Wednesday, April 6, 2011

Taxpayer's Unrealistic Valuation Of Conservation Easement Excluded; IRS's Valuation Upheld

Boltar LLC, (2011) 136 TC No. 14

In a case dealing with a charitable contribution of a qualified conservation easement, the Tax Court has held that it was within its discretion to exclude the taxpayer's expert report for failing to meet the standards of reliability and relevance that apply to both bench and jury trials. Accordingly, the Court granted IRS's motion to exclude the report as unreliable and irrelevant, and sustained the value determination that IRS set out in its statutory notice.

Background. Under Reg. §1.170A-1(c)(1), for a charitable contribution of property other than money, the amount of the contribution is the property's fair market value (FMV) at the time of the contribution. Reg. §1.170A-1(c)(2) defines FMV as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.” Similarly, under Reg. §1.170A-7(c), the allowable deduction for a contribution of a partial interest in property is the FMV of the partial interest at the time of the contribution.

The value of a “qualified conservation easement” (i.e. contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes and which prohibits the donee from making certain transfers) is the FMV of the perpetual conservation restriction at the time of the contribution under Reg. §1.170-7(c). If there aren't a sufficient number of comparable easements to that donated, then the FMV of the easement is generally equal to the amount by which the value of the property burdened by the restriction is reduced on account of the creation of the restriction. This involves determining the difference between the FMV of the affected property before and after the restriction is imposed. The before/after methodology has been adopted and applied in various contexts.

Facts. On Dec. 29, 2003, Bolstar, LLC, granted an easement to a land trust restricting the use of approximately 8 acres on land in Indiana. A substantial amount of Bolstar's land holdings in that area were forested wetlands falling within the jurisdiction of the U.S. Army Corps of Engineers. The discharge of dredged or fill material in wetlands within Federal jurisdiction is subject to both a federal and state permitting process, and the applicant must mitigate for impacted wetlands as a condition of obtaining a permit. The parcel affected by the easement was zoned for single-family residences.

On its 2003 Form 1065, U.S. Return of Partnership Income, Bolstar claimed a $3,245,000 charitable contribution deduction stemming from the donation of the easement. Boltar reported that the easement had a FMV of $3,270,000 as of Dec. 31, 2003, but reduced this amount by $25,000 as a claimed enhancement in value to adjacent parcels owned by Bolstar as a result of the donation of the subject easement.

Bolstar attached a Form 8283, Noncash Charitable Contributions, signed by Gary K. DeClark, managing director and principal of Integra Realty Resources in Chicago, Illinois (Integra), to its Form 1065. Also attached to the return was an appraisal report (the Integra appraisal) prepared by DeClark and Nancy S. Myers (Myers), senior real estate analyst for Integra, on March 7, 2004. DeClark and Myers reviewed only a draft of the easement before preparing their appraisal, not the final version.

The Integra appraisal determined that the “highest and best use” of the subject property was residential development and determined the easement value as the difference between the “Foregone Development Opportunity of 174 Condominiums on Finished Sites, Discounted to December 31, 2003” (which it valued at $3,340,000) less the “Value of Raw, Vacant and Developable Land” ($68,000).

In its Final Partnership Administrative Adjustment (FPAA), however, IRS determined that the FMV of the easement as of Dec. 29, 2003, was $42,400, based on a review by one of IRS's valuation engineers. The valuation engineer concluded that the highest and best use of the subject property was for “development of single family detached residential homes, but not until the surrounding properties are developed,” in part because the property subject of the easement was landlocked with no direct access to a public road. Other expert reports later submitted by IRS's experts opined that the value of the easement was $31,280, based on a before-easement value of $100,600 and an after-easement value of $69,320.

IRS's motion to exclude taxpayers' experts' reports. Before trial, IRS filed a motion to exclude the Integra report as neither reliable nor relevant. Notably, the report didn't provide before and after values of the property, it didn't value all of the contiguous parcels owned by the taxpayer and encumbered by the easement, and the “174 condominium unit development” was arguably not a physically possible use. IRS claimed that Bolstar's experts merely determined a value based on whatever use would generate the largest profit, “apparently without regard to whether such use is needed or likely to be needed in the reasonably forseeable future.” In response, Bolstar argued that the evidentiary principles set out by the Supreme Court in its’93 decision Daubert v. Merrell Dow Pharmaceuticals Inc,, 509 US 579, were inapplicable since there was no jury in this case.

Tax Court's decision. The Tax Court determined that the Daubert analysis wasn't limited only to jury trials, and that Rule 702 of the Federal Rules of Evidence (FRE), which sets forth standards of reliability, applied equally to bench and jury trials. Noting that unreliable evidence is an imposition both on the opposing party and on the trial process, the Court held that Bolstar's experts, although qualified, submitted valuations that were unrealistic, and the Tax Court was within its discretion to exclude them.

Notably, the experts didn't consider the property's potential for single-family residential development, even though that is what it was zoned for at the time of the contribution, and they also failed to consider the effect of the easement on the contiguous property owned by Bolstar. In the end, the valuations weren't sufficiently based on facts or data, and they didn't state the facts or data as support for their conclusions. Overall, the report was too speculative and unreliable to be useful, so the Court found that it was not admissible under FRE Rule 702. The Tax Court also rejected Bolstar's argument based on IRS's alleged acceptance of similar appraisals in other audits as irrelevant.

IRS's valuation upheld. After excluding the Integra report and testimony, the Tax Court determined that Bolstar failed to show that it was entitled to a deduction greater than that allowed by IRS, based on its valuation.

References: For evidence in the Tax Court, see FTC 2d/FIN ¶U-3201; United States Tax Reporter ¶74,536.1434. 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.

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