Tag Archives: Facade Easement

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

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: 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: 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.

Fifth Circuit Vacates Tax Court on Donation of Historical Facade Easement

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The Fifth Circuit Court of Appeals vacated the Tax Court’s valuation of an historic façade easement for charitable contribution purposes and remanded for further findings.

Whitehouse Hotel Limited Partnership v. Commissioner, Docket No. 09-60085 (5th Circuit August 10, 2010)

Façade Easement Rejected for Lack of Qualified Appraisal

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The IRS continues to scrutinize qualified appraisals in the context of façade easements, particularly in the historic districts of New York City. In a Memorandum Opinion issued July 14, 2010, Judge Cohen found that the taxpayers, Huda T. Schneidelman and Ethan W. Perry, failed to obtain a qualified appraisal for their donation of a historic façade easement. In 1997, taxpayers purchased a townhome for $255,000 in the Fort Greene Historic District of Brooklyn. In 2002, taxpayers received a postcard from the National Architectural Trust (NAT) announcing an upcoming meeting in the New York City area to provide information regarding the donation of a façade conservation easement and possible related tax benefits.

The taxpayer contacted her accountant, who had 40 years of experience, and asked him about the façade easement. He had not heard of façade easements before, but attended the NAT meeting and determined that the façade easement contribution deduction was appropriate under the Internal Revenue Code.

In March of 2003, taxpayers completed a façade conservation easement application and made a fully refundable $1,000 deposit to NAT. NAT accepted and processed taxpayer’s application and provided her information about the appraisal process. The taxpayer waited to pursue the donation until 2004, so that she could save enough money to pay for the appraisal. In April of 2004, taxpayer hired an appraiser from the NAT provided list of appraisers “qualified to do easement appraisals.”

The appraiser taxpayer used was a “qualified expert in the field of real estate appraisal and valuation.” In his report, the appraiser used the sales comparison approach to determine that the estimated market value of the property was $1,015,000 as of the appraisal date. Looking at historical comparisons of attached row homes in New York City, the appraiser determined that the façade easement value was 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.

NAT accepted the appraisal and the City of New York recorded the conservation deed of easement for the property. Taxpayer attached Form 8283 to her 2004 tax return reporting a $115,000 gift to charity. She applied part of the deduction to her 2004 return and carried over $63,083 of the reported contribution to her 2005 and 2006 tax returns.

The IRS conducted an examination of Ms. Scheidelman and disallowed 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. The Tax Court held that Ms. Scheidelman did not meet the threshold statutory requirement to deduct her donation because she did not have a “qualified appraisal.”

The Tax Court noted that the Form 8283 attached to taxpayer’s 2004 tax return did not include the date and manner of acquisition of the property or the cost or other basis of the property contributed. While these issues were not controlling, the Court noted, “there has not been strict compliance with the regulation requirements.” Particularly, the Tax Court took issue with the basis for the appraised value. Citing Friedman v. Commissioner, T.C. Memo. 2010-45, the Court emphasized the need for “reasoned analysis” and information about the valuation method to complete a “qualified appraisal.”

The Tax Court rejected the appraiser’s idea that façade easements were generally valued between 10% and 15% of the total property value. The Court relied on Nicoladis v. Commissioner, T.C. Memo. 1988-163, to emphasize the point that valuation is a question of facts and circumstances. For that reason the Court rejected the appraiser’s report because it “failed to outline and analyze qualitative factors for the Vanderbilt property.” The application of a percentage of value lost because of the easement without a detailed explanation was not enough to constitute a valid method of valuation under Treas. Reg. § 1.170A-13(c)(3)(ii). The Tax Court did not address the valuation of the easement.

The Tax Court considered two other issues including whether the taxpayer’s payment to NAT was deductible as a charitable contribution and whether the taxpayer was liable for an accuracy related penalty under IRC § 6662. The Court found that the payments to NAT were not deductible because taxpayer failed to provide evidence necessary to show that they did not receive anything of substantial value in return for the cash payment. The taxpayer did not have to pay the § 6662 penalty because she reasonably relied on a competent tax professional and acted in good faith as to any underpayment for 2004.

Read the opinion here:
Scheidelman v. Commissioner, T.C. Memo. 2010-151