Tag Archives: Conservation Easement

Tax Court Denies Conservation Easement that Allowed Substitution of Property

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us_tax_courtAs the IRS continues to challenge charitable deductions for the contribution of conservation and facade easements, the Tax Court is considering the details of these arrangements with greater scrutiny. In doing so, the Court is refining the law governing these transactions. In its most recent opinion on this issue, the Court clarified yet another requirement for taxpayers who wish to claim this charitable deduction.

In Belk v. Commissioner, the taxpayers donated a conservation easement over a 184 acre golf course and claimed a $10.5 million deduction on their 2004 tax return. The conservation easement agreement executed by the parties included a provision which allowed the owner of the property (i.e., the taxpayers) to substitute the property subject to the easement with “an area of land owned by Owner which is contiguous to the Conservation Area for an equal or lesser area of land comprising a portion of the Conservation Area.”

The IRS challenged the validity of the entire donation on the grounds that the real property interest (i.e., the golf course) was not donated in perpetuity because the substitution provision allowed it to be replaced by another property. The IRS argued that the substitution provision violated the requirement that the contribution be an interest in real property that is subject to a use restriction granted in perpetuity under IRC §170(h)(2)(C).

The IRS previously had argued that certain facade easements violated the “in perpetuity” requirement. See, Kaufman v. Commissioner, 134 T.C. 182 (2010) (Kaufman I) and Kaufman v. Commissioner, 136 T.C. 294 (2011) (Kaufman II). The Kaufman argument, however, was based on the language of IRC §170(h)(5) which requires that the conservation purpose of the easement be protected in perpetuity. Though the IRS prevailed in the Tax Court, Kaufman and the §170(h)(5) argument was overturned by the First Circuit Court of Appeals. Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012).

In Belk, the IRS, and apparently the taxpayers (see footnote 17), combined the two provisions of §170 while making the perpetuity argument. Judge Vasquez, writing for the Court, parsed the issue more carefully. He noted that §170(h)(2)(C) requires that the property must be subject to a perpetual restriction on use as distinguished from § 170(h)(5) which requires that the conservation purpose be protected in perpetuity. The Court made it clear that the two provisions were separate and distinct and based its decision on the former.

The Court held that the donation made by the Belk’s did not constitute a “qualified real property interest” under §170(h)(2)(C) because the conservation easement agreement allowed for substitution of the contributed property. The court found that the contributed property was not subject to a use restriction in perpetuity but in fact subject to the restriction only so long as the substitution provision in the agreement was not exercised. Accordingly, the charitable donation did not meet the requirements of §170(h) and the deduction was denied in full. The Court did not reach the question of conservation purpose or valuation.

Read the entire opinion here:
Belk v. Commissioner, 140 T.C. No. 1 (2013)

Second Circuit Vacates Tax Court in Façade Easement Case

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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).

1st Circuit Vacates Tax Court on Historical Facade Conservation Easement

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In a case that has been followed closely by many interested parties, the First Circuit Court of Appeals ruled in favor of the taxpayers and the validity of their charitable contribution of an historical façade conservation easement in Kaufman v. Shulman. The 1st Circuit vacated the Tax Court’s legal ruling on partial summary judgment and remanded the matter for further findings on the questions of penalties and valuation.

The taxpayers in Kaufman owned an approximately 150 year-old row house in the historic district of South End in Boston. The home reflected mid-nineteenth century architecture and included a unique Venetian-Gothic style façade. In 2003, the taxpayers executed a “Preservation Restriction Agreement” donating an easement over the property to a qualified charitable organization for the purpose of protecting and preserving the historical features of the home. On the advice of the donee, the taxpayers obtained an appraisal of the contribution from an experienced appraiser who valued the easement at $220,800. The taxpayers took deductions on their 2003 and 2004 tax returns for the value of the donated easement, subject to the limits of IRC Sec. 170(b)(1)(E).

