Jeff Blau, Tax Matters Partner of RERI Holdings I, LLC v. Commissioner of IRS

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 9, 2018 Decided May 24, 2019

No. 17-1266

JEFF BLAU, TAX MATTERS PARTNER OF RERI HOLDINGS I,

LLC,

APPELLANT

v.

COMMISSIONER OF INTERNAL REVENUE SERVICE,

APPELLEE

On Appeal from the Decision

of the United States Tax Court

Kathleen Pakenham argued the cause for appellant. With

her on the briefs were Stephen D. Gardner, Adriana Lofaro

Wirtz, and Clint Massengill.

Jacob Earl Christensen, Attorney, U.S. Department of

Justice, argued the cause for appellee. With him on the brief

was Richard Farber, Attorney.

Before: ROGERS and MILLETT, Circuit Judges, and

GINSBURG, Senior Circuit Judge.

Opinion for the Court filed by Senior Circuit Judge

GINSBURG.

2

GINSBURG, Senior Circuit Judge: RERI Holdings, LLC

(RERI) claimed a charitable contribution deduction of $33

million on its 2003 federal tax return. The Internal Revenue

Service determined that RERI was not entitled to this deduction

and imposed a 40% penalty for underpayment of tax. RERI

unsuccessfully challenged both rulings before the Tax Court,

and now appeals to this court on a variety of grounds. For the

reasons set forth below, we affirm the judgment of the Tax

Court.

I. Background

At a high level of generality, the facts of this case are

simple: RERI acquired and donated a future interest in a piece

of commercial property to the University of Michigan. RERI

maintains the donation is a bona fide deduction that it valued

reasonably at $33 million. The IRS says RERI artificially

inflated the value of the donated property in order to offset the

tax liability of its owners.

The corporate arrangements and transactions involved in

this case are fairly complicated. For the sake of clarity, we lay

them out in some detail.

A. Facts

On February 7, 2002, RS Hawthorne, LLC — a shell

company, whose only member was RS Hawthorne Holdings,

LLC (RSHH), the only member of which was Red Sea Tech I,

Inc. — purchased a 288,000 square-foot web-hosting facility

located in Hawthorne, California for $42,350,000. At the time

of the purchase, the Hawthorne Property was leased to AT&T.

The lease had an initial term of 15.5 years, ending in May 2016;

AT&T then had the option to renew it three times for periods

3

of five years each. The rent for each year during the initial term

was spelled out in the lease; if AT&T renewed the lease, then

the rent would be re-set at the then-market rate but not less than

$14 per square foot per year.

RS Hawthorne financed its purchase with a mortgage loan

from BB&T Bank. In connection with the loan, BB&T had the

Hawthorne Property appraised by Bonz/REA, Inc. The

appraisal “concluded that the Hawthorne property was worth

$47 million as of August 16, 2001.” RERI Holdings I, LLC v.

Comm’r, 149 T.C. 1, 4 (2017).

Also on February 7, 2002, Red Sea divided its member

interest in RSHH into two temporal interests: (1) a Term of

Years (TOYS) interest lasting until December 31, 2020 and (2)

the remainder, which the Tax Court refers to as the “successor

member interest” (SMI). The SMI in RSHH is the donated

property at issue in this case. Red Sea assigned the TOYS

interest to PVP-RSG Partnership and sold the SMI to a

company called RJS Realty Corporation for $1,610,000. The

4

agreement assigning the SMI to RJS imposes several

conditions on Red Sea’s TOYS interest, which the Tax Court

assumed would also bind subsequent assignees. Id. at 6 n.4.

First, the TOYS holder is prohibited from “causing or

permitting any transfer of the Hawthorne property or the

member interest in [RS] Hawthorne or the imposition of any

lien or encumbrance on either” and is obligated to “take all

reasonable actions necessary” to prevent waste of the

Hawthorne property. Id. at 5. Of particular relevance to this

appeal, the assignment also contained a non-recourse

provision:

In the event of any Breach of the provisions of this

Assignment on the part of Assignor or any of its

successors in interest hereunder, the recourse of

Assignee or any of its successors in interest hereunder

shall be strictly limited to the [TOYS interest]. In no

event may any relief be granted that imposes on the

owner from time to time of the [TOYS interest] any

personal liability, it being understood that any and all

remedies for any breach of the provisions hereof shall

be limited to such owner's right, title and interest in

and to the [TOYS interest].

In March 2002 RERI purchased the SMI from RJS for

$2,950,000. RERI was a limited liability company that was

formed on March 4, 2002 and dissolved on May 11, 2004.

RERI Holdings I, LLC v. Comm’r, 107 T.C.M. (CCH) 1488,

1489 (2014).

In August 2003 Stephen M. Ross, one of RERI’s members,

pledged a gift of $4 million to the University of Michigan; he

later increased the pledge to $5 million. In partial fulfillment

of Ross’s pledge, RERI assigned the SMI to the University

pursuant to a Gift Agreement dated August 27, 2003. The Gift

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Agreement provided, among other things, that the University

“shall hold the Remainder Estate for a minimum of two years,

after which the University shall sell the Remainder Estate in a

manner and to a buyer of its choosing.”

In December 2005 the University sold the SMI to HRK

Real Estate Holdings, LLC for $1,940,000 although it had had

the property appraised at $6.5 million earlier that year. The

parties have stipulated that the sale price did not represent the

fair market value of the SMI. The buyer, HRK, was indirectly

owned in part by Harold Levine, one of RERI’s members. The

proceeds of the sale were credited toward Ross’s pledge.

B. Procedural History

Because RERI is treated as a partnership for federal

income tax purposes, it filed a 2003 federal income tax return

for informational purposes only; the actual taxpayers are the

owners of shares in the LLC. RERI claimed a charitable

contribution deduction of $33,019,000 for the transfer of a

noncash asset, $32,935,000 of which represented the purported

value of the donated SMI. (The remaining $84,000 was for

appraisal and professional fees.) The valuation of

approximately $33 million derives from an appraisal conducted

by Howard Gelbtuch of Greenwich Realty Advisors, dated

September 2003. As required by Treasury regulations, RERI

attached the Gelbtuch appraisal to its return. RERI also

completed a Form 8283 for Noncash Charitable Contributions;

however, RERI left blank the space for “Donor’s cost or

adjusted basis.” It did not provide any explanation for the

omission.

