Partnership Challenges Denial of Conservation Easement Deduction

MCNORTHUP PROPERTIES, LLC, LEONARD HOUSE MANAGER, LLC,  TAX MATTERS PARTNER,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION FOR READJUSTMENT OF PARTNERSHIP ITEMS UNDER CODE SECTION 6226

PETITIONER, LEONARD HOUSE MANAGER, LLC, HEREBY PETITIONS under Section 6226(a) for a readjustment of the partnership items set forth in the notice of final partnership administrative adjustment dated August 2, 2021 (“FPAA”), pertaining to the Form 1065 (U.S. Return of Partnership Income) for McNorthup Properties, LLC (“McNorthup”) for the period ending December 31, 2017 (“2017 Form 1065”).^*

As the basis for its case, Petitioner alleges as follows:

1. McNorthup's current address is 718 W. Business Hwy. 60, Dexter, Missouri 63841. Its principal place of business is in Georgia.

2. McNorthup is a North Carolina limited liability company.

3. McNorthup is a partnership for federal income tax purposes.

4. Petitioner is the Tax Matters Partner (“TMP”) for McNorthup with respect to its 2017 Form 1065.

5. McNorthup's taxpayer identification number is set forth in the Statement of Taxpayer Identification Number, which is attached to this Petition.

6. Petitioner is filing this Petition within the 90-day period set forth in Section 6226(a) in its capacity as TMP of McNorthup.

7. Respondent's office located in Gainesville, Georgia issued the FPAA. A complete copy of the FPAA is attached to this Petition as Exhibit A.

8. Petitioner disputes all proposed adjustments in the FPAA.

9. In the FPAA, Respondent erred in the following ways:

a. By asserting any adjustment for any amount;

b. By failing to describe any meaningful factual, tax, or legal basis for his adjustments;

c. By asserting an adjustment to “[c]haritable contribution 50 percent” in the amount of $45,698,000;

d. By asserting that McNorthup did not establish that it made a noncash charitable contribution;

e. By asserting, in the alternative, that McNorthup did not establish that its noncash charitable contribution satisfied all the requirements of Section 170 and the corresponding Treasury Regulations;

f. By asserting, in the alternative, that McNorthup did not establish the value of the noncash charitable contribution;

g. By asserting penalties based, alternatively, on gross valuation misstatement pursuant to Section 6662(h), a reportable transaction understatement pursuant to Section 6662A, negligence or disregard of rules and regulations pursuant to Section 6662(c), substantial understatement of income tax pursuant to Section 6662(d), or substantial valuation misstatement pursuant to Section 6662(e), and fraud penalty pursuant to Section 6663; and

h. By failing to consider that McNorthup and its partners exercised reasonable cause with respect to all positions taken by McNorthup on the 2017 Form 1065 and all other defenses to the proposed penalties.

10. Based on information and belief, the facts, and mixed points of fact and law, upon which Petitioner relies include, but are not limited to, the following:

General

a. McNorthup was a partnership for federal tax purposes during 2017.

b. McNorthup had less than 100 partners during the tax year that ended December 31, 2017.

c. Petitioner owned one percent of the profit, loss, and capital of McNorthup on December 31, 2017.

d. On December 31, 2017, Petitioner was a member-manager of McNorthup.

e. Petitioner was treated as a general partner for purposes of applying Section 6231(a)(7).

f. McNorthup designated Petitioner as TMP on its 2017 Form 1065.

g. McNorthup's designation of Petitioner as TMP complies with the Internal Revenue Code and related regulations.

h. McNorthup meets the net worth criteria described in Section 7430(c)(4)(A)(ii).

Property Background

i. During the year at issue, McNorthup owned land together with improvements located thereon, located at 123 Biltmore Avenue in Asheville, North Carolina (the “Property”).

j. The Property is located in Buncombe County, North Carolina.

k. On October 19, 2001, McNorthup acquired the Property, via a General Warranty Deed, which was recorded by the Buncombe County Resister of Deeds on October 22, 2001.

l. McNorthup held the Property for over one year prior to December 22, 2017.

m. The Property includes the Snider-Sawyer-Leonard House (“Leonard House”).

n. The National Park Service included the Leonard House in the Downtown Asheville Historic District.

o. The National Park Service designated the Leonard House as a contributing building within the Downtown Asheville Historic District.

