UNITED STATES TAX COURT
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T.C. Memo. 1998-204
UNITED STATES TAX COURT
JANE CROCKER, F.K.A. JANE C. JACOBS, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 11020-94, 11022-94,
11985-94, 11986-94.
Filed June 8, 1998.
Peter S. Buchanan, for petitioner Jane Crocker.
John Gigounas, Edward B. Simpson, and Todd M. Moreno, for
petitioner Justin M. Jacobs, Jr.
Elizabeth L. Groenewegen and Bryce A. Kranzthor, for
respondent.
1
Cases of the following petitioners were consolidated
herewith for trial and opinion but not for briefing: Jane
Crocker, docket No. 11020-94; Jane Crocker, docket No. 11022-94;
Justin M. Jacobs, Jr., docket No. 11985-94; and Justin M. Jacobs,
Jr., docket No. 11986-94.
- 2 MEMORANDUM FINDINGS OF FACT AND OPINION
WRIGHT, Judge:
Respondent determined deficiencies in
petitioners' Federal income taxes, an addition to tax, and
penalties as follows:2
Jane Crocker, docket No. 11020-94, and Justin M. Jacobs, Jr.,
docket No. 11985-94:
Year
1988
1989
Deficiency
$152,905
187,343
Addition to Tax
Sec. 6653(a)(1)
$7,645
Penalty
Sec. 6662(a)
$37,469
Jane Crocker, docket No. 11022-94:
Year
1990
1991
Deficiency
$8,621
26,842
Penalty
Sec. 6662(a)
$1,724
5,368
Justin M. Jacobs, Jr., docket No. 11986-94:
Year
1990
2
Deficiency
$395,134
Penalty
Sec. 6662(a)
$79,027
Respondent issued one notice of deficiency for taxable
years 1988 and 1989 to petitioners, each of whom filed a separate
petition with the Court. Respondent also issued separate notices
of deficiency, one to petitioner Justin M. Jacobs, Jr., for the
year 1990, and the other to petitioner Jane Crocker for the years
1990 and 1991. Each petitioner filed a separate petition with
the Court with respect to these notices.
- 3 After concessions,3 the issues for decision are:
(1) The
fair market value of improved real property and personal property
donated by petitioners to an eligible charitable donee for
purposes of determining the allowable charitable contribution
deductions under section 170 to which petitioners were entitled
for 1986, the year of the gift, and for the years 1988, 1989,
1990, and 1991 by way of carryovers; and (2) whether petitioner
Justin M. Jacobs, Jr. is liable for an addition to tax under
section 6653(a) for 1988 and accuracy-related penalties under
section 6662(a) for 1989 and 1990.
We find and hold that the value of the improved real
property was $3,100,000, and that the value of the personal
property was $96,000, for a total of $3,196,000 when the gift was
made.
We hold that petitioner Justin M. Jacobs, Jr. is not
liable for the addition to tax and accuracy-related penalties for
the years at issue.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue.
All
Rule references are to the Tax Court Rules of Practice and
Procedure.
3
Respondent conceded that petitioner Jane Crocker is not
liable for the addition to tax and penalties for the taxable
years at issue. The parties agree that petitioners are entitled
to an investment interest carryover deduction from taxable year
1987 to taxable year 1988 and subsequent years in the total
amount of $411,539.
- 4 FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The first and second stipulations of facts and the attached
exhibits are incorporated herein by this reference.
Petitioners
resided in Atherton, California, when their petitions were filed.
I.
Background
Petitioner Justin M. Jacobs, Jr. (Jacobs) is a real estate
developer and licensed attorney.
Since the late 1960's, Jacobs
has primarily worked in the real estate development business,
having stopped the active practice of law in 1970.
Jacobs has
principally built office buildings for the high-tech industry in
the Silicon Valley and San Francisco Bay areas of California.
As
of the date of trial in these cases, Jacobs had constructed
approximately 45 buildings.
Jacobs has also had an interest in historic buildings.
Consistent with this, he has been involved in the restoration and
subsequent sale of historic properties.
Jacobs has renovated
several houses in California, including a large Victorian-era
house in Atherton, California, and a 33,000-square foot mansion
situated on 6 acres in Hillsborough, California.
He has also
restored an 11th-century chateau located in Loiret, France, and a
five-story townhouse on Sutton Square overlooking the East River
in New York City.
Jacobs has also been involved in the antiques business.
Sometime prior to May 1981, Jacobs decided to purchase a large
- 5 building to house his antiques business.
He looked at several
buildings and eventually narrowed his choices to two properties,
the Redwood City Fox Theater Building (the Redwood City Fox or
the property) in Redwood City, California, and the Stanford
Theater in Palo Alto, California.
In May 1981, Jacobs purchased the Redwood City Fox. He also
purchased personal property associated with the theater.
He
chose the Redwood City Fox over the Stanford Theater because the
Redwood City Fox was in much better condition physically than the
Stanford Theater.
Additionally, the Redwood City Fox building
included commercial space, both retail and office, adjacent to
the theater, which Jacobs wanted to utilize for his antiques
business.
The purchase price for the Redwood City Fox and
associated personal property was $1,000,000,4 allocated $912,556
to the theater and commercial space and $87,444 to the personal
property.5
4
Jacobs believed he purchased the Redwood City Fox for a
good price because the prior owners "didn't have the money or the
desire or the knowledge * * * to fix it up, and they just wanted
* * * get rid of it." Jacobs considered the May 1981 sale of the
Redwood City Fox to be a "distress sale".
5
There is conflicting evidence in the record concerning the
purchase price of the Redwood City Fox and the associated
personal property. Jacobs testified he paid "somewhere around
$1,080,000." An appraisal of the Redwood City Fox prepared by
David Ingram Jr. and William J. Ewing at Jacob's request and
dated April 1987 indicates that Jacobs paid $1,090,344 to acquire
the property, allocated $399,146 to the land, $610,783 to the
building, and $80,415 to the equipment. The Ingram/Ewing
appraisal report also states that Jacobs was the source of this
(continued...)
- 6 II.
Description of the Redwood City Fox
The Redwood City Fox is a steel-reinforced concrete building
that was constructed in 1928 and is comprised of a theater with
adjacent commercial space.
The Redwood City Fox is an example of
an American "movie palace"--a distinct phase of theater
architecture which occurred primarily between 1915 and 1945, with
its peak period in the 1920's.
The Redwood City Fox was built to
serve both as a vaudeville house for live entertainment and as a
"fantasy" movie palace.
The inclusion of commercial space within
the larger theater building is indicative of a trend during the
1920's and 1930's to use theaters to create more distinctive
office and retail buildings.
The facade of the Redwood City Fox building is Gothic
Revival with Art Deco themes, and is representative of the late
1920's.
The theater incorporates many architectural features of
that generation, including an ornate terrazzo sidewalk, a
recessed entrance, an expansive "Grand Lobby", a high level of
interior decoration, a pipe organ and organ lofts, and numerous
5
(...continued)
information. The May 1, 1981, Purchase Agreement executed by
Jacobs and the sellers, Redwood Theatre, Ltd., indicates a
purchase price of $1,000,000, with $87,444 of the purchase price
allocated to the personal property and $912,556 allocated to the
real property. Escrow instructions dated May 8, 1981, also
indicate a sales price of $1,000,000, with an additional
$16,675.36 paid by Jacobs for closing costs and prorated property
taxes. Based on the evidence presented, we find that Jacobs paid
$1,000,000 for the Redwood City Fox and associated personal
property, exclusive of closing costs and property taxes.
- 7 design flourishes.
To accommodate live performances, the stage
house of the theater is equipped with a fly loft, rigging,
dressing rooms, and an orchestra pit.
For films, the theater has
a projection booth and a sound system.
The Redwood City Fox Theater originally opened as the
Sequoia Theater on January 5, 1929.
In October 1929, the
property was bought by the Fox West Coast Theaters chain.
The
theater operated until June 1950, when a portion of the
auditorium's plaster ceiling collapsed.
The theater was closed
by Fox West Coast Theaters for 3 months while an extensive
renovation was completed.
The renovation involved the
installation of a new ceiling in the auditorium with perimeter
indirect lighting, the installation of new seating, the design
and installation of a new acoustic system, as well as new
restrooms in the main foyer.
The theater's interior, originally
designed as an "atmospheric" Spanish courtyard, was redecorated
in the Fox West Coast Theaters' “Skouras”6 style.
Additionally,
the Sequoia marquee and vertical signs were removed, and a new Vshaped marquee was installed, bearing the new "Fox" designation.
The newly renamed Redwood City Fox Theater opened in September
1950.
The Redwood City Fox Theater continued to operate until the
1970's when, due to the decline of the downtown Redwood City
6
So named after Charles Skouras, the then-president of Fox
West Coast Theaters.
- 8 commercial district as well as the advent of large suburban
multiscreen theaters, it lost its audience.
In June 1976, the
Redwood City Planning Department listed the Redwood City Fox as a
key building in the Historic Resources Inventory of Redwood City.
Despite its listing in the Historic Resources Inventory, the
Redwood City Fox stage was rarely used throughout much of the
1970's,7 though the retail/office spaces did have tenants.
After Jacobs' purchase and subsequent donation of the
property, the City Council of Redwood City designated the Redwood
City Fox an official historic landmark on July 27, 1987.
In
1989, the City Center Action Committee of Redwood City was
formed, which focused on the Redwood City Fox as one element in a
plan for the revitalization of downtown Redwood City.
In 1991,
the City of Redwood City also established the Fox Theater Task
Force (Task Force).
The Task Force was organized to conduct
activities that would benefit Redwood City through the
preservation of the Redwood City Fox.
The potential benefit of
these activities was described in a Task Force Report as "the
preservation of an historic building, assistance in the
revitalization of Downtown [Redwood City] by increasing activity
at the Fox and increasing the availability of cultural activities
in the City."
7
One of the activities of the Task Force was the
Jacobs testified that prior to his purchase of the Redwood
City Fox in May 1981, the then-owners of the property were
"making almost no use of the theater" other than to show secondrun and old films.
- 9 pursuit of national landmark status for the Redwood City Fox.
This goal was achieved when the Redwood City Fox was awarded a
listing in the National Register of Historic Places on May 5,
1994.8
The Redwood City Fox is located at 2215 Broadway in downtown
Redwood City.
The site area of the property has 100 feet of
frontage along Broadway, and approximately 15 feet of frontage in
the nature of access lanes on each of the other surrounding
streets.
The shape of the site is basically rectangular with the
three, 15-foot wide access lanes extending from the main parcel,
which is located in the center of the block, to the side and rear
streets.
The depth of the lot relative to Broadway is 243 feet.
The 100-foot wide building facade is comprised of a 4-story
building with an added 3-story plaster tower reaching
approximately 63 feet above the street.
The total site area is
approximately 26,583 square feet.
For purposes of this opinion, the Redwood City Fox will be
analyzed as two separate components:
(1) The theater component,
8
A letter from a representative of the National Park
Service to the Mayor of the City of Redwood City described the
Redwood City Fox as follows:
The 1928 theater building is an excellent local
example of Late Gothic Revival style design and
reflects the romantic nature of small-town movie palace
construction during the golden age of movies. Listing
in the National Register recognizes the importance of
the New Sequoia Theater Building to the rich cultural
history of Redwood City.
- 10 which includes the lobby and auditorium; and (2) the
retail/office component, which is in turn composed of (a) the
West retail space, which includes the ground floor and mezzanine
level;9 (b) the East retail space, which includes the ground
floor and mezzanine level; (c) the Second floor office space; and
(d) the Third floor office space.10
The square footage of
building areas, both gross and net rentable, is as follows:
Area
Gross
Sq. Ft.
Net Rentable
Sq. Ft.
Theater
24,358
24,358
East retail:
Ground floor
Mezzanine
2,625
2,625
2,611
2,475
West retail:
Ground floor
Mezzanine
2,625
2,625
2,06511
2,174
Second floor office
6,090
6,090
Third floor office
876
876
9
Logistically, the mezzanine levels can only be leased in
conjunction with their respective first floor retail spaces.
10
The appraisers refer to the different areas by a variety
of designations. For clarity, when discussing the experts'
reports, we will refer to the different areas by the designations
we have assigned. We note, however, that our designation of the
East retail and West retail spaces as "retail" spaces in no way
implies that we find these areas to be suitable only for retail
use to the exclusion of office use.
11
The West retail space contains an entryway vestibule with
both a staircase and an elevator which services the Second and
Third floor office spaces. The square footage of the entryway
vestibule is not rentable with the West retail space, and is thus
deducted from the gross square footage of the area.
- 11 A.
The Theater Component
The middle 30 feet of the Broadway frontage bears the
theater marquee, which projects over the sidewalk, and the
recessed theater entry.
A bank of 6 decorated wood entry doors
is inset from the sidewalk approximately 29 feet.
The entry area
has a decorative terrazzo floor and tiled walls.
The entrance of the theater leads to the main lobby, which
has a ceiling height of approximately 30 feet.
Decorative
features include mirrors, aluminum panels, murals, Art Deco
chandeliers resembling plants, and gilt decorative work.
The
risers of a double staircase lead to the second floor mezzanine
lobby along either side of the main lobby.
At the rear of the main lobby is a concession area which
features an attractive wood bar with a large mirror.
The bar is
an Art Deco piece that was installed by Jacobs in the 1980's.
The main lobby also houses public restrooms and several small
service and storage rooms.
The seating in the theater auditorium consists of a main
floor, a mezzanine or lower balcony, and an upper balcony.
originally designed, the theater contained 1,469 seats.
As
The 1950
renovation reduced the seating capacity to 1,325 seats to permit
more space between the rows.
As of the date of the donation, the
theater contained a total of 755 seats, 602 of which were located
on the main level and 153 of which were located in the lower
balcony level.
Most of the seats in the center section of the
- 12 main floor were replaced by Jacobs during his ownership of the
Redwood City Fox.12
The balance of the seats were comprised of
seats and components from the 1950 renovation.
At some point
prior to the gift, Jacobs intended to reinstall 350 seats in the
upper sections of the auditorium, as well as 24 seats behind the
orchestra pit, for a total seating capacity of 1,130 seats.
However, as of the date of trial, the additional seating was not
installed, and there remained 755 seats in the auditorium.13
The theater auditorium is highly improved in terms of
architectural detailing and artistic design.
approximately 40 feet high and arched.
The ceiling is
The auditorium also
contains an orchestra pit and organ lofts.
The walls on either
side of the theater are improved with spun glass composition
sound insulation panels on which large Art Deco murals are
painted.
The stage house, with a ceiling height of approximately 60
feet, features a gridiron "fly" system which is suspended
approximately 50 feet above the stage floor and supports a
network of sheaves, cables and counter weights used to raise
scenery, drapes, and curtains from the stage floor into the fly
12
Jacobs installed 168 rocker-type theater chairs which he
had purchased from the Orinda Theater.
13
As of the date of trial, the 153 seats located in the
mezzanine level had not been used for seating purposes. The
mezzanine level had been used by the charitable donee for the use
and storage of stage lighting equipment.
- 13 loft under the gridiron.
The stage house floor is approximately
24 feet deep and 80 feet wide, with a proscenium width of 40
feet.
A small L-shaped basement is located under the stage.
As
of the date of donation, the fly system and stage house were
highly functional and in working condition.
At the rear of the stage house is a one-story concrete block
annex which houses the dressing rooms and the greenroom.
This
area includes restrooms and a large delivery door for dock-high
loading.
As of the date of donation, the exterior of the Redwood City
Fox was in good condition.
Over the course of its existence, the
property had survived several earthquakes with no observable
structural weakening.
The interior finishes were also in good
condition and did not require additional restoration.
B.
Retail/Office Component
1.
East Retail Space
The East retail space has 35 feet of frontage on Broadway,
east of the theater entrance.
The space is rectangular, with
8-foot glass windows in the front overlooking Broadway and a
glass and aluminum entry door.
The mezzanine floor, which also
has windows overlooking Broadway, is accessed from the ground
floor by two staircases.
The ceiling height of the mezzanine
floor is 7.3 feet, which is lower than normal.
restroom.
The space has one
At the time of the donation, the East retail space was
- 14 in very good condition, but needed the installation of heating
elements.
2.
West Retail Space
The West retail space has 35 feet of frontage on Broadway,
west of the theater entrance.
The space contains an entryway
vestibule facing Broadway, with an elevator and staircase, which
serves the Second and Third floor office spaces.
The West retail
space, both the ground floor and the mezzanine floor, consists of
two retail suites which form a "U" shape around the entryway
vestibule for the Second and Third floor office spaces. The
ground floor of the West retail space has two entrance doors onto
Broadway, one at each end of the "U".
The mezzanine floor has
windows facing Broadway, as well as a reduced ceiling height of
7.3 feet.
Each retail suite has one restroom.
As of the date of
donation, the West retail space was in very good condition.
3.
Second Floor Office Space
The Second floor office is a "U"-shaped space, located
directly above the East and West retail spaces, and excludes the
area used by the vaulted ceiling of the theater lobby, which
reaches to the roof of the building.
The ceiling height is 9.8
feet, with skylights illuminating much of the space.
The space
has several chandeliers, and all outside walls have windows.
The
space contains 31 partitioned offices, separate restrooms for men
and women, one handicapped-equipped restroom, and a storage room.
- 15 As of the date of donation, the Second floor office space was in
very good condition.
4.
Third Floor Office Space
The Third floor office space has 30 feet of frontage on
Broadway in the center of the parcel.
ceilings.
