The Tax Court in Brief – December 19th – December 23rd, 2022
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Tax Litigation: The Week of December 19th, 2022, through December 23rd, 2022
- Starer v. Comm’r, T.C. Memo. 2022-124 | December 20, 2022 |Wells, J. |Docket No. 615-13
- Ayria v Commissioner, T.C. Memo. 2022-123 | December 19, 2022 | Lauber, J.| Dkt. No. 13745-20
- Mamadou v. Comm’r, T.C. Memo. 2022-121 | December 20, 2022 | Lauber, J. | Dkt. No. 9759-21L
- Schwartz v. Comm’r, T.C. Memo. 2022-125| December 21, 2022 | Vasquez, J. | Dkt. No. 17291-14L
Brooks v. Comm’r, T.C. Memo. 2022-122 | December 19, 2022 |Wells, J. |Docket No. 28206-15
Summary: This lengthy, detailed, and fact-intensive opinion regards a notice of deficiency issued to Kenneth Brooks and Anita Brooks (the “Brooks”) which disallowed substantial carryover charitable contribution deductions relating to the Brooks’ limited liability company’s (“LLC”) noncash charitable contribution of a conservation easement. In focus are 26 U.S.C. § 170(h) (qualified conservation contribution) and Treasury Regulation, 26 C.F.R. § 1.170A-14 (qualified conservation contributions).
The Conservation Easement Grant. On December 15, 2006, the LLC purchased 85.314 acres of real property known as Cotton Row Farm in Liberty County, Georgia, for $1,350,000. The LLC subdivided the property into two parcels of 44.113 and 41.201 acres. The LLC granted and recorded a conservation easement over the 41.201-acre parcel (encumbered parcel) on December 27, 2007, to Liberty County, Georgia, a qualified organization pursuant to section 170(h)(3). The deed that granted the easement (Easement Deed) provided:
Grantor, for and in consideration of the sum of ten dollars ($10.00) and other good and valuable consideration and in consideration of the covenants, mutual agreements, conditions and promises herein contained, does hereby grant unto the Grantee, its successors and assigns, forever a conservation easement as defined in O.C.G.A. §§ 44-10-1 et seq. in perpetuity, over the Protected Property of the nature and character and to the extent herein set forth.
The Easement Deed did not otherwise refer to any consideration paid by Liberty County. Various donor-directed restrictions were applied to the encumbered parcel. However, the LLC reserved various rights numbered and described (1) through (7), including to use the encumbered parcel for personal enjoyment not adverse to the conservation values. The terms and conditions applicable to the grant and the parties’ respective rights were encompassed in the Easement Deed, although the Easement Deed did not state whether it constituted the entire agreement between the parties. The deed included a “Boundary Description and Protected Property Reference,” consisting of a description, a map showing the outside boundaries, and a second map adding only that the parcel is bisected by an unidentified element. The deed also included a Baseline Report prepared by a biologist and which contained limited and brief written descriptions about the property, its potential uses, benefits, soil types, and means of access. The property was located, essentially, in rural southeastern Georgia. Some residential development was underway about 15 miles from the property, but for the most part, there were no immediate growth prospects for the area.
Charitable Contribution Deduction Claimed. The LLC claimed a charitable contribution deduction of $5,100,000 on its Form 1065, U.S. Return of Partnership Income, for the contribution of the easement to Liberty County for the taxable year ending December 31, 2007. A Form 8283, Noncash Charitable Contributions, with an appraisal summary was attached to the LLC’s 2007 tax return. The Form 8283 reported that the donated property was a qualified conservation contribution on a 41.201-acre tract of vacant land; that the donation was valued at $5,100,000; and that the property was purchased on December 15, 2006. The adjusted or cost basis of the donated property was reported as $1,350,000, the cost basis of the entire 85.314-acre contiguous parcel, instead of the cost basis of only the 41.201-acre encumbered parcel. The Brooks claimed a deduction of $748,702 on their Form 1040X, Amended U.S. Individual Income Tax Return, for the 2007 taxable year resulting from their interest in the LLC’s contribution deduction and carried forward the remaining deduction of $4,351,298 to future tax years.
