Tag Archives: Tax Court

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 Filing Deadlines during Government Shutdown

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us_tax_courtFacing a deadline to file a petition to challenge your Statutory Notice of Deficiency or seek a Redetermination of Collection Due Process Hearing while the federal government is shut down?

Your deadline is not extended.

Statutory Filing Deadlines

The Tax Court lacks the authority to extend statutory filing deadlines imposed in the Internal Revenue Code. So, even though you may not hand deliver the petition to the Tax Court (since it is closed), you still must file by the statutory deadline.

Accomplish your filing and preserve your rights by timely mailing the petition. The post office is still open during the shutdown.

You may also deliver the petition by an approved private express delivery company (FedEx, UPS, etc.). Note that the standard for determining compliance with the deadline by mail is a timely USPS postmark. However, the standard for timely filing for express companies is a certificate of delivery. Confirm that the delivery company you are using will deliver or issue a certificate of delivery to an office that is closed, such as the Tax Court, before relying on that option to file your petition.

Other Tax Court Due Dates Extended

Due dates previously set by Tax Court Rule or Order for filing a document, completing discovery, or any other act shall be extended. All such due dates on or after October 1, 2013, shall be extended by the number of days that Court operations are suspended, up to a maximum extension of 5 days from the date the Court resumes operations. If the extended due date falls on a Saturday, Sunday, or a “legal holiday”, the due date shall then be the next succeeding day that is not a Saturday, Sunday, or a legal holiday.

Read the Tax Court guidance here:
Tax Court Government Shutdown Public Statement

Tax Court: Business Expense Deductions Still Require…a Business

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bowling-w-fred-flintstoneIn a case that would have Fred Flintstone rolling over in his grave, the Tax Court reminded us that expenses incurred while pursuing a hobby cannot be claimed as deductions – no matter how you see it.

Bruce Phillips was a career postal worker. He was also a self-taught bowler. Until 2004, he worked the night shift and spent a far amount of time at the bowling alley.

2000 was a very good year for Mr. Phillips. He won over $50,000 in bowling tournaments. It seemed his pastime might be lucrative enough to become a business. He invested heavily in the bowling venture – to the tune of $30,000 per year. He was not an overnight sensation though. He only won more than $10,000 in a year once more. He nonetheless continued to view bowling as his business.

That brings us to 2008. In 2008, Mr. Philips was working days for the post office and apparently found less time to bowl. Even though he had not won a tournament in three years, he continued to devote substantial resources to his bowling endeavors – or at least he claimed that he did on his 2008 tax return. Mr. Phillips claimed earnings of $67,171 from the postal service and deductions for business expenses of $28,243 related to his bowling endeavors in 2008. (Credit Mr. Phillips’ accountant who refused to sign the return.)

The IRS denied Mr. Phillips’ business expenses and he challenged the Commissioner’s determinations by filing a pro se petition in Tax Court. The Tax Court walked through the nine factors in Treas. Reg. §1.183-2(b), which defines activities not engaged in for profit, concluding that Mr. Phillips satisfied none of them. The Court’s conclusion probably had as much to do with Mr. Phillips’ failure to produce evidence that he even participated a bowling tournament in 2008 as it did with his failure to show that he carried out his bowling venture in any kind of business-like manner. It seems from the evidence and testimony recounted in the opinion that he did neither.

Mr. Phillips’ business expense deductions were denied in full and he found himself subject to an accuracy-related penalty of 20%. Gutter ball.

Read the entire opinion here:
Phillips v. Commissioner, TC Memo. 2013-215

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

Tax Court Reminder: Hours Alone Do Not Turn a Hobby into a Business

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430_horse0One of my best friends emailed me yesterday. He’s up for partner at one of the largest law firms in the world. He has dedicated many hours to the practice of law since our days together as law clerks at the Tax Court.

However, the key to partnership in the modern practice of law requires more than substantial legal skill – it takes a business plan. He has been asked to write one and I have no doubt that it will be thorough, detailed and realistic. That is, it will be the product of the same skills that have made him a great lawyer already. When he is invited into the partnership of his firm, which I am confident that he will be, I know that he will be expected to execute on that business plan, and I know that he will. After all, the objective of a law firm is to provide excellent legal services and make a profit while doing it.

