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November 4, 2009
Easement Audit Nightmare
After being audited by the IRS in 2006 for the easement deduction we took in 2004, we were just handed a bill by the IRS for $145,000. We plan to fight the IRS and want to know if anyone else is on our position. Our brownstone (which we have since sold) is in Fort Greene, it was appraised for 1.2 million in 2004, and we deducted @ 90,000 over the next three years. The bill the IRS sacked us with included interest and penalties. We went on to sell the brownstone in 2007 for 1.8 million, so we feel confident our appraisal was on target. We are currently looking to hire a tax lawyer, and have several names, but would welcome any recommendations. We are aware that a similar case in Brooklyn has already gone before the court and is awaiting a decision. Any advice and/or information is greatly appreciated.
Comments
Could you explain the "easement deduction?"
Not sure what's going on but for amortization and/or cost basis accounting, you use actual dollar amounts, not appraisal numbers.
Posted by: daveinbedstuy at November 4, 2009 11:30 AM
Wow, that sounds terrible. The best thing you can do is arm yourself with an attorney who is well-versed in negotiating with the IRS. Often the interest can be negotiated, and you can ask for penalties to be waived (although that is rare). Has NYS also jumped into the fray? An audit by the IRS (and thus an amendment to your return) is a red flag to the NYS Department of Taxation to get involved.
Posted by: AEPE at November 4, 2009 11:44 AM
Properties that are listed on the National Register can donate facade easements to non-profit groups. As with an open space easement, you are donating control of a piece of your property to a third party, and in return, you are allowed to deduct the value of that donation on your taxes. Any changes you want to make to your facade would - in perpetuity - need to be approved by the non-profit that holds the easement. Not a great burden if its already a local landmark, but potentially a big burden if it's not.
The IRS has been aggressively auditing these donations, focusing on three areas - the appraisal itself, the value of the facade as a percentage of the total value of the property (which in this case sounds like 15%), and whether the donation has any value in a locally landmarked district. The appraisal might be on target, but the IRS could certainly question the 15% if the building is a local landmark (the reasoning being that a third party - LPC - already controls what you can do with the facade, thus diminishing the value of what you are donating to the third party - the IRS would like to set that value at 0%, but past cases put it higher, perhaps in the 8 to 12% range, maybe a bit higher).
Long story short - listen to AEPE, hire a good attorney who is versed in dealing with the IRS and with easement donations.
Posted by: WBer at November 4, 2009 12:16 PM
There's an old bstoner post about this...
http://www.brownstoner.com/brownstoner/archives/2007/09/facade_easement.php
I'd have to say I can see the logic of IRS to challenge this - you're claiming a charitable deduction (to some organization?) for leaving your historic facade as is in perpetuity. But why's the value to the charitable org 15% of the value of the property when you were already restricted from changing the facade by LPC?
Posted by: Bklnite at November 4, 2009 12:28 PM
By easement deduction I mean we took advantage of a program offered by an historic preservation organization to receive a tax deduction in return for donating our facade to the organization, as have hundreds of other throughout the city. The appraisal number is relevant in that the irs has been focusing on appraisals in their audits. The value of the facade and thus the deduction amount is derived from a percentage of the value of the house, usually 10 to 15%.
Posted by: vcthomas at November 4, 2009 12:32 PM
This link explains conservation easements pretty well I believe, but is more geared toward rural property.
http://www.grandriverpartners.org/easements.htm
I think the main concept behind the easement is that you donated portion of the value of your home toward the greater good (by preventing development/alterate uses/aesthetic alterations, etc) and are taking a deduction on the loss you incurred because of this donation. The easement is attached to the deed, so any new buyer must also use the home according to the easement you put on it (hence where your loss comes in, because you theoretically wouldn't be able to sell it for the same price as you would get without an easement).
i.e. If the house is appraised at 1.2 million before easement and 1.1 after easement you are eligible to deduct the 100,000 you "donated". The problem you will probably run into is that you may not have actually lowered the value of the property at all with the easement (since alterations to the structure are already regulated by LPC). And since you sold if for $600,000 more 3 years later, it also may be very difficult to show that you suffered any sort of financial loss by putting the easement on the property for which you deserve a tax deduction. You may want to try pulling comps that show you could have gotten a higher price for the home if you had sold the property without any easements.