Battle of the Experts’ Valuations. Each party provided its own expert to value the conservation easement. There were no sales of comparable conservation easements during the relevant period. Both experts calculated the fair market value of the easement by subtracting the value of Cotton Row Farm after the granting of the easement from the value before the granting of the easement. Both experts determined that the highest and best use of Cotton Row Farm before recordation of the Easement Deed was residential subdivision and development. The experts agreed that when determining the legal permissibility of a particular “highest and best use,” the appraiser may consider the likelihood that the subject property could be rezoned to result in a better return on investment.
The Brooks’ Expert. The Brooks’ expert applied the income approach to determine the potential value, less expenses, of developing and selling single family homes on Cotton Row Farm. The expert concluded that before the Easement Deed, the property could be developed into lots, sold over a period of several years. The Tax Court’s opinion details the analysis, information, and factors that the expert considered (and failed to consider) in the valuation. For example, the expert did not include the 2006 sale of Cotton Row Farm to the LLC as the sale of a comparable property in the expert’s test of reasonableness. Ultimately, the Brooks’ expert assumed that Cotton Row Farm would be developed only on the unencumbered parcel into 22 residential lots rather than 42 initially estimated. The expert determined a value of $3,969,900; the encumbered parcel on its own was valued at $61,800. The present value for the whole property after the granting of the easement was $4,030,000, according to the expert.
The IRS’s Expert. As for the Brooks’ expert, the Tax Court’s opinion details the analysis, information, and factors that the IRS’s expert considered in the valuation. Ultimately, the expert determined that the value of Cotton Row Farm, as of the effective date before the conservation easement, was $1,410,000. He determined that after recordation of the Easement Deed, the value of the unencumbered parcel and the encumbered parcel was $940,000. By subtracting the “after” value of $940,000 from the “before” value of $1,410,000, the IRS’s expert concluded that the fair market value of the conservation easement on the effective date was $470,000.
Notice of Deficiency and Trial. The IRS mailed a notice of deficiency to the Brooks, with respect to their taxable years ending December 31, 2010, 2011, and 2012. The only adjustments in the notice were disallowances of the carryforward deductions resulting from the 2007 charitable contribution deduction and an increase in taxable income resulting from qualified dividend income. The IRS also determined 40% accuracy-related penalties resulting from gross valuation misstatements pursuant to section 6662(h). The notice did not determine or calculate a 20% accuracy-related penalty pursuant to section 6662(a). Seven days before the trial date, the IRS provided notice to the Brooks of the existence of a Civil Penalty Approval Form approving the penalties in issue. The Standing Pre-Trial Order required that all documents be stipulated or provided to opposing counsel at least 14 days before the trial date (14-day rule). The IRS sought at trial to introduce a signed, sealed, and certified copy of the form, which (1) states that the gross valuation misstatement penalties under section 6662(h) applied to the easement contribution carryforwards to 2010, 2011, and 2012; (2) is signed by the group manager under the heading “Group Manager Approval to Assess Penalties Identified Above”; and (3) is dated October 28, 2014, more than nine months before respondent issued the notice of deficiency to the Brooks. The Brooks object to the admission of the form.
Whether the Brooks are entitled to deduct carryover charitable contributions of $657,135, $763,835, and $743,862 for the years in issue (2010, 2011, and 2012)?
Whether the Brooks are liable for accuracy-related penalties for those years?
Primary Holdings: No, the Brooks are not entitled to deduct carryover charitable contributions. Yes, the Brooks are liable for accuracy-related penalties due to their gross valuation misstatement.
The Easement Deed did not satisfy the contemporaneous written acknowledgment (CWA) requirements for a charitable contribution of a partial interest in real property. The Brooks’ attempt to prove the facts that should have been included in the CWA cannot replace the strict substantiation requirements of section 170(f)(8). The Easement Deed did not meet the requirements of section 170(f)(8) and cannot serve as the CWA required by the statute. The entire deduction was disallowed.
