On February 28, 2022, the Tax Court issued a Memorandum Opinion in the case of Corning Place Ohio LLC v. Commissioner (T.C. Memo. 2022-12). The primary issue presented in Corning Place Ohio LLC v. Commissioner was whether the taxpayer and the tax matters partner substantially complied with the reporting requirements necessary to substantiate a conservation easement deduction for the façade of a historic building.
Background to Corning Place Ohio LLC v. Commissioner
This case involves a charitable contribution deduction claimed by Corning Place Ohio, LLC (Corning Place), for a conservation easement. The IRS issued Corning Place a notice of final partnership administrative adjustment (FPAA) disallowing this deduction. Before the Court on the IRS’s motion for summary judgment were three issues: (1) whether the easement deed failed to protect the conservation purpose in perpetuity, in alleged violation of IRC § 170(h)(5)(A); (2) whether Corning Place’s appraisal and baseline documentation failed to meet the substantiation requirements of IRC § 170(h)(4)(B)(iii); and (3) whether the deduction should be disallowed because Corning Place did not timely pay the $500 filing fee specified in IRC § 170(f)(13).
A Lauberian Frolic and Detour
The easement at issue in Corning Place Ohio LLC v. Commissioner is a historic preservation easement associated with the Garfield Building, an 11-story building at 1965 E. Sixth Street in Cleveland, Ohio. The building was constructed in 1893 for Harry A. and James R. Garfield, sons of President James A. Garfield, and built on land owned by John D. Rockefeller.
The Garfield Building, built in the Renaissance Revival style, was designed by Henry Ives Cobb, a noted Chicago architect. It exemplifies an architectural trend of the late 19th and early 20th centuries, when architects worked to adapt traditional styles to large-scale commercial buildings then being erected in major American cities.
The Garfield Building is considered the first steel-frame “skyscraper” east of Cleveland’s Public Square, making it an early local example of a significant technological shift in building construction. It has been listed on the National Register of Historic Places since 2002. The Secretary of the Interior has denominated the Garfield Building a “certified historic structure” that contributes to integrity of the Euclid Avenue Historic District.
The Easement at Issue in Corning Place Ohio LLC v. Commissioner
In January 2015, Corning Place purchased the Garfield Building and the land it occupies for $6 million. It then began a “certified rehabilitation” to convert the building from vacant office space to residential apartments. In May 2016, Corning Place recorded an easement deed in Cuyahoga County donating a façade easement on the Garfield Building to the Historic Gateway Neighborhood Corporation (HGNC), a “qualified organization” within the meaning of IRC § 170(h)(3). According to the deed, the easement’s purpose is to ensure that the façade of the Garfield Building
will be retained and maintained forever in its rehabilitated condition and state[,] exclusively for conservation and preservation purposes, for the scenic, cultural and historic enjoyment of the general public, and to prevent any use or change of the Façade or air space directly above or adjacent to the Building that is inconsistent with the historical character of the Façade.
The deed recognizes the possibility that the easement might be extinguished at some future date if fulfillment of the conservation purpose became impossible or impractical.
In the event the Garfield Building (Property) were sold following judicial extinguishment of the easement, the deed directs that the sale proceeds shall be shared between Corning Place (Grantor) and HGNC (Grantee) as follows:
In accordance with Treas. Reg. § 1.170A-14(g)(6)(ii) for purposes of allocating proceeds, Grantor and Grantee stipulate that…Grantor and Grantee are each vested with real property interests in the Property and that such interests have a stipulated percentage in the fair market value of the Property. Grantee’s percentage interest shall be determined as the fair market value of this Easement as of the Recording Date divided by the fair market value of the Property as a whole as of the Recording Date.
Grantor’s percentage interest shall be the difference between 100% and the Grantee’s percentage interest. The values upon the Recording Date of this Deed shall be those values used to calculate the deduction for federal income tax purposes allowable by reason of this grant pursuant to IRC § 170(h). The percentage interests of Grantor and Grantee in the fair market value of the Property shall remain constant.
The Return, Examination, and Notice of Final Partnership Administrative Adjustment in Corning Place Ohio LLC v. Commissioner
In September 2017, Corning Place timely filed Form 1065, U.S. Return of Partnership Income, for its short 2016 taxable year. It claimed a charitable contribution deduction of $22.6 million for the conservation easement. It attached to this return an appraisal of the easement, photographs of the building’s exterior taken before rehabilitation, and a Baseline Data Report. The report described the historic and architectural significance of the Garfield Building.
