Kaufman v. Shulman

United States Court of Appeals
For the First Circuit
Nos. 11-2017, 11-2022
GORDON KAUFMAN; LORNA KAUFMAN,
Petitioners, Appellants/Cross-Appellees,
v.
DOUGLAS SHULMAN, COMMISSIONER OF INTERNAL REVENUE,
Respondent, Appellee/Cross-Appellant.
APPEALS FROM THE UNITED STATES TAX COURT
Before
Lynch, Chief Judge,
Boudin and Lipez, Circuit Judges.
Catherine M.A. Carroll with whom Seth P. Waxman, Thomas R.
Dettore and Wilmer Cutler Pickering Hale and Dorr LLP were on brief
for petitioners, appellants/cross-appellees.
Rebecca K. Troth, David R. Hill, Ryan C. Morris, Sidley Austin
LLP, Paul W. Edmondson, Elizabeth S. Merritt and Ross M. Bradford,
National Trust for Historic Preservation, on brief for the National
Trust for Historic Preservation, Amicus Curiae.
Patrick J. Urda, Tax Division, Department of Justice, with
whom Tamara W. Ashford, Deputy Assistant Attorney General, and
Kenneth L. Greene, Tax Division, Department of Justice, were on
brief for respondent, appellee/cross-appellant.
July 19, 2012
BOUDIN, Circuit Judge. This case comprises appeals by
both sides--the Commissioner of Internal Revenue ("the IRS") and
the taxpayers Gordon and Lorna Kaufman--from a decision of the Tax
Court. The subject is deductions on the couple's joint returns of
the asserted value of Lorna Kaufman's donation to the National
Architectural Trust of a façade easement restricting alterations on
her Boston house. A brief description of the background events and
proceedings follows, which is elaborated where necessary later in
this decision.
In 1999, Lorna Kaufman bought for $1,050,000 a row house
in the South End of Boston, an area (not to be confused with South
Boston), which is subject to local restrictions aimed at historic
preservation.1 The row house, 19 Rutland Square, was designed by
physician Elbridge Dudley and built between 1859 and 1861; it
reflected popular mid-nineteenth-century architectural trends but
also featured a Venetian Gothic-style façade that distinguished it
from redbrick row houses elsewhere in the South End.
1
The South End Landmark District is one of nine neighborhoods
designated as a historic district by the Boston Landmarks
Commission pursuant to state law. See Eckstein v. Bos. Landmarks
Comm'n, 17 L.C.R. 401, 401, 2009 Mass. LCR LEXIS 75, at *2-3 (Mass.
Land Ct. June 26, 2009). Exterior alterations to buildings in the
South End neighborhood must be approved by a local district
commission. See S. End Landmark Dist., Standards and Criteria 1
(rev. Apr. 27, 1999); Landmarks Frequently Asked Questions, City of
Boston, http://www.cityofboston.gov/landmarks/FAQ (last visited
June 25, 2012).
-2-
The Kaufmans renovated the house, which included the
restoration of original details of the façade. In 2003, the couple
learned about a tax incentive program for historic preservation,
promoted in this instance by an organization then known as the
National Architectural Trust, since renamed the Trust for
Architectural Easements. A Trust representative advised the
Kaufmans that the Trust could help the couple qualify for a tax
deduction equal to 10 to 15 percent of the fair market value of
their home and that the Trust "as part of our service . . . will be
handling all the red tape and paperwork."
A provision of the Internal Revenue Code, 26 U.S.C.
§ 170(h) (2006), creates an incentive for taxpayers to donate real
property interests to nonprofit organizations and government
entities for "conservation purposes." Adopted in 1976 and amended
the following year, the statute allows taxpayers to claim a
deduction for donating a real property interest--including an
easement--"exclusively for conservation purposes." Tax Reform Act
of 1976, Pub. L. No. 94-455, § 2124(e)(1)(C), 90 Stat. 1520, 1919
(1976); see also Tax Reduction and Simplification Act of 1977, Pub.
L. No. 95-30, § 309(a), 91 Stat. 126, 154 (amending statute); 26
U.S.C. § 170(h)(1)-(2) (current codification). These purposes
include the preservation of "historically important" land areas or
structures. Pub. L. No. 94-455, § 2124(e)(1)(D), 90 Stat. at 1919;
see also 26 U.S.C. § 170(h)(4)(A)(iv) (current codification). Cf.
-3-
26 U.S.C. § 170(f)(3)(B)(iii) (exempting "qualified conservation
contributions" from general denial of deduction for donations of
partial interests in property).
