Saturday, June 28, 2014
Seventeen Seventy Sherman Street, LLC v. Commissioner—Conservation Easement Conveyed for Quid Pro Quo Not Deductible and Negligence Penalty Applied
In Seventeen Seventy Sherman Street, LLC v. Comm’r, T.C. Memo. 2014-124, the Tax Court sustained the IRS’s complete disallowance of the LLC's claimed $7.15 million deduction for the conveyance to Historic Denver of interior and exterior conservation easements restricting the use of the Mosque of the El Jebel Shrine of the Ancient Arabic Order of Nobles of the Mystic Shrine. The shrine, which was built in 1906-1907 and includes many original features (including ornate stenciling, gilded bronze elevator doors, Tiffany glass, and ornate woodworking), is listed on the National Register of Historic Places and as a historic landmark by the City and County of Denver.
Quid Pro Quo
The LLC owned two properties on Sherman Street—the shrine and a parking lot. Prior to granting the easements, the LLC and the City of Denver entered into a development agreement in which, among other things, the LLC agreed to convey the easements to Historic Denver and rehabilitate the shrine in exchange for certain zoning changes to the shrine and the parking lot.
The Tax Court’s opinion nicely details the elements of a quid pro quo analysis in the charitable deduction context.
- A taxpayer's contribution is deductible ‘only if and to the extent it exceeds the market value of the benefit received.’
- ‘[t]he sine qua non of a charitable contribution is a transfer of money or property without adequate consideration.’
- ‘a charitable gift or contribution must be a payment made for detached and disinterested motives. This formulation is designed to ensure that the payor’s primary purpose is to assist the charity and not to secure some benefit personal to the payor.’
- The consideration received by the taxpayer need not be financial. Medical, educational, scientific, religious, or other benefits can be consideration that vitiates charitable intent.
- In ascertaining whether a given payment was made with the expectation of anything in return, courts examine the external features of the transaction. This avoids the need to conduct an imprecise inquiry into the motivations of individual taxpayers.
- The taxpayer claiming a deduction must, at a minimum, demonstrate that “he purposely contributed money or property in excess of the value of any benefit he received in return.”
- Thus, a taxpayer who receives goods or services in exchange for a contribution of property may still be entitled to a charitable deduction if the taxpayer (1) makes a contribution that exceeds the fair market value of the benefits received in exchange and (2) makes the excess payment with the intention of making a gift. Treasury Regulation § 1.170A–1(h)(1). If the taxpayer satisfies these requirements, the taxpayer is entitled to a deduction not to exceed the fair market value of the property the taxpayer transferred less the fair market value of the goods or services received. Id. § 1 .170A–1(h)(2).
The Tax Court explained that a quid pro quo analysis in the conservation easement donation context ordinarily requires two parts—(1) valuation of the contributed conservation easement and then (2) valuation of the consideration received in exchange for the easement. The court explained, however, that when a taxpayer grants a conservation easement as part of a quid pro quo exchange and fails to identify or value all of the consideration received, the taxpayer is not entitled to a deduction because he failed to comply with § 170 and the regulations. In such a case, explained the court, it is unnecessary to determine either the value of the easement or whether the taxpayer made an excess payment with the intention of making a gift. The taxpayer’s failure to identify or value all of the consideration received and, thus, to prove that the value of the easement exceeded the value of the consideration is fatal to the deduction.
In this case, the Tax Court found that the LLC had received two types of consideration in exchange for its conveyance of the interior and exterior easements:
- a zoning change that eliminated authorization to develop residential condominium units within the shrine but also permitted development on the parking lot up to 650 feet, subject to a “view plane” restriction of 155 feet (a view plane restriction limits the height of buildings from a specified view point within Denver's city park and is meant to preserve the view of the Rocky Mountain Skyline from that view point), and
- the Denver Community Planning and Development Agency’s recommendation to the Denver Planning Board to approve a view plane variance (which variance was ultimately approved).
On its 2003 tax return, however, the LLC claimed a $7.15 million charitable deduction for its conveyance of the easements and made no adjustment for the consideration it received in exchange. At trial, the LLC conceded it had received the zoning change in exchange for its conveyance of the easements and argued that its deduction should be reduced by just over $2 million as a result. The LLC also asserted that the Planning and Development Agency’s recommendation to the Planning Board to approve a view plane variance was either not consideration received in exchange for the grant of the easements, or was consideration but had no real value. The Tax Court disagreed, finding that the Agency’s view-plane-variance recommendation was consideration and had substantial value. The court concluded that the LLC’s failure to identify or value all of the consideration received, or to provide any credible evidence to permit the court to accurately value all of the consideration received was fatal to the deduction.
In support of its holding, the Tax Court cited an earlier case, Pollard v. Comm’r, T.C. Memo. 2013-38, in which it sustained the IRS’s complete disallowance of a deduction claimed for the conveyance of a conservation easement because the easement was conveyed in exchange for the receipt of a subdivision exemption and the taxpayer did not establish that the value of the easement exceeded the value of that exemption.
The IRS argued that the LLC was liable for either the 40% gross valuation misstatement penalty or, alternatively, the 20% accuracy-related penalty for negligence or disregard of the rules or regulations.
Gross Valuation Misstatement Penalty
At trial, the IRS’s valuation experts asserted that the interior easement decreased the value of the shrine by only $400,000 and the exterior easement did not have any effect on the value of the shrine because of already existing local historic preservation restrictions. The court found, however, that the exterior easement was more protective of the shrine than local law—i.e., the LLC had decreased flexibility to modify the exterior as a result of the easement and Historic Denver more regularly monitored the property than local authorities. The court also inferred from the City of Denver's insistence that the LLC grant the exterior easement that the exterior easement had value to the City over and above the local landmark designation. Accordingly, the court found that the IRS failed to meet his burden of establishing that the value of the easements claimed on the LLC’s return (i.e., $7.15 million) exceeded 400% of the correct value of the easements.
Accuracy-Related Penalty for Negligence or Disregard of Rules or Regulations
The Tax Court agreed with the IRS that the LLC was liable for the accuracy-related penalty because it acted negligently or in disregard of the requirements of § 170 and the regulations. “Negligence,” said the court, is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a deduction that would seem to a reasonable and prudent person to be “too good to be true.” And a taxpayer acts with “disregard” when, among other things, he does not exercise reasonable diligence to determine the correctness of a return position.
The LLC conveyed the easements as part of a quid pro quo exchange but reported the conveyance on its 2003 return as a charitable contribution without making any adjustment for the consideration it received in exchange. The court found that the LLC acted negligently or with disregard because it did not make a reasonable attempt to ascertain the correctness of the deduction.
The LLC argued that it was eligible for the reasonable cause and good faith exception to the penalty because it relied on professional advice. The Tax Court disagreed. Although the LLC had consulted with a tax attorney regarding the conveyance, that attorney testified at trial that he had advised the LLC that it had to reduce the value of its deduction by the consideration received in the quid pro quo exchange. The Tax Court noted that it would be unreasonable for the court to believe that at the time of the contribution or at the time of filing the LLC’s return either the LLC or its advisers believed that the contribution of the easements was an unrequited contribution or that the consideration received had no value. Consequently, the LLC's disregard of the attorney’s advice was not reasonable and in good faith, and the LLC could not rely on the professional advice of the attorney to negate the penalty.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law