On September 20th, 2018, the Tax Court issued its memorandum decision granting a partial summary judgment in favor of the Internal Revenue Service (“IRS”). This decision arrives after a series of other decisions relating not about the traditional valuation disputes and battles of the experts, but instead a quick “gotcha” by the IRS negating the deduction entirely for simple technical issues. In this case, that was the omission of basis from Form 8283.
Other cases presented arguable technical issues, particularly issues revolving around compliance with the extinguishment regulations.1While in some of those cases a technical fault could substantively alter the underlying charitable gift, here no such impediment on the actual gift was discussed.2 Before discussing the actual problems in the Belair Woods case, let’s think for a moment what would be the true impact of omitting basis, why does the IRS request the basis, and why should a failure to provide that information result in automatic denial of the deduction in some cases?
Impact of Omission of Basis
The regulations require a donor to “attach a fully completed appraisal summary” to the tax return on which the charitable contribution deduction is first claimed. Treas. Reg. 1.170A-13(c )(2)(I)(B). This summary must include the cast or adjusted basis of the donated property. Id. at subpara. (4)(ii)(E ).
Belair, in its pre-Notice environment, upon indirect advice of counsel, did not include its basis for the property in its Form 8283.3 The Court disagreed with this, and based on the tone of the Court’s opinion, the Court seemed to believe that the omission was to mislead and potentially fly under the radar. Belair, on the other hand, had some good points for omitting basis, which in certain circumstances could arguably be excusable.4 Particularly, Belair stated it was unsure of what basis to use exactly. Belair unfortunately did not state this in its attachment to its Form 8283, instead stating that the basis was omitted because “[b]asis of the property is not taken into consideration when computing the amount of the deduction…”, which the Court promptly pointed out in its decision.
Why does the IRS Request Basis Anyway?
Basis can be used as a litmus in determining whether the contributed property may have been overvalued for deduction purposes. 5 Prior to the passage of DEFRA, which included these heightened reporting requirements, the IRS warned that taxpayers were using inflated appraisals to claim deductions that were several multiples of that actually paid for the donated property. See, e.g., Roscoe L. Egger, “Warning: Abusive Tax Shelters Can Be Hazardous,” 68 A.B.A. J. 1674, 1676 (1982).
On December 23, 2016 (after the events in this case), the IRS released Notice 2017-10 in which the IRS targeted syndicated conservation easement transactions by labeling such transactions as “listed transactions.” However, after going through the notice a few times, what stuck out was the 2.5 multiple for the transaction to be reportable per the notice. Considering the top marginal rate at the time, the IRS’ intent was pretty clear – go after those who may be getting more than they give. At a 2.5 multiple and above, the value of the tax benefits from the deduction can be exceed the original cost of the property in question. As discussed in the case and as pointed out in this article, the basis information seems to be useful for the IRS in measuring the amount of potential benefit to the taxpayer in making the gift. Accordingly, the IRS seems to want to use this information to focus on the low-hanging fruit when possible.
Should Failure to Include Basis Result Automatic Denial
While this is phrased very much as a policy question, I am unsure of whether a complete denial of deductions should be allowed in many cases for failure to comply with some technical requirements of the statute and relevant regulations.6 While I understand this to be an effective enforcement measure, the failure to provide the basis, something that is clearly only provided for audit and enforcement measures, should not result in denial of an almost $4.8 million deduction. At the end of the day, valuable property interests were still transferred away from the taxpayer. The fact that the taxpayer stands to take a hit twice is troubling, especially for just failing to provide ancillary information.
In sum, the case at hand is an unfortunate additional illustration of what happened when taxpayers fail to follow the technical requirements for reporting charitable deductions. It is easy to see and relate to both sides of the argument on this case and, while there should be some penalty for failure to disclose the basis, the $4.8 million loss of deduction seems to be a little heavy given the circumstance. Based on the the wave of recent cases, this case is not an outlier in reaching this result. Compliance is becoming an all to common issue with many easements notwithstanding Congresses outward showing of desire for the American people to conserve.7
- See ESA articles on Champions Retreat, Harbor Lofts, and PBBM-Rose Hill.
- See PBBM-Rose Hill, LTD v. Comm’r, 900 F.3d 193 (5th Cir. 2018).
- An interesting note here is that the Tax Court did not grant summary judgment with respect to the penalties. An issue of the case was reliance on the attorney of the advisor who stated that basis need not be included on the Form 8283. This leaves open the question of reliance on someone else’s tax professional.
- See Belair Woods, LLC v. Comm’r., T.C.M. 2018-159, at 12.
- See RERI Holdings I, LLC, v. Comm’r, 149 T.C. ___, ____ (slip op.at 22-23) (July 3, 2017).
- However, see BC Canyon II, L.P. v. Comm’r (867 F.3d 547 (5th Cir. 2017) (stating “The Tax Court’s hyper-technical requirements for baseline documentation, if allowed to stand, would create uncertainty by imposing ambiguous and subjective standards for such documentation and are contrary to the very purpose of the statute. If left in place, that holding would undoubtedly discourage and hinder future conservation easements.”)
- Congress has clearly made it a point to incentivize taxpayers to conserve. Through the years, Congress has extended a 15 year carry-forward, 50% deduction limitation (versus 30%), and made permanent these provision through multiple pieces of legislation.