Due Diligence and Potential Development

p. McNorthup performed due diligence on various potential development options related to the Property.

q. McNorthup hired Rowhouse Architecture to prepare a Lost Development Study (“Lost Development Study”).

r. McNorthup hired Vannoy Construction to prepare a Construction Estimate.

s. McNorthup hired HVS Consulting & Valuation Division of TS Worldwide, LLC to prepare a Hotel Market Study (“Market Study”).

t. McNorthup hired STR, Inc. to prepare a TREND Report and HOST Report.

u. McNorthup hired Gill Group, Inc. to prepare a Need and Demand Analysis (“N&D Analysis”).

v. McNorthup hired Midas Development, LLC to prepare a Design and Procurement Services Report for the Purchase of FF&E for the Subject Property (“FF&E Report”).

Donation of Conservation Easement

w. On December 22, 2017, McNorthup granted a Perpetual Deed of Facade and Preservation Easement (“Deed”) encumbering the Property (“Conservation Easement”) to the Preservation Society of Asheville and Buncombe County, Inc. (“PSABC”).

x. The Conservation Easement preserved the facade of the Leonard House in perpetuity.

y. PSABC was a “qualified organization” for purposes of Section 170 and the underlying regulations as of December 22, 2017.

z. PSABC was an “eligible donee” for purposes of Section 170 and the underlying regulations as of December 22, 2017.

aa. The Property was not encumbered by a mortgage or otherwise as of December 22, 2017.

ab. The Conservation Easement constituted a “qualified real property interest” for purposes of Section 170 and the underlying regulations.

ac. McNorthup did not restrict PSABC's right to use or dispose of the Conservation Easement, except as provided in the Deed.

ad. McNorthup did not reserve to any person any right to income from the Conservation Easement, or to the possession of the Conservation Easement (other than to PSABC), or to designate the person having such income or possession.

ae. Other than protecting the conservation purposes identified in the Deed, McNorthup did not earmark or otherwise identify the Conservation Easement for a particular use.

af. McNorthup did not grant the Conservation Easement to PSABC in a bargain sale.

ag. McNorthup did not receive any consideration from PSABC in exchange for donating the Conservation Easement to PSABC.

ah. McNorthup did not receive any consideration from a third party in exchange for donating the Conservation Easement to PSABC.

Deed of Conservation Easement

ai. The Deed was recorded with the Register of Deeds in Buncombe County, North Carolina on December 22, 2017.

aj. The Deed identifies the conservation purpose of the donation.

ak. The Deed indicates that the Conservation Easement will protect the preservation of an historically important land area or a certified historic structure as defined by Section 170(h)(4)(A)(iv).

al. The Deed describes the purpose of the Conservation Easement as protecting the conservation values of the Property in perpetuity and preventing any use of the Property that will impair or interfere with the conservation values of the Property.

am. The Deed identifies the specific conservation values of the Property.

an. The Baseline Report, which is discussed further below, identifies the specific conservation values of the Property.

ao. The Deed granted PSABC the right to preserve and protect the conservation values of the Property in perpetuity.

ap. The Deed imposed on PSABC the duty to preserve and protect the conservation values of the Property in perpetuity.

aq. Among other rights, the Deed granted PSABC the right to enter the Property at reasonable times, to inspect the Property, to monitor compliance with the Deed, and to enforce the purposes of the Conservation Easement.

ar. The Deed prohibits McNorthup and all future owners of the Property from extracting, transferring, leasing, or otherwise separating minerals, oil, gas, or other hydrocarbons, soils, sands, gravel, rock, or other materials on or below the surface of the Property.

as. The restrictions on the use of the Property stated in the Deed are binding on McNorthup and all future owners of the Property in perpetuity.

at. The Deed granted PSABC an immediately vested right to a proportionate share of any proceeds that may result from a sale, exchange, or involuntary conversion of the Property, if the Conservation Easement is extinguished in future legal proceedings.

au. The Deed provides a formula for calculating PSABC's proportionate share of extinguishment proceeds that complies with the requirements of Treas. Reg. § 1.170A-14(g)(6)(ii).

Baseline Report

av. The Baseline Report confirms the condition of the Property prior to the donation (“Baseline Report”).

aw. The Baseline Report was completed before McNorthup donated the Conservation Easement to PSABC.

ax. The Baseline Report documented the conservation values on the Property, as well as the physical condition of the Property, at the time of the donation of the Conservation Easement.

ay. The Baseline Report concluded that the Property possessed significant historical value.

az. The Baseline Report contains photographs taken at various locations on the Property and aerial photographs of the Property.

ba. The Baseline Report contains the North Carolina State Historic Preservation Office's National Register of Historic Places that includes the Property.

bb. The Baseline Report contains McNorthup's completed National Register of Historic Places Registration Form.

bc. The Deed confirms that the PSABC received and reviewed the Baseline Report prior to accepting the easement donation.

