penalties. The taxpayers petitioned the Tax Court.

The case was submitted to the Court without trial on stipulated facts. The Court found that the promises in the comfort letter made the gifts conditional and thus incomplete for purposes of the deduction. It found that the possibility that the IRS would disallow the contributions was not “so remote as to be negligible” – a standard imposed under the regulations governing the deductibility of conservation easements. The Court noted IRS administrative guidance issued prior to the donation announcing increased scrutiny of somewhat similar transactions and the donee organization’s “standard policy” to refund contributions for challenged transactions as evidence that an IRS disallowance was not “so remote as to be negligible.” The Court did not address the penalties, reserving that issue for future proceedings.

Read the entire opinion here:
Graev v. Commissioner, 140 T.C. No. 17 (2013)

Value Matters, Even as Tax Court Denies Conservation Easement Deduction

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Autosave-File vom d-lab2/3 der AgfaPhoto GmbHAlthough disappointing to the petitioning taxpayer, yesterday’s Tax Court opinion in Mountanos v. Commissioner is of some relief to practitioners and counsel who follow conservation easement cases closely. Recent decisions in the Tax Court (Belk, Averyt) and the Courts of Appeals (Kaufman, Scheidelman) have turned on technical aspects of the Treasury regulations that govern the deductibility of these charitable contributions.

Mountanos, instead, is a “traditional” conservation easement case in that the validity of the donation, documentation and recordation of the easement were not at issue. We note, however, that the government did argue that the taxpayers did not acquire a “contemporaneous written acknowledgment” from the donee organization or a “qualified appraisal” as required under the applicable statute and regulations but the court did not address these arguments.

Rather this case turned entirely on the value attributed to the taxpayer’s donation of an 882 acre tract of undeveloped land in north central California. The taxpayer’s valuation was based on the before and after approach. Using that method, where the “before” value is based on the highest and best use of the property, the taxpayer’s $4.6 million valuation was based on use of the property as part vineyard and part residential development. The “after” valuation – that is, after the restrictive easement was imposed – was based entirely on recreational use (such as deer hunting).

Judge Kroupa was not persuaded that a 287 acre vineyard “was a legally permissible, physically possible and economically feasible use of the ranch.” The taxpayer’s restricted access to the property (across Federally controlled parkland) and lack of access to proper irrigation made the likelihood of a viable vineyard slim, even if it could have been economically viable (which the court found equally unlikely).

The proposed use of the property for residential development was no more impressive to the court. The entire parcel was subject to a contract with the county, governed by a state statute (the Williamson Act), that forbade residential development – even before the conservation easement donation had been made. The taxpayers did not put on evidence to convince the court that the state law restrictions would not apply if the taxpayer indeed tried to pursue residential development. Accordingly, the court concluded that the taxpayers failed to show that “the conservation easement had any value.”

The court also sustained the 40% gross valuation overstatement penalty asserted against the taxpayers. It is unclear whether the taxpayers put forth a reasonable cause defense to the penalty or not but the court noted that such a defense does not apply “in the case of a gross valuation overstatement with respect to property for which a charitable contribution deduction was claimed under section 170. Sec. 6664(c)(3).”

This was unquestionably a bad result for the taxpayers but still an encouraging note for taxpayers who have made carefully executed and fairly valued conservation or facade easements – you should at least have a day in court.

Read the opinion here:
Mountanos v. Commissioner, TC Memo 2013-138

Conservation Easement Deduction Denied as Quid Pro Quo for Subdivision Approval

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The Tax Court denied the taxpayers’ deduction for the donation of a conservation easement where the taxpayer granted the easement pursuant to negotiations with a local zoning authority for approval of a subdivision exemption.

The deductibility of conservation easement donations is drawn from the general rule allowing the deduction of charitable contributions under IRC §170. Charitable contributions must be freely given, i.e., a gift, to qualify for the deduction. If the contribution is made in exchange for a specific benefit, i.e., a quid pro quo, then it does not qualify for the deduction.

The Tax Court found that the taxpayer’s donation of the easement was not a gift because it was “part of a quid pro quo exchange for Boulder County’s approving his subdivision exemption request.” The court also approved the application of the 20% substantial understatement penalty under IRC §6662(b)(2) against the taxpayer. The court denied the taxpayer’s reasonable cause argument to avoid the penalty, specifically noting the lack of testimony from the CPA who prepared the returns and invoking the “Wichita Terminal rule” to find for the government. The Wichita Terminal rule is drawn from a 67 year-old Tax Court case and generally provides that when a litigant fails to produce the testimony of a person that might be expected to testify, that failure gives rise to a presumption that the testimony would be unfavorable to the litigant’s case.

While the taxpayer lost on the 20% penalty, the court did reject the government’s argument for the 40% gross valuation penalty under IRC §6662(h)(2). In support of its position the commissioner alleged that the appraisal:

(1) was made more than 60 days before the grant of the second conservation easement; (2) does not describe the property; (3) does not contain the expected date of contribution; (4) does not contain the terms of the second conservation easement; (5) does not include the appraised fair market value of the second conservation easement on the expected date of contribution; and (6) does not provide the method of valuation Mr. Roberts used in that the report does not adequately identify the highest and best use of the property.

The taxpayer urged that the penalty did not apply under the exception provided in IRC §6664(c)(2) because the taxpayer obtained a “qualified appraisal” from a “qualified appraiser” and made a good faith investigation of the value of the property before making the donation. The court sided with the taxpayer and rejected the government’s arguments. The court voiced its particular concern with the government’s claim that the appraisal was not qualified because did not provide a method of valuation. The court noted that the appraisal specifically identified the well-established “before and after” valuation method and repeated, though without citation, the same concerns expressed by the Second Circuit Court of Appeals in Scheidleman v. Commissioner, that is, that the government’s claim really was directed at the reliability of the report and not its validity or “qualification”.

Read the entire opinion here:
Pollard v. Commissioner, T.C. Memo 2013-38