United States Tax Court
T.C. Memo. 2023-73
MURFAM ENTERPRISES LLC,
WENDELL MURPHY, JR., TAX MATTERS PARTNER,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 8039-16. Filed June 15, 2023.
—————
M, a TEFRA partnership, owned a rural,
undeveloped tract of land (“Tract”) that had been granted
certificates by State authorizing hog-farming activities.
Rather than using these certificates to construct and
operate a hog farm, M donated by deed in 2010 a perpetual
conservation easement (constituting a “qualified real
property interest” under I.R.C. § 170(h)(1)(A)) on Tract to
T (a “qualified organization” under I.R.C. § 170(h)(1)(B)) for
“conservation purposes” under I.R.C. § 170(h)(1)(C).
Relying on an appraisal, M claimed a charitable
contribution deduction of $5,744,600 for a “qualified
conservation contribution” under I.R.C. § 170(h) on its tax
return, prepared by competent professionals who were
given all the information they requested. M’s expert
valued its deduction on the basis of the forgone value of the
hog-farming certificates attached to the Tract that were
rendered useless under the easement deed. Attached to the
return was an incomplete Form 8283, “Noncash Charitable
Contributions”, that did not report M’s basis in the Tract
and other information.
R examined M’s return and issued a Notice of Final
Partnership Administrative Adjustment (“FPAA”)
determining to reduce the deduction (but not to disallow it
Served 06/15/23
2
[*2] altogether). The FPAA asserted that the easement should
be valued according to the Tract’s use as timberland,
because it determined that the value of the hog-farming
certificates was zero. The FPAA did not assert any
penalties. M filed a petition in this Court challenging the
FPAA.
In his amended answer, R asserted (for the first
time, i.e., as “new matter”) accuracy-related penalties
under I.R.C. § 6662. Before trial, R also asserted (again, as
“new matter”) that M’s charitable contribution deduction
should be entirely disallowed for failure to comply with the
substantiation and reporting requirements for charitable
contribution deductions under I.R.C. § 170(f)(11). R agrees
he has the burden of proof as to “new matter”.
The issues for decision are (1) whether M failed to
comply with the substantiation and reporting
requirements of I.R.C. § 170(f)(11), and if so, whether that
failure is excusable for reasonable cause under I.R.C.
§ 170(f)(11)(A)(ii)(II); (2) the value of the easement granted
on the Tract; and (3) whether any penalty under I.R.C.
§ 6662 is applicable.
Held: M failed to comply (strictly or substantially)
with the substantiation and reporting requirements of
I.R.C. § 170(f)(11), but that failure was due to reasonable
cause because R failed to carry his burden to disprove
reasonable cause.
Held, further, the value of the easement granted on
the Tract is $5,637,207 (about $107,000 less than M
claimed)—which constitutes the forgone value of the hog-
farming certificates.
Held, further, to the extent applicable, any accuracy-
related penalty under I.R.C. § 6662 is excused by
reasonable cause under I.R.C. § 6664(c).
—————
3
[*3] David D. Aughtry, John W. Hackney, and Kristen S. Lowther, for
petitioners.
Amy Dyar Seals, Olivia Hyatt Rembach, Corey R. Clapper, and Ashley
M. Bender, for respondent.
TABLE OF CONTENTS
MEMORANDUM FINDINGS OF FACT AND OPINION ..................... 4
FINDINGS OF FACT .............................................................................. 6
The Murphy family ........................................................................... 6
Murfam and the Rose Tract ............................................................. 6
Murfam’s Rose Tract easement donation ........................................ 7
Valuing the Rose Tract easement .................................................... 8
Reporting the easement donation on Murfam’s 2010 return ......... 8
Examination, FPAA, and Tax Court proceedings ........................... 9
IRS examination and FPAA ..................................................... 9
Petition and answer ................................................................ 10
Trial of this case ...................................................................... 10
The value of the Rose Tract easement ........................................... 10
OPINION ................................................................................................ 11
I. Burden of proof ............................................................................... 11
A. The general rule ...................................................................... 11
B. The “new matter” exception.................................................... 11
1. The nature of “new matter” ............................................. 12
2. The “reasonable cause” defense as to “new matter”
penalty ............................................................................. 12
4
[*4] 3. The “reasonable cause” defense as to a “new matter”
substantiation issue under section 170(f)(11)(A)(i) ........ 13
II. Charitable contribution deduction under section 170 for
donation of a conservation easement ............................................. 15
A. Whether Murfam made a “qualified conservation
contribution” under section 170(h)(1)..................................... 15
B. Whether Murfam satisfied the substantiation
requirements of section 170(f)(11) and Treasury
Regulation § 1.170A-13(c) ....................................................... 16
1. A description of the requirements .................................. 16
2. Murfam’s noncompliance and reasonable cause ............ 17
C. The value of Murfam’s easement donation ............................ 24
1. The method of valuing the conservation easement ........ 24
2. The valuation of the Rose Tract easement ..................... 26
III. Penalties under section 6662 ......................................................... 31
A. Penalty principles ................................................................... 31
B. Section 6662 penalties with respect to Murfam .................... 32
1. Valuation misstatement penalty .................................... 32
2. Other accuracy-related penalty ...................................... 32
IV. Conclusion ....................................................................................... 34
MEMORANDUM FINDINGS OF FACT AND OPINION
GUSTAFSON, Judge: At issue is a charitable contribution
deduction for the donation in 2010 of a conservation easement by a
TEFRA partnership, 1 Murfam Enterprises, LLC (“Murfam”), to the
1 Before its repeal, see Bipartisan Budget Act of 2015, Pub. L. No. 114-74,
§ 1101(a), 129 Stat. 584, 625, the Tax Equity and Fiscal Responsibility Act of 1982
(“TEFRA”), Pub. L. No. 97-248, §§ 401–406, 96 Stat. 324, 648–71, governed the tax
5
[*5] North American Land Trust (“NALT”). Pursuant to section
6223(a)(2), 2 the IRS issued to Murfam an FPAA determining to reduce
from $5,744,600 to $446,000 the amount of the deduction claimed on
Murfam’s Form 1065, “U.S. Return of Partnership Income”, for the tax
year ending on January 1, 2011. 3 Wendell (“Dell”) Murphy, Jr., as tax
matters partner (“TMP”) of Murfam and thus as petitioner in this case,
timely filed a Petition for Readjustment of Partnership Items in this
Court challenging the determination.
After concessions, the remaining issues for decision are:
(1) whether Murfam’s tax return satisfied the substantiation and
reporting requirements of section 170(f)(11) for claiming the deduction;
(2) the fair market value of the easement; and (3) whether any accuracy-
related penalties under section 6662 are applicable. We hold (1) that
Murfam did not satisfy the reporting requirements of section 170(f)(11),
but that its failure to do so was for reasonable cause; (2) that the value
of the easement donated by Murfam was $5,637,207 (i.e., about $107,000
less than Murfam claimed on its return); and (3) that reasonable cause
exists under section 6664(c)(1) to excuse any section 6662 penalty.
treatment and audit procedures for many partnerships—including Murfam. TEFRA
partnerships are subject to special tax and audit rules. See I.R.C. §§ 6221–6234.
TEFRA requires the uniform treatment of all “partnership item[s]”—a term defined by
section 6231(a)(3)—and its general goal is to have a single point of adjustment for the
Internal Revenue Service (“IRS”) rather than having it make separate partnership-
item adjustments on each partner’s individual return. See H.R. Rep. No. 97-760,
at 599–601 (1982) (Conf. Rep.), as reprinted in 1982-2 C.B. 600, 662–63. If the IRS
decides to adjust any partnership items on a partnership return, it must notify the
individual partners of the adjustment by issuing a Notice of Final Partnership
Administrative Adjustment (“FPAA”). § 6223(a).
2 Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C., as in effect at the relevant times, regulation references are to
the Code of Federal Regulations, Title 26 (Treas. Reg.), as in effect at the relevant
times, and Rule references are to the Tax Court Rules of Practice and Procedure. Some
dollar amounts are rounded. A citation of a “Doc.” in this Opinion refers to a document
as numbered in the Tax Court docket record of this case, and a pinpoint citation therein
refers to the pagination as generated in the digital file.
3 Murfam reports its taxes according to a fiscal year ending on a Saturday,
which results in some years having more than 365 days and other years having fewer
than 365 days.
6
[*6] FINDINGS OF FACT
When its petition was filed, Murfam’s principal place of business
was in North Carolina. 4
The Murphy family
The Murphy family is a multi-generation farming family from
Bladen County, North Carolina, which has operations throughout the
country. The Murphy family is well known for its success and
innovation in the hog-farming industry, and Wendell Murphy, Sr. (the
patriarch of the family), helped develop various processes that became
industry-standard practices in hog farming. One such process is known
as ISO wean, or three-site production, in which farmers use separate
facilities during the various stages of hog farming (birth, growth, and
slaughter) to separate the animals and reduce the transmittal of
bacteria and potential diseases which affect swine differently depending
on their ages and immune systems. Wendell Murphy also taught
agriculture classes to high school students and was active in various
environmental projects and policy proposals submitted to the North
Carolina state legislature. Wendell remained actively involved in the
Murphys’ business until sometime around 2010, when he retired to
Florida. By that time his son, Dell Murphy, was managing the Murphys’
business, which included 50 hog-farming facilities as well as various real
estate projects and investments in North Carolina.