The deduction for granting the easement is intended to
reflect the value of what the taxpayer has donated which, in the
absence of a "market" for such easements, can be measured by "the
difference between the fair market value of the entire contiguous
parcel of property before and after the granting of the
restriction." 26 C.F.R. § 1.170A-14(h)(3)(I) (2004). A central
condition of the deduction, reflecting a change made in the 1977
amendment to the statute, is that the lease, option or easement be
granted "in perpetuity." Pub. L. No. 95-30, § 309(a), 91 Stat. at
154 (codified as amended at 26 U.S.C. § 170(h)(2)(C)).
On or about October 31, 2003, Lorna Kaufman submitted an
application on the Trust's own form and made a $1,000 "good faith
deposit"; she further agreed, as specified by the Trust, to make a
"cash endowment contribution" to the Trust equal to 10 percent of
the value of the ultimate deduction for the easement. This is at
least one means by which the Trust finances its work. The deposit
was to be returned if the "the necessary approvals cannot be
obtained" and the cash endowment contribution reduced in part if
the easement donation could not be processed in time to qualify for
a 2003 deduction.
-4-
The Trust advised Lorna Kaufman that if her property was
under mortgage, she needed to obtain consent from the mortgagee to
subordinate its interest in the property to the easement.
Accordingly, the Kaufmans sent a letter to their mortgage lender,
Washington Mutual Bank, asking it to subordinate its rights to the
easement being granted to the Trust. The letter stated that
restrictions on the property imposed by the easement were
"essentially the same restrictions as those imposed by current
local ordinances that govern this property." If this were so, the
bank would lose little or nothing by consenting.
On December 22, 2003, Lorna Kaufman executed a
Preservation Restriction Agreement supplied by the Trust and, a few
days later, sent it back to the Trust together with a further
contribution that the Trust had solicited in the amount of $15,840
(over and above her earlier $1,000 good-faith deposit). This
further contribution, the Trust said, could be adjusted dependent
on the appraised value of the easement.2
The Trust also offered the names of two recommended
appraisers, and the Kaufmans selected one of the two, Timothy
Hanlon, a certified appraiser who for the previous nineteen years
2
The Kaufmans' cash transfers to the Trust of $16,840 in 2003
and $3,032 in 2004 total 9 percent of the $220,800 value set by the
appraiser. Although the Trust normally asks for a cash endowment
equal to 10 percent of the value of the easement, the Trust applied
a 1 percentage point reduction due to the delay in obtaining the
requisite approvals.
-5-
had managed his own residential appraisal company. Hanlon
inspected the 19 Rutland Square property in January 2004 and
submitted his report on January 30, estimating that the fair market
value of the donated easement was $220,800. Gordon Kaufman
expressed concern that the reduction in the value of the property
due to the easement might be "so large as to overwhelm the tax
savings that accrue from it," but a representative of the Trust
sought to reassure him that it was "very unlikely" that the
easement would affect the marketability of the property.
Meanwhile, the Kaufmans successfully secured consent from
their lender, Washington Mutual, to an agreement "subordinating
[the bank's] rights in the [19 Rutland Square] Property to the
right of the Grantee [i.e., the Trust], its successors or assigns,
to enforce the conservation and historic preservation purposes of
[the Preservation Restriction] Agreement in perpetuity." The
lender agreement included several stipulations, one of which would
become relevant in the subsequent litigation:
The Mortgagee/Lender and its assignees shall
have a prior claim to all insurance proceeds
as a result of any casualty, hazard or
accident occurring to or about the Property
and all proceeds of condemnation, and shall be
entitled to same in preference to Grantee
until the Mortgage is paid off and discharged,
notwithstanding that the Mortgage is
subordinate in priority to the [Preservation
Restriction] Agreement.
On their joint return for 2003, the Kaufmans claimed (1)
a cash contribution of $16,870 to the Trust (the correct figure
-6-
would have been $16,840, see note 2, above, but the Kaufmans
attribute the discrepancy to a "typographical error"), and (2) a
noncash contribution of $220,800 for the easement donation. They
sought the $16,870 cash-contribution deduction on their 2003
returns and, in light of statutory limits on deductions in a single
year, 26 U.S.C. § 170(b)(1)(E), spread the deduction for the
noncash contribution across their 2003 and 2004 returns. The
Kaufmans claimed an additional $3,032 cash contribution to the
Trust in 2004.
