APPEAL FROM THE UNITED STATES TAX COURT. Hon. James S. Halpern, U.S. Tax Court Judge.
Frank Agostino, with whom Tara Krieger, Agostino & Associates, PC, Michael E. Mooney, and Nutter McClennen & Fish LLP were on brief, for appellants.
Patrick J. Urda, Attorney, Tax Division, United States Department of Justice, with whom David A. Hubbert, Deputy Assistant Attorney General, and Jonathan S. Cohen, Attorney, Tax Division, United States Department of Justice, were on brief, for appellee.
Before Lynch, Chief Judge, Thompson and Kayatta, Circuit Judges.
LYNCH, Chief Judge.
This appeal turns on a straightforward question: did the Tax Court clearly err when it found that taxpayers Gordon and Lorna Kaufman must pay penalties for claiming a charitable deduction on their tax returns for a worthless historic preservation easement on their home? Finding no clear error, we affirm.
The Kaufmans claimed a charitable deduction of $220,800 on their 2003 and 2004 returns. The deduction corresponded to the purported value of a historic preservation facade easement on their Boston home, which they donated to the National Architectural Trust, since renamed the Trust for Architectural Easements (" the Trust" ). The Commissioner of Internal Revenue disallowed the deduction and assessed deficiencies and accuracy-related penalties for both tax years in question.
The Tax Court affirmed the disallowance of the deduction on a motion for summary judgment, holding that the charitable deduction was invalid as a matter of law,
see Kaufman v. Comm'r, 134 T.C. 182 (2010) [hereinafter " Kaufman I" ], and it reaffirmed this ruling after holding a trial on the remaining issues in the case, see Kaufman v. Comm'r, 136 T.C. 294 (2011) [hereinafter " Kaufman II" ]. The Kaufmans appealed to this court, and we vacated the Tax Court's decision and remanded for further proceedings.
See Kaufman v. Shulman, 687 F.3d 21, 33 (1st Cir. 2012) [hereinafter " Kaufman III" ]. On remand,
the Tax Court found that the value of the easement was zero and that the Kaufmans were liable under applicable IRS regulations for a 40% accuracy-related penalty for making a gross valuation misstatement. Kaufman v. Comm'r, T.C. Memo 2014-52, 107 T.C.M. (CCH) 1262 (2014) [hereinafter " Kaufman IV" ].
The Kaufmans appeal for a second time. They do not contest the Tax Court's finding that the value of the easement was zero, but they argue that the court erred in imposing the accuracy-related penalties. They also advance, for the first time, an argument that the Commissioner did not comply with the procedural requirements of 26 U.S.C. § 6751(b)(1) in assessing those penalties.
We affirm. The Tax Court's finding that the Kaufmans are liable for accuracy-related penalties was neither clearly erroneous nor infected by any error of law. The Kaufmans failed to raise their second argument before taking this appeal (or, indeed, at any earlier point in the labyrinthine history of this litigation), and so we deem it waived.
I. Facts And Procedural History
A. The Easement Donation
In 1999, Lorna Kaufman, a company president with a Ph.D. in psychology, bought a single-family residence for herself and her husband Gordon at 19 Rutland Square in the South End of Boston for just over $1 million. Kaufman III, 687 F.3d at 22. The home is subject to certain zoning restrictions by virtue of its location in the South End historic preservation district. Around October 2003, she and Gordon, an emeritus professor of statistics at MIT, " learned about a tax incentive program for historic preservation" promoted by the Trust, which the Trust represented would allow the couple to qualify for a charitable deduction in the amount of 10-15% of the value of the South End residence. Id. at 23. As explained in Kaufman III,
A provision of the Internal Revenue Code, 26 U.S.C. § 170(h) (2006), creates an incentive for taxpayers to donate real property interests to nonprofit organizations and government entities for " conservation purposes." . . . [T]he statute allows taxpayers to claim a deduction for donating a real property interest -- including an easement -- " exclusively for conservation purposes." These purposes include the preservation of " historically important" land areas or structures.
The deduction for granting the easement is intended to reflect the value of what the taxpayer has donated which, in the absence of a " market" for such easements, can be measured by " the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the restriction."
Id. (citations omitted).
In December 2003, the Kaufmans entered into a Preservation Restriction Agreement (PRA) with the Trust, which granted to the Trust an " easement in gross, in perpetuity, in, on, and to the Property, Building, and the Facade" and limited alterations to the property. Under the Trust's system, donors were also required to give a cash contribution to the Trust equal to 10% of the value of the donated easement.
Kaufman III, 687 F.3d at 23. The Kaufmans did so.
