Three Recent Tax Court Cases Affect How Land Trusts Operate
Three landowners lost each of their entire federal tax deductions from the donation of preservation and conservation easements in Massachusetts, Alabama and Indiana in three separate cases decided at the end of March and early April due to various failures in technical compliance issues with the Tax Code and the Treasury Regulations.
Lender Agreements, Proceeds Priority and Stewardship Costs Affected by Kaufman Reconsideration 136 T.C. No. 13 (2011)
On April 4th after reconsideration of its 2010 summary judgment decision (134 T.C. 182 (2010), “Kaufman I”), the US Tax Court affirmed its position that the holder of the easement must have an absolute guaranteed right to its proportional share of proceeds from a sale after extinguishment of the easement prior to the lender right to any remaining proceeds. If the lender has proceeds priority, Judge Halpern opined, then the preservation (or conservation) easement does not comply with the perpetuity requirement. Lorna Kaufman granted a historic preservation façade easement to National Architectural Trust (NAT). NAT obtained a subordination of Kaufman’s mortgage to the easement conditioned on the lender priority to any casualty insurance or condemnation proceeds until the mortgage was paid. Both Kaufman and the IRS asked the Tax Court for reconsideration, and many preservation organizations petitioned to be heard as amici, leading to the reconsideration decision, “Kaufman II”. The Court stated that it decided Kaufman I because NAT might not receive its proportional share of any future proceeds, the lender agreement failed to satisfy the extinguishment and perpetuity requirements. Kaufman had also argued that chance of an eminent domain taking or casualty loss were so negligible that whatever rights the lender had in proceeds from such events should come under the “so remote as to be negligible” exception.The Kaufman II Court held that exception does not apply to the extinguishment requirements because the easement must give the holder of the easement “an absolute right to compensation from the post-extinguishment proceeds for the restrictions judicially extinguished” to satisfy the extinguishment provision. “It is Lorna Kaufman’s failure to accord NAT an absolute right to a fixed share of the post-extinguishment proceeds that causes her gift to fail the extinguishment provision. It is not a question as to the degree of improbability of the changed conditions that would justify judicial extinguishment of the restrictions. Nor is it a question of the probability that, in the case of judicial extinguishment following an unexpected change in conditions, the proceeds of a condemnation or other sale would be adequate to pay both the bank and NAT.” Whatever you think of the Court’s decision, it appears to be thoughtful with an extensive discussion of common law starting at page 15 and followed by application of the Treasury Regulations to common law means of extinguishing easements through page 32.
The Kaufman court had better news for conservation on the stewardship contribution front than in Scheidelman. The Kaufman II Court’s decision about the deductibility of the stewardship contribution was fact dependent. In December 2003 NAT told Kaufman they’d accept her easement subject to various conditions, including that an appraisal of the easement’s value be completed by February 2004 and that she make a contribution before the end of 2003 based on 8% percent of the anticipated appraised value (“the 2003 contribution”) with a second contribution to be given in 2004 based on the difference between the 2003 contribution and 10% of the actual appraised value of the easement (“the 2004 contribution”). The court reviewed all of the extensive correspondence between the parties as well as testimony and concluded that the 2004 contribution was not conditioned on receiving a charitable contribution deduction and was not ‘required’ by NAT since Kaufman received no benefit from the cash contribution. The Court also rejected the IRS claim of a quid pro quo between the parties for the 2004 contribution. The Kaufman II Court disallowed the 2003 contribution (as a conditional payment because the value of the easement might not be more than zero) but allowed the 2004 contribution.
The Court also noted starting on the bottom of page 49 that it had no obligation and no desire to consider valuation in the case, and that the Court should not be required to invest substantial time and effort to resolve difficult factual questions of intent and value presented by the IRS claims of taxpayer negligence. The Court then cited the ‘laborious’ undertaking of determining value illustrated by the recently decided Trout Ranch v Commissioner case (TC Memo. 2010-282).
Landowners Lose Entire Easement Deduction Due to Failure to Obtain Contemporaneous Written Substantiation
In a recent Tax Court case, Schrimsher v Commissioner, TC Memo 2011-71, the court granted summary judgment for the IRS disallowance of the entire land owner claimed deduction. The Court found the deduction invalid because the donor did not have a contemporary written acknowledgment of the donation that specifically stated that no goods or services were received in exchange for the donation. The donors’ attempts to claim substantial compliance were summarily rebuffed. Additionally this donor had a non-compliant Form 8283. It was not signed or dated by either the appraiser or the Alabama Historical Commission (as is required); and did not attach the appraisal to their tax return (required by law if the donation exceeds $500,000).
The donor argued that the easement was the contemporaneous written acknowledgement. The court said it did not clearly either deny that any goods or services were received in exchange, or estimate the value of those goods and services – both required by law to be part of a contemporaneous written acknowledgement by IRC sec. 170(f)(8). Conservation tax experts now routinely advise both land trusts and landowners that the IRS position has hardened on compliance with technical requirements. Karin Gross, an attorney in the IRS Chief Counsel Office, regularly states at Rally sessions that the IRS will strive to dispose of cases on the simplest grounds possible to avoid dealing with more difficult valuation issues. Learn more.
Entire Deduction Disallowed Due to Numerous Appraisal Failures
In Boltar v. Commissioner 136 T.C. No. 14 (2011) the Court excluded the developer partnership’s experts’ appraisal as unreliable and irrelevant. The Court sustained the IRS allowance of only $42,400 out of $3,245,000 claimed as a charitable contribution deduction on the partnership return of Boltar, L.L.C. (Boltar) for a conservation easement on 8 land-locked acres in Indiana. Boltar’s experts failed to apply the correct legal standard by failing to determine the value of the donated easement by the before and after valuation method, failed to value contiguous parcels owned by a partnership, and assumed development that was not feasible on the subject property. The Court specifically stated that the appraiser qualifications were not in question. What motivated the Court to reject Boltar’s appraisals was the multiple failures and abuses in the appraisal methodology as well as significant factual errors affecting value. The Court stated, “The problem is created by their willingness to use their resumes and their skills to advocate the position of the party who employs them without regard to objective and relevant facts, contrary to their professional obligations.” And later, “…we need not blindly admit absurd expert opinions.” And finally, ” In addition, the cottage industry of experts who function primarily in the market for tax benefits should be discouraged.” At least from the context of the decision, the Court appears to be directing the last comment at those who enable abusive appraisals and tax schemes. Learn more by visiting http://taxtrials.com/, then click on Boltar. Note that this site has many tax opinions available.
View the Practical Pointers Factsheets to help you and your land owners avoid trouble with the IRS, or login to The Learning Center to browse the Conservation Defense Practical Pointer Collection, which includes help on Form 8283, Baselines to ‘Wow’ the IRS, Contemporaneous Written Substantiation, Lender Agreements and Kaufman, Stewardship Contributions and Appraisal Checklists and Rules.