Wills and Trusts

Wyatt, Tarrant & Combs, LLP

Leave a comment

Portability and the New Paradigm

Portability and the New Paradigm

The newest feature on the estate planning landscape is portability. A full discussion of the planning implications of portability is beyond the scope of this outline and there are resources publicly available that cover the subject in a comprehensive manner.[1] In the context of the “new paradigm” in estate planning discussed above, portability, at least in theory, can provide additional capacity for the surviving spouse’s estate to benefit from a “step-up” in basis with little or no transfer tax costs.

In traditional by-pass trust planning, upon the death an individual who has a surviving spouse, assets of the estate equal in value to the decedent’s unused Applicable Exclusion Amount fund a trust (typically for the benefit of the surviving spouse and, perhaps, descendants). The trust is structured to avoid estate tax inclusion at the surviving spouse’s estate. The marital deduction portion is funded with any assets in excess of the unused Applicable Exclusion Amount. The by-pass trust avoids estate tax inclusion at the surviving spouse’s estate. From an income tax standpoint, however, the assets in the by-pass trust do not receive a “step-up” in basis upon the death of the surviving spouse. Furthermore, while the assets remain in the by-pass trust, any undistributed taxable income above $12,150 of taxable income will be subject to the highest income tax rates at the trust level.[2]

In portability planning, the decedent’s estate would typically pass to the surviving spouse under the marital deduction, and the DSUE Amount would be added to the surviving spouse’s Applicable Exclusion Amount. Because all of the assets passing from the decedent to the surviving spouse in addition to the spouse’s own asset will be subject to estate taxes at his or her death, the assets will receive a “step-up” in basis. Additional income tax benefits might be achieved if the assets that would otherwise have funded the by-pass trust are taxed to the surviving spouse, possibly benefiting from being taxed a lower marginal income tax bracket. In addition, if the by-pass trust would have been subject to a high state income tax burden (for example, California), having the assets taxed to a surviving spouse who moves to a low or no income tax state would provide additional income tax savings over traditional by-pass trust planning.

Of course, there are other considerations, including creditor protection and “next spouse” issues, which would favor by-pass trust planning. However, from a tax standpoint, the trade-off is the potential estate tax savings of traditional by-pass trust planning against the potential income tax savings of portability planning. Because the DSUE Amount does not grow with the cost-of-living index, very large estates ($20 million or above, for example) will benefit more with traditional by-pass trust planning because all of the assets, including any appreciation after the decedent’s death, will pass free of transfer taxes. On the other hand, smaller but still significant estates (up to perhaps $7 million, for example) should consider portability as an option because the combined exclusions, the DSUE Amount frozen at $5.25 million and the surviving spouse’s Applicable Exclusion Amount of $5.25 million but growing with the cost-of-living index, is likely to allow the assets to pass at the surviving spouse’s death with a full step-up in basis with little or no transfer tax costs (unless the assets are subject to significant state death taxes at that time).

In evaluating the income tax savings of portability planning, planners will want to consider that even for very large estates, the surviving spouse has the option of using the DSUE Amount by making a taxable gift to an IDGT. The temporary Treasury Regulations make clear that the DSUE Amount is applied against a surviving spouse’s taxable gift first before reducing the surviving spouse’s Applicable Exclusion Amount (referred to as the basic exclusion amount).[3] The IDGT would provide the same estate tax benefits as the by-pass trust would have, but importantly the assets would be taxed to the surviving spouse as a grantor trust thus allowing the trust assets to appreciate out of the surviving spouse’s estate without being burdened by income taxes.[4] If the assets appreciate, then this essentially solves the problem of the DSUE Amount being frozen in value. Moreover, if the IDGT provides for a power to exchange assets of equivalent value with the surviving spouse,[5] the surviving spouse can exchange high basis assets for low basis assets of the IDGT prior to death and essentially effectuate a “step-up” in basis for the assets in the IDGT.[6] The ability to swap or exchange assets with an IDGT is discussed in more detail below.

