Kaufman v. Shulman

• Decision Date: 19 July 2012
• Docket Number: 11–2022.,Nos. 11–2017,s. 11–2017
• Citation: 687 F.3d 21,110 A.F.T.R.2d 2012
• Parties: Gordon KAUFMAN; Lorna Kaufman, Petitioners, Appellants/Cross–Appellees, v. Douglas SHULMAN, Commissioner of Internal Revenue, Respondent, Appellee/Cross–Appellant.
• Court: U.S. Court of Appeals — First Circuit

687 F.3d 21

110 A.F.T.R.2d 2012-5278

Gordon KAUFMAN; Lorna Kaufman, Petitioners, Appellants/Cross–Appellees,

v.Douglas SHULMAN, Commissioner of Internal Revenue, Respondent, Appellee/Cross–Appellant.

Nos. 11–2017, 11–2022.

United States Court of Appeals, First Circuit.

Heard May 7, 2012.

Decided July 19, 2012.

Catherine M.A. Carroll with whom Seth P. Waxman, Thomas R. Dettore and Wilmer Cutler Pickering Hale and Dorr LLP were on brief for petitioners, appellants/cross-appellees.

Rebecca K. Troth, David R. Hill, Ryan C. Morris, Sidley Austin LLP, Paul W. Edmondson, Elizabeth S. Merritt and Ross M. Bradford, National Trust for Historic Preservation, on brief for the National Trust for Historic Preservation, Amicus Curiae.

Patrick J. Urda, Tax Division, Department of Justice, with whom Tamara W. Ashford, Deputy Assistant Attorney General, and Kenneth L. Greene, Tax Division, Department of Justice, were on brief for respondent, appellee/cross-appellant.

Before LYNCH, Chief Judge, BOUDIN and LIPEZ, Circuit Judges.

BOUDIN, Circuit Judge.

This case comprises appeals by both sides—the Commissioner of Internal Revenue (“the IRS”) and the taxpayers Gordon and Lorna Kaufman—from a decision of the Tax Court. The subject is deductions on the couple's joint returns of the asserted value of Lorna Kaufman's donation to the National Architectural Trust of a façade easement restricting alterations on her Boston house. A brief description of the background events and proceedings follows, which is elaborated where necessary later in this decision.

In 1999, Lorna Kaufman bought for $1,050,000 a row house in the South End of Boston, an area (not to be confused with South Boston), which is subject to local restrictions aimed at historic preservation.¹ The row house, 19 Rutland Square, was designed by physician Elbridge Dudleyand built between 1859 and 1861; it reflected popular mid-nineteenth-century architectural trends but also featured a Venetian Gothic-style façade that distinguished it from redbrick row houses elsewhere in the South End.

The Kaufmans renovated the house, which included the restoration of original details of the façade. In 2003, the couple learned about a tax incentive program for historic preservation, promoted in this instance by an organization then known as the National Architectural Trust, since renamed the Trust for Architectural Easements. A Trust representative advised the Kaufmans that the Trust could help the couple qualify for a tax deduction equal to 10 to 15 percent of the fair market value of their home and that the Trust “as part of our service ... will be handling all the red tape and paperwork.”

A provision of the Internal Revenue Code, 26 U.S.C. § 170(h) (2006), creates an incentive for taxpayers to donate real property interests to nonprofit organizations and government entities for “conservation purposes.” Adopted in 1976 and amended the following year, the statute allows taxpayers to claim a deduction for donating a real property interest—including an easement—“exclusively for conservation purposes.” Tax Reform Act of 1976, Pub.L. No. 94–455, § 2124(e)(1)(C), 90 Stat. 1520, 1919 (1976); see also Tax Reduction and Simplification Act of 1977, Pub.L. No. 95–30, § 309(a), 91 Stat. 126, 154 (amending statute); 26 U.S.C. § 170(h)(1)-(2) (current codification). These purposes include the preservation of “historically important” land areas or structures. Pub.L. No. 94–455, § 2124(e)(1)(D), 90 Stat. at 1919; see also26 U.S.C. § 170(h)(4)(A)(iv) (current codification). Cf.26 U.S.C. § 170(f)(3)(B)(iii) (exempting “qualified conservation contributions” from general denial of deduction for donations of partial interests in property).

The deduction for granting the easement is intended to reflect the value of what the taxpayer has donated which, in the absence of a “market” for such easements, can be measured by “the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the restriction.” 26 C.F.R. § 1.170A–14(h)(3)(i) (2004). A central condition of the deduction, reflecting a change made in the 1977 amendment to the statute, is that the lease, option or easement be granted “in perpetuity.” Pub.L. No. 95–30, § 309(a), 91 Stat. at 154 (codified as amended at 26 U.S.C. § 170(h)(2)(C)).

