KERRIGAN, Judge.
This case involves a noncash charitable contribution deduction. Respondent determined the following tax deficiencies and penalties:
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. We round all monetary amounts to the nearest dollar.
After concessions we must consider (1) whether petitioners are entitled to a charitable contribution deduction under section 170 for the donation of a facade easement and (2) whether petitioners are liable for a gross valuation misstatement penalty pursuant to section 6662(h) or, in the alternative, for an accuracy-related penalty pursuant to section 6662(a).
Some of the facts have been stipulated and are so found. Petitioners resided in New York when they filed the petition.
Petitioner husband graduated from the University of Pennsylvania Wharton School of Business where he received a bachelor of science degree in economics. Petitioner husband attended the New York University Stern School of Business graduate program for one year. For approximately 30 years petitioner husband has been involved with commercial real estate transactions in Manhattan. Petitioner husband has also maintained an interest in architecture from the Victorian period for many years. Petitioner wife practiced as a tax attorney with Mobil Oil from 1978 to 1981. Thereafter, petitioner wife left her position as a tax attorney and worked full time raising petitioners' children.
On May 17, 1993, petitioners purchased a townhouse at Block 1520, Lot 9 in the borough of Manhattan with a street address on East 91st Street, New York, New York (property). The property is in the Carnegie Hill Historic District of New York City. The property is a single-family residence with four stories; it is 15 feet wide and approximately 3,300 square feet.
In March 2006 a real estate agency listed the property for sale at $5,800,000. Petitioners reduced the price to $5,575,000 on June 23, 2006. On September 19, 2006, petitioners further reduced the price to $5,295,000. The property was taken off the market in March 2007.
On or about January 11, 2007, the National Park Service certified that the property contributes to the significance of the Carnegie Hill Historic District and is a "certified historic structure" for a charitable contribution for conservation purposes in accordance with the Tax Treatment Extension Act of 1980, Pub. L. No. 96-541, sec. 6(b), 94 Stat. at 3207. The property is not classified as "sound, first-class condition".
On December 18, 2006, petitioners executed a conservation deed of easement (deed) with the Trust for Architectural Easements (Trust), which was known at the time as the National Architectural Trust (NAT).
At all times relevant the Trust was a nonprofit organization exempt from taxation pursuant to section 501(c)(3). For the purposes of this case the Trust is a "qualified organization" within the meaning of section 170(h)(3).
The primary mission of the Trust is to encourage participation in the voluntary historic preservation program funded by the Federal Government with the Federal Tax Incentive Program. The Trust also engages in additional preservation activities that relate to historic architecture. The Trust monitors the properties where it holds easements by sending employees to visit the properties. The Trust employs three people to monitor 550 properties. Trust employees inspect visually the properties. During these annual inspections Trust employees also photograph the properties. The Trust uploads the resulting pictures and notes onto a server and compares the pictures to images from previous years to determine whether there are changes to the property.
If Trust employees find a violation through their inspection process, the deed gives the Trust the right to institute legal proceedings to procure an injunction against violations of the deed. The deed also gives the Trust the right to enter the property to correct any violations and then place a lien on the property for the cost of such repairs.
Before 2006 Springfield Management Services (SMS) performed services for the Trust. SMS did not perform services for the Trust while the Trust held an easement for the property.
The terms of the deed, in pertinent part, include the following:
The New York City Landmarks Preservation Commission (LPC) is the New York City agency responsible for identifying and designating the city's landmarks and buildings in the city's historic districts. The LPC regulates changes to designated buildings. The LPC consists of 11 Commissioners and approximately 50 full-time staff members, including architects, architectural historians, and restoration specialists. The LPC is responsible for the preservation of 26,000 structures and had a staff of four employees responsible for inspection during relevant times.
New York City adopted its Landmarks Preservation Law (Landmarks Law) in 1965 in response to concerns about the destruction of buildings with significant historical, architectural, and cultural value.
Petitioners' property is subject to the Landmarks Law, which requires property owners to keep designated properties in good repair and to obtain an LPC permit before starting work if the work will affect a landmark's exterior or if the work requires a Department of Buildings permit. Violations of the Landmarks Law occur either when work is performed on a landmark without a permit or when work does not comply with a permit. The Landmarks Law provides, in pertinent part:
N.Y. City Admin. Code sec. 25-307(b)(1). The Landmarks Law further provides: "[The commission is not authorized] to regulate or limit the height and bulk of buildings, [or] to regulate and determine the area of yards, courts and other open spaces". N.Y. City Admin. Code sec. 25-304(a). The Landmark Law defines "exterior architecture feature" as:
N.Y. City Admin. Code sec. 25-302(g).
The task of administering the law was given to the LPC.
The LPC does not monitor yearly each of the structures in its jurisdiction. The LPC does not photograph each structure and does not compare the annual photograph of the previous year. In order to track violations, the LPC uses referrals from sources other than its staff. The LPC receives approximately 800 to 1,000 reports of violations each year. In 2006 and 2007 the LPC retained four employees who were responsible for the enforcement and preservation of approximately 26,000 structures in New York City.
