RERI Holdings I, LLC, Harold Levine, Tax Matters Partner v. Commissioner , 143 T.C. No. 3 ( 2014 )

143 T.C. No. 3UNITED STATES TAX COURT
RERI HOLDINGS I, LLC, HAROLD LEVINE, TAX MATTERS PARTNER,
Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9324-08. Filed August 11, 2014.
LLC1 contributed a successor member interest in a second LLC
(LLC2) to University. R moves for partial summary judgment that (1)
the actuarial tables under I.R.C. sec. 7520 do not apply to value the
successor member interest and (2) TMP failed to substantiate the
value of the successor member interest with a qualified appraisal as
defined in sec. 1.170A-13(c)(3), Income Tax Regs.
Held: Pierre v. Commissioner, 133 T.C. 24 (2009), followed;
LLC2, a disregarded entity, is not disregarded in determining value of
the successor member interest in LLC2 that LLC1 contributed to
University.
Held, further, Estate of Gribauskas v. Commissioner, 116 T.C.
142 (2001), rev'd and remanded, 342 F.3d 85 (2d Cir. 2003),
distinguished on ground that successor member interest involved
right to receive a capital asset in the future and not a stream of fixed
payments.
Held, further, we will deny R's motion.
-2-
Randall Gregory Dick and Rebekah E. Schechtman, for petitioner.
Travis Vance III, Kristen I. Nygren, John M. Altman, and Leon St. Laurent,
for respondent.
OPINION
HALPERN, Judge: This is a partnership-level action brought in response to
a notice of final partnership administrative adjustment. The action involves RERI
Holdings I, LLC (RERI). On its 2003 income tax return RERI reported a
charitable contribution of property worth $33,019,000. Respondent determined
that RERI overstated the value of the contribution by $29,119,000. He also
determined that, on account of the overstatement, he would apply an accuracy-
related penalty to any resulting underpayment of income tax. Petitioner assigned
error to respondent's determinations. Respondent answered, supporting his
determination that RERI had overstated the value of the contribution with the
allegation that the transaction giving rise to RERI's charitable contribution "is a
sham for tax purposes or lacks economic substance, and therefore the transaction
should be disregarded for federal tax purposes and the deduction disallowed in its
entirety."
-3-
The case is presently before us on respondent's motion for partial summary
judgment (motion). Respondent moves for partial summary adjudication in his
favor that (1) the actuarial tables under section 75201 do not apply to value the
future (remainder) interest in property that RERI contributed to the University of
Michigan (University) in 2003 and (2) RERI failed to substantiate the value of its
contribution with a qualified appraisal. Petitioner objects. We will deny the
motion.
Background
Previously in this case we disposed by order of a motion by respondent for
partial summary judgment2 and by Memorandum Opinion and order of a motion
by petitioner for partial summary judgment. RERI Holdings I, LLC v.
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for 2003, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
2
Respondent moved for partial summary adjudication in his favor that, if the
valuation tables provided for in sec. 7520 are to be used in valuing the charitable
contribution in issue, the value of the real property underlying the contribution
must be reduced by (1) depreciation and (2) the entire amount of the indebtedness
encumbering the underlying property. By order dated May 5, 2011 (order), we
granted that motion with respect to respondent's first prayer and denied it with
respect to his second prayer, which we treated as asking for judgment that the
charitable contribution had to be reduced by the amount of the indebtedness. We
denied the motion on the ground that there was a genuine dispute as to a material
fact. See Rule 121(b).
-4-
Commissioner, T.C. Memo. 2014-99 (rejecting petitioner's claim that, as a matter
of law, the doctrines of "sham" and "lack of economic substance" are inapplicable
to the determination of whether a taxpayer's charitable contribution is allowed
under section 170). In doing so we relied on certain facts that we believed are not
in dispute. We shall, therefore, with minor modifications and additions as relevant
to the motion, again rely on those facts. The facts we rely on are as follows.
RERI
RERI was formed as a Delaware limited liability company on March 4,
2002. It was dissolved on May 11, 2004. RERI is classified as a partnership for
Federal income tax purposes. For 2003, RERI filed a Form 1065, U.S. Return of
Partnership Income (return).
The Charitable Contribution
RERI reported on the return as a charitable contribution its transfer to the
Regents of the University of what RERI described on the return as "100% of the
remainder estate in the membership interest in H.W. Hawthorne Holdings, LLC"
(Holdings). Holdings, RERI reported, "owns all of the membership interest of a
['single purpose, single member'] Delaware limited liability company". That
Delaware LLC is RS Hawthorne, LLC (Hawthorne), which RERI described on the
return as owning "the fee simple absolute in a parcel of land improved as a AT&T
-5-
web hosting facility located at 2301 West 120th Street, Hawthorne, California"
(Hawthorne property).
Red Sea Tech I, Inc.
The Hawthorne property had come to be owned by Hawthorne on February
6, 2002, pursuant to Hawthorne's execution of a real estate contract that
Hawthorne had received from Red Sea Tech I, Inc. (Red Sea). Hawthorne
purchased the Hawthorne property from InterGate LAII, LLC (Intergate), for
$42,350,000. To fund that purchase, Hawthorne borrowed $43,671,739 from
Branch Banking & Trust Co. (BB&T), signing a promissory note (promissory note
or note) and securing its repayment obligation by, among other things, a deed of
trust (mortgage) and an "Absolute Assignment of Rents and Lease". The
promissory note called for payments in installments (including interest) over a
period of 14 years and 3 months (February 15, 2002--May 15, 2016), with the final
payment, due May 15, 2016, constituting a "balloon" payment of $11.8 million.
AT&T occupied the Hawthorne property pursuant to a triple net lease between it
and Intergate. That lease had commenced on December 1, 2000, and was for a
term of 15½ years, until May 31, 2016, with AT&T having three renewal options
of 5 years each.
-6-
The Temporal Interests
Initially, Red Sea was the sole member of Holdings. On February 7, 2002,
Red Sea created two temporal interests in its membership interest in Holdings
(Holdings membership interest or, sometimes, Holdings)--a possessory term of
years member interest (TOYS interest) and a future, successor member interest
(SMI). The TOYS interest commenced in February 2002 and is to run almost 18
years, through December 31, 2020. The SMI becomes possessory on January 1,
2021, on termination of the TOYS interest.
Sale to RJS
RJS Realty Corp. (RJS) is a Delaware corporation. On February 7, 2002,
RJS purchased the SMI for $1,610,000. By the agreement of sale (assignment
agreement), among other things, Red Sea agreed to prohibit Holdings or
Hawthorne from encumbering the Hawthorne property without the consent of RJS.
Red Sea also agreed to prohibit the transfer of any interest in the Hawthorne
property or the creation of any "lien or encumbrance" on the property that would
"materially adversely affect" its value. The assignment agreement limits Red Sea's
(and any successor in interest's) liability for breach of the agreement. An
assignee's recourse for breach of the agreement is limited to the interest (the
TOYS interest) retained by Red Sea. The assignment agreement provides that it
-7-
"shall be interpreted and construed in a manner consistent with the common law of
estates in property of the State of New York and the statutory scheme of future
interests and estates in property of the State of New York that is set forth in the
New York Estates, Powers and Trust Law as in effect on the date hereof".
RERI's Purchase
On March 25, 2002, RJS sold the SMI to RERI for $2,950,000, RERI
paying $1,880,000 in cash and executing a nonrecourse promissory note for the
balance.
The Gift Agreement
On August 27, 2003, RERI's principal investor, Stephen M. Ross, pledged
that he would make a gift of $4 million (later increased to $5 million) to the
University for the benefit of its Department of Athletics (gift agreement).
Under the gift agreement, Mr. Ross pledged and agreed "to transfer, or to
have transferred" the SMI to the University no later than December 31, 2003.
Upon receiving the SMI, the University was to hold it at a nominal value of $1 and
credit Mr. Ross' pledge in the amount of $1. The University agreed to hold the
SMI for a minimum of two years, "after which the University shall sell" the SMI
and credit Mr. Ross' account "to a value equal to the net proceeds received by the
University" for the SMI. RERI's donation of the SMI to the University was
-8-
completed on the same day as the gift agreement, August 27, 2003. Consistent
with the gift agreement, the agreement embodying RERI's donation of the SMI to
the University required the University to hold the SMI "for a period of two years".
(We shall hereafter refer to the University's obligations--first, to hold the SMI for
a minimum of two years and, then, to sell it--as the two-year hold-sell
requirement.)
Appraisal of the Hawthorne Property
In September 2003, RERI retained Howard C. Gelbtuch of Greenwich
Realty Advisors to appraise a hypothetical remainder interest in the Hawthorne
property. Mr. Gelbtuch concluded that the fair market value of "the leased fee
interest in the * * * [Hawthorne] property as of August 28, 2003, is US
$55,000,000", and that the "investment value" of a hypothetical remainder interest
in that property vesting on January 1, 2021, was $32,935,000.3 Mr. Gelbtuch
determined that value by multiplying his valuation of the underlying leased fee
interest by an actuarial factor taken from the tables promulgated under sections
2031 and 7520. See sec. 20.2031-7(d)(1), Estate Tax Regs. (2003); sec. 1.7520-
3
The appraisal and professional fees were calculated as $84,000, for a total
reported charitable contribution by the partnership of $33,019,000.
-9-
1(a)(1), Income Tax Regs. (2003).4 In his appraisal report, Mr. Gelbtuch states
that he was "advised that the applicable Remainder Interest Actuarial Factor as
provided in Section 7520 of the Internal Revenue Code of 1986 for the month of
contribution is .598793705." Mr. Gelbtuch appraised the leased fee interest
assuming that it was "free and clear of any and all liens or encumbrances".
Sale of the SMI
On or about December 23, 2005, after the expiration of the required
two-year holding period, and after obtaining its own appraisal of the remainder
interest in the Hawthorne property as of July 20, 2005, which valued that interest
at $6.5 million (on the basis of a "Reversion Value" of the Hawthorne property
after 15 years), the University sold the SMI to HRK Real Estate Holdings, LLC
(HRK), a Delaware LLC indirectly owned by petitioner and one of his associates,
for $1,940,000.5
4
Mr. Gelbtuch was asked to and did, in fact, appraise a hypothetical
remainder interest in the Hawthorne property, not the SMI.
5
As a result of petitioner's donation of the SMI to the University and other
donations of similar successor member interests in other LLCs arranged by Mr.
Ross, the University derived sale proceeds of $4,276,604, which it credited to Mr.
Ross' $5 million pledge. Respondent alleges that, in at least some of those cases,
the amounts realized by the University on its sales of the donated successor
remainder member interests were far less than the appraisal thereof for which the
donor, presumably, claimed a sec. 170 deduction.
- 10 -
HRK had pre-sold the SMI to a third-party individual for $3 million on or
about December 20, 2005. On December 26, 2005, that third party donated the
SMI to another charitable organization and claimed a charitable contribution
deduction of $29,930,000 in connection therewith, again on the basis of an
appraisal by Mr. Gelbtuch of a hypothetical remainder interest in the Hawthorne
property.