In March 2007, evidently as part of a wide-ranging
investigation into perceived abuses of the easement program, the
IRS opened an investigation into the Kaufmans' claimed charitable
deductions. On May 5, 2009, the IRS sent a "Notice of Deficiency"
to the Kaufmans relating to the 2003 and 2004 tax years. In the
Notice, the Service cited three grounds for disallowing the
Kaufmans' noncash contribution claim:
-the Kaufmans had failed to "establish[] that
all of the requirements of I.R.C. section 170
and all of the regulations thereunder have
been satisfied";
-the contribution "was made subject to
subsequent event(s)"; and
-as an "alternative[]" ground, "it has not
been established that the value of the
contributed property interest was $220,800."
The IRS also disallowed the Kaufmans' claimed cash
contribution of $16,870 to the Trust for 2003 "because it was made
-7-
subject to or in contemplation of subsequent event(s)" and
calculated that the Kaufmans owed an additional $39,081.25 for 2003
and an additional $36,340.00 for 2004. It also imposed large
penalties for underpayment. The Kaufmans petitioned for review by
the Tax Court. See 26 U.S.C. § 6213(a) (authorizing petition to
the Tax Court for redetermination of deficiency); id. § 7442 (Tax
Court jurisdiction).
On an IRS motion for summary judgment, the Tax Court on
April 26, 2010, disallowed any deduction for the easement but found
"genuine issues of material fact" remained with regard to the cash
contribution deduction and the IRS's imposition of penalties.
Kaufman v. Comm'r (Kaufman I), 134 T.C. 182 (2010). In a second
decision after a trial on the reserved issues, the Tax Court on
April 4, 2011, reaffirmed its ruling on the easement, but held that
the Kaufmans were entitled to deduct their $16,840 cash
contribution on their 2004 return (as opposed to their 2003 return)
and were subject only to a small penalty for negligence in taking
the deduction in the earlier year. Kaufman v. Comm'r (Kaufman II),
136 T.C. 294 (2011).
Both sides have now appealed to this court. The Kaufmans
challenge the disallowance of the deduction for the façade
easement; the IRS attacks the disallowance of most of the penalties
it had imposed but does not question the Tax Court's allowance of
the cash contribution deduction on the 2004 return. Here, the Tax
-8-
Court granted partial summary judgment to the IRS "only
because . . . Lorna Kaufman's contribution of the facade easement
to [the Trust] failed as a matter of law to comply with [relevant
regulations]," Kaufman II, 136 T.C. at 325-26, so our review on
this issue is de novo.
Our legal analysis begins with § 170, the statute
governing deductions for charitable contributions and gifts.
Section 170(a) requires that deductions conform to Treasury
regulations, and subsequent subsections impose an elaborate list of
conditions relating to deductions of different types. Section
170(h) provides in detail for conservation contributions, of which
the provisions most pertinent to this appeal require that "a
qualified appraisal" be provided, see 26 U.S.C. §
170(h)(4)(B)(iii)(I); cf. § 170(f)(11)(E)(I) (definition of
"qualified appraisal"), and that a donated "restriction" on use be
"in perpetuity," see § 170(h)(2)(C), (h)(5)(A).
The regulations establish further substantive
requirements that conservation contributions must satisfy in order
to be deductible (independent of the appraisal requirements that we
address separately hereafter). Four provisions relevant here are:
-Paragraph (g)(1), the "[e]nforceable in
perpetuity" requirement, states that "any
interest in the property retained by the donor
. . . must be subject to legally enforceable
restrictions . . . that will prevent uses of
the retained interest inconsistent with the
conservation purposes of the donation." 26
C.F.R. § 1.170A-14(g)(1).
-9-
-Paragraph (g)(2), the mortgage subordination
requirement, states that "no deduction will be
permitted under this section for an interest
in property which is subject to a mortgage
unless the mortgagee subordinates its rights
in the property to the right of the [donee]
organization to enforce the conservation
purposes of the gift in perpetuity." 26
C.F.R. § 1.170A-14(g)(2).
-Paragraph (g)(3), the "[r]emote future event"
provision, adds a noteworthy qualification to
the regulatory requirements: "A deduction
shall not be disallowed . . . merely because
the interest which passes to, or is vested in,
the donee organization may be defeated by the
performance of some act or the happening of
some event, if on the date of the gift it
appears that the possibility that such act or
event will occur is so remote as to be
negligible." 26 C.F.R. § 1.170A-14(g)(3).
-Paragraph (g)(6), the extinguishment
provision, requires that "when a change in
conditions give rise to the extinguishment of
a perpetual conservation restriction [by
judicial proceeding], the donee organization,
on a subsequent sale, exchange, or involuntary
conversion of the subject property, must be
entitled to a portion of the proceeds at least
equal to that proportionate value of the
perpetual conservation restriction, unless
state law provides that the donor is entitled
to the full proceeds from the conversion." 26
C.F.R. § 1.170A-14(g)(6)(ii).