The area has 9-foot
As of the date of donation, the Third floor office
space was unfinished and accessible only from the roof.
Subsequent to the gift, Jacobs installed a spiral staircase from
the Second floor office space and finished the Third floor area.
Jacobs intended to finish the Third floor office space prior to
his donation of the property.
III.
Location of the Redwood City Fox
Redwood City, California, was incorporated in 1867 and is
the county seat of San Mateo County.
San Mateo County is one of
the nine counties comprising what is commonly referred to as the
"Bay Area" of San Francisco.
San Mateo County occupies most of
the peninsula south of the city and county of San Francisco.
The
counties of Santa Cruz and Santa Clara are adjacent to the south.
As of 1985, San Mateo County had a population of
approximately 620,016, and was the 11th largest county in
California.
The median household income in San Mateo County was
$31,806 in 1980, which was the highest in the State of
California.
As of 1986, San Mateo County's economy offered
employment in construction, manufacturing, transportation,
communications, retail and wholesale trades, financial services,
- 16 and government.
During the relevant period, two of the major
growth areas affecting San Mateo County were high technology and
office-oriented employment.
In the mid-1980's, land values in
the area were escalating rapidly.
Redwood City is located in the southeasterly portion of San
Mateo County, approximately 25 miles south of San Francisco and
25 miles north of San Jose.
Redwood City is bordered by the San
Francisco Bay to the east, the city of Woodside to the west, the
city of San Carlos to the north, and the cities of Menlo Park and
Atherton to the south.
Its population in 1985 was estimated at
57,300 persons, making it the third largest city in San Mateo
County.
Though primarily residential in nature, commercial and
industrial uses exist, clustered mostly adjacent to Highway 101
in Redwood City's east end and emanating outward from Redwood
City's downtown core.
The Redwood City Fox is located on Broadway, one of the main
thoroughfares in downtown Redwood City.
The property is situated
on the south side of Broadway, on a block bounded by Hamilton
Street, Middlefield Road, and Winslow Street.
Across Broadway
from the property is the old San Mateo County Courthouse, which
dates from 1908.
As of the date of trial, the Redwood City
Council was in the process of opening the San Mateo County
Historical Museum in the old San Mateo County Courthouse.
The area surrounding the Redwood City Fox houses both the
City of Redwood City and the County of San Mateo government
- 17 offices.
The new San Mateo County Courthouse, as well as the
balance of the County of San Mateo and City of Redwood City
government offices, are located within two blocks of the Redwood
City Fox.
In general, the improvements within the vicinity of the
Redwood City Fox are dominated by older commercial structures
which are small in scale, ranging from two to four stories.
Many
financial institutions and title companies have branches in the
area.
Additionally, the Caltrain commuter railroad station is
within 1 block of the property.
The Redwood City Fox has two parking spaces on the west side
of the building in one of the access lanes.
There are two
municipally owned public parking lots in the vicinity of the
property, one across Winslow Street, behind the Redwood City Fox,
and the other two blocks to the southeast, by City Hall.
There
is also metered street parking in the area around the property,
which is free on weekday evenings and on weekends.
The Redwood City Fox is zoned CB, or Central Business.
The
purpose of the Central Business District is "to designate and
promote the orderly development of the downtown business district
as a central shopping facility for the whole city and surrounding
area."
Permitted uses include a variety of commercial and office
uses, including retail, theater, and restaurant commercial uses,
and professional and administrative office uses.
parking requirements vary by use.
Off-street
The subject property is
- 18 considered a legal nonconforming use due to the lack of on-site
parking.
A.
Theater Market
As of the valuation date, there was a need for a largecapacity live performance theater in San Mateo County.
The only
other large live performance theater in the area was the San
Mateo Performing Arts Center (SMPAC) at San Mateo High School,
approximately 9 miles northwest of the Redwood City Fox.
The
SMPAC has a seating capacity of 1,605, and is the largest
publicly owned theater facility in San Mateo County.
It was
considered the best large theater in the area for live stage
performances and was tightly scheduled.
B.
Commercial Market
Overall, the downtown commercial core of Redwood City has
declined as a community shopping district, but has grown as a
governmental and banking base.
Office rental in downtown Redwood
City is primarily based on a desire to be near the City of
Redwood City and the County of San Mateo government offices.
Similarly, the majority of the commercial users in downtown
Redwood City cater to the City and County employees, the dominant
workforce in the area.
As a result, traffic along Broadway is
diminished during the evenings and on weekends.
- 19 IV.
Jacobs' Use of the Property
From 1981 to 1986, Jacobs spent approximately $829,41514 to
restore and improve the Redwood City Fox.
The work performed
included, among other things, an upgrade of the electrical
system, including installation of a Dolby sound system and
replacement of much of the stage lighting; the installation of
stairs in, and the rehabilitation of, the plenum area of the
auditorium; renovation of the restrooms in the public areas of
the auditorium and the retail/office areas; repair of the roof;
installation of new carpet, draperies, tile work, and painting;
restoration of the wood and plaster parts of the theater;
installation of new doors and door frames, including oak doors at
the main theater entrance; installation of new theater seating;
rehabilitation of the ceiling perimeter neon lighting system in
the auditorium; and complete retrofitting of the dressing rooms.
Additionally, the retail/office spaces were completely renovated,
including installation of the mezzanines in both the West and
East retail spaces.
Jacobs oversaw the renovation, putting in
about 2,000 hours of his time, while the workers he hired
performed about 60,000 hours of work.
14
While the record is not clear as to the exact amount
Jacobs spent to restore and renovate the Redwood City Fox, we are
satisfied, and respondent agrees, that Jacobs spent at least
$800,000 to restore the property. We find that the most accurate
figure is $829,415 based upon the evidence.
- 20 During his ownership of the Redwood City Fox, Jacobs showed
classic films in the theater, as well as some live performances.
He also attempted to operate the Redwood City Fox as a dinner
theater.
To this end, he installed an upscale French
delicatessen in the West retail space, which was operated by his
wife for 2 years.15
He used the East retail space to house his
antiques business and periodically held antique auctions.
Additionally, Jacobs moved his real estate development business
offices from nearby Sunnyvale, California, into offices he had
constructed in the backstage area of the theater.
Jacobs also leased the Second floor office space to the
County of San Mateo, commencing December 15, 1984.
It was a 3-
year lease, but was terminated on December 14, 1986, prior to the
end of the lease term.
The rent was $7,150 per month, with
Jacobs paying all expenses.
This rent equated to approximately
$.90 to $1.00 per square foot.
By 1986, Jacobs was convinced that he could not operate the
Redwood City Fox profitably.
Jacobs believed he had the
following alternatives with respect to the property:
Raze the
building and develop the site himself for the construction of an
office building; sell the property to developers; or donate it to
an organization which would preserve the property.
15
Jacobs wanted
After he closed the delicatessen, Jacobs renovated the
West retail area and converted it back to commercial use.
- 21 to preserve the property, as he considered it an historic
treasure.
The Redwood City Fox had been placed on the Historic
Resources Inventory of Redwood City in 1976, and, while not
legally protected, he believed there would be a public outcry if
he demolished the building.
Jacobs decided to donate the Redwood City Fox to an
organization that would use the theater as a community resource
and preserve it from demolition.
After investigation, Jacobs
selected the Palo Alto Players, Inc. (the Players), a California
nonprofit corporation, to receive the Redwood City Fox as a gift.
The Players is a community-based dramatic arts organization that
qualified at all times relevant to these cases as a section
501(c)(3) exempt organization.
The Players is based in Palo
Alto, a community 10 miles to the south of Redwood City.
At the
time of the gift, Jacobs communicated his intention to place the
Redwood City Fox on the local, State, and National Register of
Historic Places.
The donation of the Redwood City Fox and associated personal
property to the Players was accepted by the Players' Board of
Directors on December 22, 1986, by corporate resolution.
The
gift was accomplished by an agreement (Agreement) executed by
- 22 Jacobs and the Players on December 29, 1986.16
The property
donated by Jacobs to the Players consisted of the following:
Parcel of real property situated in the City of Redwood
City, County of San Mateo, State of California, located
at 2215 Broadway consisting of approximately 26,500
square feet of land; together with all improvements,
and furniture, fixtures and equipment constructed
thereon or affixed thereto which are owned by Jacobs,
including (without limitation) the Fox Theater
consisting of approximately 24,000 square feet, and
related office, retail and storage space consisting of
an additional 13,000 square feet and all easements and
other rights appurtenant thereto.
The Agreement contained the following use restrictions,
termed "covenants running with the land":
Article 2
Restrictions
2.1 Designation Of The Theater As An Historical
Landmark. Jacobs intends to cause the Theater to be
designated as an historical site by the appropriate
authorities of the State of California and the United
States Government, and to be registered on the State of
16
Jacobs and the Players also executed an "Assignment and
Assumption of Existing Leases" on Dec. 29, 1986, whereby Jacobs
assigned to the Players the following three leases recited in the
assignment:
(1) A lease entered into on September 24, 1985,
between * * * [Jacobs] and Big Brothers/Big Sisters of
the Peninsula, Inc. granting non-exclusive rights to
use a portion of the Building for semi-weekly bingo
games, which lease has no definite term;
(2) An oral lease entered into as of April 1,
1984, between * * * [Jacobs] and Bayshore Auction
granting non-exclusive rights to use a portion of the
Building for periodic auctions, with a percentage of
revenue derived therefrom paid as rent, which lease has
no definite term; and
(3) A lease between * * * [Jacobs] and Sonitrol
of a portion of the Building dated March 1, 1979.
- 23 California Registry of Historical Sites and/or the
National Registry of Historical Sites of the United
States. Players shall fully cooperate with Jacobs in
such efforts, shall execute and deliver any documents
reasonably requested by Jacobs in furtherence [sic] of
the above, and shall use its good faith best efforts to
cause such designation to occur.
2.2 Maintenance Of The Theater. Players shall
maintain the facade of the Theater in good condition
and repair, and shall not take or allow any action
which would compromise the architectural integrity of
the art deco facade.
2.3 Use Of Premises. Players shall use the
Theater as the "Peninsula Center for the Performing
Arts". Players shall use the Theater only as a
performance auditorium and shall not use the theater
for sporting events or any use other than as an
auditorium for the performing arts, or as provided in
section 2.4 herein.
2.4 Availability Of The Theater For Other Civic
Uses. Players shall allow and shall have the right to
allow other performing arts organizations, civic and
community organizations, the City of Redwood City, and
the County of San Mateo to use the Theater on a
financial basis which is affordable to all parties
involved, during times which do not unreasonably
conflict with Players' use. The Theater shall be made
available to such other parties to the greatest extent
possible which does not interfere with Players' use,
but in no event less than ten percent (10%) of the
hours that similar performance auditoriums are usually
and customarily used.
2.5 Memorial Plaque. Jacobs is donating the
Theater to Players in the name and memory of his late
father, Justin Manning Jacobs, Sr., and Jacobs will
affix an appropriate bronze memorial plaque to the
Theater at his sole cost. Players shall maintain the
plaque in good condition and repair in the location at
which it was originally installed by Jacobs.
The gift deed transferring the property to the Players was
recorded on December 31, 1986.
- 24 As part of the donation to the Players, Jacobs gifted items
of personal property, described in the bill of sale executed on
December 29, 1986, between Jacobs and the Players.
The items
donated were in good condition and all were functional.
The fair
market value of the personal property on the date of donation was
$96,000.17
Contemporaneous with the gift of the property to the Players
and pursuant to the December 29, 1986, Agreement, Jacobs leased
from the Players approximately 12,268 square feet of the Redwood
17
Jacobs estimated the fair market value of the personal
property donated to the Players to be between $90,000 and
$100,000. Peter Morrison of Adamson Associates, Inc., a
professional cost estimating firm retained by petitioners in
1986, listed the following items of personal property donated and
their estimated values:
Bingo equipment
Fox film library
Fireplace
Baldwin theater organ
Kitchen and deli equipment
Stacking chairs
Double-decker London bus
Safe
Piano
Total
$ 4,000
25,000
15,000
5,000
17,000
3,000
21,000
1,000
1,000
$92,000
In their appraisal report, Ingram/Ewing stated that the correct
figure for the safe was $5,000, rather than the $1,000 listed in
the Adamson report. In light of the $87,444 allocated to the
personal property when Jacobs purchased the property in May 1981
and the fact that he subsequently purchased additional items
which he donated to the Players, we are satisfied that the
$96,000 figure is accurate. Respondent makes no argument against
this figure. Accordingly, we find that, on the valuation date,
the fair market value of the personal property donated by
petitioners to the Players was $96,000.
- 25 City Fox's commercial space (the Jacobs lease).
The Jacobs lease
included the West retail space (ground floor and mezzanine),
Second floor office space, and unfinished Third floor office
space.18
The lease was for an initial term of 5 years at a rate
of $3,000 per month.
The terms of the lease provided that Jacobs
was obligated to pay all expenses associated with the leased
portion of the premises, including all janitorial services,
utilities, real property taxes allocable to leased portion of the
premises, and comprehensive general liability insurance.
Jacobs
was also required to make all major repairs.
The Jacobs lease granted Jacobs ten separate options to
extend the lease term for a period of 5 years for each option.
Additionally, the lease granted Jacobs an option to repurchase
the commercial portion of the property for $10,000 if the
commercial portion of the property could be subdivided legally
into condominiums.
Shortly after the gift to the Players, Jacobs determined
that subdivision of the commercial portion of the property would
not be commercially feasible.
Consequently, Jacobs and the
Players amended the lease on June 26, 1987.
The amended lease
rescinded Jacobs' right to subdivide the commercial space and his
option to purchase after such subdivision.
18
The amended lease
As mentioned, Jacobs installed a staircase and finished
the Third floor office space subsequent to his gift of the
property.
- 26 provided it became effective as of December 29, 1986.
Jacobs
executed a quitclaim deed on September 29, 1987, disclaiming the
rights under the original lease.
After the donation of the Redwood City Fox, Jacobs
negotiated, on behalf of the Players, a short-term lease between
the Players and the County of San Mateo for the East retail space
(including mezzanine), for the period of March 2, 1987, to
December 1, 1987.19
Rent was $4,720 per month, with the County
of San Mateo paying utility expenses, including gas, electrical,
and janitorial services.
The Players were responsible for paying
all real property taxes, structural repairs, and fire insurance.
By agreement dated December 23, 1992, Jacobs and the Players
terminated the Jacobs lease.
At that time, Jacobs assigned two
existing subleases he had negotiated to the Players.
V.
Players' Use of the Redwood City Fox
The Players have offered live theater productions at the
Redwood City Fox from 1987 until the present.
Currently, the
Players, operating as the "Peninsula Center Stage", mount 3
productions a year at the Redwood City Fox.
for approximately 13 performances.
Each production runs
The Players use the West
retail space as the box office for the Peninsula Center Stage.
When not used by the Players, the theater is available for use by
19
The lease agreement between the Players and the County of
San Mateo states the leased premises consists of "approximately
4,000 square feet".
- 27 community organizations.
The Players operate the Peninsula
Center Stage with financial support from the City of Redwood
City.
The Players receive approximately $30,000 per year from
the City of Redwood City.
In 1990 and 1991, the Players received from the City of
Redwood City a grant to upgrade the water delivery system for the
sprinkler system located over the stage area of the theater.
Since 1986, the Players have spent less than $100,000 in repairs
and renovations on the Redwood City Fox, primarily for the
sprinkler system upgrade and the addition of new roofing over the
theater.
Despite the lack of on-site parking, there was "ample"
parking around the property, and parking for events at the
Redwood City Fox has not been considered a problem.
VI.
Petitioners' Valuation and Charitable Contribution
Deductions
A.
Ingram/Ewing Appraisal
In order to ascertain the amount of their charitable
contribution deduction for their donation of the Redwood City Fox
in taxable year 1986, petitioners retained David Ingram, Inc., a
real estate appraisal firm located in Foster City, California, to
prepare an appraisal of the Redwood City Fox.
The appraisal of
the property was performed by David Ingram, Jr. (Ingram)20 and
20
David Ingram, Jr. died in November 1993.
Consequently,
(continued...)
- 28 William J. Ewing (Ewing).
Ingram and Ewing prepared their report
in early 1987 and delivered it to Jacobs in April 1987.
At the
time they prepared their report, Ingram had been active in the
field of real estate appraisal since 1946, and was a member of
the American Society of Real Estate Counselors, the American
Institute of Real Estate Appraisers, member and past-president of
the Menlo Park-Atherton Board of Realtors, and member and pastdirector of the California Real Estate Association.
Ewing had
worked as an independent appraiser since 1970 and was a candidate
for membership with the American Institute of Real Estate
Appraisers.
Ewing testified at trial regarding the Ingram/Ewing
appraisal report.
Ingram/Ewing commenced their appraisal by breaking down the
Redwood City Fox into four “appraisal units”, which they valued
separately.
The theater space was designated Unit A.
The East
retail space, including the first floor and mezzanine, was
designated Unit B.
The West retail space, including the first
floor and mezzanine, was designated Unit C.
The Second and Third
floor office spaces, including space from the West retail area
for the elevator, staircase, and entryway vestibule, were
designated Unit D.
20
(...continued)
William J. Ewing testified regarding the April 1987 appraisal of
the Redwood City Fox.
- 29 Ingram/Ewing concluded that the highest and best use of the
Redwood City Fox was its continued use as a performing arts
center and as retail/office space.
