Comm. v. Simmons, (CA DC 6/21/2011) 107 AFTR 2d ¶2011-966
The Court of Appeals for the District of Columbia Circuit, affirming the Tax Court, has held that a taxpayer was entitled to charitable contribution deductions for her donation of conservation easements on the facades of two buildings located in a historic district. The Court rejected IRS's contention that her contribution wasn't exclusively for conservation purposes, as required by Code Sec. 170(h)(1)(C), and that she failed to obtain qualified appraisals under Reg. §1.170A-13(c)(3)(ii).
Background on qualified conservation contributions. 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))
For a contribution to be deemed exclusively for a conservation purpose, that purpose must be protected in perpetuity. (Code Sec. 170(h)(5)(A)) Any interest in the property retained by the donor must be subject to legally enforceable restrictions that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation. (Reg. §1.170A-14(g)(1)) The possibility that certain events may defeat the donated interest won't render a gift nonperpetual if the possibility is so remote at the time of the gift as to be negligible. (Reg. §1.170A-14(g)(3))
Background on qualified appraisals. Reg. §1.170A-13(c)(2) provides that for any noncash charitable contribution exceeding $5,000, the donor must: (1) obtain a qualified appraisal for the contributed property; (2) attach a fully completed appraisal summary (i.e., Form 8283) to the tax return on which the deduction is claimed; and (3) maintain records relating to the claimed deduction, as required in Reg. §1.170A-13(b)(2)(ii).
A qualified appraisal must include: a description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property appraised is the property that was contributed; a description of the property's physical condition; the valuation method used to determine the fair market value, and the specific basis for the valuation. (Reg. §1.170A-13(c)(3)(ii))
Facts. During the years at issue, Dorothy Jean Simmons contributed conservation easements on the facades of two buildings she owned in Washington, D.C. (one on Logan Circle and one on Vermont Avenue) to the L'Enfant Trust, Inc., a tax-exempt organization dedicated to the preservation of historic properties. The two properties were subject to the District of Columbia's Historic Landmark and Historic District Protection Act of’78. The D.C. Historic Preservation Office could fine any person who violated D.C.'s preservation laws and could compel that person to restore a structure that she impermissibly altered.
Simmons executed a Conservation Easement Deed of Gift that granted to L'Enfant “an easement in gross, in perpetuity, in, on, and to the Property, the Building and the Facade” on the properties. Each deed prohibited Simmons from materially altering the facades without L'Enfant's written consent, and required her to maintain the properties in good repair, periodically clean the facades, and ensure any change to a façade would comply with applicable federal, state and local governmental laws and regulations. The deeds gave L'Enfant the right to inspect the facades and to seek equitable remedies for any violation of the easements. By their terms, the easements were binding upon Simmons and her “successors, heirs and assigns,” ran in perpetuity with the land, and survived any termination of Grantor's or the Grantee's existence.
The deeds also allowed L'Enfant to give its consent (e.g., to changes in a Facade) or to abandon some or all of its rights. The deeds acknowledge the properties were already encumbered by deeds of trust securing loans to a mortgage company, but recited that the lenders had agreed to subordinate their rights in the property to the rights of L'Enfant.
IRS's position. IRS argued that Simmons's contribution wasn't exclusively for conservation purposes, pointing to the clause in the deeds which stated that “nothing herein contained shall be construed to limit the Grantee's right to give its consent (e.g., to changes in a Facade) or to abandon some or all of its rights hereunder.” Since this clause left L'Enfant free to consent to a change in the façade and to abandon altogether its right to enforce the restrictions set out in the deed, IRS contended that there wasn't the required conservation in perpetuity. IRS also asserted that the deeds wouldn't prevent uses of the properties inconsistent with their conservation because neither easement included a clause providing for the perpetuation of the easements in the event L'Enfant ceased to exist or simply abandoned its right to enforce the easements.
In addition, IRS argued that Simmons's appraisals were inadequate because the appraiser failed to explain the method of valuation that he used or include a substantive basis for the valuation. The appraiser relied upon an article prepared by an IRS employee which stated that IRS Engineers had concluded that the proper valuation of a façade easement should range from approximately 10% to 15% of the value of the property. IRS suggested that the appraiser had arbitrarily picked a percentage between 10% and 15%, rather than stating any identifiable method to determine the after-easement value.
Deduction allowed. The D.C. Circuit concluded that the easements met the requirement of perpetuity in Code Sec. 170(h)(5)(A). The deeds imposed an affirmative obligation on Simmons “in perpetuity” to maintain the properties in a manner consistent with their historic character and granted L'Enfant the authority to inspect the properties and to enforce the easements. By their terms, the deeds would “survive any termination of Grantor's or the Grantee's existence.” Although the deeds did not specify what would happen upon the dissolution of L'Enfant, under D.C. law the easement initially would revert to the District, which would then seek to assign it to a conservation organization.
The Court also concluded that the clauses dealing with consent to change and abandonment didn't affect the perpetuity of the easements. The Court reasoned that any donee might fail to enforce a conservation easement, whether or not there was such a clause, but that a tax-exempt organization would do so “at its peril.” The Court also noted the explanation by the National Trust for Historic Preservation, L'Enfant, and the Foundation for the Preservation of Historic Georgetown (in a “friend of the court” brief) for this type of clause. It was needed to allow a charitable organization to accommodate changes necessary to make a building livable or usable for future generations while still ensuring that the change was consistent with the conservation purpose of the easement. Further, the Court noted that any change would have to comply with all applicable laws and regulations, including D.C.'s historic preservation laws.
IRS had failed to show that the possibility that L'Enfant (which had been holding and monitoring easements in the District since’78) would actually abandon its rights was more than negligible. The Court found that Simmons's deductions couldn't be disallowed based upon the remote possibility that L'Enfant would abandon the easements.
Qualified appraisal. The D.C. Circuit found that the appraisals sufficiently identified the method and basis for the valuations and that Simmons had provided IRS with qualified appraisals. To determine the property's fair market value before being encumbered, the appraiser consulted sales of similar properties and identified some of these sales in the appraisals. In determining the fair market value after encumbrance, he spoke with and considered the mindset of competent buyers and sellers and took account of the considerations they have actually had, or are likely to have, in buying or selling a property encumbered by a facade easement. For example, the appraisals noted the property would lose some value because the easement imposed more onerous requirements than did D.C. law. It also listed several factors that would lower the value of the encumbered property, such as potential legal exposure if the donor were to breach the easement and L'Enfant's right of prior approval for any change to the façade.
After examining sales of easement-encumbered properties and speaking with interested parties, he determined the Logan Circle and the Vermont Avenue properties would lose, respectively, 13% and 11% of their values. Although noting that the appraisals might have elaborated further upon the specific bases for reaching each valuation (and thus avoided litigation on this issue), the Court found that it wasn't clear error for the Tax Court to conclude that the substantiation requirements had been met.
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.