The IRS thereafter selected RERI for audit and in March

2008 issued a Notice of Final Partnership Administrative

Adjustment (FPAA). It disallowed $29 million of RERI’s

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deduction, based upon its determination that the SMI was

worth only $3.9 million. Accordingly, it also imposed a

penalty equal to 20% of the tax underpayment for a substantial

valuation misstatement, pursuant to IRC § 6662(e)(1). 1

In April 2008 RERI filed a petition in the Tax Court

challenging the FPAA. In its answer, the IRS revised its

determinations, asserting RERI was entitled to no deduction for

a charitable contribution on the ground that the transaction

giving rise to the deduction was “a sham for tax purposes or

lacks economic substance.” It argued in the alternative that the

deduction should be limited to $1,940,000, the amount the

University had realized from the sale of the SMI. Finally, the

IRS claimed the valuation misstatement was “gross” rather

than merely “substantial,” triggering a penalty equal to 40% of

the tax underpayment. See IRC § 6662(h)(1).

After a four-day trial, the Tax Court issued a judgment

sustaining both the IRS’s determination that RERI was not

entitled to any charitable contribution deduction and its

assessment of the 40% penalty. The Tax Court, however, did

not base its decision upon the “lack of economic substance”

theory advanced by the IRS; instead, it concluded that RERI

had failed to substantiate the value of the donated property as

required by Treasury regulations. 2 149 T.C. at 17.

1

All references to the Internal Revenue Code and Treasury

regulations contained herein refer to the 2003 version in effect during

the tax year at issue.

2

The IRS acknowledges that it did not raise the substantiation issue

at any point during the proceedings before the Tax Court, and that

RERI consequently did not have notice of the issue or an opportunity

to argue that it substantially complied with the regulations. Yet,

RERI does not argue to this court that it was denied procedural due

process as a result, nor did it file a motion for reconsideration before

7

Nonetheless, on its way to affirming the penalty for a gross

valuation misstatement, the Tax Court found the SMI was

worth $3,462,886 on the date of the donation. The court also

held RERI did not qualify for the “reasonable cause” exception

to accuracy-related penalties. See IRC § 6664(c).

II. The Charitable Contribution Deduction

RERI first challenges the Tax Court’s ruling that it was not

entitled to a charitable contribution deduction.

A. Statutory Framework

Section 170 of the Internal Revenue Code permits a

taxpayer to claim a deduction for a contribution to a charitable

organization. This deduction can be abused by a taxpayer who

inflates the valuation of the donated property. For that reason,

IRC § 170(a)(1) provides that “[a] charitable contribution shall

be allowable as a deduction only if verified under regulations

prescribed by the Secretary.”

In the Deficit Reduction Act of 1984 (DRA), the Congress

directed the Secretary of the Treasury to increase the stringency

of its requirements for verification. Pub. L. No. 983-69,

§ 155(a)(1), 98 Stat. 494, 691. Specifically, the DRA instructs

the Secretary to promulgate regulations that require a taxpayer

claiming a deduction for a noncash charitable contribution

A. to obtain a qualified appraisal for the property

contributed,

the Tax Court. See Tax Court Rule 161. We therefore consider any

such argument forfeit. See, e.g., United States v. TDC Mgmt. Corp.,

Inc., 827 F.3d 1127, 1130 (D.C. Cir. 2016).

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B. to attach an appraisal summary to the return on

which such deduction is first claimed for such

contribution, and

C. to include on such return such additional

information (including the cost basis and

acquisition date of the contributed property) as

the Secretary may prescribe in such regulations.

In fulfillment of this mandate, the Secretary promulgated 26

C.F.R. § 1.170A-13, subsection (c) of which is most relevant

to this case. Paragraph (c)(2) instantiates the three statutory

requirements: The donor must (A) “[o]btain a qualified

appraisal”; (B) “[a]ttach a fully completed appraisal summary

... to the tax return”; and (C) “[m]aintain records” containing

specified information. Paragraph (c)(3) defines a “qualified

appraisal” and paragraph (c)(4) details the necessary elements

of an “appraisal summary,” one of which is “[t]he cost or other

basis of the property.” § 1.170A-13(c)(4)(ii)(E). The taxpayer

must provide the appraisal summary on IRS Form 8283.

§ 1.170A-13(c)(4)(i)(A).

A deduction is typically disallowed if these requirements

are not met. There is an exception, however, “[i]f a taxpayer

has reasonable cause for being unable to provide the

information ... relating to the manner of acquisition and basis

of the contributed property” in the appraisal summary.

§ 1.170A-13(c)(4)(iv)(C)(1). In that case, the deduction will

still be allowed if the donor attaches “an appropriate

explanation” to the appraisal summary. Id.

B. Application

The Tax Court disallowed RERI’s charitable donation

deduction on the ground that it failed to comply with the

substantiation requirements. First, the Tax Court held “the

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reporting requirements of section 1.170A-13, Income Tax

Regs., are directory and not mandatory,” such that a taxpayer

who “substantially complies” with the requirements is entitled

to the claimed deduction. 149 T.C. at 15 (citing Bond v.

Comm’r, 100 T.C. 32, 40-41 (1993)) (cleaned up). The court

went on to conclude that RERI failed substantially to comply

because it did not disclose its basis in the donated property.

The IRS urges this court to affirm the Tax Court on the

alternative theory that substantial compliance with the

regulation does not suffice, so that RERI’s failure to include

the basis on Form 8283 was automatically fatal. RERI, for its

part, does not dispute that it failed to supply its basis in the SMI

and to provide an explanation for the omission. Instead, RERI

maintains that the substantial compliance doctrine does apply

here, and that providing its basis in the donated property is not

necessary for compliance. It emphasizes that both the Second

Circuit and the Tax Court have concluded the substantiation

requirements can be satisfied by substantial compliance. See

Scheidelman v. Comm’r, 682 F.3d 189, 199 (2d Cir. 2012);

Bond, 100 T.C. at 40-41.

In general, the Tax Court’s determination as to whether an

appraisal summary and appraisal satisfy the requirements of the

Treasury Regulation is a mixed question of law and fact, which

we review only for clear error. Comm’r v. Simmons, 646 F.3d

6, 9 (D.C. Cir. 2011). We have not, however, previously

decided whether substantial compliance rather than literal

compliance suffices under § 1.170A-13 (or, for that matter,

under any other federal tax regulation). See id. at 12 n*.