In an August 2018 letter, the IRS advised Corning Place that its 2016 return had been selected for examination. During the examination the IRS noted that the appraisal accompanying the return did not include “addenda” that set forth the appraiser’s qualifications. Corning Place sent the IRS the “addenda.”
In September 2018, Corning Place also paid—and the IRS accepted—a $500 filing fee required for conservation easement deductions. Corning Place alleges that it filed an amended return in November 2018; however, such return did not appear in the record. In July 2020, the IRS issued an FPAA to the petitioner, disallowing the claimed charitable contribution deduction in full. The petitioner, naturally (and timely), petitioned the Tax Court for review.
The “Protected in Perpetuity Requirement”
IRC § 170 allows a deduction for charitable contributions made in the taxable year, with deductions for donations of partial interests in property generally being prohibited. However, the Code excepts specific types of partial interests from this prohibition—one of which is a “qualified conservation contribution.”
For the donation of an easement to be a “qualified conservation contribution,” the conservation purpose must be “protected in perpetuity.” The Treasury Regulations, specifically Treas. Reg. § 1.170A-14(g)(6), set forth detailed rules for determining whether this “protected in perpetuity” requirement is met.
Editor’s Note: On December 19, 2021, the Eleventh Circuit Court of Appeals struck down Treas. Reg. § 1.170A-14(g)(6) in the case of Hewitt v. Commissioner. In striking down the regulation, the Eleventh Circuit held that the Treasury Department did not comply with the notice-and-comment requirements of the Administrative Procedure Act when promulgating the “judicial extinguishment” regulation.
Hewitt was a remand of a 2020 Tax Court memorandum opinion written by Judge Goeke. In the appellate opinion, the court specifically held that the Treasury Regulation, which establishes the value of the donor and the donee’s respective proportionate interests upon the judicial extinguishment of a “perpetual” conservation easement for purposes of the charitable contribution deduction, and which prohibited the subtraction of the value of post-donation improvements to easement property from proceeds allocated to the donor and the donee in the event of extinguishment, was arbitrary and capricious due to the Treasury Department’s failure to comply with APA’s procedural requirements.
Although the Treasury Department stated it had considered “all comments” in promulgating the regulation, the Treasury Department failed to respond to relevant and significant comments from conservancies as to the effect of post-donation improvements on the proceeds subsequent to extinguishment, which could thwart purpose of regulation and related Code provision. Further, the court held that the “revisions” made by the Treasury Department to the regulation in “response” to such comments were simply “clarifications” in response to other comments expressing uncertainty about meaning of regulation, rather than any actual, substantive changes.
Hewitt was followed by the Sixth Circuit’s decision, which affirmed the full Tax Court opinion of Oakbrook Land Holdings, LLC v. Commissioner, in which Judge Lauber denied the taxpayer’s conservation easement deduction on the basis that the proportionate value of the easement violated the perpetuity requirements of Treas. Reg. § 1.170A-14(g)(6). We discuss the Hewitt and Oakbrook cases much more thoroughly in this article on conservation easements. Time will tell how the Hewitt case affects Corning Place Ohio LLC v. Commissioner and the other conservation easement cases that have turned on the perpetuity requirement.
Key to the Tax Court’s analysis were the rules governing the mandatory division of proceeds in the event the property is sold following a judicial extinguishment of the easement.
Analyzing the Regulations
Treas. Reg. § 1.170A-14(g)(6)(i) recognizes that “a subsequent unexpected change in the conditions surrounding the property…can make impossible or impractical the continued use of the property for conservation purposes.” Despite that possibility, “the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding” and the easement deed ensures that the charitable donee, following the sale of the property, will receive a proportionate share of the proceeds and use those proceeds consistently with the conservation purposes underlying the original gift.
The Tax Court observed that this requirement is strictly construed, and if a donee is not absolutely entitled to a proportionate share of extinguishment proceeds, then the conservation purpose of the contribution is not protected in perpetuity.