Posted by: setancre at November 4, 2009 12:39 PM
You're only entitled to the deduction the year in which the donation was made. I'm not sure why you would be deducting $90K over 3 years.
Posted by: Colonel Steve Austin at November 4, 2009 12:47 PM
the reason that it is over three years is that there is a maximum against your income you can deduct for charitable purposes, when this amount is exceeded you can carry forward the excess for a period of time until the time period is exhausted or until the amount is exhausted. These rules are complicated. Normally if its just an appraisal issue, this get settled at some point however I have seen the IRS make a criminal case where they think the appraisal has been unjustly inflated and influenced.
If the area is already land marked the donation of the easement is not going to be worth much.
The case before the court awaiting a decision should let you know where it is going...
Posted by: smeyer418 at November 4, 2009 1:04 PM
A few years back I attended a presentation by the Historic Districts Council, describing themselves as a qualified easement-holding organization for purposes of such charitable donations. I also remember reading about various problems that resulted for property owners who made such donations. I don’t have any of the specifics handy right now, but links below are to the HDC brochure (see page 6, in particular), to an IRS Bulletin, and to some info by the National Trust for Historic Preservation:
http://www.hdc.org/financial%20incentives%20brochure.pdf
Internal Revenue Tax Code Section 170(h)
http://www.irs.gov/irb/2004-28_IRB/ar09.html
http://www.preservationnation.org/resources/legal-resources/easements/nthp-nhra-irs-examinations.html
http://www.preservationnation.org/resources/legal-resources/easements/
Posted by: vinca at November 4, 2009 1:05 PM
I think you should just pay the IRS the money.
Posted by: tybur6 at November 4, 2009 1:44 PM
Doing the math...it appears you tried to deduct 22.5% of the appraised value of the house. Digging around online it appears that 10%-15% is the norm. You were exactly on 15% of the final sale price in 2007 at 1.8MM...but its the worth of the house when you claim the easement that counts, not how much it's worth 3 years later!
Plus there's the whole issue of already being under the auspices of the LPC.
It looks like the IRS is probably questioning at least two things here - one, your value appraisal in 2004. And two, the actual loss you were incurring from the easement. Given LPC is already restricting you, the easement is practically worthless from the IRS point of view e.g. you'd get the same amount for the house with or without the easement.
Frankly, it looks like you and/or your tax lawyers made a very high valuation and discounted the LPC impact entirely. In other words, you took a very risky deduction for a very high dollar amount. I'm not surprised the IRS is going after you given that. From their point of view it looks a helluva lot like you were trying to sneak out of at least 60K in income taxes.
Posted by: northridger at November 4, 2009 1:54 PM
oh, yes, tybur6, writing a check for $145K without a fight sounds like a great idea.
Posted by: AEPE at November 4, 2009 2:08 PM
@northridger: thanks for correcting my math - was having trouble multiplying by three this morning. I'm assuming the property in question is a landmark (most private residences that use deduction are), but I don't know. Still, landmark or not, if the numbers are correct that is a very high valuation for the exterior of the building.
Posted by: WBer at November 4, 2009 2:24 PM
@WBer...yeah. The problem the IRS is seeing is a $270,000 claim on a house appraised at $1.2MM. It seems a long stretch to prove to the IRS that the OP expected a $270K loss from the easement. A really, really long stretch.
It's impossible to say what the IRS valued the easement at without all the details, but if you apply some common sense SWAGs to what the penalties and interest might be, then a $145K bill implies that the IRS thought the loss in sale value of the home was pretty small, if not just plain zero. To do it right you'd have to figure out the taxes owed on $270K for that home owner....
Posted by: northridger at November 4, 2009 2:36 PM
"a program offered by an historic preservation organization"...ie not LPC? who?
Why does this sound unkosher to me...ie a dubious tax-shelter scheme?
Posted by: cmu at November 4, 2009 2:38 PM
It sounds unkosher because very few people would knowingly lower the real value of their home by $200,000 in order to take $200,000 in tax deductions (of which you would only get back maybe 30% or $60,000 on your taxes). Why give away $200k to get back $60k at tax time?
