MARVEL, Judge.
Respondent determined deficiencies in petitioners' Federal income tax of $113,893, $93,581, $144,727, and $149,030 for 2003, 2004, 2005, and 2006, respectively. In the answer respondent asserted that petitioners are liable for accuracy-related penalties under section 6662(a) and (b)(2) and (3)
Some of the facts have been stipulated and are so found. The stipulations of facts are incorporated herein by this reference. Petitioners resided in Colorado when they petitioned this Court.
Mr. Schmidt graduated from the University of Oregon in 1971. Mr. Schmidt gained experience in restaurant management, and in 1987 he became a McDonald's restaurant franchisee. By June 2000 Mr. Schmidt owned two McDonald's franchises and was in the process of buying a third.
Mr. Schmidt also entertained the notion of becoming a builder, and while still living in Oregon, he built eight homes in partnership with other builders. However, he never developed a subdivision from raw land.
On May 5, 2000, Mr. Schmidt purchased an approximately 40-acre parcel of vacant land in northern El Paso County, Colorado, for $525,000 (subject property) with the intention of subdividing and developing it. The subject property is in northern El Paso County, west of Interstate 25 and the Town of Monument, Colorado, and south of the Town of Palmer Lake, Colorado. As of May 5, 2000, the subject property was raw land with no development entitlements.
The subject property is near Pike National Forest,
On June 7, 2000, Mr. Schmidt retained the services of David F. Jones and Land Resource Associates (LRA) to provide land planning and consulting services with respect to the development of the subject property. Mr. Jones informed Mr. Schmidt of the possibility of developing the subject property in conjunction with a 68.8-acre adjoining parcel (adjacent property) along the southern edge of the subject property.
When Mr. Jones informed Mr. Schmidt of the possibility of developing the subject property in conjunction with the adjacent property, King's Deer Development, LLC (King's Deer Development), was in the process of purchasing the adjacent property from Red Rock Ranch, Inc. (Red Rock Ranch), and intended to develop it. On a date that is unclear from the record Mr. Schmidt agreed to pursue the development of the subject property along with the adjacent property as a 108.8-acre residential subdivision with King's Deer Development (Raspberry Ridge subdivision).
Mr. Jones began the entitlement process for both landowners. He obtained a preliminary ground water investigation report from Wm. Curtis Wells & Co., and he hired other professionals to prepare reports for the entitlement applications. On December 12, 2000, Mr. Jones met with El Paso County's planning department for a preapplication meeting regarding the proposed Raspberry Ridge subdivision and filed a preapplication form.
On February 27, 2001, LRA submitted an application for underground water rights and plan for augmentation to the State of Colorado Water Court (Colorado Water Court). The Colorado Water Court approved the application on February 20, 2002. On March 23, 2001, Mr. Jones sent to the landowners of properties adjoining the proposed Raspberry Ridge subdivision a "Notification to Adjoining Land Owner", notifying them of the proposed project. On March 26, 2001, LRA submitted to El Paso County a petition for rezoning of the subject property and the adjacent property and a preliminary plan application with respect to the Raspberry Ridge subdivision.
On April 16, 2001, Elizabeth Hacker of the El Paso County planning department sent an email to Mike Hrebenar of the El Paso County planning department providing initial feedback with respect to the Raspberry Ridge subdivision. In the email Ms. Hacker stated that "[t]he proposed 2.5 acre subdivision is consistent with the type of subdivisions in" the area.
During the fall of 2001 El Paso County Development Services and the State geologist identified seven lots within the proposed Raspberry Ridge subdivision that required further study because of various topographical and geological issues. Only one of the seven lots was within the subject property, and LRA prepared further studies to illustrate the potential development of that site.
By a fax dated November 2, 2001, Mr. Jones sent to Mr. Schmidt a cost estimate for the proposed Raspberry Ridge subdivision. In the cover letter Mr. Jones wrote:
In the attached cost estimate Mr. Jones estimated development costs of $42,437 per lot.
At some point during 2002 King's Deer Development canceled its purchase contract with Red Rock Ranch and abandoned the proposed Raspberry Ridge subdivision. Mr. Schmidt subsequently considered developing the Raspberry Ridge subdivision with a different codeveloper. One of the potential codevelopers offered to reimburse Mr. Schmidt for his acquisition costs and to give to him a lot of his choice in the finished project. Mr. Schmidt chose not to develop the Raspberry Ridge subdivision with any codeveloper.
On April 30, 2003, after an inquiry by Mr. Schmidt, LRA mailed a letter to him regarding the likelihood of obtaining El Paso County's approval of the development applications. In the letter LRA explained that the El Paso County Planning Department concluded in its review of the Raspberry Ridge subdivision that the zoning change request conformed with the 2000 Tri-lakes Comprehensive Plan. The letter further explained that relevant agencies had already signed off on the various studies, plans, and reports submitted by LRA with respect to the suitability of the subject property for rezoning. On May 9, 2003, Mr. Schmidt and Red Rock Ranch executed a purchase agreement for the sale of the adjacent property to Mr. Schmidt for $1.25 million. On May 27, 2003, Mr. Schmidt obtained land title insurance on the adjacent property. On August 5, 2003, Mr. Schmidt terminated the purchase agreement with Red Rock Ranch.