The regulations implement this so-called “proportionate share” rule by requiring that the easement deed vest the donee with “a property right…with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time.” The “proportionate value of the donee’s property rights,” as thus computed, “shall remain constant.” In effect, the regulation determines an apportionment fraction, calculated as of the date of the gift, that is multiplied by the sale proceeds to ascertain the donee’s share.
The Tax Court notes that “upon initial inspection” the Corning Place easement deed seemed to track the regulation precisely. However, the IRS lost sleep over the sentence, which read “[t]he values upon the Recording Date of this Deed shall be those values used to calculate the deduction for [F]ederal income tax purposes allowable by reason of this grant pursuant to IRC § 170(h).” The IRS pointed to the deed in the Carroll case, which similarly (but not grammatically identically, as we’ll see) provided that the value of the donee’s property right was “the deduction for federal income tax purposes allowable by reason of this grant, pursuant to IRC § 170(h).”
In Carroll, the Tax Court held that this formula violated the regulation, noting that, if the IRS denied the deduction for reasons other than valuation—in which case no deduction would be “allowable”—the numerator of the apportionment fraction (the value of the donee’s property right) “will be zero.” In the event of extinguishment the taxpayers could argue that they “never received a tax deduction;” hence, that the donee was entitled to no share, rather than to a proportionate share, of the sale proceeds. Such an argument, the Tax Court found, would be “supported by the literal terms of the easement, and there is no evidence of a different intent.”
Distinguishing the Corning Place Easement Deed from the Carroll Deed
Ultimately, the Tax Court’s decision turned on the proper interpretation of the Corning Place easement deed, which is a question governed by state law. A contract should be “read as a whole and the intent of each part gathered from a consideration of the whole.” A court applying Ohio contract law should attempt to “harmonize all the provisions rather than produce conflict in them.”
The Tax Court observed that the extinguishment provision in Carroll was drafted “quite differently from the one here,” and the court found that the IRS erred in equating the two easement deeds. The deed in Carroll defined the numerator as “the deduction…allowable” for Federal income tax purposes, and the Tax Court construed this phrase (consistently with its context) to mean the deduction allowable to the taxpayer in that case. The deduction allowable to the taxpayer, in other words, was itself the numerator, and that deduction could be zero.
In the Corning Place deed, however, the instrument defines the numerator as “the fair market value of this easement as of the Recording Date.” It then says that this value (and the value appearing in the denominator) “shall be those values used to calculate the deduction…allowable…pursuant to IRC § 170(h).” Grammatically speaking, the “allowable” phrase here does not define the numerator. It simply specifies the deduction in question—namely, the deduction that is allowable to taxpayers generally under IRC § 170(h).
Three other features of the instant deed distinguish this case from Carroll. The first is the phrase “values used to calculate,” which does not appear in the Carroll deed. As a grammatical pedant, I am amused by Judge Lauber’s observation, “[a]s often happens with the passive voice, one is forced to ask, ‘Used by whom?’”
Editor’s Note: Being the unabashed grammar snob that I am, I cannot in good conscience pass over the glaring fact that the very phrase Judge Lauber uses to criticize the use of the passive voice (“one is forced”) is, itself, passive. And yes, my wife did buy me a shirt that says, “I am silently correcting your grammar.” And yes, I wear it all the time. And yes, I am. At least he used the accusative form of “who” properly (“by whom”). Credit given where credit is due…
The IRS appears to contend that the phrase means “the values used by the IRS or a court to calculate the deduction ultimately allowed to the taxpayer.” On this reading, the provision would resemble that in Carroll. But this phrase could also mean “the values used by the taxpayer to calculate the deduction claimed on its return.” On that reading the numerator would be very large and consistent with the regulation. Ultimately, the Tax Court found that the latter interpretation was more plausible because of a second feature of the Corning Place deed, namely, its repeated references to “the recording date.”
As noted earlier, the Corning Place deed initially says that the “Grantee’s percentage interest shall be determined as the fair market value of this Easement as of the Recording Date divided by the fair market value of the Property as a whole as of the Recording Date.” This phrase appears again in the sentence that gives the IRS heartburn (or gives the IRS IBS, if you want to get alliteratively acronymic—which technically is assonance, rather than alliteration…and perhaps even rhyme…).