The property was subject to a mortgage when the taxpayers made the donation. The taxpayers obtained an agreement from the lender subordinating certain of the mortgage-holder’s rights in the property to the donee in accordance with the regulations governing the charitable donation of conservation easements. The agreement included several restrictive clauses, one of which became the focus of the Tax Court’s determination and the 1st Circuit’s ruling. That clause read as follows:

The Mortgagee/Lender and its assignees shall have a prior claim to all insurance proceeds as a result of any casualty, hazard or accident occurring to or about the Property and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged, notwithstanding that the Mortgage is subordinate in priority to the [Preservation Restriction] Agreement.

Following an examination of their 2003 and 2004 returns, the IRS issued a notice of deficiency to the Kaufmans disallowing the deductions for the charitable contribution of the easement. The IRS maintained that the donation did not meet the regulatory requirements of Section 170(h). The taxpayers petitioned the U.S. Tax Court.

The Tax Court, in a division opinion by Judge Halpern, ruled for the IRS on a motion for partial summary judgment. Kaufman v. Commissioner, 134 T.C. 182 (2010). The Tax Court held that the conservation easement as executed failed to satisfy the requirement of Treas. Reg. Sec. 1.170A-14(g)(6). The Tax Court’s position on summary judgment, as summarized by the First Circuit, was that

although the Kaufmans in the Preservation Restriction Agreement governing 19 Rutland Square granted the Trust an entitlement to a proportionate share of post-extinguishment proceeds, thus seemingly complying with the regulation, the lender agreement executed by Washington Mutual undercut this commitment–and so defeated the deduction–by stipulating that “[t]he Mortgagee/Lender and its assignees shall have a prior claim to all insurance proceeds . . . and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged.”

Even though the Tax Court decided for the government “entirely” on the basis of Treas. Reg. Sec. 1.170A-14(g)(6), the Court of Appeals also addressed paragraphs (g)(1) (perpetuity), (g)(2) (remote events), and g(3) (subordination) of the regulation in its opinion. The First Circuit observed that the IRS’s arguments in support of the Tax Court’s decision under g(6) would “appear to doom practically all donations of easements, which is surely contrary to the purpose of Congress.” The appellate court continued that it “cannot find reasonable an impromptu reading [of a regulation] that is not compelled and would defeat the purpose of the statute, as we think is the case here.” So on the big issue in the case, whether the mortgage subordination clause that granted the lender a prior claim to insurance and condemnation proceeds defeated the deduction, the First Circuit vacated the Tax Court’s legal conclusion.

The First Circuit made clear that it did not rest its decision on either the application of paragraphs (g)(3), addressing the defeasance of the deduction by remote future events, or (g)(2) which the taxpayers argued would have upheld the subordination agreement regardless of the extinguishment provision. This caveat seems to preserve the Tax Court’s recent opinion in Mitchell v. Commissioner from the scope of this ruling.

The appellate panel also addressed the “in perpetuity” requirement of Treas. Reg. Sec. 1.170A-14(g)(1) and the language in the agreement stating that “nothing herein contained shall be construed to limit the [Trust’s] right to give its consent (e.g., to changes in the façade) or to abandon some or all of its rights hereunder.” The First Circuit noted its agreement with the D.C. Circuit who decided the same issue in Commissioner v. Simmons, 646 F.3d 6 (D.C. Cir. 2011) and added that the question was not whether the paragraph was a reasonable interpretation of the underlying statute, Sec. 170(h)(5), but whether the IRS’s interpretation of the regulation was reasonable. The court concluded that the regulation did not support the IRS’s stringent view.

Read the entire opinion here:
Kaufman v. Shulman, Docket No. 11-2017P-01A (1st Cir., July 19, 2012)

Tax Court: Deed Is Substantiation of Conservation Easement Donation

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The Tax Court continues to define the limits on the charitable donation of conservation easements while the IRS maintains its frontal assault on these transactions. In Averyt v. Commissioner, the Tax Court considered respondent’s motion for summary judgment and petitioner’s cross-motion for partial summary judgment on the question of whether or not the timely recorded deed of conservation easement satisfied the substantiation requirements of IRC Sec. 170(f)(8).

IRC Sec. 170(f)(8) generally requires that a charitable contribution of $250 or more must be substantiated with a contemporaneous written acknowledgment from the donee organization. A written acknowledgement must include

(i) the amount of cash and a description (but not value) of any property other than cash contributed; (ii) whether the donee organization provided any goods or services in consideration, in whole or in part, for any property; and (iii) a description and good faith estimate of the value of any goods or services.