In addition to its historical
significance, Ingram/Ewing based their highest and best use
conclusion on the apparent market demand in the surrounding
community and region for a performing arts center with a large
seating capacity, such as the Redwood City Fox.
Ingram/Ewing
estimated 1,130 seats to be the appropriate seating capacity of
the Redwood City Fox, and used this number of seats in their
valuation analysis.
Ingram/Ewing determined that the highest and best use of the
commercial space would be for use as office space.
Should the
East and West retail spaces be leased for retail use,
Ingram/Ewing determined that the spaces would return one-half to
two-thirds of the rent that would be probable with office use.
In appraising the value of the Redwood City Fox as of
December 31, 1986, Ingram/Ewing concluded that because the
theater portion of the Redwood City Fox was special use property,
the replacement cost method should be relied upon to estimate
value.
However, because of the recent sale of the San Jose Fox
Theater (San Jose Fox), another Fox movie palace located near the
Redwood City Fox and sold close in time to the valuation date,
- 30 Ingram/Ewing also employed the comparable sales21 method to value
the theater portion of the Redwood City Fox.
Recognizing that
the theater would be run by a non-profit group and that there
were no income comparison data available, Ingram/Ewing did not
employ the income capitalization approach to value the theater
portion of the Redwood City Fox.
With respect to valuing the commercial portion of the
Redwood City Fox, Ingram/Ewing employed the replacement cost
approach and the market approach.
Ingram/Ewing did not utilize
the income capitalization method for the retail/office component,
and they did not provide any reason for not employing this
method.
Ingram/Ewing also did not consider the impact of the
Jacobs lease on the value of the retail/office portion of the
property.
1.
Adamson Cost Estimate
To perform their appraisal, Ingram/Ewing required Jacobs to
retain a professional cost estimator to do a cost analysis of the
property.
In December 1986, Adamson Associates, a construction
cost planning and management firm located in San Francisco,
California, prepared a detailed report for petitioners estimating
the probable cost to construct a new building matching, in plan
21
In their appraisal report, Ingram/Ewing refer to the
comparable sales method as the market data method. For clarity,
we shall refer to this method as the comparable sales method.
- 31 and construction style, the Redwood City Fox.
The materials and
construction methods would match the existing materials and
methods, except where new materials could mimic the existing
materials at a lower cost.
Historical features were replaced
with new equivalents, not replicated.
painted murals) was not replaced.
The artwork (mainly
No allowance was made in the
Adamson report for the historical value of any item in the
Redwood City Fox, nor was allowance made for depreciation of the
property.
In summary, the replacement building estimated in the
Adamson report would be completely new, with finishes and
fixtures of similar style and character to the existing property,
would be functionally identical to the existing Redwood City Fox,
but would have no historical value.
The Adamson estimate was based on the total direct
construction costs of 16 components: (1) Foundations; (2)
vertical structural members; (3) floors and roofs; (4) exterior
cladding; (5) roofing and waterproofing; (6) interior partitions;
(7) floor, wall and ceiling finishes; (8) building
function/specialties and equipment;22 (9) vertical
transportation; (10) plumbing; (11) heating, ventilating, and air
conditioning; (12) electrical; (13) fire protection; (14) site
preparation; (15) site development; and (16) utilities.
22
Added to
Under the component “8. Specialties and Equipment” for
the theater, a quantity of 760 seats at a cost of $350.00 per
seat was used to calculate the cost of seating.
- 32 these total direct construction costs were 7 percent for “General
Conditions” and 5 percent for “Overhead and Profit”.
The Adamson
report estimated the probable replacement cost of the Redwood
City Fox to be $7,016,000, broken down as follows:
Theater
Second Level Office
East Retail
West Retail
Total
Square Feet
24,430
6,892
5,550
4,940
Price per
Square Foot
$222.06
132.33
61.62
68.22
Total Cost
$5,425,000
912,000
342,000
337,000
$7,016,000
The Adamson estimate did not include the cost of demolishing
the existing structure, nor did it include the cost of any
improvements to the building, such as increasing seismic
performance or improving accessibility.
Also excluded from the
Adamson cost estimate were legal and financing costs, fire and
all risk insurance costs, building permits, utility connections
and fees, and fees for professional design, testing, inspection,
and management.
2.
Replacement Cost Approach
Under the replacement cost approach, Ingram/Ewing first
valued the land utilizing comparable sales.
Ingram/Ewing viewed
6 sales of commercially zoned vacant land in Redwood City as
comparables.
Ingram/Ewing made adjustments to the sale prices
for factors such as location, size, time of sale, and potential
use.
Ingram/Ewing valued the land, as if vacant, at $27.00 per
square foot, or $720,000 rounded (26,583 square feet x $27.00 per
square foot = $717,741).
Ingram/Ewing assigned 20,089 square
- 33 feet to the theater, for a land value estimate of $542,403, and
they assigned 6,493 square feet to the retail space, for a land
value estimate of $175,311.
Ingram/Ewing then utilized the cost estimate in the Adamson
report to value the improvements.
For the theater portion, Unit
A, Ingram/Ewing made the following adjustments to the $5,425,000
figure estimated in the Adamson report.
First, Ingram/Ewing
determined that optimum seating for the theater would be 1,130
seats.
Consequently, they recommended the addition of 370 seats
to the 760 seats used in the Adamson report.
At a cost of $350
per seat, Ingram/Ewing made an upward adjustment of $129,500 (370
seats x $350/seat = $129,500) for additional seating.
Next, under component number 8, “Specialities and
Equipment”, the Adamson report had listed the cost of items that
Ingram/Ewing considered to be “personal goods” which should not
be part of the real estate appraisal.
They thus deducted the
cost of these items and made a downward adjustment of $69,000.
Ingram/Ewing next made an upward adjustment of $4,000, to reflect
the $5,000 cost of a floor safe, rather than the incorrect cost
of $1,000 used in the Adamson estimate.
In conclusion, with respect to the replacement cost of
$5,425,000 estimated in the Adamson report for the theater,
Ingram/Ewing added $129,500 and $4,000 for a total of $133,500,
- 34 from which they deducted $69,000, for a net addition of $64,500.
To this figure, they added 7 percent for General Conditions and
5 percent for Profit, for a total upward adjustment of $72,240 to
the $5,425,000 estimate in the Adamson report, for a total
replacement cost estimate of $5,497,240 for theater portion, Unit
A, of the Redwood City Fox.
Ingram/Ewing next estimated the “Projected Restoration and
Deferred Maintenance Cost” of repairing/restoring the Redwood
City Fox to a condition they term “Market Condition”.
Ingram/Ewing explained their methodology as follows:
Appraisal of this property employs the Cost Approach
which is calculated by estimating the replacement cost
less depreciation, added to the estimated land value.
Since this property is in the process of being
restored, it is appropriate to project the costs of
restoration or rehabilitation to bring it to the
condition that it may be offered at market rent or
market sale for it[s] highest-and-best use, which we
will call “Market Condition”. These projected costs
are then deducted as capital expenses from the
estimated market value of the property as if the
property was completely rehabilitated and ready for
market. The projected costs are estimated separately
for each of the four unit spaces * * * .
Ingram/Ewing estimated the cost of “restoration and maintenance”
for the theater portion to be $1,222,045.
They estimated the
cost of “restoration and maintenance” for the retail/office
portions, Units B, C, and D, to be $55,295.
Ingram/Ewing next estimated accrued depreciation, both
physical deterioration and functional obsolescence, for the
Redwood City Fox.
On the valuation date of December 31, 1986,
- 35 the Redwood City Fox was 58 years old.
However, rather than
estimating accrued depreciation for the Redwood City Fox as it
existed on December 31, 1986, Ingram/Ewing estimated depreciation
for the Redwood City Fox as if the projected maintenance and
restoration work discussed above had already been completed.
They thus concluded that both the theater and the retail/office
components of the property had an “effective age” which was less
than the Redwood City Fox’s actual age.
To explain their reason
for estimating depreciation in this manner, with respect to the
theater portion, Ingram/Ewing listed 4 theaters that ranged in
age from 79 to 131 years old, and explained:
These theaters are from 79 to 131 years old and still
remain in good to excellent condition and are in
current use, a characteristic that is specific to
performing arts theaters. For this reason it is
difficult to predict depreciation or remaining life.
This RCFox Theatre is in good condition and with the
projected restoration is expected to be brought to
“market condition” as previously discussed which is
projected to be excellent condition. Therefore, in
considering these facts and relying on Marshall
Valuation Service, together with appraisal experience,
it is concluded that based on 45 years life expectancy,
the subject theater has an effective age of 18 years
and based on the Marshall Depreciation Table for
Commercial Properties, is 19 percent depreciated. This
amounts to $1,044,475 depreciation leaving Net
Depreciated Value of Improvements of $4,995,168.
Utilizing the same methodology with respect to the retail/
office space, Ingram/Ewing estimated depreciation as follows:
Marshall Valuation Service has a guideline of typical
building lives of 50 years for class C average offices.
Therefore, we must consider that this office space is
an integral part of the theatre space in coexisting for
- 36 the life of the property. The office space has already
been restored, except for the Fourth Floor where tenant
finish is needed, some minor deferred maintenance yet
to complete. This office space is in very good to
excellent condition having been renovated to the extent
of refinishing most surfaces and installing new
restrooms. In consideration of these facts and
experience in appraising commercial properties it is
concluded that the effective age is 18 years, resulting
in a depreciation estimate of 15 percent. * * *
Ingram/Ewing estimated depreciation for the retail/office space
to be $238,650.
Ingram/Ewing estimated a value of $3,773,123 under the
replacement cost approach for the theater space, computed as
follows:23
Cost Approach Analysis for Theater Use Space
Estimated Replacement Cost,
As completed with 1,130 seats,
for 24,358 square feet at
$226 per square foot
$5,497,240
Less Provision for Depreciation at 19%1
(Utilizing Marshall Valuation Service and
computed after restoration)
1,044,475
Net Depreciated Value of Improvements
4,452,765
Add Land Value Estimate
542,403
Total Estimated Value by the Cost Approach
After Provision for Depreciation
As Completed with Planned Restoration
4,995,168
Less Estimated Cost of Restoration and
Maintenance
1,222,045
23
In the various tables produced by the experts and
reproduced in our opinion, several of the experts' dollar totals
do not appear to be correct. However, the dollar figures
appearing in the experts' tables and reproduced in our opinion
were rounded by the experts to what they considered the nearest
dollar amount. We note that the dollar totals presented are in
fact correct when the unrounded figures are considered.
- 37 Estimated Value by the Cost Approach
After Deduction for Cost of Restoration
$3,773,1232
1
Ingram/Ewing considered the theater space to be in "good condition",
and that, after the planned restoration, it would be in "excellent condition".
Thus, relying on the condition of other operating historic theaters, the
Marshall Valuation Service, and their own judgement, Ingram/Ewing concluded
that the theater has an effective age of 18 years, which results in 19-percent
depreciation.
2
In their appraisal report in a table titled “Summary of Values”,
Ingram/Ewing state that the value estimate under the replacement cost approach
for the theater is $3,776,390. No explanation is given to account for the
difference between this figure and the $3,773,123 figure calculated above.
Consequently, we use the $3,773,123 figure.
Under the replacement cost approach, Ingram/Ewing valued
the retail/office space at $1,472,366, computed as follows:
Cost Approach for Retail/Office Space
Estimated Actual Gross Floor Area
17,518 square feet
Estimated Replacement Cost
$1,591,000
Less Provision for Depreciation at 15%1
(Utilizing Marshall Valuation Service and
computed after restoration)
Net Depreciated Value of Improvements
Add Estimated Land Value at
$27 per square foot
Total Estimated Value by Cost Approach
After Provision for Depreciation as
Completed with Planned Restoration
Less Estimated Restoration and
Maintenance Cost
Estimated Value by Cost Approach After
Deduction for Cost of Restoration
238,650
1,352,350
175,311
1,527,661
55,295
$1,472,366
1
Ingram/Ewing considered the retail/office space to be in "very good to
excellent condition" and thus concluded that the effective age of the
retail/office improvements on the valuation date was 18 years, which resulted
in a depreciation estimate of 15 percent based on the Marshall Valuation
Service.
Thus, under the replacement cost method, Ingram/Ewing valued
the Redwood City Fox at $5,245,489.
- 38 3.
Comparable Sales Approach--Theater Component
Ingram/Ewing based their comparable sales approach on the
sale of the San Jose Fox Theater (San Jose Fox), which occurred
in September 1985.
The San Jose Fox is located at 345 South
First Street in downtown San Jose, California, a city located
approximately 25 miles south of Redwood City in Silicon Valley.
The population of San Jose was in excess of 700,000 people in
1985.
The San Jose Fox opened in April 1927.
It is also a movie
palace, providing both live performance and motion picture
capabilities, and was the first Fox movie palace in Northern
California.
The theater has an art deco facade and Spanish
Baroque architecture, and is similar to the Redwood City Fox
theater in configuration, as well as in both grandeur and
historical appeal.
The site area of the San Jose Fox is
approximately 20,200 square feet, and the building area of the
theater totals about 24,363 square feet.
It was originally
designed to have a seating capacity of 2,000 seats.
Similar to
the Redwood City Fox, the San Jose Fox was listed on the Historic
Resources Inventories of both the City of San Jose and the County
of Santa Clara, and was eligible for listing with the National
Register of Historic Places.
The San Jose Fox operated continuously from 1927 to 1955,
and operated intermittently until 1974, at which time it was
- 39 finally closed.
In 1975, the San Jose Fox was purchased by Dr.
Jose Borges for $300,000.
Dr. Borges wished to preserve the
historic splendor of the theater and to reopen it for use as a
movie theater.
Consistent with this, Dr. Borges spent
approximately $700,000 for artistic restoration of the ceiling
and walls of the auditorium.
removed.
The seating and all carpeting were
However, Dr. Borges never reopened the San Jose Fox for
business.
In September 1985, the Redevelopment Agency of the City of
San Jose (Redevelopment Agency) purchased the San Jose Fox from
Dr. Borges for $2,010,000 in cash.
The Redevelopment Agency
planned to revitalize downtown San Jose which, at that time, was
rather seedy.
At the time of its purchase by the Redevelopment
Agency, the San Jose Fox had been dark since 1974 and was not in
operating condition.
There were neither seats nor carpeting in
the theater, and the entire theater needed cleaning, refinishing,
and restoration.
Additionally, the San Jose Fox was without a
ticket sales office, concession or food service areas, and public
restrooms to serve the ground floor seating area.
The balcony
restrooms needed expansion, and there was no handicapped access.
The theater required, among other things, upgraded plumbing,
electrical (including lighting) and HVAC systems, a new audio
system, and seismic reinforcement.
- 40 In 1985, the Redevelopment Agency commissioned Design
Professionals, Inc. (Design Professionals), an architectural
firm, to develop cost estimates for renovation of the San Jose
Fox to bring it to an operating level of quality.
In their
report, entitled “Preliminary Analysis for Renovation of the Fox
Theater for the City of San Jose, August 1, 1985", Design
Professionals presented three alternative schemes of development
based on variations in the level of projected use for the San
Jose Fox.
Each of the 3 schemes was analyzed in terms of
architectural, structural, mechanical, electrical, lighting,
theater systems, acoustical, and audiovisual requirements,
including cost estimates for implementation.
Design
Professionals relied on cost estimates provided by several
consultants with the requisite expertise.
Scheme 1 consisted of cost estimates to renovate the San
Jose Fox for use as an assembly hall in conjunction with the new
convention center being built across the street from the theater.
A new 2-story lobby with a pedestrian bridge to connect the San
Jose Fox to the convention center was recommended.
Scheme 2
consisted of the improvements recommended in Scheme 1, as well as
developing the theater for use as a symphony hall.
Scheme 3
proposed to transform the San Jose Fox into a multifunctional
facility with capabilities for opera, ballet, and other types of
live performances.
Scheme 3 required the construction of added
- 41 floor space for a loading area, offices, new dressing rooms,
stage storage, and a truck dock.
In their appraisal report, Ingram/Ewing used the costs
estimates provided by Design Professionals for each of the
proposed improvement schemes for what they termed a “market
comparison” of the Redwood City Fox to the San Jose Fox.
First,
Ingram/Ewing concluded that the Scheme 2 level of use of the San
Jose Fox was very similar to the existing level of use of the
Redwood City Fox if the proposed lobby/pedestrian walkway
addition to the San Jose Fox were ignored.
The Scheme 2 cost to
bring the San Jose Fox to operating condition, minus $952,000 for
the cost of the lobby addition, was $4,762,500.
With 1,538
planned seats, the Scheme 2 estimated construction cost of
rehabilitation for the San Jose Fox was $3,097 per seat.
Ingram/Ewing then adjusted the Scheme 2 cost estimate by adding
$162,000 for the cost of restrooms and $60,000 for the cost of
stage lighting, and deducting $350,000 (one-half the amount spent
by Dr. Borges) for what Ingram/Ewing considered the superior
artistic decoration of the San Jose Fox.
To this total was added
the original $2,010,000 purchase price of the San Jose Fox.
Ingram/Ewing next deducted the $1,222,045 they estimated to be
the restoration cost of the Redwood City Fox.
They then added a
time adjustment of 4 percent per annum for the 1.3 years between
the sales dates.
