Brooks v. Comm’r

The IRS (respondent) issued a notice of deficiency to Kenneth M. Brooks and Anita Wolke Brooks (petitioners) in which the respondent disallowed carryover charitable contribution deductions relating to the petitioners’ interest in the Kenneth Brooks and Anita Wolke Brooks Family LLC’s noncash charitable contribution of a conservation easement. The questions were whether they were entitled to the carryover charitable deductions and whether they were liable for the accuracy-related penalties.

Findings of fact.

Easement deed and attachments. The Family LLC granted and recorded a conservation easement over a 41.201-acre parcel in 2007 to Liberty County, Ga. The deed provided, in part, for “$10.00 and other good and valuable consideration.” The easement granted an easement in perpetuity. No other consideration paid from Liberty County was referred to in the deed. The easement deed placed a number of restrictions on the use of the property (relating primarily to conservation). The easement deed did not state that it constituted the entire agreement between the parties. Exhibit B to the deed was a baseline report providing detailed information on the features of the property.

The property including the easement was called Cotton Row Farm, which was surrounded at least in part by Hampton Island Preserve, a portion of which was zoned as a PUD. As of the date the easement was granted, 36 lots and seven farm properties were sold in Hampton Island Preserve, but only two lots were developed with homes. Cotton Row Farm was mostly wooded. “The public road is accessed via an ingress and egress easement over private property owned by an unrelated party.”

Charitable contribution deduction claimed. For the 2007 tax year, the LLC claimed a charitable contribution deduction of $5,100,000. An appraisal Form 8283 and an appraisal were attached to the Form 1065. The $1,350,000 cost basis for the entire 85-acre parcel instead of the 41-acre easement was mistakenly reported instead of only the cost of the easement portion. “Petitioners claimed a deduction of $748,702 on their Form 1040X, Amended U.S. Individual Income Tax Return, for the 2007 taxable year resulting from their interest in the LLC’s contribution deduction and carried forward the remaining deduction of $4,351,298 to future tax years.” The carryover deductions for 2010, 2011, and 2012 were the subject of this case.

Expert valuations.

Experts from both sides determined the value of the easement by deducting the value of Cotton Row Farm after the easement from the value before the granting of the easement. Both determined the highest and best use as residential subdivision and development. The petitioners’ expert, Mr. Miller, used the income approach to determine the value of the development. Details of his methodology and assumptions were outlined in the opinion. Miller’s analysis relied entirely on the development of the LLCs property. Miller mischaracterized the zoning. He looked at “comparable lots” and made six adjustments, one downward, two not noted, and the remainder were positive. To determine the value of Cotton Row Farm after the encumbrance of the easement, he again used the income approach. He determined a value of the whole property after the easement of $4,030,000.

The respondent’s expert, Mr. Petkovich, considered rezoning of the properties but concluded that sales of undeveloped properties was the most accurate method of valuation. “Mr. Petkovich has experience relying on the reasonably probable legal permissibility of a potential highest and best use to appraise property using reasonably probable facts.” He considered that there was no frontage access to the property. He also concluded that rezoning was feasible to provide a certain premium. He determined the value of Cotton Row Farm before the easement at $1,400,000. He determined a value after the easement of $940,000 for the unencumbered parcel. Thus, he concluded the value of the easement at $470,000.

Notice of deficiency and trial.

In addition to the disallowance of the charitable contributions and some other issues, the IRS also determined 40% accuracy-related penalties (section 6662(h)). The petitioners rejected the introduction of the 14-day rule form noticing the penalties. The taxpayer must substantiate the contribution by a contemporaneous written acknowledgement (CWA) from the donee. The deed itself may satisfy the CWA requirement, but the deed “taken as a whole” must prove compliance with the pertinent section(s) of IRC Section 170. Here, the easement deed did not meet the section 170 requirements and thus did not serve as the CWA requirement. Further, no other documents in the record would satisfy the CWA requirement, and, thus, the contribution deductions must be disallowed “as a matter of law.” In addition, “[t]he deficiencies in the Baseline Report undermine the protection of the conservation interests associated with the encumbered parcel and cannot be said to comply with the regulation’s requirements. Accordingly, this is also a basis on which petitioners’ LLC’s claimed deduction must be disallowed.”

The petitioners also reported in the “baseline report” for the appraisal the full cost of the entire property and not just the portion related to the easement. “Accordingly, petitioners failed to meet the requirements of Treasury Regulation § 1.170A-13(c)(2)(i), and this is also a basis on which the deduction must be disallowed.”

Penalties.

As noted, accuracy-related penalties were assessed for each of the three years. The commissioner bore the burden of “production” with respect to the liability of the taxpayers for these penalties.

The respondent’s burden of production.

The petitioners contended that, since the IRS violated the 14-day notice rule, it prevented them from producing a defense for the burden of production and accepting the approval form would result in imposition of the penalties without following required procedures. However, “this Court has routinely found that reopening the record to admit the Civil Penalty Approval Form into evidence serves the interest of justice and is not prejudicial.” The court determined that the respondent had met his burden and the Approval Form will be admitted into evidence.

Gross valuation misstatement.

In the instant case, the value of the conservation easement was “the fair market value of the perpetual conservation restriction at the time of the contribution.” Treas. Reg. § 1.170A-14(h)(3)(i). The respondent must show that the petitioners’ valuation of the easement was 200% or more of the correct valuation. The petitioners claimed a value of $5,100,000 on the return, so the correct value must be at least $2,550,000. The petitioners now contend the value of the easement was $3,630,000, and the respondent contended it was $470,000. Here, the FMV of the easement was equal to the difference between the FMV of the property that the easement encumbers before the easement and after the easement. The FMV must take into account not only the current use of the property, “but also an objective assessment of how immediate or remote the likelihood is that the property, absent the restriction, would in fact be developed.”

The court, here, agreed with Petkovitch that the value of the property before the easement was $1,400,000 and that the income approach was too speculative to use in this case. Miller, who used the income approach, had errors in his calculations significantly increasing his value, and the court agreed with the respondent that Miller’s value appeared incredible as a practical matter. The court determined that the easement had a value of $470,000 and the petitioners were liable for a 40% accuracy-related penalty. Decision was entered for the respondent.

Editor’s note: Compare and contrast this case with Champions Retreat Golf Founders, LLC v. Comm’r, T.C. Memo 2022-106; 2022 Tax Ct. Memo LEXIS 108, which is also included in the BVLaw database.