Qualified Appraiser

bd. A North Carolina licensed and certified appraiser (“Appraiser”) prepared the “Historic Preservation/Façade Easement Appraisal 123 Biltmore Building” (“Easement Appraisal”).

be. Appraiser performed appraisals on a regular basis.

bf. Appraiser had local knowledge and experience in preparing appraisals related to conservation easements.

bg. Appraiser was not a direct partner of McNorthup.

bh. Appraiser was not an indirect partner of McNorthup.

bi. Appraiser did not claim, report, or otherwise take a deduction under Section 170 or any other tax provision for the donation of the Conservation Easement.

bj. Appraiser was not a party to the transaction in which McNorthup acquired the Property.

bk. Appraiser was not an agent of a party to the transaction in which McNorthup acquired the Property.

bl. Appraiser was not the donee of the Conservation Easement.

bm. Appraiser was not “related” under Section 267(b) to McNorthup.

bn. Appraiser was not an employee of (i) McNorthup, (ii) a direct or indirect partner of McNorthup, (iii) a party to the transaction in which McNorthup acquired the Property, (iv) PSABC, or (v) Petitioner.

bo. Appraiser was not “related” under Section 267(b) to any of the persons described immediately above.

bp. Appraiser was a “qualified appraiser,” as that term is defined under Section 170 and the underlying regulations.

Qualified Appraisal

bq. The Easement Appraisal was dated July 9, 2018.

br. The Easement Appraisal was not dated more than 60 days before the date on which McNorthup donated the Conservation Easement.

bs. The Easement Appraisal was dated before the extended deadline for McNorthup to file its 2017 Form 1065.

bt. Appraiser signed and dated the Easement Appraisal.

bu. McNorthup provided Appraiser with copies of due diligence completed regarding the Property.

bv. The Easement Appraisal contains a detailed legal description of the Property.

bw. The Easement Appraisal contains a description of the Conservation Easement.

bx. The Easement Appraisal contains a description of the physical condition of the Property.

by. The Easement Appraisal states that McNorthup donated the Conservation Easement to PSABC.

bz. The Easement Appraisal contains the name, address, and appraiser certification license number of each of the Appraiser, and contains the name, address, and taxpayer identification number of the appraisal company.

ca. The Easement Appraisal contains a list of the qualifications of the Appraiser, including his background, experience, education, and membership in professional appraisal associations.

cb. The Easement Appraisal contains a statement that it was being prepared for income tax purposes.

cc. The Easement Appraisal provides the basis for the conclusions by the Appraisers regarding the fair market value (“FMV”) of the Conservation Easement.

cd. The Easement Appraisal states that the FMV of the Property was based on market conditions as of December 22, 2017.

ce. The Easement Appraisal concludes that the FMV of the Property before donation of the Conservation Easement was $46,540,000.

cf. The Easement Appraisal concludes that the FMV of the Property after donation of the Conservation Easement, but before facade diminution of eight percent, was $915,000.

cg. The Easement Appraisal concludes that the facade diminution of eight percent was $73,120.

ch. The Easement Appraisal concludes that the FMV of the Property after donation of the Conservation Easement was $842,000.

ci. The Easement Appraisal concludes that the FMV of the Conservation Easement was $45,698,000.

cj. The Easement Appraisal concludes that the Conservation Easement did not enhance the value of any other property owned by McNorthup.

ck. The Easement Appraisal concludes that the highest and best use (“HBU”) of the Property, before the donation of the Conservation Easement, was an upscale limited-service boutique hotel (“Before-Donation-HBU”).

cl. The Easement Appraisal concludes that the Before-Donation-HBU was legally permissible.

cm. The Easement Appraisal concludes that the Before-Donation-HBU was physically possible.

cn. The Easement Appraisal concludes that the Before-Donation-HBU was financially feasible.

co. The Easement Appraisal concludes that the Before-Donation-HBU was maximally productive.

cp. The Easement Appraisal concludes that the HBU of the Property, after the donation of the Conservation Easement was as rental office space (“After-Donation-HBU”).

cq. The Easement Appraisal concludes that the After-Donation-HBU was legally permissible.

cr. The Easement Appraisal concludes that the After-Donation-HBU was physically possible.

cs. The Easement Appraisal concludes that the After-Donation-HBU was financially feasible.

ct. The Easement Appraisal concludes that the After-Donation-HBU was maximally productive.

cu. The appraisal fee charged by the Appraiser for the preparation of the Easement Appraisal was not based on a percentage of the appraised value of the Conservation Easement.

cv. The appraisal fee charged by the Appraiser for the preparation of the Easement Appraisal was not based on a percentage of the amount allowable as a charitable contribution deduction under Section 170.

cw. The Easement Appraisal was a “qualified appraisal,” as that term is defined in Section 170 and the underlying regulations.

