Logan M. Chandler & Nanette Ambrose-Chandler v. Commissioner , 142 T.C. 279 ( 2014 )

LOGAN M. CHANDLER AND NANETTE AMBROSE-CHANDLER,
PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE,
RESPONDENT
Docket No. 16534–08. Filed May 14, 2014.
Ps granted to a qualified organization facade easements on
two historic homes they owned. They claimed charitable con-
tribution deductions for 2004, 2005, and 2006 based on fair
market value appraisals of the easements. A portion of each
of the 2005 and 2006 deductions resulted from a carryforward
of a deduction they first claimed for 2004. R disallowed the
deductions because he determined the easements were value-
less. R imposed gross valuation misstatement penalties on the
underpayments resulting from the alleged easement overvalu-
ations. Ps sold one of the homes in 2005 and reported capital
gain. In calculating the gain Ps reported a basis in the home
that exceeded their purchase price. They claim the basis
increase resulted from costs they incurred to improve the
home. They failed to substantiate the full amount of the
improvement costs. R disallowed the entire basis increase and
imposed an accuracy-related penalty on the resulting under-
payment. Ps contend they had reasonable cause for any
underpayments and thus should not be liable for penalties. R
claims that recent amendments to the gross valuation
misstatement penalty preclude Ps from raising a reasonable
cause defense for their 2006 underpayment. Ps argue that
part of that underpayment resulted from a deduction carried
forward from a return they filed before the amended rules
took effect. They argue that applying the amended reasonable
279
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00001 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
280 142 UNITED STATES TAX COURT REPORTS (279)
cause rules to their 2006 return would give the penalty
amendments retroactive effect. Held: Ps failed to prove their
easements had any value and consequently were not entitled
to claim related charitable contribution deductions. Held, fur-
ther, Ps adequately substantiated a portion of the basis
increase they claimed on the home they sold and were entitled
to reduce their capital gain by the substantiated amount.
Held, further, Ps are liable for an accuracy-related penalty for
the portion of their 2005 underpayment resulting from
unsubstantiated basis increases they claimed on the home
they sold. Held, further, Ps are not liable for gross valuation
misstatement penalties for their 2004 and 2005 underpay-
ments, because they underpaid with reasonable cause and in
good faith. Held, further, Ps are liable for a gross valuation
misstatement penalty for their 2006 underpayment because
the rules in effect when they filed their 2006 return did not
provide a reasonable cause exception. Denying Ps’ reasonable
cause defense does not amount to retroactive application of
the gross valuation misstatement penalty amendments.
Denis J. Conlon, Steven S. Brown, and Mason N. Floyd, for
petitioners.
Carina J. Campobasso, for respondent.
GOEKE, Judge: Petitioners owned two single-family resi-
dences in Boston’s South End Historic District. They granted
a facade easement on each property to the National Architec-
tural Trust (NAT) and claimed related charitable contribu-
tion deductions for taxable years 2004, 2005, and 2006. In
2005 petitioners sold one of the properties and reported a
capital gain. Petitioners claimed a basis in the property that
reflected $245,150 of improvements.
Respondent disallowed petitioners’ charitable contribution
deductions because he determined the easements had no
value. He also found that petitioners had understated their
gain on the property sale because they had overstated their
basis in the property. Finally, respondent determined that
petitioners were liable for accuracy-related penalties under
section 6662. 1
1 Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00002 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 281
After concessions, 2 the issues remaining for decision are:
(1) whether the charitable contribution deductions peti-
tioners claimed for granting conservation easements to NAT
exceeded the fair market values of the easements. We hold
they did;
(2) whether petitioners overstated their basis in the prop-
erty they sold in 2005. We hold they did, but they were enti-
tled to increase their basis for improvement costs they prop-
erly substantiated; and
(3) whether petitioners are liable for accuracy-related pen-
alties under section 6662. We hold they are but in amounts
less those respondent determined.
FINDINGS OF FACT
Some facts were stipulated and are so found. Petitioners
resided in Massachusetts when they filed their petition.
A. Background
Petitioners filed joint Forms 1040, U.S. Individual Income
Tax Return, for each of the years in issue. Mr. Chandler has
a law degree and a master’s in business administration and
works as a business consultant. Mrs. Ambrose-Chandler
owns and operates an interior design company.
In 2003 petitioners purchased a home at 24 Claremont
Park in Boston, Massachusetts (Claremont property). In 2005
petitioners purchased another home in Boston at 143 West
Newton Street (West Newton property). Both homes are in
Boston’s South End, which the Federal Government has
included in the National Register of Historic Places and des-
ignated a National Historic Landmark District.