Murfam and the Rose Tract
The Murphy family formed Murfam in December 1999, and in
January 2000 Murfam obtained ownership of the “Rose Tract”—6,171
acres of undeveloped, rural land in Bladen County, North Carolina,
which is mostly covered with trees and has a few dirt roads. The State
of North Carolina granted certificates permitting 1,115 acres (i.e., about
18% of the area) of the Rose Tract to be used for hog farming. These
hog-farming certificates covered eight specific sites (i.e., fixed locations)
on the Rose Tract and regulated the extent of allowable hog farming (to
limit the volume of waste on the property), which it stated in terms of
the number of hogs to be permitted for a given stage of production. The
hog-farming certificates were “attached” to the Rose Tract, meaning that
the hog-farming rights they authorized passed to future grantees of the
4 Under section 7482(b)(1), venue for an appeal in this case would be the U.S.
Court of Appeals for the Fourth Circuit.
7
[*7] Rose Tract and could not be exercised on any other property. The
hog-farming certificates that were attached to the Rose Tract authorized
a 58,752-swine “feeder-to-finish” facility, but (important to the valuation
of the Rose Tract) could have been converted to a “farrow-to-wean”
facility. 5 If the hog-farming certificates had been converted to a “farrow-
to-wean” operation, the total number of sows permissible would have
been 19,538.
After 2007 (i.e., at the time of the donation at issue here), new
hog-farming certificates were no longer available to properties in North
Carolina, because of a state-imposed moratorium under which no new
certificates would be issued but existing certificates remained valid,
thus making the Rose Tract valuable for its possible use as a hog farm.
However, to use the hog-farming certificates, the owner would need to
prepare the Rose Tract by clearing trees, constructing various facilities,
and digging a lagoon for waste treatment. Although the Murphy family
could have taken the steps to construct and operate a hog farm on the
Rose Tract, they left it undeveloped and used it for recreational purposes
such as hunting.
Murfam’s Rose Tract easement donation
In 2010 the Murphy family donated five conservation
easements—one of which is the subject of this Opinion 6—to NALT, a
section 501(c)(3) charitable organization that is a “qualified
organization” for the purposes of section 170(h)(1)(B). The Murphys
donated the easement at issue (located on the Rose Tract) through
Murfam.
On December 27, 2010, ten years after it had first acquired the
Rose Tract, Murfam granted to NALT a deed of easement titled
“Conservation Easement and Declaration of Restrictions and
5The various stages of hog farming include “farrow-to-wean” (the stage from
the sow’s giving birth to a litter of piglets until that litter is weaned after six to eight
weeks) and “feeder-to-finish” (the stage during which a weaned pig grows to finished
weight).
6 The Commissioner initially challenged the deductibility of all five of the
conservation easements donated by the Murphy family, but he has since conceded that
the Murphys are entitled to charitable contribution deductions for two of them
(referred to by the parties as “Magnolia #3” and “Magnolia #4”). Two other
conservation easement donations are at issue in related cases (Docket Nos. 14536-16
and 14541-16) that were previously consolidated with the instant case for trial but now
are severed, to be addressed in a separate opinion.
8
[*8] Covenants” covering 1,115 acres of the Rose Tract. (We refer to this
deed as the “Rose Tract easement deed” and to the resulting easement
as the “Rose Tract easement”.) The Rose Tract easement covers the
same portions of the Rose Tract as the hog-farming certificates. The
Rose Tract easement deed was recorded with the State of North
Carolina, County of Duplin, on December 30, 2010. The Rose Tract
easement deed specifically prohibits any agricultural activities on the
Rose Tract pursuant to the hog-farming certificates. The deed required
the Murphy family to “proceed immediately to extinguish” the
certificates, and further provided that the certificates could not be
“transferred to any real property owned by Owner or other real property
in Bladen County.” The donation of the Rose Tract easement therefore
prevented the Murphy family (or its transferees) from ever using the
Rose Tract as a hog farm, thereby rendering the hog-farming certificates
useless.
Valuing the Rose Tract easement
Before making the conveyance, Murfam engaged Andrew Piner,
of Moore & Piner, LLC, to appraise the Rose Tract easement, and
Mr. Piner’s appraisal considered the value of the forgone rights under
the hog-farming certificates. As of Murfam’s contribution on December
27, 2010, the hog-farming certificates had not been (though they could
have been) converted from “feeder-to-finish” to “farrow-to-wean”.
Furthermore, the Murphy family had not constructed any hog farm
facilities on the Rose Tract, although the hog-farming certificates had
permitted the construction of such facilities on the Rose Tract without
an additional building permit.
Mr. Piner appraised the Rose Tract as of December 27, 2010,
using a “before and after” valuation method. He determined that the
highest and best use of the Rose Tract before the easement donation
would have been to convert the hog-farming certificates to a farrow-to-
wean facility, to construct the necessary facilities, and to grow timber
on the remaining acreage. On these assumptions, Mr. Piner ultimately
determined the value of the Rose Tract before donation of the easement
to be $10.5 million, computed the after value to be $4.8 million, and
reasoned that the easement therefore had a value of $5.7 million.
Reporting the easement donation on Murfam’s 2010 return
The Murphy family engaged Dixon Hughes Goodman (“Dixon
Hughes”)—one of the largest certified public accountancy (“CPA”) firms
9
[*9] in North Carolina—to prepare Murfam’s tax return for its tax year
ending January 1, 2011. Dixon Hughes requested from the Murphy
family all the information it deemed necessary to prepare Murfam’s
return, and the Murphy family provided to Dixon Hughes all the
information that the firm had requested. Dixon Hughes prepared
Murfam’s Form 1065 on the basis of the information received from the
Murphy family, and Murfam’s return was filed as it was prepared by
Dixon Hughes. Murfam’s return reported the donation of the Rose Tract
easement and claimed a corresponding charitable contribution
deduction of $5,744,600 (i.e., the value of the Rose Tract easement as
appraised by Mr. Piner).
Murfam’s return included Form 8283, “Noncash Charitable
Contributions”. The Form 8283 was signed by the appraiser, Mr. Piner;
it included the cover letter of his appraisal; and it was also signed by
Andrew L. Johnson, the president of NALT, the donee organization.
However, certain portions of the Form 8283 were either missing or
incomplete: Page 1 was not included. On Page 2, Part 1 of Section B did
not report the date or the manner in which the donor acquired the
property, the donor’s cost or adjusted basis in the property, or whether
the contribution was made as part of a bargain sale.
Examination, FPAA, and Tax Court proceedings
IRS examination and FPAA
The IRS examined Murfam’s 2010 return, and on December 21,
2015, the IRS issued to Dell Murphy, as Murfam’s TMP, an FPAA
determining to reduce Murfam’s charitable contributions by $5,298,600.
The FPAA included Form 886–A, “Explanation of Adjustments”, which
stated:
It has not been established that the value of the noncash
charitable contribution of a Qualified Conservation
Easement deducted on your return was $5,744,600. It is
determined that the value of the charitable contribution
attributable to the Qualified Conservation Easement is
$446,000; therefore, the charitable contribution is
decreased by $5,298,600 for the taxable year ended
January 01, 2011.
The FPAA issued to Murfam did not assert liability for any penalty, nor
did it determine to deny the charitable contribution deduction on the
basis of Murfam’s failure to fully complete Form 8283 (and thereby to
10
[*10] satisfy the substantiation and reporting requirements of section
170(f)(11)).
Petition and answer
Dell Murphy, as TMP, timely filed in the Tax Court a petition to
challenge the adjustment in the FPAA. In his answer, the
Commissioner asserted—for the first time—a gross valuation
misstatement penalty under section 6662(e) or (h) or, in the alternative,
an accuracy-related penalty under section 6662(a). Like the FPAA, the
Commissioner’s answer did not allege noncompliance with the
requirements of section 170(f)(11) to report in the return and attach to
the return certain information with respect to the taxpayer’s basis in the
donated property and the appraisal thereof. Rather, the Commissioner
first made this contention in his pretrial memorandum.
Trial of this case
This case was consolidated for trial with cases at Docket
Nos. 14536-16 and 14541-16 (pertaining to two other conservation
easements donated by the Murphy family through an S corporation in
2010), during which the parties offered expert reports and testimony
regarding the values of the Rose Tract easement. Additionally, the
Murphy family testified regarding their businesses and the preparation
of the tax returns in these cases.
