T.C. Memo. 2011-84
UNITED STATES TAX COURT
1982 EAST, LLC, SOLOMON D. ASSER, TAX MATTERS PARTNER,
Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 30052-08. Filed April 12, 2011.
John P. Barrie, for petitioner.*
Michael D. Wilder, Sameera Y. Hasan, Michael Y. Chin, and
Michael A. Sienkiewicz, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
LARO, Judge: This case is a partnership-level proceeding
under the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. 97-248, sec. 402, 96 Stat. 648, as amended. The
*
Brief amicus curiae was filed by Kathryn Keneally for Trust
for Architectural Easements.
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TEFRA partnership, 1982 East, LLC (LLC), claimed a $6,570,000
deduction on its 2004 Form 1065, U.S. Return of Partnership
Income (2004 return), for a December 30, 2004, contribution of a
historic preservation easement (facade easement) and unused
development rights (UDRs) (collectively, donated property).1
Respondent disallowed that deduction in a notice of final
partnership administrative adjustment (FPAA) issued to LLC’s tax
matters partner, Solomon D. Asser (Mr. Asser). Respondent also
determined in the FPAA that an accuracy-related penalty applied
to any underpayment of tax attributable to the $6,570,000
disallowance. Respondent’s primary determination in that respect
was that the penalty equaled 40 percent of the underpayment
because of a gross valuation misstatement under section 6662(h).2
Alternatively, respondent determined that the penalty equaled 20
percent of the underpayment because of negligence or disregard of
rules or regulations under section 6662(b)(1) or a substantial
understatement of income tax under section 6662(b)(2).
We decide two issues. First, we decide whether LLC is
entitled to any part of the $6,570,000 deduction. We hold it is
1
LLC also claimed on the 2004 return that it was entitled to
deduct cash contributions of $452,500 which were related to the
contribution of the donated property. Respondent did not
disallow LLC’s deduction of the cash contributions, and that
deduction is not in issue.
2
Unless otherwise indicated, section references are to the
applicable versions of the Internal Revenue Code, and Rule
references are to the Tax Court Rules of Practice and Procedure.
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entitled to none of the deduction. Second, we decide whether LLC
is liable for a 20-percent accuracy-related penalty under section
6662(a) on any underpayment of tax attributable to the
disallowance of the deduction.3 We hold it is not liable for the
penalty.
FINDINGS OF FACT
I. Preliminaries
Some facts were stipulated and are so found. The
stipulations of fact and the accompanying exhibits are
incorporated herein by this reference. When the petition was
filed, LLC’s principal place of business was in New York, New
York (New York City).
II. LLC, Mr. Asser, and NAT
A. LLC
LLC is a limited liability company formed in May 2002
primarily to purchase and operate real estate at 19 East 82d
Street in New York City. LLC has both domestic and foreign
members. LLC is characterized for Federal tax purposes as a
partnership subject to TEFRA. During 2004, LLC owned real
property (subject property) in New York City at 19 East 82d
Street.
3
Given our holding on the first issue, respondent abandons
his primary determination that the 40-percent accuracy-related
penalty under sec. 6662(h) applies in this case.
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B. Mr. Asser
Mr. Asser is one of LLC’s domestic members, and he is a
managing member of LLC and its tax matters partner. He holds
three professional degrees, the first in architecture, the second
in urban planning, and the third in architecture and urban
design. For more than two decades, Mr. Asser has been in the
design, building, and rehabilitation of buildings in New York
City, including buildings in landmark districts. He currently
owns and operates a construction management and general
contracting firm, Tecny Group, Inc., the primary business of
which is the rehabilitation of buildings.4 Mr. Asser is familiar
with the New York City Landmarks Preservation Commission (LPC)
and the New York City zoning rules as applicable to the subject
property.5
C. NAT
The National Architectural Trust (NAT) is tax exempt under
section 501(c)(3) and a qualified organization under section
170(h)(3).6 NAT advertises that taxpayers can receive
significant tax benefits by contributing historic preservation
4
Tecny Group, Inc., was formerly named Tecny Landmark Corp.
We refer to both entities as Tecny.
5
The LPC is a New York City agency responsible for
identifying and designating New York City landmarks and historic
districts. The LPC is also responsible for protecting and
preserving those landmarks and historic districts.
6
NAT changed its name in 2007 to “Trust for Architectural
Easements”. We refer to both entities as NAT.
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easements to NAT and assists taxpayers who make such
contributions to structure and report the contributions in a way
that NAT believes will entitle the taxpayers to the advertised
benefits.
III. Subject Property
As of December 30, 2004, the date LLC contributed the
donated property to NAT, the subject property included a
rectangular lot and a five-story townhouse (townhouse). The lot
was approximately 2,554 square feet. The townhouse was
constructed in 1894 and had 10,375 square feet of living area
(excluding the cellar).
