Are you planning to gift a conservation easement on your land or home in accordance with Section 170 of the IRS Code? Or have you gifted a conservation easement a few years ago and are benefiting from the carryforward year after year? Listen up conservation easement advocates: The IRS may be watching you. The government could be planning on auditing your charitable deductions and unleashing a value diminution trap (VDT). What you ask is a VDT and how can a VDT be used against you in US Tax Court? Please continuing reading to learn how to protect your charitable deduction carryforwards as we observe the VDT in action in a recent US Tax Court case decided May 2014, :Chandler v IRS 142 T.C. No. 16. Avoid the mistakes the Chandlers made when they deducted their conservation easement and learn how to bullet proof your tax return so that your deductions and carryforwards are safe and protected in the event of an IRS audit and ultimate appeal to US Tax Court.
The Chandlers had gifted facade easements on two of their homes. The Chandlers then retained professional appraisers. According to the appraisers, the properties lost $562,650 of their combined value. because of all the restrictions placed on the homes by the facade easements. The Chandler’s CPA then deducted a large charitable deduction in 2004 which carried forward to subsequent years 2005 and 2006 and beyond. The IRS audited Chandlers for tax years 2004, 2005 and 2006. The IRS disallowed all the charitable deduction and carryforwards claiming that the easement deduction was overstated and the appraisals were worthless. How did this happen?
Let’s look specifically at the facts: Both Chandler homes were in Boston’s South End, which the Federal Government has included in the National Register of Historic Places and designated a National Historic Landmark District. Chandler’s donated a “facade easement” to the National Architectural Trust (NAT) which severely restricted what the Chandler’s could do to the property without the permission of NAT. The Chandler’s were told by their professional appraisers the easement under NAT would reduce the value of the homes by $562,650. Unfortunately for the Chandlers this tax strategy had them walk directly into an IRS trap, the VDT trap. After the trap was sprung on the Chandlers during the government audit, the IRS argued that the easements under local government, South End Landmark District Commission (SELDC), were equally restrictive as those of NAT, thereby making the easements under NAT worthless. The Chandlers appealed to US Tax Court.
US Tax Court Judge Goeke gave much weight to the value diminution traps that had been spread all over the country by the IRS. Judge Goeke also relied heavily on Kaufman T.C. Memo. 2014-52, finally decided in March of 2014, just a few months before Chandler.
Judge Halpern handed a major victory to the IRS and this victory appears final.. I say appears final because Kaufman lost (Kaufman 1),. had resubmitted the case for reconsideration (Kaufman 2) and then after Kaufman lost again, appealed to the 1st Circuit (Appeal). The 1st Circuit reversed Judge Halpern and remanded the case back to Tax Court (Kaufman 3). Kaufman v. Commissioner, T.C. Memo. 2014-52. Kaufman 2 and Kaufman 3, on remand from the U.S. Court of Appeals for the First Circuit, Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012). Let’s take a closer look at Kaufman 3. where as I mentioned appears final now.
On review of Kaufman 3 Judge Halpern relies heavily on the IRS star expert witness appraiser John C. Bowman III. Mr. Bowman has been certified by the Commonwealth of Massachusetts as a State-certified general real estate appraiser. He has received a Certificate of Completion for the Valuation of Conservation Easements program offered by the American Society of Appraisers (and other organizations) and is endorsed by the Land Trust Alliance. His appraisal work includes a particular emphasis on conservation and preservation restrictions. He has served on the Boston Landmarks Commission for 10 years, serving as chairman of the commission for 6 years. He has extensive experience appraising partial interests in real property, including conservation easements.
Mr. Bowman believed that no value was lost after Kaufman received a facade easement on his property thus no charitable contribution deduction was available. Kaufman's experts and original appraiser, Hanlon did not seem credible to Judge Halpern who had little confidence in Hanlon's opinions. The Court concluded both “Kaufman and Hanlon failed to persuade us on account of the preservation agreement, lack of control and lack of marketability that the easement reduced the value of the property. To the contrary, Mr. Bowman’s expert testimony has convinced us that the restrictive components of the preservation agreement are basically duplicative of, and not materially different from, the South End Standards and Criteria, and we so find.”
By the way, just so you know, guess who the IRS used as their expert witness in Chandler? You guessed it, Bowman. I am not sure if Bowman is still testifying for the IRS, but just in case he is, you probably want to retain the services of a really good and probably very expensive army of qualified appraisers who are equally as good as Bowman before you file a tax return with a conservation easement charitable deduction..
How critical is the expertise of your appraiser? I found a very informative piece underscoring the importance of performing a good appraisal to bullet proof your tax return in a Journal of Accountancy article written in 2011 by C Andrew Lafond CPA and Jeffrey J Schrader CPA. The article emphasizes the importance of obtaining at least two appraisals with the following caveat: “Given the significance of the appraisal as to the value of the donation and the ability of the donation to withstand an IRS audit, donors should engage an appraiser who has experience in valuation of conservation easements and whose appraisals have successfully withstood IRS examination during audit and appeal to US Tax Court. If the dollar value of the donation is significant, it may be wise to obtain two appraisals.”
In conclusion, as I see it, your charitable tax deduction is simply in many cases based solely on an educated guess by appraisers some of whom are better than others. What this means for any of you contemplating gifting a conservation easement is that much of whether you win or lose in US Tax Court is going to depend primarily on how good your expert witness appraiser does on the witness stand and how much time the appraisers used to assess and back up their numbers and conclusions. Indeed, in my view, if you want to bullet proof your tax return from IRS attack and subsequent US Tax Court appeal, you had better get the best two appraisers out there to avoid an IRS VDT. On second thought, get three if you think Bowman has set a VDT in your neighborhood..
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