Tuesday, October 12, 2010

No Charitable Deduction For Gift Of Façade Easements To Historic Trust But No Overvaluation Penalty

Evans, TC Memo 2010-207

The Tax Court has concluded that while taxpayers had no charitable deduction for their gift of façade easements to a historic trust because of their failure to establish the gift's value, they nonetheless escaped being penalized for their overvaluation of the gift.

Background on deduction for charitable gift of façade easement. Under Code Sec. 170, a charitable deduction is available for a gift of an easement in property that is a qualified conservation contribution, including an easement designed to preserve the façade of a historic structure. However, establishing the fair market value (FMV) of such a gift can be tough. There are usually no comparable sales to resort to because the creation of such easements is normally by gift, and IRS generally won't accept an appraisal that substantiates the FMV of a facade easement if the appraisal was arrived at merely by valuing the entire property before the donation and then applying a percentage discount to that valuation.

Background on accuracy-related penalty. Under Code Sec. 6662(a), a 20% accuracy-related penalty is imposed on certain substantial income tax understatements. There is a reasonable cause/good faith exception but in the case of an underpayment attributable a gross or substantial valuation overstatement as to charitable deduction property, the exception only applies if the claimed value of the property was based on a "qualified appraisal" made by a "qualified appraiser." IRS has the burden of proof on the application of the accuracy-related penalty.

No charitable donation for gift of façade easement. Taxpayers, who owned two rowhouses in Washington, D.C., gave façade easements to the Capitol Historic Trust. In the Tax Court, two expert appraisals were produced, each of which discounted the "before" value of the rowhouses by 11% to arrive at the amount of the charitable deduction. However, the Tax Court disregarded this valuation evidence because of the taxpayers' failure to actually produce the two experts as witnesses before the court, where they could be questioned as to their methodology and qualifications. The Tax Court concluded that no deduction could be allowed. Ordinarily any encumbrance on real property tends to have some negative effect on the property's value, even in the case of an encumbrance that is only nominal. However, taxpayer failed to provide sufficient credible evidence as to the FMV of the facade easements to meet the burden of sustaining the claimed charitable contribution deduction.

20% accuracy-related penalty avoided. In challenging the application of the reasonable cause/good faith exception to the penalty, IRS argued that neither of the expert appraisals contained any meaningful explanation for the valuation arrived at, or for the use of the 11% discount. According to IRS, this percentage discount factor was derived from amounts allowed in other, unrelated tax cases. The Tax Court said that if this were true, then such a percentage discount unaccompanied by a recognized methodology or specific basis for the calculated after-donation value would be too significant to ignore for purposes of accepting the reports as a qualified appraisals. However, IRS's claims attacking the reports' methodology didn't constitute evidence. IRS could itself have called the experts as witnesses and questioned them on the methodology or specific basis of valuation that they had used, but failed to do so. Consequently, IRS had failed to carry its burden of proof that the deduction hadn't been based on a qualified appraisal made by a qualified appraiser. Finally, the taxpayers had acted reasonably and in good faith in their reliance on the appraisers, whose names had been provided to them by the donee organization.

Deduction based on discount from property's pre-easement value allowed in another case. In Hilborn (1985), 85 TC 677, the value of a qualified conservation contribution of an easement in perpetuity in the facade of a historic building in the New Orleans French Quarter was determined under a before-and-after approach. The "before" value was arrived at by determining the highest and best use of the property unrestricted by the easement; the "after" value was based on the highest and best use of the property as encumbered by the easement. In arriving at these values, two expert appraisals took into account a number of factors, including the easement's terms, zoning regulations, size and location of the property, neighborhood character, and trend of development to estimate in a detailed manner the extent to which the easement would affect the use of the property. Under this approach, the Tax Court found a 10% diminution in value because of the donation of the facade.

References: For charitable deduction allowed for qualified conservation contributions, see FTC 2d/FIN ¶K-3501; United States Tax Reporter ¶1704.47; TaxDesk ¶331,619; TG ¶19201. For valuation of facade easement gift, see FTC 2d/FIN ¶P-6139. For the 20% accuracy related penalty, see FTC 2d/FIN ¶V-2001; United States Tax Reporter ¶66,624; TaxDesk ¶863,001; TG ¶71626.

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