Opinion
21596-22
02-05-2024
APARTMENTS AT NAUTICA, LLC, DEV X, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Albert G. Lauber, Judge
This case involves a charitable contribution deduction claimed by Apartments at Nautica, LLC (Nautica or Grantor), for a façade easement. The Internal Revenue Service (IRS or respondent) disallowed the deduction and determined penalties. On September 29, 2023, respondent filed a Motion for Partial Summary Judgment contending that the deduction was properly disallowed because the easement's conservation purpose was not "protected in perpetuity." See § 170(h)(5)(A). Specifically, respondent asserts that the easement deed "improperly determines the value of the donor's and donee's percentage interests" in the proceeds of any sale following a judicial extinguishment of the easement. See Treas. Reg. § 1.170A-14(g)(6)(ii). Finding that there exist genuine disputes of material fact, we will deny the Motion.
Unless otherwise indicated, statutory references are to the Internal Revenue Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and Rule references are to the Tax Court Rules of Practice and Procedure.
Background
The following facts are derived from the pleadings, the parties' Motion papers, and the Exhibits and Declarations attached thereto. They are stated solely for purposes of deciding respondent's Motion and not as findings of fact in this case. See Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994).
Nautica is a limited liability company (LLC) organized in Ohio. It is treated as a partnership for Federal income tax purposes and had its principal place of business in Ohio when the Petition was timely filed. Absent stipulation to the contrary, appeal of this case would lie to the U.S. Court of Appeals for the Sixth Circuit. See § 7482(b)(1).
In 2017 Nautica owned the Theodor Kundtz Company Building (Building) in Cleveland, Ohio, which is listed on the National Register of Historic Places. On December 28, 2017, Nautica executed a Deed of Easement (Deed) granting a façade easement over the Building to the Historic Warehouse District Development Corporation (Grantee), a "qualified organization" within the meaning of section 170(h)(3).
The Deed grants an easement over "the Building Façade and the Development Rights." The former term refers to "the Building's entire exterior, including but not limited to, the front, side and rear exterior walls, height, roof, roof lines, color, building materials and above and adjacent to the Building, encompassing all such air space of the Property." According to the Deed, the easement's purpose is to ensure that the façade of the Building:
will be retained and maintained forever in its rehabilitated condition and state exclusively for conservation and preservation purposes . . . and to prevent any use or change of the Building Façade or the air space on the Property directly above or directly adjacent to the Building that is inconsistent with the historic character of the Building Façade.
The Deed recognizes the possibility that the easement might be extinguished at some future date if fulfillment of the conservation purpose became impossible. Section 9.2, captioned "Extinguishment," provides that such circumstances "may include, but are not limited to, partial or total destruction of the Building resulting from casualty." In the event that the Building (Property) were to be sold following judicial extinguishment of the easement, the deed provides that Nautica and Grantee:
shall share in any proceeds . . . after satisfaction of any costs or expenses customarily associated therewith ("Net Proceeds"), and after distribution to Grantee of any proceeds specifically allocated to the Development Rights, in accordance with their respective percentage interests in the fair market value of the Property as such interests are determined under the provisions of Section 9.1. . . . Net Proceeds shall include, without limitation, insurance and condemnation proceeds. In the event that the amount of proceeds actually received by Grantee is insufficient to cover Grantee's percentage interest . . . Grantor hereby agrees to pay to Grantee an amount equal to such insufficiency and such amount . . . shall be deemed to be Net Proceeds.