Portability planning is slightly less appealing to couples in community property states because, as discussed below, all community property gets a “step-up” in basis on the first spouse’s death. Thus, the need for additional transfer tax exclusion in order to benefit from a subsequent “step-up” in basis is less crucial. This is not true, however, for assets that are depreciable (commercial real property) or depletable (mineral interests). As discussed below, these types of assets will receive a “step-up” in basis but over time, the basis of the asset will be reduced by the ongoing depreciation deductions. As such, even in community property states, if there are significant depreciable or depletable assets, portability should be considered.

Turney P. Berry

Louisville, Kentucky


[1] See Franklin, Law and Karibjanian, Portability – The Game Changer, ABA-RPTE Section (January 2013) (http://meetings.abanet.org/webupload/commupload/RP512500/otherlinks_files/TheGameChanger-3-12-13v11.pdf)

[2] See Rev. Proc. 2013-35, Section 3.

[3] Treas. Reg. § 25.2505-2T(d).

[4] See Rev. Rul. 2004-64, 2004-27 I.R.B. 7.

[5] § 675(4)(C) and

[6] See Rev. Rul. 85-13, 1985-1 C.B. 184 and PLR 9535026


Leave a comment

Charitable Deduction Allowed for Undivided Interest in a Unitrust Payment

In PLR 201249002 spouses created a two-life charitable remainder unitrust. They proposed to irrevocably designated a particular charity as the remainder beneficiary of an undivided interest in the trust and then to contribute an identical undivided interest in the unitrust interest to the same charity. The ruling notes that the taxpayers stipulated that when the charity received the unitrust interest, and was the irrevocable remainder beneficiary, those interests would merge for state law purposes and the trustee (who was also the donor spouse) would distribute outright to the charity the relevant portion of the CRUT corpus while continuing to hold the remaining corpus under the terms of the CRUT. The taxpayers also stipulated that the portion distributed to the charity would be “fairly representative” of the adjusted basis of the CRUT assets on the date of distribution.

The IRS approved the transaction, ruling that the donors will receive an income tax deduction for the value of the unitrust interest, that the CRUT’s status would continue, and that “[t]o the extent that in prior years the Trust realized capital gain income, and that income was not included in the income of Donor, such capital gain shall not be included in the income of Donor solely because of the transfer of the undivided interest in the unitrust payment to Charity.”

See also PLR 201321012.

Turney P. Berry
Louisville, Kentucky

Leave a comment

Contributions to Domestic Disregarded Entities may Qualify for the Charitable Deduction

In Notice 2012-52; 2012-35 IRB 1, the IRS sets forth its position that if a charity owns a single member LLC a contribution to the LLC is the same as a contribution to the charity.  For more than a decade the IRS had refused to rule on the issue, for mysterious if not downright inexplicable reasons.  The Notice states:

If all other requirements of § 170 are met, the Internal Revenue Service will treat a contribution to a disregarded SMLLC that was created or organized in or under the law of the United States, a United States possession, a state, or the District of Columbia, and is wholly owned and controlled by a U.S. charity, as a charitable contribution to a branch or division of the U.S. charity. The U.S. charity is the donee organization for purposes of the substantiation and disclosure required by §§ 170(f) and 6115. To avoid unnecessary inquiries by the Service, the charity is encouraged to disclose, in the acknowledgment or another statement, that the SMLLC is wholly owned by the U.S. charity and treated by the U.S. charity as a disregarded entity. The limitations of § 170(b) apply as though the gift were made to the U.S. charity.

Unfortunately, the ruling does not refer to sections 2055 or 2522 but all but the most conservative practitioner appears to be overlooking the potential gift tax issue.