The value of the Rose Tract easement
The parties agree, in principle, that the value of the Rose Tract
easement is in effect the value of the hog-farming certificates. Murfam
forfeited that value when it made the donation of the easement; but the
parties disagree about what that value is. In preparation for trial,
Murfam again engaged Mr. Piner to value the Rose Tract easement, and
the Commissioner engaged Matthew Hawk to value it. After due
consideration of the expert reports and testimony offered by both
parties, and for the reasons explained below in Part II.C.2, we find that
the highest and best use of the Rose Tract before the easement donation
was (as Murfam contends) operating a hog farm after converting the
hog-farming certificates for use as a farrow-to-wean facility (with timber
growing on the remaining acreage), and that the corresponding value of
the Rose Tract before the easement donation was $11,438,207. We find
that the highest and best use of the Rose Tract after the easement
11
[*11] donation was to grow timber, 7 and the parties agree that the value
of the Rose Tract after the easement donation was $5,801,000.
Therefore, we find that the fair market value of the Rose Tract easement
was $11,438,207 minus $5,801,000, or $5,637,207.
OPINION
I. Burden of proof
A. The general rule
Rule 142(a) provides that “[t]he burden of proof[8] shall be upon
the petitioner, except as otherwise provided by statute or determined by
the Court”. Generally, the IRS’s adjustments in an FPAA are presumed
to be correct, and the taxpayer bears the burden of proving them wrong.
See Welch v. Helvering, 290 U.S. 111, 115 (1933). Petitioner thus
generally bears the burden of proving Murfam’s entitlement to the
charitable deduction for qualified conservation contributions under the
applicable provisions of section 170. However, in this case the
Commissioner concedes that “[t]he Rose Tract conservation easement
contribution satisfies the requirements of Internal Revenue Code
section 170(h)(1)(C)” and that “[t]here is no issue in concern to the
conservation purpose of the Rose Tract donation by Murfam
Enterprises, LLC.” Consequently, petitioner bears only the remaining
burden of proving the value of the Rose Tract conservation easement.
B. The “new matter” exception
The general rule that the taxpayer bears the burden of proof is
subject to an exception that affects the outcome of some issues in this
case: Not the taxpayer but the Commissioner bears the burden of proof
7 The value of timber on the Rose Tract before easement donation was the same
as the timber value after the easement donation, therefore not affecting the valuation
of the Rose Tract easement.
8 As to burden of production, section 7491(c) provides that the Commissioner
“shall have the burden of production in any court proceeding with respect to the
liability of any individual for any penalty, addition to tax, or additional amount”.
(Emphasis added.) However, section 7491(c) does not apply to TEFRA partnership-
level proceedings (such as this case). See Dynamo Holdings Ltd. P’ship v.
Commissioner, 150 T.C. 224, 234 (2018). Consequently, as a general rule, in a TEFRA
partnership case the petitioner has not only the burden proof but also the burden of
production, even as to any penalty.
12
[*12] “in respect of any new matter, increases in deficiency, and
affirmative defenses, pleaded in the answer”. Rule 142(a).
1. The nature of “new matter”
“A new theory that is presented to sustain a deficiency is treated
as a new matter when it either [1] alters the original deficiency or
[2] requires the presentation of different evidence. A new theory which
merely clarifies or develops the original determination is not a new
matter in respect of which respondent bears the burden of proof.” Wayne
Bolt & Nut Co. v. Commissioner, 93 T.C. 500, 507 (1989) (citations
omitted).
2. The “reasonable cause” defense as to “new matter”
penalty
Under section 6664(c)(1), “No penalty shall be imposed under
section 6662 or 6663 with respect to any portion of an underpayment if
it is shown that there was a reasonable cause[9] for such portion and that
the taxpayer acted in good faith with respect to such portion.”
(Emphasis added.) Where the Commissioner asserts a penalty for the
first time as “new matter” in his answer and reasonable cause is at issue,
the Commissioner’s burden of proof on the imposition of that penalty
includes showing the absence of “reasonable cause”. See, e.g., RERI
Holdings I, LLC v. Commissioner, 149 T.C. 1, 38–40 (2017), aff’d sub
nom. Blau v. Commissioner, 924 F.3d 1261 (D.C. Cir. 2019); Rader v.
Commissioner, 143 T.C. 376, 389 (2014), aff’d in part, appeal dismissed
in part, 616 F. App’x 391 (10th Cir. 2015); Arnold v. Commissioner, T.C.
Memo. 2003-259, 86 T.C.M. (CCH) 341, 344; Collins v. Commissioner,
T.C. Memo. 1994-409, 68 T.C.M. (CCH) 484, 488; Taylor v.
Commissioner, T.C. Memo. 1989-201, 57 T.C.M. (CCH) 276, 279–80;
Pickett v. Commissioner, T.C. Memo. 1975-33, 34 T.C.M. (CCH) 213, 224;
Bruner Woolen Co. v. Commissioner, 6 B.T.A. 881, 882 (1927).
In this case, the FPAA included no penalty determination.
Rather, the Commissioner first asserted penalties in an amended
answer to the petition that pleaded liability for gross valuation
9 In addition to the “reasonable cause” exception of section 6664(c), a
“reasonable basis” provision built into the very definition of a penalty-incurring
“substantial understatement” in section 6662(d)(2)(B)(ii)(II) states that “[t]he amount
of the understatement . . . shall be reduced by that portion of the understatement which
is attributable to . . . any item if . . . there is a reasonable basis for the tax treatment
of such item by the taxpayer.” (Emphasis added.)
13
[*13] misstatement penalties under section 6662(e) and (h), or in the
alternative, accuracy-related penalties under section 6662(a). Because
the penalties asserted by the Commissioner in his amended answer
would increase the liability determined in the FPAA issued to Murfam,
they are “new matter” for which the Commissioner bears the overall
burden of proof. That burden includes the burden to prove the absence
of “reasonable cause”. See Rader, 143 T.C. at 389; Arnold, 86 T.C.M.
(CCH) at 344; Bruner Woolen Co., 6 B.T.A. at 882.
3. The “reasonable cause” defense as to a “new matter”
substantiation issue under section 170(f)(11)(A)(i)
A second “reasonable cause” provision is also significant in this
case. As is explained below in greater detail in Part II.B, the Code has
a demanding regime for substantiating charitable contribution
deductions like the ones at issue here. Section 170(f)(11) and Treasury
Regulation § 1.170A-13(c)(2)(i)(B) require that the taxpayer “[a]ttach a
fully completed appraisal summary” (emphasis added) to his return, and
that appraisal summary is to include “[t]he cost or other basis of the
property”. Id. subpara. (4)(ii)(E). If a donor fails to meet these
requirements, then section 170(f)(11)(A)(i) provides that “no deduction
shall be allowed”.
However, there is an exception to this disallowance.
Section 170(f)(11)(A)(ii)(II) provides that the taxpayer’s deduction will
not be disallowed “if it is shown that the failure to meet such
requirements is due to reasonable cause and not to willful neglect”; and
“reasonable cause” is, of course, the same phrase we mentioned in
Part I.B.2 above in connection with penalties, where we showed that a
shift in the burden of proof as to a penalty affects the burden of proof as
to a “reasonable cause” defense to that penalty. This Court has not
previously addressed explicitly the question of the burden of proof on the
“reasonable cause” defense when the Commissioner raises the issue of
noncompliance with section 170(f)(11) as “new matter” in litigation and
reasonable cause for the noncompliance is at issue. But in Belair Woods
we considered the relatedness of the section 170(f)(11)(A)(ii)(II)
“reasonable cause” defense to the “reasonable cause” defense in the
penalty context, and we concluded that the same standard—“ordinary
business care and prudence”, United States v. Boyle, 469 U.S. 241, 246
(1985) (quoting Treas. Reg. § 301.6651-1(c)(1))—should apply in both
instances, see Belair Woods, LLC v. Commissioner, T.C. Memo. 2018-
159, at *22–23 (first citing Alli v. Commissioner, T.C. Memo. 2014-15,
14
[*14] at *60–61; and then citing Crimi v. Commissioner, T.C. Memo.
2013-51, at *98–99).
Consistent with that conclusion in Belair Woods that penalty
principles properly inform our construction of “reasonable cause” under
the substantiation provisions of section 170(f)(11)(A)(ii)(II), we hold that
the determination of which party bears the burden of proof on
reasonable cause under the substantiation provisions depends (as it
does for penalty liability) on whether the Commissioner’s contention of
noncompliance with the substantiation provisions is new matter. If the
Commissioner’s contention about noncompliance with the
substantiation requirements of section 170(f)(11) is new matter, then he
bears the burden on that contention and on the “reasonable cause”
defense to it—i.e., the Commissioner must prove the absence of
reasonable cause.
This shift in the burden of proof occurs here. As we discuss below
in Part II.B.2, the Commissioner argues that Murfam’s charitable
contribution deduction should be entirely disallowed because of
Murfam’s failure to comply with the substantiation requirements of
section 170(f)(11)(C) and Treasury Regulation § 1.170A-13(c)(2) and (4),
since Murfam did not attach a “fully completed appraisal summary” on
Form 8283 to its tax return; and the Commissioner denies the existence
of “reasonable cause” for that noncompliance under
section 170(f)(11)(A)(ii)(II). The Commissioner first made this
contention not in the FPAA, not in his answer to the petition nor in his
amended answer, but rather in his pretrial memorandum. We conclude
that compliance with the appraisal summary requirement of
section 170(f)(11)(C) and Treasury Regulation § 1.170A-13(c)(2) and (4)
was “new matter” at the trial of this case; and we further conclude,
guided by our penalty jurisprudence as we construe and apply the
section 170(f)(11)(A)(ii)(II) reasonable cause defense, that the
Commissioner’s burden includes showing that the failure to fully
complete the appraisal summary was not due to reasonable cause or was
due to willful neglect. See Belair Woods, LLC, T.C. Memo. 2018-159,
at *22–23; Alli, T.C. Memo. 2014-15, at *60–61; Crimi, T.C. Memo.