You would only "donate" $200,000 and take the deduction, if you knew it didn't actually lower the value of your home by as much as you are claiming it does. That's why the IRS is looking so hard at this, generally speaking, they know the donation probably didn't change the value of the house as much as is being claimed. Not that many people are preservation-minded enough to honestly donate away hundreds of thousands of dollars in real equity.
Posted by: setancre at November 4, 2009 2:52 PM
I attended a seminar on this topic a few years ago as well. I remember sitting in the room, listening to some guy in a bow tie describe the scheme, which basically goes like this-- you claim an easement agreeing not to change the facade of your building which, hello?, you know you would never do anyway. WHat? You were going to be vinyl siding on it but now you aren't?? Dress it up how you like with a lot of palaver about historic preservation, but I thought it was unethical then and I still do. Audits are awful. My sympathies. But this is a little like the Madoff victims who kept getting 12 % when everyone else was down and didn't want to inquire too closely.
Posted by: Cobblekrill at November 4, 2009 2:54 PM
@cmu - it is not a dubious tax-shelter scheme, it is a legitimate tax deduction. You are donating something of value to a non-for-profit (LPC is a government agency, not an historic preservation organization). There are some non-profits that have been established pretty much solely for accepting easements, and these organizations have raised red flags, but there are a lot of legitimate preservation organizations that hold easements as part of their larger preservation program (and by the way, I don't think HDC is one of them).
Posted by: WBer at November 4, 2009 3:00 PM
The HDC presentation did not sit well with me, but as you can see from their brochure, they claim to be qualified. Caveat emptor.
Posted by: vinca at November 4, 2009 3:12 PM
It's sorta like donating your junker car to a charitable organization and taking a tax deduction for the 5k blue book value of the car, even though the charity contracts with a company that tows away and sells the junker for $100 and gets 50 bucks out of the deal. I did that once before the IRS tightened up on that game. Now you can deduct the fair value of the donated car.
If you take a 270k deduction and when the change in value for adding the easement to the property in a landmarked district is de minimus, then I'd say a fair outcome is to argue you were not negligent, made some reasonable attempt to do the legal thing, and pay the tax you should have paid when you took the questionable deduction and try to negotiate the interest and penalties.
Posted by: Bklnite at November 4, 2009 3:18 PM
I just read the links that vinca provided, and the IRS one is chilling as it relates to this sort of case. The bulletin is:
"Internal Revenue Bulletin: 2004-28
July 12, 2004
Notice 2004-41
Charitable Contributions and Conservation Easements ".
Note that the bulletin is from 2004.
There's lots of talk about the intent behind the easements, and lots of technical terms, but near the end has the chilling paragraph:
"If the donor (or a related person) reasonably can expect to receive financial or economic benefits greater than those that will inure to the general public as a result of the donation of a conservation easement, no deduction is allowable. Section 1.170A-14(h)(3)(i). If the donation of a conservation easement has no material effect on the value of real property, or enhances rather than reduces the value of real property, no deduction is allowable. Section 1.170A-14(h)(3)(ii)."
Reading the whole document, it's pretty clear the intent of the deduction is to allow someone to deduct when they're making clear donations for conservation purposes that in some way contribute to the public good. For example, if the a rich family gave 20,000 acres of land to the NY/NJ trail conference for public use, they'd probably get a tax deduction for the full value of that land.
In the case of facades....the IRS wants you to show that what you're doing is in the public good, and that you're taking a material financial hit in doing so, and that the organization taking the easement is a true non-profit. If this is an LPC area than I'd say based on those rules you are SOL. If it's not LPC, then there's some wiggle room. But $270K still seems very, very excessive.
A question for vcthomas...did a tax attorney go over this deduction with you when you took it? Or did only the "historic preservation organization" help you out? Hopefully not just the latter. If you're taking any single deductions more than 10K or so it makes sense to have a tax attorney take a look at it. Not doing so just leaves you totally open to scammers and people's skirting the fringes of the IRS tolerance.
Posted by: northridger at November 4, 2009 3:30 PM
Ouch, it gets worse if you google it. Take a look here:
http://www.irs.gov/newsroom/article/0,,id=136337,00.html
The document, from 2005, shows that the IRS explicitly considers an easement on a home's facade in an area with a local historic preservation organization to be an invalid deduction. In fact, the article implicitly calls it a notorious tax scam. Here's the relevant bits...it's #9 on the "dirty dozen" scam list from 2005.