Discussion
I. Summary Judgment
Pursuant to Rule 121(a), "[e]ither party may move, with or without
supporting affidavits or declarations, for a summary adjudication in the moving
party's favor upon all or any part of the legal issues in controversy." A summary
judgment is appropriate "if the pleadings, answers to interrogatories, depositions,
admissions, and any other acceptable materials, together with the affidavits or
declarations, if any, show that there is no genuine dispute as to any material fact
and that a decision may be rendered as a matter of law." Rule 121(b). A summary
judgment may be made upon part of the legal issues in controversy. See id. In
response to a motion for summary judgment, an adverse party may not rest upon
mere allegations or denials of the moving party's pleading but "must set forth
specific facts showing that there is a genuine dispute for trial." Rule 121(d).
- 11 -
II. Application of the Actuarial Tables Under Section 7520 in Valuing the SMI
A. Applicable Law
Section 170(a)(1) allows a deduction for "any charitable contribution * * *
made within the taxable year * * * only if verified under regulations prescribed by
the Secretary." Section 1.170A-1(c)(1), Income Tax Regs., generally provides that
the amount of a contribution "made in property other than money * * * is the fair
market value of the property at the time of the contribution". Section 1.170A-
1(c)(2), Income Tax Regs., provides that "fair market value is 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."
In most cases, the willing buyer-willing seller standard is not applied
directly to annuities, life estates, terms of years, remainders, reversions and similar
partial interests in property. In general, those interests are valued by determining
the fair market value of the underlying property and dividing the value among the
several interests in the property on the basis of their present values. In pertinent
part, section 7520(a) provides with respect to remainder interests:
- 12 -
SEC. 7520(a). General Rule.--For purposes of this title, [i.e.,
title 26, U.S.C., the Internal Revenue Code] the value of any * * *
remainder * * * interest shall be determined--
(1) under tables prescribed by the Secretary, and
(2) by using an interest rate (rounded to the nearest 2/10ths
of 1 percent) equal to 120 percent of the Federal midterm rate
in effect under section 1274(d)(1) for the month in which the
valuation date falls.
If an income * * * tax charitable contribution is allowable for any part
of the property transferred, the taxpayer may elect to use such Federal
midterm rate for either of the 2 months preceding the month in which
the valuation date falls for purposes of paragraph (2). * * *
Section 1.7520-1(a)(1), Income Tax Regs.,6 applicable to remainder
interests, provides: "Except as otherwise provided in this section and in
§ 1.7520-3 (relating to exceptions to the use of prescribed tables under certain
circumstances), in the case of certain transactions after April 30, 1989, subject to
the income tax, the fair market value of * * * remainders * * * is their present
value determined under this section." Section 1.7520-1(c), Income Tax Regs.,
generally provides that "present value" is to be computed by using tables (section
7520 tables) reflecting the section 7520 interest rate component and, if necessary,
the mortality component described in the section 7520 regulations. See also
6
The regulations cited and discussed herein are those that were in effect for
2003, the year in issue.
- 13 -
section 1.7520-2(a)(1), Income Tax Regs., which provides: "Valuation.--Except
as otherwise provided in this section and in § 1.7520-3 * * * the fair market value
of * * * remainders * * * for which an income tax charitable deduction is
allowable is the present value of such interests determined under § 1.7520-1."
Section 1.7520-3(b)(1)(i)(C), Income Tax Regs., describes an "ordinary
remainder or reversionary interest" as "the right to receive an interest in property
at the end of one or more measuring lives or some other defined period." The
regulation provides that such an interest may be present-valued using a "standard
section 7520 remainder factor" as defined therein. Id.
Section 1.7520-3(b)(1)(ii), Income Tax Regs., describes a "restricted
beneficial interest", in part, as a remainder interest "that is subject to a
contingency, power, or other restriction, whether the restriction is provided for by
the terms of the * * * governing instrument or is caused by other circumstances."
That regulation further provides: "In general, a standard section 7520 * * *
remainder factor may not be used to value a restricted beneficial interest." Id. It
provides, however, that "a special section 7520 * * * remainder factor may be used
to value a restricted beneficial interest under some circumstances", citing an
- 14 -
example in section 1.7520-3(b)(4), Income Tax Regs., that is not germane to this
case.7 Id.
If neither the section 7520 tables nor a special section 7520 factor is
applicable to determining the value of a remainder interest, then the fair market
value of the remainder interest is determined without regard for section 7520 on
the basis of all of the facts and circumstances. See sec. 1.7520-3(b)(1)(iii), Income
Tax Regs.
Section 1.7520-3(b)(2), Income Tax Regs., is entitled "Provisions of
governing instrument and other limitations on source of payment." Section
1.7520-3(b)(2)(iii), Income Tax Regs., provides with respect to remainder and
reversionary interests:
7
As discussed infra pp. 37-39, respondent alleges that the SMI was a
restricted beneficial interest precluding Mr. Gelbtuch's use of the sec. 7520 tables.
Respondent appears to treat that preclusion as mandated by and synonymous with
the statement in sec. 1.7520-3(b)(1)(ii), Income Tax Regs., that "[i]n general, a
standard section 7520 * * * remainder factor may not be used to value a restricted
beneficial interest." Petitioner does not allege the right to file on RERI's behalf a
ruling request under sec. 1.7520-1(c), Income Tax Regs., seeking from respondent
a "special section 7520 * * * remainder factor" in order to value the SMI. See sec.
1.7520-3(b)(1)(ii), Income Tax Regs. Nor do the parties discuss the possible use
of such a factor herein in lieu of the "standard" sec. 7520 factor or what that might
mean in arriving at a value of the SMI. Therefore, we will address the issue as
framed by the parties: whether petitioner is entitled to use the sec. 7520 tables
(i.e., a "standard" sec. 7520 remainder factor) in valuing the SMI.
- 15 -
(iii) Remainder and reversionary interests. A standard section
7520 remainder interest factor for an ordinary remainder or
reversionary interest may not be used to determine the present value
of a remainder or reversionary interest (whether in trust or otherwise)
unless, consistent with the preservation and protection that the law of
trusts would provide for a person who is unqualifiedly designated as
the remainder beneficiary of a trust for a similar duration, the effect of
the administrative and dispositive provisions for the interest or
interests that precede the remainder or reversionary interest is to
assure that the property will be adequately preserved and protected
(e.g., from erosion, invasion, depletion, or damage) until the
remainder or reversionary interest takes effect in possession and
enjoyment. This degree of preservation and protection is provided
only if it was the transferor's intent, as manifested by the provisions
of the arrangement and the surrounding circumstances, that the entire
disposition provide the remainder or reversionary beneficiary with an
undiminished interest in the property transferred at the time of the
termination of the prior interest.
See also section 1.7520-3(b)(2)(ii)(A), Income Tax Regs., which, in
addressing the requirements of a "governing instrument" with respect to "[i]ncome
and similar interests", provides that the income beneficiary's interest is adequately
protected (i.e., is an ordinary beneficial interest subject to valuation using a
"standard section 7520 income factor") "only if it was the transferor's intent, as
manifested by the provisions of the governing instrument and the surrounding
circumstances, that the trust provide an income interest for the income beneficiary
during the specified period of time that is consistent with the value of the trust
corpus and with its preservation." (Emphasis added.)
- 16 -
The wasting nature of depreciable and depletable real property is reflected
in a special rule requiring that, in determining the value of a remainder interest in
real property for purposes of section 170 (allowing an income tax deduction for
any charitable contribution), depreciation and depletion be taken into account.
Section 170(f)(4) provides: "For purposes of this section, in determining the value
of a remainder interest in real property, depreciation (computed on the straight line
method) and depletion of such property shall be taken into account, and such value
shall be discounted at a rate of 6 percent per annum, except that the Secretary may
prescribe a different rate."
B. Whether on the Authority of Pierre v. Commissioner We Should
Disregard the Check-the-Box Regulations in the Context of a
Valuation for Purposes of Section 170, and, if So, Whether That
Disregard Necessarily Invalidates Mr. Gelbtuch's Valuation as a
Valuation of the SMI Because He Improperly Applied the Section
7520 Tables to the Hawthorne Property Rather Than to the Value of
the Holdings Membership Interest
1. The Parties' Arguments
Respondent argues that Mr. Gelbtuch improperly appraised a hypothetical
remainder interest in the Hawthorne property rather than the SMI that RERI did, in
fact, donate to the University. He argues that, assuming the section 7520 tables
are applicable to value the SMI, the section 7520 remainder interest factor should
have been applied "to the fair market value of Holdings, a recognized legal entity
- 17 -
formed under Delaware law, rather than [to] the market value of the Hawthorne
Property."
Petitioner defends Mr. Gelbtuch's application of the section 7520 tables to
the fair market value of the Hawthorne property on the ground that both Holdings
and its wholly owned subsidiary, Hawthorne, which owned the Hawthorne
property, were LLCs wholly owned by Red Sea and, therefore, were "disregarded
entities" pursuant to section 301.7701-3(b)(1)(ii), Proced. & Admin. Regs.
Petitioner argues that our Opinion in Pierre v. Commissioner, 133 T.C. 24 (2009),
in which we held that an LLC constituting a disregarded entity under the foregoing
regulation may not be disregarded for purposes of valuing the gift of an interest
therein, is applicable only for Federal gift tax purposes, not for purposes of
determining the income tax deduction for a charitable contribution of an interest in
a disregarded LLC, the sole asset of which is an interest in real estate. Respondent
rejects petitioner's reliance on the check-the-box regulations to disregard Holdings
and Hawthorne, noting that, although this Court "considered * * * [the] issue in
the context of the federal gift tax provisions, the Tax Court's rationale in Pierre is
equally applicable to the instant case."
Petitioner, recognizing that Pierre involved gifts and valuations of fractional
interests in an LLC, posits that "had 100% of the Pierre LLC interests been
- 18 -
transferred to one person the Court in Pierre would have agreed that no discounts
were appropriate"; i.e., that the transferred LLC interests and the underlying assets
represented thereby would be of equal value. In further support of that argument,
petitioner notes that "respondent fails to discuss how one would go about valuing
the interests transferred since the 100% owner of the LLC could collapse the
structure, terminating the LLC", again suggesting that the SMI and the remainder
interest in the Hawthorne property were of equal value. Similarly, in defending
the Gelbtuch appraisal as a "qualified appraisal" under section 1.170A-13(c)(3),
Income Tax Regs., petitioner questions how an appraisal of the SMI "would
produce a different result as the underlying asset would still have to be valued",
and he further notes: "[w]hile respondent argues the wrong property was * * *
valued, * * * [he] does not suggest how else the value of the * * * [SMI] would be
determined." Thus, petitioner suggests that, even if Mr. Gelbtuch did apply the
section 7520 tables to a fair market valuation of the wrong property, that
impropriety was of no economic consequence and, therefore, should be ignored.