B. Conservation Easements
Congress has created the Federal Historic Preservation
Tax Incentives Program to encourage the preservation of his-
toric structures. Under the program, owners of historic
buildings may be entitled to charitable contribution deduc-
2 Petitioners
have conceded their liability for a $1,064.85 addition to tax
under sec. 6651(a)(1) for delinquently filing their 2004 return. Respondent
has conceded that petitioners’ donation of the easements complies with the
requirements for deduction under sec. 170. Respondent disputes only peti-
tioners’ valuation of the easements.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00003 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
282 142 UNITED STATES TAX COURT REPORTS (279)
tions when they grant conservation easements on their
buildings to organizations that will protect the buildings’ his-
toric character. The National Park Service (NPS) publicizes
the program and assists the IRS in administering it. Mr.
Chandler read about the program in a newspaper, and peti-
tioners decided to grant a facade easement to NAT on the
Claremont property. When they purchased the West Newton
property, they again decided to grant a facade easement to
NAT.
Under the terms of each easement, the property owner
must obtain NAT’s approval before beginning any construc-
tion that will alter the exterior of the building. NAT periodi-
cally sends representatives to inspect properties on which
NAT holds easements. If the inspector determines that a
property owner has made unauthorized changes, NAT can
order remediation.
Boston’s municipal government has formed nine local his-
toric district commissions to regulate construction within
their jurisdictions. The South End Landmark District
Commission (SELDC) has jurisdiction over the properties at
issue here. The SELDC’s powers closely approximate NAT’s
powers under the easement agreements with some excep-
tions.
First, the SELDC has no power to regulate construction
that is not visible from a public way and may not require
property owners to make repairs. The easement agreements
grant NAT authority to regulate construction and order
repairs on any exterior surface of the home. Second, NAT has
staff members who perform annual site visits, while the
SELDC relies on the public to alert it to potential violations.
Finally, NAT has absolute authority to enforce the terms of
its easements, even when doing so would produce substantial
economic hardship for the property owner. Under Massachu-
setts law, a property owner who faces significant financial
hardship may receive an exemption from the SELDC’s
enforcement. See Mass. Gen. Laws ch. 772, sec. 8 (1975).
Petitioners claimed charitable contribution deductions
related to the easements on their 2004, 2005, and 2006 tax
returns. Petitioners followed guidance from the NPS and con-
sulted their easement holding organization to find an
appraiser to value their easements. NAT recommended
George Riethof and George Papulis, who valued the Clare-
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00004 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 283
mont easement at $191,400 and the West Newton easement
at $371,250. Petitioners consulted with their accountant con-
cerning the appraisals before claiming deductions on their
returns. Because of relevant limitations, petitioners deducted
the values of the easements over several years. For the years
in issue (2004, 2005, and 2006) petitioners claimed deduc-
tions for the easements of $73,059, $83,939, and $296,251
respectively.
Respondent determined the easements had no value
because they did not meaningfully restrict petitioners’ prop-
erties more than local law. Petitioners have abandoned their
original appraisals, but they have presented new expert testi-
mony supporting the values they claimed on their returns.
C. Gain on Home Sale
Petitioners purchased the Claremont property for $755,000
in 2003 when it was in poor condition. They renovated the
property and in 2005 sold it for $1,540,000. On their 2005
return, petitioners reported an adjusted basis in the property
that included $245,150 of improvement costs. During his
examination, respondent requested documentation substan-
tiating the basis increase, but petitioners had misplaced their
receipts. Later, petitioners produced receipts for expenses
totaling $147,824.
Respondent’s examiner initially concluded that petitioners
had substantiated $60,000 of renovation costs. However,
upon closer review, respondent noticed that petitioners had
claimed larger than average cost of goods sold deductions for
Mrs. Ambrose-Chandler’s interior design business for the
years during the renovations. Respondent believed that peti-
tioners had deducted the renovation expenses on their Sched-
ules C, Profit or Loss From Business, for 2004 and 2005, and
accordingly respondent disallowed the entire $245,150 basis
increase. Respondent did not seek substantiation for peti-
tioners’ Schedule C deductions during the audit.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00005 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
284 142 UNITED STATES TAX COURT REPORTS (279)
OPINION
I. Conservation Easements
A. Background
Congress has provided tax benefits to taxpayers who grant
conservation easements over historic properties they own. A
conservation easement allows a third party, typically a chari-
table organization, to monitor the owner’s use of property. An
organization holding an easement may prevent the owner
from changing the property in a way that would destroy its
historic character.
