Taxpayer Lacked Qualified Appraisal for Facade Easement
Friedberg, TC Memo 2011-238, RIA TC Memo ¶2011-238, 102 CCH TCM 356 .
In Friedberg,1 the Tax Court denied a charitable contribution deduction for a facade easement based on defects in the appraisal report. However, the court also denied the IRS request for summary judgment regarding the charitable contribution of development rights, finding that the taxpayer had substantially complied with Regulations regarding the contents of an appraisal.
In 2003, Mr. Friedberg donated a facade easement and all development rights on a townhouse in a historic district in Manhattan to the National Architectural Trust (NAT). Friedberg hired an appraiser to appraise the property. The appraisal report compared the potential sales value of the property both before and after the contribution of the facade easement and the development rights. In preparing his report, the appraiser reviewed nine comparable sales occurring within the previous two years of similar New York properties. In order to determine the value of the easement, the appraiser considered six sales of property in Washington, D.C., occurring in the 1980s and two in New Orleans during the 1990s. According to the appraiser, the average reduction in value of the property as a result of the facade easement was 17.4%. The appraiser concluded that the percentage that should be used for the New York facade easement would be a reduction in value of 11%, but he did not explain how that final percentage was derived.
Friedberg claimed a charitable income tax deduction on his income tax return and attached IRS Form 8283, Non-Cash Charitable Contributions, to his return. The form was signed by the appraiser and the President of NAT. Friedman also attached the appraisal to his income tax return.
On audit, the IRS determined that the appraisal and Form 8283 did not comply with applicable Regulations and denied the charitable deduction in its entirety. Friedberg filed a petition in Tax Court and the IRS sought summary judgment that both the facade easement and the gift of development rights did not qualify for a charitable deduction.
The court first considered the facade easement. The court rejected the appraiser's use of sales in locales other than Manhattan, finding that the use of easement valuations from the 1980s in Washington and New Orleans was not appropriate. In addition, the court held that the percentage diminution method used by the appraiser was not an acceptable appraisal method. In addition, the appraiser also made multiple errors in his determination of the Washington easement values. For example, in one case he used the asking price rather than the selling price to determine the percentage reduction in value. As a result, the court granted the IRS summary judgment and held that the appraisal report was not a qualified appraisal because the report failed to comply with the requirement of Reg. 1.170A-13(c)(3)(ii)(J) to properly apply the comparable sales method in valuing the subject property after the facade easement.
The court next examined the issue of the contribution of development rights. The court granted Friedberg summary judgment that the appraisal was qualified under Reg. 1.170A-13(c)(3)(ii)(K) with respect to its valuation of development rights and denied summary judgment to the IRS because the court believed material factual issues were in dispute regarding the value of the development rights. The court reasoned that while the report contained many errors, the report nevertheless explained the method of valuation and the specific basis for the valuation. The court said it was a matter of factual determination whether Friedberg could have been able to transfer or otherwise use the development rights before the donation, and whether the appraisal adequately assessed the market demand for those rights.
With respect to the fact that the date of the report was different from the date of the contribution, the Tax Court denied the IRS's request for summary judgment and held that Friedberg had substantially complied with the requirements of the Regulations because the errors regarding the date of the appraisal report did not relate to the substance or essence of the contribution.
In addition, the court also held that Friedberg had substantially complied with the requirement to attach a fully completed appraisal summary to his return even though the summary did not adequately describe the property, its overall physical condition, the manner of acquisition, or the cost or other basis. These flaws were overcome because Friedberg also attached the appraisal report, which did provide the necessary information, to his income tax return.
This case highlights that when a client makes a charitable contribution of a facade easement, it is essential to have a complete "before and after" method appraisal that thoroughly explains the specific comparables and valuation methodology used by the appraiser. It appears that the IRS is increasing its examination of charitable contributions of facade easements since the number of reported cases in this area is increasing.2 While it is comforting to see the court willing to apply the doctrine of substantial compliance, advisors should carefully review the appraisal reports being submitted to the IRS to ensure that all the requirements of the Regulations are complied with so as to avoid the expense of an audit or litigation.
1 TC Memo 2011-238, RIA TC Memo ¶2011-238, 102 CCH TCM 356 .
2 See Kaufman, 134 TC 182 (2010); 1982 East, LLC, TC Memo 2011-84, RIA TC Memo ¶2011-084, 101 CCH TCM 1380 ; Simmons, 107 AFTR 2d 2011-2632, 646 F3d 6, 2011-1 USTC ¶50469 (CA-D.C., 2011), aff'g TC Memo 2009-208, RIA TC Memo ¶2009-208, 98 CCH TCM 211 .