- 19 -
2. Analysis
a. Applicability of Pierre
In Pierre, the LLC, wholly owned by the individual donor of the fractional
interests therein, was validly formed under New York law. We determined that,
even though the LLC was a disregarded entity under the check-the-box
regulations, that designation did not control the valuation of the fractional LLC
interests transferred by the donor taxpayer for Federal gift tax purposes. In
holding that the gifts were of fractional interests in the LLC rather than of pro rata
shares of the LLC's underlying assets, we noted that, under New York law, the
taxpayer "did not have a property interest in the underlying assets of" the LLC and
that "Federal law could not create a property right in those assets." Pierre v.
Commissioner, 133 T.C. at 29-30. We further noted that the question of how the
transfer of an ownership interest in an LLC should be valued for Federal gift tax
purposes "is not the question addressed by the check-the-box regulations". Id. at
35.
We also find significant Judge Cohen's admonition in her concurring
opinion (joined by 8 of the other 9 Judges joining in the 10-Judge majority
opinion), that "[w]here the property transferred is an interest in a single-member
- 20 -
LLC * * * validly created and recognized under State law, the willing buyer
cannot be expected to disregard that LLC." Id. at 37.
We were faced in Pierre, as we are faced here, with identifying the
appropriate property against which to apply the customary willing seller and
willing buyer standard (here, as a first step in applying the section 7520 tables).
The customary willing seller and willing buyer standard is described in
substantially identical language both for valuing charitable contributions of
property for income tax purposes and for valuing gifts of property for gift tax
purposes. Compare sec. 1.170A-1(c)(2), Income Tax Regs., with sec. 25.2512-1,
Gift Tax Regs. See sec. 20.2031-1(b), Estate Tax Regs. (same definition for estate
tax valuations). And it is only on account of a charitable contribution deduction
provided for in the gift tax statute that gifts to charity are not included in the
amount of taxable gifts. See sec. 2522. We see no reason to identify the property
to be valued for income tax purposes (and subject to a charitable contribution
deduction) differently from the property to be valued for gift tax purposes (and
subject to a charitable contribution deduction).8
8
Nevertheless, the value of a remainder interest in real property contributed
to a qualified charitable organization may be greater for gift tax or estate tax
purposes than it is for income tax purposes. Unlike sec. 170(f), neither the gift tax
nor the estate tax provisions contain an express requirement that depreciation or
(continued...)
- 21 -
Thus, we agree with respondent that, on the rationale of Pierre, for purposes
of determining the value of RERI's charitable contribution to the University, the
property RERI transferred to the University was the SMI. We also agree with
respondent that, on the face of it, Mr. Gelbtuch did not determine the value of the
SMI; rather, on the face of it, by applying the section 7520 tables to the value of
the Hawthorne property, he determined the value of a hypothetical remainder
interest in that property. The question is whether the latter value may serve as an
acceptable substitute for the former value.
8
(...continued)
depletion be taken into account in determining the value of a remainder interest in
real property. Apparently, the Commissioner takes that omission to be intentional.
See Rev. Rul. 76-473, 1976-2 C.B. 306 (gift tax value of charitable remainder
interest in personal residence following 20-year possessory interest determined
without taking into consideration depreciation for period before charity's
possession. "The value of the charitable remainder interest is higher for gift tax
purposes than for income tax purposes."); see also Nat'l Bank of Commerce in
Memphis v. United States, 422 F.2d 1074, 1076 (6th Cir. 1970) (estate tax
deduction for transfer of charitable remainder computed simply by multiplying
current asset value by factor from tables); Estate of Bachman v. Commissioner,
T.C. Memo. 1975-186 (to same effect).
- 22 -
b. Whether Mr. Gelbtuch's Application of the Section 7520
Tables to the Value of the Hawthorne Property
Necessarily Invalidates Mr. Gelbtuch's Valuation as a
Valuation of the SMI
On the basis of the rationale of Pierre, the property that RERI transferred to
the University was the SMI, and it thus would have been no error for Mr. Gelbtuch
to have determined the value of the Holdings membership interest and to have
applied the section 7520 tables to that value to determine the value of the SMI.
That, however, does not necessarily mean that RERI fatally erred in determining
the value of the SMI by having Mr. Gelbtuch determine the value of a hypothetical
remainder interest in the Hawthorne property. Pierre involved transfers of present
interests in a single-member LLC to two trusts, which interests, because of
discounts for lack of marketability and control, were argued to be worth less than
the donees' pro rata shares of the assets of the LLC. Petitioner points out that
RERI transferred to the University a future interest in Holdings that, when it
becomes a present (possessory) interest at the termination of the TOYS interest,
will encompass 100% of the membership interest in Holdings. Therefore,
petitioner argues, there is not necessarily any difference between the value of the
property owned by Holdings indirectly (the Hawthorne property) and the value of
the property (Holdings) to which Mr. Gelbtuch should have applied the section
- 23 -
7520 tables in determining the value of the SMI. It follows, petitioner suggests,
that, absent restrictions applicable to one and not the other, see discussion infra,
there is no difference between the value of Holdings and the value of the leased
fee interest in the Hawthorne property that was, in effect, Holdings' sole asset. If
so, petitioner continues, then Mr. Gelbtuch's valuation of the latter, in effect,
would have constituted a valuation of the former, so that the section 7520 tables
could properly be applied to the latter in arriving at a value for the SMI. In
response to petitioner's suggestion, respondent admits that, "[i]n normal course,
there exists a unity of interest between a single-member entity and the assets
owned by such entity."9 But he argues that Red Sea's split of Holdings into the
TOYS interest and the SMI gave rise to "'a multiple ownership structure' unlike
where one party owned 100 percent."
It is true that Red Sea did divide the Holdings membership interest into a
present (TOYS) interest and a future (SMI) interest; it is also true that, applying
the section 7520 tables to determine the present value of each, neither value is
equal to the combined value of the two interests. Pursuant to section 7520 and its
9
In support of that statement, respondent states: "See e.g., Pierre at 43
(Halpern, dissenting) citing 18 C.J.S., Corporations, at § 4 (2007) and Smart v.
Int'l Bd. of Elec. Workers, Local 702, 315 F.3d 721, 723 (7th Cir. 2002) regarding
the rule of unity which exists amongst a sole proprietor and such entrepreneur's
business."
- 24 -
implementing regulations, the method for determining the value of an ordinary
income interest or an ordinary remainder interest (or, in some cases, an income or
a remainder interest constituting a restricted beneficial interest) is to determine the
fair market value of the property out of which the two interests were created and to
divide that value among the two interests on the basis of their present values. See
1.7520-1(a)(1), Income Tax Regs. For a remainder interest following a term of
years interest, the section 7520 tables reflect only interest rate and timing
variables. See sec. 1.7520-1(c), Income Tax Regs. But, if those section 7520
tables do apply to value the SMI, they fully reflect Congress' and the Secretary's
concerns that the SMI represents less than the 100% of the Holdings membership
interest. And if it can be assumed that (1) the Hawthorne property and Holdings
are of equal value and (2) no restrictions burden the SMI, then nothing may be lost
in allowing the Hawthorne property to substitute for the Holdings membership
interest in applying the section 7520 tables to determine the value of the SMI.10
10
We note in passing that, in valuing the Hawthorne property, Mr. Gelbtuch
assumed that it was unencumbered by any indebtedness. Our intuition is that any
valuation of Holdings (a holding company) would reflect Hawthorne's net asset
value (i.e., the value of its assets less the value of its liabilities), thus taking into
account the liability represented by the promissory note and the mortgage. In that
event, Mr. Gelbtuch's valuation of the Hawthorne property on the assumption that
it was "free and clear of any and all liens or encumbrances" could not be
considered a substitute for a valuation of Holdings, and, hence, his valuation of a
(continued...)
- 25 -
There is an unresolved issue of fact concerning whether the value of a
hypothetical remainder interest in the Hawthorne property can stand proxy for the
SMI. That issue involves the two-year hold-sell requirement imposed on the
University with respect to its possession of the SMI. Does that requirement cause
the SMI to be a restricted beneficial interest for which a standard section 7520
remainder factor may not be applied to determine fair market value, see sec.
1.7520-3(b)(1)(ii), Income Tax Regs., or, if not, does it at least reduce the value of
the SMI below that of a hypothetical remainder interest in the Hawthorne
property? We discuss the restricted beneficial interest issue infra pp. 37-50.
If we determine the fact issue adversely to petitioner, we would agree with
respondent that Mr. Gelbtuch's application of the section 7520 tables to the fair
market value of the Hawthorne property necessarily resulted in a valuation (of a
hypothetical remainder interest therein) that may not substitute for a valuation of
the SMI.11 If, on the other hand, we are persuaded that an appraisal of a
10
(...continued)
hypothetical remainder interest in the Hawthorne property (applying the sec. 7520
tables to the debt-free value of that property), could not be considered a substitute
for a valuation of the SMI. It is incumbent on the parties to address that issue at
the appropriate time. In the order, see supra note 2, we did not address that
specific issue.
11
The same would be true should we ultimately determine that Mr.
(continued...)
- 26 -
hypothetical remainder interest in the Hawthorne property can substitute for an
appraisal of the SMI, we would be inclined to apply the often invoked principle of
"[n]o harm; no foul", see, e.g., King v. Nat'l Human Res. Comm., Inc., 218 F.3d
719, 724 (7th Cir. 2000), and reject respondent's argument that we must, as a
matter of law, disregard Mr. Gelbtuch's appraisal because he improperly applied
the section 7520 tables to the fair market value of the Hawthorne property rather
than to the fair market value of Holdings. It would be premature to apply that
principle herein, however, because there exist unresolved questions of both law
and fact.
C. Whether the Regulations Preclude Application of the Section 7520
Tables to Value the SMI
1. Introduction
The SMI is a remainder interest in Holdings, and its fair market value is its
present value determined by applying the section 7520 tables only if (1) the SMI is
an ordinary remainder interest and the provisions of section 1.7520-3(b)(2)(iii),
Income Tax Regs. (requiring that preservation and protection of the underlying
property (the Holdings membership interest) is assured) are satisfied or (2) the
11
(...continued)
Gelbtuch's appraisal cannot substitute for a valuation of the SMI because of his
failure to take the mortgage into account.
- 27 -
SMI is a restricted beneficial interest for which a standard section 7520 remainder
factor may be used. See sec. 1.7520-3(b)(1)(ii), Income Tax Regs.
2. Summary of the Parties' Arguments
Respondent's principal argument is that section 1.7520-3(b)(2)(iii), Income
Tax Regs., precludes application of the section 7520 tables to determine the value
of the SMI. Respondent argues that, because the holder of the SMI does not
"enjoy the same protections as would be afforded to a trust remainderman", there
is no assurance that such holder "will receive the Hawthorne Property in its
original form." Respondent worries about devaluation of the Holdings
membership interest because of depreciation of the Hawthorne property, its sale,
or additional or unpaid mortgage indebtedness. Therefore, respondent argues,
whether the SMI constitutes an ordinary remainder interest or not, the preservation
and protection requirements of section 1.7520-3(b)(2)(iii), Income Tax Regs.,
preclude application of the section 7520 tables.