These requirements are in addition to the recordkeeping and return
regulations of 26 C.F.R. § 1.170A-13, discussed in more detail
below.
Paragraph (g)(6). The Tax Court, in denying the
Kaufmans a deduction for the façade easement, relied entirely on
the last of these requirements. Although the extinguishment
-10-
provision was unexplained when first promulgated, 51 Fed. Reg.
1496, 1505 (Jan. 14, 1986), paragraph (g)(6) appears designed in
case of extinguishment both (1) to prevent taxpayers from reaping
a windfall if the property is destroyed or condemned and they get
the proceeds from insurance or condemnation3 and (2) to assure that
the donee organization can use its proportionate share of the
proceeds to advance the cause of historic preservation elsewhere.
The Tax Court's position, briefly stated, was that
although the Kaufmans in the Preservation Restriction Agreement
governing 19 Rutland Square granted the Trust an entitlement to a
proportionate share of post-extinguishment proceeds, thus seemingly
complying with the regulation, the lender agreement executed by
Washington Mutual undercut this commitment--and so defeated the
deduction--by stipulating that "[t]he Mortgagee/Lender and its
assignees shall have a prior claim to all insurance proceeds . . .
and all proceeds of condemnation, and shall be entitled to same in
preference to Grantee until the Mortgage is paid off and
discharged." See Kaufman II, 136 T.C. at 299, 313; Kaufman I, 134
T.C. at 185-87.
Certainly the IRS has good reason to assure that the
Kaufmans could not recapture the value of what they gave up by
3
As the Kaufmans note, paragraph (g)(6) only applies when the
easement is "extinguished by judicial proceeding," 26 C.F.R.
§ 1.170A-14(g)(6)(I). Accordingly, paragraph (g)(6) does not
necessarily entitle the donee organization to a share of casualty
insurance proceeds if the easement remains in place.
-11-
granting the easement in order to get the deduction; but the
Kaufmans had no power to make the mortgage-holding bank give up its
own protection against fire or condemnation and, more striking, no
power to defeat tax liens that the city might use to reach the same
insurance proceeds--tax liens being superior to most prior claims,
1 Powell on Real Property § 10B.06[6] (Michael Allan Wolf ed.,
Matthew Bender & Co. 2012), including in Massachusetts the claims
of the mortgage holder.4
The IRS reads the word "entitled" in the extinguishment
regulation to mean "gets the first bite" as against the rest of the
world, a view the Tax Court accepted in reading "entitled" to mean
"ha[s] an absolute right." Kaufman II, 136 T.C. at 313. But a
grant that is absolute against the owner-donor is also an
entitlement, Black's Law Dictionary (7th ed. 1999) ("entitle"
defined as "[t]o grant a legal right to"); Collins English
Dictionary (10th ed. 2009) ("to give (a person) the right to do or
have something"), and almost the same as an absolute one where
4
Mass. Gen. Laws ch. 60, § 37 (2010); Carpenter v. Suffolk
Franklin Sav. Bank, 346 N.E.2d 892, 899-900 (Mass. 1976); see also
United States v. A Certain Parcel of Land with Buildings Thereon
Known as Hotel Buckminster, in City of Boston, 59 F. Supp. 65, 68
(D. Mass. 1944) ("Under Massachusetts law, real estate taxes are
liens paramount to any mortgage on the real estate."). Such super-
priority for tax liens is widespread. Alexander, Tax Liens, Tax
Sales, and Due Process, 75 Ind. L.J. 747, 770-71 nn. 129-30 (2000).
Likewise, proceeds from condemnation go to satisfy a municipal tax
lien "before any payment of damages for such taking is made to any
other party." Mass. Gen. Laws ch. 79, § 44A; cf. id. ch. 80A, § 15
(applying provisions of chapter 79 to takings by judicial
proceeding).
-12-
third-party claims (here, the bank's or the city's) are contingent
and unlikely.
Equally important, given the ubiquity of super-priority
for tax liens, the IRS's reading of its regulation would appear to
doom practically all donations of easements, which is surely
contrary to the purpose of Congress. We normally defer to an
agency's reasonable reading of its own regulations, e.g., United
States v. Cleveland Indians Baseball Co., 532 U.S. 200, 220 (2001),
but cannot find reasonable an impromptu reading that is not
compelled and would defeat the purpose of the statute, as we think
is the case here. Cf. Grunbeck v. Dime Sav. Bank of N.Y., FSB, 74
F.3d 331, 336 (1st Cir. 1996).