Under section 170, if taxpayers meet certain criteria, they
may claim charitable contribution deductions for the fair
market value of conservation easements they donate to cer-
tain organizations. See sec. 170(f)(3)(B)(iii); sec. 1.170A–
1(c)(1), Income Tax Regs. Respondent concedes that peti-
tioners have satisfied the technical requirements for the
deductions, but he disputes their valuations of the ease-
ments. Petitioners bear the burden of proving their deduc-
tions reflected the easements’ fair market values. See Rule
142(a)(1).
Easements are usually transferred by gift; consequently,
we rarely have an established market on which to rely in
determining their value. Simmons v. Commissioner, T.C.
Memo. 2009–208, aff ’d, 646 F.3d 6 (D.C. Cir. 2011); see also
Hilborn v. Commissioner, 85 T.C. 677, 688 (1985). We have
often used the ‘‘before and after’’ approach to value restric-
tive easements for which taxpayers have claimed deductions.
See, e.g., Hilborn v. Commissioner, 85 T.C. at 688–689; Sim-
mons v. Commissioner, T.C. Memo. 2009–208; Griffin v.
Commissioner, T.C. Memo. 1989–130, aff ’d, 911 F.2d 1124(5th Cir. 1990). Under this approach the fair market value
of the restriction is equal to the difference (if any) between
the fair market value of the property without the restriction
(before value) and its fair market value with the restriction
(after value). Sec. 1.170A–14(h)(3)(i), Income Tax Regs. When
a conservation easement enhances or does not materially
affect the property’s value, the taxpayer may not claim a
deduction. Sec. 1.170A–14(h)(3)(ii), Income Tax Regs.
An appraiser may use the comparable sales method or
another accepted method to estimate the before and after
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00006 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 285
values of the property. Hilborn v. Commissioner, 85 T.C. at
689–690. An appraiser using the comparable sales method
identifies property sales that meet three criteria: (1) the
properties themselves are similar to the subject property; (2)
the sales are arm’s-length transactions; and (3) the sales
have occurred within a reasonable time of the valuation date.
Wolfsen Land & Cattle Co. v. Commissioner, 72 T.C. 1, 19
(1979). The appraiser uses the sale prices of the comparable
properties to estimate the value of the subject property.
Both parties submitted expert reports concerning the
values of petitioners’ easements. Petitioners’ expert was
Michael Ehrmann, and respondent’s expert was John C.
Bowman III.
B. The Ehrmann Report
Using the comparable sales approach Mr. Ehrmann cal-
culated before values for the Claremont property and the
West Newton property of $1,385,000 and $2,950,000 respec-
tively.
To estimate the properties’ after values, he attempted to
quantify the effect of petitioners’ easements. Mr. Ehrmann
analyzed sales of seven properties encumbered with ease-
ments similar to petitioners’. He compared those sales with
sales of comparable unencumbered properties to determine
whether the easements diminished property values. Of the
seven encumbered properties he chose, four were in Boston
and three were in New York City. Accounting for Mr.
Ehrmann’s adjustments, the encumbered properties in the
sample sold for an average of 18.5% less than the
unencumbered properties. 3
Mr. Ehrmann also included in his report information con-
cerning a settlement agreement arising from the sale of
encumbered property in New Orleans. The property’s seller
did not disclose an existing conservation easement to the
buyer. After the buyer bought the property, he discovered the
easement and sued the seller. The parties settled the dispute
3 Mr. Ehrmann’s report contains procedural errors. He calculated the
easement values by dividing the difference in sale prices by the encum-
bered property’s price. He then applied that percentage to the before value
of petitioners’ properties to calculate the easement values. He should have
divided the difference in sale prices by the unencumbered property’s sale
price. We have adjusted the data in his report to account for this error.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00007 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
286 142 UNITED STATES TAX COURT REPORTS (279)
for 14.6% of the sale price. Mr. Ehrmann claims that the
settlement represents direct market valuation of the ease-
ment restriction on the property.
On the basis of his data, Mr. Ehrmann estimated that peti-
tioners’ easements diminished their property values by 16%.
Accordingly, he valued the easements at about 16% of their
before values—$220,000 for the Claremont easement and
$470,000 for the West Newton easement.
