Conrad Teitell
Conrad Teitell ()

What happened: Donor claimed $4.7 million in charitable deductions for conservation easement gifts.

The IRS disallowed the deductions: Donors lacked donative intent; failed to satisfy various reporting requirements; overvalued the donated property; and received return benefits in exchange for their gifts.

The IRS determined tax deficiencies totaling $1,500,377 for the years 2007 through 2011.

Penalties determined by the IRS: (1) accuracy-related penalties under IRC §6662(h), computed as 40 percent of the underpayments; and (2) in the alternative under IRC §6662(a), computed as 20 percent of the underpayments.

Tax Court holds: Donors are entitled to charitable deductions for their gifts, but smaller than claimed. And donors aren’t liable for accuracy-related penalties.

The IRS is presumed right rule: IRS determinations in a notice of deficiency are generally presumed correct, though the taxpayer can rebut this presumption. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace, and taxpayers generally bear the burden of proving their entitlement to the deductions claimed. INDOPCO v. Commissioner, 503 U.S. 79, 84 (1992).

Donors contended that the IRS bears the burden of proof: (1) they satisfied the requirements of IRC §7491(a) for shifting the burden of proof; and (2) the IRS raised a “new matter.” See Rule 142(a)(1). The Tax Court: “Because we decide all factual issues on a preponderance of the evidence, we need not decide who has the burden of proof.” See IRC §7491(a); Estate of Turner v. Commissioner, 138 T.C. 306, 309 (2012).

The IRS’s Hail Mary pass that the donors lacked donative intent is of special interest. The IRS contended that donors’ charitable deductions should be entirely denied on the theory that donors lacked donative intent and/or failed to satisfy statutory and regulatory reporting requirements.

The IRS’s in any event position: Donors deductions should be reduced substantially because they overvalued the donated property and/or received a return benefit that partially offsets the value of their gifts.

Tax Court on donative intent: “The sine qua non of a charitable contribution is a transfer of money or property without adequate consideration.” United States v. Am. Bar Endowment, 477 U.S. 105, 118 (1986). “If a transaction with a charity ‘is structured as a quid pro quo exchange’—i.e., if the taxpayer receives from the charity property or services equal in value to what he conveyed—there is no ‘contribution or gift’ within the meaning of the statute. Hernandez v. Commissioner, 490 U.S. 680, 701-02 (1989).”

More on donative intent—Tax Court:

In assessing whether a transaction constitutes a quid pro quo exchange, we give most weight to the external features of the transaction, avoiding imprecise inquiries into taxpayers’ subjective motivations. See Hernandez, 490 U.S. at 690-691; Christiansen v. Commissioner, 843 F.2d 418, 420 (10th Cir. 1988). If it is understood that the property will not pass to the charitable recipient unless the taxpayer receives a specific benefit, and if the taxpayer cannot garner that benefit unless he makes the required ‘contribution,’ the transfer does not qualify the taxpayer for a deduction under section 170. Costello v. Commissioner, T.C. Memo. 2015-87; see Christiansen, 843 F.2d at 420-421; Graham v. Commissioner, 822 F.2d 844, 849 (9th Cir. 1987), aff’g 83 T.C. 575 (1984), aff’d sub nom. Hernandez v. Commissioner, 490 U.S. 680.

Tax Court determines:

The external features of the transactions at issue show that [donors'] gifts were not part of a “quid pro quo exchange.” [Donors'] conveyed a fee simple interest in Parcel A to [charity] on January 24, 2007. This was an outright gift that [donors] could not claw back. Their conveyance of Parcel A was not conditioned on [charity's] provision of any return benefit, and [charity] in fact supplied [donors'] with no return benefit.

The same is true of [donors'] conveyance to the Township, on July 10, 2007, of a conservation easement over Parcel B. [Donors] retained the right to make improvements to their 2-acre residential envelope; their gift took the form of an easement over the remaining 23 acres. That gift was made with no strings attached. The grant of the easement was not conditioned on the Township’s provision of any return benefit, nor was it made in the expectation that the Township would supply a return benefit.

In urging that there was a “quid pro quo exchange,” [IRS] focuses chiefly, not on any specific benefit [donors] received, but on their supposed ability to steer the entire set of transactions in a way that benefitted them. In [IRS's] view, [donors] were motivated by a desire to protect their privacy and to prevent suburban development from spoiling the attractive views from their residence. Noting that [donors] were involved in the negotiations from the outset, [IRS] surmises that the Township and [charity], if not ceding [donors] actual control, allowed them to guide the transactions in a direction that achieved their personal goals.

Tax Court concludes:

In deciding whether [donors] had the requisite donative intent, we look to the external features of the transaction to ascertain whether they expected to receive a quid pro quo that canceled out their charitable gifts. We do not find the expectation of any such quid pro quo. Whenever a homeowner places a conservation easement over his property, or a neighbor places a conservation easement over neighboring property, the homeowner in a sense “benefits” by having natural landscapes rather than suburban sprawl in his immediate surroundings. When the Township approved a conservation subdivision on the Rorer Tract, [donors] may be said to have “benefitted” because the Rorer Tract surrounded their property. But [donors] were mere incidental beneficiaries of this action. [Charity] and the Township executed these transactions not to benefit [donors] or the Creeks Bend homeowners but to accomplish their charitable purposes of conserving rural and agricultural land. See McLennan v. United States, 24 Cl. Ct. 102, 107 (1991) (upholding charitable contribution deduction where “[a]ny benefit which inured to *** [the taxpayer] from the conveyance was merely incidental to an important, public spirited, charitable purpose”), aff’d 994 F.2d 839 (Fed. Cir. 1993).

The court allowed a charitable deduction for an amount smack in the middle of that claimed by donors and the IRS’s valuation.

Tax Court’s primer on valuation:

We typically consider one or more of three approaches to determine fair market value: (1) the market approach, (2) the income approach, and (3) the asset-based approach. Bank One v. Commissioner, 120 T.C. 174, 306 (2003), aff’d in part, vacated in part, and remanded on another issue sub nom. J.P. Morgan Chase & Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006). Determining which method to apply presents a question of law. See Chapman Glen Ltd., 140 T.C. at 325-326. Here, all three expert witnesses agreed that the market approach supplies the appropriate methodology, and we concur in that assessment.

The market approach—sometimes called the “sales comparison” approach—is normally used to value residential property. It values the subject property by reference to the prices paid for similar properties that were sold near the valuation date.

Tax Court on penalties:

The IRS bears the burden of production with respect to the liability of an individual for any penalty. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). If the Rule 155 computations show a substantial understatement of income tax for any of the five years at issue, respondent will have carried his burden of production under section 6662(b)(2) for that year. See Cooper v. Commissioner, 143 T.C. 194 (2014) … .

A taxpayer must meet additional requirements in order to raise a “good faith” defense to the substantial overvaluation penalty. “[W]ith respect to charitable deduction property,” this defense may be raised only if the value claimed on the return “was based on a qualified appraisal made by a qualified appraiser” and if, “in addition to obtaining such appraisal, the taxpayer made a good-faith investigation of the value of the contributed property.” Sec. 6664(c)(3).

We conclude that [donors] are not liable for any penalty. Regarding the negligence and substantial understatement penalties, we find that they relied in good faith on the appraisals performed by Mr. Quinn and on the advice of the tax return preparer who had competently represented them for many years … .

Regarding the penalty for substantial valuation misstatement, we find that [donors] satisfied the additional tests that are prerequisite to raising the “good faith” defense.

McGrady, T.C. Memo, 2016-233