Tuesday, November 26, 2013

Recent Tax Court Decision Provides Another Warning for Appraisers Performing Conservation Easement Appraisals

Gorra v. Commissioner, U.S. Tax Court, T.C. Memo 2013-254.

On November 12, 2013, the U.S. Tax Court decided a petition challenging the IRS' disallowance of a tax deduction for a donated conservation/preservation easement.  The donated easement was for the ostensible purpose of preserving a building façade and other historical characteristics of a property located in New York City. The gist of the decision is that the Tax Court found that the taxpayers were entitled to a deduction for the easement and that the appraisal submitted with their return was a "qualified" appraisal, but that a "gross valuation misstatement" had been made.  The original appraisal submitted by the taxpayers with their return had valued the donated easement at $605,000.  A different appraiser hired by the taxpayers to provide a valuation as an expert witness in the tax court proceeding valued the easement at $465,000 -- in other words, the taxpayers' own expert witness would not support the original appraiser's valuation submitted with the tax return.  The IRS' expert opined that the easement had no value because of the local historic preservation laws already restricting development of the eased property.  In the end, the Tax Court concluded that the value was $104,000.  As a result, the Tax Court also concluded that the taxpayers were liable for a 40% penalty for  a "gross valuation misstatement."

The Tax Court's decision, which is available in Google scholar here, provides an excellent overview of the technical requirements applying to whether an appraisal is a "qualified appraisal" for charitable contribution purposes and contains many useful references to other tax cases concerning the valuation of conservation easements.  Just as importantly, with respect to the potential liability that appraisers may face in the hazardous field of appraising easements for tax returns, it provides yet another warning to appraisers: namely, appraisals of any type of conservation easements and especially those of building preservation easements are subject to intense scrutiny by the IRS and by the Tax Court.  Appraisals that are significantly off the mark, even when technically complaint, can and do result in penalties assessed against the taxpayers or the appraisers.

IRS imposition of penalties against appraisers has become much more common in the last three years.  That is the situation at issue in a federal court case filed by three appraisers in the Chicago area: Fishman, et al. v. United States, U.S. District Court, N.D. Ill., Case No. 13-CV-03222.  In this case, the appraisers prepared a series of appraisals of building façade easements as employees of a large appraisal firm in Chicago.  The appraisal reports generally concluded that each façade easement had a value equal to 15% of the value of the property before the easement was granted.  The IRS disallowed the deductions.  It also assessed penalties against the appraisers under I.R.C. section 6702 for "aiding and abetting" the taxpayers in the understatement of income taxes.  The IRS penalized the appraisers $1,000 for each appraisal they had provided, which totaled $17,000 for one of the appraisers.  Faced with these penalties, the appraisers have hired tax counsel and filed a complaint in the case seeking to have the penalties assessed against them removed.  Their complaint is available here on www.appraiserlaw.com.

What many appraisers don't know is that the potential IRS penalties are actually trivial when compared to an appraiser's liability risk. The risk is that a taxpayer who has been denied a deduction based on an appraisal issue may choose to bring a legal action against the appraiser for professional negligence.  There is no suggestion that any such claims have been made relating to the above cases (and, in the case of the New York City easement, such a claim might well be time-barred under New York's strict statute of limitations), but in other situations involving denied deductions, taxpayers have then chosen to pursue legal action against the appraisers.  How to minimize such potential liability exposure is one of the subjects of a new seminar we have developed: “Liability Issues for Appraisers Performing Litigation and Other Non-Lending Work.”  In the seminar, we advise appraisers to have very strong engagement agreements for this type of work and to include provisions such as the following:

Client intends to utilize Appraiser’s appraisal(s) and/or report(s) prepared under this Agreement in connection with a tax matter. Appraiser provides no warranty, representation or prediction as to the outcome of Client’s tax matter. Client understands and acknowledges that the taxing authority (whether it is the Internal Revenue Service, any state or local tax authority) or a court may disagree with or reject Appraiser’s appraisal(s) and report(s) or otherwise disagree with Client’s tax position, and further understands and acknowledges that the taxing authority may seek to collect from Client additional taxes, interest, penalties or fees. Client agrees that Appraiser shall have no responsibility or liability to Client or any other party for any such taxes, interest, penalties or fees and that Client will not seek damages or other compensation from Appraiser relating to any taxes, interest, penalties or fees imposed on Client or for any attorneys’ fees, costs or other expenses relating to Client’s tax matter.
A recent article in Bloomberg confirms the high risk for appraisers in this area of practice: http://www.bloomberg.com/news/2013-11-06/irs-cracks-down-on-breaks-in-land-of-rich-americans.html.