C. Ehrmann Report Analysis
Although Mr. Ehrmann used an appropriate methodology
to isolate the easements’ effects on property values, certain
factors undermine its persuasiveness. The locations of the
sample properties are our first concern. Mr. Ehrmann chose
seven encumbered properties to measure against comparable
unencumbered properties. Of those seven properties, only
four are in Boston; the other three are in New York City. He
also provided information concerning a property settlement
in New Orleans. We find Mr. Ehrmann’s analysis of the
properties outside Boston unpersuasive. The values of ease-
ments in other markets tell us little about easement values
in Boston’s unique market.
Our second concern is the size of Mr. Ehrmann’s sample.
We recognize that the lack of encumbered property sales in
petitioners’ neighborhood limited the depth of Mr. Ehrmann’s
analysis. Nevertheless, we must adjust our confidence in his
estimates accordingly. Although Mr. Ehrmann reviewed four
encumbered property sales in Boston, only one, ‘‘Easement
Encumbered Sale #1’’, is not obviously flawed. ‘‘Easement
Encumbered Sales #s 2 and 4’’ are flawed because the ‘‘com-
parable’’ unencumbered property sales Mr. Ehrmann chose
were not actually comparable. ‘‘Easement Encumbered Sale
#3’’ is flawed because one of the comparable ‘‘unencumbered’’
properties was not actually unencumbered.
1. Easement Encumbered Sale # 1
‘‘Easement Encumbered Sale #1’’ refers to the sale of the
encumbered Claremont property. Mr. Ehrmann compared
this sale to the sale of unencumbered property at 30 Clare-
mont Park. Mr. Ehrmann determined the properties were in
the same condition and adjusted the comparable property’s
sale price by only 1.3% for other minor differences. The
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00008 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 287
encumbered property sold for 12.5% less than the
unencumbered property.
2. Easement Encumbered Sales #s 2 and 4
‘‘Easement Encumbered Sale #2’’ refers to the sale of the
encumbered West Newton property. Mr. Ehrmann compared
this sale to sales of unencumbered properties at 118 West
Newton Street and 176 West Canton Street. ‘‘Easement
Encumbered Sale #4’’ refers to the sale of encumbered prop-
erty at 306 Marlborough Street. Mr. Ehrmann compared this
sale to sales of unencumbered properties at 285 Marlborough
Street and 381 Beacon Street. Mr. Ehrmann significantly
adjusted the sale prices of the ‘‘comparables’’ before he com-
pared them to the encumbered property’s sale price. The
adjustments ranged from 11.2% to 20.3% and included
significant adjustments based on Mr. Ehrmann’s subjective
evaluation of the properties’ ‘‘condition’’. 4 Because of these
significant subjective adjustments, Mr. Ehrmann’s conclu-
sions flowing from these comparisons largely reflect his
opinion rather than the objective market values of the ease-
ments. When an appraiser makes numerous adjustments to
a subject property’s comparables, the subject property’s valu-
ation becomes less reliable. See Gorra v. Commissioner, T.C.
Memo. 2013–254, at *59. Accordingly, we give these two
comparisons little weight.
3. Easement Encumbered Sale # 3
‘‘Easement Encumbered Sale #3’’ refers to the sale of
encumbered property at 3 Cazenove Street. Mr. Ehrmann
compared this sale to sales of comparable ‘‘unencumbered’’
properties at 6 St. Charles Street and 139 Appleton Street.
After adjustments, Mr. Ehrmann concluded that the
Cazenove Street property sold for 12.8% and 18.5% less than
the St. Charles Street and Appleton Street properties respec-
tively. He attributed these differences to the encumbrance on
the Cazenove Street property. However, the St. Charles
Street property’s deed contains restrictions that are substan-
tially the same as those the Cazenove Street property’s ease-
ment imposes. This indicates that the difference in price
4 The ‘‘condition’’ adjustments were: 5% for 118 West Newton, 15% for
176 West Canton, 20% for 285 Marlborough, and 10% for 381 Beacon.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00009 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
288 142 UNITED STATES TAX COURT REPORTS (279)
resulted from some other factor that Mr. Ehrmann did not
consider. This error undermines Mr. Ehrmann’s credibility
concerning not only this comparison, but the entire report.
D. The Bowman Report
Mr. Bowman did not independently evaluate the prop-
erties’ before values, but he reviewed the appraisals peti-
tioners relied on for their return. Those appraisals included
comparable sales analyses for each property. Mr. Bowman
determined that the appraisals were reasonable aside from
one minor error that resulted in a 10% undervaluation of the
Claremont property. Mr. Bowman corrected that error and
assigned before values to the Claremont and West Newton
properties of $1,450,000 and $2,750,000, respectively.