Ingram/Ewing thus concluded that the “Market
- 42 Approach Value Estimate” for the Redwood City Fox, as of December
31, 1986, was $3,850,115, computed as follows:
Purchase Price of SJFox
Purchase Price per seat for 1,538 seats
Estimated Restoration and
Rehabilitation Cost for Scheme
2 without Mkt. St. Lobby
Cost per seat for 1,538 seats
$4,762,500
$3,097
Adjustments for Comparison:
Add stage lighting
Add restrooms
Deduct Architectural Decorat.
Total Net Adjustment
60,000
162,000
-350,000
-128,000
Estimated Cost Less Adjustment
Value per seat for 1,538 seats
Add purchase price per seat
Total Est. Cost per seat SJFox
4,634,500
3,013
1,307
4,320
$2,010,000
$1,307
Estimated Value by Comparison for
RC Fox Theatre Use Space
for 1,130 seats at $4,320 each
4,881,850
Less Estimated Cost to Restore
Estimated Net Value Before Restoration
1,222,045
3,659,805
Time Adjustment from September 12, 1985
to December 30, 1986 at Annual
4.00%
474 days/365 days = 1.30 years
1.30
$3,850,115
4.
Comparable Sales Approach--Retail/Office Component
Under the comparable sales approach for the retail/office
space, Ingram/Ewing chose sales of 5 improved properties, all
office buildings.
The unit of comparison was the price paid per
square foot of gross functional building area, including land.
Ingram/Ewing made adjustments for such factors as location, age
and condition of improvements, size, and date of sale.
Under the
comparable sales approach, and after subtracting the estimated
cost of restoring the retail/office space, Ingram/Ewing estimated
- 43 the value of the retail/office spaces to be $1,448,419, broken
down as follows:
Price Per
Square Foot
Total
Square Feet
East Side Retail/Office
Space (without mezzanine)
$103.00
2,625
West Side Retail/Office
Space (without mezzanine)
103.00
2,105
216,815
East Side Mezzanine
65.92
2,625
173,040
West Side Mezzanine
65.92
2,226
146,738
Office Space (without
Fourth Floor)
103.00
6,090
627,270
Fourth Floor
79.31
876
16,547
69,476
$1,503,713
Less Estimated Cost of Restoration
$
270,375
(55,295)
Total Market Value Estimate
5.
Total
$1,448,419
Ingram/Ewing--Value Reconciliation
In summary, Ingram/Ewing estimated the following values for
the Redwood City Fox under their application of the replacement
cost approach and the comparable sales approach:
Theater
Retail/Office
Cost
$3,776,390
1,472,366
Market
$3,850,115
1,448,419
Total
Final Estimate
$3,850,000
1,448,000
$5,299,000
Ingram/Ewing rounded this figure to arrive at $5,300,000 as their
estimate of the fair market value of the Redwood City Fox as of
December 31, 1986.
B.
Petitioners’ Charitable Contribution Deduction
Petitioners used the services of an accountant to prepare
their 1986 Federal income tax return.
Based on the Ingram/Ewing
- 44 appraisal, petitioners claimed a charitable contribution
deduction for the donation of the Redwood City Fox on their 1986
Federal income tax return in the amount of $5,300,000.
Petitioners attached the Ingram/Ewing appraisal and a completed
Form 8283 to their 1986 return.
Petitioners claimed carryover
deductions of the remaining amount on petitioners' joint returns
for 1988 and 1989, Jacob's return for 1990, and Crocker's returns
for 1990 and 1991.
In the notices of deficiency, respondent determined that the
fair market value of the Redwood City Fox on the date of the
transfer to the Players was $1,290,000, rather than $5,300,000 as
reported by petitioners on their 1986 Federal income tax return.
Respondent's valuation was based on an appraisal performed by
Mansbach Associates, Inc., for respondent in 1994.
Respondent
also determined that Crocker was liable for an addition to tax
under section 6653(a) for taxable year 1988 and accuracy-related
penalties under section 6662(a) for taxable years 1989, 1990, and
1991, and that Jacobs was liable for an addition to tax under
section 6653(a) for taxable year 1988 and accuracy-related
penalties under section 6662(a) for taxable years 1989 and 1990.
Respondent concedes that Crocker is not liable for the
addition to tax under section 6653(a) for taxable year 1988 and
the accuracy-related penalties under section 6662(a) for taxable
years 1989, 1990, and 1991.
- 45 VII.
The Expert Reports
To establish the fair market value of the Redwood City Fox
and associated personal property, each party offered the report
and testimony of an expert witness:
William J. Ewing and Anthony
Reynolds for Jacobs, Christopher Carneghi for Crocker, and
Lawrence Mansbach for respondent.
The parties and their experts
rely extensively on the Ingram/Ewing appraisal for facts about
the Redwood City Fox, including its history, physical dimensions,
and use and condition in 1986, as well as for facts about movie
palaces in general and other theaters in the area.
Much of the
comparable sales data presented in the Ingram/Ewing appraisal is
used by the parties’ experts in their estimates of fair market
value.
A.
Jacobs' Expert
Because of Ingram’s death in 1993, Jacobs engaged the firm
of Mitten & Reynolds, Inc., a real estate appraisal firm located
in Washington, D.C., to prepare an appraisal of the Redwood City
Fox.
The Mitten/Reynolds report was prepared by Anthony Reynolds
(Reynolds) and Carol Mitten (Mitten) in February and March 1996
and delivered to Jacobs in April 1996.
Both Reynolds and Mitten
are members of the Appraisal Institute, and both have
considerable experience in valuing historic properties such as
the Redwood City Fox.
expert.
Reynolds testified at trial as Jacobs’
Reynolds had not appraised any properties in California
prior to his appraisal of the Redwood City Fox.
- 46 Mitten/Reynolds determined that preservation was the highest
and best use of the Redwood City Fox.
They based this
determination on the property’s character and its use as an
operating theater and related commercial space, which they found
to be consistent with its zoning and location on Broadway.
They
also acknowledged the quality of the Redwood City Fox as an
example of an early movie palace and as an example of Gothic
Revival architecture.24
Mitten/Reynolds valued the theater component of the Redwood
City Fox separately from the retail/office component.
For the
theater, Mitten/Reynolds relied upon the replacement cost and the
comparable sales approaches.
Because they concluded that the
highest and best use of the Redwood City Fox was preservation,
Mitten/Reynolds found that the value of the theater was not
determined by its income potential and that consequently the
income capitalization method was inappropriate for the theater.
For the retail/office space, Mitten/Reynolds relied upon
the replacement cost approach, the comparable sales approach, and
the income capitalization approach.
Mitten/Reynolds considered
the impact of the Jacobs’ lease on the property’s value in their
report.
24
Highest and best use considerations for historic
properties, according to Mitten/Reynolds, include “the degree of
historical significance, the physical integrity of the structure,
the level of deterioration and obsolescence, and the physical and
economic environment in which the property is located.”
- 47 1.
Replacement Cost Approach--Theater
Under the replacement cost method, Mitten/Reynolds estimated
the value of the underlying land to be $770,000 (rounded), using
seven sales of commercially zoned vacant25 land as comparables
($29.00 per square foot times 26,583 square feet).
Mitten/Reynolds made adjustments to the sales prices for
financing, date of sale, location, block orientation,
configuration, size, existing improvements, and buyer motivation.
Mitten/Reynolds allocated 15,929 square feet of land area to the
theater, for a land value of $461,000, and 10,654 square feet of
land area to the retail/office component, for a land value of
$309,000.
For the replacement cost of the theater, Mitten/Reynolds
used the cost estimate in the Adamson report, which they adjusted
by:
(1) Subtracting $92,000 for the personal property donated to
the Players; (2) adding the costs of nonconstruction items
(design costs, permits and fees, financing cost, etc.); and (3)
adding an entrepreneurial fee of 10 percent.
Mitten/Reynolds
estimated the total replacement cost of the theater, excluding
the land, to be $7,000,862, computed as follows:
Total Direct Construction Cost
Deduction for Non-Operating Personalty
Adjusted Direct Construction Cost
General Conditions (7%)
25
$4,829,000
92,000
4,737,000
331,590
Mitten/Reynolds’ Comparable #4 was sold with an existing
improvement, which was subsequently demolished by the purchaser.
Consequently, Mitten/Reynolds made an upward adjustment of the
sales price.
- 48 Contractor’s Overhead and Profit (5%)
Adjusted Total Construction Cost
236,850
5,305,440
Non-Construction Items
Design
Permits, Fees, Taxes, Insurance, Etc.
Occupancy
Financing
530,000
200,000
0
328,980
Out-of-Pocket Replacement Cost
6,364,420
Entrepreneurial Incentive (10%)
636,442
Total Replacement Cost (Excluding Land)
$7,000,862
Mitten/Reynolds then estimated total depreciation, both
physical and functional,26 to be 55 percent of the $7,000,862
replacement cost, or $3,850,474.
Mitten/Reynolds estimated the
value of the theater component under the replacement cost method
as follows:
Total Replacement Cost
Depreciation (55%)
Depreciated Replacement Cost
Land Value Allocation
$7,000,862
3,850,474
$3,150,388
461,000
Value Indication
$3,611,388
Mitten/Reynolds concluded that the value of the theater component
of the Redwood City Fox, indicated by the replacement cost
approach, was $3,600,000 (rounded), for a value of $147.80 per
square foot ($3,600,000 divided by 24,358 square feet of building
area).
26
Mitten/Reynolds cited issues relating to seating, toilet
facilities, air-conditioning, the age of the structure, and its
systems and surfaces as elements of depreciation that affected
their appraisal of the property.
- 49 2.
Comparable Sales--Theater
Under the comparable sales approach, Mitten/Reynolds chose
the sale of the San Jose Fox and the sale of the Stanford Theater
(the Stanford) in Palo Alto, California, as comparables.
As
mentioned, the San Jose Fox is another historic movie palace that
was purchased by the City of San Jose in September 1985.
The Stanford was sold to the nonprofit David and Lucille
Packard Foundation (Packard Foundation) in December 1987 for
$1,600,000 in an all cash transaction.
The Stanford is located
on University Avenue near the campus of Stanford University in
Palo Alto, an affluent community approximately 30 miles south of
Redwood City.
The Stanford was built in 1925 and is similar in size and
attractiveness to both the Redwood City Fox and the San Jose Fox,
although less ornate than the Fox theaters.
Unlike the Redwood
City Fox and the San Jose Fox, the Stanford was designed for
movie projection only; there are no stage facilities to
accommodate live performances.
The Stanford has 22,313 square
feet of building space with a post-renovation seating capacity of
1,175.
The precise seating capacity prior to its sale is
unknown, but, due to different seating standards, was probably
greater.
At the time of its purchase, the Stanford was in extremely
poor condition and void of any decorative work.
Due to its
physical condition, the Packard Foundation undertook a complete
- 50 rehabilitation of the Stanford.
The rehabilitation included
seismic reinforcement, all new plumbing, and mechanical and
electrical improvements, as well as historically accurate
restoration of all areas of the building, including the facade,
restrooms, auditorium, balconies, floor coverings, concession
stand, and ticket booth.
The building was gutted, a new roof was
constructed, and the foundation was reinforced.
The renovation
cost $6,000,000, and took 18 months to complete.
The renovated
Stanford reopened in December 1989 and is operated by the Packard
Foundation for the exhibition of classic films.
Mitten/Reynolds also mentioned the sale of the Redwood City
Fox to Jacobs in May 1981.
However, Mitten/Reynolds concluded
that due to the lapse of time between the acquisition date and
the appraisal date, as well as the refurbishment performed by
Jacobs, the sale of the Redwood City Fox in May 1981 neither
supported nor refuted their appraisal opinion.
The unit of comparison employed by Mitten/Reynolds was the
price paid per square foot of gross building area, including
land.
Mitten/Reynolds did not believe that the price paid per
seat was a proper unit of comparison because the number of seats
in a theater is not fixed.
Mitten/Reynolds compared the theater sales on the basis of
seller financing, date of sale, size, physical condition,
physical/historical quality, and location.
After adjustment,
Mitten/Reynolds concluded that the value of the theater portion
- 51 of the Redwood City Fox indicated by the comparable sales
approach was $135.00 per gross square foot, for a total of
$3,288,330, which they rounded to $3,300,000 (24,358 square feet
times $135.00 per square foot).
3.
Replacement Cost Approach--Retail/Office
Under the replacement cost approach for the retail/office
space, Mitten/Reynolds started with the cost estimate contained
in the Adamson report, which they adjusted by adding nonconstruction costs and an entrepreneurial incentive.
Based on
their determination that the physical condition of the
retail/office space was “very good”, Mitten and Reynold estimated
all forms of depreciation to amount to 25 percent of the total
replacement cost.
Under the replacement cost approach,
Mitten/Reynolds valued the retail/office space at $1,800,000
(rounded), computed as follows:
Total Construction Cost
Non-Construction Items
Design
Permits, etc.
Occupancy
Financing
Out of Pocket Replacement Cost
$1,587,040
Entrepreneurial Incentive (5%)
Total Replacement Cost
Depreciation (25%)
Depreciated Replacement Cost
Land Value Allocation
Value
94,717
1,989,049
497,262
1,491,787
309,000
$1,800,787
4.
111,093
50,000
40,000
106,199
1,894,332
Comparable Sales--Retail/Office
Under the comparable sales approach, Mitten/Reynolds chose
the sales of 6 small commercial properties located in the
- 52 vicinity of the Redwood City Fox.
All the sales, except for one,
occurred prior to the valuation date of December 31, 1986.
The
selected unit of comparison was price paid per square foot of
gross building area.
The elements of comparison included seller
financing, date of sale, building size, physical condition,
parking, and location.
After adjustment, Mitten/Reynolds
concluded that the value for the retail/office component of the
Redwood City Fox was $110.00 per gross square foot, for an
indicated value under the comparable sales approach of
$2,000,000, rounded (18,489 square feet times $110.00 per square
foot).
In summary, under the comparable sales approach,
Mitten/Reynolds concluded that the value of the Redwood City Fox
was $3,300,000 for the theater, $2,000,000, for the
retail/office, for a total of $5,300,000.
5.
Income Capitalization--Retail/Office
Mitten/Reynolds concluded that the income capitalization
method was not appropriate for the theater.
With respect to the retail/office space, Mitten/Reynolds
examined the lease rates for 8 properties (lease comparables).
Seven of the lease comparables were rented on a fully serviced27
basis, while only one was on an unserviced basis.
Consequently,
Mitten/Reynolds estimated the market rent of the Redwood City Fox
27
“Fully serviced”, in the context of commercial leases, is
one in which the landlord pays all operating expenses.
- 53 on a fully serviced basis.
Full service operating expenses were
estimated at a rate of $.30 per square foot per month.
Due to
its lower ceiling height and because it would have to be rented
in conjunction with the ground floor retail space,
Mitten/Reynolds concluded that the mezzanine space would command
less rent.
Mitten/Reynolds estimated the market rental rates for
the different areas of the retail/office portion of the property
as follows:
3rd Floor
2nd Floor
Mezzanine
1st Floor
$1.35
$1.35
$1.00
$1.35
Mitten/Reynolds did not consider the lease of the property in
1984 by the County of San Mateo in their analysis.
Though not
entirely clear from the record, it does not appear that
Mitten/Reynolds considered the lease of the property by the
County of San Mateo in 1987 either.
Mitten/Reynolds estimated the net operating income for the
retail/office space28 as follows:
Income per Month
3rd Floor:
876 sq.ft. x $1.35
2nd Floor: 6,090 sq.ft. x $1.35
Mezzanine: 4,649 sq.ft. x $1.00
1st Floor: 4,676 sq.ft. x $1.35
Total
16,291 sq.ft.
Total per annum
Vacancy/Collection Loss (10%)
Total Collections
Expenses
28
$
1,183
8,221
4,649
6,313
$ 20,366
x 12 months
$244,392
24,439
$219,953
Mitten/Reynolds used the rentable square footage
determined by Ingram/Ewing in their report.
- 54 16,291 sq.ft. x $.30 x 12
Net Operating Income
58,648
$161,305
Mitten/Reynolds then used the capitalization rate
information for the lease comparables to estimate a
capitalization rate of 8.5 percent for the property.
Mitten/Reynolds arrived at a value of $1,900,000 (rounded) under
the income capitalization approach for the retail/office
component of the Redwood City Fox.
Mitten/Reynolds next adjusted this figure for the impact of
the Jacobs lease.
Jacobs leased the Second floor office, the
Third floor office, and the West retail space, including the
mezzanine, at a rate of $3,000 per month, completely net.
Referring to the Jacobs lease as the “Master Lease”,
Mitten/Reynolds modified thus modified their net operating income
estimate as follows:
Income
Master Lease: 11,205 sq.ft. x $0.27 net
Mezzanine:
2,475 sq.ft. x $1.00 gross
1st Floor:
2,611 sq.ft. x $1.35 gross
Total per month
Total per Annum
Vacancy/Collection Loss (10%)
(Applied to non-Master only)
Annual Collections
Expenses (non-Master only)
5,086 sq.ft. x $.30 x 12
Modified Net Operating Income
$ 3,000
2,475
3,525
$ 9,000
x 12 months
$108,000
7,200
$100,800
18,310
$ 82,490
Mitten/Reynolds then determined that because 69 percent of
the commercial space was rented under a long-term below-market
lease and that the risk of not receiving that net income was
slight, a lower capitalization rate was warranted to reflect the
- 55 lower level of risk.
Consequently, Mitten/Reynolds applied a
capitalization rate of 7.5 percent to the modified net operating
income for a value, reflecting the lease, of $1,100,000
(rounded).
