First Circuit breathes new life into facade easement deductions.

• Author: Durant, Monique O.

Conservation easements and facade easements have been the subject of many Tax Court cases in recent years) (1) A recent First Circuit decision (2) will affect how the tax benefits of certain facade easements are litigated in the First Circuit and may result in appeals of some of the Tax Court's recent easement holdings. (3) The First Circuit held in Kaufman that the Tax Court had imposed an unreasonably restrictive interpretation of regulations (4) under Sec. 170(h) that "would appear to doom practically all donations of easements, which is surely contrary to the purpose of Congress." (5)

The Tax Court had held in Kaufman that a subordination agreement giving a lender priority on insurance and condemnation proceeds violated the Regs. Sec. 1.170A-14(g) "enforceable in perpetuity" requirement, particularly its "extinguishment" provisions. (6) The First Circuit rejected the Tax Court's interpretation of the regulation as well as the IRS's alternate theory that the easement should be rejected due to clear defects in its appraisal summary, finding that the defects didn't necessarily "doom" the summary.

The case was remanded to the Tax Court on the issues of the valuation of the easement and recalculation of penalties.

The First Circuit vacated the Tax Court's decisions regarding the penalties associated with the easement deduction but did not disturb the Tax Court's findings regarding partial deductions for, and penalties relating to, cash endowment contributions made in connection with the easement donation.

Facts

Kaufman concerned a mid-19th-century row house in the South End of Boston, an area known for its historic architecture and subject to local historic preservation restrictions. Lorna Kaufman purchased the house in 1999, and she and her husband, Gordon Kaufman, renovated it, including restoring its original facade. In 2003 the couple entered into a preservation restriction agreement supplied by the National Architectural Trust (later renamed the Trust for Architectural Easements) and made cash endowment contributions to the organization totaling $16,840. The Kaufmans selected an experienced, certified appraiser from two recommended by the Trust. After inspecting the property in January 2004, the appraiser submitted his report, estimating the fair market value (FMV) of the donated easement at $220,800.

The Kaufmans secured consent from their mortgage lender to an agreement subordinating the bank's right in the property to the Trust to enforce the conservation and historic preservation purposes of the preservation restriction agreement in perpetuity. The lender agreement added several stipulations to the restriction agreement, one of which stated:

The Mortgagee/Lender and its assigns shall have a prior claim to all insurance proceeds as a result of any casualty, hazard or accident occurring to or about the Property and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged, notwithstanding that the Mortgage is subordinate in priority to the [preservation restriction] Agreement. (7) On their 2003 tax return, the Kaufmans claimed a charitable contribution for the cash endowment donation of $16,8408 and a noncash contribution of $220,800 for the facade easement donation as a qualified conservation contribution. The noncash contribution was limited by Sec. 170(b)(1) to $103,377 for 2003, with the remainder of $117,423 carried over. On their 2004 tax return, the Kaufmans claimed a charitable contribution of $3,032 for additional cash endowed to the Trust, and the remainder of the noncash contribution of the facade easement donation.

IRS Audit

On audit, the IRS disallowed the noncash deductions taken in 2003 and 2004 for the historic facade easement donations as well as the deductions for the cash endowment contributions, and in 2009 issued a notice of deficiency to the Kaufmans for the 2003 and 2004 tax years, citing three grounds for disallowing the noncash contribution:

1. The Kaufmans had failed to establish that all of the requirements of Sec. 170 and all the regulations thereunder were satisfied;

2. The contribution was made subject to subsequent events; and

3. The Kaufmans had not established that the value of their contributed property interest was $220,800.

   In addition, the IRS disallowed the Kaufman's cash endowments to the Trust for 2003 because they were made subject to, or in contemplation of, subsequent events. The IRS assessed a...