UNITED STATES TAX COURT

T.C. Memo. 2013-18

UNITED STATES TAX COURT

HUDA T. SCHEIDELMAN AND ETHAN W. PERRY, Petitioners y.

COMMISSIONER OF INTERNAL REVENUE, Respondent*

Docket No. 15171-08.

Filed January 16, 2013.

Frank Agostino, Eduardo S. Chung, and Matthew Viera, for petitioners.

John V. Cardone, Marc L. Caine, and Marie E. Smáll, for respondent.

SUPPLEMENTAL MEMORANDUM OPINION

COHEN, Judge: This case is before us on remand from the U.S. Court of

Appeals for the Second Circuit, Scheidelman v. Commissioner, 682 F.3d 189 (2d

*This opinion supplements our previously filed opinion, Scheidelman v.

Commissioner, T.C. Memo. 2010-151, vacated and remanded, 682 F.3d 189 (2d

Cir. 2012).

668V60 JAN 1 6 2013

-2[*2] Cir. 2012), vacating and remanding T.C. Memo. 2010-151. The Court of

Appeals vacated our decision, entered in accordance with our conclusions in

Scheidelman, that petitioners were not entitled to noncash or cash charitable

contribution deductions relating to the grant of a historic facade easement and a

cash contribution to the National Architectural Trust (NAT). The Court of

Appeals held that the appraisal petitioners relied on at the time their 2004 tax

return was filed (Drazner report) was a "qualified appraisal" for purposes of

section 170(f)(11) and that the disputed cash contribution was deductible.

The case was remanded for a determination of the fair market value of the

easement if we do not accept respondent's other statutory and regulatory

arguments, which relied on section 170(h)(5)(A) (a contribution shall not be

treated as exclusively for conservation purposes unless the conservation purpose is

protected in perpetuity) and section 1.170A-14(g), Income Tax Regs.

(requirements which must be met for the perpetuity requirement to be satisfied).

See Kaufman v. Commissioner, 136 T.C. 294 (2011), aff'd in part, vacated in part

and remanded in part, 687 F.3d 21 (1st Cir. 2012). Respondent no longer

contends that the conservation deed and the annexed lender agreement failed the

requirements of section 1.170A-14(g)(6), Income Tax Regs., that the contribution

be protected in perpetuity.

-3[*3] The appeal also involved respondent's challenge to our decision not to

sustain section 6662(a) penalties against petitioners. Vacation of our decision

mooted that portion of the appeal. If we had been correct that the Drazner

appraisal was not a qualified appraisal under the statute, the case for penalties

would have been stronger than it is now. See Evans v. Commissioner, T.C.

Memo. 2010-207, slip op. at 29. We see no reason to.reconsider our prior

conclusion with respect to the penalties, and do not do so here.

The parties have agreed that this case may be decided on remand on the

evidence and arguments already in the record. Unless otherwise indicated, all

section references are to the Internal Revenue Code for the year in issue, and·all

Rule references are to the Tax Court Rules of Practice and Procedure.

Background

For convenience, we repeat here portions of the findings of fact in our prior

Memorandum Opinion describing the relevant history of petitioner Huda T.

Scheidelman's donation of a historic facade easement and the Drazner appraisal

obtained in relation to that donation.

On September 24, 1997, Huda T. Scheidelman (petitioner) purchased a

property on Vanderbilt Avenue within the Fort Greene Historic District in

Brooklyn, New York, for $255,000 and became the fee simple owner. The Fort

-4[*4] Greene Historic District is designated (1) a "registered historic district'?

within the meaning of section 47(c)(3)(B) by the Secretary of the Interior through

the National Park Service (NPS), a bureau within the U.S. Department of the

Interior; and (2) a historic district by New York City and its Landmarks

Preservation Commission (LPC). In New York City it is unlawful to alter,

reconstruct, or demolish a building in a historic district without the prior consent

of the LPC. N.Y. City Admin. Code sec. 25-305 (2002).

Sometime in the fall of 2002, petitioner received a postcard from the

National Architectural Trust (NAT), a section 501(c)(3) organization (that later

became known as the Trust for Architectural Easements), announcing an

upcoming meeting in the New York City area to provide information regarding the

donation of a facade conservation easement, including possible related tax

benefits. Petitioner was interested in preserving the historic facade of her house,

particularly because she observed real estate development increasing in and

around Fort Greene. She also wanted to obtain the tax benefits suggested by NAT.