According to Mitten/Reynolds, the $800,000 reduction
in value reflected the extent to which the Jacobs lease was below
market, as well as the 55-year potential duration of the lease.
6.
Mitten/Reynolds--Value Reconciliation
Mitten/Reynolds determined the following values for both
components of the Redwood City Fox under the respective
approaches:
Method
Replacement Cost
Comparable sales
Income Capitalization
Theater
$3,600,000
$3,300,000
n/a
Retail/Office
$1,800,000
$2,000,000
$1,900,000
Total (incl. Land)
$5,400,000
$5,300,000
n/a
After correlating all the values, Mitten/Reynolds estimated the
market value of the theater to be $3,500,000, and the market
value of the retail/office component to be $1,900,000, for a
total of $5,400,000.
After reduction for the impact of the
Jacobs lease, which reduced the value of the retail/office
component to $1,100,000, Mitten/Reynolds arrived at a fair market
value of $4,600,000 for the Redwood City Fox as of December 31,
1986.
B.
Crocker's Expert
Crocker engaged the firm of Carneghi-Bautovich & Partners,
Inc. (Carneghi-Bautovich), a real estate appraisal firm with
offices in San Francisco and San Jose, to appraise the Redwood
- 56 City Fox.
The Carneghi-Bautovich report was prepared by
Christopher Carneghi (Carneghi) and Ronald Blum (Blum), and
delivered to Crocker in September 1994.
Carneghi and Blum are
both certified general real estate appraisers in California and
members of the American Institute of Real Estate Appraisers.
Carneghi, who is the president of Carneghi-Bautovich, testified
at trial regarding his report.
Carneghi determined that the highest and best use of the
Redwood City Fox, as improved on the valuation date, was to
retain the property as a theater and market it to a nonprofit
public or private group capable of generating funds in the future
to renovate the building.
Carneghi concluded that the property
was in good physical condition and was suited for its current use
as a performing arts theater and retail/office space.
Carneghi
also noted that “public outcry” would have made demolition of the
property “very difficult”.
Carneghi valued the theater component separately from the
retail/office component of the property.
Carneghi utilized the
replacement cost approach and the comparable sales approach for
valuing the theater.
Due to its lack of income potential,
Carneghi did not consider the income approach an appropriate
methodology for valuing the theater.
With respect to valuing the
retail/office space, Carneghi utilized the replacement cost,
comparable sales, and income capitalization approaches.
- 57 1.
Replacement Cost Approach--Theater
Under the replacement cost approach, Carneghi estimated the
value of the underlying land to be $660,000 (rounded), using 5
sales of commercially-zoned vacant land located in Redwood City
as comparables ($25.00 per square foot of land area times
26,52829 square feet).
Carneghi adjusted the sales prices on the
basis of location, size, site configuration, financing, and date
of sale.
Carneghi determined the gross building area of the
theater component to be 24,358 square feet, which he found was
58.16 percent of the total gross building area of 41,876 square
feet.
Carneghi thus allocated a land value of $383,902 (58.16
percent of the $660,000 land value) to the theater.
Carneghi next estimated the total direct and indirect
construction costs of the theater to be $4,829,000, based on the
Adamson estimate.
Carneghi did not subtract the cost of the
personal property from the Adamson estimate.
Carneghi next added
7 percent for “General Conditions”, 5 percent for “Contractor’s
Overhead and Profit”, and 12.5 percent for “Developer’s Profit”,
for a total replacement cost new of $6,103,554.
29
Carneghi's estimate uses 24,528 square feet of land area.
Ingram/Ewing and Mitten/Reynolds use 26,583 as the number of
square feet of land area. Mansbach, respondent’s expert, uses
the figure 26,584 as the square feet of land area. Carneghi did
not explain this discrepancy in his square footage of land area.
At $25.00 per square foot, using what we find to be the correct
total square footage of the property, 26,583, Carneghi’s land
value estimate should be $664,575. However, when rounded to
$660,000, we find the error in Carneghi’s square footage of land
area to have no effect on his estimate.
- 58 To estimate depreciation, Carneghi determined that, due to
the several renovations, the effective age of the theater was
less than its chronological age of 57 years.
Carneghi thus
estimated the effective age of the theater to be 30 years.30
Based upon the Marshall Valuation Cost Estimation Manual, which
estimates the economic life of a good quality, Class C (concrete
construction) motion picture or performing arts theater to be 45
years, Carneghi determined that the remaining economic life of
the theater was 15 years.
Based on the effective age and
remaining economic life of the theater, and after consulting the
Marshall Valuation Manual depreciation tables, Carneghi estimated
the amount of depreciation due to incurable physical
deterioration for the theater to be 45 percent, or $2,746,599.
Carneghi did not find that deductions for functional obsolescence
or external obsolescence were warranted.
Under the replacement cost method, Carneghi valued the
theater at $3,740,000 (rounded), computed as follows:
Total Replacement Cost New
Less: Depreciation
Total Depreciated Value of Improvements
Add: Land Value
Indicated Market Value by Cost Approach
30
$6,103,554
(2,746,599)
3,356,955
383,902
$3,740,857
At one point in his report, Carneghi states that the
effective age of both the theater and the retail/office component
is “35 years”. However, in his table entitled “Cost Analysis”
and in his calculations, Carneghi uses the 30 year figure as the
effective age of the property. Consequently, we find the 35 year
figure to be a typographical error.
- 59 2.
Replacement Cost Approach--Retail/Office
Under the replacement cost method for the retail/office
component of the property, Carneghi estimated the value of the
underlying land to be $276,098 (41.83 percent of the $660,000
total land value).
He then estimated the replacement cost new of
the retail/office component to be $1,790,999.
Again, Carneghi
relied on the Adamson cost estimate, to which he added 7 percent
for “General Conditions”, 5 percent for “Contractor’s Overhead
and Profit”, and 12.5 percent for “Developer’s Profit”.
Accrued
depreciation for physical deterioration was estimated to be 34
percent or $608,940, based on an economic life of 50 years (per
the Marshall Valuation Cost Estimation Manual), an effective age
of 30 years, and the resulting remaining economic life of 20
years.
Carneghi estimated the total value for the retail/office
portion of the property under the replacement cost approach to be
$1,460,000 (rounded), computed as follows:
Total Replacement Cost New
Less: Depreciation
Total Depreciated Value of Improvements
Add: Land Value
Indicated Market Value by Cost Approach
3.
$1,790,999
(608,940)
1,182,060
276,098
$1,458,158
Comparable Sales Approach--Theater
For the comparable sales approach, Carneghi analyzed the
sales of the San Jose Fox and the Stanford.
Carneghi also looked
at the sale of the Circle Star Theater (Circle Star), a live
performance theater located in the City of San Carlos, near the
- 60 Redwood City border.
The Circle Star is a 72,192-square foot
“theater in the round” which was built in 1965.
The Circle Star
lacks the ornate architectural quality of the Redwood City Fox,
as well as the other comparables.
The site area of the Circle
Star is 8.44 net acres and has onsite parking.
The Circle Star
has 3,713 seats, 5 cocktail bars, 2 snack bars, a ticket sales
and lobby area, and an adjacent 300-seat restaurant with a full
kitchen.
The Circle Star was purchased in April 1987 from First
Federal Savings Bank of California for $6,450,000, plus a
broker’s commission paid by the buyers of $96,750, for a total
purchase price of $6,546,750.
The purchase price did not include
furniture, fixtures, and equipment, which were valued at
$750,000.
The buyer renovated the Circle Star at a cost of
approximately $2,000,000, and subsequently operated it as a
performing arts theater.
In January 1994, a sealed bid auction
was held for the sale of the Circle Star, with an asking price of
$14,725,000.
As of September 1994, the date of Carneghi’s
appraisal report, the Circle Star remained for sale.
Carneghi also considered the purchase of the Redwood City
Fox by Jacobs in 1981.
Due to Jacobs’ renovation of the Redwood
City Fox, as well as what Carneghi termed “booming” real estate
prices in California between 1981 and 1986, Carneghi gave the
1981 sale secondary consideration “because significant
- 61 appreciation occurred between the date of this sale and the
appraisal date.”
Using both price per seat and price per square foot as units
of measurement, Carneghi found that the comparable sales
indicated a range of unit values between $1,307 and $1,737 per
seat, and $71.71 and $88.36 per square foot.
Carneghi adjusted
the sales prices on the basis of physical condition, date of
sale, location, size, seating capacity, and other physical
characteristics.
On a per seat basis, Carneghi estimated a value of $1,600
per seat.
Carneghi determined the appropriate number of seats
for the Redwood City Fox, based on modern standards (including
seat width and handicapped seating and accessibility), to be
1,130 seats.
Thus, with 1,130 seats at $1,600 per seat, the
indicated value was $1,810,000 (rounded).
On a per square foot basis, Carneghi concluded that a value
of $85.00 per square foot was indicated.
With 24,358 square feet
of gross building area, Carneghi estimated the value of the
theater to be $2,070,000 (rounded).
After considering the two values, Carneghi concluded that
the value on a per square foot basis was slightly less subjective
than on a per seat basis.
Carneghi thus concluded the indicated
value for the theater component under the comparable sales method
was $2,000,000.
- 62 4.
Comparable Sales Approach--Retail/Office
Under the comparable sales method for the retail/office
space, Carneghi looked at 5 sales of small office and commercial
buildings, 4 of which were located in Redwood City and 1 of which
was located in nearby Menlo Park.
Using the net area square
footage as the unit of measurement, Carneghi found that the
comparables indicate a range of sales prices between $73.17 and
$144.55 per square foot.
Carneghi adjusted the comparable sales
prices on the basis of date of sale, building age, size (both lot
and gross building area), quality, location, parking, conditions
of sale, and economic factors.
Carneghi concluded that a unit
value of $90.00 per square foot was indicated for the
retail/office space of the Redwood City Fox.
With 16,291 square
feet at $90.00 a square foot, Carneghi valued the retail/office
space under the comparable sales method at $1,470,000.
This
value did not take into account the Jacobs lease.
5.
Income Capitalization Method--Retail/Office Space
To calculate annual gross potential income under the income
capitalization approach, Carneghi used the income generated by
Jacobs’ lease (what he termed “contract income”) of the West
retail space (both ground floor and mezzanine) and the Second and
Third floor office spaces, to which he added his estimate of
market rent for the East retail space (both ground floor and
mezzanine).
Carneghi did not use in his calculations the income
- 63 generated by the 1984 lease or the 1987 lease of portions of the
property by the County of San Mateo.
Carneghi determined that the rental rate of the Jacobs lease
was $.27 per square foot, net of expenses.
Carneghi determined
that this rental rate was below market.
To estimate market rent (and to make his determination that
the rental rate in the Jacobs lease was below market), Carneghi
used 8 lease comparables, 5 for ground level spaces and 3 for
upper level spaces.
Carneghi determined that the range of rents
for the upper floor office spaces was $1.07 to $1.30 per square
foot on a full service basis,31 and that the range for the ground
floor commercial spaces was $1.03 to $1.30 per square foot on a
triple net basis after adjustment for expenses.
He further
determined that a survey of the relevant area indicated that the
lowest rent for office space in Redwood City on the valuation
date was $1.15 per square foot, fully serviced.
After considering the location, quality, age, and lack of
parking at the Redwood City Fox, Carneghi estimated market rent
of $1.10 per square foot, full service, for the Second floor
31
According to Carneghi, office leases are typically on a
“gross” basis, whereby operating expenses are borne by the
tenant. Office leases can also be on a “full service” basis,
whereby operating expenses are borne by the landlord. With
respect to retail space, in a “triple net” lease, operating
expenses are borne by the tenant, and in a "gross" lease,
operating expenses are borne by the landlord.
- 64 office space.
Because it was unfinished at the time, Carneghi
estimated a lower market rent of $.80 per square foot for the
Third floor office space.
After subtracting operating expenses,
which he estimated at $.35 per square foot, Carneghi determined
the triple net equivalent rent of $.75 per square foot for the
Second floor office space, and triple net equivalent rent of $.45
per square foot for the Third floor office space.
For the ground floor of the East retail space, Carneghi
estimated a triple net rental rate of $1.20 per square foot.
For
the mezzanine floor, he estimated a lower rental rate, triple
net, of $.60 per square foot.
Using the net rentable square footage determined by
Ingram/Ewing for the different areas, Carneghi estimated the
monthly gross potential income for the property.
From this
figure, he subtracted a “vacancy and credit loss” for both the
space covered under the Jacobs lease and the eastern retail
space.
Carneghi stated that a vacancy and credit loss estimate
“is often utilized in the market to account for eventual vacancy
and credit loss over an investment period.”
For the space
covered under the Jacobs lease, Carneghi estimated that a zero
vacancy deduction was appropriate, and that for the East retail
space, a “standard” vacancy and credit loss allowance of 5
percent was appropriate.
- 65 Carneghi next subtracted landlord expenses from the annual
gross potential income.
Because the market rents were estimated
on a triple net basis (whereby the tenant is responsible for all
expenses including taxes, insurance, maintenance, utilities, and
janitorial), the only expenses Carneghi determined to be incurred
by the landlord were management and structural reserves.
He
projected these expenses at 3 percent and 1 percent of effective
gross income, respectively.
After subtracting the estimated expenses, Carneghi arrived
at an estimate of net operating income for the property.
To this
figure he applied a capitalization rate of 7.5 percent.
Carneghi
chose this capitalization rate based on his comparable office
building sales, which encompassed a range of capitalization rates
of 6.5 percent to 10.5 percent.
Carneghi concluded that, after
consideration of the quality of the property, its lack of
parking, the fact that the retail/office space is small and is
part of a larger building, a capitalization rate of 8.0 percent
was appropriate.
However, in light of the below-market Jacobs
lease, which created a low-risk situation for the building owner,
a lower capitalization rate of 7.5 percent was warranted.
Carneghi arrived at a value of $1,130,000 (rounded) for the
retail/office space under the income capitalization approach,
calculated as follows:
- 66 Income - All triple net
Contract income-Western space + Office
Market rent-Eastern space-Ground floor
Market rent-Eastern space-Mezzanine
Monthly Gross Potential Income
11,205 sq.ft. at $0.27
$3,000
2,611 sq.ft. at $1.20
3,133
2,475 sq.ft. at $0.60
1,485
16,291
$0.468 $ 7,618
X 12 X
12
Annual Gross Potential Income
Less: Vacancy and credit loss at
Leased space
0.0%
Eastern space
5.0%
Effective Gross Income
$5.61
$91,418
$
0
2,771
$88,647
Less: Landlord expenses
Reserves
1.0% of effective gross income
Management
3.0% of effective gross income
Total expenses
$0.05 $
886
0.16
2,659
$0.22 $ 3,546
Stabilized Net Operating Income
$5.22 $85,102
Overall Capitalization Rate
0.0750
Indicated Stabilized Value
$1,134,688
Rounded
$1,130,000
6.
Carneghi--Value Reconciliation
a.
Theater Value Conclusion
Under the replacement cost approach, Carneghi estimated a
value of $3,740,000 for the theater.
Under the comparable sales
approach, he estimated a value of $2,000,000.
With respect to
the replacement cost approach, Carneghi stated:
The Cost Approach is considered a poor indicator
of value in this case. No deduction was made in the
Cost Approach for functional obsolescence. However,
the theater was designed for film exhibition and
therefore has some disutility for performance use.
Renovations and upgrading will be required as discussed
in this report, and the Cost Approach does not fully
account for this. Also, for older special purpose
buildings, estimating physical obsolescence is
subjective. This approach is considered highly
unreliable for older special purpose buildings like the
subject.
- 67 Carneghi considered the comparable sales approach, which was
based on contemporaneous sales of “similar old theater buildings”
like the Redwood City Fox, to be more reliable.
Consequently,
Carneghi accorded the value indicated by the comparable sales
approach all the weight and accorded no weight to the value
indicated by the replacement cost approach.
Carneghi thus valued
the theater portion of the Redwood City Fox at $2,000,000.
b.
Retail/Office
For the retail/office component of the Redwood City Fox,
Carneghi arrived at the following values under the following
appraisal methods:
Replacement Cost Approach
Comparable Sales Approach
Income Approach-Direct Capitalization
$1,460,000
$1,470,000
$1,130,000
With respect to the replacement cost approach, Carneghi again
stated that valuation under this method “is not considered a good
indicator in valuation of a renovated older building with
specialized improvements.”
Carneghi found that valuation under
the comparable sales approach was a “good indicator” of value,
but that the approach did not “consider” the below-market Jacobs
lease.
With respect to the income capitalization approach, which
utilized both the market rent estimate and the rent generated by
the Jacobs lease, Carneghi found that the approach
is considered a good indicator for the subject property
which is impacted by a below market lease. However,
this approach may be unduly impacted by the below
market rent although the upside income potential was
accounted for in the selection of the capitalization
rate.
- 68 For these reasons, Carneghi gave more weight to the income
capitalization approach, and less weight to the comparable sales
and replacement cost approaches.
Carneghi’s final estimate of
the value of the retail/office portion of the Redwood City Fox
was $1,150,000.
c.
Final Value Conclusion
Carneghi valued the theater component of the Redwood City
Fox at $2,000,000, and valued the retail/office component at
$1,150,000, for a final value estimate for the Redwood City Fox
of $3,150,000 as of December 31, 1986.
C.