As for the penalties, the Standing Pre-Trial Order required that all documents be stipulated or provided to opposing counsel within the 14-day rule. The IRS did not comply with that Order with respect to the Civil Penalty Approval Form. However, the Brooks did not raise compliance with section 6751(b)(1) before or, substantively, during trial. The Tax Court found that it is appropriate to accept the form into evidence. Accordingly, the IRS met its burden of production as to the penalty, and the requirements of section 6751(b)(1) were met because the Civil Penalty Approval Form shows written supervisory approval of the initial penalty determination before issuance of the notice of deficiency. And, the Brooks grossly misstated the valuation of the charitable easement in issue such that the Brooks are liable for the 40% accuracy-related penalty pursuant to section 6662(h) as determined for each of the years in issue.
Key Points of Law:
Presumption of Correctness. A notice of deficiency is generally presumed correct, and it is a taxpayer’s burden to rebut this presumption. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Deductions. Deductions are a matter of legislative grace, and taxpayers generally bear the burden of proving their entitlement to the deductions claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Deductions are strictly construed and allowed only to the extent there is a clear provision for them. Id.
Charitable Contribution Deductions. Section 170 allows individuals to deduct charitable contributions, subject to certain percentage limitations, with a carryover of any excess contributions. See 26 U.S.C. § 170(a), (b), (d). Generally, the contribution must consist of the donor’s entire interest in the contributed property. Id. at § 170(f)(3)(A). However, under section 170(f)(3)(B)(iii), a deduction for a partial interest is allowed for a qualified conservation contribution.
Qualified Conservation Contribution. A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. 26 U.S.C. § 170(h)(1); Treas. Reg. § 1.170A-14(a). A qualified real property interest is a restriction granted in perpetuity on the use that may be made of real property, including an easement or similar interest. Treas. Reg. § 1.170A-14(b)(2).
Carryover Charitable Contribution Deductions
Contemporaneously Written Acknowledgement Requirement of Section 170(f)(8). “No deduction shall be allowed under subsection (a) for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization that meets the requirements of subparagraph (B).” 26 U.S.C. § 170(f)(8)(A). The contemporaneous written acknowledgment (CWA) must include the amount of cash and a description of any property other than cash contributed, and whether the donee organization provided any goods or services in consideration for the property.
A deed of easement may satisfy the CWA requirement. See, e.g., Averyt v. Commissioner, T.C. Memo. 2012- 198. In the absence of an explicit statement describing whether the donee provided goods or services in exchange for the charitable contribution, “the deed taken as a whole must prove compliance with section 170(f)(8)(B)(ii).” French v. Commissioner, T.C. Memo. 2016-53, at *11–12. “[F]actors that support compliance are that the deed recites no consideration other than the preservation of the property and that the deed contains a provision stating that the deed is the entire agreement of the parties.” Id. at *12. The absence of such a provision may prove fatal to the charitable contribution deduction. See id. at *12–13. A deed provision stating, for example, “for and in consideration of the sum of ten dollars ($10.00) and other good and valuable consideration and in consideration of the covenants, mutual agreements, conditions and promises herein contained” may be deemed boilerplate and ignored. See, e.g., Big River Dev., T.C. Memo. 2017-166, at *11; 310 Retail, LLC, T.C. Memo. 2017-164, at *16–17; RP Golf, LLC v. Commissioner, T.C. Memo. 2012- 282, at *10 n.7.
However, the Tax Court in Brooks determined that use of the word “donation” in the deed and two references that the terms of the donation are set forth “herein” did not satisfy the CWA requirements. The Court stated, in part, that “use of the word “donation” [does not] necessarily impl[y] that there was no consideration given, in whole or in part. Neither do we read “herein” to necessarily mean “exclusively herein.”” On this point, the Court concluded: “Proving the facts that should have been included in the CWA cannot replace the strict substantiation requirements of section 170(f)(8). The entire deduction must be disallowed.” Brooks, at pg. 12 (citing 26 U.S.C. § 170(f)(8)(A); Addis v. Commissioner, 374 F.3d 881, 887 (9th Cir. 2004), aff’g 118 T.C. 528 (2002)).