When Mr. Schmidt terminated the purchase agreement the zone change and preliminary plan applications were ready to be forwarded to the El Paso County Planning Commission and the El Paso County Board of County Commissioners for public hearing. It is highly probable that the El Paso County Development Services Department would have endorsed both applications, and approval would have vested the subdivision's development entitlements. Following approval, the proposed subdivision would have entered the final plat phase, in which several local entities would review the previously approved zoning and preliminary plan entitlements.
Because he was listed on the zone change and preliminary plan applications, Mr. Schmidt could have severed the subject property from the adjacent property and pursued rezoning and a preliminary plan for the subject property alone under the existing applications. However, because the pending applications were nontransferable, a new owner would have had to submit new applications.
At some point during the development process for the proposed Raspberry Ridge subdivision, Mr. Schmidt considered granting a conservation easement on the subject property. Mr. Schmidt engaged the services of W.D. Park of Park & Associates to value the proposed easement.
In a preliminary development cost analysis dated May 12, 2003 (May 12, 2003, cost estimate), LRA estimated the following development costs and development costs per lot for the proposed Raspberry Ridge subdivision:
The May 12, 2003, cost estimate refers to the Nevins units as "phase 1" and the Schmidt units as "phase 2" and assumes for other purposes that the Nevins units would sell for $225,000 per lot and that the Schmidt units would sell for $300,000 per lot.
On or about May 14, 2003, Mr. Park met with Mr. Schmidt and Mr. Jones to discuss the valuation of the easement.
On May 30, 2003, Michael G. Figgs, a natural resources planner and the president of LREP, Inc., inspected the subject property for the purpose of preparing a baseline report for the proposed conservation easement. In July 2003 Mr. Figgs prepared the baseline report.
In a letter dated June 10, 2003, Mr. Park notified Mr. Schmidt that his firm had concluded that the value of the proposed conservation easement would be $1.6 million. Mr. Park stated that, in reaching this conclusion, his firm estimated that the before value of the subject property was $2 million and the after value was $400,000. Mr. Park subsequently provided to Mr. Schmidt an appraisal of the proposed conservation easement with a valuation date of July 25, 2003 (2003 appraisal), in which he reached the same conclusions as he previously reached in the June 10, 2003, letter. Mr. Park used a discounted cashflow analysis to determine a before value for the subject property. He relied on the May 12, 2003, cost estimate for the development cost input in his discounted cashflow analysis.
On July 3, 2003, Mr. Schmidt entered into a due diligence agreement with respect to the proposed conservation easement with El Paso County's board of commissioners. Concurrently, El Paso County passed a resolution approving and accepting the due diligence agreement and the form of the proposed conservation easement. During July 2003 petitioners began construction of their personal residence on the subject property. On August 1, 2003, Mr. Schmidt executed an easement deed, granting a conservation easement on the subject property to El Paso County. The conservation easement permitted one homesite on the subject property.
On or about August 29, 2003, Red Rock Ranch entered into a contract to sell the adjacent property to an unrelated developer, Raspberry Ridge Development, RLLP, a Colorado registered limited liability limited partnership (Raspberry Ridge Development), for $1.25 million. On November 13, 2003, Raspberry Ridge Development purchased the adjacent property for $1.25 million.
Raspberry Ridge Development did not purchase the pending rezoning and preliminary plan applications submitted by LRA with respect to the Raspberry Ridge subdivision. Instead, it submitted new applications for a residential subdivision called the Red Rock Reserve project. During 2005 El Paso County approved the rezoning of the adjacent property. Approval of the final plat for the Red Rock Reserve project was delayed by the presence of the Preble's meadow jumping mouse
Petitioners timely filed Forms 1040, U.S. Individual Income Tax Return (returns), for 2003, 2004, 2005, and 2006. Petitioners claimed a charitable contribution deduction of $1.6 million on a Form 8283, Noncash Charitable Contributions, attached to their 2003 return. The entire $1.6 million deduction related to the conservation easement that Mr. Schmidt granted to El Paso County on the subject property. Because of limitations petitioners claimed only $325,407 of the contribution on a Schedule A, Itemized Deductions, attached to their 2003 return. Petitioners carried over the remainder of the charitable contribution deduction and claimed portions of it on their 2004, 2005, and 2006 returns.
On November 28, 2011, respondent issued to petitioners a notice of deficiency with respect to petitioners' 2003, 2004, 2005, and 2006 tax years. In the notice of deficiency respondent determined that petitioners failed to meet the requirements of section 170 in claiming a charitable contribution deduction for the conservation easement on the subject property. Alternatively, respondent determined that the correct value of the conservation easement was $195,000.