Whether a taxpayer may satisfy the substantiation requirements

through substantial compliance is a purely legal question,

which we decide de novo. Byers v. Comm’r, 740 F.3d 668, 675

(D.C. Cir. 2014).

10

The Tax Court formulated the test for substantial

compliance as “whether the donor provided sufficient

information to permit the Commissioner to evaluate the

reported contributions, as intended by Congress.” 149 T.C. at

16 (quoting Smith v. Comm’r, 94 T.C.M. (CCH) 574, 586

(2007), aff’d, 364 F. App’x 317 (9th Cir. 2009)). The IRS

advocates a significantly more stringent test under which

anything short of complete compliance is excused only if “(1)

[the taxpayer] had a good excuse for failing to comply with the

regulation and (2) the regulation’s requirement is unimportant,

unclear, or confusingly stated in the regulations or statute.”

The Fourth, Fifth, and Seventh Circuits have adopted this

formulation of the substantial compliance standard, albeit for

different provisions of the tax code. See Volvo Trucks of N.

Am., Inc. v. United States, 367 F.3d 204, 210 (4th Cir. 2004);

McAlpine v. Comm’r, 968 F.2d 459, 462 (5th Cir. 1992);

Prussner v. United States, 896 F.2d 218, 224 (7th Cir. 1990).

We conclude that, even if a taxpayer can fulfill the

requirements of § 1.170A-13 through substantial compliance,

RERI failed substantially to comply because it did not disclose

its basis in the donated property; accordingly, we assume but

do not decide that substantial compliance suffices. As we read

the Tax Court’s decision, a taxpayer must supply its basis (or

an explanation for failing to do so) in order to “provide[]

sufficient information to permit the Commissioner to evaluate

the reported contributions, as intended by Congress.” 149 T.C.

at 16. If that is correct, and we think it is despite RERI’s

several arguments to the contrary, then we need not choose

between the Tax Court’s standard for substantial compliance

and the IRS’s more exacting one.

RERI first argues that the taxpayer’s basis in a donated

property is not necessary to evaluate the taxpayer’s charitable

contribution because the deductible amount is the fair market

11

value (FMV) of the property, and the basis is not an input in

calculating the fair market value. But RERI fails to recognize

that the purpose of the substantiation requirements is not

merely to collect the information necessary to compute the

value of donated property. The requirements have the broader

purposes of assisting the IRS in detecting and deterring inflated

valuations. Because the cost or other basis in property typically

corresponds with its FMV at the time the taxpayer acquired it,

an unusually large difference between the claimed deduction

and the basis alerts the IRS to a potential over-valuation,

particularly if the acquisition date, which must also be reported,

is not much earlier than the date of the donation. In addition,

as the Tax Court recognized, there are circumstances under

which the basis affects the amount of the deduction allowed.

149 T.C. at 17 n.11 (citing § 170(e)(1)(A), under which the

amount of a deduction must be reduced by “the amount of gain

which would not have been long-term capital gain,” had the

property “been sold … at its fair market value”). It is therefore

unsurprising that the DRA expressly lists “the cost basis ... of

the contributed property” as information to be provided in

substantiation of a charitable deduction. Though the Congress

left it to the discretion of the Secretary of the Treasury to

impose additional reporting requirements, the Congress

specifically identified the basis and the date of acquisition as

the bare minimum that a taxpayer must provide. We should be

very reluctant to set to naught what the Congress deemed

essential.

Moreover, in this case, the Tax Court found there was in

fact a “significant disparity between the claimed fair market

value [of $33 million] and the [$3 million] RERI paid to

acquire the SMI just 17 months before it assigned the SMI to

the University.” 149 T.C. at 17. Hence, the Tax Court did not,

as RERI claims, merely “hypothesize” that providing its basis

would have alerted the IRS to a potential over-valuation.

12

RERI contends in the alternative that the omission of a

number in a tax filing is typically construed as a zero, and that

a zero provides the same red flag as does an unusually low

basis. The point would have some force had the Secretary not

provided for the donor to substitute an explanatory statement if

it is “unable” to provide information on the cost basis.

§ 1.170A-13(c)(4)(iv)(C)(1). Because a taxpayer may lack

information about its basis, the IRS reasonably chose not

automatically to treat a blank box as a zero. RERI did not lack

information about its basis or have any other excuse for its

failure to report its basis.

Finally, RERI argues the Tax Court’s ruling “conflicts

with ... its prior holding in Dunlap v. Commissioner, 103

T.C.M. (CCH) 1689 (2012).” That the Tax Court came to a

conclusion in this case different from that in Dunlap does not

mean it clearly erred. In Dunlap, the court excused the

petitioners’ failure to supply their basis on Form 8283 on the

ground that supplying the basis was not “necessary to

substantially comply with the Instructions.” Id. at 1706.

A memorandum opinion, such as the one in Dunlap, does

not bind the Tax Court. See, e.g., Dunaway v. Comm’r, 124

T.C. 80, 87 (2005). In any event, Dunlap is quite different from

the present case. There the Tax Court discussed the

completeness of Forms 8283 only in deciding whether the

taxpayers had “made a good-faith attempt to report their

contributions” so as to qualify for the reasonable cause and

good faith exception to accuracy-related penalties. Dunlap,

103 T.C.M. at 1707; see also Belair Woods, LLC v. Comm’r,

T.C. Memo 2018-159, slip op. at 21 n.8 (Sept. 20, 2018). The

court did not consider whether the taxpayers satisfied the

substantiation requirements. Nor did the Dunlap court find

there was in fact a significant disparity between the basis and

13

the claimed deduction; there indisputably is such a disparity in

this case.

In short, we agree with the Tax Court that RERI fell short

of the substantiation requirements by omitting its basis in the

donated property. Therefore, we do not reach the IRS’s further

argument that RERI failed to satisfy the substantiation

requirements because the appraisal it submitted was not a

“qualified appraisal” within the meaning of § 1.170A-13(c)(3).

III. The Valuation Misstatement Penalty

Having affirmed the Tax Court’s denial of the charitable

contribution deduction, we proceed to consider whether the

Tax Court properly approved a penalty for misstating the value

of the donated property. IRC § 6662 instructs the IRS to levy

an “accuracy-related penalty” if “any portion of an

underpayment of tax” in excess of $5,000 is “attributable to ...