The IRS argued that, as a matter of law, the taxpayers had not met the substantiation requirements of Section 170(f)(8). The taxpayers argued that the conservation deed was a contemporaneous written acknowledgment of the charitable contribution that satisfied Section 170(f)(8).

The Commissioner relied on Schrimsher v. Commissioner, T.C. Memo. 2011-71, where the court held that the contribution of a conservation easement was not deductible because the taxpayers did not receive a contemporaneous written acknowledgment from the donee organization. The taxpayers in Schrimsher relied on the conservation deed as evidence that the donee acknowledged the donation. The deed recited consideration of “the sum of TEN DOLLARS, plus other good and valuable consideration.” The Court held that the deed did not meet two of the three requirements of Section 170(f)(8) because it did not describe the property donated or provide a good faith estimate of its value.

The deed recorded in this case, however, recited consideration more particularly. The conservation easement in Averyt was granted “in consideration of the foregoing recitations and of the mutual covenants, terms, conditions, and restrictions hereinunder set forth.” The Court found that the deed language in this case compared favorably with the deed in Simmons v. Commissioner, T.C. Memo. 2009-208, aff’d, 646 F.3d 6 (D.C. Cir. 2011) where the Court held that the deed satisfied the Sec. 170(f)(8) substantiation requirements. Accordingly, the Court found that the deed in this case met all of the requirements of Section 170(f)(8) including the provision that no goods or services were received in exchange for the donation.

The Court granted petitioner’s motion for partial summary judgment. The Court also determined that material questions of fact remained with regard to the other issues in dispute, so a trial may be forthcoming to determine those facts.

Read the opinion here:
Averyt v. Commissioner, TC Memo. 2012-198

Tax Court: Facade Easement Denied on Summary Judgment

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The Tax Court rejected a pro se taxpayer’s deduction for the contribution of a facade easement on the government’s motion for summary judgment.

The court found in favor of respondent as a matter law based on its decision in Kaufman v. Commissioner, 134 T.C. 182 (2010). Kaufman held that where the subordination agreement to the mortgagee under the easement does not grant the donee a priority interest in the distribution of proceeds upon involuntary conversion or foreclosure, then the easement fails the perpetuity requirement of Treas. Reg. Sec. 170A-14(g)(6). Kaufman was reheard on a motion for reconsideration with the same result, 136 T.C. No. 13, and currently is under appeal to the 1st Circuit Court of Appeals.

In a final note on this decision, the respondent conceded penalties in its motion for summary judgment, which would have required a trial to satisfy the government’s burden of proof, in order to meet the requirement for summary judgment under Tax Ct. R. 121 that no material facts are in dispute.

Read the opinion here:
Wall v. Commissioner, T.C. Memo 2012-169

Tax Court Denies New York Facade Easement

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us_tax_courtIn Rothman v. Commissioner, T.C. Memo. 2012-163, the Tax Court held that petitioners failed to provide a qualified appraisal under IRC § 70(f)(11) for the donation of a facade easement on their residence in Brooklyn, New York.    The Court followed its decision in Scheidelman v. Commissioner, T.C. Memo. 2010-151, finding that “applying a fixed percentage to the before value of the subject property, without explanation, does not constitute a valuation method under IRC § 1.170A-13(c)(3).”

The case came to the Court on petitioners’ motion for partial summary judgment and respondent’s motion for partial summary judgment on the issue of whether petitioners obtained a qualified appraisal in connection with their charitable deduction for the donation of a facade easement in 2004.  The petitioners donated an open space and architectural facade easement to the National Architectural Trust (NAT) on their home in Brooklyn, New York.  The petitioners hired a New York real estate appraisal firm to appraise the property and the easement.

The appraiser used the before and after method to determine the easement’s fair market value.  He estimated the value of the property before the easement to be $2.6 million by comparing five sales of similar properties in the area.  Similar to Scheidelman, the appraiser was unable to identify sales of comparable eased properties to determine the after value of the property, so he cited historical precedence to reduce the subject property’s before value by 11.15%.  Thus, the appraisal valued the petitioners’ facade easement at $290,000.  The petitioners claimed a noncash charitable deduction of $247,010 on their 2004 Federal income tax return and an excess charitable contribution carryover of $42,990 on their 2005 Federal income tax return.