Petitioners introduced the expert report and testimony of Mr. Park with respect to the value of the conservation easement on the subject property. Mr. Park is a real estate appraiser who has practiced for over 37 years. He is certified as an appraiser by the State of Colorado, and he is a member of the Appraisal Institute and holds its MAI and SRA designations. He is a certified Appraisal Institute instructor and has taught classes for the Appraisal Institute on basic and intermediate appraisal and on the appraisal of conservation easements. He is also a certified Uniform Standards of Professional Appraisal Practice instructor.
Mr. Park appraises real estate throughout Colorado. His practice includes residential and commercial appraisal, eminent domain, valuing tracts of vacant land for residential development purposes, and appraisal of conservation easements.
Mr. Park's report is substantially derived from his 2003 appraisal. Mr. Park used the before and after method to determine the value of the conservation easement. He determined that the highest and best use of the subject property before the granting of the conservation easement was a residential subdivision, and he used the subdivision development method to determine the before value of the subject property. He also used a method entitled "Direct Sales Analysis" to determine the before value of the subject property. Mr. Park opined that the before value of the subject property was $2 million.
Mr. Park determined that the highest and best use of the subject property after the granting of the conservation easement was a 40-acre homesite, and he used the market method to determine an after value for the subject property. Mr. Park opined that the after value of the subject property was $400,000, and he therefore opined that the value of the conservation easement was $1.6 million.
Petitioners introduced the expert report and testimony of Mr. Jones with respect to the possible subdivision of the subject property and the costs associated with such development. Mr. Jones is a professional land planner, landscape architect, and development manager. He has provided development, design, construction, and management services in El Paso County for over 41 years. Mr. Jones holds a bachelor's degree in landscape architecture from Kent State University College of Architecture and Environmental Design.
Mr. Jones opined that, if Mr. Schmidt had moved forward with the Raspberry Ridge subdivision applications the subject and adjacent properties would have obtained an RR-2 zoning and preliminary plan approval. Mr. Jones further opined that the preliminary development cost estimates in the May 12, 2003, cost estimate were accurate and complete.
Respondent introduced the expert report and testimony of Thomas Fellows with respect to the value of the conservation easement on the subject property. Mr. Fellows is a real estate appraiser who has practiced for over 40 years. He is certified as an appraiser by the State of Colorado, and he is a member of the Appraisal Institute and holds its MAI designation. He is experienced in appraising conservation easements.
Mr. Fellows used the before and after method to determine the value of the conservation easement. He determined that the highest and best use of the subject property before the granting of the conservation easement was a residential subdivision developed in conjunction with the adjacent property. He used both the market and subdivision development methods to determine a before value for the subject property. Mr. Fellows opined that the subject property had a before value of $750,000.
Mr. Fellows determined that the highest and best use of the subject property after the granting of the conservation easement was a 40-acre homesite. He used the market method to determine an after value for the subject property. He opined that the after value of the subject property was $270,000, and he therefore opined that the value of the conservation easement was $480,000.
At trial petitioners introduced a supplemental report prepared and submitted to the Court by respondent's expert, Mr. Fellows.
After a trial the parties submitted a joint report in which they stipulated certain areas of agreement and disagreement with respect to the value of the conservation easement at issue in this case.
Before Mr. Schmidt granted the conservation easement the subject property could have been developed as a 13-lot subdivision either separately or in conjunction with the development and subdivision of the adjacent property. The mean lot selling price for the finished lots on the subject property would have been $220,000 and would have appreciated at a rate of 6% per annum. A prospective buyer could have developed the subject property and begun selling lots within 12 months from the easement grant date. It is likely that all 13 lots on the subject property would have sold within two years of being offered for sale. Development costs for a hypothetical subdivision of the subject property would have been $580,416. Marketing/administrative costs for a hypothetical subdivision of the subject property would have been 10% of gross sales. The appropriate discount rate is 22%.
The before value of the subject property is $1,422,445. The after value of the subject property is $270,000. Accordingly, the value of the conservation easement is $1,152,445.
Generally, the taxpayer bears the burden of proving that he is entitled to any claimed deduction.
Petitioners contend that the burden of proof should shift to respondent pursuant to section 7491(a) because they introduced credible evidence and cooperated with respondent. Respondent contends that petitioners have not satisfied the requirements of section 7491(a)(1) and (2).
Petitioners point to stipulated exhibits that show that they voluntarily agreed to extend the period of limitations for four years during the audit and to the fact that respondent has not filed a motion to compel discovery in this case. Both of these points, however, fail to carry petitioners' burden of showing that they cooperated with respondent. To meet their burden petitioners were required to produce evidence showing that they "cooperated with reasonable requests by the Secretary for witnesses, information, documents, meetings, and interviews". Sec. 7491(a)(2)(B). The limited evidence that petitioners introduced regarding their conduct during the examination falls short of demonstrating that they cooperated with respondent's reasonable requests during the examination. Accordingly, the burden of proof remains with petitioners with respect to the deficiencies at issue in this case.