[a]ny substantial valuation misstatement.” IRC §§ 6662(a),

(b)(3), and (e)(2). If the taxpayer claims the value of the

property for which it seeks a charitable deduction is 200% or

more of the true value of the property, then the misstatement is

“substantial,” § 6662(e)(1)(A), and the penalty is 20% of the

resulting underpayment of tax. § 6662(a). If the taxpayer’s

claimed value is 400% or more of the true value, then the

misstatement is “gross,” § 6662(h)(2)(A), and the penalty is

40% of the resulting underpayment. §§ 6662(a), (h)(1).

IRC § 6664(c), however, provides a defense to the

accuracy-related penalty: “No penalty shall be imposed ... with

respect to any portion of an underpayment if it is shown that

there was a reasonable cause for such portion and that the

taxpayer acted in good faith with respect to such portion.”

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The Tax Court found RERI liable for the 40% penalty

reserved for a gross valuation misstatement because its stated

value of the donated property ($33 million) is more than 400%

of the true value of the property ($3,462,886), as determined

by the court. 149 T.C. at 37. RERI raises four objections to

this ruling, each of which would be an independent ground for

reversal. We reject all of them and affirm the judgment of the

Tax Court. 3

A. Supervisory Approval Requirement

RERI first contends the IRS failed to meet a procedural

requirement in IRC § 6751(b)(1), which provides:

No penalty under this title shall be assessed unless the

initial determination of such assessment is personally

approved (in writing) by the immediate supervisor of

the individual making such determination or such

higher level official as the Secretary may designate.

The IRS concededly did not present evidence establishing

that it had met this requirement. At the time of the proceedings

below, the IRS took the position that the statute does not

require approval until assessment, which does not occur until a

decision of the Tax Court becomes final. See also Graev v.

Comm’r, 147 T.C. 460, 478 (2016) (Graev I) (adopting the

IRS’s position).

3

The parties dispute whether the IRS bore the burden of production

in the Tax Court pursuant to § 7491(c) with regard to RERI’s liability

for the penalty. We need not decide the issue, however, because the

IRS clearly met that burden with respect to the three challenges that

were not forfeited.

15

RERI, however, failed to raise its objection before the Tax

Court, which would ordinarily mean it is forfeit. See, e.g.,

Petaluma FX Partners, LLC v. Comm’r, 792 F.3d 72, 78 (D.C.

Cir. 2015). RERI attempts to avoid this result on the ground

that a recent Second Circuit decision, Chai v. Commissioner,

851 F.3d 190 (2017), represents an “intervening change in

law.” In Chai the court held written approval must be obtained

“no later than the date the IRS issues the notice of deficiency

(or files an answer or amended answer) asserting such penalty.”

Id. at 221; see also Graev v. Comm’r, 149 T.C. 485, 493 (2017)

(Graev II) (vacating Graev I in light of Chai).

RERI asks us to excuse its failure to raise this argument

before the Tax Court on the ground that prior to Chai it did not

clearly have a claim the IRS violated § 6751(b)(1).

Fiddlesticks. The fact is that when RERI was before the Tax

Court, it “was free to raise the same, straightforward statutory

interpretation argument the taxpayer in Chai made” there.

Mellow Partners v. Comm’r, 890 F.3d 1070, 1082 (D.C. Cir.

2018); accord Kaufman v. Comm’r, 784 F.3d 56, 71 (1st Cir.

2015). We therefore see no reason to excuse RERI’s failure to

preserve its claim.

B. “Attributable to” Requirement

Recall that an accuracy-related penalty applies only to the

“portion of the underpayment ... attributable to one or more

gross valuation misstatements.” § 6662(h)(1). RERI’s second

argument is that, even if it misstated the value of the donated

property, its underpayment is not “attributable to” that

misstatement within the meaning of the penalty statute because

the Tax Court’s stated reason for disallowing the deduction —

which resulted in the underpayment — was RERI’s failure

properly to substantiate the donation per IRC § 170 and the

associated regulations. This ground for the adjustment does

16

not relate to a misstatement of the value of the contributed

property. Subsequently, however, the Tax Court also

determined the taxpayer misstated the value of the donated

property. In these circumstances, is the underpayment fairly

“attributable to” the valuation misstatement? Put another way,

can an underpayment be attributable to two independent

grounds for an adjustment?

Consistent with its own precedent, the Tax Court answered

this question in the affirmative. 149 T.C. at 21 (citing AHG

Invs., LLC v. Comm’r, 140 T.C. 73 (2013)). Because the proper

interpretation of the phrase “attributable to” is a legal issue, we

resolve the question de novo. See Byers, 740 F.3d at 675. For

the reasons that follow, we agree with the Tax Court that an

underpayment can be “attributable to” more than one cause if

one of the causes is a misstatement of value.

To begin, nowhere does the statute suggest there can be

only a single cause for an underpayment. The phrase

“attributable to” comfortably comprehends situations in which

the IRS has multiple reasons for adjusting a charitable

deduction. Moreover, as the First Circuit has recognized,

RERI’s reading of § 6662 has the perverse result of “allow[ing]

the taxpayer to avoid a penalty otherwise applicable to his

conduct on the ground that the taxpayer had also engaged in

additional violations that would support disallowance of the

claimed losses.” Fidelity Int’l Currency Advisor A Fund, LLC

v. United States, 661 F.3d 667, 673 (2011). A penalty is meant

to deter and punish abuse of the tax laws; those purposes would

be frustrated if it were interpreted in such a way as to reward a

taxpayer for committing multiple abuses. See id.

RERI nonetheless advances an argument based principally

upon the Supreme Court’s decision in United States v. Woods,

571 U.S. 31 (2013), which postdates the precedent upon which

17

the Tax Court relied. In Woods the district court had concluded

the taxpayers’ partnerships lacked economic substance; it

therefore disallowed deductions for losses generated by those

partnerships. Id. at 37. The taxpayer argued that a penalty

under § 6662 for misstatement of its basis did not apply

because the underpayment was “attributable to” the lack of

economic substance as opposed to the misstatement of its basis.

Id. at 46-47. The Court rejected the argument because “the

economic-substance determination and the basis misstatement

are not ‘independent’ of one another.” Id. at 47. On the

contrary, they were “inextricably intertwined”: “The partners

underpaid their taxes because they overstated their outside

basis, and they overstated their outside basis because the

partnerships were shams.” Id. (cleaned up).

RERI reads this decision to imply that, had the two

grounds for disallowance been independent rather than

“inextricably intertwined,” the Court would not have upheld

the penalty. That implication is unfounded: Having “reject[ed]

the argument’s premise,” the Court did not reach Woods’s

claim that the underpayment was attributable only to one of the

two “independent legal ground[s].” Id.