Contemporaneous Written Acknowledgement

cx. PSABC issued a letter to McNorthup dated December 22, 2017, acknowledging receipt of the donation of the Conservation Easement (“Conservation Easement Acknowledgment Letter”).

cy. PSABC issued a letter to McNorthup dated December 22, 2017, acknowledging receipt of stewardship/endowment funds of $35,000 (“Stewardship Funds Acknowledgment Letter”).

cz. The Conservation Easement Acknowledgement Letter confirms that PSABC did not provide any goods or services in exchange for the donation of the Conservation Easement.

da.The Stewardship Funds Acknowledgement Letter confirms that PSABC did not provide any goods or services in exchange for the donation of the stewardship/endowment funds of $35,000.

db .Both the Conservation Easement Acknowledgement Letter and Stewardship Funds Acknowledgment Letter constitute “contemporaneous written acknowledgement” for purposes of Section 170 and the underlying regulations.

2017 Form 1065 Tax Filing

dc. McNorthup timely filed its 2017 Form 1065.

dd. The 2017 Form 1065 reports, among other items, the donation of the Conservation Easement to PSABC.

de.Schedule K (Partner's Distributive Share Items) to the 2017 Form 1065 reports, among other items, total charitable contributions of $45,733,000 related to the donation of the Conservation Easement and stewardship/endowment funds to PSABC.

df. The Statement attached to the 2017 Form 1065 indicates that the total charitable contribution deduction of $45,733,000 was comprised of (i) a noncash charitable contribution of $45,698,000 (i.e., the Conservation Easement to PSABC), and (ii) a cash charitable contribution of $35,000 (i.e., stewardship/ endowment funds to PSABC).

dg. McNorthup attached the Easement Appraisal to its timely 2017 Form 1065.

Form 8283 for Donation of Conservation Easement

dh. McNorthup attached Form 8283 (Noncash Charitable Contributions) to its 2017 Form 1065.

di. McNorthup attached immediately after Form 8283 a document titled “Supplemental Statement for Form 8283” (“Supplemental Statement”).

dj. Form 8283 and the Supplemental Statement comply, or substantially comply, with the information requirements of Treas. Reg. § 1.170 A-13 (c)(4) with respect to the donation of the Conservation Easement.

dk. Form 8283 indicates that McNorthup made a qualified conservation contribution with a value of $45,698,000 to PSABC.

dl. Form 8283 reports McNorthup's adjusted basis in the Property.

dm. Form 8283 reports the manner by which McNorthup obtained the Property.

dn. Form 8283 reports the date on which McNorthup obtained the Property.

do. The Executive Director of PSABC signed and dated Form 8283.

dp. Form 8283 contains the name and taxpayer identification number of McNorthup.

dq. Form 8283 contains the name, address, and taxpayer identification number of PSABC.

dr. Form 8283 identifies the date on which PSABC received the donation of the Conservation Easement as December 22, 2017.

ds. Form 8283 contains the name, address, and tax identification number of the appraisal company.

dt. Form 8283 contains a certification that an Appraiser (i) performed appraisals on a regular basis, (ii) was qualified to make appraisals of the type of property being valued, (iii) the fee charged for the appraisal was not based on a percentage of the appraised property value, (iv) was not one of the persons described in Treas. Reg. § 1.170A-13(c)(5)(iv), (v) understood that an intentionally false or fraudulent overstatement of the value of the property may subject him to a civil penalty under Section 6701, and (vi) was not barred from presenting evidence or testimony by the Office of Professional Responsibility.

du. The statements in Form 8283 described immediately above were accurate.

dv. The Supplemental Statement attached to the Form 8283 contains a summary of the physical condition of the Property at the time of the donation.

History of the Tax Dispute

dw. McNorthup maintained all records required with respect to the 2017 Form 1065.

dx. McNorthup and its representatives cooperated with Respondent during the audit.

dy. McNorthup and its representatives cooperated with all requests by Respondent for information, documents, meetings, site visits, and interviews during the audit.

dz. McNorthup and its representatives timely responded to each Information Document Request that Respondent issued to McNorthup during the audit.

ea. Representatives of McNorthup offered to provide a tour of the Property to Respondent during the audit.

