U.S. Tax Court, T.C. Memo 2014-52, March 31, 2014: Façade Easement had zero value; penalties imposed.
The issues in this case about the federal tax deduction for a “qualified conservation contribution” (a historic preservation façade easement) were principally the valuation of the façade easement and what, if any, penalties the taxpayer should pay for misstating the value in their tax return. The case was before the tax court on remand from the U.S. Court of Appeals for the First Circuit. Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012), aff’g in part, vacating and remanding in part Kaufman v. Commissioner, 136 T.C. 294 (2011), and 134 T.C. 182 (2010). It is the latest in a number of decisions involving problematic appraisal of façade easements granted to the National Architectural Trust (NAT).
The property is in Boston’s designated South End historic district and is subject to the South End Landmark District Residential Standards and Criteria (South End Standards and Criteria). The court described those rules as requiring approval by the South End Landmarks Commission (commission) for almost all exterior alterations to any property within the district, and providing specific repair criteria for many elements of the exterior.
The court weighed the credibility of competing appraisals’ assumptions and conclusions about whether and to what extent the preservation easement reduced the value of the property any more than the South End Standards and Criteria did. The court found the weight of evidence convincing that that the restrictions of the NAT façade easement are “basically duplicative of, and not materially different from, the South End Standards and Criteria.”
The Kaufmans’ appraiser, Hanlon (who had been recommended by NAT), concluded the façade easement reduced the property’s value prior to the easement donation by 12%, allowing a deduction of $220,800. The IRS appraiser, Bowman, concluded the easement caused no reduction in the property’s “after” value, yielding zero deduction.
The court found the IRS appraisal far more credible and decided the façade easement had no deduction value. The court did not like Hanlon’s starting point of accepting a general 15% reduction in value as proposed in the now-infamous IRS article, “Facade Easement Contributions,” by Mark Primoli (Primoli article). Hanlon had also modified this general number by assigning a percentage value to each separate “burden” that he thought were imposed by the easement (with the sum of the assigned percentages equal to 15%), and then adjusting the weight of those separate burdens by the differences he identified between the restrictions in the Kaufman preservation easement as compared to those imposed by the South End Standards and Criteria. The court wrote, “Even were we to accept that he identified the constituent burdens constituting the overall burden imposed by a facade easement, we accept neither his 15% starting point nor the relative percentages that he assigned to each constituent burden.” While the court did not entirely reject Hanlon’s concepts it did find “the lack of general acceptance and the uniqueness of his method are facts relevant to our determining its reliability … support[s] our conclusion that his method is not reliable.”
The court found credible the opinions of IRS’s appraiser, Bowman, that the easement did not change the highest and best use of the property (which Hanlon had conceded), there was no significant difference between the restrictions in the NAT easement and the underlying South End Standards and Criteria “that would likely be recognized by a typical buyer” [emphasis added], and no evidence of diminution in value or difficulty in marketing or financing preservation restriction-encumbered properties. The court also gave credence to Bowman’s testimony that insurance and maintenance costs for the property would not be greater than for other property in the historic district owned by a prudent owner or subject to mortgage lender requirements.
Because of the infinite percentage difference between the claimed deduction ($280,000) and what the court found to be appropriate ($0), it found that an accuracy-related penalty of 40% on account of a gross valuation misstatement (Code Sec. 6662(h)(1) and (2)(A)(i)) could be imposed unless the “reasonable cause exception” (Code Section 6664(c)) applies. The reasonable cause exception would not be available for a gross valuation overstatement of a charitable contribution deduction unless the claimed value of the property was based on a “qualified appraisal” by a “qualified appraiser” and the taxpayer made a good-faith investigation of the value of the contributed property. (Code Sec. 6664(c)(2) and (3); sec. 1.6664-4(h), Income Tax Regs.) The court, while finding that Hanlon and his appraisal minimally met the standards of a qualified appraiser and appraisal, did not find that the Kaufmans conducted a good faith investigation.
The court did not say what would constitute a good faith investigation but did say that the Kaufmans had not met their burden of proving that they had conducted one by simply (a) believing that the preservation easement was more restrictive than the South End Standards and Criteria, (b) having their accountant review the appraisal and tell them it was “consistent in form with other real estate appraisals that he had seen,” (c) relying on the Primoli article’s range of values, and (d) expressing concern to a NAT representative about resale value. The court held it against Mr. Kaufman that he is “a sophisticated consumer of statistical analyses” and opined he had good reason to question the appraisal’s value conclusion.
In the alternative, the court held that an accuracy-related penalty on account of negligence may be imposed. In addition to the absence of a good faith investigation, the court found negligence based on the Kaufmans’ certification to their lender, after getting the Hanlon appraisal, that “[t]he easement restrictions are essentially the same restrictions as those imposed by current local ordinances that govern this property.” The court brushed aside the Kaufmans’ attempt to say that they had not really read what they signed, saying that at the very least they were careless, “whether in not reading what they signed, in not reading carefully what they signed, or, in Gordon Kaufman’s case, in reaching a subjective conclusion in willful ignorance of relevant data.”
Decision available at http://www.ustaxcourt.gov/InOpHistoric/KaufmanMemo.Halpern.TCM.WPD.pdf