Respondent's Expert
Respondent determined in the notice of deficiency that the
value of the Redwood City Fox at the time of the gift was
$1,290,000.
This valuation figure was based upon an appraisal
report prepared by Lawrence Mansbach (Mansbach).32
Mansbach is a
member of the Appraisal Institute and a certified General Real
Estate Appraiser in California.
Mansbach is a principal in the
San Francisco-based firm of Mansbach Associates, Inc., and, in
the 1980's, worked for Carneghi, petitioner Crocker’s expert, as
a principal in Carneghi’s firm.
Mansbach testified at trial as
respondent's expert.
32
Mansbach's associate, Jean Rote, assisted Mansbach with
the preparation of his appraisal report. The record does not
contain additional information regarding Ms. Rote's professional
qualifications.
- 69 Mansbach initially prepared his appraisal report in early
1994 and submitted it to respondent on March 16, 1994.
In early
1996, Mansbach revised his appraisal report, performing what he
termed “editorial type * * * modifications” at respondent’s
request.
Mansbach's revised appraisal report was submitted to
respondent on April 4, 1996.
Mansbach testified that there were
no changes in the revised report with respect to his reasoning or
his conclusions as to the value of the Redwood City Fox.
For valuing the Redwood City Fox, Mansbach found that the
replacement cost method was (1) inappropriate because it would
not be "economically feasible to replace the existing structures
in today's market", and (2) unreliable due to the subjective
nature of estimating accrued depreciation on a 65-year old
building with significant functional, exterior, and physical
deterioration.
Additionally, with respect to the theater
component of the property, Mansbach found that the income
capitalization approach was inappropriate because "the purchaser
of the theater is likely to be a non-profit entity which places
little emphasis on its income producing capabilities."
Consequently, Mansbach utilized the comparable sales approach for
the theater component of the property.
For the retail/office
component, which Mansbach valued separately from the theater,
Mansbach utilized both the sales comparison and income
capitalization approaches.
Mansbach also included a valuation of
the underlying land, as if vacant.
- 70 Mansbach determined the following area measurements for the
Redwood City Fox:33
Area
Gross
Sq.Ft.
Rentable
Sq.Ft.
Theater
East side retail/office
East Mezzanine
Ground floor west retail/office
West Mezzanine
Second floor office space
Third floor space
24,358
2,625
2,625
2,625
2,677
6,090
876
24,358
2,611
Total
41,876
36,040
Mezzanine
Storage
2,475
2,105
2,226
6,090
876
4,701
Mansbach cites the Ingram/Ewing appraisal as the source of these
area measurements.
Mansbach also cites the Ingram/Ewing
appraisal as the source of information regarding "the extent of
renovation [of the Redwood City Fox] in 1950 and in the 1980s."
1.
Highest and Best Use
a.
As Vacant
Mansbach first determined the highest and best use of the
property as vacant.
Considering the location and size of the
Redwood City Fox, its zoning, neighborhood characteristics, and
market influences, Mansbach found that the highest and best use
of the property as vacant was for "office development with ground
floor retail or business/service use."
However, Mansbach
recognized that analyzing the property as vacant was essentially
"an academic exercise" because:
33
Mansbach cites the Ingram/Ewing appraisal as the source
of his building area square footage. We note, however, that
Mansbach's gross and rental square footage measurements for the
West retail space, both ground floor and mezzanine, differ from
those found in the Ingram/Ewing appraisal.
- 71 The deed restrictions effectively prohibit demolition
of the building. Furthermore, without even such
restrictions, any attempt to demolish the building
would likely encounter vocal public opposition and a
complicated process to obtain a demolition permit.
b.
As Improved
With respect to the highest and best use of the property as
improved, Mansbach gave consideration to the Redwood City Fox's
"poor operating history", "average" physical condition, and its
"poor suburban location".
Mansbach also considered the Redwood
City Fox's "limited purchase market appeal":
Overall, it is concluded that there is a very
narrow purchase market for the subject theater. The
primary purchaser of the historic movie palaces
nationwide is a public or non-profit entity. However,
this purchase segment typically involves redevelopment
agencies within cities, and/or historic foundations.
Even public entity purchases of historic theaters over
the past decade have generally been limited to urban
locations and involved only a few transactions. As
such, due to the lack of activity within this purchase
market, there is scant evidence to support a highest
and best use conclusion for the subject improvements to
renovate it to a modern stage facility.
Despite these considerations, Mansbach found that the integrated
retail/office portions of the property would have "stronger
demand", and that the "value of the subject as currently improved
exceeds the value on the land only basis."
Mansbach also noted
that the Redwood City Fox was "architecturally significant", and
that it had some "intrinsic value regardless of its
profitability."
Mansbach thus concluded that overall,
preservation of the existing improvements on the subject site
- 72 represented the highest and best use of the property, as
improved, on the valuation date.
2.
Land Valuation
Mansbach chose 5 sales of commercially zoned vacant land as
comparables to value the underlying land.34
After adjustments
for factors such as size, location, date of sale, and buyer
motivation, Mansbach determined a land value for the site, as if
vacant, of $25.00 per square foot.
Assigning 26,584 square feet
to the property, Mansbach estimated the value of the underlying
land to be $665,000 (rounded).
3.
Comparable Sales Approach--Theater
For the comparable sales approach, Mansbach viewed as
comparables the sales of the San Jose Fox, the Circle Star
Theater, and the Laurel Theater.
Mansbach also considered
Jacobs' May 1981 purchase of the Redwood City Fox.
The Laurel Theater was located in the downtown district of
San Carlos, California.
The property consisted of a 17,500-
square foot building on a 27,759-square foot site, which included
a 10,259-square foot parking lot.
The improvements were built in
1949, and consisted of the Laurel Theater and three retail
stores.
The improvements were not architecturally significant.
The property was purchased in March 1984 for $775,000, and again
34
Mansbach's comparable land sales include 2 sales of the
same property, which occurred 12 months apart. At the time of
the initial sale, the site was improved with a vacant bakery
building.
- 73 in December 1989 for $1,200,000.
The improvements were
demolished thereafter.
Mansbach determined that the 1984 purchase price of the
Laurel Theater equated to $44.29 per square foot of building area
and $27.92 per square foot of site area.
He further determined
that the 1989 purchase price of the Laurel Theater equated to
$68.57 per square foot of building area and $43.23 per square
foot of site area.
Mansbach did not provide per seat prices for
the two sales of the Laurel Theater.
Mansbach determined that the $2,010,000 purchase price of
the San Jose Fox in 1985 equated to $1,300 (rounded) per seat,
based on 1,538 "planned" seats, and $82.50 per square foot of
building area.
Because the San Jose Fox did not have any seats
installed when it was sold, Mansbach estimated it would cost
between $600,000 to $700,000 to install seats and carpeting in
the San Jose Fox.
For the Circle Star Theater, Mansbach determined the 1987
purchase price equated to $1,743 per seat based on the 3,700
seats in the theater, $88.36 per square foot of building area,
and $17.08 per square foot of site area.
With respect to Jacobs' purchase of the Redwood City Fox in
May 1981, Mansbach determined that the purchase price equated to
$1,336 per seat based on 756 seats, $24.85 per square foot of
rentable building area, and $37.99 per square foot of site area.
Mansbach next added the $829,415 expended by Jacobs for
- 74 renovation of the property to the original purchase, which
resulted in a per seat price of $2,433, a per square foot of
building area price of $69.19, and a per square foot of site area
price of $45.25.
Mansbach noted that the purchase price paid by
Jacobs included the entire building, while he was only valuing
the theater component.
Mansbach considered the appropriate unit of comparison among
his comparable sales to be the price paid per seat.
For the
Redwood City Fox, Mansbach determined that the "appropriate seat
count to apply in the valuation" was 602.
Mansbach acknowledged
that the seating capacity of the Redwood City Fox at one time
exceeded 1,300, and further acknowledged that 756 seats were
installed in the auditorium on the valuation date (602 on the
floor and 154 in the balcony).
However, due to a "lack of
documented demand for the mezzanine seats", Mansbach concluded
that a buyer "would not allocate value to these seats in making
its price decisions."
Mansbach explained his choice of 602 seats
as follows:
The appraiser was not provided information on the total
potential capacity of the theater given modern
requirements for seat and aisle width, as well as
handicapped seating. Nevertheless, the valuation of
the subject property based on the theoretical maximum
seating would require a deduction from value to account
for the cost of installing such seats. More
importantly, with inadequate demand, the market would
not place a value on the subject property based on the
theoretical maximum seating. Rather, with demand for
only 602 seats at best, there would be no economic
reason to spend such money for additional seats, as
well as bear the added costs for maintenance,
management and potentially insurance.
- 75 Among his comparables, Mansbach considered the San Jose Fox
to be the most comparable to the Redwood City Fox.
Mansbach
adjusted the $1,300 per planned seat purchase price of the San
Jose Fox downward on the basis of its purchase by a public entity
and its urban San Jose location.
Mansbach then considered this
downward adjustment to be largely offset by the San Jose Fox's
lack of seating and carpeting at the time of purchase.
Overall,
Mansbach found that the purchase of the San Jose Fox supported an
estimated value of the Redwood City Fox of $1,300 per seat.
With respect to the Circle Star Theater and the Laurel
Theater, Mansbach determined that the purchase prices equated to
land value only, with little allocation to the improvements.
Mansbach concluded that these sales supported a value for the
Redwood City Fox equivalent to land value.
Allocating 20,089
square feet to a footprint of the theater site and a land value
of $25.00 per square foot, Mansbach determined a land value of
$502,225 for the theater component of the property.
Mansbach
found that this $502,225 value allocation equated to $835 per
seat for the 602 seats in the theater.
After considering the $1,300 per seat value supported by the
purchase of the San Jose Fox and the $835 per seat value,
assuming a land only value allocation, Mansbach concluded that a
"mid-range average per seat value" of $1,100 was appropriate.
With 602 seats, Mansbach valued the theater portion of the
- 76 Redwood City Fox under the comparable sales method at $660,000
(rounded).
4.
Comparable Sales Approach--Retail/Office
Under the comparable sales approach for the retail/office
portion of the Redwood City Fox, Mansbach utilized 5 sales of
commercial property in Redwood City.
involve the same property.
Two of Mansbach's sales
All the sales were for fully occupied
free standing buildings located within a 1-mile radius of the
Redwood City Fox.
Mansbach's unit of comparison was price per square foot of
building area.
The comparable sales ranged in price from
approximately $77.00 to $142.00 per square foot.
Mansbach
adjusted the sales for factors such as date of sale, condition,
location, physical characteristics, and income characteristics.
Mansbach determined that the sales supported a value for the
retail/office component of the Redwood City Fox of $87.50 per
square foot of "true rentable area".
Mansbach determined the
"true rentable area" of the property to be 11,682 square feet,
consisting of the following:
Area
Rentable
Sq.Ft.
East Retail
West Retail
Second Floor Office
Third Floor Office
2,611
2,105
6,090
876
Total
11,682
- 77 Mansbach did not include the mezzanine floors as rentable space
because
[g]iven the storage use and low income potential
associated with the mezzanine space due to its low
ceiling heights, it is anticipated that a potential
buyer would not allocate value to this space in making
its price decision.
Mansbach also allocated 50 percent of the $87.50 determined value
to the 876 square feet available in the Third Floor office space
due to its "shell condition" and use as storage space at the time
of donation.
Under the comparable sales method, Mansbach estimated the
value of the retail/office component of the property to be
$983,850, computed as follows:
10,806 square feet x $87.50 = $945,525
876 square feet x $43.75 =
38,325
Total indicated value
5.
$983,850
Income Capitalization Approach--Retail/Office
With respect to the income capitalization approach, Mansbach
determined a value for the retail/office component, both with and
without the Jacobs lease.
Mansbach did not consider either the
1984 lease or the 1987 lease by the County of San Mateo in his
income capitalization calculations.
To determine economic rent for the property, Mansbach looked
at average income and expense information for suburban office and
retail buildings in the San Francisco Bay Area in 1987 compiled
- 78 by the Building Owners & Management Association (BOMA).35
The
BOMA information reported median income of $1.26 per square foot
for office space and $1.40 per square foot of retail space, both
on a full service expense structure.
In addition to the BOMA information, Mansbach utilized 4
full service leases of commercial property, which he viewed as
comparables.
One of the properties used by Mansbach as a lease
comparable was located in Belmont, a city neighboring Redwood
City.
The other three were located in Redwood City.
However,
Mansbach did not provide an address for one of the properties
located in Redwood City, nor did he provide an address for the
property located in Belmont.36
Mansbach stated that the lease
information was provided by Cornish & Carey, a local commercial
real estate firm.
In addition to providing the lease
information, brokers from Cornish & Carey told Mansbach that
rents within the mid-San Mateo County area for office space, as
well as commercial space within the immediate subject market
area, averaged at $1.00 per square foot per month on a full
service expense structure.
After consideration of the lease comparables and the other
information, Mansbach concluded that an average market rent, with
35
According to Mansbach, BOMA is an organization which has
"established industry standards in terms of building area
measurements, income and expenses, on a nationwide basis."
36
Mansbach listed "NA" as the location for these properties
in his comparable office leases table. We assume "NA" to mean
"not applicable".
- 79 a full service expense structure, would be $1.00 per square foot
per month for the retail/office portion of the Redwood City Fox.
Mansbach assigned 50 percent of this value, or $.50, to the 876
square feet of the Third Floor office space.
For the 4,701
square feet of mezzanine space, Mansbach assigned a "storage
rent" of $.25 per square foot per month.
Mansbach estimated total potential gross income from the
property as of the valuation date, based on the above market
rents, to be $149,031.
From this figure, Mansbach deducted a
vacancy and collection loss of 5 percent to arrive at effective
gross income of $141,579.
Mansbach's market rent estimates were stated on a full
service basis, whereby the landlord is responsible for all
associated expenses.
Based on the actual expenses incurred by
Jacobs' lease of the property from 1987 through 1992, as well as
average reported expenses from the BOMA survey, Mansbach
estimated expenses for the retail/office component at $4.95 per
square foot, per month.
Included in his estimated expenses were
a "management and administration" expense of 3 percent of
effective gross income, and a "reserves" expense of 2 percent of
effective gross income.
Mansbach chose a capitalization rate of 9 percent.
In
estimating this rate, Mansbach analyzed a survey reported in the
January 1987 issue of the Appraisal Journal which identified
institutional investors' criteria for investment, as of the
- 80 summer of 1986.
11 percent.
This survey indicated a range of rates from 8 to
Mansbach also considered the capitalization rates
based on his comparable sales, all of which were fully occupied
by tenants when sold.
His comparables indicated a range of
capitalization rates from 8.25 to 11.48 percent.
Mansbach
concluded that the 9-percent rate was appropriate based on the
Redwood City Fox's lack of onsite parking and lack of investment
appeal, due to the fact that the retail/office space was not a
free standing building.
Mansbach estimated the value of the retail/office component
of the Redwood City Fox under the income capitalization method,
without considering the impact of the Jacobs lease, to be
$930,000 (rounded), computed as follows:
REVENUE
Market Rent:
Total Potential
Gross Income
10,806 sq.ft. @ $12.00 =
876 sq.ft. @
6.00 =
4,701 sq.ft. @
3.00 =
16,383 sq.ft. @
Less Vacancy & Collection Loss
@
$129,672
5,256
14,103
9.10 Avg.
$149,031
5.00%
(7,452)
Effective Gross Income
$141,579
EXPENSES
Taxes
Utilities
Maintenance & Repairs
Insurance
Management
Reserves
$1.50 per sq.ft.
1.75 per sq.ft.
0.30 per sq.ft.
3.00% effective gross income
2.00% effective gross income
$9,303
17,523
20,444
3,505
4,247
2,832
Total Expenses
$4.95 per sq.ft.
$57,853
(57,853)
Net Operating Income
$83,726
Capitalized @ 9.00%
Rounded to
$930,294
$930,000
- 81 Without considering the Jacobs lease, Mansbach estimated the
following values for the retail/office component of the Redwood
City Fox:
Comparable Sales Approach:
Income Capitalization Approach:
$983,850
$930,000
Mansbach considered the comparable sales approach to be "weakened
by the lack of directly comparable properties, as none of the
properties had both commercial and office income potential, nor a
location within the immediate neighborhood."
Consequently,
placing more emphasis on the income capitalization approach,
Mansbach estimated the value of the retail/office component of
the Redwood City Fox, as of December 31, 1986, and without
consideration of the Jacobs lease, to be $950,000.
Mansbach also determined a value for the retail/office
component of the Redwood City Fox under the income capitalization
approach incorporating the provisions of the Jacobs lease.
Mansbach found that the rentable area leased by Jacobs was 9,071
square feet.
Mansbach excluded the 2,226 square feet of space on
the mezzanine floor from his calculations.
Utilizing both his
estimated market rent and the contract rent paid by Jacobs,
Mansbach estimated potential gross income to be $71,019.
From
this figure he again deducted 5 percent for a vacancy and
collection loss.
With respect to expenses, Mansbach noted that the Jacobs
lease was triple net, whereby Jacobs was responsible for his pro
rata share of expenses.
Mansbach determined that the Jacobs
- 82 lease covered all but 22 percent of the rentable area.
Consequently, Mansbach reduced effective gross income by only 22
percent of the expenses he had previously estimated.
With
respect to the capitalization rate, Mansbach did not change it
from the 9 percent he previously estimated without consideration
of the Jacobs lease.