The subject property is sited within the Metropolitan Museum
Historic District and is in a C5-1 restricted central commercial
zoning district within the Special Madison Avenue Preservation
District. Because of its location, the subject property is
subject to New York City’s landmark and zoning laws. Those laws
set the maximum building capacity for each square foot in a lot
by reference to a formula known as the “floor area ratio”.7 The
laws also set a maximum height at which a structure may be built
on the lot.
7
For example, if a 5,000-square-foot lot had a floor area
ratio of 10, then the zoning rules would allow a building of up
to 50,000 square feet on the lot. To the extent that the
building was less than 50,000 square feet, the difference between
the actual square footage and 50,000 would be the lot’s UDRs.
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IV. Mr. Asser’s Contacts With NAT
Mr. Asser first heard about NAT in 2002, when one of his
partners gave Mr. Asser a NAT promotional handout. Mr. Asser
discussed the promotion with others in his business and with
representatives of NAT. He also attended free seminars where NAT
representatives (none of whom was a lawyer) discussed the
significant tax benefits that could be obtained through the
contributions of preservation easements to NAT with little to no
practical effect on the use, value, or marketability of the
servient property.
NAT prepared and gave to Mr. Asser literature discussing
NAT’s promotion. Mr. Asser read all of this literature, and he
read most of it before LLC decided to participate in the
promotion. The literature suggested that a donor of an easement
could receive a significant charitable contribution deduction for
Federal and State tax purposes equal to a set percentage (between
10 and 15 percent but usually 11 percent) of the fair market
value of the property burdened with the easement. The literature
indicated that the donor of a facade easement to NAT would have
to obtain NAT’s permission before changing the property’s
exterior. The literature stated, however: “Since these
properties reside in historic districts, pre-approval of exterior
changes is, in most cases, already required by local government
regulations” and “Properties qualifying for this program are
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usually regulated by local government ordinances that restrict
exterior changes”.
V. LLC’s Purchase of the Subject Property
LLC purchased the subject property on November 5, 2002, for
$8 million, aiming to take advantage of the promotion while at
the same time expeditiously reselling the subject property at a
profit. LLC paid the $8 million with $2 million cash and $6
million obtained through a mortgage loan from Wachovia Bank, N.A.
(Wachovia). When LLC purchased the subject property, the
townhouse was in need of complete renovation. LLC opted to
renovate the townhouse as a single-family townhome and solicited
and received the requisite approval of the LPC to fully gut the
townhouse and to perform that renovation.
VI. LLC’s Facade Conservation Easement Application
On April 10, 2003, before the renovation work began, LLC
applied to NAT for approval to contribute the donated property to
NAT, and LLC gave NAT a required $1,000 “good faith deposit”.8
The next day, NAT wrote to LLC thanking it for its application.
On May 12, 2003, the U.S. Department of the Interior National
Park Service classified the subject property as a “certified
historic structure”, noting that “This property is noteworthy for
8
NAT’s acceptance of a preservation easement was generally
contingent on the donor making a “cash contribution” to NAT of 10
percent of the fair market value of the easement. The “good
faith deposit” was a downpayment on the required “cash
contribution”.
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the retention of its exterior presence and much of the property’s
period details remain within. This neo-Italian Renaissance
structure stands in contrast to its more retrained [sic]
neighbors”. NAT helped get the subject property certified as a
historic structure.
VII. Deed of Easement
NAT structured LLC’s contribution of the donated property to
be complete when a conservation deed of easement (deed of
easement) was executed by LLC, notarized, and executed by NAT.
On or about June 10, 2003, NAT prepared a deed of easement dated
June 10, 2003. The deed of easement prohibited LLC and its
successors (collectively, LLC) from altering the subject
property’s “Protected Facade” without the written consent of NAT
or its successors (collectively, NAT). The “Protected Facade”
included all exterior surfaces, e.g., walls, roofs, and chimneys,
that were visible from the street level on the opposite side of
East 82d Street. Among other things, the deed of easement
prohibited LLC from erecting “any new or additional exterior
improvements on the [subject] Property or in the open space above
or surrounding the * * * townhouse” without the express written
consent of NAT.
The deed of easement stated that the UDRs included “any and
all rights, however designated, now or hereafter associated with
the [subject] Property or any other property that may be used
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pursuant to applicable zoning laws or other government laws or
regulations to compute permitted size, height, bulk or number of
structures, development density, lot yield, or any similar
development variable on or pertaining to the [subject] Property
or any other property.” The deed of easement also stated that
neither LLC nor NAT could use, exercise, or transfer the UDRs and
that LLC was donating those rights to NAT for the purpose of
forever removing and extinguishing those rights. The deed of
easement stated that in the event that the donated easement was
ever extinguished through a judicial decree, NAT
will be entitled to receive upon the subsequent sale,
exchange, or involuntary conversion of the [subject]
Property, a portion of the proceeds from such sale,
exchange or conversion equal to the same proportion
that the value of the initial * * * donation bore to
the entire value of the property at the time of the
donation as estimated by a state licensed appraiser,
unless controlling state law provides that * * * LLC is
entitled to the full proceeds in such situations,
without regard to the Easement. * * * NAT agrees to
use any proceeds so realized in a manner consistent
with the conservation purpose of the original
contribution.