As the Trust requested, the Kaufmans also sent a form letter in late 2003 to their mortgage lender, Washington Mutual Bank, asking it to subordinate its interest in the property to the Trust's easement. Id. at 23-24. The letter stated that the easement " convey[ed] the right of prior approval or [ sic ] any future changes [the owner] wish[ed] to make on the exterior of the property." Significantly, the letter also noted that " [t]he easement restrictions are essentially the same restrictions as those imposed by current local ordinances that govern this property." Gordon later testified that he " [d]idn't notice" the sentence stating that the PRA restrictions were the same as the South End zoning restrictions already in place and that he " made a mistake" in signing the form. He stated that he thought the PRA restrictions were " much tougher," but admitted that he did not compare the two sets of restrictions. Lorna testified similarly, stating that she " probably didn't focus on" the sentence in question and that she believed that granting the easement would subject their home to stricter controls.
In order to obtain a charitable deduction for the donation of the easement, the Kaufmans were required to obtain an appraisal of its fair market value. See 26 U.S.C. § 170(f)(11). The Trust offered the names of two appraisers it recommended, and the Kaufmans selected Timothy Hanlon.
Kaufman III, 687 F.3d at 24. Hanlon was a certified professional appraiser who managed his own residential appraisal company. Id. However, the only appraisals of partial interests in real property that he had done were nine appraisals of the value of facade easements donated to the Trust. As the Tax Court explained, Hanlon had learned to appraise facade easements by speaking with representatives from the Trust, who had told him that " the range of values for facade easements is between 11% for properties in highly regulated areas and ('towards') 15% in less regulated or unregulated areas." Trust representatives also suggested language for him to include in his appraisals, which Hanlon in fact incorporated " almost verbatim" into all of his reports, regardless of the property involved.
Hanlon's January 2004 appraisal attempted to arrive at the value of the easement through the " before and after" method of valuation, which involved " determining the difference between 'the fair market value of the property prior to donation of the easement and the fair market value of it after donation of the easement.'" He determined that the value of the property before the grant of the easement was $1,840,000. He acknowledged that there was " much overlap" between the burdens imposed by the PRA and the burdens imposed by the South End zoning restrictions, but concluded that the PRA restrictions were " stricter." His explanation for why the PRA controls were purportedly stricter, however, was vague, nonspecific, and not entirely logical. A representative excerpt from his report reads as follows:
The [PRA] easement is granted in perpetuity while the historic district ordinances and local zoning practices may change over time to reflect changes in political, economic and aesthetic needs and tastes in a community. The Historic District ordinances contain relief for economic hardship, which the [PRA] does not. The [PRA] may result in higher insurance and property maintenance costs than those on properties not
so encumbered. Rehabilitation costs may be higher also as the property owner could be obligated to restore or replace deteriorated materials rather than replace them with cheaper substitute materials. . . . Marketability could be affected as a segment of the buying public may show resistance to being subjected to yet additional limitations and restrictions on their property rights.
Despite his conclusion that the PRA imposed more robust restrictions on the use of the property than did the South End zoning restrictions, Hanlon also opined that the PRA did not change or inhibit the property's development to its highest and best use as a single-family dwelling.
Hanlon estimated that the burdens imposed by the PRA would reduce the property's fair market value by 12%, and so he calculated the value of the easement at $220,800. To reach this conclusion, Hanlon relied on a document prepared by IRS employee Mark Primoli stating that " the proper valuation of a facade easement should range from approximately 10% to 15% of the value of the property."  Hanlon then made a list of burdens that he believed would affect the value of a property encumbered by a facade easement and assigned a percentage to each such that the percentages added up to 15%. These calculations were based on his " judgment, experience, and . . . 'common sense,'" not on any data or statistical analysis.
Kaufman IV, 107 T.C.M. (CCH) 1262, T.C. Memo 2014-52 at 26. He then " adjusted the percentages" to " reflect th[e] differences and similarities" between the South End zoning restrictions and the restrictions imposed by the PRA. Hanlon acknowledged that his method was " unique" and that it was " not a generally accepted appraisal practice or valuation method."
Gordon testified that he thought Hanlon's appraisal " looked like a professionally [ sic ], respectable appraisal by a credentialed appraiser." He sent the appraisal to his longtime accountant, David Cohen. According to Gordon, Cohen replied that " the appraisal looked professional and well done, [and] the results were reasonable." Cohen testified that he " had seen many real estate appraisals" and the Hanlon appraisal " seemed very similar to the other ones [he] had seen." He also stated that he offered the Kaufmans no opinion on whether the magnitude of the easement valuation was reasonable.
A week after receiving Hanlon's appraisal, Gordon e-mailed Mory Bahar, a representative of the Trust. Lorna and Cohen were copied on the e-mail. Gordon expressed concern as to whether " the reduction in resale value of the property due to the easement [would be] so large as to overwhelm the tax savings that accrue from it." He then asked if Bahar had " statistical documentation that bears on how much of a reduction in resale value takes place for residential properties." Gordon also noted Hanlon's statement " that the restrictions imposed by the . . . Trust are much stricter than Boston Landmark's restrictions," and he asked Bahar to " read that section of the appraisal and give me your comments about it."
Bahar's reply to Gordon, copied to Lorna and Cohen, reads, in relevant part, as ...