To analyze the impact of petitioners’ easements, Mr. Bow-
man selected nine recently encumbered Boston properties
that sold between 2005 and 2011. He compared their prices
in the sales immediately preceding and succeeding the
imposition of their easements. Each property had sold for
more after it had been encumbered. Mr. Bowman annualized
the appreciation rates between the sales and compared them
to city wide appreciation rates for upper-tier properties. He
found that the properties in his sample appreciated at a
higher-than-average rate. On the basis of his analysis, he
concluded that easements like petitioners’ do not diminish
the values of the properties they restrict and thus have no
value. Mr. Bowman acknowledged that many of the homes in
his sample had been significantly renovated, but he did not
try to remove the renovations’ effect on appreciation from his
analysis.
E. Bowman Report Analysis
Mr. Bowman’s sales analysis is not persuasive, because it
does not isolate the effect of easements on the properties in
his sample. The properties in his sample appreciated in spite
of their restrictions. However, many of the properties had
been significantly renovated, and Mr. Bowman’s report does
not account for the renovations’ effects on the property
values. The report demonstrates that, combined, the renova-
tions and easements positively affected value, but the report
does not isolate the effect of the easements. To measure one
variable’s effect, one must hold all other variables constant.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00010 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 289
Mr. Bowman’s report does not measure easements’ effect on
value, because he has not held other variables constant.
F. Conclusion
We do not find Mr. Ehrmann’s report credible and there-
fore reject his conclusion that petitioners’ easements dimin-
ished their property values by 16%. However, Mr. Ehrmann’s
failure to persuasively value the easements does not nec-
essarily mean they had no value. Petitioners cite several
cases in which we have upheld valuations similar to theirs.
See, e.g., Whitehouse Hotel Ltd. P’ship v. Commissioner, 139
T.C. 304 (2012); Dorsey v. Commissioner, T.C. Memo. 1990–
242; Griffin v. Commissioner, T.C. Memo. 1989–130; Losch v.
Commissioner, T.C. Memo. 1988–230. However, each of those
cases involved commercial property. Restrictions on construc-
tion impair the value of commercial property more tangibly
than they impair the value of residential property. Commer-
cial property derives its value from its ability to generate
cashflows. For commercial property, development generally
correlates with increased future cashflows. More retail space,
more space for tenants, and more room for customers gen-
erally increase profitability. Restrictions on the development
of commercial property reduce potential for increased future
cashflows and thus diminish value.
Construction restrictions affect residential property values
more subtly. People do not buy homes primarily to make
money, and personal rather than business reasons usually
motivate any construction on their homes. The loss of
freedom to make changes to the exterior of one’s home has
a price, but it is difficult to quantify. The task becomes even
more difficult when we consider the already existing restric-
tions on the property. Even if petitioners had not granted the
easements, local law would have prevented them from freely
altering their homes. The easements had value only to the
extent their unique restrictions diminished petitioners’ prop-
erty values.
Petitioners have identified several differences between the
easement provisions and local law. The differences concern
the scope, monitoring, and enforcement of the construction
restrictions.
The easements have a broader scope than local law
because they restrict construction on the entire exterior of
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00011 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
290 142 UNITED STATES TAX COURT REPORTS (279)
the home and require property owners to make repairs. Local
law restricts construction only on portions of the property
visible from a public way, and local law does not require
property owners to make repairs.
Petitioners also were subject to different monitoring proce-
dures under the easement agreements. NAT inspects each of
its properties annually for compliance with applicable stand-
ards. The SELDC relies on the public to report violations.
NAT’s historical compliance standards are also slightly dif-
ferent from the SELDC’s.
Finally, NAT has greater power to enforce the terms of its
easements than the SELDC has to enforce local law. Unlike
the SELDC, NAT has a right to enter property to inspect for
compliance, and NAT can require corrective action. NAT can
also enforce its easement terms even when doing so would
impose substantial economic hardship on the property owner.
Under State law an owner may obtain an exemption from
local standards if compliance would cause a substantial eco-
nomic burden.
We must determine the value diminution resulting from
these additional restrictions. We recently performed this
analysis under identical circumstances. In Kaufman v.
Commissioner, T.C. Memo. 2014–52, we reviewed a NAT
easement on a property in the South End Historic District.
There we determined that the differences outlined above do
not affect property values, because buyers do not perceive
any difference between the competing sets of restrictions. Id.
at *57. We see no reason to break with that result here. Mr.