As RERI points out, however, the Fifth and Ninth Circuits

have adopted its position. See Todd v. Comm’r, 862 F.2d 540,

542 (5th Cir. 1988); Gainer v. Comm’r, 893 F.2d 225, 228 (9th

Cir. 1990). Like the First Circuit in Fidelity and the Federal

Circuit in Alpha I, L.P. ex rel. Sands v. United States, 682 F.3d

1009 (2012), we regard the reasoning in those cases as flawed.

Both cases relied upon the General Explanation of the

Economic Recovery Tax Act of 1981, also known as the “Blue

Book.” Todd, 862 F.2d at 542-43; Gainer, 893 F.2d at 227-28.

Prepared by the staff of the Joint Committee on Taxation, the

Blue Book explains how to calculate a valuation misstatement

penalty: “The portion of a tax underpayment that is attributable

18

to a valuation overstatement will be determined after taking

into account any other proper adjustments to tax liability.”

Staff of the J. Comm. on Taxation, 97th Cong., General

Explanation of the Economic Recovery Tax Act of 1981, at 333

(Comm. Print 1981). In particular, Todd and Gainer focused

upon the following example:

Assume ... an individual files a joint return showing

taxable income of $40,000 and tax liability of $9,195.

Assume, further, that a $30,000 deduction which was

claimed by the taxpayer as the result of a valuation

overstatement is adjusted down to $10,000, and that

another deduction of $20,000 is disallowed totally for

reasons apart from the valuation overstatement.

These adjustments result in correct taxable income of

$80,000 and correct tax liability of $27,505.

Accordingly, the underpayment due to the valuation

overstatement is the difference between the tax on

$80,000 ($27,505) and the tax on $60,000 ($17,505)

... or $9,800.

Id. at 333 n.2, quoted in Todd, 862 F.2d at 543, and in Gainer,

893 F.2d at 228 n.4. From this example, both courts concluded

that, when there is another reason for disallowing a deduction,

the taxpayer’s overvaluation “becomes irrelevant to the

determination of any tax due.” Gainer, 893 F.2d at 228. The

Federal Circuit has aptly explained the flaw in that reasoning:

The Blue Book ... offers the unremarkable proposition

that, when the IRS disallows two different deductions,

but only one disallowance is based on a valuation

misstatement, the valuation misstatement penalty

should apply only to the deduction taken on the

valuation misstatement, not the other deduction,

which is unrelated to valuation misstatement. The

19

court in Todd mistakenly applied that simple rule to a

situation in which the same deduction is disallowed

based on both valuation misstatement- and non-

valuation-misstatement theories.

Alpha I, L.P., 682 F.3d at 1029.

We note also that more recent Fifth and Ninth Circuit

decisions retreat from Todd and Gainer. In PBBM-Rose Hill,

Ltd. v. Commissioner, for instance, the Tax Court had denied

PBBM’s charitable contribution deduction for failing to meet

the statutory requirements for “a qualified conservation

easement.” 900 F.3d 193, 209 (5th Cir. 2018). The Fifth

Circuit nonetheless affirmed the Tax Court’s imposition of a

penalty for a gross valuation misstatement for having also

misstated the value of the easement. Id. at 215; see also Keller

v. Comm’r, 556 F.3d 1056, 1060-61 (9th Cir. 2009)

(recognizing the approach we take here as “sensible,” but

explaining that its decision is “constrained by Gainer”).

In sum, because the Tax Court determined that RERI made

a gross valuation misstatement and that misstatement was an

independent alternative ground for adjusting RERI’s

deduction, the penalty properly applies.

C. Whether RERI Misstated the Value of the Donated

Property

Next, RERI contests the Tax Court’s factual finding that it

grossly misstated the value of the donated property. The Tax

Court determined that the correct value of the SMI was

$3,462,886; the $33 million RERI reported was well over

400% of that figure. 149 T.C. at 37. RERI maintains the Tax

Court undervalued the SMI as a result of two independent

errors. First, RERI claims the Tax Court was required to

20

determine the value of the SMI using actuarial tables, pursuant

to IRC § 7520. Second, RERI argues that, even if the Tax

Court did not err in setting aside the actuarial tables, it applied

too-high a discount rate in calculating the fair market value of

the donated property.

1. Applicability of the actuarial tables

In general, a deduction for a charitable contribution is

equal to “the fair market value [FMV] of the property at the

time of the contribution.” 26 C.F.R. § 1.170A-1(c)(1).

Treasury regulations define FMV as “the price at which the

property would change hands between a willing buyer and a

willing seller, neither being under any compulsion to buy or

sell and both having reasonable knowledge of relevant facts.”

§ 1.170A-1(c)(2).

As the Tax Court recognized, however, “the willing buyer-

willing seller standard is not applied directly” to a remainder

interest, 149 T.C. at 25, the value of which depends upon

various economic and demographic facts, such as the

applicable depreciation rate or the life expectancy of the holder

of a life estate. Because making and — for the IRS —

evaluating case-specific estimates would be inefficient, IRC

§ 7520(a) instructs that “the value of any annuity, any interest

for life or a term of years, or any remainder or reversionary

interest shall be determined ... under tables prescribed by the

Secretary.” Published periodically by the IRS, these tables

contain actuarial factors that “divide the fair market value of

the underlying property among the several interests in the

property.” 149 T.C. at 25. The factors incorporate uniform

assumptions in order to make valuations more convenient and

consistent. As a result, they inevitably produce estimates that

differ somewhat from a more particularized calculation of the

FMV of any specific partial interest.

21

Some situations, however, may be so inconsistent with the

assumptions underlying the tables that actuarial valuation will

not produce a reasonably accurate estimate. For that reason,

the implementing regulations contain various exceptions. See

26 C.F.R. § 1.7520-3. As relevant here, § 1.7520-3(b)(2)(iii)

prohibits the use of the tables to calculate the value of a

remainder or reversionary interest unless the relevant legal

instruments “assure that the property will be adequately

preserved and protected (e.g., from erosion, invasion,

depletion, or damage) until the remainder or reversionary

interest takes effect in possession and enjoyment.” Without

that protection, there is a risk that waste or other damage will

impair the value of the future interest, which risk is not

reflected in the actuarial tables. Hence, the exception provides

the appropriate valuation is “the actual [FMV] of the interest

(determined without regard to section 7520) ... based on all of

the facts and circumstances.” § 1.7520-3(b)(1)(iii).