2013-51, at *98–99.
The FPAA issued to Murfam, quoted above at page 9, determined
that a deduction under section 170(h) is allowable, but for a significantly
lesser amount than what Murfam claimed on its return. The FPAA
therefore states the grounds for its determination as valuation, and (as
15
[*15] stated above) Murfam bears the burden to prove the value of the
charitable contribution deduction claimed on its return.
However, the Commissioner’s appraisal summary theory, if
correct, would deny the charitable contribution deduction entirely, see
§ 170(f)(11)(A)(i), would accordingly increase the deficiency beyond the
determination in the FPAA, and would require different evidence (to
prove reasonable cause for the noncompliance). For this reason, the
Commissioner’s appraisal summary theory is new matter for which he
bears the overall burden of proof, including showing a lack of reasonable
cause for Murfam’s noncompliance.
II. Charitable contribution deduction under section 170 for donation
of a conservation easement
To show its entitlement to the charitable contribution deduction
at issue, Murfam must (a) show that it made a qualifying contribution,
(b) show that it satisfied (or is excused from) the substantiation
requirements for such a contribution, and (c) prove the value of the
contribution. We discuss each of these issues in turn.
A. Whether Murfam made a “qualified conservation
contribution” under section 170(h)(1)
Section 170(a)(1) allows a deduction for any charitable
contribution made within the taxable year. The Code generally restricts
a taxpayer’s charitable contribution deduction for donations of “an
interest in property which consists of less than the taxpayer’s entire
interest in such property”. § 170(f)(3)(A). That is, if someone owns
property and donates to charity only a partial interest in that property,
he may not claim a charitable contribution deduction for that donation.
However, the statute provides an exception—and allows a deduction—
for a “qualified conservation contribution”. § 170(f)(3)(B)(iii). Section
170(h)(1) defines a “qualified conservation contribution” to be (1) the
contribution of a “qualified real property interest,” (2) to a “qualified
organization,” (3) “exclusively for conservation purposes.” In this case
there is no dispute that the Rose Tract easement contribution meets
these three requirements.
16
[*16] B. Whether Murfam satisfied the substantiation requirements
of section 170(f)(11) and Treasury Regulation
§ 1.170A-13(c)
1. A description of the requirements
“A charitable contribution shall be allowable as a deduction only
if verified under regulations prescribed by the Secretary.” § 170(a)(1).
Section 170(f)(11) imposes, for charitable contribution deductions,
heightened substantiation requirements on taxpayers depending on the
value of the contribution. 10 Section 170(f)(11)(A)(i) provides that “no
deduction shall be allowed . . . for any contribution of property for which
a deduction of more than $500 is claimed unless such person meets the
requirements of subparagraphs (B) [for deductions greater than $500],
(C) [for deductions greater than $5,000], and (D) [for deductions greater
than $500,000], as the case may be, with respect to such contribution.”
For contributions of $500 or more, a taxpayer must attach “a description
of such property and such other information as the Secretary may
require”. § 170(f)(11)(B). For contributions of $5,000 or more, a
taxpayer must also obtain “a qualified appraisal of such property” and
attach to the return “such information regarding such property and such
appraisal as the Secretary may require”. § 170(f)(11)(C). Accordingly,
Treasury Regulation § 1.170A-13(c)(2)(i) provides:
10 In the Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369, § 155(a)(1)
and (2), 98 Stat. 494, 691—an off-Code statutory provision—Congress directed the
Secretary to issue regulations under section 170(a)(1) “which require any individual,
closely held corporation, or personal service corporation claiming a deduction under
section 170” greater than $5,000 to “obtain a qualified appraisal for the property
contributed,” “attach an appraisal summary to the return on which such deduction is
first claimed for such contribution,” and “include on such return such additional
information (including the cost basis and acquisition date of the contributed property)
as the Secretary may prescribe in such regulations.” In response to DEFRA’s directive,
the Secretary added paragraph (c) to Treasury Regulation § 1.170A-13. But in the
American Jobs Creation Act of 2004, Pub. L. No. 108-357, § 883(a), 118 Stat. 1418,
1631, Congress added paragraph (11) to subsection (f) of section 170 to “extend[] to all
C corporations the present and prior law requirement, applicable to an individual,
closely-held corporation, personal service corporation, partnership, or S corporation,
that the donor must obtain a qualified appraisal of the property if the amount of the
deduction claimed exceeds $5,000.” Staff of J. Comm. On Taxation, 108th Cong.,
General Explanation of Tax Legislation Enacted in the 108th Congress, at 462 (Comm.
Print 2005). “The Act also provide[d] that if the amount of the contribution of property
. . . exceeds $500,000, then the donor (whether an individual, partnership, or
corporation) must attach the qualified appraisal to the donor’s tax return.” Id.
17
[*17] [A] donor who claims or reports a deduction with respect to
a charitable contribution to which this paragraph (c)
[entitled “Deductions in excess of $5,000 for certain
charitable contributions of property made after
December 31, 1984”] applies must comply with the
following three requirements:
(A) Obtain a qualified appraisal (as defined in
paragraph (c)(3) of this section) for such property
contributed. If the contributed property is a partial
interest, the appraisal shall be of the partial
interest.
(B) Attach a fully completed appraisal
summary (as defined in paragraph (c)(4) of this
section) to the tax return (or, in the case of a donor
that is a partnership or S corporation, the
information return) on which the deduction for the
contribution is first claimed (or reported) by the
donor.
(C) Maintain records containing the
information required by paragraph (b)(2)(ii) of this
section.
Under Treasury Regulation § 1.170A-13(c)(4)(ii), the required appraisal
summary must include, among other things, the following information:
(1) the date the donor acquired the property; (2) the cost or other basis
of the property; and (3) the date the donee received the property. Treas.
Reg. § 1.170A-13(c)(4)(ii)(D), (E), (G). For contributions of $500,000 or
more, a taxpayer must also attach the “qualified appraisal of such
property” to the return. § 170(f)(11)(D). However, as is explained above
in Part I.B.3, a taxpayer’s deduction will not be disallowed for failure to
comply with the heightened substantiation requirements of section
170(f)(11) “if it is shown that the failure to meet such requirements is
due to reasonable cause and not to willful neglect.” § 170(f)(11)(A)(ii)(II).
2. Murfam’s noncompliance and reasonable cause
Because section 170(f)(11)(A)(i) entirely disallows a claimed
charitable contribution deduction unless a taxpayer complies with its
substantiation rules, we consider first whether Murfam met the
substantiation requirements with respect to the easement donation at
issue. We conclude that Murfam did not satisfy the substantiation
requirements of section 170(f)(11) either strictly or substantially, but
that their failure to do so should be excused for reasonable cause
18
[*18] because the Commissioner failed to prove an absence of reasonable
cause.
a. Strict compliance
Although Murfam acknowledges that it did not report its cost
basis in the donated easement on the Form 8283 attached to its return,
as required by Treasury Regulation § 1.170A-13(c)(4)(ii)(E), it
nonetheless insists that it strictly complied with section 170(f)(11)(C)
because it provided its cost basis elsewhere (but nonetheless) “on such
return” (quoting DEFRA § 155(a)(1)(C)). Specifically, Murfam asserts
that the IRS could have deduced its cost basis in the donated easements
either by looking on Schedule L, “Balance Sheet per Books”, at line 12,
“Land (net of any amortization)”, and subtracting the beginning of year
amount from the end of year amount, or alternatively by looking at
statement 11 from Schedule M–1, “Reconciliation of Income (Loss) per
Books With Income (Loss) per Return”, and subtracting its reported
values from the claimed charitable contribution amounts on Form 8283.
We rejected a similar argument in Belair Woods, LLC, T.C.
Memo. 2018-159, at *19–20 (citations omitted), in which we held:
The regulations require that “an appraisal summary shall
include” information concerning basis. The explicit
disclosure of basis on Form 8283 is essential in alerting the
Commissioner as to whether (and to what extent) further
investigation is needed.
The IRS reviews millions of returns each year for
audit potential, and the disclosure of cost basis on the
Form 8283 itself is necessary to make this process
manageable. Revenue agents cannot be required to sift
through dozens or hundreds of pages of complex returns
looking for clues about what the taxpayer’s cost basis might
be.
Because section 170(f)(11)(C) and Treasury Regulation
§ 1.170A-13(c)(4)(i)(A) and (ii)(E) require that a donor’s cost basis be
reported on Form 8283, and Murfam’s Form 8283 left the donor’s basis
box blank, Murfam did not strictly comply with the reporting
requirements of section 170(f)(11).