On December 18, 2006, petitioners obtained an appraisal of their property for tax purposes from Jerome Haims Realty, Inc. The NAT provided petitioners with Eric Haims' name, along with the name of one other appraiser, and advised that Mr. Haims is a preapproved appraiser of conservation easements. Petitioners paid Jerome Haims Realty, Inc., $3,000 for Mr. Haims' appraisal services.
Mr. Haims, who is a qualified appraiser as defined in section 1.170A-13(c)(5), Income Tax Regs., appraised the easement that petitioners donated to the NAT. Mr. Haims prepared an appraisal report that included a description of petitioners' property and estimated the fair market value of the easement donated to the NAT. The appraisal valued the donated property as of December 11, 2006.
The appraisal described petitioners' property as 3,300 square feet of gross living area (as per New York City records), and 15 feet of frontage on the north side of East 91st Street by 100 feet 8½ inches of depth, containing 1,515 square feet of lot area. The appraisal stated that although the property was listed for sale on the market at an asking price of $5,295,000, on the basis of Mr. Haims' analysis the property's market value
The Haims appraisal used the sales comparison approach and determined the market value of the property before the donation of the easement. The appraisal established the diminution of the value of the easement reflected as a percentage of the "before" market value of the property. Mr. Haims conducted a market study using paired sales data of residential properties in New York. The appraisal stated that on the basis of the data and analysis presented, the value of the historic preservation easement was equal to 11% of the property's market value, or $605,000.
After signing the easement deed on December 18, 2006, petitioners entrusted the Trust to record it. On December 26, 2006, the vice president of the Trust executed the deed on behalf of the Trust. On December 28, 2006, the Trust delivered the deed to the New York City Department of Finance, Office of the Register (city register). The Trust also paid the city register $122 for recording fees and taxes.
The cover sheet for the recording forms that were presented to the city register, however, contained an error: The property's street number was incorrectly listed on the cover sheet. Because the address on the cover sheet did not match the address on the deed, the city register requested that the Trust resubmit the deed with the discrepancy resolved. The Trust resubmitted the deed in January 2007 to correct the discrepancy. The deed was recorded by the city register on January 18, 2007.
On October 18, 2007, the Trust sent petitioners a letter informing them that the inspector noted no alteration had been made to their property and the inspection was done on May 11, 2007. The letter reminded petitioners that "the exterior of the Property may not be altered legally without the prior approval of the Trust".
On November 22, 2007, petitioners notified the Trust in writing that they wanted to replace the rear windows. The Trust approved the changes on December 24, 2007.
On March 2, 2008, petitioners received a letter from the Trust informing them that their property would be inspected in spring 2008. On August 7, 2008, the Trust sent petitioners a letter informing them that the inspector noticed that no alterations had been made since the last inspection and the property appeared to be in good repair.
On February 13, 2009, the Trust sent petitioners a letter stating that the property would be visited during spring 2009. On May 20, 2009, the Trust inspected the property. On November 17, 2009, the Trust sent petitioners a letter which stated that the window replacement at the rear facade was consistent with the approved plan and that the Trust had no objection.
The November 17, 2009, letter also noted that petitioners had installed a retractable awning. The Trust reminded petitioners that making alterations without its written consent was a violation of the easement and that if there were any unauthorized alterations inconsistent with the historic character of the property, petitioners would be required to restore the property to its prior condition. The Trust, however, determined that the awning was consistent with the historical character of the property.
A certified public accountant prepared petitioners' 2006 and 2007 Federal income tax returns. Petitioners timely filed both tax returns.
Petitioners filed a Form 8283, Noncash Charitable Contributions, with their 2006 Federal income tax return and reported a noncash charitable contribution of $605,000 for the donation of the facade easement to the NAT. Petitioners then deducted $238,778 of their 2006 reported noncash charitable contribution. For 2007 petitioners deducted a noncash charitable contribution carryforward of $68,456.
On April 8, 2010, respondent issued the notice of deficiency to petitioners for tax years 2006 and 2007, disallowing the noncash charitable contribution deductions petitioners claimed on their 2006 and 2007 income tax returns. The notice of deficiency also determined that petitioners were liable for the gross valuation misstatement penalty under section 6662(h) or, in the alternative, the accuracy-related penalty under section 6662(a). In response, petitioners filed a petition.
