C applies strict reasonable cause test on penalty for overvalued facade easement
Whitehouse Hotel Limited Partnership, QHR Holding-New Orleans, LTD., Tax Matters Partner, (2012) 139 TC No. 13
In a recent decision, the Tax Court, on remand from the Fifth Circuit Court of Appeals, has reaffirmed its decision that a realty limited partnership overstated its charitable contribution deduction for a contribution of a facade easement on a historic structure and that the overstatement was a gross valuation misstatement. The Court further held that the Code Sec. 6664(c) reasonable cause exception to the accuracy-related penalty didn't apply, despite the taxpayer having followed the advice of both accountants and attorneys, because of the partnership's failure to make a good faith investigation of the value of contribution.
Background. Under Code Sec. 6662(a), an accuracy-related penalty equal to 20% of the portion of any underpayment of tax required to be shown on a return applies to, among other items, any substantial valuation misstatement under subtitle A, chapter 1, of the Code. The penalty is increased to 40% in the case of a gross valuation misstatement under that chapter. For the years at issue in the case, a substantial valuation misstatement existed if the value of any property claimed on the return was 200% or more of the amount determined to be the correct amount. A gross valuation misstatement existed if the claimed value was 400% or more of the value determined to be the correct amount. (Code Sec. 6662(h)(2)(A)(i)) The applicability of the penalty (except for partner-level defenses) is determined at the partnership level. (Reg. § 301.6221-1(c))
Under the reasonable cause exception in Code Sec. 6664(c), the underpayment penalty doesn't apply for valuation overstatements if the taxpayer can show (1) that the claimed value of the property was based on a qualified appraisal made by a qualified appraiser, and (2) in addition to obtaining such an appraisal, the taxpayer made a good faith investigation of the value of the contributed property. (Reg. § 1.6664-4(h)(3)) These determinations are made at the partnership level.
Facts. From '95 to '97, Whitehouse Hotel Limited Partnership (Whitehouse) spent a total of $13.4 million to assemble a New Orleans parcel of property containing historic structures. The contiguous buildings at issue were the Maison Blanche structure and the Kress structure. Late in '97, Whitehouse donated a facade easement to the Maison Blanche structure to a Louisiana nonprofit corporation called the Preservation Alliance of New Orleans. Whitehouse promised to keep the building facade in good repair and to do nothing to the facade to alter its appearance. Because of the nature of the Maison Blanche easement, Whitehouse was prevented from building on top of the Kress building. The day after the easement donation, Whitehouse converted the Maison Blanche and Kress buildings into a single, indivisible condominium unit. Subsequently, the buildings were renovated and turned into first-class hotel space.
On its '97 Form 1065, Whitehouse claimed a charitable contribution deduction of $7.445 million for the gift of the facade. It attached Form 8283, Noncash Charitable Contributions, signed by its appraiser. On audit of the return, IRS said the value of the gift was only $1.15 million and also determined that a Code Sec. 6662(a) accuracy-related penalty applied.
In the original decision, the Tax Court agreed with IRS. (Whitehouse Hotel Limited Partnership, QHR Holding-New Orleans, LTD., Tax Matters Partner, 131 TC 112; see Weekly Alert ¶ 3 11/06/2008). Since Whitehouse overstated the value of the easement on its '97 Form 1065 by more than 415%, the Tax Court held that it made a gross valuation misstatement. It concluded that Whitehouse owed an accuracy-related penalty under Code Sec. 6662(a). The Court also found that the reasonable-cause-and-good-faith exception didn't apply.
Appellate decision. The Fifth Circuit ruled that the Tax Court erred in its determination with regard to the easement's value. In making this valuation, on remand, the Tax Court was to reconsider the experts' reports and valuation methods and its conclusions regarding highest and best use as a luxury or non-luxury hotel. It also told the Tax Court to reconsider, if necessary, its penalty determination. In particular, the Fifth Circuit said that given that Whitehouse offered proof that it relied on its accountants' and attorneys' opinions for its appraisal, a possible issue on remand was whether Whitehouse needed to prove more to show reasonable cause. (Whitehouse Hotel Limited Partnership, QHR Holding-New Orleans, LTD., Tax Matters Partner, (CA 5 8/10/2010) 106 AFTR 2d 2010-5759; see Weekly Alert ¶ 3 08/19/2010)
Remanded Tax Court decision. While noting that IRS conceded that the partnership satisfied the qualified-appraisal requirement, the Tax Court found that Whitehouse failed to prove that it made a good-faith investigation of the value of the easement. It therefore failed to satisfy the conditions of Code Sec. 6664(c)(2) for the reasonable-cause-and-good-faith exception in Code Sec. 6664(c)(1). Further, Whitehouse failed to show that in relying on its expert's appraisal, the partnership had reasonable cause for, and it acted in good faith with respect to, the underpayment in tax resulting from its gross misstatement of the value of the easement.
The Tax Court rejected Whitehouse's contention that by retaining and relying on the advice of qualified professionals, it demonstrated that it exercised ordinary business care and prudence in attempting to value the charitable donation and should—without any further showing—be considered to have satisfied the requirements of Code Sec. 6664(c)(2). The Court found that the requirement of the statute was plain. Besides obtaining and relying on a qualified appraisal by a qualified appraiser, the taxpayer must make a good faith investigation of the value of the contributed property.
To qualify for the reasonable-cause-and-good-faith exception, the Tax Court determined that Whitehouse must prove both that (1) before claiming a $7.445 million charitable contribution deduction on its '97 Form 1065, the partnership in good faith investigated the value of the easement's restriction; and (2) it had reasonable cause for, and it acted in good faith with respect to, the resulting underpayment in tax.
For the good-faith-investigation requirement to have any meaning, Whitehouse must show how in good faith the partnership's partners or its advisers could have believed that a $7.445 million charitable contribution deduction was reasonable beyond simply being the amount determined in the appraisal. However, there was no testimony reconciling the $7.445 million deduction (i.e., the value of the easement's restriction) with the approximately $9 million that, less than three years earlier, the partnership paid for the building (an 83% reduction in value). Nor was there any testimony on any inquiry as to the appraiser's assumption in valuing the easement's restriction that, over less than three years, the building had appreciated in value by approximately 970%. The Court reasoned that Whitehouse's failure to provide evidence that anyone considered these points is indicative that, aside from obtaining the appraisal, no one made a good-faith investigation of the value of the easement's restriction.
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