National Historic Tax Credit Conference November 7-9, 2007 Omni Shoreham Hotel, Washington, DC Easements Update: Revised Tax Rules and Current Audit Environment Paul W. Edmondson Vice President & General Counsel National Trust for Historic Preservation

Summary review of new special rules and related changes under the Pension Protection Act of 2006 Update on IRS Actions –Current Audit Environment –IRS Views on Appraisal Methodology –Form 990 Revisions

Public Law , August 17, 2006

New Special Rules for certified historic buildings in registered historic districts Disallowance of deductions for non-building structures and land areas in registered historic districts (unless on the NR or qualifying as a historically important land area Tax reduction for donations of easements on any building that has been used to obtain historic rehabilitation tax credits New qualifications for Qualified Appraisers and Qualified Appraisals Lower thresholds for overvaluation penalties for taxpayers New overvaluation penalties for appraisers [But note: Also includes new enhancements for any conservation easement donation for , including higher cap on annual deductions and greater carry-forward period.] Public Law , August 17, 2006

Special Rules (For Contributing Buildings in Registered Historic Districts) Easements must protect the entire exterior of a property (including the front, sides, rear and height) Easements must prohibit changes that are inconsistent with the historical character of the buildings exterior The donor and donee must enter into an agreement certifying under penalty of perjury that the easement-holding organization is qualified to accept easements, and has the resources and commitment to manage and enforce the easement The owner must provide the IRS more detailed substantiation to prove the value of the donation, including photographs of the entire exterior, and a description of all restrictions on the building The taxpayer must pay a new filing fee of $500 if he or she claims an easement deduction in excess of $10,000 Public Law , August 17, 2006

Special Rules Application Issues... Are the special rules applicable to National Register-listed properties? How about historically important land areas? What does it mean to protect the height of a building? What is the standard for determining what is inconsistent with the historical character of the buildings exterior? Does the donor really have to certify that the easement- holding organization is qualified to accept easements, and has the resources and commitment to manage and enforce the easement? What does it mean that the organization has the resources and commitment to manage and enforce the easement? Public Law , August 17, 2006

Elimination of deductions for non-building structures or land areas in registered historic districts... –Does NOT eliminate deductions for structures or land areas that separately qualify because they are on the National Register, or that separately qualify as historically important land areas –Raises application questions for adjacent historic settings… New reduction for easements on buildings that have also qualified for the rehabilitation tax credit –Not an elimination, but simply a percentage reduction of the charitable contribution for the deduction, using the ratio of (1) the sum of the RTC credits received for the last 5 years divided by (2) the FMV of the building on the date of the contribution –Note that conveyance of an easement within the 5 year recapture period will still be considered by the IRS to be a partial disposition resulting in a ratable recapture of the RTC. (See Rev. Rul ) Other Changes…

New Appraiser and Appraisal Qualifications... –Qualified Appraisers must (1) either have earned an appraisal designation from a recognized professional appraiser organization or otherwise met minimum education and experience requirements set by the Treasury, and (2) demonstrate verifiable education and experience in valuing a specific type of property –Qualified Appraisals can only be done by a Qualified Appraiser and follow generally accepted appraisal standards and Treasury Regs. –IRS Notice provides interim guidance tied to current Treasury Regs; the notice references the Uniform Standards of Professional Appraisal Practice (USPAP) as example of generally accepted appraisal standards. Other Changes (contd)…

Lower Overvaluation Penalty thresholds –Substantial Valuation Misstatements reduced from 200% to 150% of the amount determined to be the correct amount of the value –Gross Valuation Misstatements reduced from 400% to 200% –reasonable cause exception for gross valuation misstatements eliminated New Appraiser Penalties for Overvaluations if appraiser knew or reasonably should have known that it would be used for a return resulting in a substantial or gross valuation misstatement

On the plus side, for easements donated in tax years 2006 and 2007, new enhancements also apply to qualified historic preservation easements... Expands the availability of the charitable tax deduction by increasing the annual amount deductible for most taxpayers from 30 percent to 50 percent of a taxpayer's contribution base. Extends the carry-over period for deductions from five to fifteen years. Grants even more favorable limitations apply for conservation contributions by qualified farmers and ranchers. (Think rural historic sites and battlefields, subject to the new exclusion for non-building structures and land areas in historic districts.)

The IRS... Audits: Extensive audit activity Disallowance of percentage-based methodologies Zero based valuation assumptions

Another problem that is showing up arises in connection with historic easements. The problem here is that taxpayers are taking improperly large deductions for façade easements. These taxpayers have houses listed in the National Register, or houses located in a registered historic district. They purport to agree not to modify the façade of their historic house, and give an organization an easement to this effect. But if the façade was already subject to restrictions under zoning rules, the taxpayers may not be giving up anything at all. A taxpayer cannot get a charitable contribution if he or she has nothing to give up. The taxpayer cant give up a right to change the façade of a building if he or she doesnt hold that right in the first place. Remarks of Steven T. Miller, IRS Commissioner, Tax Exempt and Government Entities, before the American Society of Appraisers, October 22, 2004 Early warning signs...

We also are hearing of charities that tell their historic easement donors that they are entitled to claim, as a façade easement deduction, a fixed percentage of the fair market value of their property. This, of course, is not accurate, since the rules on the valuation of historic property are based on the facts and circumstances of each case, including prior restrictions on the use or modification of the property. Remarks of Steven T. Miller, IRS Commissioner, Tax Exempt and Government Entities, before the American Society of Appraisers, October 22, 2004 More warning signs...

[The IRS is conducting an] ongoing pre-audit review of 400 open-space easements, to be followed by a similar review of 700 façade easements. - IRS Commissioner Mark Everson, March 30, 2005 The [IRS Conservation Easment] team is currently comparing the NPS data on some 1600 [NPS Part 1] certifications to our master file to determine which cases to pursue next. We are also comparing this data to partnership return data in order to identify and select appropriate cases involving commercial property. - IRS Tax-Exempt Division Commissioner Steven Miller, June 23, 2005 And more warning signs...

Internal Revenue Service Engineers have concluded that the proper valuation of a façade easement should range from approximately 10 percent to 15 percent of the value of the property.

Valuation Factors (Per 26 CFR § 1.170A–14(h))

Current IRS actions have been interpreted by some taxpayers and easement-holding organizations as merely replacing one Rule of Thumb (i.e. ten to fifteen percent) with a new Rule of Thumb (zero percent) for valuation of easements on historic structures. While we acknowledge that there is a level of subjectivity inherent in any deduction based in part on an appraised value, an approach which generally assumes a zero or de minimis valuation for historic easement donations is not good tax policy, and would not be consistent with IRC 170(h) and the applicable Treasury Regulations... Taxpayers and the preservation community would welcome additional guidance by the IRS that would help to assure both potential donors and IRS staff alike that the Service recognizes the legitimacy of historic preservation easement donations, and has no pre-established bias that would favor a zero or de minimis valuation result over the established valuation methodology reflected in the applicable Treasury Regulations.