Generally, the Commissioner's determinations in a notice of deficiency are presumed correct, and the taxpayer bears the burden of proving, by a preponderance of the evidence, that those determinations are incorrect. Rule 142(a)(1);
Section 7491(a)(1) provides an exception that shifts the burden of proof to the Commissioner as to any factual issue relevant to a taxpayer's liability for tax if (1) the taxpayer introduces credible evidence with respect to the issue, sec. 7491(a)(1); and (2) the taxpayer satisfies certain other conditions, including substantiation of any item and cooperation with the Government's requests for witnesses and information, sec. 7491(a)(2);
Petitioners contend that because they also introduced credible evidence establishing both compliance with the technical provisions of section 170 and the value of the easement, the burden should shift to respondent under section 7491(a)(1). Credible evidence is evidence that the Court would find sufficient upon which to base a decision on the issue in favor of the taxpayer if no contrary evidence were submitted.
A deduction is allowed for any charitable contribution for which payment is made within the taxable year if the contribution is verified under regulations prescribed by the Secretary. Sec. 170(a)(1). Generally, a charitable contribution deduction is not allowed for a charitable gift of property consisting of less than the donor's entire interest in that property. Sec. 170(f)(3)(A). Section 170(f)(3)(B)(iii), however, provides an exception for a "qualified conservation contribution". Section 170(h)(1) defines a qualified conservation contribution as follows:
All three requirements must be met for a donation to be a qualified conservation contribution.
S. Rept. No. 96-1007, at 9 (1980), 1980-2 C.B. 599, 603.
Section 170(f)(11) further provides that no charitable contribution deduction shall be allowed under section 170(a) for any contribution of property for which a deduction of more than $5,000 is claimed unless the taxpayer obtains a qualified appraisal of the property. Sec. 170(f)(11)(A), (C). For contributions of property for which a deduction of more than $500,000 is claimed, the taxpayer must also attach the qualified appraisal of the property to his or her Federal tax return. Sec. 170(f)(11)(D).
The parties agree that the Trust was at all relevant times an organization exempt from Federal taxation under section 501(c)(3) and a qualified organization under section 170(h)(1)(B), as defined by section 170(h)(3). The parties do not dispute that petitioners properly attached an appraisal (qualified or not) to their Federal income tax return as specified by section 170(f)(11)(D).
Therefore, we must determine (1) whether petitioners' easement contribution was a qualified real property interest, as defined by section 170(h)(2); (2) whether petitioners' easement contribution was made exclusively for conservation purposes, as defined by section 170(h)(4) and (5); and (3) whether the Haims appraisal was a qualified appraisal under section 170(f)(11)(C). We must also determine the value of the easement contribution.
For purposes of section 170(h)(2)(C) the term "qualified real property interest" includes "a restriction (granted in perpetuity) on the use which may be made of the real property." A restriction granted in perpetuity on the use of the property must be based on legally enforceable restrictions that will prevent uses of the retained interest in the property that are inconsistent with the conservation purposes of the contribution.
We addressed the issue of what constitutes a "qualified real property interest" in
Unlike the conservation easement agreement in
In addition, the deed grants "an Easement in gross, in perpetuity, in, on, and to the Property". It further states: "This Easement is binding not only upon Grantor, but also upon its successors, heirs and assigns and all other successors in interest to the Grantor, and shall continue as a servitude running in perpetuity with the land." The deed mandates specifically that the Trust will not transfer, assign, or otherwise convey its rights under the easement unless it is to a qualified organization under section 170(h)(3) and the transferee agrees to continue to carry out the conservation purposes for which the easement was created.
Accordingly, we hold that petitioners' easement contribution was a qualified real property interest.
Section 170(h)(4)(A)(iv) provides, in pertinent part, that a valid conservation purpose is the preservation of a historically important land area or a certified historic structure.
Section 170(h)(4)(C) defines the phrase "certified historic structure" as (i) any building, structure, or land, which is listed in the National Register, or (ii) any building that is located in a registered historic district (as defined in section 47(c)(3)(B)) and is certified by the Secretary of the Interior to the Secretary of the Treasury as being of historic significance to the district. For this purpose, a structure means any structure, whether or not it is depreciable; accordingly, easements on private residences may qualify. Sec. 1.170A-14(d)(5)(iii), Income Tax Regs.
The enactment of the Pension Protection Act of 2006 (PPA), Pub. L. No. 109-280, 120 Stat. 780, created additional requirements under section 170(h)(4)(B) for any contribution of property in a registered historic district. PPA sec. 1213(a)(1), 120 Stat. at 1075. Section 170(h)(4)(B) provides:
With respect to section 170(h)(4)(B) the General Explanation of Tax Legislation Enacted in the 109th Congress prepared by the Staff of the Joint Committee on Taxation states as follows:
Staff of J. Comm. on Taxation, General Explanation of Tax Legislation Enacted in the 109th Congress 590 (J. Comm. Print 2007).
If restrictions to preserve a building or land area within a registered historic district permit future development on the site, a deduction will be allowed only if the terms of the restrictions require that such development conform with appropriate local, State, or Federal standards for construction or rehabilitation within the district. Sec. 1.170A-14(d)(5)(i), Income Tax Regs. In general, a facade easement is a restriction the purpose of which is to preserve certain architectural, historic, and cultural features of the facade, or front, of a building. The terms of a facade easement might permit the property owner to make alterations to the facade of the structure if the property owner obtains consent from the qualified organization that holds the easement. This Court has held that a facade easement may constitute a qualifying conservation contribution.