19
[*19] b. Substantial compliance
Thirty years ago we held in Bond v. Commissioner, 100 T.C. 32,
41–42 (1993), that some of the reporting requirements of Treasury
Regulation § 1.170A-13(c) are “directory and not mandatory”, so that a
donor’s failure to comply strictly with those requirements may be
excused if the donor nonetheless demonstrates “substantial
compliance”. To determine whether a taxpayer has substantially
complied with the reporting requirements of Treasury Regulation
§ 1.170A-13(c), we “consider whether [the taxpayers] provided sufficient
information to permit [the IRS] to evaluate their reported contributions,
as intended by Congress.” Smith v. Commissioner, T.C. Memo. 2007-
368, 94 T.C.M. (CCH) 574, 586 (first citing Bond, 100 T.C. 32; and then
citing Hewitt v. Commissioner, 109 T.C. 258 (1997), aff’d per curiam
without published opinion, 166 F.3d 332 (4th Cir. 1998)), aff’d, 364
F. App’x 317 (9th Cir. 2009).
However, we observed in RERI Holdings I, 149 T.C. at 16–17:
[B]ecause RERI’s omission of its basis . . . from the Form
8283 it attached to its 2003 return prevented the appraisal
summary from achieving its intended purpose, RERI’s
failure to meet the requirement of section
1.170A-13(c)(4)(ii)(E), Income Tax Regs., cannot be excused
by substantial compliance. As explained above, Congress
directed the Secretary to adopt stricter substantiation
requirements for charitable contributions to alert the
Commissioner, in advance of audit, of potential
overvaluations of contributed property and thereby deter
taxpayers from claiming excessive deductions in the hope
that they would not be audited. S. Rpt. No. 98-169 (Vol. 1),
supra at 444; 1984 Blue Book, supra at 503–504; see also
Hewitt v. Commissioner, 109 T.C. at 264. . . . Because
RERI failed to provide sufficient information on its
Form 8283 to permit respondent to evaluate its reported
contribution, cf. Smith v. Commissioner, 2007 WL 4410771,
at *19, we cannot excuse on substantial compliance
grounds RERI’s omission from that form of its basis . . . .
Therefore, RERI did not “[a]ttach a fully completed
appraisal summary” to its 2003 return as required by
section 1.170A-13(c)(2)(i)(B), Income Tax Regs. Because
RERI did not meet the substantiation requirements
provided in section 1.170A-13(c)(2), Income Tax Regs., it is
20
[*20] not entitled to any deduction under section 170 . . . . See
sec. 170(a)(1); sec. 1.170A-13(c)(1), Income Tax Regs.
To the same effect, we followed RERI Holdings I in Belair Woods, LLC,
T.C. Memo. 2018-159, at *17, and determined:
The requirement to disclose “cost or adjusted basis,”
when that information is reasonably obtainable, is
necessary to facilitate the Commissioner’s efficient
identification of overvalued property. . . . Unless the
taxpayer complies with the regulatory requirement that he
disclose his cost basis and the date and manner of
acquiring the property, the Commissioner will be deprived
of an essential tool that Congress intended him to have.
Therefore, under the reasoning set forth in Belair Woods, LLC,
T.C. Memo. 2018-159, at *17–19, and RERI Holdings I, 149 T.C.
at 16–17, there can be no substantial compliance with Treasury
Regulation § 1.170A-13(c) where—as here—the taxpayer fails to
disclose its cost or adjusted basis in the contributed property on Form
8283. Because Murfam’s Form 8283 did not report its cost basis in the
contributed property, it failed to substantially comply with the reporting
requirements of Treasury Regulation § 1.170A-13(c), and its charitable
contribution deduction must be disallowed unless its failure was “due to
reasonable cause and not to willful neglect.” See § 170(f)(11)(A)(ii)(II).
c. Reasonable cause for noncompliance
Section 170(f)(11)(A)(ii)(II) provides that the taxpayer’s deduction
will not be disallowed “if it is shown that the failure to meet such
requirements is due to reasonable cause and not to willful neglect.” 11 As
11 As we explained in Belair Woods, LLC, T.C. Memo. 2018-159, at *22–23, the
statutory reasonable cause defense under section 170(f)(11)(A)(ii)(II) is broader than
the regulatory reasonable cause defense under Treasury Regulation § 1.170A-
13(c)(4)(iv)(C)(1), which provides:
If a taxpayer has reasonable cause for being unable to provide the
information required by paragraph (c)(4)(ii)(D) and (E) of this section
(relating to the manner of acquisition and basis of the contributed
property), an appropriate explanation should be attached to the
appraisal summary. The taxpayer’s deduction will not be disallowed
simply because of the inability (for reasonable cause) to provide these
items of information.
21
[*21] is noted above, we concluded in Belair Woods, LLC, T.C. Memo.
2018-159, at *22–23, that the same standard—“ordinary business care
and prudence”, Boyle, 469 U.S. at 246 (quoting Treas. Reg. § 301.6651-
1(c)(1))—should apply to both the reasonable cause defense in the
penalty context, see § 6664(c)(1); Treas. Reg. § 1.6664-4, and the
reasonable cause defense of section 170(f)(11)(A)(ii)(II). On the basis of
our allocation of the burden of proof above in Part I.B.3, the
Commissioner must show that Murfam’s failure to report cost basis in
the donated properties on its Forms 8283 was not due to reasonable
cause.
A frequent ground for claiming “reasonable cause”—and the
ground under consideration here—is reliance on professional advice.
“Reliance on . . . professional advice . . . constitutes reasonable cause and
good faith if, under all the circumstances, such reliance was reasonable
and the taxpayer acted in good faith.” Treas. Reg. § 1.6664-4(b)(1).
Instructed by Treasury Regulation § 1.6664-4(c), we have held that
reasonable cause is based on reliance on an advisor where (1) the advisor
was a competent professional who had sufficient expertise to justify
reliance, (2) the taxpayer provided necessary and accurate information
to the advisor, and (3) the taxpayer actually relied in good faith on the
advisor’s judgment. Neonatology Assocs., P.A. v. Commissioner, 115 T.C.
43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). We now follow this
penalty-context analysis in determining reasonable cause under section
170(f)(11)(A)(ii)(II); and we look to see whether the Commissioner—
given his burden of proof on this new matter, see supra Part I.B.3—has
shown that Murfam’s omission of basis from Form 8283 is not excused
by its reliance on its advisors.
The straightforward and unchallenged trial testimony of Rebecca
Welker (the Dixon Hughes CPA who prepared Murfam’s Form 1065)
established that Dixon Hughes was a well-known firm with a good
reputation in North Carolina, that Murfam retained Dixon Hughes to
prepare all of its returns during a three-year period and relied on it to
do so, that Dixon Hughes requested all the information it thought
necessary for preparing Murfam’s returns, that Dixon Hughes received
all the information that it had requested from Murfam, that Dixon
Murfam did not attach to its appraisal summaries any explanations for its failure to
report cost basis nor does it assert reasonable cause under Treasury Regulation
§ 1.170A-13(c)(4)(iv)(C)(1). Accordingly, we do not address reasonable cause under
Treasury Regulation § 1.170A-13(c)(4)(iv)(C)(1) in this Opinion, and instead we
consider only the statutory “reasonable cause” defense under
section 170(f)(11)(A)(ii)(II).
22
[*22] Hughes prepared the returns in accordance with that information,
and that Murfam filed the returns as they had been prepared by Dixon
Hughes.
That testimony seems to check all the boxes prescribed in
Neonatology Associates. However, Treasury Regulation § 1.6664-4(b)(1)
provides that “[r]eliance on . . . the advice of a professional tax advisor
or an appraiser does not necessarily demonstrate reasonable cause and
good faith.” Paragraph (c)(1) further explains:
In no event will a taxpayer be considered to have
reasonably relied in good faith on advice (including an
opinion) unless the requirements of this paragraph (c)(1)
are satisfied. The fact that these requirements are
satisfied, however, will not necessarily establish that the
taxpayer reasonably relied on the advice (including the
opinion of a tax advisor) in good faith.
The subdivisions of paragraph (c)(1) thereafter provide the following
requirements:
(i) All facts and circumstances considered. The
advice [upon which the taxpayer relies] must be based
upon all pertinent facts and circumstances and the law as
it relates to those facts and circumstances. . . . In addition,
the requirements of this paragraph (c)(1) are not satisfied
if the taxpayer fails to disclose a fact that it knows, or
reasonably should know, to be relevant to the proper tax
treatment of an item.
(ii) No unreasonable assumptions. The advice must
not be based on unreasonable factual or legal assumptions
(including assumptions as to future events) and must not
unreasonably rely on the representations, statements,
findings, or agreements of the taxpayer or any other
person. For example, the advice must not be based upon a
representation or assumption which the taxpayer knows,
or has reason to know, is unlikely to be true . . . .