In this case, the Tax Court ruled that the § 7520 tables were

inapplicable because “the SMI does not meet the adequate

protection requirement” quoted above. 149 T.C. at 27. The

court went on to make an independent valuation of the SMI of

$3.4 million based upon evidence introduced at trial. Id. at 37.

As an initial matter, RERI contends the applicability of the

tables is a legal determination to be reviewed de novo. See

Anthony v. United States, 520 F.3d 374, 377 (5th Cir. 2008)

(applying de novo review to the question whether the

taxpayer’s annuities were restricted beneficial interests). We

disagree. Whether the agreements governing the SMI

“adequately preserved and protected” it within the meaning of

§ 1.7520-3(b)(2)(iii) is a mixed question of law and fact. We

22

therefore review the Tax Court’s decision for clear error and,

as explained below, see none. 4

The Treasury regulations indicate protection is adequate if

it is “consistent with the preservation and protection that the

law of trusts would provide for a person who is unqualifiedly

designated as the remainder beneficiary of a trust for a similar

duration.” § 1.7520-3(b)(2)(iii). In this case, the assignment

agreement contained a non-recourse provision under which the

liability of the TOYS holder is “strictly limited to” early

forfeiture of the property. Consequently, in the event of waste

or other harm to the property, the only recourse of the SMI

holder (the University) is to take possession of the damaged

property; the SMI holder does not have the right to sue the

TOYS holder for damages. By contrast, a trustee that failed to

preserve and maintain a trust asset would be liable to the

remainderman for damages. See, e.g., United States v.

Mitchell, 463 U.S. 206, 226 (1983). Indeed, as the Tax Court

recognized, “the holder of a remainder interest in property,

even outside of a trust, would be protected against waste and

other actions that would impair the value of the property.” 149

T.C. at 28. The Tax Court therefore concluded “the inability

of the SMI holder to recover damages for waste or other acts

that prejudice its interests exposes the SMI holder to a

sufficient risk of impairment in value that the SMI holder does

not enjoy a level of protection consistent with that provided by

the law of trusts.” Id. at 26-27.

RERI does not dispute the Tax Court’s interpretation of

the assignment agreement or its understanding of the law of

4

As a result, we need not pass upon the IRS’s alternative theory that

the SMI is a “restricted beneficial interest” to which the actuarial

factors do not apply. See § 1.7520-3(b)(1)(ii).

23

trusts. Instead, RERI claims the exceptions to § 7520 are to be

construed narrowly and applied in only limited circumstances.

RERI accuses the Tax Court of ignoring the protections the

assignment agreement does contain, in effect requiring the

property to be “perfectly preserved and protected” rather than

“adequately preserved and protected.” At the outset, we do not

agree the exceptions are to be applied, as RERI claims, “only

when the circumstances indicate there is little likelihood that

the interest being valued will have any meaningful worth.” To

the contrary, the regulation expressly states protection is

adequate

only if it was the transferor’s intent, as manifested by

the provisions of the arrangement and the surrounding

circumstances, that the entire disposition provide the

remainder or reversionary beneficiary with an

undiminished interest in the property transferred at the

time of the termination of the prior interest.

§ 1.7520-3(b)(2)(iii). Moreover, the Tax Court did not require

that the SMI be preserved as if it were held in trust. For one,

the court did not specify that the SMI holder must be made

whole in the event of waste or other material breach, see

Restatement (Third) of Trusts § 100 (Am. Law Inst. 2012); it

simply held there must be some remedy beyond early

forfeiture. Although there is no doubt some daylight between

the law of trusts and what is required to satisfy § 1.7520-

3(b)(2)(iii), we cannot say the Tax Court clearly erred in

concluding the level of protection here is “inadequate.” We

therefore affirm its decision not to apply the actuarial tables.

2. Actual fair market value

Because it found the actuarial tables were inapplicable, the

Tax Court calculated “the actual [FMV]” of the SMI as of

24

August 2003, the date of the gift, using the “discounted cash

flow method.” See 149 T.C. at 29. The premise of this method

is that the value of an asset is equal to the future income it is

expected to produce, discounted to the valuation date. The

discount rate used should account for both the time value of

money and the risk of the future income stream not

materializing. Thus, a higher discount rate implies the future

cash flow is more uncertain.

Applying this method, the Tax Court first projected the

cash flow for the SMI in perpetuity starting from January 1,

2021, when the SMI becomes possessory. Id. The court then

discounted that amount to August 2003, using a discount rate

of 17.75% rather than RERI’s proffered rate of 11.01%. 149

T.C. at 30, 32, 36. RERI now challenges the Tax Court’s

calculation of the actual FMV of the SMI solely on the ground

that the court used “a wildly inflated discount rate,” leading it

to understate the value of the property.

We review the Tax Court’s selection of the appropriate

discount rate for clear error. See Energy Capital Corp. v.

United States, 302 F.3d 1314, 1332 (Fed. Cir. 2002) (“The

appropriate discount rate is a question of fact”). In so doing,

we are mindful that valuation is not an exact science; it requires

making the most of the available data. We therefore defer to

the Tax Court’s choice of discount rate so long as it “is

plausible in light of the record viewed in its entirety.”

Anderson, 470 U.S. at 574 (“Where there are two permissible

views of the evidence, the factfinder’s choice between them

cannot be clearly erroneous”).

To determine the discount rate, the Tax Court relied upon

the analysis of Dr. Michael Cragg, one of the IRS’s experts;

details of his analysis are laid out in the Appendix. Of

relevance here, Dr. Cragg’s method was based upon the

25

premise that the $42.35 million RS Hawthorne paid for the

Hawthorne Property represented the fee value of that property

in February 2002, which in turn was equal to the discounted

value of future cash flow in perpetuity. By calculating cash

flow from 2002 onward, Dr. Cragg solved for the discount rate

implied by that fee value. This produced a discount rate of

18.99%, which implies “a risk premium of 13.39% over the

February 2002 long-term applicable Federal rate (AFR) of

5.6%.” 149 T.C. at 30 (citing Rev. Rul. 2002-5, 2002-1 C.B.

461). The AFR, which is published monthly by the IRS,

approximates the interest rate on Treasury securities, IRC §

1274(d); it represents the risk-free time value of money.