Incorporating the provisions of the Jacobs lease, Mansbach
estimated the value of the retail/office component of the Redwood
City Fox under the income capitalization method to be $631,000
(rounded), computed as follows:
REVENUE
Contract Rent:
Market Rent:
9,071 sq.ft. @ $ 3.97 =
2,611 sq.ft. @ 12.00 =
2,475 sq.ft. @
3.00 =
Total Potential
Gross Income
14,157 sq.ft. @
Less Vacancy & Collection Loss
@
$36,000
31,332
7,425
5.28 Avg.
$74,757
5.00%
(3,738)
Effective Gross Income
71,019
EXPENSES
Taxes
Utilities
Maintenance & Repairs
Insurance
Management
Reserves
$1.50 per sq.ft.
1.75 per sq.ft.
0.30 per sq.ft.
3.00% effective gross income
2.00% effective gross income
$1,389
3,917
4,569
783
2,131
1,420
Total Expenses
$1.22 per sq.ft.
$14,209
(14,209)
Net Operating Income
$56,810
Capitalized @ 9.00%
Rounded to
$631,227
$631,000
6.
Mansbach--Value Reconciliation
Mansbach estimated the value of the Redwood City Fox, as of
December 31, 1986, and considering the Jacobs lease, to be
$1,290,000 (rounded), computed as follows:
- 83 Theater Value Estimate
Retail/Office Value Estimate
Total Value Estimate
$660,000
631,000
$1,291,000
OPINION
I.
Introduction
There is no dispute that petitioners' gift of the Redwood
City Fox and associated personal property to the Players is a
charitable contribution deductible under section 170(a)(1).
We
find and hold that the fair market value of the personal property
on the date of donation was $96,000.
Consequently, we need only
decide the fair market value of the Redwood City Fox as of
December 31, 1986, for purposes of determining the proper amount
of petitioners' charitable contribution deduction and carryover
deductions.37
We must also decide whether Jacobs is liable for
an addition to tax and penalties for the years at issue.
The fair market value of donated property is the price at
which the property would change hands between a willing buyer and
37
Petitioners initially argued that respondent was
precluded from redetermining the value of petitioners' 1986
charitable donation because the period of limitations under sec.
6501 had expired for taxable year 1986 at the time respondent
issued the notices of deficiency. Petitioners make no argument
regarding the statute of limitations in their briefs and appear
to have conceded this point. We note, however, that petitioners
executed extensions pursuant to sec. 6501(c)(4), and the notices
of deficiency were timely issued for each taxable year within the
period as set forth in sec. 6501(a). Although the charitable
contribution from which the carryovers arose was outside of these
periods, sec. 6501 does not foreclose this Court from looking to
a closed year to redetermine petitioners' tax liability for the
years at issue. See Barenholtz v. United States, 784 F.2d 375,
380-381 (Fed. Cir. 1986); see also Angell v. Commissioner, T.C.
Memo. 1986-528, affd. without published opinion 861 F.2d 723 (7th
Cir. 1988).
- 84 a willing seller, neither being under any compulsion to buy or
sell and both having reasonable knowledge of relevant facts.
Sec. 1.170A-1(c)(2), Income Tax Regs.
The standard is objective,
using a purely hypothetical willing buyer and seller.
Propstra
v. United States, 680 F.2d 1248, 1251-1252 (9th Cir. 1982);
Estate of Newhouse v. Commissioner, 94 T.C. 193, 218 (1990).
The
fair market value of property as of any given date is an issue of
fact to be resolved by considering and weighing all the relevant
evidence in the record.
Symington v. Commissioner, 87 T.C. 892,
896 (1986); Skripak v. Commissioner, 84 T.C. 285, 320 (1985);
Zmuda v. Commissioner, 79 T.C. 714, 726 (1982), affd. 731 F.2d
1417 (9th Cir. 1984).
While we must consider the entire record,
we have broad discretion to decide what facts are most important
in reaching our conclusion because "finding market value is,
after all, something for judgment, experience, and reason."
Colonial Fabrics, Inc. v. Commissioner, 202 F.2d 105, 107 (2d
Cir. 1953), affg. a Memorandum Opinion of this Court.
Petitioners have the burden of proving that the fair market value
of the donated property exceeds the value determined by
respondent in the notices of deficiency.
Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933); Estate of Gilford v.
Commissioner, 88 T.C. 38, 50-51 (1987); McGuire v. Commissioner,
44 T.C. 801, 806-807 (1965).
II.
Fair Market Value of the Redwood City Fox
The experts' conclusions regarding the fair market value of
the Redwood City Fox as of December 31, 1986, are as follows:
- 85 Theater
Retail/Office
Total Value
Ingram/Ewing
$3,850,000
$1,448,000
$5,300,000
Mitten/Reynolds
3,500,000
1,100,000
4,600,000
Carneghi
2,000,000
1,150,000
3,150,000
Mansbach
660,000
631,000
1,290,000
Based upon their respective expert's report and testimony,
the parties take the following positions regarding the fair
market value of the Redwood City Fox:38
Theater
Retail/Office
Total Value
Jacobs:
$3,850,000 to
3,500,000
$1,150,000 to
1,100,000
$5,000,000 to
4,600,000
Crocker:
2,000,000
1,000,000
3,000,000
Respondent:
660,000
631,000
1,290,000
In arriving at their estimated fair market values, the
experts in these cases relied upon one or more of the three
commonly recognized methods of valuing real property and other
assets:
(1) The replacement cost approach;39 (2) the comparable
sales approach;40 and (3) the income capitalization approach.41
38
Respondent requests that we sustain the value determined
by Mansbach and find that the fair market value of the Redwood
City Fox was no greater than $1,290,000. Thus, while respondent
does not request separate findings of fact with respect to the
theater and retail/office components of the property, we assume
the values for the separate components estimated by Mansbach to
be reflective of respondent's position.
39
See Marine v. Commissioner, 92 T.C. 958, 983 (1989),
affd. without published opinion 921 F.2d 280 (9th Cir. 1991).
For purposes of this opinion, the terms "replacement" and
"reproduction", when used to describe cost, are synonymous.
40
See Estate of Spruill v. Commissioner, 88 T.C. 1197, 1229
(continued...)
- 86 The significant divergence in the above estimates and the
parties' positions can be attributed mainly to their disagreement
as to validity of the replacement cost method for judging the
fair market value of the Redwood City Fox on the date it was
transferred to the Players.
Before addressing the parties'
contentions regarding the most appropriate valuation methodology,
we note several points on which the parties agree.
First, the experts agreed that the highest and best use of
the Redwood City Fox, as improved on the date of the gift, was
its preservation and continued use as theater and retail/office
space.
We agree that the evidence supports preservation of the
property as its highest and best use, and we so find.42
Accordingly, our decision with respect to the fair market value
of the property shall reflect its preservation and continued use
as a theater and retail/office space.
See Frazee v.
Commissioner, 98 T.C. 554, 563 (1992); Stanley Works & Subs. v.
Commissioner, 87 T.C. 389, 400 (1986).
Second, the parties agree, and we find that, because the
theater will not be operated for the production of income, the
income capitalization approach is not appropriate to value the
40
(...continued)
n.24 (1987); Wolfsen Land & Cattle Co. v. Commissioner, 72 T.C.
1, 19 (1979).
41
See Narver v. Commissioner, 75 T.C. 53, 90 n.17, affd.
per curiam 670 F.2d 855 (9th Cir. 1982).
42
We agree with Reynolds, Jacobs' expert, that the Redwood
City Fox is a property "for which the profit is cultural rather
than monetary."
- 87 theater component of the Redwood City Fox.
Conversely, the
parties agree, and we find, that the income capitalization
approach is an appropriate method to value the retail/office
component of the property.
Finally, consistent with our findings regarding the highest
and best use of the property and the nonincome producing nature
of the theater, we agree with the appraisers that the willing
purchaser for the Redwood City Fox would be a public or private
nonprofit entity that intends to use the property as it was on
the date of donation.
We now turn to the parties' dispute regarding the validity
of the replacement cost approach with respect to valuing the
Redwood City Fox.
Jacobs contends that the property should be valued primarily
by use of the replacement cost method, with secondary
consideration given to the comparable sales approach.
He submits
that the comparable sales approach to fair market value alone is
not reliable where "there is a limited market and limited
comparable sales, where there is special purpose property and
where preservation is the highest and best use."
Because the
Redwood City Fox is "unique and of a significant historical
importance to the Redwood City community" and because "there are
only two possible comparables, i.e., the Stanford Theatre and the
San Jose Fox", Jacobs argues that the replacement cost approach,
supported by the comparable sales approach, is the proper method
of valuation.
- 88 Crocker contends that the best method to value both the
theater component and the retail/office component of the property
is the replacement cost method because there are no true
comparable sales:
There are no comparable sales of a historic movie
palace such as the Fox Theater with its appendage, the
Retail/Office Space. There are comparable sales of the
parts, but not the whole, and in our case, for
appraisal value purposes, the whole is bigger than the
sum of its parts.
Because each appraiser determined that the property should be
preserved, and "the whole is inseparable", Crocker argues the
property must be valued by use of the replacement cost method.
Respondent's position is that comparable properties--the San
Jose Fox and the Stanford Theater--were sold during the relevant
time period, and, therefore, these transactions should be given
primary emphasis in the determination of fair market value.
Respondent disputes the reliability of the replacement cost
method in this instance for a number reasons, and further argues
that the comparable sales transactions demonstrate that the fair
market value of the Redwood City Fox is "not equal to * * * [its]
replacement cost, but rather, it is far less."
This Court has held that replacement cost may be considered
in valuing property.
(1975).
Cupler v. Commissioner, 64 T.C. 946, 955
However, replacement cost is an appropriate measure of
value only where the taxpayer establishes a probative correlation
between such cost and the fair market value of the property.
- 89 Estate of Palmer v. Commissioner, 839 F.2d 420, 424 (8th Cir.
1988), revg. and remanding 86 T.C. 66 (1986).43
Generally, a correlation between replacement cost and fair
market value has been proved where the property is unusual in
nature and other methods of valuation, such as comparable sales
or income capitalization, are not applicable because of the
property's uniqueness and nonincome-producing nature.
Estate of Palmer v. Commissioner, 839 F.2d at 424.
See, e.g.,
While we have
found that the income capitalization method is not appropriate to
value the theater portion of the Redwood City Fox, the comparable
sales method is appropriate because two properties which we find
to be substantially similar to the Redwood City Fox were sold
close in time to the valuation date of December 31, 1986.
The San Jose Fox is a 24,363-square foot "movie palace" that
opened in 1927.
The Redevelopment Agency of the City of San Jose
purchased the San Jose Fox in September 1985 with the intent to
renovate the theater and revitalize the downtown area of San
Jose.
Similarly, the Stanford Theater is a 22,313-square foot
movie theater that was built in 1925, and, while not a live
performance theater, is similar in size and attractiveness to
both the San Jose Fox and the Redwood City Fox.
43
It was purchased
In published guidelines, respondent has taken a similar
approach to the use of reproduction cost in valuing property for
purposes of the sec. 170 deduction. Such guidelines direct that
"fair market value depends upon value in the market and not on
intrinsic worth", and that reproduction cost is to be considered,
but only to the extent it is probative of value. Rev. Proc. 6649, secs. 2.04, 2.07, 1966-2 C.B. 1257, 1257-1258.
- 90 in December 1987 by the Packard Foundation, which then completely
renovated the theater and reopened it for the exhibition of
classic films.
We think the sale of the San Jose Fox and the sale of the
Stanford establish a benchmark by which to value the Redwood City
Fox.
It is true that these properties did not have adjacent
commercial space.
However, the value of the Redwood City Fox
would be no less than the value of its theater component.
And we
find that the theater component can be reliably valued by looking
to the sales of the San Jose Fox and the Stanford.
The fact that
the theater component could not be purchased separately from the
retail/office component and vice versa, is, in our view, an
important element deserving of consideration in the process of
determining the fair market value of the Redwood City Fox.
However, we think that the adjacent commercial space does not
preclude valuation on the basis of the sales of comparable
properties.
All of the experts considered these transactions to
represent comparable sales.
Additionally, all of the experts
presented evidence of sales of retail and office property which
they considered comparable to the retail/office component of the
Redwood City Fox.
And finally, all the experts arrived at a fair
market value for the Redwood City Fox by valuing the theater
component separately from the retail/office component, and then
adding the resulting values together.
We see no need to deviate
from the approach adopted by the experts in order to reach our
ultimate determination of fair market value.
- 91 We agree with petitioners that the Redwood City Fox was
possessed of much architectural significance and was a unique
property.
However, we do not agree that the presence of both
theater space and commercial space mandates reliance on the
replacement cost method to value the property.
When dealing with an older, historic structure such as the
Redwood City Fox, it is questionable whether the replacement cost
method can be used to provide a true indication of the fair
market value of the property.
Crocker's expert, Carneghi,
recognized in his appraisal report that the replacement cost
approach is considered "highly unreliable for older special
purposes buildings" like the Redwood City Fox.44
This
unreliability is demonstrated by the variation in the amount of
accrued depreciation utilized by the experts.45
A further
problem recognized with the use of the replacement cost method is
the assumption that one would actually reproduce the improvements
involved.
United States v. Toronto, Hamilton & Buffalo
Navigation Co., 338 U.S. 396, 403 (1949).
It is questionable
whether a willing buyer, such as a public entity or philanthropic
44
Jacobs' expert, Reynolds, also stated in his appraisal
report that the replacement cost method is commonly used to value
proposed or new buildings.
45
Ingram/Ewing used 19 percent for the theater and 15
percent for the retail/office component. Reynolds used 55
percent for theater, and 25 percent for the retail/office
component. Carneghi used 45 percent depreciation for the
theater, and 34 percent for the retail/office component.
Carneghi subsequently testified that the replacement cost method
was inappropriate under the circumstances.
- 92 organization, would pay to reproduce the Redwood City Fox, which
derives a great deal of its appeal from the fact that it was
built in 1928 and reflects the architectural charm of that era.
Consistent with this, Jacobs' expert, Reynolds, testified that
"one wouldn't replicate this theater, because it wouldn't be
historic if it were replicated."
Moreover, in light of the many
historically distinctive features, it is doubtful that a building
such as the Redwood City Fox could be constructed today.
Indeed,
Jacobs testified that he would not replicate the property:
The Fox Theater, to me, if I had to -- and I've built
forty-five concrete buildings before in my time. If I
had to take the contract to replicate the Fox Theater
from scratch, I wouldn't take it for $10 million. I
think it would be a very difficult thing to build,
rebuild for that price.
After considering the evidence presented and the arguments
of the parties, we find that petitioners have not proven the
requisite probative correlation between the reproduction cost of
the Redwood City Fox and its fair market value.46
Accordingly,
we confine ourselves to an examination of the expert valuations
utilizing the comparable sales method, as well as the income
capitalization method for the retail/office component.
While we do not consider the replacement cost of the Redwood
City Fox to be indicative of its fair market value, after
comparing the substance and reasoning of each appraisal report,
46
Both petitioners recognize that the replacement cost
approach to valuation is not favored. On brief, Jacobs stated
that "[t]here is no question that there exists a preference for
the market data approach." Crocker also stated on brief that the
"comparable sales method is the preferred method."
- 93 as well as the testimony presented at trial, we conclude that
petitioners have successfully established that respondent's
determination with respect to the fair market value of the
Redwood City Fox is deserving of adjustment.
We again note that valuation is not a precise science, and
determining the fair market value of donated property on a given
date is a question of fact to be resolved on the basis of the
entire record.
See McShain v. Commissioner, 71 T.C. 998, 1004
(1979); Kaplan v. Commissioner, 43 T.C. 663, 665 (1965).
Expert
opinion evidence is obviously admissible and relevant on the
question of value and is intended to help the Court understand
areas requiring specialized training, knowledge, or judgment.
However, expert opinion sometimes aids the Court in determining
valuation; other times it does not.
92 T.C. 101, 129 (1989).
See Laureys v. Commissioner,
We evaluate expert opinions in light of
the demonstrated qualifications of the expert and all other
evidence of value in the record.
Estate of Christ v.
Commissioner, 480 F.2d 171, 174 (9th Cir. 1973), affg. 54 T.C.
493 (1970); Estate of Newhouse v. Commissioner, 94 T.C. 193, 217
(1990); Parker v. Commissioner, 86 T.C. 547, 561 (1986).
As the
trier of fact, we are not bound by the opinion proffered by any
expert witness when that opinion contravenes our judgment.
Helvering v. National Grocery Co., 304 U.S. 282, 295 (1938);
Estate of Newhouse v. Commissioner, supra at 217; Parker v.
Commissioner, supra at 561.
While we may accept the opinion of
an expert in its entirety, Buffalo Tool & Die Mfg. Co. v.
- 94 Commissioner, 74 T.C. 441, 452 (1980), we may also be selective
in the use of any portion of such an opinion, Parker v.
Commissioner, supra at 562.
Consequently, we consider expert
opinion testimony only to the extent that it aids us in arriving
at the fair market value of the property.
Moreover, because
valuation is necessarily an approximation, it is not required
that the value we determine be one as to which there is specific
testimony, provided that it is within the range of figures that
properly may be deduced from the evidence.
Silverman v.
Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo.
1974-285; Anderson v. Commissioner, 250 F.2d 242, 249 (5th Cir.
1957), affg. in part and remanding in part T.C. Memo. 1956-178.
With these principles in mind, we turn to valuation of the
Redwood City Fox.
