Gоrdon KAUFMAN; Lorna Kaufman, Petitioners, Appellants/Cross-Appellees, v. Douglas SHULMAN, Commissioner of Internal Revenue, Respondent, Appellee/Cross-Appellant.
Nos. 11-2017, 11-2022
United States Court of Appeals, First Circuit
July 19, 2012
Heard May 7, 2012.
CONCLUSION
After taking a good look at Howard‘s arguments, we are satisfied that none have merit. The judgment below is affirmed.
Rebecca K. Troth, David R. Hill, Ryan C. Morris, Sidley Austin LLP, Paul W. Edmondson, Elizabeth S. Merritt and Ross M. Bradford, National Trust fоr Historic Preservation, on brief for the National Trust for Historic Preservation, Amicus Curiae.
Patrick J. Urda, Tax Division, Department of Justice, with whom Tamara W. Ashford, Deputy Assistant Attorney General, and Kenneth L. Greene, Tax Division, Department of Justice, were on brief for respondent, appellee/cross-appellant.
Before LYNCH, Chief Judge, BOUDIN and LIPEZ, Circuit Judges.
BOUDIN, Circuit Judge.
This case comprises appeals by both sides—the Commissioner of Internal Revenue (“the IRS“) and the taxpayers Gordon and Lorna Kaufman—from a decision of the Tax Court. The subject is deductions on the couple‘s joint returns of the asserted value of Lorna Kaufman‘s donation to the National Architectural Trust of a façade easement restricting alterations on her Boston house. A brief description of the background events and proceedings follows, which is elaborated where necessary later in this decision.
In 1999, Lorna Kaufman bought for $1,050,000 a row house in the South End of Boston, an area (not to be confused with South Boston), which is subject to local restrictions aimed at historic preservation.1 The row house, 19 Rutland Square, was designed by physician Elbridge Dud-
The Kaufmans renovated the house, which included the restoration of original details of the façade. In 2003, the couple learned about a tax incentive program for historic preservation, promoted in this instance by an organization then known as the National Architectural Trust, since renamed the Trust for Architectural Easements. A Trust representative advised the Kaufmans that the Trust could help the couple qualify for a tax deduction equal to 10 to 15 percent of the fair market value of their home and that the Trust “as part of our service ... will be handling all the red tape and paperwork.”
A provision of the Internal Revenue Code,
The deduction for granting the easement is intended to reflect the value of what the taxpayer has donated which, in the аbsence of a “market” for such easements, can be measured by “the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the restriction.”
On or about October 31, 2003, Lorna Kaufman submitted an application on the Trust‘s own form and made a $1,000 “good faith deposit“; she further agreed, as specified by the Trust, to make a “cash endowment contribution” to the Trust equal to 10 percent of the value of thе ultimate deduction for the easement. This is at least one means by which the Trust finances its work. The deposit was to be returned if the “the necessary approvals cannot be obtained” and the cash endowment contribution reduced in part if the easement donation could not be processed in time to qualify for a 2003 deduction.
The Trust advised Lorna Kaufman that if her property was under mortgage, she needed to obtain consent from the mortgagee to subordinate its interest in the property to the easement. Accordingly, the Kaufmans sent a letter to their mortgage lender, Washington Mutual Bank, asking it to subordinate its rights to the easement being granted to the Trust. The letter stated that restrictions on the property imposed by the easement were “essentially the same restrictions as those imposed by current local ordinances that
On December 22, 2003, Lorna Kaufman executed a Preservation Restriction Agreement supplied by the Trust and, a few days later, sent it back to the Trust together with a further contribution that the Trust had solicited in the amount of $15,840 (over and above her earlier $1,000 good-faith deposit). This further contribution, the Trust said, could be adjusted dependent on the appraised value of the easement.2
The Trust also offered the names of two recommended appraisers, and the Kaufmans selected one of the two, Timothy Hanlon, a certified appraiser who for the previous nineteen years had managed his own residential appraisal company. Hanlon inspected the 19 Rutland Square property in January 2004 and submitted his report on January 30, estimating that the fair market value of the donated easement was $220,800. Gordon Kaufman expressed concern that the reduction in the value of the property due to the easement might be “so large as to overwhelm the tax savings that accrue from it,” but a representative of the Trust sought to reassure him that it was “very unlikely” that the easement would affect the marketability of the property.