In reaching our conclusion, we do not rely on the general
provision of paragraph (g)(3) that aims to prevent deductions from
being lost by improbable events, 26 C.F.R. § 1.170A-14(g)(3),
because, as the Tax Court noted, "[o]ne does not satisfy the
extinguishment provision . . . merely by establishing that the
possibility of a change in conditions triggering judicial
extinguishment is unexpected." Kaufman II, 136 T.C. at 313. Nor
do we rest our conclusion on the Kaufmans' expressio unius reading
of paragraph (g)(2), for "expressio unius is an aid to construction
-13-
and not an inflexible rule," Hewlett-Packard Co. v. Berg, 61 F.3d
101, 106 (1st Cir. 1995).5
Paragraph (g)(1). A provision in the agreement between
the Kaufmans and the Trust states that "nothing herein contained
shall be construed to limit the [Trust's] right to give its consent
(e.g., to changes in the Façade) or to abandon some or all of its
rights hereunder." According to the IRS, this provision is a
"blank check" to the Trust "to consent to any type of change,
irrespective of its compatibility with the donation's conservation
purpose," and so "[t]he easement fails to include restrictions that
'will' prevent uses inconsistent with the conservation purpose as
required by [paragraph (g)(1)]."
The D.C. Circuit considered and rejected this same
argument in Commissioner v. Simmons, 646 F.3d 6, 10 (D.C. Cir.
2011):
The clauses permitting consent and
abandonment, upon which the Commissioner so
heavily relies, have no discrete effect upon
5
The Kaufmans argue that because paragraph (g)(2) deals
expressly with subordination and only requires that "the mortgagee
subordinate[] its rights in the property to the right of the
qualified organization to enforce the conservation purposes of the
gift," it is per se improper for the IRS to argue that some other
right of the bank--here, to insurance and condemnation proceeds--
should have been subordinated. But the Kaufmans' argument could be
turned against them by reading "conservation purposes" broadly to
include the donee organization's right to post-extinguishment
proceeds (which, by regulation, must be used to advance
"conservation purposes," cf. 26 C.F.R. § 1.170A-14(g)(6)(I)). As
the IRS disclaimed this broad reading of paragraph (g)(2), we need
not pursue this issue.
-14-
the perpetuity of the easements: Any donee
might fail to enforce a conservation easement,
with or without a clause stating it may
consent to a change or abandon its rights, and
a tax-exempt organization would do so at its
peril. . . . [T]his type of clause is needed
to allow a charitable organization that holds
a conservation easement to accommodate such
change as may become necessary to make a
building livable or usable for future
generations while still ensuring the change is
consistent with the conservation purpose of
the easement.
Id. (internal quotation marks omitted).
The IRS insists that paragraph (g)(1) is a "reasonable
interpretation" of the perpetuity language of 26 U.S.C.
§ 170(h)(5), and is therefore entitled to deference. See Mayo
Found. for Med. Educ. & Research v. United States, 131 S. Ct. 704,
711-13 (2012). Yet the question here is not whether paragraph
(g)(1) is reasonable, but whether the IRS's interpretation of that
regulation is reasonable. The language of paragraph (g)(1) nowhere
suggests the stringent outcome that the IRS seeks to ascribe to it
and the consequences of the reading would be to deprive the donee
organization of flexibility to deal with remote contingencies.
In addition, the concern posited by the IRS is within its
power to control: the IRS's own regulations require that tax-exempt
organizations such as the Trust be operated "exclusively" for
charitable purposes, 26 C.F.R. § 1.501(c)(3)-1, a requirement that
the IRS can enforce against the Trust. See, e.g., Alexander v.
"Americans United" Inc., 416 U.S. 752 (1974); Music Square Church
-15-
v. United States, 218 F.3d 1367 (Fed. Cir. 2000). We agree with
Simmons that such deductions "cannot be disallowed based upon the
remote possibility [that the donee organization] will abandon the
easements." 646 F.3d at 10.
Recordkeeping and Reporting Requirements. As a further
alternative ground, the IRS argues that the Kaufmans failed to
comply with certain recordkeeping and reporting requirements that
are imposed by statute, 26 U.S.C. § 170(f)(11), and elaborated in
an accompanying regulation, 26 C.F.R. § 1.170A-13. Clauses
(c)(3)(ii)(J)-(K) of that regulation require taxpayers who claim
easement contribution deductions to obtain a "qualified appraisal"
report that explains "[t]he method of valuation used to determine
the fair market value" of the contribution and "[t]he specific
basis for the valuation." See also Deficit Reduction Act of 1984,
Pub. L. No. 369, § 155(a)(1)-(2), 98 Stat. 494, 691 (instructing
Treasury Department to promulgate regulations regarding
appraisals).
