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Keeping up a cheerful facade in New Orleans

October 31, 2008

A few years ago "facade easements" were a big tax gimmick. Owners of old, I mean "historic" buildings would give a legal promise to a local preservation charity to not alter the outside of a building, and then take a big tax deduction for the fair market value of that gift.

A New Orleans hotel project that took a $7 million-plus deduction for a facade easement gift came to grief in Tax Court yesterday. The IRS won a battle of dueling appraisers when the Tax Court held that the entire building was worth just north of $12 million, and the facade easment was only worth $1,792,301 (why it's not $1,792,300 isn't explained).

Worse for the taxpayer, the Tax Court said taxpayer didn't have reasonable cause for a "gross valuation misstatement" - one of over 400% - and was subject to a penalty of 40% of the the underpaid taxes:

...petitioner must establish the fact that, in addition to obtaining a qualified appraisal, it made a good faith investigation of the value of the servitude. Petitioner offers a hotch-pot of arguments that, either together or separately, are not convincing.

The penalty is 40% of the understatement of tax attributable to the gross misstatement. As the taxpayer in this case is a partnership, the penalty depends on the tax status of the partners; assuming they are all top-bracket taxpayers, that should work out to a penalty of around $791,000. In contrast, the entire tax savings from the the $1,702,301 deduction works out to about $596,000. All in all, a pretty poor return on the facade donation project.

Cite: WHITEHOUSE HOTEL LIMITED PARTNERSHIP, 131 T.C. No. 10

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