Originally published on Forbes.com April 5th, 2014
If you have a sincere desire to preserve property that you own from future development, the donation of an easement is something of a free lunch. Out in the country, where you are worried about your acres of forest being turned into a massive shopping mall, you call it a conservation easement. In the big city, where you are worried about your historic brownstone being replaced by golden arches, you call it a facade easement. You make the donation to a qualified organization which will also expect you to give them some money, since there is work involved in keeping an eye on your property. You get a tax deduction, possibly save some property taxes and get to keep the property just the way you like it.
If you are less than idealistic, you would want to get a tax deduction for granting an easement without actually reducing the value of your property. It appears that the donation of facade easements headed more or less predictably in that direction. The big problem with facade easements is valuation. Generally, the best way to value things is by looking at what similar things sell for. There is not a lot of buying and selling of facade easements. So what you do is value the property as it is and then value it as encumbered by the easement. If you can’t find sales of similar properties both with and without the easement, it all becomes rather hypothetical.
Appraisers came up with a solution. They started referring to an IRS report written by Mark Primoli. Included in the report was the sentence:
Internal Revenue Service Engineers have concluded that the proper valuation of a façade easement should range from approximately 10% to 15% of the value of the property.
The great thing about that sentence is that even accountants can understand it and use it to project tax savings. Two recent developments indicate that Mr. Primoli’s observation which supported something of a mini-industry can no longer be relied on.
Kaufman Case – Round 2
One development is the recent Tax Court decision in the case of Gordon and Lorna Kaufman. The Kaufman’s easement deduction had been disallowed on technical ground in an earlier Tax Court decision, but the First Circuit overturned that decision. I covered the First Circuit decision here. So the Tax Court got the case back in order to decide what the value of the easement was.
The problem with valuing the easement was that the property was already subject to a lot of restrictions due to its location in Boston’s South End Landmark District. Giving up your rights to change the façade of a building in such a neighborhood can be a bit like me renouncing my superpowers. That ended up being the Tax Court’s conclusion on valuation. The court went along with the IRS expert’s criticism of the taxpayer’s appraiser
Mr. Hanlon’s starting point-that properties in lightly regulated areas suffer a 15% reduction in value on account of the severance and conveyance of a facade easement-is based on neither reliable market data nor specific attributes of the property. It is based on what he believes the courts and the IRS had allowed in prior cases.
Penalties
There were also penalties and the discussion around the penalties is a good lesson in why should think before you hit send. When the taxpayers saw what a big deduction they were getting for granting the easement they were concerned about how that might hurt the resale value. They figured the value downgrade would more than wipe out the tax advantage they were getting. That started an e-mail exchange with the National Architecture Trust (NAT) which would be receiving the easement (and some money, of course).
By email dated February 6, 2004, to Mr. Bahar, Gordon Kaufman expressed his concern that “the reduction in the resale value of the property due to the easement so large as to overwhelm the tax savings that accrue from it.” He asked Mr. Bahar: “o you have statistical documentation that bears on how much of a reduction in resale value takes place for residential properties?” Mr. Bahar responded by email of the same date, reassuring him as follows
Impact of the Facade conservation easements on the value of the property 1. In areas that are regulated by local historic preservation ordinances and bodies such as Boston historic neighborhoods (including yours) *** properties with an easement are not at a market value disadvantage when compared to other properties in the same neighborhood. In support of his conclusion, Mr. Bahar set forth the following data: …………… One of our directors, Steve McClain, owns fifteen or so historic properties and has taken advantage of this tax deduction himself. He would have never granted any easement if he thought there would be a risk or loss of value in his properties.
In their response, the NAT is, in effect, admitting that the easements are worthless if you do a before and after appraisal. They state that, in writing, to the taxpayer, who teaches statistics at MIT. That bit them in the penalty discussion.
Gordon Kaufman was a sophisticated consumer of statistical analyses, and both the Bahar email and the Hanlon appraisal gave him good reason to question Mr. Hanlon’s value conclusion. We do not believe that he acted with reasonable cause and in good faith in relying without question on the Hanlon appraisal in subscribing tax returns on which he represented the value of the facade easement to be $220,800.
Rounding Up The 15% Gang
The other sign that an arbitrary percentage method will no longer work is this news release.
The Internal Revenue Service today announced its Office of Professional Responsibility (OPR) has entered into a settlement agreement with a group of appraisers from the same firm accused of aiding in the understatement of federal tax liabilities by overvaluing facade easements for charitable donation purposes. ….
The appraisers agreed to a five-year suspension of valuing facade easements and undertaking any appraisal services that could subject them to penalties under the Internal Revenue Code. The appraisers also agreed to abide by all applicable provisions of Circular 230.
The appraisers prepared reports valuing facade easements donated over several tax years. On behalf of each donating taxpayer, an appraiser completed Part III, Declaration of Appraiser, of Form 8283, Noncash Charitable Contributions, certifying that the appraiser did not fraudulently or falsely overstate the value of such facade easement. In valuing the facade easements, the appraisers applied a flat percentage diminution, generally 15 percent, to the fair market values of the underlying properties prior to the easement’s donation.
It seems like the appraisers are getting off pretty easy. They are basically agreeing to stop doing something that does not work anymore.
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