Baseline Document Requirements of Treasury Regulation § 1.170A-14(g)(5). The deduction for charitable contributions shall be allowed only if verified under the Treasury Regulations. 26 U.S.C. § 170(a)(1). When the donor reserves rights the exercise of which may impair the conservation interests of the property, the donor must provide documentation sufficient to establish the condition of the property. Treas. Reg. § 1.170A-14(g)(5)(i). The regulation describes the sorts of items that may constitute adequate baseline documentation. See id. at § 1.170A-14(g)(5)(i)(C) and (D). The purpose of the baseline documentation requirement is “to protect the conservation interests associated with the property, which although protected in perpetuity by the easement, could be adversely affected by the exercise of the reserved rights.” Id. subdiv. (i).
Substantiation Requirements of Treasury Regulation § 1.170A-13(c). Anyone claiming a deduction under section 170 for a contribution of property valued at more than $5,000 must attach an appraisal summary and include certain information, including the cost basis and acquisition date of the contributed property, to the return on which the deduction is first claimed. See Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369, § 155(a), 98 Stat. 494, 691–92. The purpose of the requirement to report cost basis in donated property was “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.” RERI Holdings I, LLC v. Commissioner, 149 T.C. 1, 16–17 (2017). The failure to fully complete an appraisal as required by Treasury Regulation § 1.170A-13(c)(2)(i) may be independently sufficient to warrant disallowance of the deduction. See 26 U.S.C. § 170(f)(11)(A)(i).
A taxpayer may overcome an appraisal shortcoming if the failure was due to “reasonable cause and not to willful neglect.” See id. at § 170(f)(11)(A)(ii)(II). “Reasonable cause” requires a taxpayer to exercise ordinary business care and prudence. See, e.g., United States v. Boyle, 469 U.S. 241, 246 (1985); Presley v. Commissioner, T.C. Memo. 2018-171, at *66, aff’d, 790 F. App’x 914 (10th Cir. 2019). Whether a taxpayer had reasonable cause is a fact-intensive inquiry that requires examination of all the facts and circumstances. Presley, T.C. Memo. 2018-171, at *66. If a taxpayer alleges reliance on the advice of an accountant, return preparer, or other tax professional, the taxpayer must show that he “actually relied in good faith on the professional’s advice.” Crimi, T.C. Memo. 2013-57, at *99; see Treas. Reg. § 1.6664-4(c)(1).
Penalties. The IRS bears the burden of production with respect to an individual’s liability for any penalty, including the accuracy-related penalty. 26 U.S.C. § 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). To meet that burden, the IRS must come forward with sufficient evidence indicating that it is appropriate to impose the relevant penalty. Higbee, 116 T.C. at 446. Once the IRS has met the burden of production, the taxpayer bears the burden of proving that the penalty is inappropriate. See Rule 142(a); Higbee, 116 T.C. at 446–49.
Respondent’s Burden of Production: Section 6751(b)(1). The IRS’s burden of production includes showing proper written approval of the initial penalty determination by an immediate supervisor. 26 U.S.C. § 6751(b)(1). Pursuant to Rule 131(b), an unexcused failure to comply with a standing pretrial order (such as the 14-day rule for provision of evidence and penalty approval information) may subject a party to sanctions. One such sanction may be the exclusion of evidence offered in violation of the 14-day rule. Kanofsky v. Commissioner, T.C. Memo. 2006-79, aff’d, 271 F. App’x 146 (3d Cir. 2008). In weighing the appropriate sanction for violation of the 14-day rule, the Court considers whether the opposing party was prejudiced by the failure. See Thompson v. Commissioner, T.C. Memo. 2011-291, 2011 WL 6382704, at *2; Morris v. Commissioner, T.C. Memo. 2008-65, 2008 WL 704208, at *1, aff’d, 431 F. App’x 535 (9th Cir. 2011). The Tax Court has routinely found that reopening the record to admit a Civil Penalty Approval Form into evidence serves the interest of justice and is not prejudicial. See, e.g., Degourville v. Commissioner, T.C. Memo. 2022-93. See also Frost v. Commissioner, 154 T.C. 23, 34–35 (2020); Hatfield v. Commissioner, T.C. Memo. 2022-59, at *7.