On March 24, 2003, petitioner completed a facade conservation easement

application for the Vanderbilt property to be considered for a facade conservation

easement donation to NAT. On the application, petitioner identified two lenders

that held mortgages on the property. NAT required a deposit of $1,000 to be

-5[*5] submitted with the application, which was fully refundable if the necessary

approvals for the facade easement donation could not be obtained. The

application stated that NAT's "operating funds come solely from cash donations

made by persons donating an easement. An agreed-upon cash donation of 10% of

the easement value is required at the time the easement donation is accepted by

* * * [NAT]".

In a letter dated April 2, 2003, the NAT Director of Operations informed

petitioner that her application had been accepted and that processing would

commence. The letter informed petitioner that NAT:

will place significant effort to the processing of your application.

Processing an application is complex and time consuming. It

involves obtaining approvals from the State and Federal

Governments, and your lender. * * *

There is nothing required of you until all approvals are

received.

NAT sought the approval of petitioner's mortgage holders regarding the placement

of a preservation restriction agreement on her Vanderbilt property. The two

mortgage holders executed lender agreements that were submitted to NAT during

the approval process.

On May 12, 2003, to comply with another component of the approval

process, petitioner executed a National Park Service Form 10-168, Historic

-6[*6] Preservation Certification Application Part 1 - Evaluation of Significance, to

request that the NPS certify the historic significance of the Vanderbilt property.

The NPS determined that petitioner's Vanderbilt property contributes to the

significance of the Fort Greene Historic District and is a "certified historic

structure" for a charitable contribution for conservation purposes in accordance

with the Tax Treatment Extension Act of 1980.

Later in 2003, petitioner informed NAT that she had decided not to pursue

the donation until 2004. Petitioner needed time to save the additional required

cash due, as outlined in the application. By letter dated April 22, 2004, NAT informed petitioner that all of the necessary approvals had been received and that

she needed to order an appraisal. NAT provided in the letter a list of appraisers

"qualified to do easement appraisals". Petitioner hired one of the listed appraisers,

Michael Drazner, formerly of Mitchell, Maxwell & Jackson, Inc. (MMJ), to

.perform an appraisal of the Vanderbilt property.

Drazner and James Kearns, president of NAT, first communicated in

December 2001 when Kearns contacted Drazner to inquire whether he would be

able to prepare appraisals for homeowners who were interested in donating facade

easements to NAT. Kearns sent copies of reports to Drazner that had been

prepared by another appraisal firm outside of the New York City area along with

-7[*7] some information regarding court cases that involved the charitable

cdntribution of facade easements.

Drazner completed an appraisal of the subject property on May 20, 2004.

Tl e Drazner report states that the appraisal was completed in accordance with title

XI of the Federal Financial Institutions Reform, Recovery, and Enforcement Act

of 1989 and the Uniform Standards of Professional Appraisal Practice. Drazner is

a ualified expert in the field of real estate appraisal and valuation.

Petitioner's Vanderbilt property was described in the Drazner report as:

an attached four story, three family townhouse located in the Boerum

Hill neighborhood of Kings County. The subject is physically and

functionally adequate 'as is' * * * [and] features a rear deck, patio,

and clean tiled subcellar below the garden level. This home also

includes a wealth of turn of the century details that generate strong

demand for such homes in the area. These include wood mouldings,

paneling and wainscotting, volume ceilings, exposed brick walls,

stained glass windows, original wood planking, and fireplaces.

Drazner determined that the estimated market value of the property was

$1,015,000 as of the appraisal date. The Drazner report outlined the use of the

three classic approaches to value (sales comparison, cost, and income) that were

considered to determine the market value of the Vanderbilt property. The report

st ted that the sales comparison approach is the "most applicable and has been

given greatest weight in the determination of the final value * * * [and] the cost

-8[*8] approach was given least weight due to the age of the subject property." The

stated purpose of the report was "to estimate 'as is' value of the subject property

and to estimate the impact on the subject property if granted an 'architectural

facade easement.'" The report explained that

An easement is a particularly useful historic preservation tool in

several respects. First, it allows an individual to retain private

ownership of the property and obtain potential financial benefits.

