Whitehouse Hotel v Commissioner of Internal Revenue (Whitehouse II)

United States Court of Appeals, Fifth Circuit, No. 09-60085, August 10, 2010: Decides several issue about the deductibility and appraisal of a façade easement’s affect on the value of a building owned in common with the building being protected, vacating the Tax Court’s 2008 decision and remanding for further proceedings.

Taxpayer Whitehouse (“W”) owned the contiguous Maison Blanche and Kress buildings, within both the New Orleans Vieux Carré Historic District and the Canal Street Historic District, when W conveyed an easement that burdens only the Maison Blanche building to the Preservation Alliance of New Orleans (PRC). The day after Whitehouse executed and donated the easement, Whitehouse converted the Maison Blanche and Kress buildings into a single, indivisible condominium unit. The Appeals Court stated that under Louisiana law, “because of the easement, Whitehouse [and any successor who owned both Maison Blanche and Kress] could not build on top of the Kress building… any successor who separately owned the Kress building would not be bound by the easement…” Pursuant to the easement, PRC approved specific development plans for the Maison Blanche and Kress buildings. Those plans did not include construction on top of the Kress building. W’s claimed tax deduction included loss of value based on being prohibited from adding to the height of the Kress building. The Tax Court disallowed most of the deduction W claimed and upheld the IRS’s underreporting penalty.

Easement’s affect on Kress building value: The Appeals Court wrote, “[T]he tax court erred in declining to consider the Maison Blanche and Kress buildings’ highest and best use in the light of both the reasonable and probable condominium regime and the reasonable and probable combination of those buildings into a single functional unit, both of which foreclosed the realistic possibility, for valuation purposes, that the Kress and Maison Blanche buildings could come under separate ownership. This combination affected the buildings’ fair market value”. “To determine the easement’s effect on the fair market value of the contiguous Kress building, owned by Whitehouse, the relevant inquiry is whether, when the easement was conveyed, it was reasonable and probable that a hypothetical buyer would determine the amount he would pay for the Maison Blanche and Kress buildings, including in the light both of the pending condominium agreement’s combining the two properties into one legal unit and of the pending development’s combining the two properties into one functional unit…. the tax court should have considered the easement’s effect on fair market value in the light of the imminent legal and functional consolidation of the two buildings. In other words, the tax court was correct that, because, on the day of donation, the condominium regime was not yet in effect, a successor could have purchased the Kress building separately that day and would not have been bound by the easement; but, as a matter of valuation, the tax court erred by not considering the effect on market value of the buildings’ pending combination….”

Highest and best use: “The key inquiry is what a hypothetical willing buyer would consider in deciding how much to pay for the property….” The Appeals Court found the Tax Court’s reasoning on this issue ambiguous. Accordingly, “we are left with findings that are ‘inadequate to permit us to fairly review [the tax court's] ultimate conclusions’”, citing Curtis v. CIR, 623 F. 2d 1047, at 1053, Court of Appeals, 5th Circuit (1980).

Valuation Method: The Appeals Court did not reach whether the Tax Court erred in rejecting the income and replacement-cost methods, and ordered reconsideration of all three easement valuation methods on remand.

Other issues: (1) W incorrectly construed Bruzewicz v. US, 604 F. Supp. 2d 1197, Dist. Court, ND Illinois, Eastern Div. (2009) as holding an appraisal license alone does not qualify a witness to offer expert testimony on conservation easements; “Bruzewicz centers on appraisers’ failure to include their qualifications in their report, not their substantive qualifications as appraisers”; (2) strict compliance with Uniform Standards of Professional Appraisal Practice (USPAP) is not a pre-requisite for admissibility of an appraisal; “the tax court acted within its ample discretion in considering USPAP compliance as relevant to the weight [the IRS’s appraiser’s] report should be given, instead of whether it should be admitted”; (3) if the penalty is at issue on remand, (a) an executive employee at W’s general partner and tax-matters partner should not be deemed incompetent or not credible to testify to facts within the limited partnership’s knowledge merely because he was not associated with W until several years after the deduction was claimed, and (b) given that W offered proof that it relied on its accountants’ and attorneys’ opinions of an appraisal W obtained, a possible issue on remand is whether W needed to prove more to show reasonable cause and avoid the penalty.

Decision available at http://www.ca5.uscourts.gov/opinions%5Cpub%5C09/09-60085-CV0.wpd.pdf.

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