Ehrmann’s report, which petitioners exclusively rely on to
demonstrate their easements’ values, was not credible.
Respondent has persuasively argued that a typical buyer
would perceive no difference between the two sets of
applicable restrictions here. We recognize technical dif-
ferences between the easements and local law, but we agree
with respondent’s conclusion that the restrictions were prac-
tically the same. Because petitioners have not proved that
the easements they donated had value, we sustain respond-
ent’s disallowance of the charitable contribution deductions
they claimed.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00012 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 291
II. Gain on Home Sale
Taxpayers must recognize gain when they sell property for
more than its adjusted basis. Sec. 1001(a); sec. 1.61–6(a),
Income Tax Regs. Taxpayers may increase their adjusted
basis in property for costs they incur to improve the prop-
erty, but they generally bear the burden of proving basis
increases they claim. See sec. 1016(a); Rule 142(a); sec.
1.1016–2(a), Income Tax Regs. The burden may shift to the
Commissioner if the taxpayer introduces credible evidence
supporting a basis increase. See sec. 7491(a)(1). If taxpayers
cannot produce records of actual expenditures, we may esti-
mate the amounts of expenses if they provide credible evi-
dence that provides a factual basis for the estimate. See
Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).
Petitioners increased their basis in the Claremont property
by $245,150 for improvement costs they claim they incurred.
Petitioners concede that they bear the burden of proving they
were entitled to the basis increase. They have presented
documentary evidence that proves they incurred costs of at
least $147,824 in improving the property. They have also
submitted before and after photos of the home that dem-
onstrate they made significant renovations.
Respondent acknowledges that petitioners made improve-
ments to the home. However, he contends petitioners had
likely already received tax benefits for the improvement
expenses. In particular respondent notes that for the
years during the renovations (2004 and 2005), petitioners
reported unusually high costs of goods sold on their Sched-
ules C for Mrs. Ambrose-Chandler’s interior design business.
Respondent believes that petitioners included their renova-
tion expenses in the business’ costs of goods sold, which
would have prevented them from also increasing their basis
in the property. See Thrifty Oil Co. v. Commissioner, 139
T.C. 198, 205, 217 (2012) (holding that taxpayer was not
entitled to a double deduction for the same economic loss).
Petitioners have presented credible documentary evidence
supporting $147,824 of their basis increase. Respondent con-
tends that petitioners may have included the improvement
costs in their Schedule C costs of goods sold for 2004 and
2005. This argument, first made at trial, raises a new matter
for which respondent bears the burden of proof. See Rule
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00013 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
292 142 UNITED STATES TAX COURT REPORTS (279)
142(a)(1). Respondent cites the abnormally high costs of
goods sold petitioners reported for those years, but he has
presented no evidence concerning the expenses underlying
the total. Without more specific evidence, we cannot conclude
that petitioners included the renovation expenses in their
costs of goods sold. Respondent had ample opportunity to
investigate petitioners’ costs of goods sold during the exam-
ination, but he chose not to. He has failed to persuade us
that petitioners included renovation expenses on their 2004
and 2005 Schedules C. Accordingly, we hold that petitioners
were entitled to increase their basis in the Claremont prop-
erty by $147,824.
Petitioners urge us to allow the full $245,150 basis
increase they claimed despite their inability to produce docu-
mentary evidence for the full amount. They claim that pic-
tures of the home before and after the renovations dem-
onstrate that they made improvements beyond those for
which they could produce receipts. The pictures indicate that
petitioners made significant renovations, but we cannot say
for sure that they cost more than $147,824. Accordingly, we
decline to estimate further basis increases. Petitioners have
failed to prove their entitlement to basis increases beyond
those for which they produced documentary evidence. Peti-
tioners’ claim that they had receipts but lost them does not
affect our result, because they have not shown that the loss
was beyond their control. We hold that petitioners were not
entitled to basis increases beyond the $147,824 they substan-
tiated.
III. Accuracy-Related Penalties
Under section 6662, taxpayers may be liable for penalties
for underpaying their income tax. A 20% penalty applies
when the underpayment resulted from certain causes
including negligence, a substantial understatement of income
tax, or a substantial valuation misstatement. Sec. 6662(a)
and (b)(1), (2), and (3). A 40% penalty applies when the
underpayment resulted from a gross valuation misstatement.