VIII. LLC’s Subsequent Financing of the Property
On January 22, 2004, Wachovia assigned the mortgage on the
subject property to First Republic Bank. On the same day, LLC
took out a $3,390,000 mortgage loan from First Republic Bank to
finance the renovation of the subject property, and LLC and First
Republic Bank consolidated all mortgages on the subject property
into a single mortgage with a $9,350,000 principal amount. First
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Republic Bank was then the sole lender and mortgage holder with
respect to the subject property.
In 2003 or 2004, First Republic Bank was given the deed of
easement and a proposed lender agreement (lender agreement). The
lender agreement stated that First Republic Bank was
subordinating its rights in the subject property to NAT’s rights
to enforce the conservation purpose of the donated property in
perpetuity, subject to the following conditions and stipulations:
(a) * * * First Republic Bank and its assignees shall
have a prior claim to all insurance proceeds as a
result of any casualty, hazard or accident occurring to
or about the [subject] Property and all proceeds of
condemnation, and shall be entitled to same in
preference to * * * NAT until the Mortgage/the Deed of
Trust is paid off and discharged, notwithstanding that
the Mortgage/the Deed of Trust is subordinate in
priority to the Easement.
* * * * * * *
(c) Nothing contained in this paragraph or in this Easement
shall be construed to give * * * First Republic Bank the
right to violate the terms of this Easement or to extinguish
this Easement by taking title to the [subject] Property by
foreclosure or otherwise.
First Republic Bank scrutinized the lender agreement to determine
whether the agreement would affect the bank’s collateral value in
the subject property and concluded that it would not. First
Republic Bank signed the lender agreement on July 15, 2004, and
the lender agreement was attached to and incorporated into the
deed of easement.
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IX. 2004 Appraisal
LLC obtained an appraisal (2004 appraisal) from Jerome Haims
Realty, Inc. (Haims), on or about June 7, 2004. The 2004
appraisal was dated June 7, 2004, on which date LLC’s renovation
of the subject property was not complete. LLC had hired Tecny
and another firm to renovate the subject property. Tecny
performed that renovation in 2004 and 2005. The exterior
renovation was complete as of December 30, 2004, but interior
renovation (e.g., improvements, painting and finishing, and
installation of woodwork) was still in progress.
The 2004 appraisal valued the donated property as of
February 15, 2005, which as of June 7, 2004, was the estimated
completion date of the interior renovation. The 2004 appraisal
projected that the February 15, 2005, value of the facade
easement would be $2,600,000 and that the value of the UDRs
(which the 2004 appraisal stated totaled 15,165 square feet)
would be $3,870,000, for a total value of $6,470,000.
Mr. Asser reviewed the 2004 appraisal, and he accepted it
even though he believed that the values were too low. NAT
advertises to its contributors of conservation easements that
Haims is a preapproved appraiser of such easements, and Haims has
performed over 100 appraisals pursuant to those referrals. As of
the time of the 2004 appraisal, LLC and Haims had a solid
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business relationship and LLC had hired Haims many times to
obtain other appraisals.
X. LLC’s December 8, 2004, Application and Crossover Addendum
On December 6, 2004, NAT gave LLC: (1) A second facade
conservation easement application (which was more detailed than
the first application); and (2) a “Facade Conservation Easement
Application Crossover Addendum” (crossover addendum). On
December 8, 2004, Mr. Asser, on behalf of LLC, completed both the
second application and the crossover addendum.
The crossover addendum stated that LLC could contribute the
donated property to NAT in 2004 and qualify for a charitable
contribution deduction for that year even though some of the
deduction requirements would not be met until 2005. The
crossover addendum required that LLC obtain a “final report” from
a “qualified appraiser” within 60 days and that LLC give NAT a
“completed closing package”, consisting of a signed and notarized
deed of easement, necessary recording documents, and the cash
contribution, within 55 days of the appraisal date or December
20, 2004, whichever came first. The crossover addendum stated
that when those requirements were met, NAT would deliver to LLC a
completed Form 8283, Noncash Charitable Contributions, which had
to be filed with the 2004 return for LLC to receive a charitable
contribution deduction for the donated property.
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On December 17, 2004, Mr. Asser wrote NAT a check for
$451,500. This check represented the balance of the “cash
contribution” that NAT required LLC to make as a condition of
LLC’s contribution of the donated property.