Second, an easement binds not only the current owner, but all future

owners as well, ensuring that the property will be maintained and

observed by future owners. Third, easements are tailored to meet the

needs of the property owner, the individual resource, and the mission

of the protecting organization. * * *

If certain criteria are met, the owner also may receive a Federal

income tax deduction equivalent to the value of the rights given away

to a charitable, or governmental organization. * * * The deduction

the taxpayer is entitled to is equal to the fair market value of the

easement, which is generally the decrease in fair market value of the

property caused by the restrictions placed on the property because of

the easement.

The Drazner report briefly discussed two cases involving easement

valuation, Hilborn v. Commissioner, 85 T.C. 677 (1985), and Richmond v. United

States, 699 F. Supp. 578 (E.D. La. 1988), and stated that

As these cases depict, it is extremely difficult for appraisers to

estimate the probable and possible impact on a property's value by the

imposition of a facade conservation easement that is granted in

perpetuity. For most attached row properties in New York City, where

there are many municipal regulations restricting changes to properties

located in historic districts, the facade easement value tends to be

-9[*9] about 11 - 11.5% of the total value of the property. That figure is

based on the appraiser's experience as to what the Internal Revenue

Service has.found acceptable (on prior appraisals).

The Drazner report further stated that

This facade easement can, and often does, have an effect on

marketability and the market value of a property. The measurement of

this effect or impact is difficult to quantify with any supported

precision. Articles, periodicals, and books have been written on the

subject (measurement of the value of the historic easement).

However, in this market area, there is no measure or formula that is

applicable for all properties. The individual properties are so unique

that each case must be evaluated on its own. Additionally, while there

are accepted methods for measuring this effect, only the market can

provide the true test. Nonetheless, there are market measures that

provide sufficient data with which to bracket and support a reasonable

market indicator.

Estimating the value of a property after the donation of a

conservation easement is very much like condemnation appraisal

practice where easements or partial fee interests are taken from

property owners by a sovereign. Attempts must be made to define

what rights have been lost by the property owners and what elements

of damage (or enhancement) are involved in the loss. Because real

estate is not bought and sold in a vacuum, the appraiser has

endeavored to place himself in the mindset of competent buyers and

sellers and to examine considerations they have actually had, or are

likely to have, in the buying or selling of a property encumbered by a

facade easement.

*

*

*

*

*

*

*

It is now generally recognized by the Internal Revenue Service that the

donation of a facade easement of a property results in a loss of value

*.* * between 10% and 15%. . The donation of a commercial property

- 10 [*10] results in a loss of value of between 10% or 12% or higher if

development rights are lost. The inclusive data support at least these

ranges, depending on how extensive the facade area is in relation to

the land parcel.

It is our opinion that the presence of the facade conservation

easement would alter the market value of the subject property. In the

subject's market area, the appraiser cannot precisely estimate the

extent to which this "loss in value" will result from the facade

easement due to the lack of market data. In this situation it is the

appraiser's conclusion that the value of the facade conservation

easement * * * on the subject property would be estimated at

$115,000, which is approximately 11.33% of the fee simple value of

$1,015,000. This conclusion is based on consideration of range of

value that the I.R.S. has historically found to be acceptable as well as

historical precedents. Therefore, the presence of the historic facade

easement would decrease the fair market value of the property rights

held by the homeowner of the subject property to $900,000.

On June 23, 2004, Kearns signed the conservation deed on behalf of NAT.

On September 21, 2004, the City of New York recorded the conservation deed of

easement for the Vanderbilt property. The deed of easement for the subject

property is considered to be only an architectural facade conservation easement.

Petitioner attached Form 8283, Noncash Charitable Contributions, to her

2004 Form 1040, U.S. Individual Income Tax Return, and reported a $115,000 gift

to charity on line 16 of Schedule A, Itemized Deductions. The Form 8283 filed had

two versions of page 2, with one signed by the appraiser and president of NAT and

the other lacking these signatures. Both reported essentially the same information:

- 11 [*11] (1) a description of the donated property as a facade easement with respect to

the Vanderbilt property; (2) the overall physical condition being a "Históric .