Additionally, respondent argues that, because of the two-year hold-sell
requirement, the SMI is a restricted beneficial interest within the meaning of
section 1.7520-3(b)(1)(ii), Income Tax Regs., to which the section 7520 tables
cannot be applied.
- 28 -
Petitioner argues that the SMI follows a term of years interest (i.e., the
TOYS interest) and is therefore an ordinary remainder interest within the meaning
of section 1.7520-3(b)(1)(i)(C), Income Tax Regs. Petitioner rejects respondent's
reading of section 1.7520-3(b)(2)(iii), Income Tax Regs., arguing that "the
regulation basically provides * * * consistent with the laws of trusts, * * * [that]
the trustee * * * must protect against waste." He further argues that "the
regulation simply provides that the interest of the property [e.g., a remainder
interest] as opposed to its value, be undiminished", and that it is only "concerned
with the initial beneficiary having the power to utilize the assets of the trust so that
there is a real possibility that there will be nothing or little left for a
remainderman." Petitioner also "discerns" from the regulatory language "that the
interest being discussed is a remainder interest in a trust and not a remainder
interest in real property." Petitioner argues that the SMI holder's right to protect
its interest arises under contract and property law, not trust law (i.e., the SMI
holder is not the remainder beneficiary of a trust), and that, in any event, the SMI
is adequately protected by the severe limitations in the Red Sea-RJS assignment
agreement on the right of the TOYS interest to encumber the Hawthorne property.
He thinks that respondent overstates the possibility of a devaluation of the
Holdings membership interest, arguing that depreciation does not preclude the use
- 29 -
of the section 7520 tables and that respondent's concern that the remainder will be
diminished in value is "so remote as to be negligible."
Lastly, petitioner disputes respondent's argument that the two-year hold-sell
requirement renders the SMI a restricted beneficial interest to which the section
7520 tables are inapplicable. Rather, petitioner argues, a restriction on the right to
dispose of an interest in property is not the type of restriction contemplated in the
regulation, section 1.7520-3(b)(1)(ii), Income Tax Regs., defining the term
"restricted beneficial interest."
3. Analysis
a. Introduction
We may summarily dispose of petitioner's argument that the preservation
and protection requirements found in section 1.7520-3(b)(2)(iii), Income Tax
Regs., apply only with respect to property held in trust. They do not. The
parenthetical in the first sentence of the regulation makes that quite clear: "A
standard section 7520 remainder interest factor for an ordinary remainder * * *
interest may not be used to determine the present value of a remainder * * *
interest (whether in trust or otherwise) unless". Id. (emphasis added).
Therefore, for respondent to prevail on his claim that the section 7520 tables
are inapplicable in determining the fair market value of the SMI, he must show
- 30 -
either (1) that the SMI is an ordinary remainder interest for which the preservation
and protection requirements of section 1.7520-3(b)(2)(iii), Income Tax Regs., are
not satisfied or (2) that the SMI is a restricted beneficial interest whose value may
not be determined by application of a standard section 7520 remainder factor.
b. Preservation and Protection of the Property
i. Risk of Hawthorne's Encumbering or Selling the
Hawthorne Property
Respondent argues that, because Hawthorne may encumber or sell the
Hawthorne property, there is no assurance that the value of the Holdings
membership interest will be preserved and protected until the holder of the SMI
comes into possession of that interest. See sec. 1.7520-3(b)(2)(iii), Income Tax
Regs. As stated supra in our background discussion, by the assignment
agreement, Red Sea agreed to prohibit Holdings or Hawthorne from encumbering
the Hawthorne property without the consent of RJS, the initial transferee of the
SMI under that agreement. By that agreement, Red Sea also agreed to prohibit the
transfer of any interest in the Hawthorne property or the creation of any "lien or
encumbrance" on that property that would "materially adversely affect" its value.
Respondent argues that, in the event the Hawthorne property is either sold or
- 31 -
encumbered in violation of the assignment agreement,12 RJS and, subsequently,
RERI and the University, as owners of the SMI, would have the right, under that
agreement, only "to receive, as damages, the very interest promised", i.e., the SMI.
Thus, respondent concludes, "the successor member interest holder is afforded
substantially less protection than that of a trust remainderman", in violation of the
principal requirement for the use of a "standard section 7520 remainder interest
factor" under section 1.7520-3(b)(2)(iii), Income Tax Regs. Petitioner responds
that the risks that the SMI might be diminished by any such action are remote
possibilities that, pursuant to regulations under section 170, are not to be taken
into account in valuing a charitable contribution. See sec. 1.170A-1(e), Income
Tax Regs. (possibility that charitable transfer will not become effective
disregarded if, on the date of the gift, that possibility "is so remote as to be
negligible"). Therefore, petitioner argues the assignment agreement does not lack
assurance that the Holdings membership interest will be adequately preserved and
protected.
12
Both petitioner and respondent refer to the possibility that the owner of the
TOYS interest might encumber the Hawthorne property. In fact, it would appear
that Hawthorne, the owner of the property, would be the only person who could
encumber the property. That is the occurrence actually contemplated (and
prohibited without RJS' consent) by the parties to the assignment agreement.
- 32 -
Respondent has not shown that either Red Sea, Holdings, or Hawthorne
intends a sale of the Hawthorne property. Moreover, the property into possession
of which the SMI holder will come is the Holdings membership interest, not the
Hawthorne property. Holdings' assets (whether held directly or indirectly) may
change without necessarily putting into jeopardy the SMI holder's rights to future
possession and enjoyment of a valuable Holdings membership interest. Similarly,
respondent has not shown any intent to encumber the Hawthorne property in
violation of the assignment agreement, except, perhaps, in connection with a
refinancing or restructuring of the balloon payment. That possibility is
acknowledged by petitioner should AT&T not exercise its option to renew its
lease in May 2016, when the initial lease term is to expire and the $11.8 million
balloon payment becomes due. But even in that event, it is not clear that such a
refinancing would entail an additional, burdensome encumbrance on the
Hawthorne property as a new mortgage would, presumably, replace the existing
mortgage on the Hawthorne property and, therefore, not cause any diminution of
the property's fair market value. Moreover, even if the Hawthorne property were
otherwise encumbered, that would not necessarily put into jeopardy the SMI
holder's rights to future possession and enjoyment of the Holdings membership
interest.
- 33 -
Respondent has not made his case that the risk of Hawthorne's selling or
encumbering the Hawthorne property jeopardizes the SMI holder's rights to future
possession and enjoyment of the Holdings membership interest so as to preclude
use of a standard section 7520 remainder interest factor to determine the present
value of the SMI. See sec. 1.7520-3(b)(2)(iii), Income Tax Regs.13 At best,
respondent has identified a dispute as to a material issue of fact; i.e., Hawthorne's
(and others') intentions.
ii. Risk of Nonpayment of the Promissory Note and
Foreclosure
The parties differ sharply as to whether the possibility that Hawthorne will
be unable to make the $11.8 million balloon payment on the May 15, 2016, due
date poses a sufficient risk of foreclosure and sale of the Hawthorne property to
13
We note in passing that, in discussing the limitation-on-liability provision
of the assignment agreement, which respondent claims jeopardizes the SMI
holder's future interest in the Holdings membership interest, respondent may have
confused the TOYS interest and the SMI. That provision (paragraph C of the
covenants portion of the assignment agreement) provides that, in the event of an
assignor's (Red Sea's or one of its successor's) breach of the agreement, the
assignee's (RJS' or one of its successor's, e.g., RERI's or the University's) recourse
is limited to the assignor's "Retained Interest" (i.e., the TOYS interest) in
Holdings. Respondent's claim is that the limitation-on-liability provision "only
permits the successor member interest holder to receive, as damages, the very
interest promised", i.e., the SMI. That is not the case. The SMI holder could
receive as damages all of the TOYS interest, which, when united with the SMI,
represents complete ownership of Holdings.
- 34 -
warrant a conclusion that the Holdings membership interest value will not be
adequately preserved and protected for the benefit of the SMI. If there is
sufficient risk of foreclosure, that would foreclose use of a standard remainder
interest factor to determine the present value of the SMI. See sec. 1.7520-
3(b)(2)(iii), Income Tax Regs. Petitioner views the risk as a remote contingency
to be disregarded.
The record shows that the Hawthorne property is Hawthorne's only asset
and that the AT&T lease is its only source of income. The promissory note calls
for a final, $11.8 million balloon payment on May 15, 2016. By the end of May
2016 (the conclusion of the first term of the AT&T lease), Hawthorne should have
received sufficient payments under the AT&T lease to have made all installment
payments called for by the note and to have accumulated a surplus (assuming no
distributions) of approximately $5.7 million. That would leave $6.1 million to be
raised to make the balloon payment.
Petitioner views as remote the possibility of default on the balloon payment.
Specifically, petitioner states:
Petitioner submits that at the time of the donation it was expected that
AT&T would exercise its option to renew the lease and thus the
balloon payment paid. Defaulting on the final payment due on the
loan was as remote as Hawthorne defaulting on the underlying
mortgage. It can also be anticipated that at the time of the donation
- 35 -
the balloon payment would be refinanced or restructured or the
premises leased to another party if AT&T did not exercise its option.
In response to those arguments, respondent continues to maintain that "there
is a possibility that the balloon payment would not get paid, thus resulting in
foreclosure or acquisition of the Hawthorne Property", in which event, "the SMI
holder would possess a worthless membership interest in * * * [Holdings]."
Respondent further argues that there is no evidence that the loan would be
refinanced or even could be refinanced "due to the provisions petitioner relies
upon to argue that encumbrances are not permitted", respondent's assumption
apparently being that the parties would interpret such a replacement financing as
the type of encumbrance that is prohibited by the Red Sea-RJS Assignment
Agreement.
The foregoing arguments by both parties are based entirely on speculation.
Respondent, whose motion it is we are considering, has not convinced us that
Hawthorne, as obligor on the promissory note, would not be able to raise the more
than $6 million needed to make the $11.8 million balloon payment on May 15,
2016. Nor has respondent convinced us that the risk of refinancing the remaining
debt presents anything other than a conventional commercial risk that has little
effect on the safety of Holdings as a long-term investment. Moreover, given
- 36 -
Hawthorne's expected payment of a substantial amount of principal (close to $32
million) before the due date of the balloon payment, what equity will Hawthorne
have in the Hawthorne property, a portion of which might be recouped on a forced
sale of the Hawthorne property to safeguard Holdings' (and the SMI's) value?