Section 9.1 of the deed, captioned "Percentage Interests," directs that sale proceeds shall be shared between Nautica and Grantee as follows:
In accordance with Treas. Reg. § 1.170A-14(g)(6)(ii) for purposes of allocating proceeds pursuant to Section 9.2 and 9.3, Grantor and Grantee
stipulate that as of the Recording Date, [they] are each vested with real property interests in the Property and that such interests have a stipulated percentage interest in the fair market value of the Property. In addition to all Development Rights, Grantee's percentage interest in the Building shall be determined by dividing the difference between: (a) the fair market value of the Building before the grant of the Easement, excluding the value of the Development Rights; and (b) the fair market value of the Building after the grant of the Easement; by (c) the fair market value of the Building before the grant of the Easement, excluding the value of the Development Rights. . . . The fair market values of the Building to be used to calculate Grantee's percentage interest . . . shall be those values used to calculate the deduction for federal income tax purposes pursuant to Section 170(h) of the Code, as set forth in the qualified appraisal obtained by Grantee . . . . it being the express intentions of Grantor and Grantee that Grantee shall always retain its percentage interest for Purposes of this Agreement, including the allocation of proceeds pursuant to Sections 9.2 and 9.3.
Nautica timely filed Form 1065, U.S. Return of Partnership Income, for its 2017 tax year. On that return it claimed a charitable contribution deduction of $20,044,000 for its donation of the façade easement. It attached to its return an appraisal of the easement, which reflected a "before" value of $38,071,000 and an "after" value of $10,027,000. See § 170(h)(4)(B)(iii)(I). The appraisal determined that $872,000 of the diminution in value was attributable to the restriction on the building façade, and that $27,172,000 of the diminution in value was attributable to the restrictions prohibiting development.
Discussion
I. Summary Judgment Standard
The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). We may grant partial summary judgment regarding an issue as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. See Rule 121(b); Sundstrand Corp., 98 T.C. at 520. In deciding whether to grant partial summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party (here petitioner). Sundstrand Corp., 98 T.C. at 520.
II. Underlying Principles
The Code generally restricts a taxpayer's charitable contribution deduction for the donation of "an interest in property which consists of less than the taxpayer's entire interest in such property." § 170(f)(3)(A). But there is an exception for a "qualified conservation contribution." § 170(f)(3)(b)(iii), (h)(1). For the donation of an easement to be a "qualified conservation contribution," the conservation purpose must be "protected in perpetuity." § 170(h)(5)(A); see TOT Prop. Holdings, LLC v. Commissioner, 1 F.4th 1354, 1362 (11th Cir. 2021); PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 201 (5th Cir. 2018).
The regulations set forth detailed rules for determining whether this "protected in perpetuity" requirement is met. Of importance here is the regulation governing the mandatory division of proceeds in the event the property is sold following extinguishment of the easement. See Treas. Reg. §1.170A-14(g)(6). The U.S. Court of Appeals for the Sixth Circuit, to which appeal of this case would apparently lie, has sustained the validity of this regulation. See Oakbrook Land Holdings, LLC v. Commissioner, 280 F.4th 200 (6th Cir. 2022), aff'g 154 T.C. 180 (2020), cert. denied, 143 S.Ct. 626 (2023); but see Hewitt v. Commissioner, 21 F.4th 1336, 1352 (11th Cir. 2021), rev'g T.C. Memo. 2020-89.
The regulation recognizes that "a subsequent unexpected change in the conditions surrounding the [donated] property . . . can make impossible or impractical the continued use of the property for conservation purposes." Id. subdiv. (i). Despite that possibility, "the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding," and the easement deed ensures that the charitable grantee, following sale of the property, will receive a proportionate share of the proceeds and use those proceeds consistently with the conservation purpose underlying the original gift. Ibid. This requirement is strictly construed: If a donee is not absolutely entitled to a proportionate share of extinguishment proceeds, then the conservation purpose of the contribution is not protected in perpetuity. Carroll v. Commissioner, 146 T.C. 196, 212 (2016).
The regulations implement this "proportionate share" rule by requiring that the easement deed vest the donee with "a property right . . . with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time." Treas. Reg. § 1.170A-14(g)(6)(ii). The "proportionate value of the donee's property rights," as thus computed, "shall remain constant." Ibid. In effect, the regulation determines an apportionment fraction, calculated as of the date of the gift, that is multiplied by the sale proceeds to ascertain the donee's share. See Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 137 (2019).
