Partita Partners LLC v. US (Partita II)

U.S. District Court, S.D. New York, No. 15-cv-2561(PKC), July 10, 2017: Disqualification of façade donation opens door to valuation misstatement penalty.

In 2008, plaintiff Partita Partners LLC (“Partita”) claimed a federal tax deduction of $4,186,000 for the donation of a preservation easement to the Trust for Architectural Easements in the façade of a building that Partita owns. The IRS disallowed the deduction and assessed a “gross valuation” underpayment penalty against Partita of 40%, or in the alternative, a 20% underpayment penalty for negligence, substantial understatement of income tax or a substantial valuation misstatement. See 26 U.S.C. § 6662.

In Partita Partners LLC v. United States, 216 F. Supp. 3d 337 (S.D.N.Y. 2016) (“Partita I”) U.S. District Court for the Southern District of New York granted the government’s motion for partial summary judgment, agreeing with the IRS that, as a matter of law, Partita’s donation of the façade easement did not preserve the building’s entire exterior, as required by 26 U.S.C. § 170(h)(4)(B), and that Partita therefore was ineligible for the $4,186,000 deduction that it claimed.

The remaining issue is Partita’s motion for partial summary judgment on the issue of underpayment penalties. The court rejected the motion and agreed with the government that a trial is needed to resolve plaintiffs’ challenge to the penalties.

Under the Internal Revenue Code, a valuation misstatement penalty “shall apply to the portion of any understatement which is attributable to” the valuation misstatement. 26 U.S.C. § 6662(b)(3), (h)(1), emphasis added. The 20% penalty applies when underpayment “is attributable to “[n]egligence or disregard of rules or regulations,” “[a]ny substantial understatement of income tax” or “[a]ny substantial valuation misstatement under chapter 1,” among other things. 26 U.S.C. § 6662(b)(1)-(3).  A “substantial valuation misstatement” occurs when the value of property claimed on a return is misstated by 150% or more than the amount determined by the IRS. The 40% penalty for “gross valuation misstatements” occurs when the misstatement exceeds the IRS’s determined amount by 200% or more. 26 U.S.C. §§ 6662(h)(1), 6662(e)(1)(A).

According to Partita, the underpayment was not found by Partita I to be “attributable to” a valuation misstatement but was in fact attributed to a different cause, because Partita I concluded that the charitable deduction did not satisfy the criteria for a qualified conservation contribution, not that Partita’s statement of the value of the contribution was wrong.

The court said Partita’s position misstates the law since the U.S. Supreme Court’s decision in United States v. Woods, 134 S. Ct. 557 (2013). In that case, and in some prior lower court decisions, the use of a valuation misstatement penalty has been upheld when the taxpayer’s claimed deduction was denied in its entirety because it lacked a foundation in fact or law. In Woods, a partnership was found to have engaged in sham transactions  solely for tax benefits and the IRS imposed a penalty. The taxpayer argued that because the partnerships themselves were deemed to be shams, the underpayment of taxes could not be “attributable” to a valuation misstatement. The Supreme Court disagreed, and concluded that because the existence of the sham tax shelters was intertwined with inaccurate deductions claims, a valuation misstatement of basis was inherently part of the sham. The Supreme Court also stated “that the valuation-misstatement penalty encompasses legal as well as factual misstatements of adjusted basis . . . .” To the court, Woods thus stands for the proposition that a valuation misstatement penalty may be applied when the taxpayer’s claimed deduction was denied in its entirety because it lacked a foundation in fact or law, not just when the valuation misstatement is intertwined with the underlying sham transaction.

The court agreed with the government that a valuation misstatement penalty may be imposed if an underpayment, like Partita’s, “is attributable to” — meaning “capable of being attributed” to — a misstatement of value, and not only when the understatement in fact “was attributed to” a misstatement of value. As precedent for this, the court cited Irom v. Comm’r of Internal Revenue, 866 F.2d 545 (2d Cir. 1989), in which the Second Circuit concluded that because the penalty applied to underpayments “attributable” to tax-motivated transactions, the Tax Court should separately consider whether underpayment was “capable of being attributed to” tax-motivated transactions for the purpose of establishing the penalty. Although Irom involved a different penalty statute, the court was persuaded by Irom’s interpretation of the word “attributable.”

The court also denied Partita’s motion for partial summary judgment as to the 20 percent penalties despite Partita’s argument that the IRS had not shown that the penalties were approved in writing as required by 26 U.S.C. § 6751(b)(1).

Decision available at

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