"IRS Announces the 2005 Dirty Dozen
IR-2005-19, Feb. 28, 2005
WASHINGTON — The Internal Revenue Service today unveiled its annual listing of notorious tax scams, the “Dirty Dozen,” reminding taxpayers to be wary of schemes that promise to eliminate taxes or otherwise sound too good to be true.
Abuse of Charitable Organizations and Deductions. The IRS has observed an increase in the use of tax-exempt organizations to improperly shield income or assets from taxation. This can occur, for example, when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. A “contribution” of a historic facade easement to a tax-exempt conservation organization is another example. In many cases, local historic preservation laws already prohibit alteration of the home’s facade, making the contributed easement superfluous. Even if the facade could be altered, the deduction claimed for the easement contribution may far exceed the easement’s impact on the value of the property."
Posted by: northridger at November 4, 2009 3:40 PM
Yeah, "chilling" if you're trying to get something for nothing.I think I've now lost any sympathy I had at all for OP.
Posted by: cmu at November 4, 2009 3:41 PM
If you read that earliern thread bklner referred to, you'll see that "I told you so"
Posted by: Bob Marvin at November 4, 2009 3:50 PM
You sure did Bob, and your analysis there appears to have been spot on.
And reading the literature the IRS seems to have chosen to single out this sort of abuse and punish it pretty severely. It explicitly calls for excise taxes and "accuracy related penalties" on top of interest. It looks like the penalties are in the range of 45% to 65% on the excess valuation depending on how bad the IRS wants to view it.
This speech by one Robert Miller gives details on the IRS' view of this:
http://www.irs.gov/pub/irs-tege/miller-speechonconservationeasements.pdf
On top of everything else already mentioned here, he states:
"We also are hearing of charities that tell their historic easement donors that they are entitled to claim, as a façade easement deduction, a fixed percentage of the fair market value of their property.
This, of course, is not accurate, since the rules on the valuation of historic property are based on the facts and circumstances of each case, including prior restrictions on the use or modification of the property."
So, vcthomas, I don't think you're going to have much luck since the IRS is explicitly targetting your exact, precise circumstance. You hit every single warning bell the IRS has on this topic. And to make things worse you claimed a valuation way above what out-and-out scammers were claiming was "reasonable".
I'd normally recommend a good tax attorney, but in this case that might be just throwing good money after bad.
Posted by: northridger at November 4, 2009 4:41 PM
Yeah, OP - lot's of folks cheat a little on their taxes, but a bogus 270k deduction ?!? Busted. You profited by the 600k increase in value from 04 to 07 on top of whatever the gain from your original purchase price to the 04 value when you got involved in the scam, so you can probably afford it. tybur6 always has tongue planted firmly in cheek when posting but.....
"I think you should just pay the IRS the money.
Posted by: tybur6"
Posted by: Bklnite at November 4, 2009 4:46 PM
Not sure where the number 270K came from...we deducted 96,000.
Posted by: vcthomas at November 4, 2009 7:09 PM
Obviously we misread your "we deducted @ 90,000 over the next three years". $96K works out to a much more reasonable 8% - still needs to stand up to audit, but it's a pretty conservative number.
A lot of the IRS info that is being posted here is out of date. There was some updates to the law in 2006 (attached to pension benefit legislation by congress). (You easement is earlier, so the restrictions there would not apply, I assume. There has also been some clarification from the IRS (there is a good collection of correspondence here: http://www.architecturaltrust.org/taxadvantage/newsanalysis/irsupdate.asp - the "Trust" is the largest holder (and promoter) of easements, but the information here is objective).
The bottom line is that IRS has backed away from the "no value" position regarding easements in locally-governed historic districts, but they have also reemphasized that a straight percentage deduction is not valid. As @setancre says above, you need before and after appraisals that take into account the impact of the local legislation and any other local factors.
As I said, this is not a dubious scheme - but it is a deduction that the IRS audits frequently.
Posted by: WBer at November 4, 2009 9:00 PM
@vcthomas... Yes, as WBer mentioned, on first glance it appeared you were saying you were deducting $90K per year for three years.
