First Circuit Reverses Tax Court on Deductability of Facade Easement

First Circuit Reverses Tax Court on Deductability of Facade Easement

As reported by Forbes, the First Circuit recently reversed the Tax Court's decision to disallow a charitable deduction for a facade easement under 26 U.S.C.S. § 170(h). The Tax Court, in denying the deduction, relied on 26 C.F.R. § 1.170A-14(g), which establishes further substantive requirements that conservation contributions must satisfy. In particular, the Tax Court relied on paragraph (g)(6), the extinguishment provision, which requires that:

when a change in conditions give rise to the extinguishment of a perpetual conservation restriction ... 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. ...

The property owners, the Kaufmans, granted the National Architectural Trust (now the Trust for Architectural Easements) a façade easement restricting alterations on their Boston house. The Preservation Restriction Agreement also granted the Trust an entitlement to a proportionate share of post-extinguishment proceeds. This seemingly complied with the extinguishment provision.

The Kaufmans also secured consent from their lender, Washington Mutual, to subordinate its rights in the property to the Trust's right to enforce the conservation and historic preservation purposes of the Preservation Agreement in perpetuity. The lender agreement included the following stipulation:

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.

Although the Kaufmans had granted the Trust an entitlement to a proportionate share of post-extinguishment proceeds, the Tax Court's position was that the lender agreement undercut this commitment 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 ...."

In Kaufman v. Shulman, 2012 U.S. App. LEXIS 14858 (1st Cir. July 19, 2012) [enhanced version available to lexis.com subscribers], the First Circuit, citing Powell on Real Property, reversed and held that:

Certainly the IRS has good reason to assure that the Kaufmans could not recapture the value of what they gave up by 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.

Another provision in the agreement between the Kaufmans and the Trust stated 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." The IRS argued that this was a "blank check" to the Trust to consent to any type of change, irrespective of its compatibility with the donation's conservation purpose. Thus, the easement failed to include restrictions that would prevent uses inconsistent with the conservation purpose as required by paragraph (g)(1).

The First Circuit rejected this argument, citing Commissioner v. Simmons, 646 F.3d 6, 396 U.S. App. D.C. 133 (D.C. Cir. 2011) [enhanced version available to lexis.com subscribers]. The court held that:

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.

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