Respondent contends that the conservation purpose requirement of section 170(h)(4) is not met because the easement does not preserve the property beyond what is already required under local law. By virtue of the property's location in Carnegie Hill Historic District, petitioners' property is subject to the Landmarks Law. Petitioners are thus required to keep the property in good repair and to obtain an LPC permit before starting work if the work will affect the property's exterior or if the work requires a Department of Buildings permit.
Petitioners contend that their easement meets the conservation requirement and that the examination of local preservation law is part of the valuation process.
Petitioners' property is a certified historic structure within the meaning of section 170(h)(4)(A)(iv) because it is in a registered historic district and was certified as such by the Secretary of the Interior through the National Park Service in response to petitioners' request on January 11, 2007.
The easement at issue preserves petitioners' property as a certified historic structure. We find that the easement was more restrictive than the Landmarks Law.
The Landmarks Law mandates that petitioners obtain approval from the LPC before making changes to their property, while the deed imposes certain clearly defined restrictions and gives the Trust unlimited discretionary authority to approve or deny changes to petitioners' property. The LPC passively monitors changes to historic buildings, while the Trust actively monitors changes to historic buildings. The LPC relies heavily on complaints as part of its monitoring. The Trust performed annual inspections and kept records including photographs. When the LPC reviews a building, it looks at it from the perspective of the streetscape.
Approval from the LPC to make improvements to a property is based on a comparison of the surrounding historical properties. That means petitioners may be given authority from the LPC to make improvements to their property as long as their building remains consistent with the exterior architectural features of neighboring improvements.
The properties directly across the street from petitioners' building are five or more stories high while petitioners' property is only four stories above ground. If petitioners applied for a permit to build an additional story, there is a chance the LPC would allow petitioners to do so as long as the addition was consistent with the exterior architectural features of neighboring buildings. The deed, however, requires that improvements to the property involving the existing front, sides, rear, and height of the building need written approval from the Trust. There is a risk that the Trust will deny an improvement. At trial an employee of the Trust testified that the approval process of the Trust was different from that of the LPC and that the Trust did not approve all projects that met the qualifications of the LPC.
The Landmarks Law states specifically that the LPC is not authorized to regulate or limit the height and bulk of buildings or to regulate and determine the area of yards, courts, or other open spaces. N.Y. City Admin. Code sec. 25-304(a). The Trust, with its unlimited discretion, may deny petitioners' request to make any changes to their home for any reason, while the LPC must follow specific guidelines in its decisionmaking. The Trust has the ultimate say in granting petitioners the right to make changes to their property. Petitioners, however, have the option of appealing a denied permit request with the LPC and changing the LPC's decision.
John Weiss, deputy counsel to the LPC, testified that in order for the LPC to review a change application for a covered property, both the property owner and the easement holder must sign the change application. If the easement holder refused to sign the change application, then the LPC would not approve it. Here, the easement holder was the Trust. Therefore, the LPC would require the Trust's approval before reviewing a change application for petitioners' property.
Mr. Weiss also testified the LPC must obtain either the consent of the property owner or a court order to enter the premises of a covered property. The Trust, however, has the right to enter petitioners' property without a court order. The Trust's monitoring visits require an appointment because the Trust needs access to the property's backyard. The Trust thus places a larger burden on petitioners' property rights than the Landmarks Law.
The Court on several occasions has considered whether a conservation deed of easement was more or less restrictive than local law in order to determine whether a contribution was for conservation purposes.
In
We found in
The deed in the instant case is more restrictive than the deed of easement in
In
In
Unlike the deed in
In
Unlike the easement in
Finally, in
Although the deed in
We further note that although the deed allows the Trust to consent to changes to petitioners' property, the deed requires any rehabilitative work or new construction on the facades to comply with the requirements of all applicable Federal, State, and local Government laws and regulations. Section 1.170A-14(d)(5), Income Tax Regs., specifically allows a donation to satisfy the conservation purposes test even if future development is allowed, as long as that future development is subject to local, State, and Federal laws and regulations.
Like section 170(h)(2)(C), section 170(h)(5) specifies that the conservation purpose must be protected in perpetuity. Section 170(h)(5)(A) provides that "[a] contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity." Although subsections (h)(2)(C) and (h)(5) both require perpetuity, they are separate and distinct requirements. Section 170(h)(2)(C) specifies that the interest in real property donated by taxpayers must be subject to a use restriction in perpetuity, whereas section 170(h)(5) specifies that the conservation purpose of the conservation easement must be protected in perpetuity.
