These four deductions are termed “tax expenditures” and are all currently under review. At the October 6 hearing of the Senate Finance Committee, witnesses discussed changes in home mortgage deductions.
Sen. Baucus stated, “As we work to improve and simplify the tax code, we need to make sure tax incentives are structured to encourage certainty and stability, not booms and busts in the housing market. And as we reduce the deficit, we need to insure every dollar in tax expenditures is spent wisely – and spent efficiently.”
The senior Republican Senator on the committee is Orrin Hatch (R-UT). He expressed concern about changing the mortgage deduction and noted, “Given the still precarious status of the nation’s housing markets and past mistakes made by government to prop up these markets, it is fair to say that Congress needs to tread carefully when addressing policies that affect real estate.”
Former Sen. John Breaux was a Co-Chair of the President’s Advisory Panel on Federal Tax Reform in 2005. This panel started by reviewing the ability of taxpayers to deduct interest payments on up to “$1.1 million of housing debt on first and second homes.” They suggested that this benefit is primarily helpful to those with larger incomes who itemize deductions. The panel proposed that the mortgage deduction should be changed to a credit of 15% of mortgage payments on loans up to $412,000. In recognition of the major impact of this change on homeowners, Sen. Breaux recommended that the change would be phased in gradually over five years.
Representatives of the home building industry also testified before the panel. Gregory Nelson, Vice President for homebuilder PulteGroup, Inc. stated, “Eliminating the mortgage interest deduction would quickly turn that fear into reality and send us into another negative feedback loop of falling house prices, hundreds of thousands of mortgages sinking under water and more house foreclosures hitting banks balance sheets and the resale market.”
Editor’s Note: Sen. Baucus will continue to hold hearings on major tax reform. Your editor and this organization take no specific position on any of the proposals. This information is offered as a service to our readers.
U.S. Income Tax a “Massive Mess”
At a hearing on October 5 of the Senate Banking, Housing, and Urban Affairs Economic Policy Subcommittee, Maya MacGuineas, testified on both budget and tax reform. MacGuineas is the President of the bipartisan Committee for a Responsible Federal Budget.
Part of her testimony focused on the Joint Select Committee on Deficit Reduction (The Super Committee). She suggested five specific principles that the Super Committee should consider in its remaining six weeks of negotiations. These include the following:
1. Go Big. She recommends that the deficit solution should be much larger than the target $1.5 trillion.
2. Go Long. A significant reform that also addresses entitlement spending must be phased in over several years and perhaps two decades.
3. Go Smart. Any major changes in both the budget and taxes must be pro-growth. The nation will need pro-growth policies to increase employment and reduce future deficits.
4. Stay Honest. The Super Committee must avoid “budget gimmicks” that do not resolve the problem.
5. Make it Stick. The changes will not succeed unless there also are significant budget enforcement provisions attached to any plan.
Editor’s Note: With a short time now remaining before the final proposals due on Nov. 23, the Super Committee faces a major task. The suggestions from Maya MacGuineas and her bipartisan group are a thoughtful perspective that may be helpful in that process.
Façade Easement Deduction Denied
In Barry S. Friedberg et ux. v. Commissioner; T.C. Memo. 2011-238; No. 9530-09 (2 Oct 2011), the Tax Court considered an IRS request for summary judgment. The government sought to deny a charitable deduction for gift of a conservation easement.
Mr. Friedberg purchased a six-story residential townhouse on East 71st Street in New York City during 2002 for $9.4 million. His wife, Charlotte Moss, is an interior designer and they spent approximately $4 million to renovate the property. The residence is a “certified historic structure” as determined by the National Park Service.
Following discussions with the National Architectural Trust (NAT), Mr. Friedberg considered the donation of a façade easement to the organization. NAT Representative Sean Zalka indicated to Friedberg that there would be a deduction for a façade easement and an additional deduction for a gift of developmental rights.
The residence included an estimated 13,800 square feet of additional potential development rights. Zalka suggested that a transfer of both the façade easement and the development rights would produce a charitable gift of $3.86 million. While the zoning restrictions in the historic district would preclude use of the development rights on that parcel of land, there is the potential that they could be transferred and therefore still qualify for a charitable deduction.