Specifically, the GERD inducing sentence states that “[t]he values upon the Recording Date of this Deed shall be those values used to calculate the deduction…allowable…pursuant to IRC § 170(h).” The only values known “as of the Recording Date” would be the values that Corning Place intended to use in preparing its tax return, which would appear on the face of the appraisal.
A third feature of the Corning Place deed distinguishes this case even more sharply from Carroll. The deed in Carroll initially defined the numerator as the deduction allowable for Federal income tax purposes. It then stated that “[t]he parties shall include the ratio of those values with the Baseline Documentation and shall amend such values, if necessary, to reflect any final determination thereof by the IRS or a court of competent jurisdiction.” This final clause made it absolutely clear to the Tax Court that the parties intended the numerator to be the deduction ultimately allowed to the donor-taxpayer. No such clause appears in the Corning Place deed.
In sum, applying contract interpretation principles of Ohio law, the Tax Court concluded that its holding in Carroll does not apply to the judicial extinguishment provision involved here. In Carroll, the Tax Court found “no evidence” that the parties intended to give the donee a proportionate share whose value was fixed on the date of the grant. Here the opposite is true.
The Corning Place deed specifies that the donee’s percentage interest “shall be determined as the fair market value of this Easement…divided by the fair market value of the Property as a whole.” That formula is fully consistent with the regulation.
The deed makes clear that these values are fixed “as of the Recording Date” and “shall remain constant.” These values are not contingent on (or modifiable in the light of) an IRS audit or other future event. Further, in referring to the “deduction…allowable…pursuant to IRC § 170(h),” the deed does not define the numerator, as in Carroll. Instead, the deed in Corning Place simply specifies the deduction that Corning Place will claim on its tax return using the values determined as of the recording date—namely, the deduction allowable to taxpayers generally under IRC § 170(h). Accordingly, the Tax Court denied the IRS’s Motion for Partial Summary Judgment on this point.
The IRS next contended that Corning Place failed to submit timely all the items required to substantiate the deduction. IRC § 170(h)(4)(B) establishes special rules for historic preservation facade easements. A taxpayer claiming a deduction for donating such an easement must include with its return a “qualified appraisal” as defined in IRC § 170(f)(11)(E). A qualified appraisal must set forth (among other things) the qualifications of the appraiser. The taxpayer must also include with its return photographs of the building’s exterior.
The IRS contends that Corning Place did not meet these requirements. Although, in the table of contents, the appraisal listed an addendum setting forth the appraiser’s qualifications, such addendum was missing from the copy of the appraisal submitted with the return and was supplied to the IRS subsequently. The IRS rather pedantically (read: in true IRS style) asserts that the photographs of the Garfield Building (submitted with the return) were inadequate because they were insufficiently detailed, were undated, and neglected to capture the building’s rooftop.
Viewing the facts and the inferences drawn from them in the light most favorable to the petitioner (as the party not moving for summary judgment), the Tax Court concluded that summary judgment on these points should be denied. In support of its denial of summary judgment, the Tax Court observed that to be entitled to a charitable contribution deduction, a taxpayer need not be in “literal compliance” with every single reporting requirement.
In fact, in the case of Bond v. Commissioner, the Tax Court held that some of these requirements, while “helpful to the IRS in the processing and auditing of returns,” are “directory and not mandatory.” In appropriate circumstances, these requirements can be satisfied by substantial rather than literal compliance.
Further, even if a taxpayer cannot demonstrate substantial compliance, he may be able to show that any shortfall was due to reasonable cause and not willful neglect. Reasonable cause can include relying on the advice of a professional. As such, the taxpayer concluded that the issues of substantiation “would benefit from further elaboration at trial.”
The Damned Filing Fee
IRC § 170(f)(13)(A) provides that no deduction “shall be allowed with respect to any contribution” of a façade easement “unless the taxpayer includes with the return for the taxable year of the contribution a $500 filing fee.” The statute specifies that such filing fees “shall be used for the enforcement of the provisions of IRC § 170(h)” (dealing with qualified conservation contributions). The IRS, however, argued that the deduction must be denied in its entirety because Corning Place omitted a $500 filing fee when filing its original return for 2016.
As a reminder, the deduction was to the tune of $22.6 million, so the proportionality of this absurd argument is just that. Absurd.