The regulation also requires taxpayers to attach an
"appraisal summary" to their returns that includes, inter alia:
-"[a] description of the property in
sufficient detail for a person who is not
generally familiar with the type of property
to ascertain that the property that was
appraised is the property that was
contributed," 26 C.F.R. § 1.170A-
13(c)(4)(ii)(B);
-16-
-"[t]he manner of acquisition . . . and the
date of acquisition of the property by the
donor," id. § 1.170A-13(c)(4)(ii)(D);
- "[t]he cost or other basis of the property
adjusted as provided [elsewhere in the Code],"
id. § 1.170A-13(c)(4)(ii)(E); and
- "[t]he appraised fair market value of the
property on the date of contribution," id. §
1.170A-13(c)(4)(ii)(J).
The IRS claims that the method of valuation used by the
Kaufmans' appraiser lacked "analytical mooring" and produced an
indefensibly inflated valuation; indeed, the IRS concluded that the
Kaufmans' contribution claim constituted a "gross valuation
misstatement[]," that is, a claim more than 200 percent of the
actual value. See 26 U.S.C. § 6662(h). This is not a frivolous
contention. But the IRS's argument is largely an attempt to
convert an inherently factual issue into a set of violations of the
procedural requirements of section 1.170A-13 in disregard of their
language and purpose.
The procedural regulations requiring an appraisal report
and summary are designed to provide information "sufficient to
permit [the IRS] to evaluate the [taxpayer]'s reported contribution
and monitor and address concerns about overvaluation." Consol.
Investors Grp. v. Comm'r, 98 T.C.M. (CCH) 601, 2009 Tax Ct. Memo
LEXIS 294, at *67, 2009 WL 4840246, at *23 (T.C. 2009). But whether
the valuation was overstated, grossly or otherwise, is a factual
question different from whether the formal procedural requirements
-17-
were met, either strictly or under the "substantial compliance"
doctrine which may forgive minor discrepancies.6
True, the IRS has identified elements of the Kaufmans'
appraisal summary (submitted on Form 8283) that are in technical
noncompliance with Treasury regulations. As the IRS rightly points
out, "the Form 8283 did not include the date and manner of
acquisition of the property purportedly contributed or the cost or
other basis of the property." Yet as the Kaufmans explain, they
"did not 'acquire' the preservation easement, but created that
property interest at the moment they conveyed it to the Trust," and
"thus had no 'manner and date of acquisition' and no 'cost or other
basis' to report."
Arguably, the Kaufmans should have written "None" or "Not
Applicable" in the spaces on the Form 8283 reserved for date of
acquisition, method of acquisition, and cost/adjusted basis. But
we can hardly agree with the IRS that "[t]hese defects," in no way
prejudicial to it in this instance, "doom the appraisal summary."
Accord Scheidelman v. Comm'r, Nos. 10-3587 & 10-5316, 2012 U.S.
App. LEXIS 12272, at *15-23, 2012 WL 2161155, at *5-7 (2d Cir. June
15, 2012).
6
The substantial compliance doctrine allows taxpayers to
overcome technical noncompliance if they make "a showing that the
requirement is either unimportant or unclearly or confusingly
stated." Prussner v. United States, 896 F.2d 218, 224-25 (7th Cir.
1990) (Posner, J.); see also Volvo Trucks of N. Am., Inc. v. United
States, 367 F.3d 204, 210 (4th Cir. 2004); Shotgun Delivery, Inc.
v. United States, 269 F.3d 969, 973 (9th Cir. 2001).
-18-
One aspect of the IRS position warrants separate mention.
The regulations say that an appraiser is not "qualified" if "the
donor had knowledge of facts that would cause a reasonable person
to expect the appraiser falsely to overstate the value of the
donated property." 26 C.F.R. 1.170A-13(c)(5)(ii). This argument
is closely related to the question of whether the easement was
overvalued and, as explained in the next section, the context and
proper inferences as to the appraisal require further fact-finding
by the Tax Court, so it is not a basis for affirmance of the
summary judgment.
For the foregoing reasons, the original Tax Court
rationale for disallowing the easement deduction as a matter of law
fails, as do the alternative grounds for outright affirmance
tendered by the IRS. Accordingly, the grant of partial summary
judgment for the IRS must be vacated.7 Moreover, since the Tax
Court's decision not to impose penalties with respect to the
Kaufmans' noncash contribution claim depended on the same rationale
on which it based its grant of partial summary judgment, Kaufman
II, 136 T.C. at 325-26 (namely, paragraph (g)(6)), the Tax Court's
7
At trial, the Tax Court sustained the IRS's disallowance of
a $16,840 deduction for Lorna Kaufman's 2003 cash contribution to
the Trust, Kaufman II, 136 T.C. at 316, and sustained an accuracy-
related penalty (of approximately $1,097) resulting from the 2003
cash contribution deduction, id. at 325. As the Kaufmans do not
contest the disallowance of the 2003 cash contribution deduction or
the accompanying penalty, our decision to vacate the grant of
partial summary judgment does not disturb the Tax Court's
conclusions regarding those matters.