On December 3, 2003, Friedberg deeded an easement in perpetuity on the property to NAT. Upon the recommendation of NAT, he engaged Michael Ehrmann of Jefferson & Lee Appraisals, Inc. to prepare the required appraisal.
The appraisal was prepared with several errors with respect to dates. While the gift was on December 3, the appraisal date was November 15. There were other various technical errors in the appraisal.
Mr. Ehrmann calculated that potential development rights were available for an additional 13,731 square feet. In his view, these could be transferred by use of the New York statutes that would allow a sale of rights to an adjacent “lot, parcel, or area of land in one or more receiving districts.”
Mr. Ehrmann reviewed comparable sales of similar properties in New York and determined the property value to be $13,090,000. He also reviewed various factors to determine that the unused development rights were worth $2,335,000, for a total value of $15,425,000.
In order to determine the value of the easement, Ehrmann considered six sales of property in Washington D.C. and two in New Orleans. Most of the examples were during the 1980s. The average “easement loss” of those sales was 17.4%. Therefore, Mr. Ehrmann determined that the percentage that should be used for the New York façade easement would be a reduction in value of 11% or $1,440,000.
Adding together the development rights and the façade easement, Ehrmann valued the total charitable deduction at $3,775,000. Friedberg claimed this deduction on Form 8283, Non-Cash Charitable Contributions. The form was signed by Mr. Ehrmann and the President of NAT. Friedman also attached the appraisal to his IRS Form 1040.
The IRS determined that the appraisal and Form 8283 did not comply with Reg. 1.170A-13(b)(2) and denied the deduction. The IRS assessed a deficiency of $1,321,250 and a penalty under Sec. 6662(h) of $528,500.
The IRS sought a summary judgment that both the façade easement and the gift of development rights did not qualify for a charitable deduction.
The court first considered the façade easement. The determination by Ehrmann was a “textbook example of how the comparable sales method works.” However, an easement valuation requires a “before and after” determination. The use of easement valuations from the 1980s in Washington and New Orleans was not appropriate. In addition, the percentage diminution method is not an acceptable appraisal strategy. Ehrmann also made multiple errors in his determination of the Washington easement values. For example, in one case he used the asking price rather than the fair market value to determine the percentage reduction in value.
The properties were not sales and therefore “provide little insight about the effect of façade easements on the sales of eased properties.” Finally, one valuation by Ehrmann “was actually based upon a rumor about a settlement agreement reached during the mid-1990s of a lawsuit filed against a seller for failing to disclose the existence of a façade easement on a property in New Orleans.”
Because the appraisal was not qualified, taxpayers are not entitled to a façade easement charitable deduction.
The second major issue was the charitable deduction claimed for the gift of the development rights. The IRS noted that the transfer of development rights in New York is restricted by actions of the Landmarks Preservation Commission. Because the property was not a designated landmark, the transfer would only occur through a zoning lot merger. It was fairly unlikely that this transfer could be made.
In addition, the appraisal of unused development rights included several errors. The appraisal considered the value of development property, but did not include a reduction for transfer of development rights as opposed to actual building values. While this was not a “mechanical application” of the method and therefore was not disqualified, the court determined that the issue must be determined at trial. The Treasury request for a summary judgment was denied with respect to the development rights.
The IRS further contended that the conservation easement was not granted in perpetuity. The court determined that this issue also could be held over for the trial court.
Therefore, the court determined that the deduction for the façade easement would be denied. While there were errors on Form 8283, there was a substantial compliance on the part of the taxpayer. The trial court will determine the valuation of the development rights.
Editor’s Note: This case represents a very specific analysis of the entire appraisal process. If the court decides to deny a deduction, it may review the Form 8283 and appraisal in great detail. For façade easements, it is essential to have a complete “before and after” method appraisal that thoroughly explains the specific comparables and valuation methodology.
Applicable Federal Rate of 1.4% for October – Rev. Rul. 2011-22; 2011-41 IRB 1 (18 Sept. 2011)
The IRS has announced the Applicable Federal Rate (AFR) for October of 2011. The AFR under Sec. 7520 for the month of October will be 1.4%. The rates for September of 2.0% or August of 2.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2011, pooled income funds in existence less than three tax years must use a 2.8% deemed rate of return. Federal rates are available by clicking here.