Gross Valuation Misstatement. Section 6662(h)(1) imposes an accuracy-related penalty if any part of an underpayment of tax required to be shown on a return is due to, among other things, one or more gross valuation misstatements. A gross valuation misstatement includes any valuation misstatement where the value of the property claimed on the tax return is 200% or more of the correct value. 26 U.S.C. § 6662(h)(2)(A). The taxpayer may not rely on a reasonable cause, good-faith defense against imposition of the section 6662(h) penalty with respect to gross valuation misstatements of charitable contribution properties. Id. at § 6664(c)(2); Chandler v. Commissioner, 142 T.C. 279, 293 (2014). If imposed, the penalty is 40% of the portion of the underpayment of tax to which the section applies. 26 U.S.C. § 6662(h)(1).
The amount of a charitable contribution deduction pursuant to section 170(a) is the fair market value of the donated property at the time of the charitable contribution. Treas. Reg. § 1.170A-1(c)(1). The regulations define fair market value as 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.” Id. subpara. (2). The value of a conservation easement donation is “the fair market value of the perpetual conservation restriction at the time of the contribution.” Treas. Reg. § 1.170A-14(h)(3)(i). For a gross valuation misstatement penalty to apply, the IRS must show that a taxpayer’s valuation of a conservation easement was 200% or more of the correct valuation. See 6611, Ltd. v. Commissioner, T.C. Memo. 2013-49, at *75.
Insights: This Brooks opinion is yet another opinion on the topic of qualified conservation contribution. The Brooks failed on the front-end of the transaction in that the Easement Deed was insufficient to qualify as a contemporaneous written acknowledgement of charitable contribution under section 170 of the Code. And, the Brooks failed in trial by submitting an expert opinion that, as the Tax Court described, was “extreme” in use of examples and figures. The Brooks’ expert’s conclusions on the valuation was described as “incredible as a practical matter,” as he determined a fair market value for the conservation easement nearly six times the per-acre amount for which the LLC had purchased the fee simple interest in Cotton Row Farm just 377 days earlier.
For other opinions and analysis on the subject, see Freeman Law’s Tax Court in Brief blogs on the following Tax Court opinions issued in 2022:
- Green Valley Investors, LLC v. Comm’r, 159 T.C. No. 5 | November 9, 2022 | Weiler, J. | Dkt. Nos. 17379-19, 17380-19, 17381-19, 17382-19 (consolidated) (Notice 2017-10 deemed improperly issued by the IRS and must be set aside, rendering the I.R.C. 6662A penalties unlawful; syndicated conservation easements – four consolidated opinions on the issue of Notice 2017-10)
- Champions Retreat Golf Founders, LLC v. Comm’r, T.C. Memo. 2022-106 | October 17, 2022 | Pugh, J. | Dkt. No. 4868-15 (conservation easement valuation for charitable contribution deduction – highest and best use and (1) the market (sales comparison) method, (2) the income method, and (3) the asset-based (replacement cost) method; battle of experts)
- Sparta Pink Property, LLC v. Comm’r, T.C. Memo. 2022-88 | August 29, 2022 | Lauber, J. | Dkt. No. 12114-20 (IRS motion for summary judgment on issue of “protected in perpetuity” denied, based on 11th Cir. Court of Appeals precedence)
- Thompson v. Comm’r, T.C. Memo. 2022-80 | July 20, 2022 |Lauber | Dkt. 8792-20 (“protected in perpetuity” review)
- Morgan Run Partners, LLC, Overflow Marketing, LLC, Tax Matters Partner v. Comm’r, T.C. Memo. 2022-61 | June 14, 2022 | Lauber, J. | Docket No. 8669-20 (“protected in perpetuity” review)
- Oxbow Bend, LLC v. Comm’r, T.C. Memo. 2022-23 | March 21, 2022 |Lauber, J. | Dkt. No. 12718-19 (conservation easement, initial determination of tax, denial of $13M charitable contribution)
- Pickens Decorative Stone, LLC v. Comm’r, T.C. Memo. 2022-22 | March 17, 2022 |Lauber, J. | Dkt. No. 13614-20 (conservation easement, challenge to “protected in perpetuity”)
- Corning Place Ohio, LLC v. Comm’r, T.C. Memo. 2022-12 | Feb. 28, 2022 | Lauber, J. | Dkt. No. 12428-20 (conservation easements and deduction for facade easement; appraised value)