FCG Valuation Case E-Flash

The U.S. Court of Appeals considered whether the Tax Court properly determined the value of a historic facade easement claimed as an income tax deduction. Ultimately, the court of appeals vacated the Tax Court's decision because it failed to consider the highest and best use of the property and failed to consider the easement's effect on a building adjacent to the easement.

Façade Easement Contributed to Nonprofit

Whitehouse Hotel Limited Partnership ("Whitehouse") owned a parcel of land in New Orleans. The property included the Maison Blanche and Kress buildings. Whitehouse conveyed an easement to a nonprofit corporation on December 29, 1997. The easement prohibits changes to the terra-cotta façade of the Maison Blanche building. A day after the easement was donated, Whitehouse combined the two properties and developed the area into a single condominium unit.

Whitehouse claimed a charitable-contribution deduction for the easement in the amount of $7.445 million on its 1997 tax return. The IRS allowed a deduction in the amount of $1.15 million and asserted a gross undervaluation penalty of 40%.

In the Tax Court trial, the experts argued, among other things, which property should be valued and the nature of its highest and best use.

Gross Valuation Misstatement Asserted

Based on parts of each expert's valuation, the Tax Court determined the value of the easement was $1,792,301. Additionally, the Tax Court assessed a gross valuation misstatement penalty of 40% of the portion of underpayment of taxes.

Whitehouse challenged the Tax Court's valuation of the façade easement and the underreporting penalty.

Expert Qualifications and USPAP Compliance Challenged

Whitehouse asserted that the Tax Court erred in admitting the IRS' expert's opinion based on his qualifications. The IRS expert is a licensed appraiser in Louisiana with over 25 years of experience. Additionally, he has appraised 50 to 70 hotels, commercial properties near the Maison Blanche building, and the Maison Blanche building itself three times prior. Whitehouse argued that a facade easement appraisal requires additional or different qualifications. The court of appeals disagreed with Whitehouse and indicated that an appraiser with the IRS' expert's background is qualified to "value a specific type of interest - even one as 'esoteric and specialized' as a conservation easement".

Whitehouse also challenged whether the IRS' expert's report should have been admissible. Specifically, the IRS' expert's report failed to comply with USPAP. The court of appeals determined that strict compliance with USPAP should not render a report inadmissible. Instead, compliance with USPAP should be considered when determining the relevant weight the report should be given.

Material Post Valuation Date Event Knowable

Whitehouse challenged the Tax Court's valuation because it solely relied on the comparable-sales method. Given reproduction of the property is unlikely, the Tax Court ruled that the replacement-cost method was of little use in determining fair market value. The Tax Court recognized the income method is typically favored when comparable sales are unavailable but noted that it is unsatisfactory when the property has no track record of earnings. Without historical data to evaluate, the appraisal's reliability comes into question. The court of appeals did not determine whether the Tax Court erred in rejecting the replacement-cost and income methods. On remand, the Tax Court is ordered to reconsider all three methods.

In basing its valuation in part on the IRS' expert's analysis, Whitehouse argues the Tax Court miscomprehended the highest and best use of the Maison Blanche and Kress buildings as a non-luxury hotel rather than as a Ritz Carlton as Whitehouse's expert asserts. The court of appeals indicated that the Tax Court will have the ability to decide this issue on remand.

The buildings were not combined on the date of the donation of the easement. As a result, the Tax Court concluded that the easement did not burden the adjacent Kress building. The court of appeals indicated that the Tax Court was correct in that the easement does not burden the Kress building in the same manner that the easement burdens the Maison Blanche building. However, the condominium declaration was recorded the day after the easement conveyance. The appeals court indicated that a hypothetical buyer would have considered the pending combination of the buildings and the effect of the easement on the value of the entire contiguous property, including the subject property.