-19-
decision not to impose further penalties on the Kaufmans must be
vacated as well.
Overstatement of Value. Given our rejection of the Tax
Court's readings and the IRS's alternatives, a remand is necessary.
As the IRS noted in its brief, "If this Court disagrees with the
Tax Court's decision, and does not believe that the decision is
justified under the alternative grounds discussed, the case should
be remanded so that the Tax Court can consider, in the first
instance, the grounds left unaddressed, including the proper value
of the easement." At oral argument, counsel for the Kaufmans
agreed that it would be appropriate for us to remand the case to
the Tax Court to determine the substantive question of value in the
first instance.
Section 170(h) does not allow taxpayers to obtain six-
figure deductions for gifts of lesser or no value. "The value of
the contribution under section 170 in the case of a charitable
contribution of a perpetual conservation restriction is the fair
market value of the perpetual conservation restriction at the time
of the contribution." 26 C.F.R. § 1.170A-14(h)(3) (emphasis
added). Whether the deduction claimed by the Kaufmans exceeded
fair market value was not decided by the Tax Court.
In its Notice of Deficiency, the IRS stated that the
Kaufmans had failed to "establish[] that the value of the
[easement] was $220,800 as claimed in the 2003 return." The IRS
-20-
did not waive this objection by moving for summary judgment to
disallow the easement deduction on other grounds as a matter of
law; a summary judgment motion properly includes only such grounds
as may be susceptible to disposition without a trial. See, e.g.,
Sánchez-Rodríguez v. AT&T Mobility P.R., Inc., 673 F.3d 1, 10-11
(1st Cir. 2012). And, because the value of the gift is a factual
issue not decided by the Tax Court, the IRS could not offer the
objection here as an alternative ground to sustain the judgment.
But although the Kaufmans claimed that the value of the
easement donation was $220,800, the IRS has repeatedly pointed to
evidence that the true value of the donation was close to zero. If
so, then the Kaufmans would be liable for penalties under 26 U.S.C.
§ 6662 for substantial understatement of income tax and for
substantial or gross valuation misstatements, unless they could
show "reasonable cause." The IRS has also argued that the Kaufmans
knew or should have known that the value of the easement was
minimal, failed adequately to investigate, and so fail to establish
a "reasonable cause" defense to misstatement penalties for noncash
contribution claims. See id. § 6664(c)(3)(B).
When the Kaufmans donated the easement, their home was
already subject to South End Landmark District rules that severely
restrict the alterations that property owners can make to the
exteriors of historic buildings in the neighborhood. These rules
provide that "[a]ll proposed changes or alterations" to "all
-21-
elements of [the] facade, . . . the front yard . . . and the
portions of roofs that are visible from public streets" will be
"subject to review" by the local landmark district commission. S.
End Landmark Dist., Standards and Criteria 2 (rev. Apr. 27, 1999).
Under the Standards and Criteria, property owners of
South End buildings have an obligation to retain and repair the
original steps, stairs, railings, balustrades, balconies,
entryways, transoms, sidelights, exterior walls, windows, roofs,
and front-yard fences (along with certain "other features"); and,
when the damaged elements are beyond repair, property owners may
only replace them with elements that look like the originals. Id.
at 2-6. Given these pre-existing legal obligations the Tax Court
might well find on remand that the Kaufmans' easement was worth
little or nothing.
The Kaufmans' own appraiser, recommended to them by the
Trust, acknowledged in his report that "there is much overlap in
the restrictions imposed by the [easement] and the pre-existing
restrictions imposed on the property, particularly by the Landmark
Commission." This may be a substantial understatement. Although
the appraiser listed several ways in which the easement's
restrictions differed from the landmark district commission's,
whether the differences have any economic significance could be
disputed.
-22-
For instance, the appraiser noted that the easement
agreement would last "in perpetuity" while local ordinances might
lapse; but no specific reason was given for expecting this to
happen (other than a vague suggestion of "changes in political,
economic and aesthetic needs and tastes in a community"). He also
said that the Kaufmans would be "subject to the inconvenience of
periodic inspections" by the Trust; yet any such inconvenience
would be limited by the fact that the agreement explicitly does not
give the Trust the right to inspect the inside of the house.
