Saturday, July 5, 2014

How to Screw Up an Easement Deduction

Originally published on Passive Activities and Other Oxymorons on May 26th, 2011.
Randall A. Schrimsher, et ux. v. Commissioner, TC Memo 2011-071
Boltar, L.L.C., et al. v. Commissioner, 136 T.C. No. 14
Gordon Kaufman, et ux. v. Commissioner, 136 T.C. No. 13
1982 East, LLC, et al. v. Commissioner, TC Memo 2011-84

Several years ago I remember hearing ads on the radio encouraging me to donate my used car to charity rather than sell or trade it.  The reasoning was that it might be worth many thousands of dollars more as a tax deduction.  Being a seasoned tax professional I thought there was a flaw in there somewhere.  The practice was pervasive enough that the Code was actually amended to the effect that a charitable contribution of a motor vehicle was limited to the amount that the charity received for selling it.  People who own historic buildings or open land have been presented with a similar prospect.  Why take all the risk of trying to develop your property when the donation of a conservation easement that will be valued based on a hypothetical development can yield you so much more ? I recently did a post on an organization, established to accept conservations easements, that lost its exempt status.  In the last few months there have been several conservation easement cases (including historical facades).  They did not go well for the taxpayers.

Randall A. Schrimsher, et ux. v. Commissioner, TC Memo 2011-071

This was a case of poor execution.

On December 30, 2004, Randall A. Schrimsher (petitioner) executed a document entitled "Preservation and Conservation Easement Agreement" (the agreement) granting a facade easement to the Alabama Historical Commission (the commission). The facade easement is with respect to property in Huntsville, Alabama, commonly known as the "Times Building". The agreement states in relevant part: for and in consideration of the sum of TEN DOLLARS, plus other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Grantor [petitioner] does hereby irrevocably GRANT, BARGAIN, SELL, AND CONVEY unto the Grantee [the commission], its successors and assigns, a preservation and conservation easement to have and hold in perpetuity *** .

On Form 8283, Noncash Charitable Contributions, attached to their 2004 joint Federal income tax return, petitioners listed the appraised fair market value of the facade easement as $705,000. Petitioners' "Appraisal Summary" on the Form 8283 omitted various required items of information; in addition, it was not signed or dated by the donor, the appraiser, or any representative of the donee.Petitioners did not attach to their tax return any written appraisal of the facade easement

Without expressly alluding to the language that respondent has termed boilerplate, petitioners argue that the "clear and unambiguous" merger clause signifies that the agreement was the "entire agreement", and consequently "it is apparent" that no cash or compensation was exchanged between petitioners and the commission. Thus, petitioners seem to suggest that the consideration recited in the deed ($10 plus other good and valuable consideration) was fictitious. And indeed it might have been.

The only statement in the agreement concerning consideration is the statement that the commission provided consideration of $10 plus other good and valuable consideration. Whether or not it be considered boilerplate and whether or not it be considered in conjunction with the merger clause, this statement does not indicate that the commission provided no goods or services.

Conclusion For the reasons explained above, we conclude and hold that there is no genuine issue as to any material fact and that a decision may be rendered as a matter of law disallowing the disputed deductions for petitioners' failure to obtain a contemporaneous written acknowledgment of the facade easement. In the light of this conclusion, it is unnecessary to address respondent's alternative contention that petitioners failed to satisfy the requirements of section 170(f)(11).

That's a nice looking facade and I'm glad it is being preserved.  It is a shame that the deduction was lost due to seemingly elementary errors.  The donation is supposed to be for no consideration and the charity is supposed to explicitly state that in its acknowledgement.  The instructions for Form 8283 are fairly explicit.  For a deduction of $705,000 a little effort would seem to be reasonable.

Boltar, L.L.C., et al. v. Commissioner, 136 T.C. No. 14

The essence of an easement donation is that the property is not worth as much with the easement as without it.  The cases can become dueling expert cases.  In this one the Tax Court determined that the taxpayer's experts had gone so far into being advocates that their evidence deserved no consideration.

Held, further, P's experts failed to apply the correct legal standard by failing to determine the value of the donated easement by the before and after valuation method, failed to value contiguous parcels owned by a partnership, and assumed development that was not feasible on the subject property. R's motion to exclude P's report and expert testimony is granted.

In the reply brief, respondent aptly summarizes the deficiencies of the Integra experts' analysis as: failure: to properly apply the before and after methodology, to value all of petitioner's contiguous landholdings, to take into consideration zoning restraints and density limitations and to take into consideration the pre-existing conservation easements. As a result, the Integra Experts saw nothing wrong with a hypothetical development project that could not fit on the land they purportedly valued, was not economically feasible to construct and would not be legally permissible to be built in the foreseeable future. Respondent asserts that petitioner has departed from the legal standard to be applied in determining the highest and best use of property and instead determined a value “based on whatever use generates the largest profit, apparently without regard to whether such use is needed or likely to be needed in the reasonably foreseeable future.”