Sec. 6662(h). Although an underpayment may trigger the
penalty for more than one reason, the Commissioner may not
impose more than one penalty on a single portion of the
underpayment. Sec. 1.6662–2(c), Income Tax Regs.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00014 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 293
The Commissioner bears the burden of production with
respect to penalties. Sec. 7491(c). To meet this burden, he
must produce evidence regarding the appropriateness of
imposing the penalty. Higbee v. Commissioner, 116 T.C. 438,
446 (2001); Raeber v. Commissioner, T.C. Memo. 2011–39.
Once the Commissioner carries his burden, the taxpayer
bears the burden of proving the penalties are inappropriate
because of reasonable cause or otherwise. Higbee v. Commis-
sioner, 116 T.C. at 446.
A. Underpayments Resulting From Easement Misvalua-
tions
The Pension Protection Act of 2006 (PPA), Pub. L. No.
109–280, sec. 1219(a)(2)(B), 120 Stat. at 1083, amended the
rules for the 40% gross valuation misstatement penalty.
Before the PPA the penalty applied when taxpayers mis-
stated the value of their property by 400% or more, and tax-
payers could avoid the penalty under certain circumstances
if they made the misstatement in good faith and with reason-
able cause. The PPA lowered the threshold to 200% and
eliminated the reasonable cause exception for gross valuation
misstatements of charitable contribution property. See secs.
6662(h), 6664(c). The new rules apply to all returns filed
after July 25, 2006. 5 PPA sec. 1219(e)(3), 120 Stat. at 1086.
The years in issue here straddle the PPA’s effective date—
petitioners filed their 2004 and 2005 returns before July 25,
2006, but they filed their 2006 return after.
Petitioners misvalued their easements. They claimed
deductions of $191,400 and $371,250, but they have failed to
prove the easements had any value. Under either version of
section 6662(h) the valuation misstatements are ‘‘gross’’ and
trigger the 40% penalty. However, the facts raise a novel
issue concerning petitioners’ right to raise a reasonable cause
defense for their 2006 underpayment. Petitioners note that a
portion of the underpayment resulted from the carryover of
charitable contribution deductions they first claimed on their
2004 return, which they filed before the PPA’s effective date.
Accordingly, they argue, denying their right to raise a
5 For charitable contributions of property other than facade easements,
the effective date is August 17, 2006.
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00015 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
294 142 UNITED STATES TAX COURT REPORTS (279)
reasonable cause defense would amount to retroactively
applying the PPA.
Petitioners acknowledge that, by its plain language, the
statute applies for their 2006 return, but they urge us to look
beyond the plain language because of its retroactive effect.
We disagree with petitioners that applying the amended
reasonable cause rules for their 2006 return amounts to
retroactively applying the PPA. Accordingly, we need not
look beyond the statute’s plain language, and we apply the
amended reasonable cause rules to petitioners’ 2006 under-
payment.
When taxpayers file a return that includes carryforward
information, they essentially reaffirm that information. The
amended reasonable cause rules were in effect when peti-
tioners filed their 2006 return, which reaffirmed the Clare-
mont easement’s grossly misstated value. Applying those
rules does not amount to retroactive application. The plain
language of the statute makes the rules applicable for all
returns filed after July 25, 2006. Petitioners filed their
2006 return after that date and consequently may not
raise a reasonable cause defense for their 2006 under-
payment, which resulted exclusively from gross valuation
misstatements.
We evaluate petitioners’ reasonable cause defense for their
2004 and 2005 underpayments under the pre-PPA rules.
Even before Congress enacted the PPA, more rigorous
reasonable cause rules applied to taxpayers who substan-
tially or grossly misvalued charitable contribution property.
Under pre-PPA rules such taxpayers could raise a reasonable
cause defense only if: (1) the property value they claimed on
their return was based on a qualified appraiser’s qualified
appraisal and (2) they made a good-faith investigation of the
property’s value. Sec. 6664(c). Respondent concedes the
appraisal requirement but argues that petitioners have not
met the good-faith investigation requirement. We disagree.
Respondent’s chief criticism of petitioners’ efforts appears
to be their failure to independently assess the easements’
values. Respondent contends that because Mr. Chandler had
a law degree and worked as a business consultant, he should
have known his appraiser had overvalued the easements.
