Take-Away: The Tax Court finally allowed a charitable façade easement for historic structures as a charitable income tax deduction. The significance of that decision is that for several years now, donors of charitable easements, including façade easements, have not fared well at all in the Tax Court trying to sustain their income tax charitable deductions. The futility of taxpayers constantly losing in the Tax Court when they claimed an income tax deduction for charitable easements is akin to watching the Detroit Lions each fall.

Background: An individual is allowed to deduct the value of any charitable contribution he or she makes. [IRC 170.] There is an exception for contributions of real property if the gift consists of less than the entire interest in such property. [IRC 170(f)(3)(A).]But just to make sure that taxpayers can get confused, there is an ‘exception to the exception’ that permits an income tax deduction for a partial interest in real estate if the donation is a qualified conservation contribution.[IRC 170(f)(3)(B)(iii).]

  • Qualified Conservation Contribution: A qualified conservation contribution is a contribution (i) of a qualified real property interest, (ii) to a qualified charitable organization, that is (iii) exclusively for conservation purposes.
  • Perpetuity: A qualified real property interest must be a restriction granted in perpetuity on the use which may be made of the real property. In addition, the contribution will not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.
  • Key Point: Consequently, key to a tax deductible conservation easement is the assurance that the restrictions imposed through the conservation easement will be readily enforced and are not illusory, in perpetuity. [IRC 170(h)(1)(2)and (5).]

Painful History: Over the past decade taxpayers have regularly lost their claims to a charitable conservation or facade easement income tax deduction in the Tax Court when the power to amend the easement agreement was retained or the court concluded that the easement agreement and the protected property interest could be altered, or the enforcement of the easement in perpetuity condition was not satisfied. The enforcement of the easement was key to the success of the taxpayer in the Tax Court decision issued a year ago.

Decision: Kissling v Commissioner, Tax Court No. 19857-10, Filed November 12, 2020. This court decision is 70 pages long,  but it provides something of a mirror for many communities with historic districts and historic preservation rules and regulations. If the municipality has no funds then, to quote the Tax Court judge, the restrictions and limitations for change set forth in the municipality’s historic district are a ‘paper tiger.’

Facts: In 2004 the Kissling’s LLC contributed façade easements on three commercial buildings to the National Architectural Trust. These buildings were already in an historic preservation district in Buffalo, New York that, under local law, already restricted what building owners could do with their buildings. The charitable deduction associated with the façade easements were claimed for 2004 through 2006.

  • Façade Easement Redundant? The IRS denied the charitable income tax deductions on the basis that the façade easements had no effect on the value of the buildings, or to quote the IRS’s position, “the restrictions imposed on developing the historic buildings contained in the façade easements were redundant to the limitations imposed since the buildings are already listed in the historic Preservation District.”
  • Historic District Enforcement Illusory? While Buffalo has a Preservation Board that would approve certificates of appropriateness of proposed changes to buildings within the historic district, it has no independent powers of enforcement. The actual enforcement of the building code rules necessary to preserve the historic district is delegated to Buffalo’s Department of Permits and Inspection Services (DPI). In reality, the enforcement of the building codes applicable to the historic district is even more diffuse. If there is a perceived violation of the building code by a building owner, then the DPI sends a letter to the owner, and if the owner disregards the letter, then the matter is referred to Buffalo’s Corporate Counsel to bring a lawsuit, in the Corporate Counsel’s discretion, in Buffalo’s Housing Court. Like many big cities, Buffalo was struggling financially in the early 2000’s. Due to budgetary constraints, it struggled to conduct building inspections, e.g. each building inspector had 2,000 to 3,000 inspections assigned a year. Most of these inspector were not trained in historic building preservation standards. Nor did the city keep baseline condition records on buildings in the historic district. As such, in reality, while the three buildings were already located in an historic district, the likelihood that the preservation regulations would be enforced were pretty slim due to municipal budgetary constraints.

Tax Court Decision: While many interesting arguments were raised in the Tax Court decision, this short summary will only focus on two key decisions made by the Tax Court judge:

  • Duplicative Restrictions: The Kisslings identified what they claimed to be numerous requirements imposed by the conservation easements that were not imposed by Buffalo’s Preservation Code; they identified 12 different restrictions or limitations in the façade easement that were not covered by Buffalo’s Preservation Code, i.e. the terms of the conservation easement were more burdensome than the city’s Preservation Code, thus negatively impacting the value of the real estate warranting their charitable easement income tax deduction.

The Tax Court disagreed. In effect, the judge adopted the IRS’s redundancy argument. “The restrictive components of the preservation agreement were basically duplicative of, and not materially different from, the historic district’s preservation standards….We recognize technical differences between the easements and local law, but we agree with respondent’s conclusion that the restrictions were practically the same…We are not persuaded that the legal distinctions identified by the Kisslings would by themselves have a material effect on the properties’ values.”

  • Ineffective Preservation Code: The Kisslings also argued that although Buffalo’s Preservation Code had restrictive standards, its economic problems made its monitoring and enforcement of those standards ineffectual. The easements that they gave to the National Architectural Trust created a system of easement enforcement where none in fact had existed under the Preservation Code.
  • The Tax Court judge agreed with this argument. The judge noted that Buffalo lacked the resources to record even a baseline condition of its historic properties. In the absence of that baseline, Buffalo was unable to judge the properties’ deterioration from year to year. Trial testimony made it clear to the judge that the bigger problem in Buffalo was ‘demolition by neglect’ than demolition for new development. “All of this gives us the distinct sense that Buffalo’s enforcement of its Preservation Code was not proactive, but reactive; or as [one witness] put it, ‘crisis management.’

..numerous elements of the properties’ facades had either substantially deteriorated or been replaced with historically inconsistent materials before these easements, when the properties were subject only to the City’s Preservation Code. These alterations, which appear to have gone completely unnoticed by either the DPI or the Preservation Board, support a finding that in 2004 Buffalo had understandably focused its inspectors on health and safety hazards and not on preserving its architectural legacy from better times.

We would be less comfortable with this conclusion if the Trust also seemed to be a paper tiger. But when Kissling Interests [the LLC owner] made alterations without first getting the Trust’s consent, the Trust noticed the alterations and demanded a response. The record has no evidence that the City even noticed any alterations in the properties’ facades. We therefore do find that the Trust’s enforcement of the easements was much more proactive than the City’s enforcement of its Preservation Code…The City’s enforcement of its Preservation Code at the time of the easements’ donation was largely ineffective. This means that the easements themselves imposed material restrictions that lowered the properties’ values.”

Conclusion: This case was a rare victory for the taxpayer who claimed a conservation façade easement as a charitable income tax deduction. In fact, it might be the only taxpayer victory on this topic in the last several years in the Tax Court. Of interest was the reasoning used by the judge that the municipality which was perpetually underfunded did not enforce its own Preservation Code, while the holder of the conservation easement was much more likely to enforce the façade easement in perpetuity, which had the effect of reducing the value of the buildings, leading to the charitable deduction.