Turney P. Berry
Louisville, Kentucky

Leave a comment

Conditional Gifts and the Income Tax Charitable Deduction

In Lawrence G. Graev v. Commissioner, 140 T.C. No. 17 (2013), the taxpayer contributed a façade easement and cash to the National Architectural Trust which promised to refund the cash and remove the easement if the contribution was not deductible.  The Tax Court held that was a conditional gift and was non-deductible.  The taxpayer tried to argue that the side letter agreement was not enforceable but the court held that did not matter:

The event that might defeat the contribution to NAT is the “removal” of the easement and the return of the cash pursuant to NAT’s side letter. Even if, as a matter of law, the side letter was not enforceable for any of the reasons the Graevs advance, the question would remain whether, as a matter of fact, in December 2004 there was a non-negligible possibility that the IRS would disallow the Graevs’ contribution deduction and NAT would voluntarily remove the easement. We have found that there was. Mr. Graev evidently concluded that NAT’s promise should be believed; he took deliberate steps to obtain its promise; and his conclusion is evidence of what was likely. NAT made such promises to Mr. Graev and others precisely because it was soliciting contributions from within a community of potential donors, and the ability of such an organization to obtain solicitations might well be undermined if it got a reputation for failing to keep its promises. To decide that there was no non-negligible possibility that NAT would voluntarily extinguish the easement and return the cash would require us to find that, in order to induce Mr. Graev to make his contribution, NAT made cynical promises that it fully intended to break. Our record will not support such a finding; the stipulated evidence simply shows a non-profit organization going about accomplishing its purpose. If we speculate (without evidence) that NAT might have reneged on its promise, or even if we assume that NAT probably would have reneged on its promise, that still leaves us with at least a non-negligible possibility that NAT would have done what it said it would do. That possibility is fatal to the Graevs’ contribution deductions.

Turney P. Berry
Louisville, Kentucky

Leave a comment

The New Paradigm in Estate Planning

The New Paradigm in Estate Planning

Given how large the Applicable Exclusion Amount will be in the future, it becomes clear that increasingly the focus of estate planning will move away from avoiding the transfer tax, and more focused on the income tax.  Much of the estate planning analysis will be about measuring the transfer tax cost against the income tax savings of allowing the assets to be subject to Federal and state transfer taxes.

If we were to summarize what the new “paradigm” will be for estate planning in the future, it might look something like this:

Estate planning will be more complicated and nuanced than in the past.  Estate plans will vary significantly based upon many more variables like:

(1)  Time horizon of the client (typically measured with reference to life expectancy).

(2)  Spending and lifestyle of the client, including charitable giving.

(3)  Size of the gross estate.

(4)  Future return of the assets.

(5)  Tax nature of the types of assets (for example, to what extent will a “step-up” in basis benefit the client and other beneficiaries?).

(6)  Expected income tax realization of the assets (for example, when is it likely that the asset will be subject to a taxable disposition?)

(7)  State of residence of the client.

(8)  State of residence and marginal income tax bracket of the likely beneficiaries.

(9)  Expectations about future inflation.

Estate planners will seek to use as little of a client’s Applicable Exclusion Amount as possible during lifetime because it will represent an ever-growing amount that will be available at death to provide a “step-up” in basis with little or no transfer tax cost.  This conclusion assumes that “zeroed-out” estate planning techniques like installment sales to IDGTs and or “zeroed-out” grantor-retained annuity trusts[1] (“GRATs”) can effectively accomplish sufficient wealth transfer requiring the use of a significant portion of a client’s Applicable Exclusion Amount.  Wealth transfer is not accomplished when a taxpayer makes a gift and uses his or her Applicable Exclusion Amount toward that gift, unless the gift is of discounted assets.  There is wealth transfer only if and when the asset has a positive total return (income + appreciation).  An installment sale to an IDGT and a GRAT transfers wealth in the same manner as a gift, except that those techniques only transfer the total return above a certain rate, like the applicable Federal rate[2] (“AFR”) or the § 7520 rate.[3]

Estate planners will focus more of the tax planning for clients on the income tax, rather than the transfer taxes.  In particular, it is likely estate planning will focus on tax basis planning and maximizing the “step-up” in basis at death.

Because the “step-up” in basis may come at little or no transfer tax cost, estate planners will seek to force estate tax inclusion in the future.