XI. The Noncash Contribution
Mr. Asser, on behalf of LLC, executed the deed of easement
on December 26, 2004, and his signature was notarized on the same
day. Four days later, NAT effected its acceptance of the donated
property by executing the deed of easement. NAT sent LLC an
acknowledgment letter, dated March 31, 2005, thanking LLC for the
cash and noncash contributions and enclosing a completed copy of
page 2 of Form 8283. The New York City Department of Finance,
Office of the City Register, recorded the deed of easement on
June 10, 2005.
XII. 2005 Appraisal
Before LLC filed its 2004 return, NAT told Mr. Asser that
LLC needed to get a new appraisal because the 2004 appraisal was
prepared too early. Mr. Asser obtained a second appraisal from
Haims (2005 appraisal) on February 8, 2005. The 2005 appraisal
valued the noncash contribution prospectively as of March 31,
2005, which as of February 8, 2005, was the estimated completion
date of the interior renovation. The 2005 appraisal concluded
that the prospective fair market values of the facade easement
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and the UDRs would be $2,690,000 and $3,880,000, respectively, or
$6,570,000 in total.
XIII. LLC’s 2004 Partnership Tax Return
LLC timely filed the 2004 return on October 17, 2005. The
2004 return included the second page of Form 8283 and included
the 2005 appraisal as an attachment. The second page of Form
8283 stated a contribution date of December 30, 2004, and a fair
market value of the donated property of $6,570,000. The second
page of Form 8283 reported that the noncash contribution was a
“Historic Preservation Easement” and did not mention the UDRs.
The 2005 appraisal stated that the noncash contribution consisted
of the donated property.
XIV. Preparation of the 2004 Return
The 2004 return was prepared by Irwin Weissman (Mr.
Weissman). Mr. Weissman has been a certified public accountant
since 1962, and he has been a principal in a small accounting
firm since 1987. Mr. Weissman has prepared only one tax return
that claimed a charitable contribution deduction for a facade
easement--the 2004 return.
XV. 2009 Appraisal
Mr. Asser obtained a third appraisal (2009 appraisal) from
Haims in late 2009. Haims prepared the 2009 appraisal on or
about September 17, 2009. The 2009 appraisal valued the donated
property as of December 30, 2004.
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OPINION
I. Burden of Proof
Respondent determined that LLC’s $6,570,000 noncash
contribution did not qualify for a charitable contribution
deduction under section 170. This determination is presumed
correct, and petitioner must prove it wrong in order to prevail.
See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933);
see also Deputy v. du Pont, 308 U.S. 488, 493 (1940) (stating
that deductions are a matter of legislative grace to which
taxpayers must prove their entitlement). While section 7491(a)
may place the burden of proof upon the Commissioner in certain
circumstances, petitioner conceded at trial that petitioner has
the burden of proof.9
II. Noncash Contribution
A taxpayer is generally allowed a deduction for any
charitable contribution made during the taxable year. Sec.
170(a)(1). A charitable contribution includes a gift of property
to a charitable organization, made with charitable intent and
without the receipt or expectation of receipt of adequate
consideration. See Hernandez v. Commissioner, 490 U.S. 680, 690
(1989); United States v. Am. Bar Endowment, 477 U.S. 105, 116-118
(1986); see also sec. 1.170A-1(h)(1) and (2), Income Tax Regs.
While a taxpayer is generally not allowed a charitable
9
Petitioner’s opening brief is consistent with petitioner’s
concession in that the brief does not reference sec. 7491(a).
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contribution deduction for a gift of property consisting of less
than an entire interest in that property, an exception is made
for a “qualified conservation contribution.” See sec.
170(f)(3)(A), (B)(iii).
A “qualified conservation contribution” is a contribution
(1) of a “qualified real property interest,” (2) to a “qualified
organization,” (3) which is made “exclusively for conservation
purposes.” Sec. 170(h)(1); see also sec. 1.170A-14(a), Income
Tax Regs. We focus on the third requirement; i.e., whether LLC’s
contribution of the donated property was exclusively for
conservation purposes. A contribution is made exclusively for
conservation purposes only if it meets the requirements of
section 170(h)(4) and (5). Glass v. Commissioner, 124 T.C. 258,
277 (2005), affd. 471 F.3d 698 (6th Cir. 2006). We begin our
analysis with the requirements of section 170(h)(5).
A. Section 170(h)(5)
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.” The parties
disagree on whether the conservation purpose of the donated
property is protected in perpetuity. Respondent argues that the
donated property is not protected in perpetuity by virtue of
First Republic Bank’s mortgage on the subject property.
Petitioner argues that the conservation purpose of the donated
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property is protected in perpetuity because First Republic Bank
subordinated its interest in the subject property to NAT’s right
to enforce the terms of the easement.
The perpetuity requirement of section 170(h)(5)(A) has its
origins in the Tax Reduction and Simplification Act of 1977 (TRSA
1977), Pub. L. 95-30, sec. 309(a), 91 Stat. 154.10 In TRSA 1977
sec. 309, Congress temporarily allowed a charitable contribution
deduction for an “easement with respect to real property granted
in perpetuity to * * * [a governmental unit or qualifying
charitable organization] exclusively for conservation purposes”.