Contents of FPAA

eb. McNorthup properly reported a charitable contribution of $35,000 on its 2017 Form 1065.

ec. McNorthup's charitable contribution meets all the requirements of the Code.

ed. McNorthup properly substantiated its charitable contribution during the course of the audit.

ee. The FPAA allows a charitable contribution of $35,000.

ef. The FPAA asserts an adjustment for “[c]haritablc contribution” (i.e., donation of the Conservation Easement) of $45,698,000.

eg. The FPAA describes the basis for asserting the adjustment of $45,698,000 as “[y]ou have not established that McNorthup Properties, LLC made a noncash charitable contribution during the tax year ended December 31, 2017.”

eh. The FPAA also describes the basis for asserting the adjustment of $45,698,000 as “you failed to establish that it satisfied all the requirements of I.R.C. § 170 and the corresponding Treasury Regulations for deducting a noncash charitable contribution.”

ei. The FPAA also describes the basis for asserting the adjustment of $45,698,000 as “you have not established the value of the noncash charitable contribution.”

ej. The FPAA does not describe any specific facts, legal theories, tax theories, or analysis for asserting the adjustment of $45,698,000 to the 2017 Form 1065.

ek. The FPAA does not describe any specific facts, legal theories, tax theories, or analysis for possible defenses and/or exceptions to penalties asserted.

el. After conducting an examination lasting more than a year, having meetings with McNorthup's representatives, and issuing and receiving responses to IDRs, the Form 886-A (Explanation of Items) attached to the FPAA consists of just one page.

em. The penalties asserted in the FPAA do not meet the requirements of Section 6751(b).

Compliance Efforts

en. McNorthup fully complied with Section 170 and the underlying regulations with respect to the donation of the Conservation Easement.

eo. McNorthup substantially complied with Section 170 and the underlying regulations with respect to the donation of the Conservation Easement.

ep. In claiming the charitable deductions related to the Conservation Easement donation on its 2017 Form 1065, McNorthup relied on, among other things, the HBU Study, Construction Estimate, Market Study, N&D Analysis, STR Reports, Zoning Report, FF&E Report Baseline Report, Easement Appraisal, and Deed.

eq. McNorthup reasonably relied on, among other things, the HBU Study, Construction Estimate, Market Study, N&D Analysis, STR Reports, Zoning Report, FF& E Report, Baseline Report, Easement Appraisal, and Deed.

er. McNorthup reasonably relied on the qualified, independent, informed professionals who prepared, among other things, the HBU Study, Construction Estimate, Market Study, N&D Analysis, STR Reports, Zoning Report, FF&E Report, Baseline Report, Easement Appraisal, and Deed.

11. The contents of the FPAA, particularly the unsupported allegations that the charitable contribution deduction related to the Conservation Easement donation should be $0 and that penalties apply, are erroneous, unfair, unreasonable, arbitrary, and capricious. For these reasons as well as Section 7491(a), Respondent bears the burden of proof as to all items, including penalties.

WHEREFORE, Petitioner requests that the Tax Court:

(i) Determine that the 2017 Form 1065 is accurate as filed;

(ii) Determine that there are no adjustments, penalties, additions to tax, or other amounts with respect to the 2017 Form 1065;

(iii) If warranted by the evidence at trial, determine that McNorthup undervalued the Conservation Easement, and increase the amount of the noncash charitable donation deductions for 2017 accordingly;

(iv) Determine that Respondent has the burden of proof as to all issues, including penalties; and

(v) Grant such other and further relief that it deems appropriate.

Respectfully submitted,

Date: 10/29/2021

JOHN W. HACKNEY
Tax Court Bar No. HJ1581
john.hackney@chamberlainlaw.com

Date: 10/29/2021

HALE E. SHEPPARD
Tax Court Bar No. SH0819
hale.sheppard@chamberlainlaw.com

Date: 10/29/2021

JEFFREY S. LUECHTEFELD
Tax Court Bar No. LJ1040
jeff.luechtefeld@chamberlainlaw.com

Date: 10/29/2021

WILLIAM A. STONE, III
Tax Court Bar No. SW0964
william.stone@chamberlainlaw.com

Chamberlain, Hrdlicka, White, Williams & Aughtry
191 Peachtree Street, N.E.
Forty-Sixth Floor
Atlanta, Georgia 30303
(404) 588-3436
(404) 420-2282 Facsimile
COUNSEL FOR PETITIONER