The state of residence of the client and his or her beneficiaries will greatly impact the estate plan.  In other words, if a client is domiciled in California, and his or her beneficiaries living in California, then dying with the assets may be the extent of the tax planning.  On the other hand, if the beneficiaries live in a state like Texas that has no state income tax, then transferring the assets out of the estate during the lifetime of the client may be warranted.  As a result, estate planners will need to ask clients two questions that, in the past, did not significantly matter:

(1)  Where are you likely to be domiciled at your death?

(2)  Naturally, at your death, your children, grandchildren, and other beneficiaries will be lovingly at your bedside, but where are they likely to be domiciled then?

[1] Trust that provides the grantor with a “qualified annuity interest” under Treas. Reg. § 25.2702-3(b).

[2] § 1274.

[3] § 7520.

Leave a comment

Developments in Conservation Easement Deductions

No income tax deduction was allowed in B.V. Belk, Jr. v. Commissioner, 140 T.C. No. 1 (2013), because the taxpayer and the charity – the Smokey Mountain National Land Trust (SMNLT) – could change the land subject to the easement by substituting other land.  The easement stated:

3. Owner may substitute an area of land owned by Owner which is contiguous to the Conservation Area for an equal or lesser area of land comprising a portion of the Conservation Area, provided that:

a. In the opinion of Trust:

(1) the substitute property is of the same or better ecological stability as that found in the portion of the Conservation Area to be substituted;

(2) the substitution shall have no adverse effect on the conservation purposes of the Conservation Easement or on any of the significant environmental features of the Conservation Area described in the Baseline documentation;

(3) the portion of the Conservation Area to be substituted is selected, constructed and managed so as to have no adverse impact on the Conservation Area as a whole;

(4) the fair market value of Trust’s conservation easement interest in the substituted property, when subject to this Conservation Easement, is at least equal to or greater than the fair market value of the Conservation Easement portion of the Conservation Area to be substituted; and

(5) Owner has submitted to Trust sufficient documentation describing the proposed substitution and how such substitution meets the criteria set forth in subsections (1)-(4) above of this Section B.3.a. of this Article III.

b. Trust shall render an opinion upon a proposed substitution request of the Owner within sixty (60) days of receipt of notice. A favorable opinion of Trust shall not be unreasonably withheld. However, should Trust render an unfavorable opinion, Trust shall provide a written explanation to Owner as to the reasoning and facts used in reaching such opinion within ten (10) days of the decision. In addition, Trust will undertake a reasonable good faith effort to help Owner identify property for such trade in which Trust believes will meet the above requirements but also accomplish the Owner’s objectives.

c. No such substitution shall be final or binding upon Trust until made a subject of an amendment8 to this Conservation Easement acceptable to and executed by Owner and Trust and recorded in the Register of Deeds Office of Mecklenburg County and/or Union County. The amendment shall include, among other things, a revised Conservation Easement Plan or portion thereof showing the portions of the Conservation Area that are to be removed from the coverage of this Conservation Easement and the equal or greater area of contiguous land of the Owner to be made part of the Conservation Area, and thus, subject to the Conservation Easement.

The court held that such a clause meant the land was not held for conservation purposes in perpetuity.  That SMNLT had to approve the substitution did not save the deduction:

Petitioners argue it does not matter that the conservation easement agreement permits substitution because it permits only substitutions that will not harm the conservation purposes of the conservation easement. However, as discussed above, the section 170(h)(5) requirement that the conservation purpose be protected in perpetuity is separate and distinct from the section 170(h)(2)(C) requirement that there be real property subject to a use restriction in perpetuity. Satisfying section 170(h)(5) does not necessarily affect whether there is a qualified real property interest.20 Section 170(h)(2), as well as the corresponding regulations and the legislative history, when defining qualified real property interest does not mention conservation purpose. There is nothing to suggest that section 170(h)(2)(C) should be read to mean that the restriction granted on the use which may be made of the real property does not need to be in perpetuity if the conservation purpose is protected.

