Attorney-at-Law

A Joy Forever

In Uncategorized on 04/04/2011 at 17:38

It may be a thing of beauty, but Tax Court says it must be a joy forever. So Tax Court held in Gordon and Lorna Kaufman, 136 T.C. 13, released 4/4/11.

Lorna owned a rowhouse in Boston’s South End, with a façade worthy of historic preservation. Lorna gave a historic preservation easement to National Architectural Trust (hereinafter “NAT,” n/k/a Trust for Architectural Easements). In exchange for a hefty cash contribution to provide a trust fund for enforcing the easement, NAT shepherded Lorna’s application through the National Parks Service to get the coveted historic preservation designation that would give the Kaufmans a substantial Section 170(h)(1) deduction for the diminution of property value caused by the granting of the easement. The Kaufmans took the deduction, IRS disallowed it, and Tax Court granted partial summary judgment to IRS in Kaufman, 134 T.C. 182 (2010). Now Kaufman moves for reconsideration, joined by various preservationist groups.

Tax Court denies the preservationists the right to file briefs, telling them to devise a joint brief with Kaufman’s counsel that raises all their issues.

The whole problem is perpetuity. The easement must be enforceable forever. Certain events that might be “remote possibilities” do not impair “forever”. In any event, Kaufman claims that eminent domain, mechanics’ liens foreclosure, changed circumstances, Marketable Title acts and casualty losses do not impair “forever”, as all net proceeds arising out of any such event go to the Trust, which is permissible under Treas. Reg.1.170A-14(g)(6)(ii), a sort of cy pres application.

Tax Court cites Treas.  Reg. 1.170-14(g)(2), which requires mortgagees to subordinate their lien to the easement, as foreclosure is not a remote possibility as a matter of law.

There’s the rub. While the other possibilities for extinguishment cataloged by Tax Court: “Condemnation (eminent domain), the foreclosure of pre-existing liens, foreclosure for unpaid taxes, Marketable Title Acts, merger or abandonment, the doctrine of changed conditions, and release by the holder” 136 T.C.13, at pp. 15-16, may be so remote as not to invalidate the “in perpetuity” requirement (Reg. 1.170-14(g)(3)), a mortgage foreclosure is not.

Lorna Kaufman had mortgaged the property to now-defunct Washington Mutual Bank, F.A. (“WaMu”). NAT had guided Lorna to a deal with WaMu, whereby WaMu subordinated to the easement, but reserved to itself all casualty insurance proceeds and condemnation awards until the mortgage was paid in full.

No good, says Tax Court. Kaufman’s argument that foreclosure was a remote possibility does not survive Tax Court’s analysis:  “The drafters of section 1.170A-14, Income Tax Regs., undoubtedly understood the difficulties (if not impossibility) under State common or statutory law of making a conservation restriction perpetual. They required legally enforceable restrictions preventing inconsistent use by the donor and his successors in interest. See sec. 1.170A-14(g)(1), Income Tax Regs. They defused the risk presented by potentially defeasing events of remote and negligible possibility. See sec. 1.170A-14(g)(3), Income Tax Regs. (sometimes, simply, the so-remote-as-to-be-negligible standard). They did not, however, consider the risk of mortgage foreclosure per se to be remote and negligible and required subordination to protect from defeasance. See sec. 1.170A-14(g)(2), Income Tax Regs. (sometimes, simply, the subordination requirement).” 136 T.C. 13, at p. 21.

If there’s a mortgage on the property, however remote the chance of foreclosure, the mortgagee must subordinate all the way.  No priority to the mortgagee in any condemnation awards, casualty insurance proceeds, or anything else; everything must go first to the Trust.

Tax Court denies IRS substantial undervaluation penalties, because the valuation of the easement never comes into play, the deduction being denied in principle regardless of the value of the easement.

The takeaway? If you do one of these deals, the bank must subordinate all the way. As John Keats would say, “the thing of beauty must be a joy forever.”

  1. […] and Lorna Kaufman, 136 T.C. 13, filed almost a year ago to the day, 4/4/11, and my blogpost “A Joy Forever”, of the same […]

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