We discussed section 170(h)(5) perpetuity in 1982 East, LLC, quoting the legislative history:
We further discussed the legislative intent behind this perpetuity requirement, quoting the Senate report:
In
In
Respondent argues that there are facts to indicate that the Trust was willing to terminate the easement upon petitioners' request after the easement donation. A lawyer on behalf of petitioners reached out to the Trust about removing the easement. Respondent further argues that petitioners' easement is comparable to those in other cases in which the Court found that easements were not granted in perpetuity.
Petitioners argue that the easement was granted in perpetuity because it is binding on petitioners' successors and heirs, it continues as a servitude running in perpetuity with the land, and it survives the termination of the Trust's existence. Petitioners further argue that the Trust enforces the easement in perpetuity by (1) annually monitoring the property to ensure the property is in compliance with the easement, (2) reviewing any requests for alterations, and (3) tracking changes in ownership of the property to communicate easement obligations to new owners. At trial an employee of the Trust testified that petitioners were told the easement would not be removed.
The terms of the deed grant the easement in perpetuity under section 170(h)(5). The deed grants "an Easement in gross, in perpetuity, in, on, and to the Property". The deed further states: "This Easement is binding * * * and shall continue as a servitude running in perpetuity with the land." This language shows petitioners' intent to satisfy section 170(h)(5).
We find that the Trust was not willing to terminate the easement. Under the terms of the deed the easement is granted in perpetuity and may not be terminated at any time. The Trust has no intention of releasing the deed. Petitioners requested to have the easement terminated because they were having a difficult time selling their property, and the Trust denied this request.
Moreover, the facts in the case at hand are distinguishable from those in 1982 East, LLC because petitioners do not have a mortgage on the property, and upon sale, exchange, or involuntary conversion the Trust is entitled to its proportionate share of future proceeds, absent controlling State law that provides otherwise.
In
The deed in this case allows the easement to be extinguished by judicial decree and requires the donees to use proceeds in a manner consistent with the conservation purposes of the original contribution. The deed does not include other language regarding extinguishment. The deeds in Carpenter included the following language:
Respondent contends that the deed was not recorded under applicable New York law until 2007 and therefore its conservation purpose was not protected in perpetuity under section 170(h)(5)(A) for 2006.
N.Y. Real. Prop. sec. 317 (McKinney 2006) stated: "Every instrument, entitled to be recorded, must be recorded by the recording officer in the order and as of the time of its delivery to him therefor, and is considered recorded from the time of such delivery."
The deed was delivered for recording on December 28, 2006, and the required fee was paid. The deed delivered on December 28, 2006, is identical to the deed as recorded; the only error was on the cover sheet to the recording forms, which incorrectly listed the property's address. The Department of Finance provided a receipt for the delivery of the deed. Therefore, the deed was deemed recorded on December 28, 2006.
Furthermore, section 1.170A-14(g)(3), Income Tax Regs., provides: "A deduction shall not be disallowed under section 170(f)(3)(B)(iii) and this section merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible."
Accordingly, we find that the easement was contributed exclusively for conservation purposes.
To be a qualified appraisal under section 170(f)(11)(E), an appraisal of property (1) must be treated as a qualified appraisal under regulations or other guidance prescribed by the Secretary and (2) must be conducted by a qualified appraiser in accordance with generally accepted appraisal standards and any regulations or other guidance prescribed by the Secretary.
Section 1.170A-13(c)(3), Income Tax Regs., defines a qualified appraisal as a document that, among other things: (1) relates to an appraisal that is made not earlier than 60 days before the date of contribution of the appraised property and not later than the due date (including extensions) of the return on which a deduction is first claimed under section 170; (2) is prepared, signed, and dated by a qualified appraiser; (3) includes (a) a description of the property appraised, (b) the fair market value of such property on the date of contribution and the specific basis for the valuation, (c) a statement that such appraisal was prepared for income tax purposes, (d) the qualifications of the qualified appraiser, and (e) the signature and taxpayer identification number of such appraiser; and (4) does not involve an appraisal fee that violates certain prescribed rules. The parties stipulated that Mr. Haims, who performed the appraisal for petitioners, is a "qualified appraiser" as the term is defined in section 1.170A-13(c)(5), Income Tax Regs.
The regulation imposes substantive requirements on the content of an appraisal report.
The parties agree that the Haims report meets the reporting requirements of certain subdivisions in section 1.170A-13(c)(3)(ii), Income Tax Regs.; however, respondent claims that the Haims report fails to meet the reporting requirements of section 1.170A-13(c)(3)(ii)(C), (I), (J), and (K), Income Tax Regs.
Pursuant to section 1.170A-13(c)(3)(ii)(C), Income Tax Regs., an appraisal report must include the date or expected date of the contribution. The Haims appraisal reports the date or expected date of contribution as December 11, 2006. Therefore, petitioners' filings gave respondent sufficient information to determine that the expected date of contribution was in December 2006.