(iii) Reliance on the invalidity of a regulation. A
taxpayer may not rely on an opinion or advice that a
regulation is invalid to establish that the taxpayer acted
with reasonable cause and good faith unless the taxpayer
adequately disclosed, in accordance with § 1.6662-3(c)(2),
the position that the regulation in question is invalid.
23
[*23] Absence of reasonable cause could be demonstrated,
notwithstanding reliance on an advisor, by showing that the taxpayer
failed to comply with one or more of those requirements. We turn to the
Commissioner’s submissions to see whether he made such a showing.
In his pretrial memorandum (Doc. 57) and in his opening post-
trial brief (Doc. 128), the Commissioner pointed out the failure of
Murfam’s Form 8283 to state the donor’s basis in the contributed
property, but he made no allegation disputing “reasonable cause” for
that failure. In his post-trial answering brief (Doc. 136), the
Commissioner’s position about lack of “reasonable cause” is stated as
follows:
The partial Form 8283 attached to Murfam TMP’s return
. . . did not contain [a] fully completed appraisal summar[y]
because [it] lacked sufficient information in Section B, Part
1 of the Form[]. . . . Dixon Hughes prepared [Murfam’s
return] in accordance with the records provided to Dixon
Hughes by petitioners. See Tr. 877:10-14.[12] The tax
return preparers could not report the correct information
on the Forms 8283 because the correct information was not
provided to them by petitioners. . . . Petitioners were in the
best and perhaps only position to provide this information
to their preparers. Petitioners have yet to indicate basis
for each property separately. Entire record.
That is, the Commissioner argues that the Form 8283 lacked the basis
information not because the advisors had advised that it could or should
be omitted but because Murfam declined to provide it to those advisors.
The cited evidence does not make this showing. There is simply
no evidence as to whether the advisors asked for basis information.
There is no evidence as to whether Murfam provided basis information.
To the extent there was basis information not provided by Murfam,
there is no evidence to show why it was not provided. The reason that
there is no such evidence is that the Commissioner did not cross-
12 The cited transcript states the question: “From your conversations with the
Murphys, what was your perception, as to whether the Murphys genuinely relied upon
you and your firm to properly prepare these returns?” Mr. Robbins answered, “Well, I
mean, we prepared their return entirely. I mean, it was—we would have reviewed their
return just to make sure that it looks like that we had—there were no omissions, or
whatever, but yes, they would have relied on us to take the data provided and prepare
the return.”
24
[*24] examine the witnesses on the point. Direct examination by
Murfam’s counsel included this exchange (Tr. 874):
Q . . . In your dealings with the Murphys,
through the preparation of the earlier returns and these
returns, how responsive were they to providing you
whatever information you and your firm requested?
A They were very responsive. They had a very
good staff there.
The Commissioner did not pursue the point—neither with the witnesses
from the accounting firm nor with the Murphys. He now effectively asks
us to draw a negative inference that Murfam deliberately withheld basis
information from its advisors. Especially since the Commissioner bears
the burden of proof on this issue, we decline to do draw such an inference
against Murfam.
The record thus lacks explicit evidence on whether the blank
basis boxes on Forms 8283 were the result of Dixon Hughes’ advice or
were instead due to Murfam’s willful neglect. If Murfam bore the
burden to prove reasonable cause, then that lack of evidence might
warrant the conclusion that their omission was not due to reasonable
cause, because there is no evidence of any advice or judgment by the
CPAs to omit cost basis in the donated property. However, in this case
the burden of proof is on the Commissioner to show a lack of reasonable
cause for omission of cost basis on Murfam’s Form 8283, because he
raised this issue as new matter; and he must accordingly suffer the
consequences of any gap in the record. Therefore, we hold that the
Commissioner has failed to carry his burden to show a lack of reasonable
cause, and that Murfam’s omission of its cost basis in the donated
property on Form 8283 will accordingly be excused for reasonable cause,
so that we will not entirely disallow its charitable contribution
deductions for failure to comply with the reporting requirements of
section 170(f)(11) and Treasury Regulation § 1.170A-13(c). We will
instead now proceed to determine whether Murfam has proved the value
of its charitable contribution deduction for its donation of the Rose Tract
easement.
C. The value of Murfam’s easement donation
1. The method of valuing the conservation easement
Generally, the amount of a charitable contribution deduction
under section 170(a) for a donation of property is the “fair market value”
25
[*25] of the property at the time of the donation. Treas. Reg. § 1.170A-
1(c)(1). Treasury Regulation § 1.170A-1(c)(2) defines fair market value
to be “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.”
With respect to valuing a donation of a partial interest in property,
Treasury Regulation § 1.170A-7(c) provides that “[e]xcept as provided in
§ 1.170A-14, the amount of the deduction under section 170 . . . is the
fair market value of the partial interest at the time of the contribution.”
And Treasury Regulation § 1.170A-14(h)(3)(i) in turn sets forth the
following method for valuing a perpetual conservation restriction:
[Sentence 2:] If there is a substantial record of sales of
easements comparable to the donated easement (such as
purchases pursuant to a governmental program), the fair
market value of the donated easement is based on the sales
prices of such comparable easements. [Sentence 3:] If no
substantial record of market-place sales is available to use
as a meaningful or valid comparison, as a general rule (but
not necessarily in all cases) the fair market value of a
perpetual conservation restriction is equal to the difference
between the fair market value of the property it encumbers
before the granting of the restriction and the fair market
value of the encumbered property after the granting of the
restriction. [Sentence 4:] The amount of the deduction in
the case of a charitable contribution of a perpetual
conservation restriction covering a portion of the
contiguous property owned by a donor and the donor’s
family . . . is the difference between the fair market value
of the entire contiguous parcel of property before and after
the granting of the restriction.
The fair market value of property on a given date is a question of
fact to be resolved on the basis of the entire record. McGuire v.
Commissioner, 44 T.C. 801, 806–07 (1965); see, e.g., Kaplan v.
Commissioner, 43 T.C. 663, 665 (1965). In this case, we do not have “a
substantial record of sales of easements comparable to the donated
easement”, and we will therefore base our valuation on the before and
after method. Treas. Reg. § 1.170A-14(h)(3)(i). To do so—
If before and after valuation is used, the fair market value
of the property before the contribution of the conservation
restriction must take into account not only the current use
26
[*26] of the property but also an objective assessment of how
immediate or remote the likelihood is that the property,
absent the restriction, would in fact be developed, as well
as any effect from zoning, conservation, or historic
preservation laws that already restrict the property’s
potential highest and best use.
Id. subdiv. (ii); see also Stanley Works & Subs. v. Commissioner, 87 T.C.
389, 400 (1986). A property’s highest and best use is the “highest and
most profitable use for which the property is adaptable and needed or
likely to be needed in the reasonably near future”. Olson v. United
States, 292 U.S. 246, 255 (1934).
To show the value of the conservation easement in this case, as
well as the property’s highest and best use, the parties have offered the
reports and testimonies of expert witnesses. See Rule 143(g). “Opinion
testimony of an expert is admissible if and because it will assist the trier
of fact to understand the evidence that will determine a fact in issue”,
and we evaluate expert opinions “in light of the demonstrated
qualifications of the expert and all other evidence of value.” Parker v.
Commissioner, 86 T.C. 547, 561 (1986) (citing Fed. R. Evid. 702). Where
experts offer competing estimates of fair market value, we decide how to
weigh those estimates by, inter alia, examining the factors they
considered in reaching their conclusions. See Casey v. Commissioner, 38
T.C. 357, 381 (1962). We are not bound by the opinion of any expert
witness, and we may accept or reject expert testimony in the exercise of
our sound judgment. Helvering v. Nat’l Grocery Co., 304 U.S. 282,
294–95 (1938); Estate of Newhouse v. Commissioner, 94 T.C. 193, 217
(1990). We may also reach a decision as to the value of property that is
based on our own examination of the evidence in the record. See
Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), aff’g T.C.
Memo. 1974-285.
Having established the subject and method of valuation, as well
as the scope of evidence with which to do so, we will now explain the
basis of our valuation of the Rose Tract easement at issue as stated
above in the findings of fact.
2. The valuation of the Rose Tract easement
The parties have stipulated that “the after-value of the Rose Tract
real property (excluding timber) on December 27, 2010, was $5,801,000.
The parties also agree that the before-value of the Rose Tract real
27
[*27] property (excluding timber) on December 27, 2010, was $5,801,000
with the impact of the swine Certificates of Coverage beyond that as the
remaining valuation issue.” The parties further stipulated that the
Certificates could have been converted to use in a farrow-to-wean
facility. The parties disagree as to the value of the forfeited Certificates
and the resulting impact, if any, on the value of the Rose Tract
easement.
Murfam relies on the expert report of Andy E. Piner 13 to assert
that the highest and best use of the Rose Tract before donation of the
conservation easement was to operate a farrow-to-wean 14 hog-farming
facility (with growth of timber on the remaining acreage) and that the
value attributable to the conservation easement is $5,669,793. 15 We
found him qualified, competent, and persuasive. The Commissioner
disputes Mr. Piner’s qualifications to appraise a conservation easement
and a farm, his use of the direct cost to construct a farrow-to-wean
facility supplied by the Murphys, and his capitalization rate used to
value the farrow-to-wean operation. The Commissioner instead offers
the expert report of Matthew Hawk, who valued the Rose Tract for use
as a feeder-to-finish facility but ultimately concluded that the cost of
Mr. Piner’s expert report is a complete copy of the qualified appraisal that
13
he prepared for Murfam and that was attached to Murfam’s return.