We discuss the theater component of the
property separately from the retail/office component.
A.
Valuation of Theater Component
Utilizing the comparable sales approach, the experts
estimated the following values for the theater component of the
Redwood City Fox:
Value Estimate
Ingram/Ewing
$3,850,115
Mitten/Reynolds
3,300,000
Carneghi
2,000,000
Mansbach
660,000
As the above figures indicate, respondent's expert,
Mansbach, valued the theater component much lower than the other
- 95 experts.
In considering Mansbach's opinion with respect to the
theater component of the Redwood City Fox, we find several
problems that seem to account for much of the difference between
Mansbach's value conclusions and the value conclusions of
petitioners' experts.
First, Mansbach considered the appropriate unit of
comparison among his comparable sales to be the price paid per
seat.
For the Redwood City Fox, he determined that the
"appropriate seat count to apply in the valuation" was 602.
Mansbach acknowledged that the seating capacity of the Redwood
City Fox at one time exceeded 1,300, and further acknowledged
that 756 seats were installed in the auditorium on the valuation
date.
However, due to a "lack of documented demand for the
mezzanine seats", Mansbach concluded that a buyer "would not
allocate value to these seats in making its price decisions."
Thus, he concluded that "the market would not place a value on
the subject property based on the theoretical maximum seating."
We disagree with this conclusion.
Jacobs' experts,
Mitten/Reynolds, found that price paid per seat was not an
appropriate unit of comparison because the number of seats in a
theater is not fixed.
Crocker's expert, Carneghi, felt that a
purchaser would consider the maximum seating capacity a theater
has to offer in making his or her decision.
Carneghi determined
that the appropriate number of seats for the Redwood City Fox,
based on modern standards, was 1,130 seats.
However, Carneghi
concluded that the value indicated on a per square foot of
- 96 building area basis was less subjective than the value indicated
on a per seat basis.
Mansbach's conclusion regarding the appropriate seat count
for the Redwood City Fox is further called into question by his
analysis of his comparable sales.
He was unable to provide the
seating capacity for one of his comparable sales, the Laurel
Theater.
Additionally, the San Jose Fox, which Mansbach
considered the most comparable to the Redwood City Fox, had no
seats when it was sold.
Mansbach thus evaluated the sale of the
San Jose Fox on the basis of 1,538 "planned" seats.
We find, for comparison purposes, the appropriate seat count
for the Redwood City Fox to be 1,130.
We do not agree with
Mitten/Reynolds that number of seats is not a proper unit of
comparison.
With respect to how the number of seats affects
value, Crocker's expert, Carneghi, stated:
I'm not relating the seats based on their income
potential. I'm relating the seats based on their
audience potential. So in the market comparison, the
prospective buyer of the subject or any of my
comparables, I believe would logically say, as San Jose
did, "I know the theater's not going to make a profit;
we all know cultural facilities don't make profits.
But what I -- what I want to know is, how much of my
population, how much of my market can this theater
accommodate -- i.e., how many people can I seat in this
theater?" That has to be an influence on value.
We agree with Carneghi's analysis on this issue.
While we
realize that a purchaser would not be interested in the number of
seats as a measure for the potential income stream the theater
could generate, we think a purchaser would assign value to the
theater based on the number of patrons the theater could
- 97 accommodate.
We also agree with Carneghi's conclusion that the
square footage of building area is a less subjective measure than
price paid per seat.
Another problem we find with Mansbach's appraisal is his
omission of the December 1987 sale of the Stanford Theater as a
comparable sale.
Mansbach admitted that his omission of the
Stanford Theater was a mistake, and we agree that it was.
Mansbach further testified that inclusion of the Stanford Theater
as a comparable sale would not have changed his value conclusion.
Despite this testimony, we have difficulty relying on his
opinion, arrived at without considering one of the two comparable
properties available.
We also find error in Mansbach's adjustments to the sales
price of the San Jose Fox.
Mansbach found that the condition of
the San Jose Fox was "inferior" on its sale date to the condition
of the Redwood City Fox.
Despite the San Jose Fox's inferior
condition, Mansbach considered any upward adjustment for
condition to be offset by downward adjustments on the basis of
the San Jose Fox's superior location and its purchase by a
nonprofit entity.
While we agree that a downward adjustment for
location is appropriate, we do not agree that a downward
adjustment is warranted on the basis of the San Jose Fox's
purchase by a government entity.
There is no evidence in the
record to suggest that this sale was anything but adversarial,
legitimate, and at arm's length.
Consequently, we do not see how
- 98 the identity of the purchaser would support a downward adjustment
to the sales price of the San Jose Fox.
On brief, respondent argues that the sales prices of the San
Jose Fox and the Stanford Theater "should be adjusted downward to
account for the thin market participant potential in Redwood
City."
While we realize that lack of a market is a factor to
consider in evaluating the fair market value of property, we do
not think it is an appropriate adjustment here.
Respondent
admits that the sale of the San Jose Fox, as well as the sale of
the Stanford Theater, represent comparable sales.
The fact that
there are comparable sales belies respondent's argument in this
regard.
Additionally, as mentioned, there is no evidence in the
record to suggest that these properties were acquired by the
respective purchasers for anything less than fair market value.
Furthermore, we are troubled by the fact that the value
conclusions proffered by Mansbach, respondent's expert, appear to
focus on the views of the buyer, to the exclusion of the seller.
See Mandelbaum v. Commissioner, T.C. Memo. 1995-255 (expert's
disregard for views of a willing seller may be fatal to the
expert's opinion), affd. without published opinion 91 F.3d 124
(3d Cir. 1996); see also Estate of Cloutier v. Commissioner, T.C.
Memo. 1996-49.
Although a buyer would most likely want to
purchase the Redwood City Fox at Mansbach's ascertained value,
the test of fair market value rests on the concept of a
hypothetical willing buyer and a hypothetical willing seller.
Ignoring the views of the willing seller is contrary to this
- 99 well-established test, and, as mentioned above, may be fatal.
In
this regard, our reading of Mansbach's appraisal report does not
persuade us that he ever considered whether a hypothetical
willing seller would sell the Redwood City Fox for the value he
determined.
In light of the prices the sellers of the San Jose
Fox and the Stanford received, as well as the income producing
potential of the retail/office component of the property, we
think it is doubtful that a hypothetical seller of the Redwood
City Fox would be willing to sell the property for $1,290,000, if
he or she were not under a compulsion to sell.
Based on the above errors, we are not convinced that
Mansbach's appraisal is a reliable reflection of the fair market
value of the theater component of the property.
We are also not
convinced that the Ingram/Ewing and Mitten/Reynolds appraisals
are reflective of the fair market value.
Ingram/Ewing performed what they termed a "market approach
value estimate" by adding the projected renovation costs of the
San Jose Fox to its $1,307 per seat purchase price.
This
resulted in an upward adjustment of $3,013, for a total of $4,320
per seat.
They then estimated the value of the Redwood City Fox,
by comparison to the San Jose Fox, to be $4,881,850 (1,130 seats
at $4,320 per seat).
From this figure, Ingram/Ewing then
deducted what they estimated to be the restoration cost of the
Redwood City Fox.
After an adjustment for inflation,
Ingram/Ewing estimated a value of $3,850,115 for the theater
component of the Redwood City Fox.
- 100 We believe their adjustment for physical condition was too
high in view of the location of the San Jose Fox.
Similarly,
Mitten/Reynolds concluded that the sales of the San Jose Fox and
the Stanford, whose purchase prices equated to $82.50 per square
foot and $71.71 per square foot, respectively, indicated a fair
market value for the Redwood City Fox of $135 per square foot.
As with Ingram/Ewing, we are not persuaded that such large upward
adjustments to the purchase prices of the San Jose Fox and the
Stanford are warranted.
We think the location of the Redwood
City Fox was inferior to the locations of the comparable
properties.
Consequently, we find that Ingram/Ewing and
Mitten/Reynolds approaches resulted in an inflated fair market
value.
After examination of the record, we find Crocker's expert,
Carneghi, to be more persuasive than the other experts.
As
mentioned above, where we find the evidence of valuation by one
of the parties sufficiently more convincing than that of the
other party, we may accept the opinion of the expert in its
Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C.
entirety.
at 452.
In these cases, with respect to the theater component of
the property, we accept Carneghi's opinion in its entirety.
Carneghi considered the sales of the San Jose Fox, the
Stanford, and the Circle Star to be comparable to the Redwood
City Fox.
Carneghi also considered the purchase of the Redwood
City Fox by Jacobs in May 1981.
Due to Jacobs’ renovation of the
Redwood City Fox, as well as what Carneghi termed “booming” real
- 101 estate prices in California between 1981 and 1986, Carneghi gave
the May 1981 sale of the Redwood City Fox to Jacobs secondary
consideration “because significant appreciation occurred between
the date of this sale and the appraisal date.”
Using both price per seat and price per square foot as units
of measurement, Carneghi found that the comparable sales
indicated a range of unit values of between $1,307 and $1,737 per
seat, and $71.71 and $88.36 per square foot.
Carneghi determined
that the Circle Star sold basically for land value, and
consequently he did not further consider its sale in his
analysis.
Carneghi adjusted the sales prices of the San Jose Fox
and the Stanford on the basis of physical condition, date of
sale, location, size, seating capacity, and other physical
characteristics.
On a per seat basis, Carneghi estimated a value of $1,600
per seat.
Carneghi determined the appropriate number of seats
for the Redwood City Fox, based on modern standards (including
seat width and handicapped seating and accessibility), to be
1,130 seats.
Thus, with 1,130 seats at $1,600 per seat, the
indicated value was $1,810,000 (rounded).
On a per square foot basis, Carneghi concluded that a value
of $85.00 per square foot was indicated.
With 24,358 square feet
of gross building area, Carneghi estimated the value of the
theater to be $2,070,000.
As mentioned above, Carneghi concluded that the value on a
per square foot basis was slightly less subjective than on a per
- 102 seat basis.
Carneghi thus concluded that the indicated value for
the theater component under the comparable sales method was
$2,000,000.
We are convinced that Carneghi's appraisal is the best
reflection of the fair market value of the theater component of
the Redwood City Fox.
Consequently, we find that the fair market
value of the theater component of the Redwood City Fox as of
December 31, 1986, was $2,000,000.
B.
Valuation of Retail/Office Component
With respect to the retail/office component of the Redwood
City Fox, we agree with petitioners that none of the office
buildings considered by the experts were truly comparable.
Unlike the Redwood City Fox, all were free standing structures
with onsite parking.
None were constructed in the 1920's, and
none possessed any historical significance.
Moreover, an
investor would be free to purchase the properties without the
additional purchase of a theater also.
While it is our view that
these differences do not mandate use of the replacement cost
method to value the property, we find that they preclude the use
of the comparable sales approach as a reliable indicator of fair
market value.
Furthermore, we think that a willing buyer, such
as a nonprofit entity, would accord value to the retail/office
component of the property on the basis of its income producing
potential.
Consequently, and in light of the Jacobs lease, which
all the experts found to be below market, we conclude that the
- 103 income capitalization approach is the most appropriate method for
valuing the retail/office component of the Redwood City Fox.
Under the income capitalization approach, with consideration
given to the impact of the Jacobs lease, the experts47 estimated
the following fair market values for the retail/office component
of the Redwood City Fox:
Value Estimate
Mitten/Reynolds
$1,100,000
Carneghi
1,130,000
Mansbach
631,000
As was the case with the theater component, Mansbach's
estimated value is significantly lower than the other experts'
estimates.
As was also the case with the theater component, in
evaluating Mansbach's opinion, we find several errors48 that seem
47
Ingram/Ewing did not estimate a value for the
retail/office component of the property under the income
capitalization method.
48
The first problem is the amount of market rent Mansbach
estimated the property would command. Mansbach cites the BOMA
survey, which indicated median market rent on a full service
basis of $1.26 per square foot per month for office space and
$1.40 per square foot per month for retail space in the Bay Area
in 1987. However, Mansbach estimates the market rent for the
property, both the ground floor and the upper floors, to be $1.00
per square foot per month on a full service basis. Mansbach
bases his estimate on "[d]iscussions with several brokers * * *
[which] revealed that average market rents in the Redwood City
area in 1986 were typically lower than as reported in the BOMA
survey." These brokers told Mansbach that rents for both retail
space and office space, including ground floor commercial space,
in the immediate subject area "generally averaged at $1.00 per
square foot on a full service expense structure." These same
brokers provided Mansbach with four leases that Mansbach
considered comparable to the Redwood City Fox. All the
(continued...)
- 104 to account for much of the difference between Mansbach's value
conclusions and the value conclusions of petitioners' experts.
However, one overriding problem we have with all the appraisers'
reports is their failure to consider the County of San Mateo's
lease of the East retail space, both the ground floor and
mezzanine, in their income capitalization analysis.
48
(...continued)
comparable leases were for office space; none were for retail
space. Additionally, comparable lease number 1, the "Jeanne
Bishop" and comparable lease number 4, "Intermodel Delivery
Service" have no address identified. Mansbach finds the
comparable leases indicate a range of $1.00 to $1.30 per square
foot per month. Mansbach states that the Second floor office
space has "an attractive appearance which retains many of the
historic and architectural details of the original structure."
In spite of these facts, Mansbach still estimates a market rent
at the lower end of the indicated range. For the mezzanines, to
reflect their lower ceiling heights and his determination that
they must be rented in conjunction with the ground floor retail
areas, Mansbach estimates a "storage rent" of $.25 per month.
Based on our review of the lease comparables provided by the
experts, and in light of the rent provided for in the County of
San Mateo lease, we believe that the market rent estimated by
Mansbach is too low.
Our second problem with Mansbach's estimate is his
capitalization rate. Without consideration of the Jacobs lease,
Mansbach estimated a 9-percent capitalization rate. The
comparables presented by the experts indicate capitalization
rates ranging from a low of 6.5 percent to a high of 10.5
percent. Based on the comparables, we find Mansbach's 9-percent
capitalization rate too conservative under the circumstances.
Still another problem we have with Mansbach's estimate is,
when considering the impact of the Jacobs lease under the income
capitalization method, Mansbach still utilizes a capitalization
rate of 9 percent. We believe this was an error. Although
basically related to the rate of interest, the capitalization
rate also includes risk and liquidity factors. See Narver v.
Commissioner, 75 T.C. 53, 90 n.17 (1980), affd. 670 F.2d 855 (9th
Cir. 1982). Because 69 percent of the retail/office component
was subject to a long-term lease, albeit below market, the risk
of receiving that portion of income is slight. Consequently, we
believe the capitalization rate should be reduced to reflect the
lower of level risk.
- 105 The County of San Mateo leased the East retail space for the
period of March 2, 1987, to December 1, 1987.
Rent was $4,720
per month, with the County of San Mateo paying utility expenses,
including gas, electrical, and janitorial services.
However, the
Players were responsible for paying all real property taxes.
Based on our finding of 5,086 rentable square feet, the rental
rate paid by the County of San Mateo equates to $.93 (rounded)
per square foot per month.
We believe it is appropriate to estimate the value of the
retail/office component of the Redwood City Fox by incorporating
the actual income from the below-market Jacobs lease and from the
County of San Mateo lease to calculate the total gross income of
the property.
We find that a vacancy and collection loss of 5
percent is appropriate under the circumstances to arrive at
effective gross income.
However, we agree with Carneghi that the
vacancy and collection loss should not be deducted from the space
subject to the Jacobs lease, because of the nature of the lease.
From effective gross income, we agree with Mansbach that
deductions for management expenses of 3 percent of effective
gross income and for reserves of 2 percent of effective gross
income are appropriate.
We also find that a deduction for the
real estate taxes the landlord must pay under the County of San
Mateo lease to be appropriate.49
49
Finally, with respect to the
Based on information provided by Mansbach in his
appraisal report, we estimate the deduction for the real estate
taxes to be $4,067. We note that no deduction for real estate
(continued...)
- 106 proper capitalization rate, our review of the record persuades us
that Carneghi's capitalization rate of 7.5 percent50 is the most
appropriate under the circumstances.
In accord with these findings, under the income
capitalization approach, we arrive at a fair market value of
$1,100,000 (rounded) for the retail/office component of the
Redwood City Fox, calculated as follows:
Contract income-Jacobs lease
Contract income-Cty. of San Mateo lease
Monthly Gross Potential Income
11,205 sq.ft. at $0.27
5,086 sq.ft. at $0.93
16,291
Annual Gross Income
Less: Vacancy and credit loss at
Jacobs space
0.0%
Cty. of San Mateo space 5.0%
Effective Gross Income
Less: Landlord expenses
Reserves
2.0% of effective gross income
Management
3.0% of effective gross income
Property taxes
Total expenses
$3,000
4,720
7,720
X
12
92,640
0
2,832
89,808
1,796
2,694
4,050
8,540
8,540
Net Operating Income
81,268
Capitalization Rate
0.0750
49
(...continued)
taxes with respect to the space subject to the Jacobs lease is
warranted, as Jacob was responsible for paying the real estate
taxes.
50
Carneghi found that
Considering the quality of the subject * * *
[Redwood City Fox], its lack of parking, the
fact that the subject space is part of a
larger building, and the small size, a rate
of 8.0 percent is concluded. However, the
below market lease for a majority of the
space creates a low risk situation for the
building owner which argues for a lower rate.
Therefore an 7.5 percent rate is used for
capitalization purposes.
- 107 Indicated Value
$1,083,568
Rounded
$1,100,000
C.
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