We find it is immaterial that SMNLT must approve the substitutions. There is nothing in the Code, the regulations, or the legislative history to suggest that section 170(h)(2)(C) is to be read to require that the interest in property donated be a restriction on the use of the real property granted in perpetuity unless the parties agree otherwise. The requirements of section 170(h) apply even if taxpayers and qualified organizations wish to agree otherwise.

We also find it immaterial that SMNLT cannot agree to an amendment that would result in the conservation easement’s failing to qualify as a qualified conservation contribution under section 170(h). The substitution provision states that a substitution is not final or binding on SMNLT until the conservation easement agreement is amended to reflect the substitution. We reject the argument that, because substitution is effected by amendment and the conservation easement agreement seemingly prohibits amendments not permitted by section 170(h), the conservation easement does not permit substitutions.

Upon petition for redetermination, the court rejected the claim that substitutions could occur under North Carolina law anyway:

Petitioners argue that in the absence of a substitution provision, State law would still permit petitioners and SMNLT to modify the terms of the contract by mutual agreement. Thus, because they could change what property was subject to the conservation easement agreement even if there was not a substitution provision, the Court cannot deny their deduction because it includes a substitution provision in the conservation easement agreement. Respondent disagrees, stating that “[p]etitioners’ interpretation of state law as giving parties unfettered ability to modify contracts is nonsensical and would make all conservation easements meaningless”.

Petitioners confuse their right under State law to modify the terms of a contract by mutual consent with the effect such a modification would have for tax purposes. Even if petitioners and SMNLT had the right to modify the terms of the conservation easement agreement under State law by mutual agreement, North Carolina law does not dictate the resulting tax consequences of the modification. Whatever modifications petitioners might have envisioned making to the conservation easement agreement after the fact are irrelevant in determining the tax consequences of those provisions that were, in fact, included.

T.C. Memo 2013-154.

In Scheidelman v. Commissioner (9th Cir. 2012), the Court reversed the Tax Court’s determination that a façade easement appraisal did not meet the regulatory requirements for a qualified appraisal, and that a cash payment to the easement organization was not deductible because the donor received consideration.  The opinion described the Tax Court decision as follows:

The Tax Court found that Scheidelman was ineligible for the deduction because the Drazner appraisal was not a “qualified appraisal”—a prerequisite for deducting a noncash charitable contribution—because it failed to state the method of valuation and the basis of valuation, as required by Treasury Regulation § 1.170A–13 (c)(2)(J) & (K). Scheidelman v. Comm’r, 100 T.C.M (CCH) 24, 2010 WL 2788205, at *8–9 (2010); see 26 U.S.C. § 170(f)(11)(A) & (C). The Tax Court therefore did not go on to determine the value of the easement de novo, which it would have done had it found that Scheidelman satisfied the prerequisites for claiming the deduction.

The Tax Court also rejected Scheidelman’s attempt to deduct her cash contribution to the Trust.1 Citing the principle that “a charitable gift or contribution must be a payment made for detached and disinterested motives,” Graham v. Comm’ r, 822 F.2d 844, 848 (9th Cir.1987), aff’d sub nom. Hernandez v. Comm’r, 490 U.S. 680, 109 S.Ct. 2136, 104 L.Ed.2d 766 (1989), it reasoned that Scheidelman had made the donation for the purpose of inducing the Trust to accept her easement so that she could enjoy a tax benefit. Scheidelman, 2010 WL 2788205, at *13.

With respect to the first issue the court stated:

The Tax Court concluded that there was no method of valuation because “the application of a percentage to the fair market value before conveyance of the facade easement, without explanation, cannot constitute a method of valuation.” Scheidelman, 2010 WL 2788205, at *9. We disagree. Drazner did in fact explain at some length how he arrived at his numbers. For the purpose of gauging compliance with the reporting requirement, it is irrelevant that the IRS believes the method employed was sloppy or inaccurate, or haphazardly applied—it remains a method, and Drazner described it. The regulation requires only that the appraiser identify the valuation method “used”; it does not require that the method adopted be reliable.6 By providing the information required by the regulation, Drazner enabled the IRS to evaluate his methodology.

