Thursday, June 26, 2014
No one is more surprised than I with how much time I spend reading about tax law these days, but I wanted to alert folks to another case regarding the valuation of historic conservation easements. This time, we are talking about Maison Blanche - a fancy former department store now an even fancier Ritz Carlton on Canal Street in New Orleans.
In 1997, the Whitehouse Hotel Ltd. (owner of the property) donated an historic preservation conservation easement to protect the facade to the Preservation Resource Center. Whitehouse's appraiser estimated the value of the conservation easement at $7.445 million (not $7,445 million as the 5th Circuit opinion mistates). The IRS cried foul and valued the conservation easement at $1.15 million and also dinged Whitehouse for an extra 40% for underpaying by more than 400%.
Unsurprisingly, litigation ensued. Whitehouse v. CIR, 2014 WL 2609866 (5th Cir. 2014), decided on June 11th is the second time the case has made it up to the 5th Circuit. The disputes have generally been battles of appraisals and valuation methods. I am not going to express any opinion about the appraisal methods but thought I'd point out a few things.
What does the conservation easement allow?
There was a big dispute here as to whether the conservation easement actually had any value. One of the appraisers suggested that because the conservation easement would not actually prevent Ritz Carlton from building what it want to build, the value should be zero. The highest and best use of the property is unchanged by the conservation easement. This conclusion turned in part on the language of the conservation easement and whether it actually prohibited the potential building of 60 additional rooms on part of the hotel complex. The Tax Court agreed with the appraiser that the conservation easement did not have such a prohibition. Whitehouse I, 131 T.C. 112 (Tax Ct. 2010). The Fifth Circuit disagreed. Whitehouse II, 615 F.3d 321 (5th Cir. 2010). On remand to the same judge, the Tax Court reviewed Louisiana servitude law and again stated its belief that the conservation easement did not restrict the additional building and should not have value BUT the Tax Court acknowledged that it was bound by the 5th Circuit's precedent and estimated the conservation easement value based on that assumption (coming up with as the 5th Circuit said "merely $1,867,716"). Whitehouse III, 139 T.C. 304 (Tax Ct. 2012).
Undoubtedly feeling that it got a raw deal from an unbiased judge, Whitehouse appealed but the 5th Circuit upheld the Tax Court stating that even though the Tax Court went out of its way to voice its disagreement with the 5th Circuit that was allowed as long as it actually followed the 5th Circuit.
Can you rely on tax professionals' assessments of your conservation easements?
Well, at first blush the answer to this question looks like "no" because the appraiser was so wrong. But the key question to consider for this case is whether Whitehouse's reliance on its appraiser and other professional should protect it from the penalty for gross underpayment (the 400% thing I mention above). There is a reasonable cause exception that allows taxpayers to get out from under this rather steep penalty. This issue is important for people interested in conservation easements because we see over and over again how far apart the private appraisals can be from those the IRS calculates. How much should we penalize landowners for their underpayments made in reliance on qualified professionals? The Tax Court imposed a 40% gross underpayment penalty, holding that Whitehouse had not done enough to demonstrate that it had reasonable cause to believe the appraisal. The court may have been particularly persuaded by the fact that the appraisal of the conservation easement exceeded the price actually paid for the property. The 5th Circuit reversed on this issue because Whitehouse had consulted with more than one appraiser and consulted other tax professionals. The 5th Circuit found this to be adequate.
I am really torn on this one. We want landowners to be able to rely on qualified appraisers and to impose a 40% tax penalty could be particularly painful to small landowners. But there have been repeated examples of bad appraisals around and it seems like there has got to be some type of smell test. Where a conservation easement is valued so much higher than the purchase price of the property, I hesitate too. Of course, I understand that the purchase price doesn't really tell you the value of the property and the value of what an entity like Ritz Carlton can get out of a property, but at the end of the day as a taxpayer, I don't even like the fact that the landowners here got a $1.8 million dollar charitable tax credit to build a big fancy hotel and condo complex that will make them oodles of dollars. Arguing that they lost $1.8 million because they couldn't make it as absolutely big as they might have just leaves a bad taste in my mouth.