Meanwhile, the Kaufmans successfully secured consent from their lendеr, Washington Mutual, to an agreement “subordinating [the bank‘s] rights in the [19 Rutland Square] Property to the right of the Grantee [i.e., the Trust], its successors or assigns, to enforce the conservation and historic preservation purposes of [the Preservation Restriction] Agreement in perpetuity.” The lender agreement included several stipulations, one of which would become relevant in the subsequent litigation:
The Mortgagee/Lender and its assignees 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.
On their joint return for 2003, the Kaufmans claimed (1) a cash contribution of $16,870 to the Trust (the correct figure would have been $16,840, see note 2, above, but the Kaufmans attribute the discrepancy to a “typographical error“), and (2) a noncash contribution of $220,800 for the easement donation. They sought the $16,870 cash-contribution deduction on their 2003 returns and, in light of statutory limits on deductions in a single year,
In March 2007, evidently as part of a wide-ranging investigation into perceived abuses of the easement program, the IRS opened an investigation into the Kaufmans’ claimed charitable deductions. On May 5, 2009, the IRS sent a “Notice of Deficiency” to the Kaufmans relating to the 2003 and 2004 tax years. In the Notice, the Service cited three grounds for disallowing the Kaufmans’ noncash contribution claim:
The IRS also disallowed the Kaufmans’ claimed cash contribution of $16,870 to the Trust for 2003 “because it was made subject to or in contemplation of subsequent event(s)” and calculated that the Kaufmans owed an additional $39,081.25 for 2003 and an additional $36,340.00 for 2004. It also imposed large penalties for underpayment. The Kaufmans petitioned for review by the Tax Court. See
On an IRS motion for summary judgment, the Tax Court on April 26, 2010, disallowed any deduction for the easement but found “genuine issues of material fact” remained with regard to the cash contribution deduction and the IRS‘s imposition of penalties. Kaufman v. Comm‘r (Kaufman I), 134 T.C. 182 (2010). In a second decision after a trial on the reserved issues, the Tax Court on April 4, 2011, reaffirmed its ruling on the easement, but held that the Kaufmans were еntitled to deduct their $16,840 cash contribution on their 2004 return (as opposed to their 2003 return) and were subject only to a small penalty for negligence in taking the deduction in the earlier year. Kaufman v. Comm‘r (Kaufman II), 136 T.C. 294 (2011).
Both sides have now appealed to this court. The Kaufmans challenge the disallowance of the deduction for the façade easement; the IRS attacks the disallowance of most of the penalties it had imposed but does not question the Tax Court‘s allowance of the cash contribution deduction on the 2004 return. Here, the Tax Court granted partial summary judgment to the IRS “only because ... Lorna Kaufman‘s contribution of the facade easement to [the Trust] failed as a matter of law to comply with [relevant regulations],” Kaufman II, 136 T.C. at 325-26, so our review on this issue is de novo.
Our legal analysis begins with
The regulations establish further substantive requirements that conservation contributions must satisfy in order to be deductible (independent of the appraisal requirements that we address separatеly hereafter). Four provisions relevant here are:
- Paragraph (g)(1), the “[e]nforceable in perpetuity” requirement, states that “any interest in the property retained by the donor ... must be subject to legally enforceable restrictions ... that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation.”
26 C.F.R. § 1.170A-14(g)(1) . - Paragraph (g)(2), the mortgage subordination requirement, states that “no deduction will be permitted under this
section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the [donee] organization to enforce the conservation purposes of the gift in perpetuity.” 26 C.F.R. § 1.170A-14(g)(2) . - Paragraph (g)(3), the “[r]еmote future event” provision, adds a noteworthy qualification to the regulatory requirements: “A deduction shall not be disallowed ... merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible.”
