FRIEDBERG and MOSS v COMMISSIONER

U.S. Tax Court, T.C. Memo. 2011-238, October 3, 2011:  Denies a contribution deduction for a facade easement based on appraisal defects. Holds: appraisal was not qualified because it did not properly apply the comparable sales method to the “after” value; appraisal adequately stated the method and specific basis for the valuation even if wrong; appraisal summary substantially complied with regulations despite errors and omissions that did not appear in attached appraisal; alleged transfer of unused development rights was not entitled to a charitable deduction because development rights became worthless at the moment of transfer; and the abandonment provision of the easement under state law  do not violate the perpetuity requirement.

Petitioner Friedberg donated a façade easement on a townhouse in a New York City historic district to National Architectural Trust (NAT) in 2003. The appraisal said it used the “sales comparison approach” for before and after values. The “before” value was based on nine Manhattan properties sales within the prior two years. (The Court refers to this analysis as “a textbook example of how the comparable sales method works.”) The “after” valuation was based on six examples of sales of eased properties in Washington, D.C., during the mid-1980s and two examples of transactions involving eased properties in New Orleans during the mid-1990s. According to the Court Memo, the appraisal stated a range of percent reduction in market value of these examples, and stated a percentage that should be applied to the Friedberg property, but did not explain how that final percentage was derived from the examples’ range of percentages.

The Court granted the IRS summary judgment that the appraisal report was not a “qualified appraisal” for one reason, which the Court said was “essential”: the appraisal did not comply with Income Tax Regs. section 1.170A-13(c) (3) (ii) ((J), method of valuation, because the appraiser did not “properly apply the comparable sales method to valuing the subject property after the facade easement…” and “diverged significantly from the accepted comparable sales method”. The Court disapproved the appraisal’s use of sales in locales other than Manhattan “without explanation”, and – even had the “after” sales been appropriate properties — the failure “to consistently apply a single method to his estimates of percentage diminution”, and the use of “unreasonable” valuation methods. The Court wrote, “the acceptable comparable sales method requires the examination of multiple similar properties and corresponding adjustments, accompanied by explanations” and “Nothing in [the appraisal] supports his conclusion about the after value of the subject property.” The Memo picks apart each of the “after” sales in detail.

The Court granted Friedberg summary judgment that the appraisal was “qualified” regarding its specific basis for the valuation of development rights (Income Tax Regs. section 1.170A-13(c) (3)(ii) (K),), and denied summary judgment to the IRS on the same subject because of issues of disputed material fact. The Court reasoned that the appraisal of developments rights, while riddled with errors, nevertheless “explained the method of valuation and the specific basis for the valuation and “was not merely a mechanical application of some predetermined figure.”  The Court said it was a matter of factual determination whether Friedberg could have been able to transfer or otherwise use the development rights before the donation, and whether the appraisal adequately assessed the market demand for those rights.

The Tax Court also refused the IRS summary judgment, and accepted Friedberg’s “substantial compliance” argument, as to whether the appraisal was “qualified” under Income Tax Regs. section 1.170A-13(c)(3)(ii)(C)[date (or expected date) of contribution],(H)[date (or dates) on which the property was appraised], (I)[ appraised value on the date (or expected date) of contribution]. The Court said: “the errors regarding the date of the appraisal report do not relate to the substance or essence of the contribution.”

The Court also held that Friedberg substantially complied with the requirement to attach a fully completed appraisal summary to his return (Income Tax Regs. section 1.170A-13(c)(2)(i)(B) and 1.170A-13(c)(4)(ii)), even though the summary didn’t adequately describe the property, its overall physical condition, the manner of acquisition or the cost or other basis. These flaws were overcome because petitioners also attached the appraisal report to their tax return, which gave the necessary information.  The Court distinguished this case from its holdings in Todd v. Commissioner, 118 T.C. 334 (2002),  Hewitt v. Commissioner, 109 T.C. 258 (1997),   and Smith v. Commissioner, T.C. Memo., 2007-368, affd. 364 Fed. Appx. 317 (9th Cir. 2009).

The Court held the purported transfer of unused development rights was not entitled to a deduction under Code section 170(a). In addition to restrictions commonly found in such easements, the Friedberg grant donated the building’s development rights under New York City Zoning law, saying, “there shall be no use, exercise or transfer by Grantor or Grantee of development rights from or to the Property, any portion thereof or derived from any portion thereof… [and] subject to all other conditions of this Easement, all current and future development rights have been donated to the Grantee for the purposes of forever (i) removing such rights from the Property, (ii) extinguishing such rights, and (iii) further preventing the transfer or use of such rights.” Friedberg argued that the value of the development rights contribution should be the fair market value at the moment before contribution even if the terms of the contribution itself make the property worthless upon consummation. The Court held that if Friedberg transferred the unused development rights (the Court did not decide whether in fact the easement did effect a transfer), the value of those development rights was zero. The Court reasoned that under the terms of the grant, “those development rights were contributed for the purpose of extinguishing those rights and NAT agreed not to use or transfer them” and therefore they became worthless at the moment of transfer. Hence, no charitable contribution could be deducted.

Further, even if the development rights portion of the easement restricted the use of development rights associated with the subject property, no deduction would be allowed unless that restriction “served a conservation purpose that permits it to qualify for a deduction pursuant to [Code] section 170(h)”. The Memo did not decide whether this case is distinguishable from Herman v. Commissioner, T.C. Memo. 2009-205,  where the Court held a transfer of some development rights was not a qualified conservation contribution because it did not preserve a “historically important land area” or a “certified historic structure” within the meaning of Code sec. 170(h)(4)(A)(iv).

Lastly, the Court held the conservation easement did not fail the perpetuity requirement of Code section 170(h)(5)(A) even though the abandonment clause of the easement said, “nothing herein contained shall be construed to limit … [NAT’s] right to give its consent (e.g., to changes in the Facade) or to abandon some or all of its rights hereunder”. The Court held that, as per the decision in Simmons v. Commissioner, 646 F.3d 6 (D.C. Cir. 2011), the terms of the easement, combined with the New York State law governing conservation easements, do not violate the perpetuity requirement.  In a swipe at NAT, the Court cautioned, however, that, “it is nonetheless essential that the donee actively monitor the property and enforce any violations of the terms of the easement” for the donation to be a qualified conservation contribution, and, “In the instant case, the parties have not addressed NAT’s history of enforcing easements, and there is nothing in the record that would allow us to consider the likelihood that NAT would abandon the easement. Accordingly, although we hold the abandonment clause does not violate the perpetuity requirement, we do not decide whether the possibility that NAT would abandon the conservation easement is ‘so remote as to be negligible’.”

Decision available at http://www.ustaxcourt.gov/InOpHistoric/Friedberg.TCM.WPD.pdf. Thanks to Leslie Ratley-Beach for bringing it to my attention so quickly.

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