* * *

The Commissioner may deem Drazner’s “reasoned analysis” unconvincing, but it is incontestably there. Treasury Regulations do provide substantive requirements for what a qualified appraisal must contain. Some would seem to be inapplicable, and others are expressly considered by Drazner. And of course, the Treasury Department can use the broad regulatory authority granted to it by the Internal Revenue Code to set stricter requirements for a qualified appraisal. Moreover, the Commissioner could review the Drazner appraisal in the context of a considerable body of data. Around the time Scheidelman was audited, the IRS had undertaken a project in which it reviewed about 700 facade conservation easements, about one-third of them all. See Internal Revenue Service Advisory Council 2009 General Report, available at http://www. irs.gov/taxpros/article/0,,id=215543,00.html.

In sum, the Drazner appraisal accomplishes the purpose of the reporting regulation: It provides the IRS with sufficient information to evaluate the claimed deduction and “deal more effectively with the prevalent use of overvaluations.” Hewitt v. Comm’r, 109 T.C. 258, 265, 1997 WL 668995 (1997), aff’d, 166 F.3d 332 (4th Cir .1998) (per curium).

Of interest is the court’s footnote 7 dealing with whether an “unreliable method” is a method at all:

Although one could argue that the IRS’s interpretation of its own regulations may be entitled to some deference under Auer v. Robbins, 519 U.S. 452, 461 (1997), the Commissioner failed to argue for such deference and we deem the argument forfeited.  See Robinson Knife, 600 F.3d at 134 n.11.  In any event, the Commissioner’s interpretation, that an unreliable method is no method at all, goes beyond the wording of the regulation, which imposes only a reporting requirement.

The court also held that receipt of a charitable deduction is not a benefit that disqualifies the deduction.  The opinion states:

Scheidelman’s cash payment was part of her donation to the Trust. She gave the Trust the easement to hold, she endowed the maintenance of it, and the whole was an unrequited contribution. Contributions toward operating expenditures are commonplace among entities like the Trust that hold and administer facade contribution easements. The National Park Service has explained that

Many easement holding organizations require the easement donor to make an additional donation of funds to help administer the easement. These funds are often held in an endowment that generates an annual income to pay for easement administration costs such as staff time and travel expenses, or needed legal services.

JA 232. Without some way of monitoring compliance, an easement of this kind is easily violated, withdrawn, or forgotten. When a cash contribution (even mandatory in nature) serves to fund the administration of another charitable donation, it is likewise an “unrequited gift.” Scheidelman received nothing in return for her cash donation and facade conservation easement. It is true the taxpayer hoped to obtain a charitable deduction for her gifts, but this would not come from the recipient of the gift. It would not be a quid pro quo. If the motivation to receive a tax benefit deprived a gift of its charitable nature under Section 170, virtually no charitable gifts would be deductible. See Mount Mercy Assocs. v. Comm’r, 67 T.C.M. (CCH) 2267, 1994 WL 53665, at *4 (1994).

Our conclusion is amply supported by Kaufman v. Commissioner, 136 T.C. 294, 2011 WL 1235307 (2011), which rejected the argument advanced here by the Commissioner, and held that a mandatory cash contribution was deductible:

Seeing no benefit to [the taxpayer] other than facilitation of her contribution of the facade easement . . . and an increased charitable contribution deduction, we shall not deny petitioners’ deduction of the cash payments on the ground that the application required a “donor endowment” to accompany the contribution of facade easement.

Id. at 319. We agree, and hold that the contribution was deductible.

On remand, the Tax Court found that the value of the deduction was zero.  T.C. Memo. 2013-18.  The court concluded that the easement did not reduce the value of the house.  Wisely the taxpayer had switched appraisers but did not hire one Judge Cohen found helpful:

Petitioners’ expert at trial was Michael Ehrmann, who also had the necessary qualifications to appraise the easement but made factual and calculation mistakes, some of which he admitted, that undermined the reliability of his report.

