On May 14, 2014, the Tax Court (Judge Goeke) issued an opinion in Chandler v. Commissioner, 142 T.C. No. 16. The opinion is consistent with a string of cases denying deductions for preservation easements in the Northeast. Nevertheless, it is worth a second glance due to its statements about the application of “gross valuation” penalties.
The Value of the Preservation Easements
The case involved two façade easements (also known as “preservation” or “conservation” easements) granted on two single-family residences in Boston. The first issue before the court was the value of the preservation easements. In determining that the value of the easements was zero, the court analyzed the appraisal reports submitted by both parties. The court found the taxpayers’ appraisal to be flawed, in part because it analyzed “comparable” properties that were located outside of Boston. Although, the court similarly found the report submitted by the IRS to be unpersuasive, it still found the value of the preservation easements to be zero. In so concluding, the court relied on the rationale of Kaufman v. Commissioner. In Kaufman, the court determined that when there are relatively minor differences in local property restrictions and the requirements imposed by an easement, such differences normally do not reduce the value of the property.
The Application of Penalties
The court next turned to the application of penalties. Importantly, the carryovers (taken in 2005 and 2006) generated by the donations (made in 2004) resulted in multiple years being at issue in the case. This, in turn, raised questions about how (and when) the 2006 Pension Protection Act (PPA) changes to the penalty provisions applied to tax returns filed after the effective date of the statute (July 25, 2006), but which contained carryover deductions attributable to a donation made prior to the PPA changes. The PPA changes to the penalty provision are important to the “gross valuation” penalty for two reasons: (1) The PPA changes caused the 40% penalty to apply anytime a taxpayer overvalues property by more than 200%, as opposed to prior law which required a 400% overvaluation and (2) the PPA changes made the gross valuation penalty a “strict liability” penalty by eliminating the “reasonable cause and good faith” exception to the penalty.
Because the court determined the value of the preservation easements to be zero, the overvaluation threshold (200% or 400%) was irrelevant. However, the court determined that the taxpayers made a good faith attempt to determine the values of the donated easements, allowing the taxpayers to avoid the 40% penalty under the law in place prior to the PPA changes. The court then determined which years the reasonable cause exception applied to. The application of the reasonable cause exception to the 2004 and 2005 tax years at issue in the case was easy because the deductions were claimed and reported prior to the 2006 changes. The 2006 year was a bit trickier because, although it reported a deduction taken prior to the PPA changes, it was filed after the PPA changes. The IRS argued the strict liability changes should apply due to the filing date of the return. The taxpayers argued the reasonable cause exception under the prior law should apply because the easements were granted and the deductions were originally taken prior to the PPA changes. The court found for the IRS, determining that the filing of the 2006 return amounted to a “reaffirmation” of the value originally claimed by the taxpayers.
The Tax Court’s decision is significant. Due to the slow pace at which tax disputes move through the courts and the frequency at which large easement donations result in carryover deductions, there are many unresolved cases involving easements (and other donations) which will be impacted by the decision. The IRS now has support for the position that any return filed after July 25, 2006 is subject to the post-PPA changes to the penalty provisions, regardless of when a charitable contribution claimed on such returns was made. Indeed, we were recently involved in settling an easement case in which this issue was raised.