Pursuant to section 1.170A-13(c)(3)(ii)(I), Income Tax Regs., an appraisal report should include the appraised fair market value of the donated property on the date or expected dated of contribution. Fair market value is "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." Sec. 1.170-1(c)(2), Income Tax Regs.
The Haims appraisal report used the phrase "market value", which it defined as follows: "The most probable price, as of a specified date, in cash, or in terms equivalent to cash, or in other precisely revealed terms, for which the specified property rights should sell after reasonable exposure in a competitive market under all conditions requisite to a fair sale, with the buyer and seller each acting prudently, knowledgeably and for self interest, and assuming that neither is under undue duress".
Although we have previously observed that the phrase "market value" is not necessarily synonymous with "fair market value" depending on how the term is defined and used,
Pursuant to section 1.170A-13(c)(3)(ii)(J), Income Tax Regs., an appraisal must include the method of valuation used to determine the fair market value. The Haims appraisal uses the "before and after" method. The Haims appraisal explained and identified the method used, including how a paired sales analysis was used and a percentage reduction was applied to the before value. The Haims appraisal meets the requirements of section 1.170A-13(c)(3)(ii)(J), Income Tax Regs.
Pursuant to section 1.170A-13(c)(3)(ii)(K), Income Tax Regs., an appraisal must report the specific basis for valuation. The Haims appraisal explains that it used an "an empirically driven market study using paired sales data residential properties in New York". The Haims appraisal also provides detail on how the properties were selected.
Mr. Haims' approach was very similar to the approach taken in
Section 170(f)(11)(E) as amended by the PPA specifies that the qualified appraisal must be conducted by a qualified appraiser in accordance with generally accepted appraisal standards. The Department of the Treasury provided guidance in the form of Notice 2006-96, 2006-2 C.B. 902. According to that Notice an appraisal will meet the specifications of section 170(f)(11)(E) if, for example, "the appraisal is consistent with the substance and principles of the Uniform Standards of Professional Appraisal Practice (`USPAP')".
Appraising is not an exact science and has a subjective nature. The Haims appraisal meets the specifications of section 170(f)(11)(E).
Accordingly, we find that the Haims appraisal was a qualified appraisal for purposes of section 170(f)(11). Petitioners are entitled to a charitable contribution deduction under section 170(a)(1).
No established market exists for determining the fair market value of an easement.
Under this approach the fair market value of the restriction is equal to the difference (if any) between the fair market value of the encumbered property before the restriction is granted and its fair market value after the restriction is granted. Sec. 1.170A-14(h)(3)(i), Income Tax Regs. Where the grant of a conservation restriction has no material effect on the value of the property, or serves to enhance, rather than reduce, the value of the property, no deduction is allowed. Sec. 1.170A-14(h)(3)(ii), Income Tax Regs.
The "before" value of the property generally reflects the highest and best use of the property in its condition just before the donation of the easement.
Both petitioners and respondent submitted expert reports regarding the value of petitioners' easement. Respondent's expert was Richard Marchitelli, executive managing director of Cushman & Wakefield. Mr. Marchitelli has appraised facade easements in New York City, including townhouses. He is a member of the Appraisal Institute. Petitioners' expert was Gary Miller, president of Nico Valuation Services, Ltd. He is a member of the Appraisal Institute. Mr. Miller has valued more than $1 billion of real estate.
Both experts agree that the "before" value of petitioners' townhouse was $5,200,000. They have different reasoning for reaching the fair market value, and they differ on the "after" value of the property. Respondent's expert believes that the "after" value of the property was $5,300,000 and that the easement had no influence on the fair market value of the property. Petitioners' expert believes that the "after" value is $4,735,000, resulting in an easement value of $465,000.
The Marchitelli report used the "before and after" method to determine the value of the easement. The report compares sales of townhouses in the Upper East Side of Manhattan that were not encumbered by easements to sales of townhouses in the Upper East Side that were encumbered by easements. The findings in the report indicate that wider, larger townhouses tend to sell for a higher price per square foot than smaller, narrower townhouses.
The report discussed seven sales involving Upper East Side landmark townhouses encumbered by facade easements. The sales took place between June 2005 and September 2007, but all the easements were donated before the PPA was enacted in 2006. The report includes copies of the deeds for the seven properties. The deeds for these easements state: "The term `facade' as herein consists of all exterior surfaces of the improvements on the Property, including all walls, roofs, and chimneys". Several of these deeds include language which limits the deed to exteriors that are visible on the opposite side of the street. Mr. Marchitelli testified that there are different types of easements and not all easements cover side walls or rear walls. He believes that the data does not support a different value for different types of easements.
The seven sales without easements had prices ranging from $1,380 to $2,949 per square foot. Only one townhouse was smaller than petitioners' property. The average price of townhouses without easements was $2,159 per square foot.