26 C.F.R. § 1.170A-14(g)(3) . - Paragraph (g)(6), the extinguishment provision, requires that “when a change in conditions give rise to the extinguishment of a perpetual conservation restriction [by judicial proceeding], the donee organization, on a subsequent sale, exchange, or involuntаry conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction, unless state law provides that the donor is entitled to the full proceeds from the conversion.”
26 C.F.R. § 1.170A-14(g)(6)(ii) .
These requirements are in addition to the recordkeeping and return regulations of
Paragraph (g)(6). The Tax Court, in denying the Kaufmans a deduction for the façade easement, relied entirely on the last of these requirements. Although the ex-
The Tax Court‘s position, briefly stated, was that although the Kaufmans in the Preservation Restriction Agreement governing 19 Rutland Square granted the Trust an entitlement to a proportionate share of post-extinguishment proceeds, thus seemingly complying with the regulation, the lender agreement executed by Washington Mutual undercut this commitment and so defeated the deduction—by stipulating that “[t]he Mortgageе/Lender and its assignees shall have a prior claim to all insurance proceeds ... and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged.” See Kaufman II, 136 T.C. at 299, 313; Kaufman I, 134 T.C. at 185-87.
Certainly the IRS has good reason to assure that the Kaufmans could not recapture the value of what they gave up by granting the easement in order to get the deduction; but the Kaufmans had no power to make the mortgage-holding bank give up its own protection against fire or condemnation and, more striking, no power to defeat tax liens that the city might use to reach the same insurance proceeds—tax liens being superior to most prior claims, 1 Powell on Real Property
The IRS reads the word “entitled” in the extinguishment regulation to mean “gets the first bite” as against the rest of the world, a view the Tax Court accepted in reading “entitled” to mean “ha[s] an absolute right.” Kaufman II, 136 T.C. at 313. But a grant that is absolute against the owner-donor is also an entitlement, Black‘s Law Dictionary (7th ed.1999) (“entitle” defined as “[t]o grant a legal right to“); Collins English Dictionary (10th ed.2009) (“to give (a person) the right to do or have something“), and almost the same as an absolute one where third-party claims (here, the bank‘s or the city‘s) are contingent and unlikely.
Equally important, given the ubiquity of super-priority for tax liens, the IRS‘s reading of its regulation would appear tо doom practically all donations of easements, which is surely contrary to the purpose of Congress. We normally defer to an agency‘s reasonable reading of its own regulations, e.g., United States v. Cleveland Indians Baseball Co., 532 U.S. 200, 220, 121 S.Ct. 1433, 149 L.Ed.2d 401 (2001), but cannot find reasonable an impromptu reading that is not compelled and would defeat the purpose of the statute, as we think is the case here. Cf. Grunbeck v. Dime Sav. Bank of N.Y., FSB, 74 F.3d 331, 336 (1st Cir. 1996).
In reaching our conclusion, we do not rely on the general provision of paragraph (g)(3) that aims to prevent deductions from being lost by improbable events,
Paragraph (g)(1). A provision in thе agreement between the Kaufmans and the Trust states that “nothing herein contained shall be construed to limit the [Trust‘s] right to give its consent (e.g., to
The D.C. Circuit considered and rejected this same argument in Commissioner v. Simmons, 646 F.3d 6, 10 (D.C. Cir. 2011):
The clauses permitting consent and abandonment, upon which the Commissioner so heavily relies, have no discrеte effect upon the perpetuity of the easements: Any donee might fail to enforce a conservation easement, with or without a clause stating it may consent to a change or abandon its rights, and a tax-exempt organization would do so at its peril. ... [T]his type of clause is needed to allow a charitable organization that holds a conservation easement to accommodate such change as may become necessary to make a building livable or usable for future generations while still ensuring the change is consistent with the conservation purpose of the easement.
Id. (internal quotation marks omitted).
