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Getting "creative" with your tax returns can cost you, as Gordon and Lorna Kaufman found out last week when the First Circuit affirmed penalties against them for an "historic preservation easement" that had no value.
After Lorna bought a $1 million house in Boston, the Kaufmans learned about a "tax incentive program" for houses in the historic preservation district where the house resided. The program allows tax deductions for the value of an historic easement. Tax deductions? Hmm ...
So they entered into an agreement to receive the easement, which placed restrictions on how they could alter the property. The restrictions on the property decreased the house's value by about $220,000. No problem so far.
Well, actually, there was a problem: The restrictions imposed by the easement were essentially the same as those already imposed by the local zoning ordinance. While the appraiser noted that the restrictions imposed by the easement were "more robust," they did nothing to change the house's ability to be developed as a single-family home.
The IRS got interested as part of an investigation into abuses of the preservation easement program. It disallowed the $220,000 deduction for two reasons: The conveyance of the easement didn't comport with applicable regulations, and the Kaufmans failed to show that the property value had diminished by that much.
This case, now on its second appeal to the First Circuit, is coming on the issue of penalties. The tax court determined that the easement's value was zero, and especially questioned the credibility of the appraiser, who was quite close to the land trust that benefited from the encumbrance. The tax court then upheld the IRS' imposition of "accuracy-related penalties," which is 40% of the overvaluing. The tax court determined that the penalty, which would have amounted to about $88,000, applied because the Kaufmans hadn't investigated the value in good faith.
Mercifully, the Kaufmans didn't appeal to the First Circuit based on the valuation -- just on whether the penalty applied. But the First Circuit had little trouble finding that the Kaufmans didn't conduct a good faith investigation into the value of the easement.
For example, they were on notice that they had received conflicting valuations of the easement, but nevertheless "made an immediate decision to press ahead with the donation." They were also made aware of the opinion of more than one person that the easement restrictions were basically the same as those already imposed by the local zoning code.
Though Lorna was a company president with a Ph.D. in psychology and Gordon was a retired professor at MIT, they both attempted to play the "we're not sophisticated enough to understand appraisal" card. But that's not the test, said the court: They don't have to be experts. They just have to be reasonable people who would have conducted more investigation upon the raising of several "red flags." How convenient that these intelligent people were blissfully unaware.
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