Ehrmann had prepared a market study for NAT’s [National Architectural Trust] counsel that was attached to his report in this case. The information that he relied on came from NAT through its counsel. He incorporated material recommended by NAT’s counsel, including earlier appraisals by his employer. Ehrmann admitted that his report did not accurately describe the easement, stating that his description was “a summary of my knowledge about the easement program that I’ve gotten over the years.” He relied on outdated information rather than contemporaneous inspection, used alleged comparables from outside the geographical area of petitioner’s property, and applied an unsupported and unrealistic adjustment to petitioner’s Brooklyn townhouse as compared to a detached house in Evanston, Illinois. His methodology is undermined by these errors. See Evans v. Commissioner, slip op. at 10.

Petitioners argue that Ehrmann’s appraisal should be accepted in part because it relied on “the cumulative results of MMJ’s ninety-one facade easement valuations”, which we reject as unpersuasive for the reasons that we reject the Drazner appraisal. Ehrmann ignored studies suggesting a contrary result and adopted those supporting his client’s desired value. Ehrmann’s testimony had all of the earmarks of overzealous advocacy in support of NAT’s marketing program and, indirectly, petitioner’s tax reporting. His conclusion that the easement should be valued at $150,000 is unpersuasive and not credible.

The IRS experts were judged helpful and were followed:

Respondent’s first valuation expert was Timothy Barnes. Barnes analyzed the terms of the easement, zoning laws, and regulations of the LPC [Landmark Preservation Committee] and concluded: “in highly desirable, sophisticated home markets like historic brownstone Brooklyn, the imposition of an easement, such as the one granted on June 23, 2004, is not a deterrent to the free trade of such properties at fully competitive prices and does not materially affect the value of the subject property.” Barnes researched the geographic area of petitioner’s property, contacting real estate brokers and valuation professionals in the Brooklyn market to determine whether the imposition of a facade easement affected the marketability of or ability to finance a townhouse within the Fort Greene Historic District. The “uniform response” was that such easements did not negatively affect buyer interest, marketing time, or financing. He explained during his testimony that the pool of prospective buyers within the five boroughs of New York City was a more reliable measure of market effect than analysis comparing communities outside of New York City, which is one of the reasons that Ehrmann’s report was not reliable. Barnes also opined that a difference between the controls available to LPC, which exercises a police power of the city, and NAT are the placement of the burden on the homeowner to go to court and seek an exception, in the first instance, and on the private party seeking to enforce the restriction to go to court, in the second.

Barnes also criticized Ehrmann’s calculations, his selection of comparables, and particularly his failure to account for differences in overall lot sizes and floor space of the allegedly comparable properties. Although petitioners claim that the errors should be disregarded as immaterial and that we should accept Ehrmann’s subjective judgments, we believe that Barnes’ reasoned judgments are more reliable.

Respondent also presented expert testimony by Stephen D. Dinklage, an engineer employed by the IRS, who used an alternative approach based on condemnation techniques and determined that the grant of the easement did not have a material effect on fair market value. Dinklage used market data to divide the value of the land from that of the building and then used a modified cost approach to isolate that portion of petitioner’s townhouse affected by the facade easement. He concluded that because only the facade was affected by the easement and the loss of utility was only to the facade, the restrictions would not have a material effect on the market value of the whole property. Dinklage reasoned that a hypothetical buyer would not pay less for the Vanderbilt property because it was already restricted by the LPC regulations and the easement did not make a difference. This conclusion is consistent with other evidence.

