It has been several years since I visited Washington D.C. I saw a bit of tax news recently that got me thinking about it. Several years ago I was involved in the planning of a conservation easement in D.C. As Washington has 26 historic districts, this was not that unusual. Our client was renovating residential property, and the easement was for the building façade. We normally associate an easement with access to real property, but it can also be a legally enforceable right to preserve real property. In my case, what was being preserved was the outside of the building, which was of historical interest in a neighborhood of historical consequence. You could say that they were donating the right for future generations to look at the building.
The tax advantage? Quite simple: if you follow the rules you can obtain a charitable contribution for the easement. The deduction is (theoretically) the decrease in property value attributable to the grant of the easement. Memory tells me that a reasonable range for a facade is 10 to 14 percent of the building’s value, which is not insignificant.
This area is fraught with danger. An appraisal – or appraisals – is mandatory. The easement will be transferred to a government or charitable organization, so an attorney is required. You may have to obtain the mortgage lender’s agreement to subordinate their right to that of the government or charity receiving the easement.
The IRS challenged some of these donations early on. In some cases, the IRS argued that the donation was zero, although the IRS took considerable punishment in the courts for this position (Akers and Symington, for example).
I was reading Janet Novak’s article in Forbes where she stated that the Justice Department filed a lawsuit to enjoin the Trust for Architectural Easements from certain practices the IRS considers improper. The lawsuit demands that the Trust turn over the names of approximately 800 property owners in Baltimore, New York City and Boston who have claimed this type of deduction. The IRS has already identified more than 300 taxpayers for audit.
The IRS has been concerned with these easements because of their potential for abuse. In some cases, taxpayers have claimed deductions approaching 50% of the property’s value. In others the charity buys the property, places the easement and then sells it to the taxpayer – at a reduced price. The taxpayer makes two checks out – one to purchase the property and the other as a “donation.” He/she of course deducts the second check on his/her return.
The IRS has taken fire from practitioners who argue that it is over-zealous and not regarding Congress’ intent to encourage these easements. I admit that I felt that way at first. It was easy to see a heavy-handed IRS. Consider the following quote from the court in Symington, for example:
"We are hard pressed to imagine a prospective purchaser of a 60-plus acre parcel of land who would not have considered the restrictions of such an open-space easement in determining his offering price. The fact that a purchaser of Friendship Farm would have been precluded from even giving away part of his land if he ever so desired, for example, to his children, or, along the same lines, precluded from ever building an additional home on his property, would certainly have affected the purchase price he would have been willing to pay."
However, I am at a loss why I would structure a transaction requiring the charity to buy the real property and for my client to subsequently write two checks. I wouldn’t. I don’t see it how it reflects normal commercial terms. It feels oily, at least to me. The IRS may have valid grounds for this action.
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