III. Analysis
Respondent contends that the Deed violates the regulation discussed above. Specifically, he asserts that the Deed's "alternative method does not guarantee Grantee, at a minimum, its proportionate share of extinguishment proceeds as required by Treas. Reg. § 1.170A-14(g)(6)(ii)." This is assertedly so because Grantee and Nautica, in the event of the easement's extinguishment due to casualty, "would share in the extinguishment (insurance) proceeds in accordance with their respective percentage interests allocable to the non-Development Rights portion." Grantee's interest with respect to that latter portion, respondent notes, "is determined by excluding the value of the restriction attributable to the air space restriction (a.k.a. the Development Rights) from both the numerator and the denominator of the proportion set out in Treas. Reg. § 1.170A-14(g)(6)(ii)."
We are not sure we understand the math underlying respondent's argument. The Deed says that, in the event of extinguishment, Grantee is entitled to all "proceeds specifically allocated to the Development Rights." According to the appraisal, the Development Rights represent 97% of the easement value. In allocating proceeds attributable to the façade restriction, representing the residual 3% of the easement value, the Development Rights are indeed excluded from the numerator and the denominator of the apportionment formula. But that does not seem illogical given the proceeds attributed to the Development Rights have already been allocated 100% to Grantee. In any event, the Deed seems to have a fail-safe clause intended to ensure compliance with the regulation: "In the event that the amount of proceeds actually received by Grantee is insufficient to cover Grantee's percentage interest . . . Grantor hereby agrees to pay to Grantee an amount equal to such insufficiency and such amount . . . shall be deemed to be Net Proceeds."
On its face, the Deed appears to entitle Grantee to extinguishment proceeds in the amount required by the regulation, perhaps even a larger share. But respondent may have identified a possible ambiguity in the Deed. Although the Deed provides that Grantee's percentage interest includes "all of the Development Rights," the Deed is silent as to precisely how sale proceeds are to be "specifically allocated to the Development Rights." If the "specific allocat[ion]" entitles Grantee to proceeds based on the proportion that the Development Rights bear to the FMV of the building as a whole-i.e., 97%-the Deed's methodology easily passes muster. If this language bears a different meaning, there could be a problem.
Under Ohio law, if a "contract is ambiguous, ascertaining the parties' intent constitutes a question of fact." Tera, LLC v. Rice Drilling D, LLC, 205 N.E.3d 1168, 1183 (Ohio Ct. App. 2023). "[I]f a term cannot be determined from the four corners of a contract, factual determinations of intent or reasonableness may be necessary to supply the missing term." Savedoff v. Access Group, Inc., 524 F.3d 754, 763 (6th Cir. 2008) (quoting Inland Refuse Transfer Co. v. Browning-Ferries Indus. of Ohio, Inc., 474 N.E.2d 271, 272-73 (1984)); see also Corder v. Ohio Edison Co., 205 N.E.3d 616, 623 (Ohio Ct. App. 2022). To the extent respondent has identified an ambiguity in the Deed, resolution of the question posed by his Motion entails a genuine dispute of material fact that must be addressed at trial.
We will accordingly deny respondent's Motion for Partial Summary Judgment at this time, without prejudice to his ability to resubmit his arguments in post-trial briefing should subsequent developments warrant his doing so. This is the course we have followed when addressing motions for partial summary judgment in cases (likewise appealable to the Sixth Circuit) involving façade easement deeds with "judicial extinguishment" provisions similar to those here. See Continental Downtown Properties, LLC v. Commissioner, T.C. Dkt. No. 6084-21 (Order served May 31, 2023); Del Monte LLC v. Commissioner, Dkt. No. 3411-21 (Order served August 4, 2023).
In consideration of the foregoing, it is
ORDERED that respondent's Motion for Partial Summary Judgment filed September 29, 2023, is denied. It is further
ORDERED that the parties shall file, on or before April 29, 2024, a status report (jointly if possible, otherwise separately) expressing their views as to the conduct of further proceedings in this case.