The conference report on TRSA 1977 explained:
While it is intended that the term “conservation
purposes” be liberally construed with regard to the
types of property with respect to which deductible
conservation easements * * * may be granted, it is also
intended that contributions of perpetual easements
* * * qualify for the deduction only in situations
where the conservation purposes of protecting or
preserving the property will in practice be carried
out. Thus, it is intended that a contribution of a
conservation easement * * * qualify for a deduction
only if the holding of the easement * * * is related to
the purpose or function constituting the donee’s
purpose for exemption (organizations such as nature
10
The Tax Reform Act of 1976, Pub. L. 94-455, sec. 2124(e),
90 Stat. 1919, authorized a deduction for the donation of an
“easement with respect to real property of not less than 30
years’ duration” granted to a governmental unit or qualifying
charitable organization made “exclusively for conservation
purposes”. See Glass v. Commissioner, 124 T.C. 258, 277-280
(2005) (examining the legislative history of the requirement that
a qualified contribution of a conservation easement be
exclusively for conservation purposes), affd. 471 F.3d 698 (6th
Cir. 2006). Congress, however, did not amend sec. 170(f)(3) to
require that the easement be granted in perpetuity until TRSA
1977.
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conservancies, environmental, and historic trusts,
State and local governments, etc.) and the donee is
able to enforce its rights as holder of the easement *
* * and protect the conservation purposes which the
contribution is intended to advance. The requirement
that the contribution be exclusively for conservation
purposes is also intended to limit deductible
contributions to those transfers which require that the
donee hold the easement * * * exclusively for
conservation purposes (i.e., that they not be
transferable by the donee in exchange for money, other
property, or services). [H. Conf. Rept. 95-263, at 30-
31 (1977), 1977-1 C.B. 519, 523.]
Congress again drew attention to the protection of a contributed
conservation easement in the Act of Dec. 17, 1980 (1980 Act),
Pub. L. 96-541, sec. 6(a), 94 Stat. 3206, which extended
permanently the deduction for a charitable contribution of a
qualified conservation easement.11 The Senate report
accompanying the enactment stated:
The bill retains the present law requirement that
contributions be made “exclusively for conservation
purposes.” Moreover, the bill explicitly provides that
this requirement is not satisfied unless the
conservation purpose is protected in perpetuity. The
contribution must involve legally enforceable
restrictions on the interest in the property retained
by the donor that would prevent uses of the retained
interest inconsistent with the conservation purposes.
* * *
* * * * * * *
11
As amended in 1977, the provisions of former sec.
170(f)(3)(B)(iii) (excepting from the partial interest limitation
a taxpayer’s contribution of a qualified conservation easement)
did not apply to contributions made after June 13, 1981. TRSA
1977 sec. 309(b)(1), 91 Stat. 154. In the 1980 Act sec. 6(c), 94
Stat. 3207, Congress effectively made permanent the deduction for
such a contribution.
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By requiring that the conservation purpose be
protected in perpetuity, the committee intends that the
perpetual restrictions must be enforceable by the donee
organization (and successors in interest) against all
other parties in interest (including successors in
interest). * * *
* * * The requirement that the conservation
purpose be protected in perpetuity also is intended to
limit deductible contributions to those transfers which
require that the donee (or successor in interest) hold
the conservation easement (or other restriction) or
other property interests exclusively for conservation
purposes (i.e., that they not be transferable by the
donee except to other qualified organizations that also
will hold the perpetual restriction or property
exclusively for conservation purposes). [S. Rept. 96-
1007, at 13-14 (1980), 1980-2 C.B. 599, 605-606.]
The Secretary published final regulations interpreting section
170(h)(5) on January 14, 1986. T.D. 8069, 1986-1 C.B. 89. These
regulations in relevant part interpret section 170(h)(5)(A) as
follows:
§ 1.170A-14. Qualified conservation contributions. * * *
* * * * * * *
(g) Enforceable in perpetuity--(1) In general.--In
the case of any donation under this section, any
interest in the property retained by the donor (and the
donor’s successors in interest) must be subject to
legally enforceable restrictions (for example, by
recordation in the land records of the jurisdiction in
which the property is located) that will prevent uses
of the retained interest inconsistent with the
conservation purposes of the donation. * * *
(2) Protection of a conservation purpose in case
of donation of property subject to a mortgage.--In the
case of conservation contributions made after February
13, 1986, no deduction will be permitted under this
section for an interest in property which is subject to
a mortgage unless the mortgagee subordinates its rights
in the property to the right of the qualified
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organization to enforce the conservation purposes of
the gift in perpetuity. For conservation contributions
made prior to February 14, 1986, the requirement of
section 170(h)(5)(A) is satisfied in the case of
mortgaged property (with respect to which the mortgagee
has not subordinated its rights) only if the donor can
demonstrate that the conservation purpose is protected
in perpetuity without subordination of the mortgagee’s
rights.
