Thursday, November 14, 2013
In Gorra v. Commissioner, T.C. Memo. 2013-254, the Tax Court held that the taxpayers were entitled to a charitable income tax deduction under IRC § 170(h) for the donation of a façade easement on a residential townhouse located in the Carnegie Hill Historic District of New York City to the National Architectural Trust, or NAT (now the Trust for Architectural Easements, or TAE). The court also held, however, that easement caused only a 2% reduction in the value of the subject property and the taxpayers were liable for a 40% gross valuation misstatement penalty. These and the other holdings in the lengthy opinion are discussed below.
Qualified Real Property Interest
The Tax Court found that the façade easement was a “qualified real property interest” for purposes of IRC § 170(h)(2)(C)--“a restriction (granted in perpetuity) on the use which may be made of the real property.” Unlike the nondeductible golf course easement at issue in Belk v. Commissioner, 140 T.C. No. 1 (2013), reconsideration denied and opinion supplemented in T.C. Memo 2013-154, which permitted the parties to remove portions of the golf course from the easement and replace them with property currently not subject to the easement (i.e., to engage in “substitutions” or “swaps”), the court found that the façade easement in Gorra “clearly defines the property donated under the easement and restricts the easement to that property” and does not authorize substitutions.
Valid Conservation Purpose
The IRS argued that the façade easement was not donated for a valid conservation purpose because the easement did not preserve the property beyond what is already required under New York’s Landmarks Preservation Law, which is enforced by the Landmarks Preservation Commission (LPC). The Tax Court disagreed, finding the easement in Gorra to be more restrictive than the Landmarks Law in a number of respects, including that it protects the front, side, rear, and measured height of the property as required by IRC § 170(h)(4) as revised by the Pension Protection Act of 2006. The court also found that (i) TAE actively monitors its easements, while LPC is passive and relies heavily on complaints to uncover violations, (ii) TAE performed annual inspections of the subject property and kept records, including photographs, while it was unclear whether LPC ever inspected the property, and (iii) the taxpayers’ arguments regarding TAE’s ability to enforce the restrictions more effectively than LPC were convincing. In its finding of facts, the court noted that TAE employs three people to monitor 550 properties (which translates to 183.3 properties per employee), while LPC is responsible for the preservation of 26,000 structures and has a staff of four employees responsible for inspection (which translates to 6,500 properties per employee).
The court also noted that, although the easement allows TAE to consent to changes to the property, the deed requires that any change must comply with all applicable federal, state, and local government laws and regulations, and Treasury Regulation § 1.170A-14(d)(5) specifically allows a facade easement donation to satisfy the conservation purposes test even if future development is allowed, provided that development is subject to applicable federal, state, and local government laws and regulations.
Conservation Purpose Protected In Perpetuity
The Tax Court found that the conservation purpose of the façade easement was protected in perpetuity as required by IRC § 170(h)(5)(A). The court noted that, while the taxpayers had requested that the easement be terminated because they were having a difficult time selling the property, TAE denied that request. “Under the terms of the deed,” said the court, “the easement is granted in perpetuity and may not be terminated at any time.” The court also found that the façade easement is distinguishable from the nondeductible easements at issue in Carpenter v. Commissioner, T.C. Memo. 2012-1, reconsideration denied and opinion supplemented in T.C. Memo. 2013-172, because the façade easement does not include a provision authorizing extinguishment of the easement by mutual agreement of the parties and, instead, allows the easement to be extinguished by judicial decree consistent with the requirements of Treasury Regulation § 1.170A-14(g)(6).
NAT delivered the easement to the recorder’s office on December 28, 2006, paid the recording fees and taxes, and obtained a receipt for the delivery. Due to a cover sheet error, however, the easement was not recorded until January 18, 2007. The IRS argued that the deed was not recorded until 2007. The Tax Court disagreed, holding that, under New York law, delivery of the deed to the recorder’s office, with receipt acknowledged, constituted recordation, even though there was a delay in the actual recording until the following year because of the cover sheet error. The court cited N.Y. Real Prop. Law § 317, which provides that every instrument entitled to be recorded is considered recorded from the time of delivery to the recording officer.
The Tax Court found that the taxpayer’s appraisal constituted a “qualified appraisal” as defined in Treasury Regulation § 1.170A-13(c)(3). Although the appraiser used the phrase “market value” in the appraisal, the court found that the appraiser’s definition of that term was synonymous with the definition of “fair market value” used in the Treasury Regulations. The court also found that the appraisal, which employed the before and after method, a paired sales analysis, and a percentage diminution, included the “method of valuation used” and reported the “specific basis for valuation” as required by the Treasury Regulations. The court noted that, as in Scheidelman v. Commissioner, 682 F.3d 189, 198 (2d Cir. 2012), while the IRS might deem the appraiser’s analysis unconvincing, “it is incontestably there.”
Generally Accepted Appraisal Standards
IRC § 170(f)(11)(E) as amended by the Pension Protection Act of 2006 specifies that a “qualified appraisal” must be conducted by a qualified appraiser in accordance with generally accepted appraisal standards, and IRS Notice 2006-96 provides that an appraisal will meet the specifications of § 170(f)(11)(E) if, for example, “the appraisal is consistent with the substance and principles of the Uniform Standards of Professional Appraisal Practice (‘USPAP’).” The Tax Court summarily dismissed the IRS’s argument that the taxpayer’s appraisal had serious defects and was inconsistent with USPAP, noting that “[a]ppraising is not an exact science and has a subjective nature.”
After a careful review of the valuation experts’ reports, the Tax Court concluded that the facade easement caused only a 2% (or $104,000) reduction in the value of the subject property, and the reduction stemmed from the heightened financial burdens of an eased façade, enforcement actions of TAE, and the scope of the easement. The court found that the taxpayers did not meet their burden of proving that the easement resulted in a 9% (or $465,000) reduction in the value of the property. The court also rejected the IRS expert’s assertion that the easement had no value, noting that the easement was more restrictive than local historic preservation laws and “[o]rdinarily, any encumbrance on real property, however slight, would tend to have some negative effect on the property’s fair market value.”
The Pension Protection Act of 2006 lowered the threshold for imposition of the 40% penalty for gross valuation misstatements under IRC § 6662(h) and eliminated the reasonable cause exception for gross valuation misstatements with respect to charitable deduction property (i.e., the penalty in a case such as this is a strict liability penalty). The taxpayers in Gorra were liable for this penalty because their original asserted value for the easement ($605,000) was more than 200% of the amount determined by the court to be the correct value ($104,000). The court rejected the taxpayers’ argument that the penalty was an “excessive fine” under the Eigth Amendment to the United States Constitution, noting that such penalties are remedial in nature, not “punishments,” and are an important tool because they enhance voluntary compliance with tax laws.
Gorra is the most recent in a string of cases involving challenges to deductions for façade easements donated to NAT. 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; Graev v. Commissioner, 140 T.C. No. 17 (2013); Friedberg v. Commissioner, T.C. Memo. 2013-224. 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 S.J. Quinney College of Law