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Kissling v. Commissioner (T.C. Memo. 2020-153)

On November 12, 2020, the Tax Court issued a Memorandum Opinion in the case Kissling v. Commissioner (T.C. Memo. 2020-153). The primary issue before the court in Kissling was how the Tax Court gauges the marginal effect of an easement in light of local law.

Background

In 2004 the Kissling Interests, LLC contributed façade easements on three commercial buildings to the National Architectural Trust. The buildings were in a historic preservation district that under local law already restricted what building owners could do with their property.

The Buffalo Purchases

The petitioner is a big city developer.  Why he chose to invest in Buffalo, N.Y., then, is anyone’s guess.  Even the petitioner acknowledged that “Buffalo was quite a dead city.  There was nothing going on.”  So, naturally, the petitioner bought three historic buildings.

Judge Holmes notes that with regard to one of the buildings, “this was something of a distress sale.” The lender had been unwilling to foreclose, even though the previous owner had disappeared, and the tenants weren’t paying rent.” It was that crappy of a historically-relevant (for Buffalo) building.  Consequently, the petitioner bought the mortgage at a discount, finished the foreclosure, and “got the building vacant.”

Author’s note: Everyone who has read Briefly Taxing knows that Judge Holmes is the person I want to be when I grow up.  If you are looking for the most beautiful architectural descriptions ever to grace the façade of a legal opinion, look no further than the Kissling opinion.  Bravo, Judge Holmes.  Sure, it’s not biting sarcasm, but you are multi-talented, after all.

The Conservation Easements

In December 2003 the United States Department of the Interior certified that all three buildings are historic. Each certification states that the property contributes to the significance of the local historic district and is a “certified historic structure” eligible for a charitable contribution for conservation purposes. See Treas. Reg. § 1.170A-14(d)(1)(iv). Once the petitioner had these certificates in hand, it contributed conservation easements on all the properties’ facades to the National Architectural Trust, intending that the façade remained “essentially unchanged and in full public view.” The easements also restrict what the petitioner could do to the properties without the Trust’s consent.  The petitioner also promised to maintain the buildings in good order.

If the petitioner violated the terms of the easements and failed to cure after being given notice, the Trust had the right to: (i) “institute legal proceedings to enjoin such violation to require the restoration of the [p]roperty to its prior condition” and seek reimbursement for legal costs and attorneys’ fees; (ii) “enter upon the [p]roperty and improvements thereon in order to correct such violation and to hold [the petitioner] responsible for the cost thereof;” and (iii) place a lien on the property. And finally, if the easements are ever extinguished, whether through condemnation, judicial decree or otherwise, the Trust is entitled to receive a portion of proceeds from any sale, exchange, or conversion of the properties.

Critically, the extinguishment clause grants the Trust “a portion of the proceeds equal to the same proportion that the value of the initial easement donation bore to the entire value of the property as estimated by a state licensed appraiser.” Though the IRS stipulated that no issue related to the extinguishment clause, the Tax Court held that the clause did not run afoul of its recent decision in Oakbrook Land Holdings, LLC v. Commissioner, T.C. Memo. 2020-54.

The Tax Court noted that the Trust took its supervisory role very seriously, including demand for an explanation why the petitioner removed flowers from the front of the building.  Though Judge Holmes does not provide said explanation, one can imagine that the petitioner’s reply was terse and pointed.  “They were dead and beginning to smell.”

Reporting the Contribution

The petitioner reported a noncash charitable contribution of $855,900 attributable to the grant of the easements to the Trust on its 2004 Form 1065. It also issued a Schedule K-1 to the petitioner’s manager (Kissling) for the 2004 tax year, which reported his distributable share of the contribution as $770,310 (90% × $855,900). The manager was limited, however, in the amount of his charitable contribution deduction in 2004 by IRC § 170(b) and had to carry forward some of the deduction to his 2005 and 2006 tax years.

Summary Disallowance

The IRS audited the petitioner’s personal returns, completely disallowing every deduction for the contribution of the easements to the Trust.  Not to be outdone, just before trial, the IRS amended its answer to assert gross valuation-misstatement penalties under IRC § 6662(h) for two of the years (2005 and 2006).

Qualified Conservation Contributions

IRC § 170 allows a taxpayer to deduct the value of any charitable contribution he makes. There is an exception for contributions of real property, if the gift consists of less than the entire interest in such property. IRC § 170(f)(3)(A). There is an exception to this exception that allows a deduction for a partial interest in real property if the donation is a “qualified conservation contribution.” IRC § 170(f)(3)(B)(iii).

A “qualified conservation contribution” is a contribution (A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes. IRC § 170(h)(1). Under IRC § 170(h)(2)(C), a qualified real-property interest must be a perpetual restriction on the use which may be made of the real property. See also IRC § 170(h)(5)(A).

The retained power of all contracting parties to change contractual terms does not by itself destroy an easement’s required perpetuity. Pine Mountain Pres., LLLP v. Commissioner, 151 T.C. 247, 280-82 (2018), aff’d in part, rev’d in part, and vacated, __ F.3d __, 2020 WL 6193897 (11th Cir. Oct. 22, 2020). Further, a donor’s retained right to add improvements appurtenant to residential development does violate the perpetuity requirement as a matter of law when the precise location of those improvements is not set forth in the deed of easement.

(T.C. Memo. 2020-153) Kissling v. Commissioner

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