Indeed, how will the value of the SMI interest be affected by the fact that principal
payments under the promissory note are to be paid from rental income that, but for
the assignment of rents to BB&T, it would seem should be distributed to the
TOYS interest holder?14 The only "fact" before us is the certainty that the lease
payments will be insufficient (by more than $6 million) to enable Hawthorne to
make that payment. And although, as petitioner argues, it was "expected" or
"anticipated" at the time of RERI's gift of the SMI that there would be a
refinancing, a lease extension, or a new lease, any one of which could have
14
In response to respondent's prior motion for partial summary judgment, see
supra note 2, petitioner stated that the mortgage would "be fully amortized by
* * * the owner of the TOY[S] Interest". 1 Joseph Rasch & Robert F. Dolan, N.Y.
Law & Practice of Real Property, sec. 6:27 (2d ed.) ("Payment of principal of
mortgage") states in pertinent part:
A life tenant is under no obligation to pay the principal of a
mortgage encumbering the property; this must be paid by the
remainderman. If the life tenant does pay it, he may recover such
payment from the remainderman.[9]
[FN9]Collins v McKenna (1921) 116 Misc 72, 189 NYS 433.
- 37 -
generated the funds needed to make the balloon payment, expectation and
anticipation are not synonymous with certainty. Therefore, we find that the
parties' dispute as to whether the risk of Hawthorne's defaulting on the $11.8
million balloon payment is the type of contingency that would jeopardize the value
of Holdings and, thus, the value of the SMI, in contravention of section 1.7520-
3(b)(2)(iii), Income Tax Regs., constitutes a dispute as to a material fact, which
precludes summary adjudication that the risk of nonpayment of the balloon
payment on the promissory note warrants a conclusion that Holdings' value will
not be adequately preserved and protected for the benefit of the SMI.
c. Restricted Beneficial Interest
i. The Parties' Arguments
Respondent summarizes his position with respect to the impact of the two-
year hold-sell requirement as follows:
As a result of the "hold-sell" restrictions imposed by the Gift
Agreement and the * * * [Assignment Agreement], the successor
member interest was a restricted beneficial interest for purposes of
section 7520. Furthermore, the consequence of these restrictions
dictated that the University would never become the owner of the
underlying Hawthorne Property or enjoy the benefits and burdens of
* * * [owning that property].
- 38 -
Respondent concludes: "Since there was no intention to transfer an interest, which
would be unrestricted prior to the expiration of the prior TOYS interest, the
section 7520 tables may not be used."
In rebuttal to respondent's arguments, petitioner cites our conclusion in
Estate of Gribauskas v. Commissioner, 116 T.C. 142, 165 (2001) (Estate of
Gribauskas I), rev'd and remanded, 342 F.3d 85 (2d Cir. 2003) (Estate of
Gribauskas II), involving the value of nonassignable future installments of lottery
winnings, that "a restriction within the meaning of * * * [section 20.7520-
3(b)(1)(ii), Income Tax Regs.] is one which jeopardizes receipt of the payment
stream, not one which merely impacts on the ability of the payee to dispose of his
or her right thereto." Petitioner also notes that we further stated in Estate of
Gribauskas I that "the cases addressing attempts to avoid use of the [section 7520]
tables * * * [generally] required a factual showing that renders unrealistic and
unreasonable the return or mortality assumptions underlying the tables." Id. at
161. Petitioner states: "Not only is the * * * [SMI] not a restricted beneficial
interest for purposes of section 7520, but such a determination is clearly factual
and cannot be determined as a matter of law as sought by respondent."
Petitioner also relies upon two U.S. Courts of Appeals cases that hold that
restrictions on the marketability of an income stream constituting an interest in
- 39 -
property are not the type of restriction that would render the section 7520 tables
inapplicable in valuing the property interest. In Cook v. Commissioner, 349 F.3d
850, 854 (5th Cir. 2003), aff'g T.C. Memo. 2001-170, the Court of Appeals stated:
"In enacting § 7520(a)(1) and requiring valuation by the tables, Congress
displayed a preference for convenience and certainty over accuracy in the
individual case." The Court of Appeals reiterated that statement in Anthony v.
United States, 520 F.3d 374, 377 (5th Cir. 2008). In petitioner's view, the two-
year hold requirement does not furnish a reason to abandon the judicial preference
for valuing partial interests in property under the section 7520 tables.
Lastly, petitioner argues that the gift agreement embodying the sell
requirement has no bearing on the issue because it did not affect the University's
rights with respect to the property "as * * * [the University] would still own and
control * * * [the SMI] regardless of whether * * * [it] adhered to the gift
agreement."
ii. Analysis
(a) The Two-Year Hold-Sell Requirement
We find fault with both parties' analyses of the impact of the two-year hold-
sell requirement.
- 40 -
Our principal problem with respondent's argument is his apparent
assumption that no restricted beneficial interest may be valued using the section
7520 tables. Section 1.7520-3(b)(1)(ii), Income Tax Regs., provides that "[i]n
general, a standard section 7520 * * * remainder factor may not be used to value a
restricted beneficial interest." (Emphasis added.) The two-year hold-sell
requirement is undeniably a restriction on the University's rights with respect to its
ownership of the SMI. But that fact, in and of itself, does not provide a sufficient
basis to conclude that the SMI is a restricted beneficial interest for which a
standard section 7520 remainder factor may not be used to determine value.
Respondent's position also ignores the admonition, uniformly expressed in the
caselaw dealing with the application of the section 7520 tables, that those tables
must be used "unless it is shown that the result is so unrealistic and unreasonable
that either some modification in the prescribed method should be made, or
complete departure from the method should be taken, and a more reasonable and
realistic means of determining value is available" (unrealistic and unreasonable
fair market value standard). Weller v. Commissioner, 38 T.C. 790, 803 (1962)
(citations omitted). To the same effect, see Anthony, 520 F.3d at 383; Cook v.
Commissioner, 349 F.3d at 854; Estate of Gribauskas II, 342 F.3d at 87;
Shackleford v. United States, 262 F.3d 1028, 1031 (9th Cir. 2001). Therefore, we
- 41 -
reject respondent's premise that any restriction applicable to a remainder interest
is, per se, a restriction that renders the interest a restricted beneficial interest for
which use of the section 7520 tables is unavailable.
Petitioner agrees that application of the section 7520 tables is conditioned
on nonviolation of the unrealistic and unreasonable fair market value standard.
But he relies on our statements in Estate of Gribauskas I, 116 T.C. at 165, that a
restriction on alienation is not a restriction covered by section 1.7520-3(b)(1)(ii),
Income Tax Regs., defining a restricted beneficial interest. Petitioner also relies
on Anthony and Cook, which reach the same result. Petitioner's argument
overlooks two important facts. First, all three of the cited cases involve the
valuation of a present right to a stream of income and not the valuation of a right
to future possession of corpus. That distinction was drawn by the Court of
Appeals in Cook v. Commissioner, 349 F.3d at 856, where it stated: "We agree
that the right to alienate is necessary to value a capital asset; however, we think it
unreasonable to apply a non-marketability discount when the asset to be valued is
the right, independent of market forces, to receive a certain amount of money
annually for a certain term." Second, our decision in Estate of Gribauskas I was
reversed by Estate of Gribauskas II, which held that a restriction on marketability
may constitute a restriction that prevents application of the section 7520 tables in
- 42 -
valuing an interest in property if it results in a violation of the unrealistic and
unreasonable fair market value standard.15
We are not bound, pursuant to the doctrine of Golsen v. Commissioner, 54
T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971), to follow Estate of
Gribauskas II because RERI, whose principal place of business was in New York,
was dissolved in 2004. Therefore, it had no principal place of business when it
filed its petition in 2008. As a result, the court to which, barring a written
stipulation to the contrary, an appeal of this case would lie would be the Court of
Appeals for the D.C. (not the Second) Circuit. See sec. 7482(b); Peat Oil & Gas
Assocs. v. Commissioner, T.C. Memo. 1993-130, 1993 WL 95592, at *6. That
court has not as yet addressed the material restriction on the transferability issue.
Nor are we bound by the doctrine of stare decisis to follow our holding in
Estate of Gribauskas I in this case. Estate of Gribauskas I involved a promised
stream of fixed payments and is thus distinguishable from the valuation problem
here before us, the present value of the right to receive a capital asset in the future.
And while that capital asset may itself represent nothing more than the expectation
15
In so holding, the Court of Appeals for the Second Circuit followed the
Court of Appeals for the Ninth Circuit in Shackleford v. United States, 262 F.3d
1028 (9th Cir. 2001), which reached that result. See Estate of Gribauskas v.
Commissioner, 342 F.3d 85, 89 (2d Cir. 2003), rev'g and remanding 116 T.C. 142(2001).
- 43 -
of a future income stream, we generally rely on market prices to determine the
value of capital assets such as shares of stock because the value of such assets is
not readily ascertainable absent a transfer from buyer to seller. See Cook v.
Commissioner, 349 F.3d at 856.
We conclude that the impact of both the restriction on alienation (i.e., the
two-year hold requirement) and the two-year sell requirement is a restriction that
must be measured against the unrealistic and unreasonable fair market value
standard. It is true, as petitioner argues, that the latter requirement is found only in
the gift agreement and not in the assignment agreement. But, as a signatory to
both agreements, the University was bound by both, and it is quite possible to
interpret the two-year hold-sell requirement in the gift agreement as, in effect, a
condition of Mr. Ross' $5 million pledge to the University thereunder. Disputes
under the gift agreement were to be governed by Michigan law, and the
assignment agreement was to be construed in accordance with Delaware law.
Neither party has addressed Mr. Ross' rights under Michigan and Delaware law in
the event the University were to violate the two-year hold-sell requirement. Thus,
there remains a question of fact16 as to whether that requirement constituted a
16
See, e.g., Moulton v. Commissioner, T.C. Memo. 2009-38, 2009 WL
416010, at *5 (holding that the characterization of a claim under applicable State
(continued...)
- 44 -
meaningful restriction relating to the SMI because the University's violation
thereof would have justified Mr. Ross' reneging on all or a portion of his pledge,
thereby reducing the value of the SMI in the University's hands.17
Neither party has presented evidence with respect to the impact, if any, of
the two-year hold-sell requirement on the fair market value of the SMI.18
16
(...continued)
law, in that case, for purposes of determining the applicability of the sec. 104(a)(2)
exclusion from income of damages for physical injury, is a question of fact).
17
In that regard, we note that, before RERI's sale of the SMI to HRK for
$1,940,000, Mr. Ross had threatened to treat his pledge as offset by the full
amount of HRK's offer of that amount if the University were to reject it and, later,
sell the SMI for less.
18
Even if the University's violation of the two-year hold-sell requirement
would have had adverse economic consequences to the University, it is not clear
that that violation would have had any impact on the actual value of the SMI
(which is the relevant inquiry herein), as the violation would have been irrelevant
to the purchaser of the SMI from the University. Conversely, if the University felt
bound to abide by the requirement (as, apparently, it did), respondent argues that
the "consequence" of the two-year hold-sell restriction "dictated that the
University would never become the owner of the underlying Hawthorne Property
or enjoy the benefits and burdens of * * * [owning it]." But respondent furnishes
no evidence that that fact would have adversely affected the SMI's value.