The IRS insists that paragraph (g)(1) is a “reasonable interpretation” of the perpetuity language of
In addition, the concern posited by the IRS is within its power to control: the IRS‘s own regulations require that tax-exempt organizations such as the Trust be operated “exclusively” for charitable purposes,
Recordkeeping and Reporting Requirements. As a further alternative ground, the IRS argues that the Kaufmans failed to comply with certain recordkeeping and reporting requirements that are imposed by statute,
The regulation also requires taxpayers to attach an “appraisal summary” to their returns that includes, inter alia:
- “[a] description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that
was appraised is the property that was contributed,” 26 C.F.R. § 1.170A-13(c)(4)(ii)(B) ; - “[t]he manner of acquisition ... and the date of acquisition of the property by the donor,”
id. § 1.170A-13(c)(4)(ii)(D) ; - “[t]he cost or other basis of the property adjusted as provided [elsewhere in the Code],”
id. § 1.170A-13(c)(4)(ii)(E) ; and - “[t]he appraised fair market value of the property on the date of contribution,”
id. § 1.170A-13(c)(4)(ii)(J) .
The IRS claims that the method of valuation used by the Kaufmans’ appraiser lacked “analytical mooring” and produced an indefensibly inflated valuation; indeed, thе IRS concluded that the Kaufmans’ contribution claim constituted a “gross valuation misstatement[,]” that is, a claim more than 200 percent of the actual value. See
The procedural regulations requiring an appraisal report and summary are designed to provide information “sufficient to permit [the IRS] to evaluate the [taxpayer]‘s reported contribution and monitor and address concerns about overvaluation.” Consol. Investors Grp. v. Comm‘r, 98 T.C.M. (CCH) 601, 2009 Tax Ct. Memo LEXIS 294, at *67, 2009 WL 4840246, at *23 (T.C. 2009). But whether the valuation was overstated, grossly or otherwise, is a factual question different
True, the IRS has identified elements of the Kaufmans’ appraisal summary (submitted on Form 8283) that are in technical noncompliance with Treasury regulations. As the IRS rightly points out, “the Form 8283 did not include the date and manner of acquisition of the property purportedly contributed or the cost or other basis of the property.” Yet as the Kaufmans explain, they “did not ‘acquire’ the preservation easement, but created that property interest at the moment they conveyed it to the Trust,” and “thus had no ‘manner and date of acquisition’ and no ‘cost оr other basis’ to report.”
Arguably, the Kaufmans should have written “None” or “Not Applicable” in the spaces on the Form 8283 reserved for date of acquisition, method of acquisition, and cost/adjusted basis. But we can hardly agree with the IRS that “[t]hese defects,” in no way prejudicial to it in this instance, “doom the appraisal summary.” Accord Scheidelman v. Comm‘r, 682 F.3d 189, 198-99 (2d Cir. 2012).
One aspect of the IRS position warrants separate mention. The regulations say that an appraiser is not “qualified” if “the donor had knowledge of facts that would cause a reasonable person to expect the appraiser falsely to overstate the value of the donated property.”
For the foregoing reasons, the original Tax Court rationale for disallowing the easement deduction as a matter of law fails, as do the alternative grounds for outright affirmance tendered by the IRS. Accordingly, the grant of partial summary judgment for the IRS must be vacated.7 Moreover, since the Tax Court‘s decision not to impose penalties with respect to the Kaufmans’ noncash contribution claim depended on the same rationale on which it based its grant of pаrtial summary judgment, Kaufman II, 136 T.C. at 325-26 (namely, paragraph (g)(6)), the Tax Court‘s decision not to impose further penalties on the Kaufmans must be vacated as well.
Overstatement of Value. Given our rejection of the Tax Court‘s readings and the IRS‘s alternatives, a remand is necessary. As the IRS noted in its brief, “If this Court disagrees with the Tax Court‘s decision, and does not believe that the decision is justified under the alternative grounds discussed, the case should be remanded so that the Tax Court can consider, in the first instance, the grounds left unaddressed, including the proper value of the easement.” At oral argument, counsel for the Kaufmans agreed that it would be appropriate for us to remand the case to the Tax Court to determine the substantive question of value in the first instance.