Preservation Easement Donation"; and (3) a stated appraised fair market value of

$115,000 for the donated property On the executed page 2, Drazner signed the

declaration of appraiser section and identified the appraisal date as May 20, 2004,

and Kearns, as president of NAT, signed an acknowledgment of receipt of the

contribution by NAT, as donee, on June 23, 2004.

Discussion

The Court of Appeals stated: "Our conclusion that Drazner's appraisal

meets the minimal requirements of a qualified appraisal mandates neither that the

Tax Court find it persuasive nor that Scheidelnian be entitled to any deduction for

the donated easement." Scheidelman v. Commissioner, 682 F.3d at 199. In a case

similar to this, the Court noted that "ordinarily any encumbrance on real property,

howsoever slight, would tend to have some negative effect on that property's fair

market value. Even a nominal encumbrance that is placed by the current owner of

the property would, at the very least, deprive a subsequent owner of the opportunity

of placing a similar encumbrance on that property." Evans v. Commissioner, T.C.

Memo. 2010-207, slip op. at 15. In Evans, the Court found that the appraisal relied

on by the taxpayers was qualified but that the taxpayers had not provided sufficient

- 12 [*12] credible evidence to shift the burden of proof to the Commissioner under

section 7491(a) or to meet their burden of establishing entitlement to their claimed

charitable contribution deduction. Id., slip op. at 7, 15-16; see also Dunlap v.

Commissioner, T.C. Memo. 2012-126. We reach the same conclusions here.

There is no dispute that the "before and after" approach is to be used to

determine the fair market value here as it has been in numerous other cases. Sem

e.g, Hilborn v. Commissioner, 85 T.C. 677, 688 (1985); Dunlap v. Commissionér,

T.C. Memo. 2012-126; Simmons v. Commissioner, T.C. Memo. 2009-208, aff'd,

646 F.3d 6 (D.C. Cir. 2011); Griffin v. Commissioner, T.C. Memo. 1989-130,

aff'd, 911 F.2d 1124 (5th Cir. 1990).

As directed by the Court of Appeals, we analyze evidence in this case de

novo-to determine whether petitioners have satisfied their burden of proving the

fair market value of the donated easement. See Scheidelman v. Commissioner, 682

F.3d at 193, 201. There is no dispute about the qualifications of the witnesses.

Therefore, we do not include in our discussion the detailed training and

background of each. To assist the Court the testimony should satisfy the standards

of rule 702 of the Federal Rules of Evidence, to wit, "(1) the testimony is based

upon sufficient facts or data; (2) the testimony is the product of reliable principles

and methods; and (3) the witness has applied the principles and methods reliably to

- 13 [*13] the facts of the case." Therefore we focus on the manner in which the value

was reached, the reliability of the methodology, and the persuasiveness as applied

to the facts in this,case.

The Drazner Report

Petitioner did not rely on Drazner at trial. Respondent called Drazner to

explain his methodology in anticipation.of respondent's position that the appraisal

did not satisfy the regulatory requirements for qualification under the statute. (For

subsequent years, the statute has been amended.. See sec. 170(f) (11) (E) (as

amended by the Pension Protection Act of 2006, Pub. L. No. 109-280, sec.

1219(c)(1), 120 Stat. at 1085, effective generally for appraisals prepared with

respect to returns filed after August 17, 2006, ùl_, sec. 1219(e)(2), 120 Stat. at

1085-1086)). On brief, however, petitioner argues that the Drazner report is·

credible evidence of value.

Respondent argues that Drazner's percentage methodology was simply part

of a pattern of appraisals NAT provided and that the Drazner report mechanically

assigned the percentage and incorporated language of a sample appraisal NAT

provided. Respondent also presented evidence that 91 reports MMJ prepared at

NAT's request used almost identical language and percentages without regard to

- 14 [*14] specific facts and circumstances regarding the property subject to the

easement and preexisting restraints on changes to the property.

There is no material dispute between the parties with respect to the value of

petitioner's property before the easement. Respondent's criticism of the Drazner

report, with which we agree, focuses on Drazner's purported determination of the

value of petitioner's property after the easement was granted. Drazner determined

the value of the easement by applying an 11.33% discount to the value of the

property. His derivation of that percentage was not based on reliable market data

or specific attributes of petitioner's property, but rather on his analysis of what the

courts and the IRS had allowed in prior cases. As we said in Nicoladis v.