The seven townhouses with easements had prices ranging from $1,616 to $2,692 per square foot. The townhouses in five of these seven sales were larger than petitioners' townhouse. The average price of those with easements was $2,195 per square foot. Mr. Marchitelli testified that wider townhouses are more desirable. None of these townhouses was in the same district as petitioners' property. Four of these townhouses were sold after the date of petitioners' easement. Mr. Marchitelli testified that there were no comparable properties at the time in the same district as petitioners' townhouse. He further testified that he determines the size of a townhouse using the tax maps rather than the square footage of the living area of the townhouse because he believes the square footage of the living area overstates the size of the home.
The Miller report uses the sales comparison approach to the "before and after" method by looking at the sales of similar property in surrounding neighborhoods. The size used for comparisons ranged from 3,072 to 3,721 square feet. To determine the value of the facade easement, the report analyzed the market to determine whether the encumbrance of properties by conservation easements has any resultant effect on value. The report describes petitioners' easement as an "envelope easement" that preserved the existing front, rear, top, and any exposed sides of the building from unauthorized alterations. The report notes that petitioners' townhouse is small for the market.
The Miller report addresses floor area ratio (FAR), which is the total floor area in a zoning lot divided by the lot area of that zoning lot. Properties in New York, New York, are subject to zoning restrictions based on FAR. If two or more buildings are in the same zoning lot, the FAR is the sum of their floor areas divided by the lot area. The Miller report concludes that petitioners could be allowed to develop an additional 2,744 square feet on the basis of the unused development right in place. The report explains that it is likely that petitioners' unused development right would be used in the form of a 15-foot extension on the rear and one or two additional levels above the fourth story. Mr. Miller testified that he would not expect a purchaser to build a four-story rear addition, which would be an 83% increase in bulk. The report contends that this expansion would be subject to strict guidelines.
In order to value the easement, the report looked at nine paired sales—four with respect to a property referred to as easement No. 1 and five with respect to another property referred to as easement No. 2. Sales of properties with easements were compared to sales of comparable properties that did not have easements. Adjustments were made, and the remaining difference in price shows the impact of the easement. The deeds for both of the properties with easements described each of the easements as a "Scenic, Open, Space and Architectural Facade Conservation Easement on the Property exclusively for conservation purposes". A ratio was used to compare the price the easement property should have sold for according to sales of comparable unencumbered properties and the actual sale price of the encumbered property. The sale price per square foot was the primary unit of comparison. The two properties with easements that were used in the paired sales analysis were much larger than petitioners' townhouse. These properties have square footage of 12,401 and 7,006. The ratios reflecting a discount ranged from -8% to -35% for the first property, which was 12,401 square feet. The range of ratios for the property with 7,006 square feet was -2% to -15%.
The Miller report concluded that petitioners' easement demonstrates a diminution in value of 9% of its encumbered value. This would reduce the value of the property to $1,435 per square foot from $1,575 per square foot. During his testimony Mr. Miller stated that "there's no scientific way to break down the parts" referring to the 9% diminution in value. He believes that his report explains how he reached the diminution in value of 9%. He testified that keeping a residence in "good repair" is more expensive if you have an easement because you are required by the easement to keep it maintained and preserved.
Respondent contends that petitioners' easement has no value. Respondent compares it to the easements in
Mr. Marchitelli had several concerns with the Miller report. He believes that people buy a house to live in, and he testified that townhouses historically have not been renovated to increase their size. He believes that the Miller report overemphasized the value of development rights and that the market does not attach significance to the development rights.
Mr. Marchitelli raised the issue that the Miller report does not compare the easement properties discussed in the report with petitioners' townhouse. He believes that comparisons are being made to two separate properties with easements and that the report does not compare these properties to petitioners' townhouse. He believes that this analysis makes the report "convoluted".
Petitioners contend that it is appropriate to make adjustments to comparable sale figures when using the compared sales approach.
Mr. Miller testified that he did not compare petitioners' property to the comparison sale properties because petitioners' property was substantially lower in value. Mr. Miller criticized the Marchitelli report for not making adjustments for the condition of property, such as an elevator and servant's quarters.
Ordinarily, any encumbrance on real property, however slight, would tend to have some negative effect on the property's fair market value.
The paired sales analysis involves a comparison of the fair market value of a property with and without an easement. The fair market value of the property with the easement is divided by the fair market value of the property without the easement to derive a diminution percentage attributable to the conservation easement involved.
Since both respondent and petitioners' experts agree that the "before" value is $5,200,000, we will use that as the "before" value. We conclude that neither petitioners nor respondent was persuasive about the value of the easement.
We do not agree with respondent that the easement had no value. To determine the value of the easement, we should consider whether the easement is more restrictive than the restrictions provided by local law.