Because Dr. Cragg’s analysis was “directed at a [valuation]

date other than August 27, 2003,” the court adjusted his rate “to

reflect changes in the AFR between February 2002 and August

2003.” 149 T.C. at 35-36. That is, it added Dr. Cragg’s risk

premium of 13.39% to the August 2003 AFR of 4.36%, which

produced a discount rate of 17.75%. Id. at 36.

RERI challenges that discount rate on the grounds that the

Tax Court erroneously (1) adopted Dr. Cragg’s “novel and

untested” method for deriving the risk premium; (2) accepted

Dr. Cragg’s flawed factual assumptions in applying this

method; and (3) made an insufficient adjustment to correct for

Dr. Cragg’s use of the wrong valuation date.

As to its first point, we see nothing at all problematic about

rearranging the commonly recognized discounting formula to

solve for the discount rate. RERI’s primary complaint appears

to be that the Tax Court should have adopted the “commonly

recognized method” used by RERI’s expert, Mr. James Myers.

He applied a discount rate of 11%, based upon “investor return

rates for comparable commercial properties,” increased for the

greater uncertainty of a longer-term projection. The Tax Court

explained why it found Dr. Cragg’s method “more credible”

26

than that of Mr. Myers: “Dr. Cragg’s analysis gives more

account to the difference in risk between the expected

cashflows during and after the initial period of the AT&T

lease.” 149 T.C. at 32. The Tax Court’s desire to account for

the change in risk after the initial period of the AT&T lease —

for which the rents are not yet determined — is perfectly

reasonable.

RERI further objects that Dr. Cragg did not check his

results against “market data” to confirm “his conclusion that at

the relevant period investors would have applied a discount rate

of 18.99%.” For instance, RERI would have had Dr. Cragg

incorporate evidence it introduced through its expert

“regarding the data center industry, the market conditions in

the area around the Property, the condition of the Property,

zoning, and market rent for powered shell data centers,

including lease comparables.” Dr. Cragg did not need to rely

upon this evidence because he was using actual data specific to

the Hawthorne Property, to wit, the sale price of the fee interest

and the terms of AT&T’s lease. To be sure, comparing his

results against market data might have bolstered the analysis,

but failing to do so does not amount to clear error.

RERI next challenges two of the inputs Dr. Cragg used to

calculate the discount rate. The first is another discount rate.

Part of Dr. Cragg’s method involved calculating the value of

the cash flow through May 2016 — the end of the initial term

on the AT&T lease — in February 2002 dollars. In doing so,

Dr. Cragg used a 7.92% discount rate. RERI argues that this

rate — which approximates AT&T’s corporate bond rate for a

14-year bond as of March 2002 — is inappropriate for valuing

an illiquid asset such as the Hawthorne Property. According to

RERI, the Tax Court should have added a 1.5 percentage point

liquidity premium. The higher discount rate would give the

cash flow during the initial lease term a lower present value,

27

which results in a higher present value for the post-2016 cash

flow, which then supports a higher valuation for the donated

future interest. As the IRS aptly explains, however, “the only

relevant risk in determining the present value of projected cash

flows during the initial lease term was AT&T’s credit risk” —

which is analogous to the risk of AT&T defaulting on its debt

obligations, as reflected in its corporate bond rate.

Accordingly, we see no clear error in the Tax Court’s relying

upon this analogy.

Another input the Tax Court needed was the fee value of

the Hawthorne property as of August 2003. The court, like Dr.

Cragg, used the $42.35 million that RS Hawthorne had paid for

the property. RERI objects that the sale took place in February

2002, “18 months before the correct valuation date.” RERI

would have us use its expert’s $52 million estimate of the fee

value as of August 2003. To be sure, the Tax Court could

reasonably have undertaken to adjust the $42.35 million figure

for changes in market conditions during that period; RERI had

introduced evidence relevant to the task. Instead, the Tax

Court, again reasonably, adopted Dr. Cragg’s estimate of the

discount rate for February 2002 and then adjusted that rate to

reflect the change in the AFR over the relevant time period.

Relatedly, RERI argues the Tax Court’s adjustment did not

suffice to correct Dr. Cragg’s use of the wrong valuation date.

The Tax Court accounted only for the change in the AFR,

whereas RERI contends Dr. Cragg’s risk premium was too high

because there was also a change in market conditions between

April 2002 and August 2003; that is, long-term rental values

rose during the intervening months. As a result, says RERI, the

expected post-May 2016 cash flow should have been higher

than in Dr. Cragg’s analysis, which would have produced a

lower discount rate.

28

Because AT&T’s lease specified the rent only through

2016, Dr. Cragg approximated post-2016 rents by assuming

they would increase by 3.29% each year thereafter; he derived

this growth rate from “an index of U.S. commercial real estate

prices.” 149 T.C. at 10. There are limits to the precision with

which the Tax Court can reasonably be expected to estimate

the inputs to its valuation. Accordingly, we reject RERI’s

suggestion that the Tax Court be required to incorporate every

available piece of data that might have affected the expected

future cash flow from the SMI. Indeed, RERI does not itself

calculate how the Tax Court’s valuation would have been

different had it incorporated every datum that RERI proffered,

except to say that future cash flow would have been “millions

of dollars higher.” Under these circumstances, we cannot say

the Tax Court clearly erred.

D. Reasonable Cause Exception

We come now to RERI’s final argument, viz., that it

qualifies for the exception to a value-misstatement penalty

because “there was a reasonable cause” for the underpayment

and “the taxpayer acted in good faith.” IRC § 6664(c)(1). In

charitable contribution cases, § 6664(c)(3) provides more

specifically that the exception applies only if:

A. the claimed value of the property was based on a

qualified appraisal made by a qualified appraiser,

and

B. in addition to obtaining such appraisal, the

taxpayer made a good faith investigation of the

value of the contributed property.

29

1. Burden of proof

The taxpayer typically bears the burden of showing that it

qualifies for the reasonable cause and good faith exception.

Barnes v. Comm’r, 712 F.3d 581, 584 (D.C. Cir. 2013). That

is, the taxpayer must prove that both elements of § 6664(c)(3)

are satisfied.

According to RERI, however, this general rule is

superseded here by Tax Court Rule 142(a)(1), which provides

that “[t]he burden of proof” is upon the Commissioner “in

respect of any new matter, increases in deficiency, and

affirmative defenses, pleaded in the answer.” In this case, the

IRS originally applied only a substantial valuation

misstatement penalty; not until it filed its second amendment

to its answer to RERI’s petition before the Tax Court did the

IRS seek to impose a gross valuation misstatement penalty.