Yesterday, the Tax Court issued a fairly lengthy Summary Opinion reminding us that the same standard applies to every business. A Summary Opinion is not a legal precedent and cannot be cited for authority, but Craig v. Commissioner amply shows that lengthy hours and dedicated labor alone are not enough to turn an activity into a business. The opinion is instructive for those who might be unsure about the right standard. There must be a plan to make money – and some profits along the way won’t hurt either.

Ms. Craig worked 25-40 hours per week as a real estate agent. She worked 25-30 more hours per week attending to her several horses – an activity for which she claimed losses for the tax years in question. She also worked part time preparing tax returns for H&R Block. The IRS denied Ms. Craig’s losses from the horse breeding activity and she challenged the Commissioner’s determinations by filing a pro se petition in Tax Court.

The Tax Court accepted the fact that Ms. Craig dedicated many hours a week to cleaning stalls, feeding, grooming, training, and otherwise caring for her horses. It did not, however, accept the fact that Ms. Craig engaged in any of those efforts with “an actual and honest objective of making a profit.”

Notable was Ms. Craig’s business plan for the horse-breeding activity. It was prepared in early 2011, months after the IRS began its examination of Ms. Craig’s tax returns, and listed a total of 10 items (all of which are reproduced in the Court’s opinion). From the time the business plan was written until the date of trial in November 2012, Ms. Craig had accomplished only one item on the business plan (she finished training one horse for handling).

Neither the concise and late-breaking business plan nor the lackadaisical approach to execution helped Ms. Craig’s case. It also didn’t help that she also didn’t maintain a separate bank account for the alleged horse breeding business, instead preferring to run expenses through her personal checking account, and reported gross receipts from the business in only one of seven years ($950 of revenue, not even profit). All of these factors contributed to the Court’s conclusion that Ms. Craig’s horse activities were a hobby and not a business. The Court also sustained a 20% accuracy-related penalty against Ms. Craig. A timely-written and well-executed business plan might not have changed the outcome of Ms. Craig’s case, but it certainly wouldn’t have hurt.

Read the entire opinion here:
Craig v. Commissioner, T.C. Summary Opinion 2013-58

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

Tax Court: Challenge to Underlying Liability Does Not Extend Period for CDP Appeal

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In a rare division opinion supplementing a previous division opinion, the Tax Court offers a primer on the definition of “deficiency” and its meaning for jurisdictional purposes. This opinion is not for the meek of heart nor for those not ready to tackle the nuance of Tax Court jurisdiction.

In response to a motion to certify an interlocutory appeal, Judge Joseph Gale lays out the statutory requirements for the court’s jurisdiction over deficiencies as well as collection actions. He also discusses the statutory grounds for variances in the 30-day response required for collection due process review (e.g., innocent spouse relief, interest abatement) and other non-deficiency actions (e.g., employment taxes, frivolous return penalties) in U.S. Tax Court.

The court did not certify the interlocutory appeal and affirmed the proposition that a challenge to the “underlying tax liability” in a collection due process hearing does not extend the period in which to file a petition for review with the Tax Court.

Read the entire opinion here:
Gray v. Commissioner (Gray II), 140 T.C. No. 9 (2013)

Tax Court: Second FPAA Invalid, Cannot Confer Jurisdiction

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us_tax_courtIn Wise Guys Holdings v. Commissioner, the Tax Court has ruled that a second Final Partnership Administrative Adjustment (FPAA) issued to the same Tax Matters Partner for the same tax period is invalid where the issuance was not a result of fraud, malfeasance, or misrepresentation of material fact. The invalid FPAA cannot confer jurisdiction on the court in a TEFRA action where neither the Tax Matters Partner nor a notice partner filed a timely petition in response to the first FPAA. The petition was dismissed.

Find out why the Wise Guys lost their bet on the second FPAA here:
Wise Guys Holdings, LLC v. Commissioner, 140 T.C. No. 8 (2013)

Tax Court: Horse Breeding Activity Not Motivated By Profit, Losses Disallowed

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Horse FarmIn a memorandum opinion, the Tax Court has held that a taxpayer’s 17 years of losses in the horse-breeding business was not an activity motivated by profit under IRC §183. The taxpayer’s deductions attributable to the activity were disallowed and a substantial underpayment penalty was imposed.

Read the opinion here:
Dodds v. Commissioner, T.C. Memo. 2013-76