Commissioner, T.C. Memo. 1988-163, 1988 Tax Ct. Memo LEXIS 187, at *21,

however,

we do not mean to imply that a general "10-percent rule" has been

established with respect to facade donations. There was a fair amount

of discussion by the parties at trial about whether the Court had

established a "10-percent rule" in Hilborn. We did not there and do

not here. Hilborn establishes as acceptable the before and after

method of valuation, and while under the circumstances of that case a

10-percent figure was relied upon, valuation itself is still a question of

facts and circumstances. * * *

Although the Drazner report set forth boilerplate standards for valuing property, it

is apparent that Drazner's bottom line was the equivalent of making a claim for "all

- 15 [*15] that the traffic would bear." He opined that the value of the easement, the

equivalent of loss in market value of the subject property due to grant of the

easement, was $115,000. That conclusion was not based on qualitative factors for

the Vanderbilt property or the specific attributes of that property but was based on

mechanical application of a percentage with no demonstrated support as to its

derivation, other than acceptance of similar percentages in prior controversies.

Thus the report was not based on sufficient facts or data and was not the product of

a reliable methodology, and Drazner's methodology was not reliably applied to the

facts of the case. For those reasons, it was not credible.

Petitioners' Expert Evidence

Petitioners' expert at trial was Michael Ehrmann, who also had the necessary

qualifications to appraise the easement but made factual and calculation mistakes,

some of which he admitted, that undermined the reliability of his report.

Ehrmann had prepared a market study for NAT's counsel that was attached

to his report in this case. The information that he relied on came from NAT

through its counsel. He incorporated material recommended by NAT's counsel,

including earlier appraisals by his employer. Ehrmann admitted that his report did

not accurately describe the easement, stating that his description was "a summary

of my knowledge about the easement program that I've gotten over the years." He

- 16 [*16] relied on outdated information rather than contemporaneous inspection, used

alleged comparables from outside the geographical area of petitioner's property,

and applied an unsupported and unrealistic adjustment to petitioner's Brooklyn

townhouse as compared to a detached house in Evanston, Illinois. His

methodology is undermined by these errors. See Evans v. Commissioner, slip op.

at 10.

Petitioners argue that Ehrmann's appraisal should be accepted in part

because it relied on "the cumulative results of MMJ's ninety-one facade easement

valuations", which we reject as unpersuasive for the reasons that we reject the

Drazner appraisal. Ehrmann ignored studies suggesting a contrary result and

adopted those supporting his client's desired value. Ehrmann's testimony had all

of the earmarks of overzealous advocacy in support of NAT's marketing program

and, indirectly, petitioner's tax reporting. His conclusion that the easement should

be valued at $150,000 is unpersuasive and not credible.

Expert opinions that disregard relevant facts affecting valuation or

exaggerate value to incredible levels are rejected. See Boltar, L.L.C. v.

Commissioner, 136 T.C. 326, 335 (2011) (and cases there cited); Chiu v.

Commissioner, 84 T.C. 722, 734-735 (1985); Garrison v. Commissioner, T.C.

Memo. 1986-261 (concluding that the taxpayers were "far too aggressive in their

- 17 [*17] claimed value of * * *. [the donated] property and in seeking to profit from

their 'good works' at the expense of Uncle Sam"): An expert loses usefulness to

the Court and loses credibility when giving testimony tainted by overzealous .

advocacy. Boltar, L.L.C. v. Commissioner, 136 T.C. at 335-336. Ehrmann's

conclusion does not help the Court because it does not satisfy the standards of rule

702 of the Federal Rules of Evidence. Because we cannot accept petitioners'

expert's testimony as credible, the burden of proof did not shift under section

7491(a).