Moreover, it is arguable that the two-year hold restriction did not adversely affect
value because, at the time of sale, the purchaser from the University would have
been two years closer to possession than was the University when it acquired the
SMI, a fact that might have enhanced its value; and the two-year sell restriction
would not have been a factor in the negotiations between the University and any
prospective purchaser because the latter would not have been restricted by it.
- 45 -
Therefore, the impact on the SMI's value of the two-year hold-sell restriction also
presents issues of material fact.
(b) Whether Use of the Section 7520 Tables Would Violate
the Unrealistic and Unreasonable Fair Market Value
Standard
In Estate of Gribauskas II, 342 F.3d at 88, the Court of Appeals for the
Second Circuit noted the Commissioner's agreement that the taxpayer's valuation
of the income stream in that case (lottery winnings in the form of an annuity),
which was more than $900,000 below the value prescribed by the section 7520
tables ($2,603,661.02 versus $3,528,058.22), accurately reflected the market
discount attributable to the restrictions on transferability of the income stream.
The court stated that, under those circumstances, "application of the tables would
clearly 'produce a substantially unrealistic and unreasonable result'". Id. (quoting
O'Reilly v. Commissioner, 973 F.2d 1403, 1408 (8th Cir. 1992), rev'g 95 T.C. 646(1990)). On that basis, the court held that "valuing the winnings pursuant to the
tables was erroneous." Id. In Anthony, 520 F.3d at 384, the Court of Appeals for
the Fifth Circuit ignored a roughly 50% disparity between the taxpayer's expert
valuation of a lottery winnings annuity and the value derived pursuant to the
section 7520 tables in sustaining the latter valuation. But that determination was
based upon its prior determination, following its holding in Cook, that such large
- 46 -
valuation disparities, if they result from marketability or transferability
restrictions, are to be ignored, a position that the Courts of Appeals for both the
Second and Ninth Circuits have rejected, and that the Court of Appeals for the
Fifth Circuit itself has indicated should not be followed in determining the
application of the section 7520 tables to a capital asset rather than an annuity.
In this case, sales of the SMI and an appraisal commissioned by the
University (University appraisal) all indicate that the actual fair market value of
the SMI, within a timeframe stretching from approximately 18 months before
RERI's August 27, 2003, gift of the SMI to the University to 2 years and 4 months
thereafter, was substantially less than Mr. Gelbtuch's $32,935,000 valuation of the
hypothetical remainder interest in the Hawthorne property using the section 7520
tables.
The relevant sales (and valuation) of the SMI are as follows:
(1) February 7, 2002: Red Sea's sale of the SMI to RJS for
$1,610,000.
(2) March 25, 2002: RJS' sale of the SMI to RERI for $2,950,000.
(3) July 20, 2005: the University appraisal determining the value of
a remainder interest in the Hawthorne property to be $6.5 million.
- 47 -
(4) On or about December 23, 2005: the University's sale of the SMI
to HRK for $1,940,000.
(5) December 26, 2005: purported sale of the SMI by HRK to an
unidentified purchaser for $3 million.
All four of the foregoing sales were for amounts substantially below Mr.
Gelbtuch's appraised value of a hypothetical remainder interest in the Hawthorne
property, determined using the section 7520 tables. The sales were for amounts
ranging from approximately 5% to 9% of Mr. Gelbtuch's $32,935,000 appraisal,
and the University appraisal was for an amount approximately 20% of that
appraisal. Even with allowances for market fluctuations during the approximately
3-year, 10-month period of the foregoing transactions, the huge disparity between
the SMI's fair market value as determined by actual sales and an independent
valuation and its value based on Mr. Gelbtuch's appraisal is prima facie violative
of the unrealistic and unreasonable fair market value standard.19 Moreover, the
19
With regard to the presence of significant market fluctuations, we note that
Mr. Gelbtuch made a second appraisal of the Hawthorne property and a
hypothetical remainder interest therein as of December 26, 2006, in which he
concluded that the fair market value of the property was $64,185,000 and that of
the hypothetical remainder interest (per the sec. 7520 tables) was $29,930,000.
That reflects an increase in the property's appraised value and a decrease (due to
application of a lower discount rate) in the hypothetical remainder interest's value,
as compared with Mr. Gelbtuch's appraisal (as of August 28, 2003), in which he
(continued...)
- 48 -
reason for the disparity is of no consequence. If the end result is a disparity of the
foregoing magnitude between actual fair market value and value derived by
applying the section 7520 tables, the tables are inapplicable under the unrealistic
and unreasonable fair market value standard.
Neither party has directly addressed this issue of actual versus derived (per
the section 7520 tables) value. Respondent cites caselaw acknowledging the
relevance of the unrealistic and unreasonable fair market value standard.
Petitioner attempts to refute respondent's argument for nonapplication of the
section 7520 tables on the ground that each of the risks and contingencies
identified by respondent is either remote (and, therefore, to be disregarded) or
irrelevant. We find nothing in the record before us that definitively explains the
foregoing large disparity in values. It may be attributable to one or more of the
restrictions or contingencies discussed supra, but, for the reasons stated, that
19
(...continued)
found those values to be $55,000,000 and $32,935,000, respectively (using a
remainder factor of 0.598793705 to calculate the value of the hypothetical
remainder interest). For the later appraisal, Mr. Gelbtuch was "advised that the
applicable Remainder Interest Discount Rate as provided in Section 7520 of the
Internal Revenue Code of 1986 for the month of contribution is 5.6 percent."
Petitioner has not reconciled for us the use of a smaller factor to calculate the
value of a remainder that was less distant. In any event, the two appraisals do not
differ significantly as regards the valuation of the remainder interest, and the lower
appraisal is still some $27 to $28 million higher that the amounts for which the
SMI was twice sold on or about the "as of" appraisal date.
- 49 -
determination must await the resolution of unresolved issues of fact. Also, it may
be attributable to the fact, discussed supra, that, compared to the application of the
section 7520 tables to Holdings' (based on Hawthorne's) net asset value to
determine the value of the SMI, the application of the section 7520 tables to the
value of the Hawthorne property without taking into account the burden of the
mortgage on that property produces a value for a hypothetical remainder interest in
the Hawthorne property that is not reflective of the value of the SMI. If so,
adjustment would have to be made for that liability or the value of a hypothetical
remainder interest in the Hawthorne property would have to be rejected as a
substitute for the value of the SMI. It also may reflect the fact that the foregoing
sales of the SMI were not intended to be truly reflective of the SMI's fair market
value on the dates of sale.20
20
RERI's contribution of the SMI to the University resulted in a claimed
deduction far in excess of RERI's investment therein. That contribution was
followed by the University's sale of the SMI to HRK and HRK's resale of it, which
was followed, ultimately, by the last purchaser's contribution of the SMI to another
charitable organization, again allegedly resulting in a large deduction in excess of
either HRK's or the donor's investment. That chain of events suggests the
presence of a scheme to generate large deductions, through application of the sec.
7520 tables, for multiple charitable contributions of the same asset, in which each
of the donors made a small investment. Such a scheme at least suggests tax shelter
aspects that the parties may want to address at trial and on brief.
- 50 -
In any event, the issue of whether the disparity between the SMI's value
based upon the University appraisal and the sales of the SMI both before and after
its contribution to the University, and its value based upon the Gelbtuch appraisal
using the section 7520 tables results in a violation of the unrealistic and
unreasonable fair market value standard is also an unresolved issue of material
fact.
4. Conclusion
Because there remain genuine disputes as to material facts, we will deny the
motion to the extent that respondent asks us to rule that the section 7520 tables do
not apply to value the SMI.
III. Whether the Gelbtuch Appraisal Was a Qualified Appraisal
A. Applicable Law
As noted supra, section 170(a)(1) allows a charitable contribution
deduction, but only if the contribution is "verified under regulations prescribed by
the Secretary." The Deficit Reduction Act of 1984 (DEFRA), Pub. L. No. 98-369,
sec. 155, 98 Stat. at 691, ordered the Secretary to prescribe regulations under
section 170(a)(1) requiring a taxpayer claiming a deduction for a contribution of
property worth more than $5,000 to "obtain [and retain] a qualified appraisal for
the property contributed", attach an "appraisal summary" to the return reporting
- 51 -
the deduction, and "include on such return such additional information * * * as the
Secretary may prescribe in such regulations." See DEFRA sec. 155(a)(1).
DEFRA defines a "qualified appraisal" as one prepared by a "qualified appraiser"
that includes:
(A) a description of the property appraised,
(B) the fair market value of such property on the date of
contribution and the specific basis for the valuation,
(C) a statement that such appraisal was prepared for income
tax purposes,
(D) the qualifications of the qualified appraiser,
(E) the signature and TIN of such appraiser, and
(F) such additional information as the Secretary prescribes in
such regulations.
[Id. para. (4), 98 Stat. at 692.]
In response to that directive, the Secretary issued section 1.170A-13(c),
Income Tax Regs. (sometimes, DEFRA regulations),21 applicable to charitable
21
The DEFRA regulations govern this case. Congress largely codified those
regulations in 2004 by enacting sec. 170(f)(11) as part of the American Jobs
Creation Act of 2004 (AJCA), Pub. L. No. 108-357, sec. 883(a), 118 Stat. at 1631.
That provision, which, unlike the DEFRA regulations, contains a "reasonable
cause" exception for failure to comply with its terms, applies to contributions
made after June 3, 2004. See AJCA sec. 883(b), 118 Stat. at 1632. Therefore, it
does not apply to the 2003 contribution at issue herein.
- 52 -
contributions of property in excess of $5,000 by certain taxpayers, including
individuals and partnerships, after December 31, 1984.
Section 1.170A-13(c)(1)(i), Income Tax Regs., provides, in pertinent part:
"No deduction under section 170 shall be allowed * * * [for a covered
contribution] unless the substantiation requirements described in paragraph (c)(2)
of this section are met." Paragraph (c)(2)(i)(A) requires the donor-taxpayer to
"[o]btain a qualified appraisal (as defined in paragraph (c)(3) of this section) for
* * * [the] property contributed." Paragraph (c)(3)(i) describes a "qualified
appraisal", in pertinent part, as "an appraisal document that * * * [i]ncludes the
information required by paragraph (c)(3)(ii) of this section". Paragraph (c)(3)(ii)
lists among the items of information that a qualified appraisal "shall include":
(A) 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
(or will be) contributed;
* * * * * * *
(D) The terms of any agreement or understanding entered
into (or expected to be entered into) by or on behalf of the donor or
donee that relates to the use, sale, or other disposition of the property
contributed, including, for example, the terms of any agreement or
understanding that--
(1) Restricts temporarily or permanently a donee's right to
use or dispose of the donated property,
- 53 -
(2) Reserves to, or confers upon, anyone (other than a donee
organization or an organization participating with a donee
organization in cooperative fundraising) any right to the income from
the contributed property or to the possession of the property,
including the right to vote donated securities, to acquire the property
by purchase or otherwise, or to designate the person having such
income, possession, or right to acquire, * * *
* * * * * * *
(I) The appraised fair market value (within the meaning of
§ 1.170A-1(c)(2)) of the property on the date (or expected date) of
contribution;
(J) The method of valuation used to determine the fair
market value, such as the income approach, the market-data approach,
and the replacement-cost-less-depreciation approach; and
(K) The specific basis for the valuation, such as specific
comparable sales transactions or statistical sampling, including a
justification for using sampling and an explanation of the sampling
procedure employed.
