For the second time in three weeks, the Tax Court denied a deduction for the charitable contribution of property for failure to comply with the “qualified appraisal” requirements of Treas. Reg. §1.170A-13: Rothman v. Commissioner, T.C. Memo 2012-163, June 11, 2012.
During 2004, Steve and Rory Rothman executed a conservation deed of easement to the National Architectural trust, a donee that likely doomed the taxpayers from the start. The deed of easement granted NAT an open space and architectural façade easement on the Rothman’s Brooklyn home, prohibiting them from altering that portion of the home’s façade visible from street level opposite the home.
The Rothmans engaged Mitchell, Maxwell & Jackson, Inc. (MMJ) to perform the qualified appraisal supporting the contribution. (For more on the qualified appraisal rules, see here).
In determining the value of the conservation easement, MMJ set out to perform a “before and after valuation,” a commonly accepted methodology. This required MMJ to first determine the value of the Brooklyn home without the easement, then the value of the home after the easement, with the reduction in value representing the value of the conservation easement.
MMJ determined the value of the home without the easement using the cost and market data approaches. Such methodology determined the value of the home to be $2,600,000.
In attempting to value the home with the easement, however, MMJ conceded that in the market place, there was no measure or formula that was applicable for all properties subject to an easement. Calling the determination of the loss of value a “complex issue,” MMJ then looked to a series of previous court cases that generally valued the loss in value caused by a conservation easement at 10-15% of the total value. MMJ then “backed in” to the loss in value of the Brooklyn property, multiplying the $2.6M “before” value by 11.5% to determine a value for the conservation easement of $290,000.
The Rothmans claimed the $290,000 deduction on their 2004 tax return. The Rothman’s also attached the MMJ appraisal, which gave a legal description and address of the property, generally described the property’s condition, and attached interior and exterior pictures of the property. Members of MMJ were named as the appraiser and supervisory appraiser.
Just as they had in Mohamed, the IRS denied the deduction in full, arguing that the Rothmans had failed to meet the requirements for a qualified appraisal. Specifically, the IRS maintained that the appraisal failed to include:
1. The required method of valuation used to determine the fair market value of the interest,[i] and
2. The specific basis for the valuation, such as specific comparable sales transactions or statistical sampling [ii].
The Tax Court, as it did in Mohamed, sided with the IRS. In concluding that the appraisal failed to include the method of valuation, the court cited a previous case with similar facts in which MMJ was also the appraiser.[iii] In Scheidelman, just as in Rothman, MMJ had fulfilled its obligation to value the property before the easement, but merely estimated the value of the conservation easement by applying a set percentage to the property’s before value. In both cases, this percentage was not determined through a detailed analysis of the easement’s terms and covenants relative to the specific contribution, but rather on a review of previously approved relative values of conservation easements to gross values.
This, the court determined, did not constitute a valuation method approved under I.R.C. § 170 for determining the property’s “after” value. Accordingly, the Tax Court agreed with the IRS that the appraisal failed to contain the required method of valuation.
Similarly, the court sided with the IRS that the appraisal did not include the specific basis for the valuation. While MMJ ‘s appraisal generally cited elements that may affect the value of eased properties, it never expounded upon how, if at all, the factors affected the fair market value of the encumbered Brooklyn property. Thus, the appraisal did not specifically method what restrictions supported the proffered 11.15% reduction in value.
As in Mohamed, the Rothmans argued that they substantially complied with the Treas. Reg. §1.170A-13 regulations, but the court was unconvinced. Citing numerous other missed appraisal requirements — for example, the appraisal was performed more than 60 days prior to the contribution – the court concluded that the appraisal was not a “qualified appraisal,” and denied the full deduction.
What can we learn?
Clearly, when read in tandem with Mohamed, the Tax Court’s decision in Rothman issues a stark warning to any taxpayer (or their tax preparer) contemplating a charitable contribution of property to take ownership of the appraisal requirements found in the statute and regulations. While Mohamed made the mistake of preparing his own appraisal, in Rothman we learn that even the experts can, and do, get it wrong.
The “qualified appraisal” requirements are lengthy and detailed, and the IRS knows them well. Perhaps you should too.