(3) Remote future event.--A deduction shall not be
disallowed under * * * 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.
See paragraph (e) of § 1.170A-1. For example, a
state’s statutory requirement that use restrictions
must be rerecorded every 30 years to remain enforceable
shall not, by itself, render an easement nonperpetual.
* * * * * * *
(6) Extinguishment.--(i) In general.--If a
subsequent unexpected change in the conditions
surrounding the property that is the subject of a
donation under this paragraph can make impossible or
impractical the continued use of the property for
conservation purposes, the conservation purpose can
nonetheless be treated as protected in perpetuity if
the restrictions are extinguished by judicial
proceeding and all of the donee’s proceeds (determined
under paragraph (g)(6)(ii) of this section) from a
subsequent sale or exchange of the property are used by
the donee organization in a manner consistent with the
conservation purpose of the original contribution.
(ii) Proceeds.--In case of a donation made after
February 13, 1986, for a deduction to be allowed under
this section, at the time of the gift the donor must
agree that the donation of the perpetual conservation
restriction gives rise to a property right, immediately
vested in the donee organization, with a fair market
value that is at least equal to the proportionate value
that the perpetual conservation restriction at the time
of the gift, bears to the value of the property as a
whole at that time. * * * For purposes of this
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paragraph (g)(6)(ii), that proportionate value of the
donee’s property rights shall remain constant.
Accordingly, when a change in conditions gives rise to
the extinguishment of a perpetual conservation
restriction under paragraph (g)(6)(i) of this section,
the donee organization, on a subsequent sale, exchange,
or involuntary conversion of the subject property, must
be entitled to a portion of the proceeds at least equal
to that proportionate value of the perpetual
conservation restriction, unless state law provides
that the donor is entitled to the full proceeds from
the conversion without regard to the terms of the prior
perpetual conservation restriction.
With our understanding of the origins of section
170(h)(5)(A) and its relevant legislative history and regulatory
interpretation in mind, we now return to the question of whether
the donated property was protected in perpetuity. Respondent
argues that the conservation purpose of the donated property is
not protected in perpetuity because NAT was not guaranteed a
proportionate share of proceeds in the event of a casualty or
condemnation before the mortgage held by First Republic Bank was
satisfied.12 Petitioner argues that the terms of the deed of
easement and New York law guarantee NAT’s right to receive a
proportionate share of future proceeds in the event of a casualty
or condemnation and that section 1.170A-14(g)(6)(ii), Income Tax
Regs., is therefore satisfied. We agree with respondent.
We recently decided whether taxpayers were entitled to a
deduction for the claimed charitable contribution of an easement
12
Respondent does not assert that LLC failed to meet the
subordination requirement of sec. 1.170A-14(g)(2), Income Tax
Regs.
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under similar facts in Kaufman v. Commissioner, 134 T.C. 182
(2010) (Kaufman I). In Kaufman I, the taxpayers contributed to a
donee organization a facade easement on a single-family rowhouse
which they owned in a historic preservation district in Boston.
At the time of contribution, the property was subject to a
mortgage which entitled the mortgagee to a “prior claim” to all
proceeds of condemnation and to all insurance proceeds resulting
from any casualty of the property. The taxpayers claimed a
charitable contribution deduction equal to the value they
assigned to the facade easement, and the Commissioner disallowed
that deduction.
In Kaufman I the Commissioner moved for summary judgment,
and we granted that motion insofar as it related to the
deductibility of the contribution of the easement. We held as a
matter of law that the facade easement was not protected in
perpetuity because the donee organization was not guaranteed a
proportionate share of proceeds in the event of casualty or
condemnation as required by section 1.170A-14(g)(6)(ii), Income
Tax Regs. We noted that the taxpayers could not avoid the
unconditional requirement that the donee organization “must” be
entitled to its proportionate share of future proceeds by showing
that they would most likely be able to satisfy their mortgage and
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their obligations to the donee organization.13 We believe our
Opinion in Kaufman I to be squarely on point.
As in Kaufman I, the lender agreement here is clear that
First Republic Bank retained a “prior claim” to all condemnation
and insurance proceeds “in preference” to NAT “until” that
mortgage was satisfied and discharged. Thus, at any point before
the mortgage was repaid, the possibility existed for First
Republic Bank to deprive NAT of value that should have otherwise
been dedicated to the conservation purpose. Such would be the
case, for example, if the servient property was substantially or
completely destroyed and no significant value remained in that
property after the mortgage was satisfied. Under such
circumstances, the right of NAT to a proportionate share of the
future proceeds of a condemnation or casualty would not be
guaranteed. LLC’s contribution of the donated property thus
fails to comply with the enforceability in perpetuity
requirements of section 1.170A-14(g)(6)(ii), Income Tax Regs. We
find that LLC’s contribution was not protected in perpetuity and
therefore not a qualified conservation contribution under section
170(h)(1).