Petitioners are well educated, but they have no experience
valuing easements. Even experienced appraisers find valuing
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00016 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 295
conservation easements difficult because they are not bought
and sold in established markets. Average taxpayers would
not know where to start to value a conservation easement,
and even well-educated taxpayers like petitioners must rely
heavily on the opinions of professionals. Petitioners retained
an appraiser to value their easements. To choose the
appraiser, petitioners relied on the National Park Service’s
advice and consulted their easement holding organization,
NAT. We have identified flaws in the initial appraisals, but
they would not have been evident to petitioners. Although
petitioners could not rely exclusively on the appraisals, they
were entitled to give them substantial weight. Petitioners
corroborated the appraisals with advice from an experienced
accountant. We think these actions represent a good-faith
attempt to determine the easements’ values. Accordingly,
petitioners may raise a reasonable cause defense for their
2004 and 2005 underpayments resulting from gross valuation
misstatements.
In Kaufman v. Commissioner, at *72–*75, we held that
taxpayers whose investigation approximated petitioners’ had
not established reasonable cause for their gross misvaluation
of a conservation easement. However, the taxpayers’ inves-
tigation of value in Kaufman took place under different cir-
cumstances. In Kaufman, after the taxpayers had received
their initial appraisal they became worried that the ease-
ment would devalue their home too much. They expressed
their concern to a representative of NAT, and he assured
them that the easement would have no effect on the resale
value of their home. The taxpayers’ continued reliance on the
initial appraisal in the face of the representative’s comments
led in part to our conclusion that the taxpayers’ investigation
of value was in bad faith. Here there is no evidence that peti-
tioners relied on the appraisals in bad faith, and we hold
that their investigation was sufficient to allow them to raise
a reasonable cause defense.
Taxpayers can establish reasonable cause by dem-
onstrating they reasonably and in good faith relied on the
advice of a tax professional or appraiser. Sec. 1.6664–4(b),
Income Tax Regs. To determine whether a taxpayer’s reli-
ance on professional advice was reasonable and in good faith
we consider all facts and circumstances, including ‘‘the tax-
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00017 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
296 142 UNITED STATES TAX COURT REPORTS (279)
payer’s education, sophistication and business experience’’.
Sec. 1.6664–4(c), Income Tax Regs.
Petitioners have established reasonable cause for
misvaluing their easements. Mr. Chandler has a law degree
and significant business experience, but he has no valuation
experience. Even without valuation experience most tax-
payers can evaluate the reasonableness of an appraisal for
most forms of real property. But easements are different
because most taxpayers have never bought or sold an ease-
ment. Petitioners followed the NPS’ suggestion for choosing
an appraiser and relied on his report. The report was not so
deficient on its face that petitioners should have reasonably
discounted it. They obtained their accountant’s assurances
before they claimed the easement deductions. On these facts
we believe petitioners have established reasonable cause, and
we hold they are not liable for accuracy-related penalties on
the portions of their 2004 and 2005 underpayments that
resulted from misvaluing their easements.
B. Underpayments Resulting From Unsubstantiated Basis
Increases
Respondent imposed a 20% accuracy-related penalty on the
portion of petitioners’ 2005 underpayment resulting from
unsubstantiated basis increases in the Claremont property.
Respondent argues that the penalty applies because that por-
tion of the underpayment resulted both from a ‘‘substantial
understatement’’ of income tax and from petitioners’ neg-
ligence. We hold that petitioners are liable for the 20%
accuracy-related penalty because this portion of the under-
payment resulted from their negligence.
‘‘Negligence * * * includes any failure by the taxpayer to
keep adequate books and records or to substantiate items
properly.’’ Sec. 1.6662–3(b)(1), Income Tax Regs. Petitioners
have not retained records supporting the full amount of the
basis increase they claimed for the Claremont property. They
have failed to properly substantiate $97,326 of the basis
increase they reported. The reasonable cause exception
applies to penalties for negligence, but petitioners have not
established reasonable cause. They claim they kept records
but that some were lost when they moved from the Clare-
mont property to the West Newton property. They have not
proved that the loss resulted from circumstances beyond
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00018 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE
(279) CHANDLER v. COMMISSIONER 297
their control, and they have failed to offer a reasonable
reconstruction of the lost records. Cf. Mears v. Commissioner,
T.C. Memo. 2013–52. Section 6001 requires taxpayers to keep
records long enough to properly substantiate items they
claim on their returns. Petitioners have failed to do so and
are accordingly liable for the 20% penalty on the portion of
their 2005 underpayment resulting from the unsubstantiated
basis increase.
To reflect the foregoing,
Decision will be entered under Rule 155.
f
VerDate Mar 15 2010 13:08 Apr 28, 2015 Jkt 000000 PO 00000 Frm 00019 Fmt 3857 Sfmt 3857 V:\FILES\BOUNDV~1.WIT\BV864A~1.142\CHANDLER JAMIE