Tuesday, September 24, 2013
In Friedberg v. Commissioner, T.C. Memo. 2013-224 (Friedberg II), the Tax Court held, in part, that a façade easement appraisal constituted a “qualified appraisal” for IRC § 170(h) deduction purposes despite being of questionable reliability. Understanding this case requires a bit of background.
Friedberg involved the donation of both a façade easement and transferable development rights (“TDRs”) to the National Architectural Trust (NAT) in 2003. In Friedberg v. Commissioner, T.C. Memo. 2011- 238 (Friedberg I), the Tax Court held that the taxpayers were not entitled to a deduction for the donation of the façade easement because the appraisal of the easement was not a “qualified appraisal” as defined in section Treasury Regulation § 1.170A-13(c)(3). Relying on its opinion in Scheidelman v. Commissioner, T.C. Memo. 2010-151 (Scheidelman I), which involved another donation of a façade easement to NAT, the Tax Court held the mechanical application of a percentage diminution to the fair market value of the subject property before the donation of the easement did not constitute a method of valuation. Accordingly, the appraisal failed to include the “method of valuation” and “specific basis for the valuation” as required by Treasury Regulation §§ 1.170A-13(c)(3)(ii)(J) and (K). With respect to the valuation of the TDRs, however, the court concluded that disputed issues of material fact remained as to whether the appraisal was a qualified appraisal.
After the decision in Friedberg I, the Second Circuit vacated and remanded Scheidelman I in Scheidelman v. Commissioner, 682 F.3d 189 (2nd Cir. 2012) (Scheidelman II). The Second Circuit held that it was irrelevant that the IRS believed the percentage diminution method employed by the appraiser in Scheidelman was sloppy, inaccurate, or haphazardly applied. The Treasury Regulation, said the Second Circuit, "requires only that the appraiser identify the valuation method ‘used’; it does not require that the method adopted be reliable.” The Second Circuit explained that (i) the IRS’s interpretation—that an unreliable method is no method at all—“goes beyond the wording of the regulation, which imposes only a reporting requirement,” and (ii) although the IRS may deem the appraiser's analysis in Scheidelman unconvincing, it was "incontestably there." The Second Circuit went on to explain, however, that its conclusion that the appraisal met the minimal requirements of a qualified appraisal mandated neither that the Tax Court find the appraisal persuasive nor that the Scheidelmans be entitled to any deduction for the donated easement.
On remand, in Scheidelman v. Commissioner, T.C. Memo. 2013-18 (Scheidelman III), the Tax Court held that, although the taxpayers’ appraisal constituted a qualified appraisal, the taxpayers did not provide sufficient credible evidence to meet their burden of establishing entitlement to their claimed charitable contribution deduction, and the preponderance of the evidence supported the IRS's position that the easement had no value. Accordingly, the Scheidelmans were not entitled to a deduction for their donation of the façade easement.
In light of the Second Circuit’s holding in Scheidelman II, the Tax Court reconsidered its opinion in Friedberg I in Friedberg II.
With regard to the façade easement appraisal, the Tax Court reversed its earlier holding and found that the appraisal was a qualified appraisal. The court explained, in part, that although it criticized and disagreed with the appraiser’s analysis in the appraisal report, the analysis was “incontestably there.” The court concluded that it was specifically not opining on the reliability and accuracy of the methodology or specific basis of valuation in the appraisal, leaving those matters to be decided at trial. However, as part of its determination that the appraisal report provided sufficient information to enable the IRS to evaluable the appraiser's methodology, the court noted that it “continue[d] to question whether the … appraisal is reliable or properly applied methodology to reach its conclusions.”
With regard to the appraisal of the TDRs, the Tax Court noted that the Second Circuit’s analysis in Scheidelman II applies as much to a valuation of TDRs as it does to a valuation of a façade easement. Accordingly, despite errors, the appraisal of the TDRs was a qualified appraisal because it explained the method of and specific basis for the valuation. The court explained that the remaining issues of material fact (e.g., the effect of the market demand, the transferability of the development rights, and the accuracy and reliability of the appraisal) were relevant to its analysis of valuation but irrelevant as to whether the appraisal constituted a qualified appraisal.
The IRS also argued that the Friedbergs' appraiser was not a “qualified appraiser” of TDRs because he had never appraised TDRs before preparing the Friedberg appraisal. The Tax Court rejected that argument, explaining that "[a]ccording to the plain language of the regulation, an appraiser is a qualified appraiser if he or she makes the requisite declaration [on Form 8283, appraisal summary] that he or she is qualified to appraise the value of the contributed property." The regulation, said the court, "does not direct the [IRS] to analyze the appraiser’s qualifications to determine whether he or she has sufficient education, experience, or other characteristics."
The court concluded that the Treasury Regulations merely impose “a reporting requirement, i.e., an appraiser is qualified if the declaration is present, regardless of whether it is ‘unconvincing.’” The court also noted, however, that (i) effective for appraisals prepared with respect to returns filed after August 17, 2006 (and therefore not relevant in Friedberg), IRC § 170(f)(11)(E) contains a new definition of the term “qualified appraiser,” and (ii) it was specifically not opining as to whether the appraiser’s qualifications were sufficient to qualify him as an expert witness regarding the value of the TDRs or whether the appraisal could be admitted as an expert report for that purpose.
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Whether the Friedbergs will ultimately suffer the same fate as the Scheidelmans and have their deduction denied for failing to provide sufficient evidence of value remains to be seen, although the Tax Court’s statements as to the unreliability of the Friedberg appraisal suggest that the court is not inclined to give that appraisal much weight.
The Friedberg appraisal was prepared by Michael Ehrmann of Jefferson & Lee Appraisals, Inc. (JLA). Mr. Ehrmann and JLA were the subject of a January 2013 DOJ suit (discussed here) alleging that Mr. Ehrmann repeatedly and continually made material and substantive errors and omissions, distorted data, and provided misinformation and unsupported personal opinions in his appraisals to significantly inflate the value of façade easements for federal deduction purposes. The parties agreed to settle the suit, and in February 2013 a District Court issued an Agreed Order of Permanent Injunction (discussed here) that, among other things, bars Mr. Ehrmann and JLA from participating in the appraisal process for any property relating to federal taxes and ordered Ehrmann and JLA to provide to counsel for the United States a list of clients for whom they prepared appraisal reports for tax purposes on or since November 1, 2009.
Deductions for the donation of façade easements to NAT have been denied in a number of other cases on a variety of grounds. See Herman v. Commissioner, T.C. Memo. 2009-205; 1982 East LLC v. Commissioner, T.C. Memo. 2011-84; Dunlap v. Commissioner, T.C. Memo. 2012-126; Rothman v. Commissioner, T.C. Memo. 2012-218; and Graev v. Commissioner, 140 T.C. No. 17 (2013). See also Kaufman v. Shulman, 687 F.3d. 21 (1st Cir. 2012) (remanding to the Tax Court on the issue of valuation and noting that, because of local historic preservation laws, the Tax Court might well find that the façade easement donated to NAT was worth little or nothing). NAT also was the subject of a 2011 Department of Justice lawsuit (discussed here) alleging that NAT was engaged in abusive practices. The suit settled with NAT denying the allegations but agreeing to a permanent injunction prohibiting it from engaging in the practices.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah SJ Quinney College of Law