Petitioner argues that notwithstanding the mortgage on the
property, the conservation purpose of the donated property is
13
The taxpayers moved the Court to reconsider our grant of
partial summary judgment, a motion which we denied in Kaufman v.
Commissioner, 136 T.C. __ (2011) (Kaufman II).
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also protected in perpetuity under New York law. Petitioner
relies on N.Y. Real Prop. Acts. Law sec. 1951(2) (McKinney 2008),
which petitioner believes “requires” that NAT be compensated
before the easement may be extinguished. We are not persuaded.
N.Y. Real Prop. Acts. Law sec. 1951(2) authorizes a New York
court to extinguish an easement where the easement “is of no
actual and substantial benefit to the persons seeking its
enforcement or seeking a declaration or determination of its
enforceability, * * * [because] by reason of changed conditions
or other cause, its purpose is not capable of accomplishment, or
for any other reason”. That section further provides that an
easement adjudged unenforceable shall be “completely
extinguished” upon payment of damages, if any, which the person
entitled to enforce the easement would sustain from the
extinguishment of that easement.
Petitioner argues that LLC has satisfied the requirement of
section 1.170A-14(g)(6)(ii), Income Tax Regs., because a New York
court “may” adjudge the facade easement unenforceable, entitling
the beneficiary of the easement to compensation. See N.Y. Real
Prop. Acts. Law sec. 1951(2). But as we have discussed above and
in Kaufman I and II, section 1.170A-14(g)(6)(ii), Income Tax
Regs., requires that NAT “must” be entitled to its proportionate
share of proceeds in the event the easement is extinguished.
Petitioner cannot avoid the unconditional requirement of section
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1.170A-14(g)(6)(ii), Income Tax Regs., by showing that a New York
court might adjudge the facade easement unenforceable, especially
where, as here, petitioner has not established that NAT would
sustain or recover actual damages in the event of extinguishment.
B. Section 170(h)(4)
We are also not convinced that the donated property
satisfies the requirements of section 170(h)(4). Under section
170(h)(4)(A)(iv), a contribution is for a conservation purpose if
it preserves a historically important land area or a certified
historic structure. See Glass v. Commissioner, 124 T.C. at 277-
278; see also sec. 1.170A-14(d)(1), Income Tax Regs. A
“certified historic structure” includes a building which is in a
registered historic district and is certified by the Secretary of
the Interior as being of historic significance to the district.
Sec. 1.170A-14(d)(5)(iii), Income Tax Regs. The subject property
is a “certified historic structure” because it is within the
Metropolitan Museum Historic District and was certified as such
by the U.S. Department of the Interior National Park Service.
Petitioner’s entitlement to a deduction for a contribution of the
donated property, therefore, depends on whether the transfer of
the donated property in fact preserved the subject property. See
Herman v. Commissioner, T.C. Memo. 2009-205.
By virtue of its location in the Metropolitan Museum
Historic District, New York City law makes it unlawful for LLC to
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alter the subject property unless LPC approves that alteration.
N.Y. City Admin. Code sec. 25-305(a)(1) (2002). In determining
whether to allow such an alteration, the LPC must consider
whether the alteration would “change, destroy or affect any
exterior architectural feature” of the subject property and, in
the case of an improvement, “whether such construction would
affect or not be in harmony with the external appearance of
other, neighboring improvements”. Id. sec. 25-306(a)(1). This
determination would of course consider not only the external
appearance of the subject property’s facade but also the ability
of LLC to alter the aesthetics of the subject property by
building above it. Thus it is local law and the rules of the LPC
that preserve the subject property and not the rights which NAT
possessed under the deed of easement. See Herman v.
Commissioner, supra. While petitioner argues that NAT’s
enforcement of the deed of easement affords additional meaningful
protection not already guaranteed by the LPC’s enforcement of
local law, petitioner has failed to persuade us that such is the
case.
C. Conclusion
We hold that LLC’s contribution of the donated property does
not comply with the requirements of section 170(h)(4) and (5).
Accordingly, LLC’s contribution of the donated property was not
made “exclusively for conservation purposes”, see sec. 170(h)(1),
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and LLC is not entitled to its claimed noncash charitable
contribution deduction under section 170(f)(3)(B)(iii).14
III. Accuracy-Related Penalty
Respondent determined that a 20-percent accuracy-related
penalty under section 6662(a) applies to any underpayment of tax
attributable to the $6,570,000 disallowance. Respondent
determined that the accuracy-related penalty was appropriate
because of negligence or disregard of rules or regulations, or
alternatively, because of a substantial understatement of income
tax. See sec. 6662(b)(1) and (2), (c), (d). Respondent bears
the burden of production on the applicability of this accuracy-
related penalty in that he must come forward with sufficient
evidence indicating that it is proper to impose it. See sec.