Petitioners also did not meet their burden of proving that the value of the easement is $465,000. We do not rely on easement sale No. 1 in the Miller report because the property with the easement is 12,401 square feet. We realize that appraisers have to rely on sales that are available at the time of the appraisal and that adjustments can be made; however, the property used for easement sale No. 1 is substantially larger than petitioners' property, and a reasonable comparison cannot be made. The property used for easement No. 1 is 26.5 feet wide, and petitioners' townhouse is only 15 feet wide. The testimony of both Mr. Miller and Mr. Marchitelli indicates that a wider townhouse has more value than a narrow townhouse. Twenty adjustments were made in this comparison. When numerous adjustments have to be made, there is a likelihood that the outcome is less reliable than in a comparison where fewer adjustments have to be made.
The easement sale No. 2 property is still larger than petitioners' property, but unlike the easement sale No. 1 property, it is not substantially larger. The property used for easement No. 2 is 7,006 square feet and 20 feet wide. This is still larger and wider than petitioners' property, but it provides a more reasonable comparison than easement sale No. 1. Mr. Miller made adjustments to the four comparable sales, and the diminution in value ranged from 2% to 13%.
The 9% diminution in value used by Mr. Miller is too high. We agree with petitioners that there is value for an envelope easement. There is a reasonable chance that the property may not be able to be developed or modified, especially in the rear of the property. Even though all the paired sales in the Miller report are based on wider properties than petitioners' townhouse, we conclude a more reasonable diminution would be 2%.
The property in the comparable sale analysis for easement sale No. 2 with the 2% diminution in value is the property closer is in size to petitioners' property. This comparable property is 4,500 square feet and 20 feet wide. The price per square foot is $1,956. According to the Miller report the "before" value of petitioners' property is $1,561 per square foot. Mr. Miller made adjustments in using this sale, including adjustments for size, physical characteristics, and condition. Both the comparable property and the easement No. 2 property are five feet wider than petitioners' property.
We note that the easement No. 2 property in the Miller report does not explicitly include the rear of the property. The easement No. 2 property, however, is larger and wider than petitioners property, and those differences balance out the easement No. 2 property does not include the rear of the property. We are not required to accept the Miller valuation in its entirety.
We have considered the expert reports and testimony and conclude that there should be only a 2% reduction in value. This decrease stems from heightened financial burdens of an eased facade, enforcement actions of the Trust, and the scope of the easement.
Respondent contends that petitioners are liable for penalties under section 6662(h) or, in the alternative, under section 6662(a).
PPA sec. 1219(a), 120 Stat. at 1083, made several changes to section 6662(h). Section 6662(h) provides a 40% penalty for gross valuation misstatements. Gross valuation misstatements occurs when the value of any property reported on an income tax return is 200% or more of the amount determined to be the correct amount, among other things.
Petitioners valued the easement at $605,000. The amounts they reported on their 2006 and 2007 Federal income tax returns reflected this value. We conclude that the easement has a value of $104,000. Thus, petitioners' valuation of $605,000 is greater than 200% of the amount determined to be the correct value. Petitioners are liable for a gross valuation misstatement. Therefore, a 40% penalty is imposed on the portion of the underpayment attributable to the gross valuation misstatement. The reasonable cause exception does not apply in the case of gross valuation misstatements with respect to charitable donations.
A penalty pursuant to section 6662(h) applies to any portion of an underpayment for the year to which a deduction is carried that is attributable to a gross valuation misstatement for the year in which the carryover of the deduction arises.
Petitioners contend that the section 6662(h) penalty should not be assessed because it is an excessive fine under the Eighth Amendment to the United States Constitution. The Eighth Amendment provides: "Excessive bail shall not be required, nor excessive fines imposed, nor cruel and unusual punishments inflicted." U.S. Const. amend. VIII. The touchstone of the inquiry is the "principle of proportionality: The amount of the forfeiture must bear some relationship to the gravity of the offense that it is designed to punish."
The purpose of civil tax penalties is to encourage voluntary compliance.
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We have similarly found contentions that civil tax penalties violate the Excessive Fines Clause to be without merit.
Section 6662(h) does not violate the Excessive Fines Clause. As the Court of Appeals for the Fourth Circuit stated: "Even assuming arguendo that the Excessive Fines Clause is implicated in this case, there is no basis for concluding that the * * * [civil tax penalty] is excessive. If the * * * [civil tax penalty] is always calculated as * * * [a percentage] of the tax deficiency regardless of the means by which the income is accrued, the sanction could not be excessive as to one person, but not excessive as to another."
Moreover, perceived overvaluation of noncash charitable contributions prompted Congress to amend the tax laws several times. Consistent with this perception the PPA lowered the threshold for imposing penalties related to deductions for charitable contribution property. Such congressional actions demonstrate the remedial nature of the penalty and Congress' intent to regulate the difficult realm of valuing charitable contribution property.
Respondent argues in the alternative that petitioners are liable for a section 6662(a) and (b)(1) and (2) accuracy-related penalty due to negligence or disregard of rules or regulations or a substantial understatement of income tax. This issue does not need to be addressed since petitioners are liable for a section 6662(h) penalty.
Any contentions we have not addressed are irrelevant, moot, or meritless.
To reflect the foregoing,