The taxpayer in Steve Rothman et ux. v. Commissioner, T.C. Memo. 2012-218 (2012) lost despite Scheidelman because, Judge Laro held, the defects in the Rothman appraisal were too numerous:

The cumulative effect of the defects discussed in Rothman, but not at issue in Scheidelman, deprives the Internal Revenue Service of sufficient information to evaluate the deductions claimed. The Rosado appraisal describes (and values) a property right different from the one petitioners contributed, and in doing so, fails to describe the easement accurately or in sufficient detail for a person unfamiliar with the property to ascertain whether the appraised property and the contributed property were one and the same. Rothman v. Commissioner, slip op. at 33-35. The Rosado appraisal does not disclose the terms of the agreement between NAT and petitioners because the appraisal attached two unexecuted deeds of easement that did not communicate the existence of the mortgages. Id., slip op. at 37-38. The mortgages alone may have caused the charitable contribution deductions to be disallowed, see id., slip op. at 11 n.7, and Mr. Rosado’s failure to disclose their existence inhibited respondent from evaluating the deductions claimed. Moreover, the Rosado appraisal values a property interest greater than the one petitioners contributed, id., slip op. at 27, 34, and it applies the wrong measure of value, id., slip op. at 40-41.

Against this backdrop, even when we view the Rosado appraisal in the light of the Court of Appeals’ decision in Scheidelman, we decline to conclude the Rosado appraisal is qualified for purposes of section 1.170A-13(c)(3), Income Tax Regs. As explained in Rothman v. Commissioner, slip op. at 28-44, the Rosado appraisal failed to satisfy 10 of 15 regulatory requirements, and following reconsideration, we conclude that the Rosado appraisal still fails to satisfy 8 of 15 requirements.2 We are hard pressed to change our view that an appraisal which fails the majority of the regulatory requirements is harmonious with the qualified appraisal regulation. For the foregoing reasons and because of the reasons stated in Rothman v. Commissioner, slip op. at 28-41, we reconfirm that the Rosado appraisal was not qualified.

To be clear, we have not denied and are not now denying petitioners’ claimed charitable contribution deduction for 2004 or the corresponding carryover for 2005. Whereas our ruling that petitioners failed to obtain a qualified appraisal generally leads towards a denial of those deductions, see sec. 170(f)(11)(A)(i), the deductions are not disallowed if the failure was due to reasonable cause and not to willful neglect, see sec. 170(f)(11)(A)(ii)(II). Whether petitioners acted with reasonable cause is, as we concluded in Rothman v. Commissioner, slip op. at 45-46, an issue that must be tried.

Turney P. Berry
Louisville, Kentucky

Leave a comment

Duty of Consistency: The relation of 2032A Special Use Valuation to Income Tax Basis

In Van Alen v. Commissioner, T.C. Memo. 2013-235, siblings inherited a cattle ranch from their father in 1994 which was valued under section 2032A.  Their step-mother was the father’s executor.  In 2007, the siblings sold a conservation easement on the property with the result that they recognized capital gain, at which point they argued that the estate had undervalued the property and their basis ought to be significantly higher than what was reported on the estate tax return.  The court rejected the siblings argument, holding that the general rule of section 1014(a)(1) did not apply but rather 1014(a)(3) applied.  This was important because 1014(a)(1) provides that basis is the fair market value of the property at the date of the decedent’s death whereas 1014(a)(3) provides that the basis for property valued under section 2032A is the value as determined under that section.  The court also noted that the special use valuation agreement had been signed by the siblings, although one, who was then a minor, by his mother as his guardian ad litem.  Finally, the court invoked the duty of consistency, which is usually thought to apply only when the executor and the beneficiary claiming a higher basis are identical, because the siblings benefitted from the lower value of section 2032A and had some involvement in the estate and audit, primarily by executing the special use valuation agreement.

The Obama Administration’s budget proposals include requiring basis to be based on transfer tax values.  Many times taxable estates are settled by trading increases in the value of some assets with decreases in the value of others, or by trading off valuation with other positions taken on the estate tax return.  Where the fiduciary and the beneficiary are identical it is fair and sensible to require consistency; in other instances, the fairness may not be clear and may put fiduciaries in a difficult position.  For example, suppose the IRS insists on certain upward adjustments on audit, but is agreeable to a discounted value on a particular asset that the executor knows is likely to be sold in the next few years by the recipient beneficiary.

Turney P. Berry
Louisville, Kentucky