Fifth Circuit - 40% penalty in conservation easement valuation case vacated 

June 11:  The U.S. Court of Appeals for the Fifth Circuit today affirmed a determination of the Tax Court that disallowed a “significant portion” of a partnership’s tax deduction for a historic conservation easement, but vacated and remanded the Tax Court’s enforcement of a 40% gross overstatement penalty. The Fifth Circuit concluded that the gross undervaluation penalty was “clearly erroneous.” Whitehouse Hotel Ltd. Partnership v. Commissioner, No. 13-60131 (5th Cir. June 11, 2014)

Read today’s 23-page decision [PDF 186 KB] from the Fifth Circuit.

Background

A partnership was formed to purchase a former department store building in New Orleans, renovate it, and reopen it as a hotel and condominium complex with retail space.


In 1997, the partnership conveyed a conservation easement to a non-profit corporation dedicated to historic preservation. On its tax return for 1997, the partnership claimed a charitable contribution deduction for the easement of approximately $7.5 million.


The IRS subsequently allowed only a deduction of $1.15 million for the easement, and assessed a gross undervaluation penalty of 40% of the portion of the underpayment. The partnership challenged both the valuation of the easement and the penalty assessment before the Tax Court.


The parties agreed that the partnership was entitled to a charitable contribution deduction on account of its having made the qualified conservation contribution to a qualified organization, but disagreed as to the amount of the contribution.


The Tax Court originally determined that the value of the easement was approximately $1.8 million and that because the partnership had overstated its deduction by about $5.6 million (almost 415% higher than the proper value), that the 40% penalty was appropriate absent a finding that the requirements of the good faith exception had been met.


The partnership appealed to the Fifth Circuit which remanded the case back to the Tax Court for consideration of the valuation issues and the denial of the good faith exception. On remand, the Tax Court ultimately concluded the value of the easement was approximately $1.8 million and that the 40% penalty continued to apply.


This appeal followed.

Fifth Circuit

The Fifth Circuit today held that the Tax Court did not err in rejecting two methods—the reproduction cost and income valuation methods—for valuing the easement. The appeals court also concluded that the Tax Court did not err in rejecting a non-local comparable sales factor. Accordingly, the Fifth Circuit affirmed the portion of the case concerning the value of the conservation easement.


However, in the penalty portion of the decision, the Fifth Circuit held that the partnership’s reliance on tax professionals was enough to give rise to the good faith exception—given the partnership sought out and then followed the advice of tax professionals and also sought a second appraisal of the building.


The Fifth Circuit concluded that the Tax Court imposed “an excessively high standard of proof for actual reliance on the advice of competent tax professionals” and disagreed with the imposition of the 40% penalty.




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