14 The Commissioner questions Mr. Piner’s conclusion that the pre-
contribution highest and best use of the Rose Tract was a farrow-to-wean facility
because the cover letter of his appraisal report states that “there are approximately
1,100–1,200 acres that could be utilized with a finishing farm facility that has been
permitted by the State of North Carolina.” However, despite this misstatement on the
cover letter and again in the “Purpose and Intended Use of the Appraisal” section of
the appraisal report, the body of the report and the substantive discussion of highest
and best use consistently value the Rose Tract on the basis of the Certificates being
converted for use as a farrow-to-wean facility. Furthermore, in valuing the Rose
Tract’s highest and best use, Mr. Piner (or any appraiser) is required to consider the
“most profitable use”, and the record in this case establishes that “farrow-to-wean” is
a more profitable use than “feeder-to-finish”. Ultimately, the parties stipulated that
the Certificates “can be converted from a feeder-to-finish facility to a farrow-to-wean
facility”. Consequently, this discrepancy in Mr. Piner’s report is immaterial, and it
therefore does not impact our view of Mr. Piner’s credibility as a valuation expert or
the determinations made in his report.
15 At trial Mr. Piner reduced his valuation of the Certificates (and therefore his
valuation of the conservation easement) to $5,669,793 from the $5,744,600 stated in
his original appraisal report. This reduction of $74,807 in the claimed value of the
Rose Tract easement is the net effect of increasing the number of sows that a farrow-
to-wean facility could accommodate from 18,317 to 19,538 (and thereby increasing the
value of the certificates) but also increasing the post-contribution value of Rose Tract
to the stipulated figure of $5,801,000 (which reduces the value of the contribution).
28
[*28] constructing such a facility exceeded its resulting value and was
therefore financially unfeasible. Mr. Hawk accordingly determined that
the highest and best use of the Rose Tract both before and after donation
of the conservation easement was to grow timber (valued at $5,801,000)
and that the value of the conservation easement was therefore zero.
However, Mr. Hawk did not consider the effect of (and at the time
he made his valuation was apparently not aware of the possibility of)
converting the Certificates to a farrow-to-wean facility on the value of
the Rose Tract easement, and the Commissioner later stipulated that
the Certificates could be so converted. Mr. Piner’s valuation of the Rose
Tract as a farrow-to-wean farm is thus largely unanswered. For
example, neither the Commissioner nor Mr. Hawk presented alternative
figures to counter Mr. Piner’s assertions that a farrow-to-wean facility
on the Rose Tract could accommodate 19,538 sows which would then
birth an average of 21 pigs per sow, which would be sold at $13.50 per
pig (yielding potential annual gross income of approximately
$5,539,023), that operating expenses for a farrow-to-wean facility would
be approximately 48% of gross income ($2,658,731), and that the total
development cost to construct a farrow-to-wean facility would be
$20,045,667. In fact, the Commissioner presumes these figures (albeit
begrudgingly) in his own attempt to value the Rose Tract as a farrow-
to-wean facility in his post-trial brief.
The only one of Mr. Piner’s figures that the Commissioner directly
disputes in that attempt is Mr. Piner’s applied capitalization rate of
10.25%, and the Commissioner argues that the capitalization rate
should instead be 13.35%. The Commissioner purports to derive his
asserted capitalization rate of 13.35% from six sales of allegedly
comparable farrow-to-wean facilities, and he argues that “[d]eriving
capitalization rates from comparable sales is the preferred technique
when sufficient information about sales of similar, competitive
properties is available.”
Murfam and Mr. Piner point out, however, that the six sales
offered by the Commissioner are in fact not sales of comparable
properties but rather are sales of farrow-to-wean facilities that are a
decade or more old and that had a capacity of less than 3,000 sows,
whereas Murfam and Mr. Piner valued the highest and best use of the
Rose Tract on the basis of a farrow-to-wean facility that was brand new
and that had a capacity of 19,538 sows. According to Mr. Piner’s
testimony, the Commissioner’s attempt to derive a capitalization rate
for the prospective farrow-to-wean facility on the Rose Tract is “taking
29
[*29] capitalization rates from 15 to 25-year-old buildings and apply[ing
them] to a brand-new structure, which is totally inappropriate” without
adjusting the capitalization rate accordingly.
Another flaw in the Commissioner’s asserted use of these six sales
to derive a less favorable capitalization rate for valuing the Rose Tract
as a farrow-to-wean facility is the methodology of computing the
capitalization rate. For each of the six sales offered by the
Commissioner, he computes the respective capitalization rate by
dividing the facility’s net annual income by the overall sale price.
Mr. Piner determined his capitalization rate using the mortgage-equity
method, “which produces a weighted average cost of capital based on the
cost of debt and equity financing for the subject property.” LeFrak v.
Commissioner, T.C. Memo. 1993-526, 66 T.C.M. (CCH) 1297, 1302.
Considering that the highest and best use of the Rose Tract before
donation of the conservation easement was to build a new high-capacity
farrow-to-wean facility, we view the mortgage-equity method of
calculating the capitalization rate as the more credible method.
We note that the Commissioner challenges neither Mr. Piner’s
use of the mortgage-equity method nor his application of the
capitalization rate to determine the value of the Certificates but
challenges only the inputs used by Mr. Piner to determine the
capitalization rate itself. The Commissioner argues that Mr. Piner’s
report “lacks support for many of his conclusions because he either relies
on information that lacks a verifiable source or utilizes figures that are
not explained or derived from any meaningful analysis.” The
Commissioner specifically criticizes Mr. Piner’s lack of stated market
data to support a 4.5% interest rate, a 15-year financing term, a 90%
loan-to-value ratio, and a 20% equity capitalization rate.
However, Mr. Piner testified that he based the input figures in
his report on contemporaneous discussions with market lenders. We
view his testimony as credible, and it is undisputed. The Commissioner
does not offer alternative figures for the interest rate, financing term,
loan-to-value ratio, or equity capitalization rate, nor did he cross-
examine Mr. Piner on the correctness of his input figures. 16 The
16 We take judicial notice that the applicable federal rate in December 2010 for
long-term debt instruments, compounding annually, was 3.53%. Rev. Rul. 2010-29,
2010-50 I.R.B. 818, 819. It appears, therefore, that Mr. Piner used a more
conservative, higher rate of 4.5%—evidently on the basis of his consultations with
market participants—than he could have used at the time of his appraisal, and that
doing so was disadvantageous to Murfam.
30
[*30] Commissioner merely complains that the input figures are not
explained in Mr. Piner’s report. But despite Mr. Piner’s imperfect
explanation, he is a credible valuation expert who used a satisfactory
method to determine a capitalization rate, and the Commissioner’s only
response is a capitalization rate based on sales of properties that are not
comparable to the Rose Tract’s proposed use as a new farrow-to-wean
facility. We therefore adopt the mortgage-equity method for
determining the capitalization rate, as well as the input figures used in
Mr. Piner’s report, with one correction: Mr. Piner calculated the
capitalization rate to be 10.2619%, and then for reasons he did not
explain rounded it down to 10.25%. However, even a minor reduction in
the capitalization rate would increase the valuation of the Rose Tract (to
the advantage of Murfam), and we therefore hold that the proper
capitalization rate is Mr. Piner’s true calculated figure of 10.2619%.
The Commissioner also criticizes as self-serving Mr. Piner’s use
of the direct cost to construct a farrow-to-wean facility as supplied by
the Murphys. However, we do not accept this criticism. As we have
found, the Murphy family is a multi-generational hog-farming family
with substantial expertise in their industry. We conclude they were able
to provide credible data on the cost to construct a large farrow-to-wean
facility. At the time of Mr. Piner’s appraisal, the Murphys were the top
hog farmers in North Carolina and had previously constructed two
farrow-to-wean facilities with capacities of 4,400. Mr. Piner also
corroborated the cost data given to him by the Murphys with other
neutral developers of large swine farm facilities. 17
Altogether, we adopt Murfam’s method of valuing the highest and
best use of the Rose Tract as a farrow-to-wean facility with a capacity
for 19,538 sows, based on an average of 21 pigs per sow per year at a
price of $13.50 per pig, yielding a projected annual gross income of
approximately $5,539,023, and net operating income of $2,880,292.
Using the capitalization rate of 10.2619% yields an overall value of
$28,067,824, from which we deduct the total development cost of
$21,381,899 (i.e., the $20,045,667 cost of constructing an 18,317-
capacity facility (as in Mr. Piner’s original valuation) plus additional
costs of $1,336,232 (as in his revised determination and trial testimony),
17 Murfam’s direct cost data is the only reliable figure in our record. The
Commissioner did not engage a valuation expert to estimate the cost of constructing a
large farrow-to-wean facility, although since the filing of the petition Murfam has
asserted that highest and best use of the Rose Tract before donation was to operate a
high-capacity farrow-to-wean facility, and the Commissioner has been well aware of
the method by which Murfam valued that use.