Respondent's Expert Evidence

Respondent's first valuation.expert was Timothy Barnes. Barnes analyzed

the terms of the easement, zoning laws, and regulations of the LPC and concluded:

"in highly desirable, sophisticated home markets like historic brownstone

Brooklyn, the imposition of an easement, such as the one granted on June 23, 2004,

is not a deterrent to the free trade of such properties at fully competitive prices and

does not materially affect the value of the subject property." Barnes researched the

geographic area of petitioner's property, contacting real estate brokers and

valuation professionals in the Brooklyn market to determine whether the

imposition of a facade easement affected the marketability of or ability to finance a

townhouse within the Fort Greene Historic District. The "uniform response" was

- 18 [*18] that such easements did not negatively affect buyer interest, marketing time,

or financing. He explained during his testimony that the pool of prospective buyers

within the five boroughs of New York City was a more reliable measure of market

effect than analysis comparing communities outside of New York City, which is

one of the reasons that Ehrmann's report was not reliable. Barnes also opined that

a difference between the controls available to LPC, which exercises a police power

of the city, and NAT are the placement of the burden on the homeowner to go to

court and seek an exception, in the first instance, and on the private party seeking

to enforce the restriction to go to court, in the second.

Barnes also criticized Ehrmann's calculations, his selection of comparables,

and particularly his failure to account for differences in overall lot sizes and floor

space of the allegedly comparable properties. Although petitioners claim that the

errors should be disregarded as immaterial and that we should accept Ehrmann's

subjective judgments, we believe that Barnes' reasoned judgments are more

reliable.

Respondent also presented expert testimony by Stephen D. Dinklage, an

engineer employed by the IRS, who used an alternative approach based on

condemnation techniques and determined that the grant of the easement did not

have a material effect on fair market value. Dinklage used market data to divide

- 19 [*19] the value of the land from that of the building and then used a modified cost

approach to isolate that portion of petitioner's townhouse affected by the facade

easement. He concluded that because only the facade was affected by the easement

and the loss of utility was only to the facade, the restrictions would not have a

material effect on the market value of the whole property. Dinklage reasoned that a

hypothetical buyer would not pay less for the Vanderbilt property because it was

already restricted by the LPC regulations and the easement did not make a

difference. This conclusion is consistent with other evidence.

Other Evidence

Respondent argues that the LPC created restraints on properties such as

petitioner's so that the NAT easement had no material effect. Petitioners contend

that the LPC does not enforce the restrictions as effectively as NAT. That

speculation is based on testimony of a representative of NAT, is not supported by

anything but anecdotes, and is contrary to evidence specifically related to the

Vanderbilt property.

The chairman of the Fort Greene Association, which has as its mission

preservation within the Fort Greene boundaries, testified specifically with respect

to the area in which the Vanderbilt property is located. In his experience, the LPC

provides guidelines to maintain the historic integrity of facades in historic districts

- 20 [*20] in New York City. The LPC enforces guidelines and issues violation notices,

but "the violation only takes effect and adds any value when the title changes

hands." Although.he was called as a witness by petitioners, on cross-examination

he testified:

Q:

You like being in the preservation district?

A:

I like being in the preservation district. The preservation

district actually has created Fort Greene to what it is today. It's

created -- it's an economic engine for Fort Greene.

Q:

So you would consider the preservation district an

effective agency for the city of New York?

A:

The Landmark Preservation agency [is] an effective

agency of the city of New York, it does what it can do in its scope.

A logical inference from this testimony is that preservation of historic facades is·a

benefit, not a detriment, to the value of Fort Greene property.

The conclusion that the easement did not materially diminish the value of

petitioner's property is also supported by petitioner's own testimony. Petitioner

testified:

Well, I was primarily interested in preserving my house

itself in light of the dramatic development that was occurring in

and around Fort Greene during those years and still is. I was

also intrigued by the tax benefit of preserving the facade which I

had intended to do anyway.

.

- 21 [*21] I thought it would be the right thing to do for the house. I

wanted to preserve the historic facade of the house. I believe in

that, I believe in doing that in communities like Fort Greene. I

also wanted to benefit tax wise. I didn't know how much I

would benefit, but I wanted to benefit from what I was already

intended to be committed to doing.

We do not believe that petitioner would have granted the easement if she had

anticipated a substantial drop in the market value of her property as a result. It is

even less likely that she would have agreed to a restriction that reduced the value of

her property by the relatively large amount claimed, $115,000, or the even larger

amount proposed by Ehrmann, $150,000.

On review of all of the evidence, we conclude that the preponderance

supports respondent's position that the easement had no value for charitable

contribution purposes. Respondent's position is the more persuasive, regardless of

the burden of proof.

We have considered the other arguments of the parties. They do not alter our

conclusions.

To reflect the deductibility of petitioner's cash payment,

Decision will be entered

under Rule 155.