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Fifth Circuit Rejects Tax Court's Enforcement of 40 Percent Penalty.
(Parker Tax Publishing July 2, 2014)

Where a taxpayer obtained a qualified appraisal, analyzed that appraisal, commissioned a second appraisal as a check against the first one, and submitted a professionally prepared tax return, the assessment of the 40 percent gross undervaluation penalty resulting from the taxpayer's overvaluation of an easement contribution was deemed clearly erroneous. Whitehouse Hotel Limited Partnership v. Comm'r, 2014 PTC 279 (5th Cir. 6/11/14).

In 1997, Whitehouse Hotel Limited Partnership conveyed a conservation easement to the Preservation Alliance of New Orleans d/b/a Preservation Resource Center (PRC), a Louisiana nonprofit corporation dedicated to historical preservation. On its 1997 tax return, which was prepared by Whitehouse's financial auditors, Whitehouse claimed a $7.445 million charitable contribution deduction for the easement donation. The amount of the deduction was determined by an appraisal opinion submitted by an appraiser well-qualified to evaluate, appraise, and testify about commercial real estate. The IRS allowed a deduction of only $1.15 million for the easement and assessed a gross undervaluation penalty under Code Sec. 6662(h) of 40 percent of the portion of the tax underpayment. Whitehouse challenged both the valuation of the easement as well as the gross undervaluation penalty in Tax Court.

The Tax Court concluded that Whitehouse had overvalued its deduction, although not by as much as the IRS had originally calculated. The Tax Court also found that Whitehouse had misstated its deduction by more than 400 percent and upheld the gross valuation misstatement penalty. According to the Tax Court, Whitehouse presented no evidence to show it had undertaken the steps required in Code Sec. 6664(c)(3) to show that it met the reasonable cause exception in Code Sec. 6664(c)(1) to be excused from the penalty. Whitehouse appealed to the Fifth Circuit.

The Fifth Circuit remanded the case back to the Tax Court, holding that the Tax Court erred in not determining the effect of the easement on the fair market value of the buildings to which the easement related. On remand, the Tax Court essentially came back with the same conclusion that Whitehouse overvalued the easement contribution and that the gross valuation misstatement penalty applied. Whitehouse again appealed to the Fifth Circuit. Whitehouse argued that, because the Tax Court rejected the expert opinion of the appraiser hired by Whitehouse and again accepted the appraisal by the IRS expert, the Tax Court ignored the Fifth Circuit's mandate.

The Fifth Circuit upheld the Tax Court's decision with respect to the valuation of the easement but rejected its enforcement of the gross undervaluation penalty. The court noted that it left the determination of the property's highest and best use, which would determine the value of the easement, up to the Tax Court and concluded that the Tax Court did not ignore its mandate. However, the court noted that, in its prior opinion, it was skeptical of the Tax Court's conclusion that following the advice of accountants and tax professionals was insufficient to meet the requirements of the good faith defense to avoid the penalty assessment, especially with respect to the complex task of valuation involving many uncertainties. Because Whitehouse obtained a qualified appraisal, analyzed that appraisal, commissioned a second appraisal as a check against the first one, and submitted a professionally prepared tax return, the Fifth Circuit concluded that the assessment of the 40 percent gross undervaluation penalty was clearly erroneous.

For a discussion of the penalty on a substantial or gross valuation misstatement with respect to charitable deduction property, see Parker Tax ¶262,120. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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