14
Respondent also determined that LLC did not properly
substantiate its claimed deduction for the noncash contribution
because none of the Haims appraisals were “qualified appraisals”
within the meaning of sec. 170(f)(11)(E) and sec. 1.170A-
13(c)(3), Income Tax Regs. To that end, respondent states that
the 2004 appraisal was prepared more than 60 days before the date
of contribution; the 2004 and 2005 appraisals did not value the
donated property as of the date of the contribution; and the 2009
appraisal was obtained long after the due date (including
extensions) of the return on which the deduction was claimed. We
agree with this determination. Sec. 170(f)(11)(D) requires that
a “qualified appraisal” be attached to the tax return reporting a
noncash contribution of more than $500,000, and LLC did not meet
this requirement for the reasons stated by respondent as to this
issue. We add that the appraisals also failed to be “qualified
appraisals” for the reasons set forth in Scheidelman v.
Commissioner, T.C. Memo. 2010-151. Whereas petitioner relies
upon the doctrine of substantial compliance to offset
petitioner’s noncompliance with any applicable requirement for
characterizing an appraisal as a “qualified appraisal”, we do not
do so. See id.
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7491(c); see also Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Once respondent meets this burden, the burden of proof
remains with petitioner, including the burden of proving that the
penalty is inappropriate because of reasonable cause. See Higbee
v. Commissioner, supra at 446-447. The facts of this case lead
us to conclude that respondent has met his burden of production
with respect to the accuracy-related penalty.
Petitioner argues that the accuracy-related penalty does not
apply because LLC meets the reasonable cause defense of section
6664(c)(1). Pursuant to that section, the 20-percent accuracy-
related penalty of section 6662(a) does not apply to any portion
of an underpayment for which petitioner establishes that LLC,
through Mr. Asser: (1) Had reasonable cause; and (2) acted in
good faith.15 Whether Mr. Asser acted with reasonable cause and
in good faith turns on the extent to which he, in the light of
his experience, knowledge, and education, tried to assess the
proper tax treatment of the contribution of the donated property.
See sec. 1.6664-4(b)(1), Income Tax Regs. Reasonable cause may
exist where a position taken on a return involves an issue that
was novel at the time the return was filed. See Bunney v.
15
We determine the application of this defense in this
partnership-level proceeding because petitioner claims that the
defense applies on account of the actions of Mr. Asser as LLC’s
managing member and tax matters partner. See Whitehouse Hotel
Ltd. Pship. v. Commissioner, 131 T.C. 112, 173 (2008), vacated
and remanded on another issue 615 F.3d 321 (5th Cir. 2010);
Tigers Eye Trading, LLC v. Commissioner, T.C. Memo. 2009-121; see
also sec. 301.6221-1(c), Proced. & Admin Regs.
- 29 -
Commissioner, 114 T.C. 259, 266 (2000); Lemishow v. Commissioner,
110 T.C. 110, 114 (1998); cf. Van Camp & Bennion v. United
States, 251 F.3d 862, 868 (9th Cir. 2001) (“Where a case is one
‘of first impression with no clear authority to guide the
decision makers as to the major and complex issues,’ a negligence
penalty is inappropriate.” (quoting Foster v. Commissioner, 756
F.2d 1430, 1439 (9th Cir. 1985), affg. in part and vacating as to
an addition to tax for negligence 80 T.C. 34 (1983))).
We agree with petitioner that Mr. Asser made a reasonable
attempt to comply with the Internal Revenue Code and that he
acted in good faith. We understand that Kaufman I is the first
time that a court has considered the effect of a mortgage on a
contribution of an easement claimed to be a qualified
conservation contribution. That interpretation of the relevant
regulation was not published until more than 4 years after Mr.
Asser filed the 2004 return. We do not believe that the
regulations interpreting the perpetuity requirement of section
170(h)(5) are so crystal clear and unambiguous as to make the
imposition of the accuracy-related penalty appropriate. We also
find that Mr. Asser acted in good faith by securing three
separate appraisals of the donated property and disclosing the
contribution of that property on LLC’s 2004 return. See Rolfs v.
Commissioner, 135 T.C. 471 (2010). Accordingly, in the light of
all of the facts and circumstances, we find that Mr. Asser acted
- 30 -
reasonably and in good faith and hold that LLC is not liable for
an accuracy-related penalty under section 6662(a).
IV. Conclusion
We have considered all arguments made by petitioner for a
contrary holding as to the deficiency, and we have considered all
arguments made by respondent for a contrary holding as to the
accuracy-related penalty. To the extent that we have not
discussed those arguments above, we have rejected them as moot,
irrelevant, or without merit.
Decision will be entered
for respondent as to the
deficiency and for petitioner
as to the accuracy-related
penalty.