September 13, 2013 The IRS vs. South End Homeowners, Round 2
Posted at 15:20h in Blog
|Boston’s Historic South End
In part one of this story, the IRS was not successful before the First Circuit Court of Appeals in disproving the validity of the preservation easement created by a South End couple. While the appeals court acknowledged that the couple arguably failed to conform to the letter of the law in the Internal Revenue Code, the court found the IRS?s interpretation of the code to be unduly rigid. In the court?s eyes, the IRS?s expectations stifled Congress?s intent in creating the preservation easement tax deduction. Much to the chagrin of the South End couple, however, the story did not end there. The appeals court sent the parties back to tax court to resolve another issue; not only did the IRS believe the preservation easement that the couple donated to the Trust for Architectural Easements was invalid, it also argued that the true value of the donated easement was zero.
A homeowner that grants a valid preservation easement receives an income tax deduction equal to the value of the easement, essentially the difference in fair market value of the property with and without the restrictions placed on the property by the easement. In essence, the IRS?s argument is that because the South End couple?s 19th-century row house was already subject to the South End Landmark District preservation restrictions imposed by the Boston Landmarks Commission, the preservation easement the couple donated to the Trust placed no additional restrictions upon fa?ade changes to the row house?s Venetian Gothic exterior. In other words, the IRS contends, the difference between the row house?s fair market value with and without the easement is zero since the restrictions imposed by the easement already existed due the home?s location in a designated landmark district.
In the process of creating the easement, the couple?s own appraiser acknowledged that ?there is much overlap in the restrictions imposed by the [easement] and the pre-existing restrictions imposed on the property, particularly by the Landmark Commission.?But in the couple?s defense, the appraiser also noted several differences in restrictions imposed by the Landmark Commission and those imposed by the easement. For example, the easement will last in perpetuity, whereas the Landmark District regulations are subject to change. Further, the easement leaves the homeowner?s subject to periodic inspections conducted by the Trust, which currently holds the easement. The trial, then, will likely center around whether these differences are economically significant enough to justify the tax deduction claimed by the couple.
The IRS, on the other hand, has several persuasive arguments of its own. The IRS will certainly point to the fact that the homeowners themselves were surprised by the value of the easement, as it suggested to them that their home may fetch significantly less should they decide to sell it. The Trust for Architectural Easements, though, assured the couple that easements of the kind in question rarely had a significant impact on resale value. This clearly bolsters the IRS?s argument that the couple, while claiming a tax deduction, was not actually sacrificing any real estate value by creating the easement. The IRS could take the argument further and suggest that the Trust had ulterior motives: because the Trust typically receives 10% of the value of any deduction, it had an incentive in ensuring a high valuation of the easement. After all, the Trust personally recommended the appraiser to the couple.
Before the tax court, the South End homeowners will have the initial burden of justifying the tax deduction they claimed. Only time will tell how sympathetic the tax court will be to the couple?s argument. Needless to say, the stakes are high for the couple: if the tax court sides with the IRS, the couple could face stiff penalties for substantially understating their income tax and face additional liability for a substantial or gross tax valuation misstatement. Stay tuned to the Historic Boston Blog for the results.