Section 170(a)(1) provides that a deduction is allowed for any charitable contribution that is paid within the taxable year. "The sine qua non of a charitable contribution is a transfer of money or property without adequate consideration."
Generally, a taxpayer may not deduct the value of a contribution of property that consists of less than the taxpayer's entire interest in that property.
Section 1.170A-14(h)(3)(i), Income Tax Regs., states in relevant part:
Generally, the fair market value of property is determined by taking into account the highest and best use of that property on the relevant valuation date.
Sec. 1.170A-14(h)(3)(ii), Income Tax Regs.
A determination of fair market value is largely a factual inquiry in which the trier of fact must weigh all relevant evidence of value and draw appropriate inferences.
The market method values a property by comparing the property to similar properties sold in arm's-length transactions in or about the same period.
The income method values a property by capitalizing or discounting expected cashflow from the property. Property value is determined under this method by adding the sum of the present value of the expected cashflow and the present value of the residual value of the property.
The replacement cost method values a property by determining the cost to reproduce it less applicable depreciation or amortization.
An expert's opinion is admissible if it assists the trier of fact to understand the evidence or to determine a fact in issue. Fed. R. Evid. 702. We evaluate expert opinions in light of each expert's qualifications and the evidence in the record.
Before we turn to the valuation of the conservation easement at issue, we first address two preliminary issues that the parties raised on brief.
Respondent argues that we should discount Mr. Park's report because of various misrepresentations in his report and his testimony at trial. First, respondent criticizes Mr. Park for assuming in his report that "[t]he development had been approved for final platting" whereas the record shows that the development applications were still pending. Second, respondent criticizes Mr. Park for significantly increasing his valuation of the conservation easement in his valuation report from the initial estimate he made in his handwritten notes. Third, respondent criticizes Mr. Park for stating that no one provided him any assistance in preparing his report even though he copied an introductory portion of his report from an amicus brief in another case that petitioners' counsel provided to him.
We do not agree with respondent that Mr. Park's report should be significantly discounted for these reasons. First, although Mr. Park appears to have misstated or misunderstood the status of the pending development applications, this error does not seem to have significantly affected his conclusion regarding the before value of the subject property because his discounted cashflow analysis assumes that none of the finished lots would be sold during the first year. Second, it is unclear when the handwritten notes were prepared and for what purpose.
That said, we are mindful of the "cottage industry of experts who function primarily in the market for tax benefits".
At trial Mr. Schmidt testified that he agreed with Mr. Park's 2003 appraisal and disagreed with Mr. Fellows' report. Petitioners contend that Mr. Schmidt's testimony should be given significant weight.
Under rule 702 of the Federal Rules of Evidence a landowner is competent to offer opinion testimony with respect to the value of his or her property.
In agreeing with Mr. Park's 2003 appraisal Mr. Schmidt offered no independent analysis other than to agree to the comparables that Mr. Park used in his 2003 appraisal. Mr. Schmidt also criticized the comparables that Mr. Fellows used in his report. Because Mr. Schmidt's opinion as to the value of the conservation easement is based on and is supported only by Mr. Park's 2003 appraisal, we give it weight only to the extent that we find Mr. Park's report— which is substantially the same as his 2003 appraisal—to be reliable.
We turn now to the valuation of the conservation easement at issue. We do so using the before and after method.
With respect to the before value of the subject property, the parties agree that both the market and subdivision development methods are appropriate, but the parties disagree with respect to which one of these methods is more appropriate in this case.
The parties disagree about the use of the market method for determining a before value for the subject property. Petitioners contend there is insufficient data available to use the market method. Respondent disagrees.
Mr. Park did not use the market method to determine a before value for the subject property because he could not find adequate sales of comparable properties.
Mr. Fellows identified four sales of raw land that he determined to be comparable to a hypothetical sale of the subject property before the granting of the conservation easement. Those sales are: (1) the prior sale of the subject property to Mr. Schmidt in May 2000; (2) the sale of the adjacent property to Raspberry Ridge Development in November 2003; (3) the sale of a property in the South Black Forest area, east of Interstate 25, in May 2001; and (4) a second sale of a property in the South Black Forest area in April 2004. Mr. Fellows adjusted the first and third property sales to account for market conditions using a factor of 5% per annum. The approximate dates, selling prices, areas in acres, prices per acre, and adjusted prices per acre of the sales are as follows:
After comparing the physical characteristics of the comparable sale properties Mr. Fellows concluded that the prior sale of the subject property and the subsequent sale of the adjacent property were most relevant in determining a before value for the subject property. Consequently, Mr. Fellows concluded that the subject property had a before value of $18,000 to $19,000 per acre and that it therefore had an estimated before value of $700,000 to $800,000.