Preservation Restriction Agreement 3 (Dec. 22, 2003). Whether any
of the offered distinctions justify any deduction is a matter for
the remand.
The Kaufmans themselves were surprised at the size of the
valuation, albeit out of concern that it implied--as it must if the
Kaufmans were conveying anything of value--a substantial reduction
in the resale value of their home. In an effort to reassure them,
a Trust representative told the Kaufmans that experience showed
that such easements did not reduce resale value, and this could
easily be the IRS's opening argument in a valuation trial. The
Trust representative explained in pertinent part that
[i]n areas that are regulated by local
historic preservation ordinances and bodies
such as Boston historic neighborhoods
(including yours) . . . , properties with an
easement are not at a market value
-23-
disadvantage when compared to the other
properties in the same neighborhood.8
As indicated by the large cash contributions required of
donors, the Trust had a substantial economic incentive for itself
in facilitating such conservation easements; and to this end and
because of the 10 percent target for donations, it also had a stake
in assuring a high valuation. Similarly, the appraiser, who
admitted receiving fees for a succession of such appraisals for
Trust easements, assuredly had an interest in remaining on the list
of those recommended by the Trust to potential donors.
The burden in the Tax Court initially rests on the
taxpayer to justify his or her deduction. See Tax Ct. R. Prac. &
P. 142(a)(1); see also INDOPCO, Inc. v. Comm'r, 503 U.S. 79, 84
(1992). The burdens and presumptions relating to penalties are
more complicated, compare, e.g., 26 U.S.C. § 7491(c), with Higbee
v. Comm'r, 116 T.C. 438, 446-47 (2001), and there is no reason to
pursue the subject of the Kaufmans' fault before determining first
whether their deduction was legitimate. Judging from the amici,
the present appeals have the hallmarks of a test case to settle
8
The Kaufmans have objected to the admission of this e-mail
into evidence on grounds of hearsay, relevance, and noncompliance
with the expert witness requirements of Rule 143(g) of the Tax
Court Rules of Practice and Procedure. While the Trust
representative's testimony may not be admissible for the purpose of
proving the value of the easement (or lack thereof), it may well be
relevant to the question of whether the Kaufmans acted in "good
faith," and at trial the Tax Court admitted the e-mail into
evidence for that purpose.
-24-
larger issues between the industry and the IRS; and on remand the
Kaufmans and the IRS could well work out a settlement without a
trial.
Doubtless it is the desire to avoid such trials, as well
as the difficulty of detecting and investigating suspicious cases
one by one, that explains the IRS's aggressive legal positions in
this case. And, despite our rejection of those particular
positions, we do not question the IRS's concern, transcending this
case, that individuals and organizations have been abusing the
conservation statute "to improperly shield income or assets from
taxation." IRS News Release IR-2005-19 (Feb. 28, 2005), see also
IRS News Release IR-2006-25 (Feb. 7, 2006) (repeating language from
2005 news release).
However, to reject overly aggressive IRS interpretations
of existing regulations is hardly to disarm the IRS. Without
stifling Congress' aim to encourage legitimate easements, one can
imagine IRS regulations that require appraisers to be functionally
independent of donee organizations, curtail dubious deductions in
historic districts where local regulations already protect against
alterations, and require more specific market-sale based
information to support any deduction. Forward looking regulations
also serve to give fair warning to taxpayers.
If taxpayers still do not get the message, the penalties
regime is formidable, see, e.g., 26 U.S.C. § 6662(h)(1) (40 percent
-25-
penalty for gross valuation misstatements); and, for willful
abusers, there are criminal penalties, e.g., 26 U.S.C. § 7201(prison term up to five years). The Justice Department has already
secured a permanent injunction against the Trust to prohibit some
of the practices alluded to in this case.9 The IRS is properly
zealous to protect the revenues and over the long run it has the
tools to do so.
The judgment of the Tax Court is vacated except with
regard to the deductibility of the taxpayers' cash contributions
and the accuracy-related penalty associated with their 2003 cash
contribution claim, and the matter remanded to that court for
further proceedings consistent with this decision. Each side shall
bear its own costs on this appeal.
It is so ordered.
9
See Stipulated Order of Permanent Injunction, United States
v. McClain, No. 11-1087 (D.D.C. July 15, 2011), which inter alia
prevents the Trust from claiming that the IRS has recognized a
"safe harbor" for easement valuations in the 10-15 percent range
and from "[p]articipating in the appraisal process for a
conservation easement in any regard, including but not limited to
recommending . . . any appraiser . . . or list of appraisers"
beyond furnishing a list of all appraisers who have been certified
to appraise conservation easements by a professional organization.
-26-