Despite “strong evidence” of negligence, a state appeals court held yesterday that an attorney representing the seller in a real estate transaction did not commit legal malpractice because his former clients failed to show that deficiencies in his performance cost them a $5.1 million tax break.

In scrutinizing a 2007 deal for the $10.2 million sale of 496 Broadway in Manhattan, a 4-1 majority of the Appellate Division, First Department, faulted Howard Stern of White Plains for telling his clients he was not qualified to handle the tax arrangement they had in mind, but nonetheless represented them in the transaction.

But the majority said Stern’s former clients—a real estate holding corporation called Wo Yee Hing Realty—failed to show that Stern’s alleged negligence caused the corporation to miss out on the deferral of $5.1 million in taxes and to incur an immediate liability.

At issue was a projected “like-kind exchange” allowing the deferral of capital gains taxes on the sale of real property if the seller can buy another like-kind property. The arrangement, under Internal Revenue Code 26 USC §1031, requires, among other thing, closing on the replacement property within 180 days of selling the initial property.

Another requirement is that a “qualified intermediary” hold the sale proceeds while the replacement property is obtained.

Justice David Saxe (See Profile), writing for the majority in Wo Yee Hing Realty v. Stern, 115517/07, said the plaintiff failed to show it was poised to buy another property within the mandated 180 days, stating the corporation “failed to demonstrate the existence of a material issue of fact as to a causal link between its inability to effect a 1031 exchange and defendant’s alleged negligence.”

But Justice Leland DeGrasse (See Profile), in a dissent, said cause had been established when sale proceeds went to the plaintiff under Stern’s watch instead of a requisite qualified intermediary.

“The opportunity for a like-kind exchange was irretrievably lost once plaintiff received the proceeds of the sale,” DeGrasse wrote.

Saxe rebutted DeGrasse writing that “it is also clear that plaintiff had failed to satisfy all the other elements required for the successful completion of other such an exchange, and that the failure to meet those requirements is not attributable to defendant’s alleged negligence.”

The ruling affirms the summary judgment dismissal granted by Acting Supreme Court Justice Debra James (See Profile) in 2011.

Justices John Sweeny Jr. (See Profile), Dianne Renwick (See Profile) and Rosalyn Richter (See Profile) joined the majority. The case was argued on Feb. 15.

Stern served as the administrator of legal services plan for landlords through the Rent Stabilization Association. In 2006, one of Wo Yee Hing’s principals asked Stern for legal services, including the sale of a SoHo building.

The corporation maintains Stern “held himself out as knowledgeable” in 1031 exchanges. But Stern said he “had no expertise or experience” structuring the transaction to accommodate the exchange.

During a subsequent meeting after getting an offer from a buyer, one the plaintiff’s principals remembered insisting on making the deal “a 1031 sale,” though he “did not really know what that meant.” Stern allegedly assured that “he would write the proper clause in the contract.”

But Stern recalled that at the meeting he had said he lacked the “requisite experience” to handle the like-kind exchange aspect and recommended a joint call with the principals’ accountant to discuss the matter.

During the closing, the principals said Stern insisted on having the checks made payable to plaintiffs for the like-kind exchange.

Stern said it was the principals who insisted on the payment going to the real estate corporation, over concerns from him and the buyer’s attorney about the funds going to the corporation.

Stern subsequently learned the transaction would have to be redone, and the corporation retained another counsel. It did not try re-doing the transaction.

When searching for a replacement property, one of the Wo Yee Hing principals said he reached a “verbal…understanding” to buy a building at 35 W. 36th St. for $31.5 million.

Although the principal said the broker gave him a contract, the decision notes there was no contract of sale or other documentation on the purported agreement.

According to the decision, the 36th Street building owner said the corporation’s offer was not sufficient and “never materialized.”

Saxe observed the case hinged on whether the corporation took “requisite actions to identify and purchase a suitable replacement property in the required time frame.”

Saxe said the majority was not suggesting the corporation had to demonstrate the purchase of a property without the exchange or that it “make the futile gesture of identifying the definitive replacement property.”

“We merely hold that plaintiff had the burden of presenting some evidence that it could have completed a like-kind exchange had defendant advised it properly. It needed only to identify the proposed replacement property and show that it would have been able to purchase that property using the like-kind exchange procedure if the matter had been properly handled,” he wrote, saying the plaintiff failed to find any property it could buy before the deadline.

Saxe said the corporation could not show it could have made the deal on the 36th Street property, noting it had proceeds of $10.2 million and the asking price was $31.5 million.

Moreover, the majority noted a bank officer had testified to only having had “preliminary conversations” with the plaintiff about financing.

But DeGrasse said the majority “dwell[ed] unnecessarily” on whether the corporation had the means to acquire another property.

He also called the majority’s holding “unrealistic,” saying it was demanding that a seller obtain “a virtual mortgage commitment without showing a prospective lender an executed purchase agreement for a new property.”

Saxe said the majority was not calling for a “virtual mortgage,” but he said “lending institutions may give a preliminary indication of whether a loan applicant would be eligible for a loan.”

Wo Yee Hing Realty was represented by Drabkin & Margulies.

Ralph Drabkin said no decision had been made on whether to appeal.

He said the dissent “outlined all the arguments we presented” and added that “this decision puts an undue burden on clients who seek the advice of attorneys and expertise of attorneys.”

Caitlin Robin of Drabkin & Margulies argued the case for Wo Yee Hing Realty.

Tracy Peterson of Braverman & Associates represented Stern.

“We believe the majority got it right and the lower court got it right that without the demonstration of proximate cause there is no legal malpractice,” she said.

Peterson said Stern had made it clear from the start that the corporation had to handle the like-kind aspect and he was “acting more as a scrivener than an attorney by inserting the requested language regarding the parties’ intent with respect to Section 1031″ in the contract of sale.

Stern could not be reached for comment.