@WBer...reading the documents I don't think the IRS has backed away from anything. It appears to me that they've tightened the rules to make it clearer what is allowed and what isn't, but the fundamental stance is the same. In particular, those documents reaffirm in detail:
- conservation easements must be shown to benefit the public
- They must be in perpetuity
- Deductions must be based on before-easement and after-easement valuations e.g. you must show that you're taking a measurable loss
- Straight percentages of fair market value of the whole property aren't allowed.
- Valuations have to be done professionally
The most recent link, a letter from Steven Miller to the "National Trust for Historic Preservation", states all of this. And it basically reaffirms a speech he gave back in 2005. Here's the link:
http://www.architecturaltrust.org/uploaded_files/2008%200313%20Letter%20from%20IRS%20to%20NTHP.pdf
He goes into detail on legitimate uses of these easements...and in the abuse that occurs around them as well.
He goes on to state that conservation easements do have value in general, and that congress is clearly pushing to preserve historic structures by these means. But he also says:
"At the same time, it is clear that Code provisions such as section 170(h) attract some who are intent on misuse and abuse, as well as others who have good intentions but who fail to take the steps required to support the claimed
deduction. Our enforcement program in the area of fagade easements is designed to address these situations. We believe that proper enforcement is necessary to preserve the integrity and the success of the section 170(h)
program."
In fact, reading the IRS literature they repeatedly come back to the idea of personal gain. The idea behind these easements and their tax advantages is conservation and the public good. Someone giving away property rights for the public good should get a tax break for the value of what they're giving away.
What they're coming down on is people using this statue for personal gain. In 2006 Mr. Miller says this on the subject, which I think is spot-on:
"Before I state my discussion let me state two things that I know are true. The first is that conservation easements serve a vital role in American Society. I ask you to consider erverything else I say this morning with that in mind.
When conservation easements are appropriately used, they bring real and enduring benefits to the American public. Thney can safeguard - and have safeguarded - fragile ecosystems, critical watersheds, land bordering state and national parks, and stunning views. We value this use of conservation easements.
At the same time there is a second thing I know to be true. It has been expressed best by Comissioner Everson, who has said publically:
'We have uncovered instances where the tax benefits of preserving open space and historic buildings have been twisted for inappropriate individual benefit. Taxpayers who want to game the system and charities that assist them will be called to account. Pretty tough words, but nothing in them, I think that shold be of concern to stewards of the states' public lands.'"
Posted by: northridger at November 5, 2009 10:13 AM
There's lots of interesting reading re: Scheidelman and Perry v. Commissioner (similar case w/ Ft. Greene owner vs. IRS)
http://www.architecturaltrust.org/taxadvantage/library/pending_cases.asp#s2
Respondent's Expert Report - Cushman Wakefield, has an appraisal of 374 Vanderbilt giving the opinion that the value in 2004 both before and after the easement was $1,000,000, supporting the IRS claim that there was no value given up with the contribution.
If you deducted 96k and avoided 30k or so of taxes, you can see how Scheidelman's case turns out, and go to court if you you think you'd prevail. I'd think if you'd be better off trying to negotiate away penalty (and interest) in exchange for saving everyone the expense in court.
Posted by: Bklnite at November 5, 2009 2:02 PM
Very interesting reading. You can condense it quite a bit by just looking at the arguments by each side..particularly the summaries at the beginning.
The IRS' POV:
..and the Scheidelman's POV:
Personally, I think the Scheidelmans are going to get creamed, but you never know. They have a very good lawyer from reading through this.
But their argument looks pretty weak compared to the governments. For all the hundreds of pages of documents, at the end of the day they claimed a massive tax break for a "loss" that they didn't incur, and the value of their property went right on increasing, easement or no.
If they can keep the argument to a narrow "valuation" argument then they've got a shot (e.g. "the govt and us disagree on valuations, but so does everyone else!").
If the IRS manages to keep the focus on the purpose of conservation easements and the impact of organizations like LPC on valuation in these cases, then the Scheidelman's will have a very, very big bill to pay.
Posted by: northridger at November 5, 2009 4:41 PM
this is the sort of thing you should seek some political help from. Contact your congress(wo)man's constituent affairs office and point out that it's a common issue for people in brownstone brooklyn.
Posted by: slick at November 6, 2009 9:08 PM
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