Respondent contends that Mr. Park wrongly rejected Mr. Fellows' comparables because the subject property had no development entitlements when Mr. Schmidt granted the conservation easement. Respondent notes that petitioners' land-use expert, Mr. Jones, stated in his report that the rezoning and preliminary plan applications for the subject property were "ready to be forwarded to the El Paso County Planning Commission and the El Paso County Board of County Commissioners for public hearing." Respondent further contends that the fact that the rezoning and preliminary plan applications were still pending and likely to be granted does not distinguish the subject property from the comparables that Mr. Fellows selected because the pending applications were nontransferable. We disagree.
Even though the pending applications were nontransferable, the record establishes that the applicants had been able to address all relevant issues that could have prevented or delayed the granting of development entitlements for the subject property
Respondent contends that all of this is irrelevant because the before and after method is concerned only with what a hypothetical purchaser would have paid for the subject property. However, the regulations look to the before and after method to value conservation easements only where there is no substantial record of comparable easement sales,
The parties agree that, if the subdivision development method is used, the following factors are relevant to the preparation of the discounted cashflow analysis that would be required to determine the before value of the subject property: (1) the number of lots; (2) the retail lot selling prices; (3) the retail lot selling price appreciation rate, (4) the time required to obtain entitlements, (5) the absorption rate of the lots, (6) development costs, (7) marketing/administrative costs, and (8) the discount rate.
The parties agree that, if the subject property was developed as a stand-alone, 40-acre subdivision, the subject property would yield thirteen 2.5-acre lots. The parties further agree that, if the subject property was developed as part of the originally proposed 108-acre subdivision, the development as a whole would yield thirty-five 2.5-acre lots, 13 of which would be on the subject property.
The parties disagree with respect to the ultimate retail lot selling prices for lots developed on the subject property. Petitioners contend that the retail lots would sell for $250,000 to $300,000 per lot. Respondent contends that the retail lots would sell for no more than $220,000 per lot.
Mr. Park prepared an analysis of the selling prices of comparable finished lots (finished lot sales analysis). Mr. Park identified sales of five specific comparable lots with addresses on the following streets: (1) Colonial Park Drive, (2) Embassy Court, (3) High Forest Road, (4) Willow Stone Height, and (5) Stratton Woods View. Mr. Park adjusted the sale prices for these lots to account for differences in location, density, topography, view, and whether the lot is in a gated community as follows:
The first two of these lots are in the Bent Tree subdivision; the third lot is in the High Forest Ranch subdivision; the fourth lot is in the Broadmoor Resort Community subdivision; and the fifth lot is in the Stratton Forest subdivision. The Bent Tree and High Forest Ranch subdivisions are in northern El Paso County, and the Broadmoor Resort Community and Stratton Forest subdivisions are in the southwestern quadrant of Colorado Springs, where some of the more expensive lots in the region are located.
In his report Mr. Park stated as follows: "The lots created by the subdivision would have above average to excellent views, would be heavily wooded and would have considerable market value after the completion of the subdivision process."
Mr. Fellows also prepared a finished lot sales analysis. In his finished lot sales analysis Mr. Fellows collected sales data from numerous subdivisions in the northern El Paso County market. Mr. Fellows then selected a sample of the data that he considered to be representative.
Mr. Fellows determined the mean selling price of the lots in each of the comparable subdivisions and adjusted that price to account for differences between the hypothetical subdivision on the subject property and the subdivisions included in his data set. However, Mr. Fellows did not specify what factors he considered in adjusting the mean prices. Mr. Fellows concluded that the average selling price for the 13 finished lots on the subject property would be between $175,000 and $200,000 as of the valuation date. In two of his three models he assumed a mean lot selling price for the subject property of $200,000.
In his rebuttal report Mr. Fellows explained the difference between his and Mr. Park's conclusions as follows:
We do not find the analysis of either expert report with respect to the retail lot selling prices to be complete and convincing. Mr. Park's finished lot sales analysis included lot sales from the High Forest Ranch, Broadmoor Resort Community, and Stratton Woods View subdivisions. All of these subdivisions are part of gated communities and have numerous amenities that would not be present in the subdivision contemplated by Mr. Park's report. Additionally, both the Broadmoor Resort Community and the Stratton Woods View subdivisions are in Colorado Springs.