Striking an egalitarian tone, Judge Lauber observed that Corning Place did submit the $500 filing fee as soon as this omission was brought to its attention. Ever so more importantly, the IRS happily accepted the filing fee—no questions asked, strings attached, provisos, quid pro quos, or any other catch (at the time). The petitioner “surmised” that the fee had, therefore, then been dedicated to the IRS’s IRC § 170(h) enforcement program, the petitioner contends that it substantially complied with the statutory mandate because the statute’s purpose has been accomplished.
Seems entirely reasonable…right? Alas, not so fast.
Judge Lauber observes in his final breaths in the opinion that “[n]either [the Tax Court] nor any other court has yet considered whether IRC § 170(f)(13) can be satisfied by substantial compliance.”
The petitioner (understandably gob smacked at the sheer disproportionate application of the filing fee to the $22.6 million deduction) also argued (read: sacrificed burnt offerings to the gods of equity) that the reference in IRC § 170(f)(13) to “the return” could be interpreted to mean either the original return or an amended return for the taxable year. The petitioner insisted that Corning Place submitted its $500 filing fee together with (or in advance of) an amended return for 2016, allegedly filed on November 1, 2018. However, no copy of the amended return was included in the record.
For these reasons the Tax Court conclude that the filing fee issue, like the reporting issues discussed above, would benefit from “further elaboration” at trial.
Editor’s Final Note: To put a contextual bow on this final issue that awaits a final adjudication at trial, the filing fee ($500) is .0022% of the claimed charitable deduction ($22.6 million). To misquote the late, great comedian Mitch Hedberg, if this were a pie, the filing fee would be the “who the $%&# cut this” slice.
- See IRC § 170(h)(4)(B)(iii)(I). ↑
- See IRC § 170(h)(4)(B)(iii)(II). ↑
- See § 170(f)(13). ↑
- IRC § 170(f)(3). ↑
- IRC § 170(f)(3)(B)(iii). ↑
- IRC § 170(h)(5)(A). ↑
- 21 F.4th 1336 (11th Cir. 2021), rev’g and remanding T.C. Memo. 2020-89. ↑
- Hewitt v. Commissioner, T.C. Memo. 2020-89. ↑
- 28 F.4th 700 (2022), aff’g 154 T.C. 180 (2020). ↑
- See Treas. Reg. § 1.170A-14(g)(6). ↑
- Treas. Reg. § 1.170A-14(g)(6)(i). ↑
- Carroll v. Commissioner, 146 T.C. 196, 212 (2016). ↑
- Treas. Reg. § 1.170A-14(g)(6)(ii). ↑
- Id. ↑
- See Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 137 (2019). ↑
- Carroll, 146 T.C. at 215. ↑
- Id. at 217. ↑
- Id. at 218. ↑
- Id. ↑
- See Hoffman Props. II, LP v. Commissioner, 956 F.3d 832, 834 (6th Cir. 2020). ↑
- Saunders v. Mortensen, 801 N.E.2d 452, 455 (Ohio 2004). ↑
- Lincoln Elec. Co. v. St. Paul Fire & Marine Ins. Co., 210 F.3d 672, 685 (6th Cir. 2000) (quoting Ottery v. Bland, 536 N.E.2d 651, 654 (Ohio Ct. App. 1987)). ↑
- One is forced… Forshame, Judge Lauber. Forshame. ↑
- Carroll, 146 T.C. at 215 ↑
- Id. at 218. ↑
- See § 170(h)(4)(B)(iii)(I). ↑
- Treas. Reg. § 1.170A-13(c)(3)(ii)(F). ↑
- IRC § 170(h)(4)(B)(iii)(II). ↑
- See Sundstrand, 98 T.C. at 520. ↑
- 100 T.C. 32, 41 (1993). ↑
- Id. at 42. ↑
- See IRC § 170(f)(11)(A)(ii)(II); Crimi v. Commissioner, T.C. Memo. 2013-51. ↑
- See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). ↑
- See Belair Woods, LLC v. Commissioner, T.C. Memo. 2018-159. ↑
- IRC § 170(f)(13)(C). ↑
- Cf. Treas. Reg. § 1.170A-13(c)(2)(i)(B) (explicitly requiring that appraisal summary be attached to the tax return “on which the deduction…is first claimed”); Treas. Reg. § 1.170A-13(c)(4)(iv)(G) (same). ↑
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