The Tax Court has previously stated that an increase in the

amount of a penalty or addition to tax asserted in an answer is

a “new matter” on which the IRS bears the burden of proof.

See Rader v. Comm’r, 143 T.C. 376, 389 (2014); Arnold v.

Comm’r, 86 T.C.M. (CCH) 341, 344 (2003). The Tax Court

has further held that when the IRS bears the burden of proof as

to a penalty, it must negate any defense thereto, such as a

taxpayer’s reasonable cause and good faith. See Cavallaro v.

Comm’r, 108 T.C.M. (CCH) 287, 299 (2014). Hence, RERI

claims the change from a “substantial” to a “gross” penalty was

a “new matter” as to which the IRS bears the burden of proving

RERI lacked reasonable cause for its underpayment.

In this case, the Tax Court assumed RERI was correct and

that the IRS therefore bore the burden of proving the absence

of reasonable cause; the court then held the IRS had carried its

burden. 149 T.C. at 40. Typically, we review the Tax Court’s

application of the reasonable cause and good faith exception

30

for clear error. See Green Gas Del. Statutory Tr. v. Comm’r,

903 F.3d 138, 146 (D.C. Cir. 2018). But the appropriate

construction of the Tax Court’s rule regarding the burden of

proof is a purely legal question, which we decide de novo.

We agree with the Tax Court’s decision not to excuse

RERI’s gross valuation misstatement under the reasonable

cause and good faith exception, albeit for a slightly different

reason: RERI bore the burden of proving it had met the

requirements and failed to do so. In prior cases involving an

increase in penalty, the Tax Court’s solution has been to apply

a “divided” burden: “In defending against the penalty initially

determined, the taxpayer bears the burden of proving

reasonable cause, while the Commissioner, to justify the

asserted increase in the penalty, must prove the absence of

reasonable cause.” 149 T.C. at 39 (citing Rader, 143 T.C. at

389; Arnold, 86 T.C.M. (CCH) at 344).

We express no opinion as to whether Rule 142 requires the

IRS to negate affirmative defenses when it pleads a new

penalty in an answer. Even under the Tax Court’s scheme

dividing the burden, however, RERI would properly have to

show (1) “the claimed value of the property was based on a

qualified appraisal made by a qualified appraiser,” and (2) it

“made a good faith investigation of the value of the contributed

property” under § 6664(c)(3) in order to qualify for the

reasonable cause exception to the original “substantial”

penalty. “Placement of the burden of proof affects only the

obligation to prove facts.” Shea v. Comm’r, 112 T.C. 183, 197

n.22 (1999). If a defense to a new matter “is completely

dependent upon the same evidence,” id., as a defense to the

penalty originally asserted, then there is no practical

significance to shifting the burden of proof. Furthermore, “the

taxpayer would not suffer from lack of notice concerning what

facts must be established.” Id. Here, the facts required to

31

establish the two elements of the reasonable cause and good

faith exception are the same regardless whether the alleged

misstatement was “substantial” or “gross.” In other words,

although the IRS may theoretically have had the burden of

proof as to the increase in penalty, there was no additional fact

to which that burden applied.

2. Good faith investigation

Having concluded that RERI must prove its entitlement to

the reasonable cause and good faith exception, we can easily

determine it has failed to show that it conducted a good faith

investigation within the meaning of § 6664(c)(3)(B).

A “good faith investigation” calls for some action beyond

“simply accept[ing] the result of a qualified appraisal for the

requirement ... to have any meaning.” 149 T.C. at 40. RERI

asserts that it met this requirement by comparing the Gelbtuch

appraisal of the Hawthorne Property at $55 million in August

2003 with (1) the Bonz/REA appraisal of $47 million in August

2001 and (2) the $42 million that RS Hawthorne paid to acquire

the property in February 2002. The Tax Court rejected these

two comparisons, stating that “marshaling evidence of a

property’s value 18 months or more before a gift is simply not

sufficient as a matter of law to qualify as a good faith

investigation.” 149 T.C. at 41 (cleaned up). Due to the amount

of time that had passed, the Tax Court explained, that evidence

“is of limited worth in assessing the property’s value in August

2003.” Id.

On appeal, RERI challenges the Tax Court’s reasoning. It

points out that, in calculating the discount rate, the Tax Court

adopted Dr. Cragg’s use of the February 2002 sale price to

approximate the fee value in August 2003. What is more,

32

RERI is correct that the Tax Court provided “no reason why

the same evidence is reliable for one purpose, but not another.”

We need not consider whether the Tax Court erred in this

respect, however, because the court also found “[t]he record

provides no evidence” on the factual question whether RERI

“was aware of those data and took them into account in

determining the amount to claim as a deduction.” 149 T.C. at

41. In other words, RERI failed to produce evidence that it

conducted any investigation beyond the appraisal, let alone one

that qualifies as a “good faith investigation” within the

meaning of the statute. Consequently, RERI has not carried its

burden and we need not reach the IRS’s additional argument

that RERI did not satisfy the other element of the defense, the

requirement of a qualified appraisal. We therefore affirm the

Tax Court’s conclusion that RERI was not entitled to the

reasonable cause and good faith exception.

IV. Conclusion

For the reasons set forth above, the judgment of the Tax

Court is

Affirmed.

33

Appendix: Dr. Cragg’s method of determining the

discount rate

1. The fee value of the Hawthorne property = (the

present value of cash flow through May 2016) +

(the present value of cash flow in perpetuity after

May 2016).

2. The fee value of the Hawthorne property is the

$42.35 million that RS Hawthorne paid in February

2002.

3. The cash flow through May 2016, the end of the

initial term of the AT&T lease, is the fixed rent to

be paid by AT&T.

4. Discounting the AT&T rents through May 2016 at

a rate of 7.92% yields a present value of $39.06

million.

5. Subtracting $39.06 million from $42.35 million

produces a present value of $3.29 million for the

post-May 2016 cash flow. This is the implied

value, as of February 2002, of the remaining years

of the TOYS interest (May 2016 to December 2020)

together with the SMI (from 2021 onwards).

6. Project the post-May 2016 cash flow by assuming

that rent will increase each year by 3.29 percent

from the scheduled rent at the end of the AT&T

lease.

7. Solve for the discount rate that would produce a

present value, as of February 2002, of $3.29 million

from the projected post-May 2016 cash flow. The

answer is 18.99%.