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Thursday, September 26, 2013

Conservation Easements: Appraisals Don't Have to be Tidy to be Qualified

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Over the past few years there have been a significant number of audits and Tax Court cases related to conservation (facade) easements, and particularly the valuation of these easements for purposes of the charitable contribution deduction. In 2011, the IRS even issued a new Conservation Easement Audit Techniques Guide to give taxpayers a blueprint for how examiners will evaluate these contributions. Though the level of scrutiny the IRS uses in looking at these deductions seems to have increased, the Second Circuit appears to have offered some reprieve.

In Scheidelman v. Commissioner, 682 F.3d 189 (2d Cir. 2012), the Second Circuit overturned a Tax Court ruling that an appraisal obtained by the taxpayer insufficiently explained the method and basis of valuation and, therefore, was not a qualified appraisal under Regs. §1.170A-13(c)(3). The Second Circuit stated that, for the purpose of gauging compliance with the reporting requirement, it was irrelevant that the IRS believed the method employed was inaccurate or haphazardly applied as long as the method was described. The Second Circuit also stated that the regulation required only that the appraiser identify the valuation method "used" to enable the IRS to evaluate it, not that the method adopted be reliable. Accordingly, the Second Circuit vacated the decision of the Tax Court and remanded the case for further consideration of the value consistent with its opinion. 

In Friedberg v. Commissioner, T.C. Memo 2013-224, a matter that is appealable to the Second Circuit, the Tax Court reversed its prior grant of summary judgment to the IRS and held that the appraisal of a facade easement on a historic townhouse in New York City's Upper East Side was a qualified appraisal. The court previously had held that the sales comparison approach used by the appraiser was not a proper basis for a qualified appraisal. But, now applying Scheidelman, the court said it was irrelevant whether the IRS believed the appraisal method was "sloppy or inaccurate, or haphazardly applied." The court stated that the information provided must only enable the IRS to evaluate the appraiser's methodology. Further, the court noted that the matter of reliability and accuracy of the methodology and specific basis of valuation is to be determined at trial.

These cases mark a significant setback for the IRS, which has been successful in several courts in disallowing a deduction for facade easements on the basis of faulty appraisals. Though they are not final determinations on the reliability of the appraisal methods used, they do indicate that the IRS will not win by simply disregarding appraisals as unqualified when they disagree with the method used, at least not in the Second Circuit. We will have to wait and see if other circuits will adopt the Second Circuit's view on this matter.

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