Kaufman v. Shulman (Kaufman III)

US Court of Appeals 1st Circuit, 687 F.3d 21 (2012), July 19, 2012: Kaufman II overturned; mortgagees may reserve insurance proceeds; remand for valuation.

The First Circuit vacated the Tax Court decision in Kaufman II (except on the uncontested issues of deductibility of cash contributions and accuracy-related penalty associated with the cash contribution claim) and remanded the case back to Tax Court for a review of the IRS determination that the Kaufman’s façade easement had no value.

Background: The Kaufmans granted a historic preservation façade easement to National Architectural Trust for their home in a Boston historic district. Because the home was mortgaged, the Kaufmans needed to get a mortgage subordination to satisfy the requirements of the Code and Treasury Regs that the easement must be enforceable in perpetuity. The Kaufmans obtained the subordination, but the lender limited the subordination by reserving the lender’s right to first priority on insurance proceeds in the event of a casualty. For a variety of reasons the IRS denied the Kaufmans’ claim for a deduction for the easement value and for a cash contribution. The Tax Court upheld the denial of a deduction for the easement, principally on the grounds that “perpetuity” requires that the donee of the easement must be absolutely guaranteed its proportionate share of insurance proceeds. The IRS and Tax Court both bound together the Treasury Regs requiring that donees must receive a portion of proceeds after judicial extinguishment of an easement with the Regs requiring subordination.

The Court focused on the word “entitled” in the section of the Treas. Regs that say that to be a qualified conservation contribution the easement must include a provision that if the easement were ever extinguished by judicial action, “the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds” (except as provided in state law). Treas. Regs. § 1.170A-14(g)(6)(ii). The Court interpreted “entitled” to mean a right that is absolute against the owner-donor, not absolute against “third-party claims (here, the bank’s or the city’s [for property taxes]) are contingent and unlikely.”

 

The Court expressly did not rely on the “negligible remote future events” exception of the Regs. (§ 1.170A-14(g)(3)). It did not discuss the likelihood of the bank’s claim on insurance proceeds or the city’s claim for property taxes, or suggest how to weigh those probabilities (involving, in the bank’s case, both a casualty and the borrower’s nonpayment of the loan principal).  Rather, using the municipal super-lien for property taxes as an example of something that cannot be subordinated, the Court characterized the Tax Court’s interpretation as “an impromptu reading” of the Regs “that is not compelled and would defeat the purpose of the statute”.

The Court also did not directly address the Tax Court’s reading together of the proceeds-entitlement provisions of Treas. Regs. § 1.170A-14(g)(6)(ii) with the subordination requirement of Treas. Regs. § 1.170A-14(g)(2).

The Court, citing Commissioner v. Simmons, 646 F.3d 6, 10 (D.C. Cir. 2011) also said that the provision in the façade easement that allowed the donee the unlimited right to “consent (e.g., to changes in the Façade) or to abandon some or all of its rights hereunder” does not warrant denial of the deduction. In addition to the reasoning in Simmons about the remoteness of the possibilitythat the donee would abandon the easement or improperly grant consent, the Court added, “the concern posited by the IRS is within its power to control: the IRS’s own regulations require that tax-exempt organizations such as the Trust be operated ‘exclusively’ for charitable purposes, 26 C.F.R. § 1.501(c)(3)-1, a requirement that the IRS can enforce against the Trust.”

Another area of the decision may broadly affect IRS enforcement actions. The Court rejected the IRS’ contention that the contribution should be denied because of the Kaufman’s failure to comply with recordkeeping and reporting requirements.  The IRS attacked the appraisal and appraisal summary, alleging failure to meet various regulatory requirements.  The Court wrote, “the IRS’s argument is largely an attempt to convert an inherently factual issue [i.e., the substance of the appraisal] into a set of violations of the procedural requirements of section 1.170A-13 in disregard of their language and purpose… whether the valuation was overstated, grossly or otherwise, is a factual question different from whether the formal procedural requirements were met, either strictly or under the ‘substantial compliance’ doctrine which may forgive minor discrepancies.”

One aspect of the Court’s discussion of technical compliance may be of interest to those preparing Form 8283 appraisal summary. Form 8283 asks that the taxpayer state the ‘manner and date of acquisition’ and ‘cost or other basis’ of the “donated property”. The Kaufmans, understanding “donated property” to mean the preservation easement, explained they “did not ‘acquire’ the preservation easement, but created that property interest at the moment they conveyed it to the Trust,” and “thus had no ‘manner and date of acquisition’ and no ‘cost or other basis’ to report.” The Court did not question this explanation, and in fact seemed to accept it by writing, “Arguably, the Kaufmans should have written ‘None’ or ‘Not Applicable’ in the spaces on the Form 8283 reserved for date of acquisition, method of acquisition, and cost/adjusted basis.”

The Court also overturned a portion of the Tax Court decision on procedural grounds. The Tax Court decision was a grant of summary judgment, which is supposed to be done when there is no material factual dispute between the parties as to the matter on which the law is in question.  The Court said that questions as to whether the easement was overvalued —  including whether the appraiser was not “qualified” because the “donor had knowledge of facts that would cause a reasonable person to expect the appraiser falsely to overstate the value of the donated property” (Treas. Regs.  1.170A-13(c)(5)(ii)) —“require further fact-finding by the Tax Court, so it is not a basis for affirmance of the summary judgment.”

The case was remanded to the Tax Court for further proceedings about the value of the easement.

On the subject of value, although the valuation issues were not in dispute on appeal, because they were not reached in the Tax Court decision, the Court saw fit to comment. Specifically, the Court offered dictum on the issue of whether the easement had any value given the municipal restrictions on facades in the historic district in which the Kaufmans’ home is located. Those restrictions were characterized by the Court as “severely restrict[ing] the alterations that property owners can make to the exteriors of historic buildings in the neighborhood.” The Court volunteered that, “Given these pre-existing legal obligations the Tax Court might well find on remand that the Kaufmans’ easement was worth little or nothing.” The appraisal had made distinctions between the preservation easement and the municipal restrictions. The Court said, “Whether any of the offered distinctions justify any deduction is a matter for the remand.” This same issue also came up when the Tax Court rejected the appraisals in Dunlap v. Commissioner, T.C. Memo, 2012-126 (May 1, 2012).

The decision is available at http://media.ca1.uscourts.gov/cgi-bin/getopn.pl?OPINION=11-2017P.01A.

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