Mr. Fellows' finished lot sales analysis included only lot sales from subdivisions that he considered to be inferior to a hypothetical subdivision on the subject property. Although Mr. Fellows adjusted for the quality of the comparables that he used, he did not specify the factors he considered in adjusting the mean lot selling prices for these subdivisions. Additionally, Mr. Fellows' analysis included mean lot sales from subdivisions with significant variations in finished lot selling prices. However, his report does not compare hypothetical individual finished lots on the subject property to any of the individual lots in any of his comparable subdivisions. Although Mr. Fellows explained that some of the finished lots on the subject property would not have excellent views and that tree cover was not uniform over the subject property, other factors suggest that the finished lots would not be subject to extreme price variations. For example, the subject property was relatively flat, and only 1 of the 13 proposed lots on the subject property was flagged as having a potential topographical or geological issue. Moreover, the interior and westerly lots that Mr. Fellows considered to have ordinary views had other amenities, such as more significant tree cover and closer proximity to Pike National Forest. Significantly, Mr. Fellows' rebuttal report does not suggest that any of the finished lots on the subject property would be inferior to the two Bent Tree subdivision lots that Mr. Park identified in his report or that any of the finished lots on the subject property would be comparable to any of the lower priced lots in the Bent Tree subdivision.
Respondent contends that Mr. Fellows' analysis is supported by our approval of a statistical approach in
Because we do not find either expert's report with respect to the finished lot selling prices to be complete and convincing, we adopt the conclusions of neither report. Instead, after giving appropriate weight to each expert's report, we draw our own conclusions based on our examination of the evidence in the record. The sales of the two Bent Tree subdivision lots on which Mr. Park relied, which we find to be sales of the most comparable lots in the record, had selling prices of $210,000 and $225,000, respectively. Because of the small sample size and the subjective nature of Mr. Park's adjustments to these lot sale prices we decline to adopt Mr. Park's adjustments. Placing slightly more weight on the sale of the second of the Bent Tree subdivision lots because it occurred closer in time to the conservation easement grant date, we estimate that the mean lot selling price for the finished lots on the subject property would have been $220,000.
The parties agree that the selling prices for the retail lots would appreciate at a rate of 6% per annum.
The parties disagree with respect to how long it would take to obtain entitlements to develop the subject property and whether to take into account the zone change and preliminary plan approval applications associated with the proposed Raspberry Ridge subdivision. Petitioners contend that Mr. Schmidt would have obtained preliminary approval of the proposed Raspberry Ridge subdivision applications within three to four months from the easement grant date. Respondent contends that a hypothetical buyer would have obtained final approval of a subdivision on the subject and adjacent properties in approximately 24 months. Accordingly, respondent contends that it would have taken at least 24 months for a hypothetical buyer to begin selling developed lots.
Mr. Park assumed in his report that the time required for development of the lots was 12 months. Mr. Jones estimated in his rebuttal report that Mr. Schmidt could have secured final plat approvals by February 2004 and begun selling developed lots on the subject and adjacent properties by March 2004.
Respondent agrees that Mr. Schmidt could have obtained preliminary approval for a subdivision on the subject and adjacent properties on the basis of the applications for the proposed Raspberry Ridge subdivision but contends that this is irrelevant because the zone change and preliminary plan applications were nontransferable. However, we concluded above,
The parties disagree with respect to the amount of time it would take for the market to absorb the retail lots. Petitioners contend that the 13 lots would have sold within 12 months. Respondent contends that the lots would have sold at a rate of approximately 5 to 6 per annum.
Mr. Jones credibly testified that Mr. Schmidt could have developed the 13 lots on the subject property in a first phase and the 22 lots on the adjacent property in a second phase. Mr. Jones further testified that, to develop the lots on the subject property before the lots on the adjacent property, a prospective buyer would have had to secure access for the subject property to the road that was accessible from the adjacent property.
Mr. Park determined that all of the finished lots on the subject property would sell within 12 months. Mr. Park relied on an absorption study and on sales data from a representative subdivision.
Mr. Park's absorption study identified 140 comparable lots in the same market as the subject property that were listed for sale during 2002-03. During that time 105 of the lots sold.
Mr. Park also relied on sales data from the Walters Commons subdivision in the Woodmor area in northern El Paso County. The Walters Commons subdivision contains 174 lots. They were sold from December 2003 to July 2008 at a rate of approximately 3.22 sales per month. Mr. Park concluded that the rate of sales in the Walters Commons subdivision supported his estimate of a 12-month absorption period.
Mr. Fellows determined that the finished lots on the subject property would sell at a rate of five per annum. His determination was based on a survey of the sales rates of five subdivisions during 2002 and 2003 and on a housing market study for El Paso County during this time.
