US Tax Court, T.C. Memo. 2011-84, April 12, 2011: Denies preservation easement tax deduction because local law already protects property and because mortgage subordination reserves insurance and condemnation proceeds priority to lender.
The taxpayer/petitioner donated a façade easement and “unused development rights” (UDRs) to Trust for Architectural Easements (formerly known as National Architectural Trust) on a townhouse within the New York City Metropolitan Museum Historic District. The City’s landmark and zoning laws set the maximum density by “floor area ratio” and maximum height, and make it unlawful to (in the Court’s words) “alter the property” unless the City Landmarks Preservation Commission (LPC) approves the alteration. The “Protected Facade” included all exterior surfaces, e.g., walls, roofs, and chimneys, that were visible from the street level. UDRs included “any and all rights, however designated, now or hereafter associated with the [subject] Property or any other property that may be used pursuant to applicable zoning laws or other government laws or regulations to compute permitted size, height, bulk or number of structures, development density, lot yield, or any similar development variable on or pertaining to the [subject] Property or any other property.”
The Court agreed with the IRS assertion that the easement and UDRs did not preserves a historically important land area or a certified historic structure, and thus failed to meet one of basic requirements of the tax code for a “qualified conservation contribution” (section 170(h)(4)), because “it is local law and the rules of the [City Landmarks Preservation Commission] that preserve the subject property and not the rights which NAT possessed under the deed of easement. The Court wrote, “While petitioner argues that NAT’s enforcement of the deed of easement affords additional meaningful protection not already guaranteed by the LPC’s enforcement of local law, petitioner has failed to persuade us that such is the case.” Apparently, the Court did not consider the possibility that the LPC, in the exercise of its discretion, would approve an alteration that the easement or UDR would forbid, or that the local laws were subject to change in a way that donation of the easement and UDRs in perpetuity could not.
The property was also subject to a mortgage, and the owner obtained a subordination of the mortgage to the easement and UDRs by way of a lender agreement that, like the lender agreement in the Kaufman I case, reserved to the mortgagee a prior claim to all casualty insurance proceeds and all proceeds of condemnation. The Court, citing Kaufman I and Kaufman II, found this reservation of priority means the donation fails to meet the perpetuity requirement of the Code and section 1.170A-14(g)(6)(ii), Income Tax Regs. The petitioner tried to argue that applicable state law distinguished this case from Kaufman. The Court determined that although “a New York court ‘may’ adjudge the facade easement unenforceable, entitling the beneficiary of the easement to compensation … section 1.170A-14(g)(6)(ii), Income Tax Regs., requires that NAT ‘must’ be entitled to its proportionate share of proceeds in the event the easement is extinguished.”
Decision is available at http://www.ustaxcourt.gov/InOpHistoric/1982EastLLC.TCM.WPD.pdf.
Regarding the portion of the decision about the interplay of local law and the façade easement, attorney Stefan Nagel has written in a recent post to the Massachusetts Land Trust Coalition, “This is a so-called ‘memo’ ruling, therefore may not have been reviewed by the entire Tax Court, and therefore doesn’t have full precedential consequence. Also… the ruling contradicts [the 2009] Simmons case out of Washington, DC.”
The Court’s reasoning regarding a preservation easement that overlaps with local protections in theory could have implications for conservation easements, agricultural easements and land trusts if applied in analogous situations where local zoning or other land use laws restricted development or non-agricultural uses.