On or about October 31, 2003, Lorna Kaufman submitted an application on the Trust's own form and made a $1,000 “good faith deposit”; she further agreed, as specified by the Trust, to make a “cash endowment contribution” to the Trust equal to 10 percent of the value of the ultimate deduction for the easement. This is at least one means by which the Trust finances its work. The deposit was to be returned if the “the necessary approvals cannot be obtained” and the cash endowment contribution reduced in part if the easement donation could not be processed in time to qualify for a 2003 deduction.

The Trust advised Lorna Kaufman that if her property was under mortgage, she needed to obtain consent from the mortgagee to subordinate its interest in the property to the easement. Accordingly, the Kaufmans sent a letter to their mortgage lender, Washington Mutual Bank, asking it to subordinate its rights to the easement being granted to the Trust. The letter stated that restrictions on the property imposed by the easement were “essentially the same restrictions as those imposed by current local ordinances that govern this property.” If this were so, the bank would lose little or nothing by consenting.

On December 22, 2003, Lorna Kaufman executed a Preservation Restriction Agreement supplied by the Trust and, a few days later, sent it back to the Trust together with a further contribution that the Trust had solicited in the amount of $15,840 (over and above her earlier $1,000 good-faith deposit). This further contribution, the Trust said, could be adjusted dependent on the appraised value of the easement.²

The Trust also offered the names of two recommended appraisers, and the Kaufmans selected one of the two, Timothy Hanlon, a certified appraiser who for the previous nineteen years had managed his own residential appraisal company. Hanlon inspected the 19 Rutland Square property in January 2004 and submitted his report on January 30, estimating that the fair market value of the donated easement was $220,800. Gordon Kaufman expressed concern that the reduction in the value of the property due to the easement might be “so large as to overwhelm the tax savings that accrue from it,” but a representative of the Trust sought to reassure him that it was “very unlikely” that the easement would affect the marketability of the property.

Meanwhile, the Kaufmans successfully secured consent from their lender, Washington Mutual, to an agreement “subordinating [the bank's] rights in the [19 Rutland Square] Property to the right of the Grantee [i.e., the Trust], its successors or assigns, to enforce the conservation and historic preservation purposes of [the Preservation Restriction] Agreement in perpetuity.” The lender agreement included several stipulations, one of which would become relevant in the subsequent litigation:

The Mortgagee/Lender and its assignees shall have a prior claim to all insurance proceeds as a result of any casualty, hazard or accident occurring to or about the Property and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged, notwithstanding that the Mortgage is subordinate in priority to the [Preservation Restriction] Agreement.

On their joint return for 2003, the Kaufmans claimed (1) a cash contribution of $16,870 to the Trust (the correct figure would have been $16,840, see note 2, above, but the Kaufmans attribute the discrepancy to a “typographical error”), and (2) a noncash contribution of $220,800 for the easement donation. They sought the $16,870 cash-contribution deduction on their 2003 returns and, in light of statutory limits on deductions in a single year, 26 U.S.C. § 170(b)(1)(E), spread the deduction for the noncash contribution across their 2003 and 2004 returns. The Kaufmans claimed an additional $3,032 cash contribution to the Trust in 2004.

In March 2007, evidently as part of a wide-ranging investigation into perceived abuses of the easement program, the IRS opened an investigation into the Kaufmans' claimed charitable deductions. On May 5, 2009, the IRS sent a “Notice of Deficiency” to the Kaufmans relating to the 2003 and 2004 tax years. In the Notice, the Service cited three grounds for disallowing the Kaufmans' noncash contribution claim:

— the Kaufmans had failed to “establish[ ] that all of the requirements of I.R.C. section 170 and all of the regulations thereunder have been satisfied”;

— the contribution “was made subject to subsequent event(s)”; and

— as an “alternative[ ]” ground, “it has not been established that the value of the contributed property interest was $220,800.”

The IRS also disallowed the Kaufmans' claimed cash contribution of $16,870 to the Trust for 2003 “because it was made subject to or in contemplation of subsequent event(s)” and calculated that the Kaufmans owed an additional $39,081.25 for 2003 and an additional $36,340.00 for 2004. It also imposed large penalties for underpayment. The Kaufmans petitioned for review by the Tax Court. See26 U.S.C. § 6213(a) (authorizing petition to the Tax Court for redetermination of deficiency); id. § 7442 (Tax Court jurisdiction).

On an IRS motion for summary judgment, the Tax Court on April 26, 2010, disallowed any deduction for the easement but found “genuine issues of material fact” remained with regard to the cash contribution deduction and the IRS's imposition of penalties. Kaufman v. Comm'r ( Kaufman I ), 134 T.C. 182 (2010). In a second decision after a trial on the reserved issues, the Tax Court on April 4, 2011, reaffirmed its ruling on the easement, but held that the Kaufmans...