Under certain circumstances, "substantial compliance" with the
requirements for a qualified appraisal will be sufficient to consider an appraisal
qualified within the meaning of DEFRA sec. 155(a)(1) and (4) and section
1.170A-13(c)(3), Income Tax Regs. See Bond v. Commissioner, 100 T.C. 32, 41-
42 (1993), in which we determined that the taxpayers' failure "to obtain and attach
to their return a separate written appraisal containing the information specified in
respondent's regulations" constituted a violation of "procedural or directory"
- 54 -
requirements as apposed to mandatory requirements that go to "the essence of the
thing to be done" and, therefore, are "a precondition to an effective election." We
held that, where all of the procedural defects concerning the appraisal and the
appraiser were corrected either on the Form 8283, Noncash Charitable
Contributions (the appraisal summary attached to the return),22 or at or near the
commencement of the audit, the taxpayers "substantially complied with section
1.170-13A, Income Tax Regs., and are entitled to the charitable deduction
claimed." Id. at 41-42. Compare Hewitt v. Commissioner, 109 T.C. 258 (1997),
aff'd without published opinion, 166 F.3d 332 (4th Cir. 1998), in which we
declined to extend Bond to circumstances in which the taxpayers neither obtained
an appraisal nor attached an appraisal summary to their return. See also Estate of
Evenchik v. Commissioner, T.C. Memo. 2013-34, in which we found that an
appraisal did not constitute a qualified appraisal of the contributed property (72%
of the stock of a corporation) because it was an appraisal of the assets of the
corporation, not of the contributed shares. In Estate of Evenchik, we relied upon
our decision in Smith v. Commissioner, T.C. Memo. 2007-368, 2007 WL
4410771, aff'd, 364 Fed. Appx. 317 (9th Cir. 2009), which involved charitable
22
See also Simmons v. Commissioner, T.C. Memo. 2009-208, 2009 WL
2950610, at *7-*8, aff'd, 646 F.3d 6 (D.C. Cir. 2011), wherein we determined that
defects in the appraisal could be cured by the Form 8283 attached to the return.
- 55 -
contributions of fractional interests in a family limited partnership (FLP),
supported by an appraisal of the FLP's sole underlying asset, shares in a closely-
held, family-owned C corporation. In Smith v. Commissioner, 2007 WL 4410771,
at *20, we held that that and other violations of the reporting requirements in the
DEFRA regulations resulted in the taxpayers' "failure to substantially comply or
otherwise provide respondent with sufficient information to accomplish the
statutory purpose" of enabling the Commissioner to "understand and monitor the
claimed contributions".
B. The Parties' Arguments
Respondent argues that, because Mr. Gelbtuch appraised the wrong
property, his appraisal "does not present a method of valuation of the property
contributed * * * [and] also fails to contain a specific basis for a method of
valuation for the actual property conveyed to the University" in violation of
section 1.170A-13(c)(3)(ii)(J) and (K), Income Tax Regs. Respondent further
argues that, by submitting an appraisal that "does not describe the property
transferred to the University", the Gelbtuch appraisal also violates the property
description requirement of section 1.170A-13(c)(3)(ii)(A), Income Tax Regs.,
citing Smith and Estate of Evenchik.
- 56 -
Respondent also argues that, by failing to mention the two-year hold-sell
requirement, the Gelbtuch appraisal violates the requirement in section 1.170A-
13(c)(3)(ii)(D)(1), Income Tax Regs., that a qualified appraisal include "[t]he
terms of any agreement or understanding * * * by or on behalf of the donor or
donee that * * * [r]estricts temporarily or permanently a donee's right to use or
dispose of the donated property". In support of that argument, respondent cites
our opinion in Rothman v. Commissioner, T.C. Memo. 2012-163, 2012 WL
2094306, vacated in part on reconsideration, T.C. Memo. 2012-218, 2012 WL
3101513, wherein we held that the taxpayers' appraisal of a historic preservation
facade easement was not a qualified appraisal because, among other reasons, the
appraisal did not adequately describe how, if at all, the restrictions on the
taxpayer-homeowners' use of their home, resulting from their donation of the
easement, "affected the fair market value of the encumbered subject property."
Id., 2012 WL 2094306, at *11.
Respondent also points to other perceived deficiencies in the Gelbtuch
appraisal: its failure to take into account (1) AT&T's right to "remove the
improvements made to the Hawthorne property should it elect not to exercise the
five year options" and (2) the "mortgage and depreciation on the Hawthorne
property". Respondent apparently views those disclosure omissions as additional
- 57 -
failures to disclose restrictions on the use or disposition of the property in
violation of section 1.170A-13(c)(3)(ii)(D)(1), Income Tax Regs. In connection
with Mr. Gelbtuch's failure to address the potential impact of the mortgage on the
value of the Hawthorne property, respondent cites our opinion in Rothman,
wherein we suggest that an appraisal's failure to reveal the existence and terms of
a mortgage on the donated property may, by itself, 2012 WL 3101513, at *4, or in
conjunction with other defects, 2012 WL 2094306, at *14, render an appraisal
unqualified under the DEFRA regulations.
In addition, respondent points to the Gelbtuch appraisal's determination of
the SMI's "investment value" rather than its fair market value as a violation of
section 1.170A-13(c)(3)(ii)(I), Income Tax Regs., which requires that the appraisal
"shall include * * * the appraised fair market value * * * of the property on the
date * * * of contribution".
Lastly, respondent argues that the Gelbtuch appraisal is not a qualified
appraisal because it grossly overvalues a hypothetical remainder interest in the
Hawthorne property.
In response to respondent's argument that the Gelbtuch appraisal fails to
constitute a qualified appraisal because it values the wrong property interest,
petitioner argues: "Regardless of whether Pierre applies [to prevent looking
- 58 -
through Holdings (and Hawthorne) to its sole, income-producing asset, the
Hawthorne property], the only way to value a single member LLC is by valuing
the underlying assets." He distinguishes Smith and Estate of Evenchik on the
ground that both involved contributions of partial interests in the entities (in
Smith, an FLP, in Estate of Evenchik, a corporation) owning the underlying assets
that were actually appraised.23
Petitioner also argues that Mr. Gelbtuch's failure to mention the gift
agreement containing the two-year hold-sell requirement does not warrant a
conclusion that the Gelbtuch appraisal failed to substantially comply with the
requirements for a qualified appraisal. He bases that argument on the fact that
petitioner gave the gift agreement to the agent at the beginning of the audit and
that respondent "had sufficient information to determine whether an audit was
necessary as intended by the purpose of the regulations." Petitioner also repeats
his argument, made in defending the application of the section 7520 tables herein,
23
Petitioner attempts to further distinguish Estate of Evenchik v.
Commissioner, T.C. Memo. 2013-34, on the ground that, in this case but not in
Estate of Evenchik, the donated asset (i.e., the SMI) "was accurately described on
[F]orm 8283 as required by the regulations and supplied the necessary information
to allow the Commissioner to assess the donation and whether an audit was
necessary." That is not a valid distinction, since, in Estate of Evenchik, we
specifically found that the Form 8283 did describe the donated property:
"15,534.67 shares Chateau Apartments, Inc. common stock". Id. at *4.
- 59 -
that, because the two-year hold-sell requirement set forth in the gift agreement was
not a condition of the donation, i.e., it did not interfere with the University's
ownership of or right to sell the SMI at any time, "there was no articulated or
perceived consequences to any violation of the agreement. Regardless of
subsequent events, Ross was still obligated to give $5 million to the University."
In response to respondent's argument that Mr. Gelbtuch's failure to mention
either the mortgage or AT&T's right to remove improvements violated the
requirement in section 1.170A-13(c)(3)(ii)(D)(1), Income Tax Regs., that a
qualified appraisal disclose "the terms of any agreement or understanding * * *
[restricting] a donee's right to use or dispose of the donated property", petitioner
argues that (1) AT&T had no right to remove improvements and (2) even if it did,
neither that right nor the mortgage arose out of "any agreement or understanding
entered into * * * by or on behalf of the donor or donee" as required by the
foregoing regulation.
Petitioner also disputes respondent's argument that the Gelbtuch appraisal is
fatally flawed because it fails to compute the SMI's fair market value, but, instead
computes the "investment value" of a remainder interest in the Hawthorne
property. Petitioner points out that, in the case of a remainder interest in real
property (in petitioner's view, the asset properly valued pursuant to the "check-the-
- 60 -
box" regulations), pursuant to section 170(f)(4), section 1.170A-12(c), Income
Tax Regs., and section 25.2512-5(d), Gift Tax Regs., fair market value is "present
value" as determined under the section 7520 tables. See sec. 25.2512-5(d)(2)(ii),
Gift Tax Regs.24
C. Analysis
1. Appraisal of the Wrong Property
We agree with petitioner that both Estate of Evenchik and Smith, upon
which respondent places principal reliance, are distinguishable. As petitioner
points out, both cases concerned contributions of partial interests in entities
holding the property that was actually appraised. In Smith, the contributions were
of minority interests in three FLPs (and were, therefore, presumably subject to
24
At the conclusion of his response to the motion, petitioner concedes that, if
we find Pierre v. Commissioner, 133 T.C. 24 (2009), applicable to this case, a new
appraisal (of the SMI) would be required. It would appear, however, that a new
appraisal at this or any future time could not constitute a qualified appraisal,
which, pursuant to sec. 1.170A-13(c)(3)(iv)(B), Income Tax Regs., must have
been "received by the donor before the due date (including extensions) of * * *
[RERI's 2003 return]". See also Jorgenson v. Commissioner, T.C. Memo. 2000-
38, 2000 WL 134332, at *4, *8 (failure to obtain a qualified appraisal before the
return due date was not cured by submission to the IRS of letters drafted by two
appraisers after the return was filed). As discussed infra, however, if petitioner is
able to persuade us that there is no difference in value between the SMI and a
hypothetical remainder interest in the Hawthorne property and that the latter was
properly appraised, we would conclude that the Gelbtuch appraisal constituted a
qualified appraisal despite our determination that Pierre requires an appraisal of
the former.
