The Significance of Simmons v. Commissioner
D.C. Court Ruling Supports Preservation Easements
By Matthew A. Eisenstein | From Forum Bulletin | September 22, 2011 |
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In recent years, and despite a clear congressional policy of creating incentives for contributions of preservation easements, the Internal Revenue Service has engaged in a campaign against income tax deductions claimed by owners of historic properties who donate preservation easements to tax-exempt organizations. Purportedly reacting to abusive transactions, the IRS has conducted many audits of individual taxpayers and rejected tax deductions on the grounds that easement donations are entirely valueless, or else not “exclusively for conservation purposes” as required by the Internal Revenue Code. The IRS has extracted favorable settlements, and litigated vigorously when donors have been unwilling to compromise on the IRS’s terms.
By attacking preservation easement programs at the taxpayer level—instead of revoking the tax-exempt status of easement holding organizations engaged in abusive practices—the IRS has deterred many owners of historic properties from donating easements, even to legitimate tax-exempt organizations. As the IRS’s own advisory council observed in a 2009 report, “[t]here is concern that any donor will hesitate to make a donation, regardless of the quality of the appraisal or the legitimacy of the donation, if the donor knows that he or she is thereby ‘buying an audit.’”1 Donations of preservation easements in fact have dwindled and, in some communities, have virtually ended.
All hope for preservation easements should not be lost, however. Earlier this summer one of the nation’s highest courts dealt a solid blow to the IRS’s campaign against preservation easement contributions. In Simmons v. Commissioner, a three-judge federal appeals court in Washington, D.C., unanimously affirmed a tax court ruling that an owner of two properties in D.C.’s Logan Circle Historic District, who donated facade easements on her properties to the D.C.-based nonprofit The L’Enfant Trust, was entitled to a tax deduction for her contributions. The decision is significant because it rejected several legal arguments that the IRS had presented in multiple cases throughout the country, and in many ways generated a clean bill of health for The L’Enfant Trust and the language in the easement deeds it uses.
Key Questions Regarding Easement Terms
The Simmons decision answered four questions about provisions that a tax-exempt preservation organization might include in its easement deeds:
1. Can an easement agreement give an easement holding organization a right to consent to change in a facade?
The IRS complained that the easements in Simmons were not “protected in perpetuity” (and thus not “exclusively for conservation purposes” as required to support a tax deduction) because they gave The L’Enfant Trust broad powers to consent to changes to the protected properties. The IRS posited that The L’Enfant Trust could misuse this power to consent to changes that are inconsistent with conservation purposes.
In rejecting the argument, the appeals court acknowledged the essential function of any legitimate easement holding organization: to exercise its own professional judgment to regulate change, consistent with the purpose of the easement to protect the historic or architectural values or attributes of the property. Indeed, no responsible preservation organization would create or hold an easement requiring it to preserve a historic property in a frozen state, forever impervious to changing surroundings and economics. As the court found, a historic property cannot be preserved perpetually unless the easement holding organization has the power to accommodate change, to make the building livable or usable for future generations.
To counter the IRS’s suggestion that The L’Enfant Trust could allow changes inconsistent with conservation purposes, the appellate court relied on The L’Enfant Trust’s tax-exempt status. By the IRS’s own definition, a charitable organization must have a commitment to protect the conservation purposes of the donation and the resources to enforce the restrictions. If an organization no longer possesses those features, the IRS could revoke the organization’s exemption. Therefore, the court ruled, a tax-exempt organization that fails to enforce its easement in a manner consistent with conservation purposes “would do so at its peril.”
2. Can an easement agreement give an easement holding organization a right to abandon the easement?
The easement deeds in Simmons gave The L’Enfant Trust a right to “abandon some or all of its rights.” Like The L’Enfant Trust’s right to consent to changes, the IRS argued that The L’Enfant Trust’s abandonment right also defeated the “perpetuity” requirement. The court disagreed. Under the IRS’s own rules, the possibility of a remote event could not invalidate an otherwise allowable conservation contribution deduction, and the court found that there was no more than a negligible possibility that The L’Enfant Trust would abandon its easements. To reach this conclusion, the court pointed to The L’Enfant Trust’s history of holding and monitoring easements in D.C. for more than 30 years, the language in the easements expressing The L’Enfant Trust’s intent for the properties to remain “essentially unchanged,” and, again, the constraints imposed by The L’Enfant Trust’s desire to retain its tax-exempt status.
3. Is an easement agreement required to specify exactly what happens if the easement holding organization ceases to exist?
The IRS insisted that the easements could not be “protected in perpetuity” because the deeds did not delineate the consequences if The L’Enfant Trust dissolved. The terms of the easements specified that they would “survive any termination of Grantor’s or the Grantee’s existence,” but contained nothing further on the point. However, according to the court, it did not matter that the easement deeds did not spell out precisely what would happen on the dissolution of The L’Enfant Trust. Under D.C. law, if The L’Enfant Trust failed to exist, the easement would be transferred to another organization that engages in activities similar to those of The L’Enfant Trust. That was sufficient for the court.