In its Notice of Deficiency, the IRS stated that the Kaufmans had failed to “establish[] that the value of the [easement] was $220,800 as claimed in the 2003 return.” The IRS did not waive this objection by moving for summary judgment to disallow the easement deduction on other grounds as a matter of law; a summary judgment motion properly includes only such grounds as may be susceptible to disposition without a trial. See, e.g., Sánchez-Rodríguez v. AT & T Mobility P.R., Inc., 673 F.3d 1, 10-11 (1st Cir. 2012). And, because the value of the gift is a factual issue not decided by the Tax Court, the IRS could not offer the objection here as an alternative ground to sustain the judgment.
But although the Kaufmans claimed that the value of the easement donation was $220,800, the IRS has repeatedly pointed to evidence that the true value of the donation was close to zero. If so, then the Kaufmans would be liable for penalties under
When the Kaufmans donated the easement, their home was already subject to South End Landmark District rules that severely restrict the alterations that property owners can make to the exteriors of historic buildings in the neighborhood. These rules provide that “[a]ll proposed changes or alterations” to “all elements of [the] facade, ... the front yard ... and the portions of roofs that are visible from public streets” will be “subject to rеview” by the local landmark district commission. S. End Landmark Dist., Standards and Criteria 2 (rev. Apr. 27, 1999).
Under the Standards and Criteria, property owners of South End buildings have an obligation to retain and repair the original steps, stairs, railings, balustrades, balconies, entryways, transoms, sidelights, exterior walls, windows, roofs, and front-yard fences (along with certain “other features“); and, when the damaged elements are beyond repair, property owners may only replace them with elements that look like the originals. Id. at 2-6. Given these pre-existing legal obligations the Tax Court might well find on remand that the Kaufmans’ easement was worth little or nothing.
The Kaufmans’ own appraiser, recommended to them by the Trust, acknowledged in his report that “there is much overlap in the restrictions imposed by the [easеment] and the pre-existing restrictions imposed on the property, particularly by the Landmark Commission.” This may be a substantial understatement. Although the appraiser listed several ways in
For instance, the appraiser noted that the easement agreement would last “in perpetuity” while local ordinances might lapse; but no specific reason was given for expecting this to happen (other than a vague suggestion of “changes in political, economic and aesthetic needs and tastes in a community“). He also said that the Kaufmаns would be “subject to the inconvenience of periodic inspections” by the Trust; yet any such inconvenience would be limited by the fact that the agreement explicitly does not give the Trust the right to inspect the inside of the house. Preservation Restriction Agreement 3 (Dec. 22, 2003). Whether any of the offered distinctions justify any deduction is a matter for the remand.
The Kaufmans themselves were surprised at the size of the valuation, albeit out of concern that it implied—as it must if the Kaufmans were conveying anything of value—a substantial reduction in the resale value of their home. In an effort to reassure them, a Trust representative told the Kaufmans that experience showed that such easements did not reduce rеsale value, and this could easily be the IRS‘s opening argument in a valuation trial. The Trust representative explained in pertinent part that
[i]n 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 the other properties in the same neighborhood.8
The burden in the Tax Court initially rests on the taxpayer to justify his or her deduction. See Tax Ct. R. Prac. & P. 142(a)(1); see also INDOPCO, Inc. v. Comm‘r, 503 U.S. 79, 84, 112 S.Ct. 1039, 117 L.Ed.2d 226 (1992). The burdens and presumptions relating to penalties are more complicated, compare, e.g.,
Doubtless it is the desire to avoid such trials, as well as the difficulty of detecting and investigating suspicious cases one by one, that explains the IRS‘s aggressive
However, to reject overly aggressive IRS interpretations of existing regulations is hardly to disarm the IRS. Without stifling Congress’ аim to encourage legitimate easements, one can imagine IRS regulations that require appraisers to be functionally independent of donee organizations, curtail dubious deductions in historic districts where local regulations already protect against alterations, and require more specific market-sale based information to support any deduction. Forward looking regulations also serve to give fair warning to taxpayers.
If taxpayers still do not get the message, the penalties regime is formidable, see, e.g.,
The judgment of the Tax Court is vacated except with regard to the deductibility of the taxpayers’ cash contributions and the accuracy-related penalty associated with their 2003 cash contribution claim, and the matter remanded to that court for further proceedings consistent with this decision. Each side shall bear its own costs on this appeal.
It is so ordered.