- 61 -
minority and, perhaps, marketability discounts) and, in Estate of Evenchik, the
taxpayer contributed a 72% interest in a corporation, the value of which 72%
interest, the parties stipulated, was only 65% of the value reported. Estate of
Evenchik v. Commissioner, at *5 n.3. In this case, petitioner transferred a future
interest (the SMI) in Holdings, whose sole asset was (indirectly) the Hawthorne
property. Disregarding for the moment Hawthorne's liabilities, whether the
section 7520 tables are applied to the value of Holdings to determine the value of
the SMI or are applied to the value of the Hawthorne property to determine the
value of a hypothetical remainder interest therein at the end of a term equal to the
duration of the SMI, the resulting values should be equal. Moreover, any
confusion respondent might have had regarding the property actually donated to
the University was eliminated by the Form 8283 attached to RERI's 2003 return,
which identified the SMI as the property contributed and clarified Holdings'
indirect interest, through Hawthorne, of 100% ownership of the Hawthorne
property. In the circumstances of this case, we attach more weight to the Form
8283 than we did in Estate of Evenchik, where the Form 8283 also identified the
actual property contributed, which, as noted supra, was not equal in value to the
appraised property. Assuming the evidence in this case demonstrates that the SMI
and the remainder interest in the Hawthorne property were of equal value, we
- 62 -
would find that the inclusion, in the Form 8283, of the missing information
required to be included in the appraisal by section 1.170A-13(c)(3)(ii)(A), Income
Tax Regs., i.e., a description of the property actually donated to the University,
constituted substantial compliance with that provision. We believe that result is
consistent with the requirement, embodied in DEFRA, that a qualified appraisal
provide sufficient return information in support of the claimed valuation so as "to
enable respondent to deal more effectively with the prevalent use of
overvaluations", which we have described as DEFRA's principal objective. See
Hewitt v. Commissioner, 109 T.C. at 265. See also Simmons v. Commissioner,
T.C. Memo. 2009-208, 2009 WL 2950610, at *8, aff'd, 646 F.3d 6 (D.C. Cir.
2011), wherein we determined that information included in the Form 8283 was
sufficient to cure the appraisal's omissions of required information.
We find that Mr. Gelbtuch's appraisal of the hypothetical remainder interest
in the Hawthorne property, rather than of the SMI, does not, in and of itself,
prevent his appraisal from constituting a qualified appraisal under section 1.170A-
13(c)(3), Income Tax Regs. Rather, the issue of whether that appraisal constitutes
a qualified appraisal turns on whether we may reasonably conclude that its failure
to take into account restrictions and encumbrances applicable to either the SMI or
- 63 -
the Hawthorne property that are cited by respondent rendered it an unacceptable
alternative to a direct appraisal of the SMI.
2. The Appraisal's Failure To Consider the Two-Year Hold-Sell
Requirement
The two-year hold-sell requirement is a restriction on the disposition of the
SMI, not of the hypothetical remainder interest in the Hawthorne property. As
such, it creates two potential problems for petitioner. First, it may mean that the
section 7520 tables, applied by Mr. Gelbtuch to determine the value of a
hypothetical remainder interest in the Hawthorne property, may not be applicable
to determine the fair market value of the SMI. See sec. 1.7520-3(b)(1)(ii), Income
Tax Regs. ("In general, standard section 7520 * * * remainder factor may not be
used to value a restricted beneficial interest."). In that case, the Gelbtuch appraisal
would be irrelevant. Second, on its face, the appraisal's failure to mention the
restriction may disqualify the appraisal as a substitute for an actual appraisal of the
SMI because the omission constitutes a violation of the directive in section
1.170A-13(c)(3)(ii)(D)(1), Income Tax Regs., that the appraisal inform as to "[t]he
terms of any agreement or understanding entered into * * * by or on behalf of the
donor or donee that * * * [r]estricts temporarily * * * a donee's right to * * *
dispose of the donated property".
- 64 -
We have determined supra that Mr. Ross' right to renege on all or part of his
$5 million pledge to the University, should it violate the two-year hold-sell
requirement, raises an unresolved issue of State law and, therefore, an issue of
material fact as to the economic impact on the University had it violated that
requirement. We also have determined that there are additional issues of material
fact concerning the adverse impact, if any, on the value of the SMI in the
University's hands should it either violate or, alternatively, observe the two-year
hold-sell requirement. Those unresolved factual inquiries are relevant because we
conclude that an appraisal's failure to take into account the terms of a restriction
described in section 1.170A-13(c)(3)(ii)(D)(1), Income Tax Regs., does not
automatically result in the failure of that appraisal to constitute a qualified
appraisal. We find it implicit in that provision that such a result is justified only if
the omission relates to a restriction that reasonably can be said to have some
adverse impact on the value of the donated asset. Otherwise, as we stated in the
context of considering whether the section 7520 tables may apply herein, it is a
case of no harm-no foul, and the omission may be disregarded.25
25
Our conclusion in that regard is consistent with our determination herein
that an appraisal of the "wrong" property might not be fatal to the appraisal's status
as a qualified appraisal if the "wrong" property is shown to have (or potentially
have) a value no different from that of the donated property.
- 65 -
3. The Appraisal's Failure To Consider AT&T's Right of Removal
on Lease Termination
The lease agreement between Intergate and AT&T provides that,
upon the expiration or termination of this Lease, all improvements
and additions to the Premises except * * * [cabling and wiring
included within the scope of AT&T's work, its alterations from all
interstitial/ceiling plenum areas, furniture, equipment and personal
property, and back-up generators and associated equipment] shall be
deemed property of Landlord and shall not be removed by Tenant
from the Premises.
All or most of the "improvements" that AT&T has a right to remove would appear
to be either personal property or easily removable fixtures, which also constitute
or are akin to personal property, rather than significant improvements to the
premises. Thus, it appears that AT&T's right of removal is quite limited and
probably of little or no effect on the value of the Hawthorne property. The
relevant point, however, is that the parties' dispute regarding the impact of
AT&T's right of removal on the Hawthorne property's value raises an issue as to
whether the Gelbtuch appraisal overvalued the Hawthorne property, not an issue
as to whether it constituted a qualified appraisal. Mr. Gelbtuch's failure to assess
the valuation impact, if any, of AT&T's right of removal does not violate any of
the requirements of section 1.170A-13(c)(3), Income Tax Regs., for a qualified
appraisal. We disagree with respondent's argument that the Gelbtuch appraisal's
- 66 -
failure to disclose AT&T's limited right of removal constituted a failure to disclose
"significant terms and conditions affecting the use and disposition of * * * [the
SMI]" in violation of section 1.170A-13(c)(3)(ii)(D)(1), Income Tax Regs. It does
not seem possible that AT&T's removal of what is largely, if not exclusively,
personal property would, in any way, interfere with the subsequent use or
disposition of the building. Most importantly, however, we agree with petitioner
that AT&T's right of removal, being a term of the lease between Intergate and
AT&T, did not constitute a term of an "agreement * * * entered into * * * by or on
behalf of the donor or donee" as required by the foregoing regulation. Therefore,
the impact of AT&T's right of removal is not germane to the qualified appraisal
issue.
4. The Appraisal's Failure To Consider the Mortgage or
Depreciation on the Hawthorne Property
Mr. Gelbtuch's failure to consider the mortgage on the Hawthorne property
in his appraisal thereof also does not constitute an omission of "[t]he terms of
* * * [an] agreement * * * entered into * * * by or on behalf of the donor or
donee", as required by section 1.170A-13(c)(3)(ii)(D)(1), Income Tax Regs.
Rather it was part of the deed of trust executed by Hawthorne (the borrower),
Commonwealth Land Title Insurance Co., and BB&T (the lender), which secured
- 67 -
the loan that financed Hawthorne's purchase of the Hawthorne property.
Therefore, that failure, like Mr. Gelbtuch's failure to consider AT&T's right of
removal, relates to the accuracy of the Gelbtuch appraisal. It is not germane to the
issue of whether it was a qualified appraisal under the DEFRA regulations.
Similarly, Mr. Gelbtuch's failure to discuss the potential impact of
depreciation on the Hawthorne property is not an omission covered by the
foregoing regulation. Therefore, it too is not germane to the qualified appraisal
issue.26
5. Mr. Gelbtuch's Finding of "Investment Value" Rather Than
Fair Market Value
In his appraisal, Mr. Gelbtuch does refer to the value he assigns to the
hypothetical remainder interest in the Hawthorne property as its "investment
value", for which he provides the following dictionary definition: "The specific
value of an investment to a particular investor or class of investors based on
individual investment requirements; distinguished from market value, which is
impersonal and detached." As defined by Mr. Gelbtuch, the term "investment
value" appears to be unrelated to the value that he actually derives for the
26
Respondent does not argue nor do we find that a failure to discuss
depreciation constitutes a failure to discuss "the physical condition of the
property", in violation of sec. 1.170A-13(c)(3)(ii)(B), Income Tax Regs.
- 68 -
hypothetical remainder interest in the Hawthorne property. We agree with
petitioner that Mr. Gelbtuch's method for valuing a hypothetical remainder interest
in the Hawthorne property was in accordance with section 170(f)(4), section
1.170A-12(c), Income Tax Regs., and section 25.2512-5(d)(2)(ii), Gift Tax Regs.,
to the extent that, when read together, those provisions require that the valuation
of a remainder interest in real property be made by applying the section 7520
tables to the fair market value of the property.27 That Mr. Gelbtuch mislabeled his
valuation of a hypothetical remainder interest as its "investment value" is of no
consequence.28
Moreover, as in the case of Mr. Gelbtuch's failure to discuss the mortgage,
depreciation of the Hawthorne property, or AT&T's right of removal, an allegedly
improper valuation of the donated property is not something that would result in
Mr. Gelbtuch's appraisal's not constituting a qualified appraisal under the DEFRA
regulations.
27
Mr. Gelbtuch did not take into account depreciation in valuing the
hypothetical remainder in the Hawthorne property, which, like his failure to
consider the mortgage, goes to the accuracy of his appraisal.
28
What's in a name? that which we call a rose
By any other name would smell as sweet;
William Shakespeare, Romeo and Juliet, act 2, sc. 2.
- 69 -
6. Alleged Gross Overvaluation of the Hypothetical Remainder
Interest in the Hawthorne Property
Respondent argues that Mr. Gelbtuch grossly overvalued the hypothetical
remainder interest in the Hawthorne property (apparently assuming, for the sake of
argument, that it may be considered a proxy for the SMI) in the light of the much
smaller amounts paid for the SMI in a series of sales thereof both shortly before
and after RERI's donation of it to the University. Once again, respondent's
argument is inapposite as it goes to the accuracy of Mr. Gelbtuch's appraisal, not
to its status as a qualified appraisal under the DEFRA regulations.
D. Conclusion
Respondent's arguments in support of his motion for partial summary
judgment that the Gelbtuch appraisal fails to satisfy the DEFRA regulations'
definition of (and, therefore, does not constitute) a qualified appraisal are either
inapposite or involve unresolved disputes of material fact. Therefore, we will
deny the motion to the extent respondent asks us to rule that petitioner failed to
substantiate the value of the SMI with a qualified appraisal.
An appropriate order will be issued
denying respondent's motion for partial
summary judgment.