Mr. Fellows relied on sales data from the following subdivisions: Forest View 3, Wissler, Kings Deer, Bent Tree, and Tall Pines. Mr. Fellows summarized the sales data as follows:
Mr. Fellows also relied on a report entitled "Colorado Springs Single Family Housing Market—April 2003" (Bamberger Report). The Bamberger Report reported that there was a 2.4 year supply of upper-end residential lots (i.e., lots that sold for more than $128,000). After combining his lot absorption estimate with his estimate for the time to obtain entitlements,
We do not find the analysis of either expert report with respect to the absorption rate to be complete and convincing. Mr. Park's absorption study does not support his conclusion that all 13 lots on the subject property would sell in one year. Instead, the absorption study indicates that approximately 75% of the lots placed on the market during 2002-03 sold during that period. Mr. Park's analysis of the sales data from the Walters Commons subdivision is similarly unconvincing because it does not follow from the fact that the lots on a 174-lot subdivision sold at a rate of 3.22 per month that a 13-lot subdivision would experience a similar rate of monthly sales. Moreover, the sales data from the Walters Commons subdivision is particularly unconvincing because the Walter Commons subdivision is a high-density townhome development in Monument.
Mr. Fellows' survey of the sales data from the five subdivisions is unconvincing because a closer look at the underlying data shows that all of the lots in each of the five subdivisions sold in less than a year and a half. The sales data for the five subdivisions that Mr. Fellows relied upon shows as follows:
Although respondent contends that the lots in the Forest View 3 subdivision were offered for sale throughout 2002 and 2003, he cites no evidence in the record to support this contention. In fact, the record shows that the final plat for Forest View 3 was approved by various boards and commissions between February 21 and April 18, 2002, the final plat for the subdivision was recorded on May 24, 2002, and patents for 13 of the 14 platted lots in the subdivision were made between August 9, 2002, and August 22, 2003.
The parties agree that development costs for the combined 108-acre subdivision would have totaled approximately $1,485,295. Respondent contends that the amount of the development costs allocable to the subject property is between $40,000 and $45,000 per lot. At trial petitioners relied on Mr. Jones' expert report. Mr. Jones' report opines that the amount of the development costs allocable to the subject property is $26,173 per lot. On brief, however, petitioners concede that the amount of the development costs allocable to the subject property is $580,416, or $44,647 per lot. We conclude that the development costs for a hypothetical subdivision of the subject property would have been $580,416.
The parties disagree as to the proper amount of marketing/administrative costs. Both Mr. Park and Mr. Fellows included inputs for cost of sales (marketing). Mr. Park included marketing costs equal to 10% of gross sales. Mr. Fellows included marketing and closing costs equal to 7% of gross sales. The 3% difference between Mr. Park's and Mr. Fellows' estimates is partially offset by the "administrative expense" of $10,000 per annum included by Mr. Fellows to account for administrative expenses, taxes, and other miscellaneous holding costs.
The parties agree that the appropriate discount rate is 22%. This rate includes a 10% entrepreneurial-profit factor.
Having determined the respective values of the various inputs that the parties agree are relevant in determining the before value of the subject property using the subdivision development method, we can now recalculate the before value of the subject property using a discounted cashflow model that is similar to the discounted cashflow models used by the parties' experts. Before we do so, however, we address the proper application of the discounted cashflow method in this case.
It is not clear from Mr. Park's report how he calculated the present value of the income and expenses from the hypothetical subdivision of the subject property.
The following represents our reconstruction of the discounted cashflow analysis of the income and expenses relating to the hypothetical subdivision of the subject property:
The total discounted value of the cashflow from the hypothetical subdivision of the subject property is $1,422,445. After a hypothetical subdivision of the subject property there would be no residual value to the subject property, all the lots having been sold off. Accordingly, the before value of the subject property is $1,422,445.
The parties agree that the after value of the subject property should be based on sales of other comparable properties with restrictions similar to those imposed by the conservation easement at issue in this case. The parties disagree, however, with respect to the ultimate after value of the subject property.
Mr. Park prepared an analysis of the selling prices of comparable, similarly sized lots. Mr. Park identified comparable lot sales with addresses on the following streets: (1) Hardy Road; (2) Crowfoot Springs Road; (3) East Jones Road; and (4) Goodson Road. Mr. Park chose these lots because they lacked development entitlements. Mr. Park adjusted the sale prices per acre for these lots to account for differences in location, access, density, and topography/view as follows:
Mr. Park determined that the estimated after value of the subject property is $10,500 per acre, or approximately $400,000 in total.
Mr. Fellows identified property sales in two subdivisions that contained real property platted as 35- to 40-acre lots. These subdivisions are the Highlands Turkey Canyon subdivision near Colorado Springs and the Majestic Park subdivision near Woodland Park. In eight lot sales between July 2001 and November 2004 in the Highlands Turkey Canyon subdivision the mean lot sale price was $4,199 per acre. In 10 lot sales between May 2000 and June 2006 in the Majestic Park subdivision the mean lot sale price was $8,439 per acre. Mr. Fellows chose these subdivisions because the 35-40 acre platting made further subdivision unlikely.
Mr. Fellows considered the Highlands Turkey Canyon lots to be inferior and the Majestic Park lots to be superior to the subject property. However, he considered the subject property to be more comparable to the Majestic Park lots. Consequently, Mr. Fellows determined that the after value of the subject property is $6,500 to $7,000 per acre, or between $260,000 and $280,000 in total. In Mr. Fellows' opinion, the after value of the subject property is $270,000.
