Kaufman, (2010) 136 TC No. 13
In a case dealing with a charitable contribution for a façade easement, the Tax Court has once again held that the gift did not result in a charitable contribution deduction because a bank held a mortgage on the underlying property and, as a result, the facade easement was not protected in perpetuity. However, the Tax Court granted a charitable contribution deduction for the donors' cash gift made to facilitate the donee's monitoring and administration of the facade easement. The deduction was granted for the year the easement was finalized, but the taxpayers' deduction of their cash gift in an earlier year resulted in an accuracy-related penalty.
Background. In general, Code Sec. 170(f)(3) bars a charitable contribution deduction for a contribution of an interest in property that is less than the taxpayer's entire interest in the property, but an exception is made for a qualified conservation contribution, i.e., the contribution of a qualified real property interest exclusively for conservation purposes. The interest in property conveyed by a facade easement must be protected in perpetuity for the contribution of the easement to be a qualified conservation contribution. (Code Sec. 170(h), Reg. §1.170A-14(b)(2))
Under Reg. §1.170A-14(g)(6)(ii), at the time of the gift, the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right, immediately vested in the donee organization, with a fair market value that, at the time of the gift, is at least equal to the proportionate value that the perpetual conservation restriction bears to the value of the property as a whole. When a change in conditions results in the extinguishment of a perpetual conservation restriction, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction.
Under Reg. §1.170A-1(e), if, as of the date of a gift, a transfer for charitable purposes is dependent on the performance of some act or the happening of a precedent event for it to become effective, no deduction is allowable unless the possibility that the charitable transfer won't become effective is so remote as to be negligible.
If the taxpayer also receives a substantial benefit in exchange for his contribution, then the amount of the deduction is limited to the excess of the contribution over the fair market value of benefit received, and the deduction for such excess payment is allowable only if it was made with the intention of making a gift. (Reg. §1.170A-1(h))
Facts. The easement involved a single-family rowhouse located in a historic preservation district in Boston that was owned by Gordon and Lorna Kaufman. In 2003, they entered into a preservation restriction agreement with the National Architectural Trust (NAT) under which they granted NAT a facade easement restricting the use of the property. NAT also required the Kaufmans to make a cash contribution, calculated as a percentage of the estimated value of the facade easement, to create an endowment to provide for monitoring and administration of the facade easement.
The agreement provided that if their donation couldn't be processed in time to qualify for a 2003 deduction, there would be a 10% reduction in the cash contribution requirement once the process was completed in 2004. In 2004, an appraiser valued the gift of the easement at $220,800 (that was the reduction in the property's fair market value on account of the gift). The Kaufmans contributed $16,840 to NAT in 2003, and paid an additional $3,332 in 2004. At the time of the contributions, a bank held a mortgage on the property.
On their 2003 return, the Kaufmans claimed a charitable contribution deduction of $220,800 for the contribution of the facade easement. Because of the Code Sec. 170(b)(1)(C) limitations on charitable contribution deductions, the Kaufmans claimed a charitable contribution deduction for the facade easement of only $103,377 and carried over the balance to 2004. They also claimed a $16,840 charitable contribution deduction in 2003 and $3,332 for their “cash contribution” to NAT.
On audit, IRS disallowed the deductions. It also assessed accuracy-related penalties under Code Sec. 6662.
In Kaufman I (Kaufman, (2010) 134 TC No. 9), IRS's motion for summary judgment was granted with respect to the facade easement contribution, but denied for the cash contribution and penalties.
Facade easement was not protected in perpetuity. In short, the problem was that a bank held a mortgage on the underlying property and in certain events, such as a casualty, was entitled to the condemnation proceeds in preference to NAT until the mortgage was satisfied and discharged. The Tax Court held in Kaufman I, that because of the mortgage on the property, NAT's right to its proportionate share of future proceeds was thus not guaranteed. The facade easement contribution failed as a matter of law to comply with the enforceability in perpetuity requirements under Reg. §1.170A-14(g). As a result, the Tax Court held that the facade easement contribution was not protected in perpetuity and thus was not a qualified conservation contribution under Code Sec. 170(h).
Cash contribution and penalties. IRS denied the Kaufmans's cash contribution to NAT on the ground that the gift was conditional and as a result violated Reg. §1.170A-1(e). Alternatively, IRS argued that the cash contribution was part of a quid pro quo and didn't give rise to a deduction. The Kaufmans argued that the possibility that the charitable transfer would not become effective, i.e., the possibility that an appraisal would find the facade easement to have no value, was so remote as to be negligible. They argued that the inquiry in arriving at the “conditional” determination was inherently factual. In Kaufman I, the Tax Court agreed with the Kaufmans. It also said that even if NAT required the Kaufmans to make a cash contribution, that wasn't enough to deny them a charitable contribution. Thus, the Tax Court denied IRS's motion for summary judgment with respect to the cash contribution.
In Kaufman I, the Tax Court also wouldn't grant summary judgment as to the 20% accuracy-related penalty for negligence and substantial understatement of income tax under Code Sec. 6662(a) because the Kaufmans raised genuine issues of material fact regarding the applicability of the reasonable cause defense to those penalties.
Kaufman II. The Kaufmans asked the Tax Court to reconsider and reverse its holding in Kaufman I, that the facade easement contribution was not deductible. However, after a detailed discussion of the regs and the effects of a subordination, the Tax Court affirmed its original holding on the grounds set forth in Kaufman I.
Additionally, the Tax Court disallowed the Kaufmans' charitable contribution deduction of $16,840 for 2003, agreeing with IRS that they were conditional payments (subject to refund) if the appraisal reported the value of the facade easement to be zero. The Tax Court held that the Kaufmans bore the burden of proving that at the end of 2003, the possibility of a zero appraisal value was not so remote as to be negligible, and they did not carry that burden. The Tax Court also sustained an accuracy-related penalty for the Kaufmans' underpayment of 2003 tax attributable to the cash payments made to NAT in 2003. However, the Tax Court held that the Kaufmans could claim a charitable contribution for 2004 of the $19,872 cash payments they made to NAT in 2003 and 2004.
References: For charitable contribution deduction for qualified conservation contributions, see FTC 2d/FIN ¶K-3501; United States Tax Reporter ¶1704.47; TaxDesk ¶331,619; TG ¶19201.