US Court of Appeals, 5th Circuit, No. 13-60131, June 11, 2014: Reliance on qualified appraisal and accountant advice can be good faith basis to avoid tax penalty, but tax court’s valuation decision upheld.
This decision is the fourth in this historic preservation façade easement tax case. The case began when Whitehouse made a charitable contribution of a façade easement on a historic property in New Orleans and claimed a federal tax deduction for it. In the first decision the IRS entirely rejected the deduction and assessed a penalty for gross underpayment of taxes under § 662(h)(2) of the tax Code. Whitehouse sought to overturn the IRS decision in the US Tax Court. In Whitehouse Hotel Ltd. P’ship v. Comm’r, 131 T.C. 112 (2008) (Whitehouse I), the tax court held that Whitehouse was entitled to a deduction but set the value of the easement contribution far below Whitehouse’s claim, found that Whitehouse did not qualify for the good faith exception to the gross underpayment penalty rules, and thus imposed the penalty.
Whitehouse appealed. In Whitehouse Hotel Ltd. P’ship v. Comm’r, 615 F.3d 321 (5th Cir. 2010) (Whitehouse II) the Fifth Circuit Court of Appeals vacated the tax court’s valuation of the easement and therefore also vacated the gross undervaluation penalty, and remanded the matter back to the tax court for further consideration on issues about the easement’s valuation and the denial of the good faith exception. The appeals court told the tax court to do three things: (1) reconsider valuation using the replacement cost and income methods, in addition to the comparable sales method; (2) determine the parcel’s “highest and best use” for the purposes of its valuation; and (3) consider the effect of the easement on an adjoining building which the tax court had said should not be considered in the valuation.
Grudgingly doing the review, on remand Whitehouse Hotel Ltd. P’ship v. Comm’r, 139 T.C. 304 (2012) (Whitehouse III) the tax court still found that Whitehouse had overvalued the easement (although it allowed about a 4% higher value that in Whitehouse I) and was subject to the overstatement penalty because it had not proved its case of a good faith exception.
Whitehouse took the case back to the 5th Circuit for appellate review of Whitehouse III. In its new decision (Whitehouse IV) the appeals court held that the tax court had taken the reconsideration steps as instructed in Whitehouse II, upheld the tax court’s valuation decision as not being wrong on the law, but overturned the tax court as to the law on the penalty question. Most of the appeals court decision focused on questions of whether the tax court had indeed complied with the remanding instructions, and not with the tax court’s factual conclusion (so long as there wasn’t clear error).
The appeals court held against Whitehouse on each of the three errors Whitehouse argued were made by the tax court’s valuation decision on remand: (1) continued refusal to use the results of a replacement cost or income analysis in valuation; (2) the “highest and best use” for valuation purposes; and (3) the exclusion of the adjoining building from the valuation.
Valuation Methods – Reproduction Cost: On remand, the tax court again rejected the reproduction cost approach because it concluded reproducing the historic façade after complete destruction would make no business sense. The appeals court questioned whether complete destruction was the only scenario to consider when evaluating “business sense” in this context, but nevertheless decided that the tax court’s conclusion about the facts in this case was not so clearly in error as to warrant a remand in this point. As a matter of law, the appeals court noted precedent for being dubious about the likelihood of reproduction as a “reasonable business venture.” On the other hand, the court also noted that this easement imposed more repair and replacement requirements in the event of partial destruction rather than total loss, and that “reproducing or repairing some substantial portion of the façade might be a significant burden that arises only because of the existence of the easement. The more limited repairs, though, might make business sense. Such obligations could diminish the value of the building to a potential owner, since the later owner would bear that cost.” The appeals court was not willing, however, to substitute its judgment for the tax court’s judgment on this question.
Valuation Methods – Income: The tax court on remand refused to use the income approach to valuation in this case because it found the income calculations of Whitehouse’s appraiser too unreliable to use, particularly since comparable sales data were available as the basis for a more reliable alternative method. The appeals court said there was no applicable legal precedence for overturning the tax court’s conclusion on this issue, and therefore let it stand.
Valuation Methods – Non-Local Comparable Sales: In its earlier decision (Whitehouse II), the appeals court questioned the tax court’s refusal to consider the non-local comparable sales in Whitehouse’s appraisal, but the appeals court did not require the tax court to weigh those non-local sales in its valuation decision. Therefore the tax court’s continued rejection of those non-local comparable sales on remand was also not grounds for another remand.
Highest and Best Use: The problem about “highest and best use” the appeals court had with the tax court’s first Whitehouse decision was that the appeals court couldn’t “decipher” whether the tax court had actually reached a conclusion about it. In the current decision, the appeals court said its instructions on remand were only to make a conclusive finding on the subject, without prejudicing the outcome. The choices for highest and best use were as a Ritz-Carlton luxury hotel or a non-luxury hotel. Solomonically, the tax court on remand said the highest and best use could be either one, which the appeals court was willing to accept as fulfilling the remand instructions.
Exclusion of Adjoining Building: The appeals court found that having reconsidered this question, the tax court did what was required of it on remand, and again that the tax court’s conclusion was not reversible error.
Good Faith Defense to Penalty: On this issue, the appeals court said its decision should be based on its own interpretation of the law, without regard to the tax court’s interpretation, and that the tax court was wrong. The tax court on remand wanted more of Whitehouse than reliance on advice of attorneys and accountants. The appeals court cited the precedent in United States v. Boyle, 469 U.S. 241, 251 (1985) that “[w]hen an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for a taxpayer to rely on that advice.” The appeals court noted that reliance on such advice is particularly appropriate in the absence of a two-party “haggle over price” of this easement or easements generally. The court threw out the tax court’s imposition of the penalty, saying, “Obtaining a qualified appraisal, analyzing that appraisal, commissioning another appraisal, and submitting a professionally-prepared tax return is sufficient to show a good faith investigation as required by law.
The decision is temporarily available at http://www.ca5.uscourts.gov/opinions%5Cpub%5C13/13-60131-CV0.pdf and should eventually be findable at http://www.ca5.uscourts.gov/opinions.aspx.