The most significant methodological difference between Mr. Park's report and Mr. Fellows' report with respect to the after value of the subject property is that Mr. Park selected sales of properties that were not platted and Mr. Fellows selected sales of properties that were platted for use as a 35-40 acre residential building site. Mr. Fellows' method seems to more accurately value the subject property after the granting of the conservation easement because the sales of the unplatted lots selected by Mr. Park were still subject to possible rezoning and development as a multilot subdivision. Consistent with Mr. Fellows' conclusion on this issue, we find that the after value of the subject property is $270,000.
We have found that the before value of the subject property is $1,422,445 and that the after value of the subject property is $270,000. Accordingly, the value of Mr. Schmidt's conservation easement is $1,152,445.
Generally, the Commissioner bears the burden of production with respect to the taxpayer's liability for a section 6662(a) penalty and must produce sufficient evidence indicating that it is appropriate to impose the penalty.
Petitioners contend that the burden of proof with respect to the penalties asserted in this case should be on respondent because they were not included in the notice of deficiency and are therefore new matters. Respondent concedes that he bears the burden of proof with respect to the penalties but contends that petitioners bear the burden of proof with respect to any affirmative defenses to the penalties.
We agree with petitioners that the penalties asserted in this case are new matters, pleaded in the answer. Accordingly, the burden of proof with respect to the penalties, both as to the production of evidence and as to persuasion, is on respondent.
Section 6662(a) and (b)(2) and (3) authorizes the Commissioner to impose a 20% penalty on an underpayment of tax that is attributable to, among other things, (1) any substantial understatement of income tax and (2) any substantial valuation misstatement. Only one section 6662 accuracy-related penalty may be imposed with respect to any given portion of an underpayment.
An understatement is substantial in the case of an individual if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return or $5,000.
Generally, the accuracy-related penalty does not apply with respect to any portion of the underpayment for which the taxpayer shows that there was reasonable cause and that he or she acted in good faith.
In the case of a substantial valuation misstatement with respect to charitable deduction property,
Because the reasonable cause defense for a substantial valuation misstatement penalty has more requirements than a reasonable cause defense for a substantial understatement of income tax penalty, we first consider whether petitioners are liable for a substantial valuation misstatement penalty.
On their 2003 return petitioners claimed a $1.6 million charitable contribution deduction for Mr. Schmidt's donation of a conservation easement on the subject property to El Paso County. A portion of that deduction was carried over to each of petitioners' 2004, 2005, and 2006 returns.
We shall assume for purposes of this analysis that petitioners understated their Federal income tax liability by an amount exceeding the greater of at least 10% of the amount required to be shown on their return for at least one of the taxable years at issue or $5,000,
In claiming a charitable contribution deduction for the conservation easement at issue, petitioners relied on Mr. Park's 2003 appraisal. Mr. Park had the requisite credentials and experience to justify petitioners' reliance on the 2003 appraisal, and respondent concedes that it was a qualified appraisal. Although we have sustained in part respondent's deficiency determination, we have done so because we did not find Mr. Park's report to be complete and convincing in certain respects. However, we do not think that the problems that we found with Mr. Park's report, and by extension with the 2003 appraisal, call into question the reasonableness of petitioners' reliance on the 2003 appraisal.
Respondent contends that there are certain facts that support an inference that Mr. Park intended to secure excessive tax benefits for petitioners with his 2003 appraisal. However, many of these facts are ambiguous and are also consistent with a good-faith attempt on the part of petitioners to reach the right result. For example, we found that Mr. Park's reliance on dissimilar comparables undermined the reliability of his finished lot sales analysis.
Respondent points to other facts, and inferences that he would like to draw from those facts, in support of his argument that Mr. Schmidt lacked good faith in accepting Mr. Park's 2003 appraisal, but we are unpersuaded. For example, respondent contends that Mr. Schmidt acquired the option to purchase the adjacent property only for the purpose of including the pending preliminary plan and zone change applications in Mr. Park's appraisal of the subject property. Respondent, however, does not explain why this is inconsistent with a good-faith attempt on the part of petitioners to achieve the right result. Similarly, respondent contends that Mr. Schmidt's decision not to purchase and develop the adjacent property shows that he did not believe that the 2003 appraisal was accurate or correct. We reject respondent's argument because the record shows that the adjacent property was more difficult to develop than the subject property and Mr. Schmidt had other businesses to manage.
Because the record establishes—without regard to the burden of proof—that petitioners had reasonable cause for the underpayment and acted in good faith, we hold that petitioners are not liable for a penalty for a substantial understatement of Federal income tax pursuant to section 6662(a) and (b)(2).
We have considered the parties' remaining arguments, and to the extent not discussed above, conclude those arguments are irrelevant, moot, or without merit.
To reflect the foregoing,