The Court noted that the appraisal presented by petitioners was “identical in all material respects, including the typographical errors, to the one petitioners obtained.”  Citing Scheidelman, the Court rejected the appraiser’s argument that applying a percentage to a property’s before provided a method or specific basis for determining a property’s after value.  The Court also questioned the appraiser’s interpretation and reliance on the decision in Hillborn v. Commissioner, 85 T.C. 677, to grant a general 10% rule for facade easement donations.  Instead, the Court held that the easement’s terms and covenants must be analyzed individually and collectively and compared to existing zoning restrictions to estimate the extent to which the easement affects the property’s fair market value.  The Court found that the appraisal language, identical to Scheidelman, failed to explain how the specific attributes of the property led to the value determined in the appraisal.

The Court held that the appraisal was not a qualified appraisal because it failed to include a valuation method or specific basis for the value of the easement determined as required under Treas. Reg. §§ 1.170A-13(c)(3)(J) and (K).

Read the Tax Court Opinion here:  Rothman v. Commissioner, T.C. Memo. 2012-16

 

Tax Court: Donation of Conservation Easement Denied

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A recent Tax Court opinion offers two new elements for consideration when making a charitable donation of a conservation easement under Section 170.

In Mitchell v. Commissioner, the Tax Court denied taxpayer’s deduction for the charitable contribution of a qualified conservation easement. The court found that where a mortgage subordination agreement is not in place at the time of the donation, the subordination requirement of the regulations has not been satisfied. The court also ruled that the so-remote-as-to-be-negligible standard of Treas. Reg. Sec. 1.170A-14(g)(3) does not to apply to determine whether a donation has satisfied the requirements of Treas. Reg. Sec. 1.170A-14(g)(2) (subordination of the easement).

Read the opinion here:
Mitchell v. Commissioner, 138 T.C. No. 16 (2012)

Tax Court: Donation of Conservation Easement Upheld

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The Tax Court affirmed the proposition that a conservation easement is still a Congressionally sanctioned charitable contribution under IRC §170(h). Conservation easements and the corresponding charitable contribution deduction for the donation of such easements have been a topic of heightened scrutiny by the IRS in recent years. So much so, that we might have forgotten that there is a legitimate basis in public policy for this deduction.

In Butler v. Commissioner, the IRS sought to disallow deductions related to conservation easements that protected thousands of acres of undeveloped rural property and impose penalties upon the donors who made the contribution. The Tax Court, however, found for the taxpayers on the validity of the qualified conservation contributions, made some adjustments to the valuation of the properties based on the testimony of several experts, and dismissed the penalties.

For those interested in the mechanics of tax litigation, Butler is instructive on two additional points. First, the petitioners prevailed in shifting the burden of proof to the government on select issues under Section 7491(a) – a feat more often considered than accomplished. Second, the court ruled on the admissibility of an expert report prepared by an expert who died before the trial began. Petitioners sought to have the deceased expert’s report admitted as evidence of fair market value, invoking alternative exceptions to the hearsay rule under Federal Rules of Evidence 804(b)(1) and 807. The court denied petitioners’ requests but admitted the report for the limited purpose of establishing reasonable cause to avoid penalties under Section 6664.

Read the opinion here:
Butler v. Commissioner, T.C. Memo. 2012-72

Tax Court: Historical Easement Denied, Cash Contributions Allowed

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The Tax Court, in a memorandum opinion by Judge Goeke, found that the donation of a facade easement of a Tribeca condo building for historical preservation purposes did not meet the requirements of IRC Section 170(h) as a qualifying charitable contribution. The court found that the petitioners failed to establish a value in the easement sufficient to support the claimed deduction.

The court did allow cash contributions made by some condo owners to the National Architectural Trust, the beneficiary of the easement, as deductible charitable contributions. The court also declined to assess accuracy-related penalties against the condo owners, finding that they established reasonable cause for their positions under IRC Section 6664(c).

Read the entire opinion here:
Dunlap v. Commissioner, T.C. Memo. 2012-126.