Tag Archives: Tax Court

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

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

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

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

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

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

Read the Tax Court opinion here.

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

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)

Tax Court: Legal Fees Not Deductible for Conduct of S Corp. Sole Shareholder

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The Tax Court has denied the deductibility of legal fees incurred to defend a wrongful death suit brought against the sole shareholder of an S Corp. Authored by Judge Holmes in inimitable style, the opinion offers a good discussion of the various instances when a corporation can, and cannot, deduct legal fees incurred on behalf of its employees.

Read the opinion here:
Cavanaugh v. Commissioner, T.C. Memo. 2012-324

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).

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 Collection Due Process Standard of Review Upended by the First Circuit

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In an decision that could dramatically change collection due process, the First Circuit Court of Appeals held that the standard of review applied to collection due process cases by the Tax Court for more than a decade is incorrect. In Dalton v. Commissioner, No. 11-2217P-01A (1st Cir. June 20, 2012), the First Circuit Court of Appeals reviewed a division opinion of the Tax Court which found that the IRS Office of Appeals abused its discretion when it sustained a collection action based on an incorrect application of the law. The First Circuit reversed the Tax Court on the basis that it applied an “improper standard of review” with respect to the Office of Appeals determination. The First Circuit held that the Tax Court’s review is limited to whether the Office of Appeals’ determination was “reasonable,” not necessarily whether or not it was correct.

In Dalton v. Commissioner, 135 T.C. 393 (2010), the Tax Court reviewed a collection due process determination applying the standard of review established in Sego v. Commissioner, 114 T.C. 604 (2000). Sego requires that

where the validity of the underlying tax liability is
properly at issue, the Court will review the matter on a de
novo basis. However, where the validity of the underlying
tax liability is not properly at issue, the Court will
review the Commissioner’s administrative determination for
abuse of discretion. Sego, at 610.

The Tax Court applied the second prong of Sego finding an abuse of discretion in the Appeals Officer’s incorrect application of the law. The underlying legal question was whether or not petitioners owned property held in a trust and which body of law, state, federal or both, should be applied to answer that question.

The Court of Appeals did not address Sego in its opinion. The appellate court, however, did hold that the role of the Tax Court in reviewing collection due process determinations was

to decide whether the IRS’s subsidiary factual and legal determinations are
reasonable and whether the ultimate outcome of the CDP proceeding
constitutes an abuse of the IRS’s wide discretion.

The First Circuit, by Senior Judge Seyla, explained that a more deferential standard of review was “consistent with the nature and purpose of the CDP process” and that the question for the reviewing court was not the correctness, or not, of the determination but rather whether the determination “falls within the universe of reasonable outcomes.” The Court further explained that regardless of whether the Appeals determination was based on a factual finding, a legal question, or a mixed question of law and fact, the reviewing Court’s role was only to evaluate the reasonableness of the determination.

The First Circuit’s opinion is the fourth milepost in petitioners’ legal saga since their first encounter with the IRS Office of Appeals. In 2006, petitioners requested review of their collection due process determination when the Appeals Officer rejected their offer in compromise. Respondent moved for summary judgment. Petitioners’ responded maintaining that their offer in compromise should have been accepted because there was doubt as to the collectibility of tax and the appeals officer erred by attributing assets to petitioners that they did not own. The Tax Court denied respondent’s motion in a memorandum decision and remanded the case to Appeals for a redetermination on the applicable law. Dalton v. Commissioner, T.C. Memo. 2008-165. Following the second review by the Appeals Officer, the case returned to the Tax Court on petitioners’ motion for summary judgment. The IRS filed a response to petitioner’s motion for summary judgment and lodged a second motion for summary judgment. In the reviewed opinion noted above, the Tax Court found that the Office of Appeals’ decision to continue with the collection action was an abuse of discretion because the Appeals Officer rejected petitioners’ offer in compromise on erroneous legal grounds. Dalton v. Commissioner, 135 T.C. 393 (2010). The Dalton’s final encounter in the Tax Court resulted in a memorandum opinion awarding them legal fees. Dalton v. Commissioner, T.C. Memo. 2011-136. All three decisions in favor of the Dalton’s were reversed by the First Circuit.

Read the First Circuit’s opinion here:
Dalton v. Commissioner, No. 11-2217P-01A (1st Cir. June 20, 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