In most cases, as in this one, there is no dispute about the qualifications of the appraisers. The problem is created by their willingness to use their resumes and their skills to advocate the position of the party who employs them without regard to objective and relevant facts, contrary to their professional obligations.

As the above cases illustrate, the same rules apply regardless of which party offers the unreliable evidence. Justice is frequently portrayed as blindfolded to symbolize impartiality, but we need not blindly admit absurd expert opinions. For these reasons, excluding unreliable and irrelevant evidence, rather than receiving it “for what it is worth” and then rejecting it or giving it no weight, serves several purposes.

In this case, in the view of the trial Judge, the expert report is so far beyond the realm of usefulness that admission is inappropriate and exclusion serves salutary purposes.

In support of the argument that the 174-unit condominium project assumed by the Integra report could not be physically placed on the subject property, respondent points out that the site plan for the proposal assumes 10 acres, whereas the subject property was only 8 acres, and the Integra experts ignored the effect of a preexisting 50-foot-wide utility easement for a gas pipeline across the property. As a result, respondent argues, at least 4 of the 29 hypothetical buildings, each containing 6 units, could not be constructed. Petitioner's only response is a bald and unpersuasive assertion that the project “will fit, it just won't fit as drawn” on the site plan.

Although the Integra experts determined that sales of comparable land nearby were occurring at approximately $12,000 an acre, their conclusion would assign a value of approximately $400,000 per acre to the subject property. Additional factual errors made by the Integra report authors undermine the reliability of their conclusions and demonstrate the lack of sanity in their result. If the report and their testimony were admitted into evidence, we would decide that their opinions were not credible. The assertion that the Eased Parcel had a fair market value exceeding $3.3 million on December 29, 2003, before donation of the easement, i.e., that it would attract a hypothetical purchaser and exchange hands at that price, defies reason and common sense. That conclusion is certainly inconsistent with the objective evidence in this case.

People expect to make money when they buy land to develop it.  A lot of that profit is not inherent in the land, but rather a return on the risk and the skill of the developer.  The valuation of a conservation easement needs to account for that reality.

Gordon Kaufman, et ux. v. Commissioner, 136 T.C. No. 13

This was a follow-up on a previous decision and had a lot going on.  The main thing I noted was that even though they were denied a deduction for the easement, they were still entitled to deduct some of their out of pocket cash contributions that were related to the easement.

While the parties have wrestled over the value of the facade easement, given our disposition of the facade easement contribution issue on legal grounds, that is not a question of fact we must decide. Moreover, respondent does not claim that the cash payments were in consideration for NAT's facilitation of a sham transfer. Seeing no benefit to Lorna Kaufman other than facilitation of her contribution of the facade easement (which we discuss in the next paragraph) and an increased charitable contribution deduction, we shall not deny petitioners' deduction of the cash payments on the ground that the application required a “donor endowment” to accompany the contribution of facade easement.

1982 East, LLC, et al. v. Commissioner, TC Memo 2011-84

This case concerns a facade easement donated to the National Architectural Trust.  I wanted to give you a link, but I am not sure that what appears to be the succesor organization really is so you will have to do your own research.  The deduction failed on two grounds.  The first is highly technical.  Basically if the building burns down then the charity that had the easement should get a proporionate part of the insurance proceeds:

 it was clear under operative lender agreement that bank would retain “prior claim” to all condemnation and ins. proceeds “in preference” to donee org. until mortgage was satisfied and thus, at any time preceding mortgage's repayment, there existed possibility that bank could deprive donee org. of value that should have otherwise been dedicated to conservation purposes.

The other is more of, I hate to say it, common sense one.  The building is in the Metropolitan Museum of Art historic district.  If you tried to make any changes to it, regardless of any easements, there are lots of people who would make your life miserable.  So the partnership granting a facade easement is a little like me renouncing my super powers.

The taxpayer does get some points for good execution though:

We agree with petitioner that Mr. Asser made a reasonable attempt to comply with the Internal Revenue Code and that he acted in good faith. We understand that Kaufman I is the first time that a court has considered the effect of a mortgage on a contribution of an easement claimed to be a qualified conservation contribution. That interpretation of the relevant regulation was not published until more than 4 years after Mr. Asser filed the 2004 return. We do not believe that the regulations interpreting the perpetuity requirement of section 170(h)(5) are so crystal clear and unambiguous as to make the imposition of the accuracy-related penalty appropriate. We also find that Mr. Asser acted in good faith by securing three separate appraisals of the donated property and disclosing the contribution of that property on LLC's 2004 return. See Rolfs v. Commissioner, 135 T.C. 471 (2010). Accordingly, in the light of all of the facts and circumstances, we find that Mr. Asser acted reasonably and in good faith and hold that LLC is not liable for an accuracy-related penalty under section 6662(a).

Conservation easements including facade easements are a good tool.  The lessons here are to not stint on execution and be reasonable on the appraisal.

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