31
[*31] for a difference of $6,685,925 as the value of the farrow-to-wean
hog-farming facility. We then add the value (based on stipulated facts)
of the timber on the remaining acreage of the Rose Tract—$4,752,282—
to the value of the farrow-to-wean hog-farming facility to compute the
total value of the Rose Tract before the easement donation—
$11,438,207. We then subtract the agreed-to value of the Rose Tract
after the easement donation—$5,801,000—to arrive at $5,637,207 as
the value attributable to the forgone use of the hog-farming certificates,
and therefore the value of the Rose Tract easement.
III. Penalties under section 6662
The Commissioner asserts that Murfam’s deduction of the Rose
Tract easement is subject to the gross valuation misstatement penalty
under section 6662(h), or, in the alternative, the penalty for substantial
valuation misstatement under section 6662(e), for substantial
understatement of income tax under section 6662(d), or for negligence
under section 6662(c). For the reasons explained below, we hold that
because of reasonable cause, Murfam is not subject to any penalty under
section 6662.
A. Penalty principles
Section 6662(a) imposes an accuracy-related penalty “equal to
20 percent of the portion of the underpayment to which this section
applies” upon a taxpayer who underpays his tax because of, inter alia,
“[n]egligence or disregard of rules or regulations”, a “substantial
understatement of income tax”, or a “substantial valuation
misstatement”. § 6662(b)(1)–(3). An understatement of income tax is
substantial if it exceeds the greater of “10 percent of the tax required to
be shown on the return for the taxable year” or $5,000. § 6662(d)(1)(A).
For 2010, the year at issue, a substantial valuation misstatement exists
if “the value of any property . . . claimed on any return . . . is 150 percent
or more of the amount determined to be the correct amount of such
valuation”. § 6662(e)(1)(A). None of these penalties will be imposed
where the taxpayer had “reasonable cause”. § 6664(c)(1).
In the case of a “gross valuation misstatement”—i.e., where the
value of property claimed on the return is 200% or more of the amount
determined to be the correct valuation—the rate of the accuracy-related
penalty is increased to 40%. § 6662(h)(1) and (2)(A)(i). There is no
reasonable cause defense available under section 6664(c) to a gross
valuation misstatement. § 6664(c)(3).
32
[*32] On the basis of these principles, the record in this case, and the
valuation we determined above in Part II.C.2, we will now determine
which penalties, if any, are applicable with respect to Murfam’s donation
of the Rose Tract easement.
B. Section 6662 penalties with respect to Murfam
Section 6221, as in effect at the relevant time, provided generally
that, in a TEFRA partnership case, “the applicability of any penalty . . .
which relates to an adjustment to a partnership item . . . shall be
determined at the partnership level.” Section 6226(f) likewise states
that our jurisdiction in TEFRA partnership cases is limited to “the
applicability of any penalty . . . which relates to an adjustment to a
partnership item.” Treasury Regulation § 301.6221-1(c) further
provides that “[p]artnership-level determinations include all the legal
and factual determinations that underlie the determination of any
penalty . . . other than partner-level defenses”. And Treasury
Regulation § 301.6226(f)-1(a) provides that “the court has jurisdiction in
the partnership-level proceeding to determine any penalty . . . that
relates to an adjustment to a partnership item. However, the court does
not have jurisdiction in the partnership-level proceeding to consider any
partner-level defenses to any penalty . . . that relates to an adjustment
to a partnership item.” Accordingly, within our jurisdiction in this
TEFRA case is the ability to determine the applicability of any section
6662 penalty; but to the extent that defenses (such as reasonable cause)
to any penalties determined depend on the particular aspects of a
partner-level return, we do not have jurisdiction in this TEFRA case to
consider them.
1. Valuation misstatement penalty
Murfam originally claimed on its partnership return a charitable
contribution deduction of $5,744,600 for its donation of the Rose Tract
easement, and above in Part II.C.2 we determined the correct deduction
to be $5,637,207. Murfam therefore overstated on its return the value
of the Rose Tract easement not by 200% or 150% but by approximately
2%. Accordingly no section 6662 penalty founded on a substantial or
gross valuation misstatement is applicable. See § 6662(e)(1)(A),
(h)(2)(A)(i).
2. Other accuracy-related penalty
Having held the valuation penalties inapplicable, we are left with
the 20% penalty attributable to an underpayment due to a substantial
33
[*33] understatement of income tax or to negligence or disregard of
rules or regulations applies.
a. Substantial understatement
Whether a TEFRA partnership adjustment results in a
“substantial underpayment” by a given partner is an issue that must be
determined at the partner level, so in this partnership-level action we
do not have jurisdiction to determine “whether any applicable threshold
underpayment of tax has been met with respect to the partner”. Treas.
Reg. § 301.6221-1(d). Rather, we “determine the applicability of the
understatement . . . penalty, at the partnership level”. VisionMonitor
Software, LLC v. Commissioner, T.C. Memo. 2014-182, at *16; see also
Triumph Mixed Use Invs. III, LLC v. Commissioner, T.C. Memo. 2018-
65, at *49–52. The Murfam partnership did overstate its charitable
contribution deduction, so insofar as the partnership is involved, there
is an “understatement of income tax” for purposes of section 6662(b)(2),
and the penalty is “applicable”—subject to partnership-level defenses,
such as the “reasonable cause” defense based on reliance on professional
advice, under the principles of Neonatology Associates discussed above
in Part II.B.2.c.
We hold that the partnership-level reasonable cause defense
overcomes any resulting penalty, because the Commissioner did not
carry his burden to show an absence of reasonable cause for any
substantial understatement. Rather, the evidence shows that Murfam
engaged a competent appraiser who valued the Rose Tract easement
using a credible method, and that the valuation was within 2% of the
amount we have determined to be the correct value. Furthermore,
Murfam hired professional, reputable accountants to prepare all the
returns associated with the easement donation, and Murfam provided
all information necessary to prepare the returns that was requested of
it. These facts demonstrate that Murfam acted in good faith with
respect to its valuation and reporting of the Rose Tract easement
donation, and that any substantial understatement that results in the
liability of a partner should be excused for reasonable cause, on the basis
of the advice of professional tax advisors and return preparers. See
§ 6664(c); see also Treas. Reg. § 1.6664-4(b).
b. Negligence
The same facts (discussed immediately above) that support a
partnership-level reasonable cause defense as to a substantial
34
[*34] understatement penalty also support a defense against the charge
of negligence by the partnership.
In his post-trial brief, the Commissioner supports his contention
of negligence by making a twofold criticism of Murfam’s motives:
“Murfam TMP’s grant of the easement was not a ‘contribution or gift,’
but a strategy [1] to reduce Murfam TMP’s tax liability and [2] to keep
the Rose Tract for personal recreational use, as it had always been.”
Doc. 128, at 339. Neither of these criticisms has merit. First, Murfam’s
tax avoidance motive does not affect its entitlement to the charitable
contribution deduction for its donation of a qualified conservation
contribution pursuant to section 170(h). It is quite true that Murfam’s
donation involved “a strategy to reduce . . . tax liability”; but the very
purpose of section 170(h) is to incentivize such contributions by offering
a tax deduction. The Code does not induce such contributions by offering
the deduction only to deny the deduction because the taxpayer
responded to the incentive. Second, it is true, for some charitable
contribution deductions, that a finding that the donor retained some
benefit to himself would contradict the claim of a gift and would defeat
the deduction, since the donor might thereby have failed to give his
“entire interest in such property”, contrary to section 170(f)(3). But
Congress’s enactment of the deduction for qualified conservation
contributions (including an easement granted in perpetuity, Treas. Reg.
§ 1.170A-14(b)(2)) expressly permits a deduction for a partial interest,
see § 170(f)(3)(B)(iii), and consequently a donation of a conservation
easement will almost always involve the donor’s retaining an interest in
the property. What the donor permissibly retains he may licitly enjoy,
provided his use does not contradict the conservation purpose of the
easement for which he claimed a deduction.
IV. Conclusion
We hold that Murfam did not satisfy the appraisal summary
requirements of section 170(f)(11) in connection with the claimed
charitable contribution deduction at issue, but that its failure to do so is
excused for reasonable cause because the Commissioner, in raising this
issue as new matter in this litigation, failed to carry his burden to show
an absence of reasonable cause. The parties have stipulated that
Murfam’s donation of the Rose Tract easement satisfies the
requirements of section 170(h) to be a “qualified conservation
contribution” for which a charitable contribution is permitted, but
disagree as to the value of the easement and the amount of the
associated deduction. Having considered all evidence presented by the
35
[*35] parties, we find the value of the Rose Tract easement to be
$5,637,207. Finally, we hold that no penalties apply with respect to
Murfam’s donation of the Rose Tract easement on account of reasonable
cause.
To reflect the foregoing,
Decision will be entered under Rule 155.