4. How explicit does a mortgage subordination need to be to ensure that the easement is perpetual?
The IRS posited that an “acknowledgement” form executed by each mortgage lender, which was attached to the deed and stated that the mortgagee “acknowledged and delivered these presents as its acts and deed,” defeated the deduction because it raised questions about whether the lenders truly agreed to subordinate their interests to the donee organization. The court rejected this point, noting that the easement deeds themselves made clear that the lenders agreed to subordinate their rights in the property to the rights of The L’Enfant Trust and “join in the execution of this Conservation Deed for the sole and limited purpose of so subordinating their interests.” (The IRS did not additionally argue, as it has in other recent cases, that the easement deeds specifically gave the mortgagee a priority right over insurance or condemnation proceeds from the protected properties; certain language in The L’Enfant Trust’s easement deeds appears to foreclose that argument.)
Appraised Value Defended
After answering these questions regarding the terms of The L’Enfant Trust’s easements, the appeals court turned to the IRS’s arguments about the appraisals, which the IRS said were not adequately substantiated. The appraisals cited an article prepared in 2000 by Mark Primoli, an IRS employee, which stated, “Internal Revenue Service Engineers have concluded that the proper valuation of a facade easement should range from approximately 10% to 15% of the value of the property.”2 The IRS made clear that it never agreed to such a “safe harbor,” and complained that the appraiser arbitrarily picked a percentage between 10% and 15% rather than stating any identifiable method to determine an “after-easement” value. The court, however, walked through each of the steps the appraiser made to ascertain the fair market value after encumbrance, and found that the tax court was not wrong to conclude that the appraisals sufficiently identified the method and basis for the valuations.
A more fundamental issue that the IRS did not pursue on appeal—but that it squarely lost in the tax court—concerned the IRS’s zero-valuation theory. As it has in many similar cases, the IRS had argued that the facade easements were worthless, largely because they duplicated requirements imposed by local preservation laws. Because the easements did not prevent anything not already covered by local law, the IRS reasoned, they were superfluous. The flaw in the logic, as the tax court found, is that there are differences between the local regulatory scheme and the restrictions included in a nonprofit’s easement program, both in the scope of what each protects and in the efforts and resources each devotes to enforcing such protections. And while the tax court did not say so expressly, the court’s rejection of the IRS zero-valuation theory was entirely consistent with other court rulings that have found an economic diminution in value caused by the donation of a preservation easement, even where the restrictions imposed by the easement and a local landmark law significantly overlapped. Indeed, as those courts have found, it is hard to imagine that a property free and clear of an encumbrance is not worth something more than an identical property encumbered by an easement. The tax court in Simmons ultimately assigned a 5% reduction in the values of the properties, which the IRS decided not to challenge on appeal.
The Simmons decision is good news for preservation easement programs. Although the decision is not binding on courts outside of D.C., it nonetheless should be persuasive to courts throughout the nation, making it hard for the IRS to present the same arguments successfully in other jurisdictions. The IRS undoubtedly will continue to look for ways to press forward in its campaign against preservation easements. But the Simmons decision may make the IRS think twice before attacking donations to legitimate organizations that have adopted appropriate language in their deeds. That would be a welcome change. Donors could be encouraged to contribute preservation easements once again, as Congress intended.
1 Report of Internal Revenue Service Advisory Council (IRSAC), p. 3, November 2009, available at http://www.irs.gov/taxpros/article/0,,id=215543,00.html.
2 Mark Primoli, Façade Easement Contributions, p. 2, Federal Historic Preservation Tax Incentives, National Park Service (Sept. 7, 2000).
Matthew A. Eisenstein is a Partner at the law firm Arnold & Porter LLP. He represented the National Trust for Historic Preservation, The L’Enfant Trust, and the Foundation for the Preservation of Historic Georgetown as amici curiae Simmons v. Commissioner, No. 10-1063(D.C. Cir.). If you are attending the National Preservation Conference and would like to learn more about easements attend the session, "Easements: Are They Still in Your Preservation Toolbox?," Thursday, October 21 from 10:15 am-11:45 am.
Matthew A. Eisenstein is a Partner at the law firm Arnold & Porter LLP. He represented the National Trust for Historic Preservation, The L’Enfant Trust, and the Foundation for the Preservation of Historic Georgetown as amici curiae Simmons v. Commissioner, No. 10-1063(D.C. Cir.).
If you are attending the National Preservation Conference and would like to learn more about easements attend the session, "Easements: Are They Still in Your Preservation Toolbox?," Thursday, October 21 from 10:15 am-11:45 am.