Opinion ID: 2796442
Heading Depth: 1
Heading Rank: 2

Heading: Penalty For Gross Valuation Misstatement

Text: The parties agree that [o]ur review of the tax court's ruling is 'in most respects similar to our review of district court decisions: factual findings for clear error and legal rulings de novo.' Schussel v. Werfel, 758 F.3d 82, 87 (1st Cir. 2014) (quoting Drake v. Comm'r, 511 F.3d 65, 68 (1st Cir. 2007)). The Tax Court has the primary function of finding the facts in tax disputes, weighing the evidence, and choosing from among conflicting factual inferences and conclusions those which it considers most reasonable, and we have no power to change or add to those findings of fact or to reweigh the evidence. Scheidelman v. Comm'r, 755 F.3d 148, 151 (2d Cir. 2014) (per curiam) (quoting Comm'r v. Scottish Am. Inv. Co., 323 U.S. 119, 123-24 (1944)) (internal quotation marks omitted). In turn, [t]he determination that a taxpayer is liable for an accuracy-related penalty is [] a factual determination reviewed for clear error. Curcio v. Comm'r, 689 F.3d 217, 225 (2d op. at 81-86. Because of our disposition of this case, we need not address these rulings. -18- Cir. 2012); accord Daoud v. Comm'r, 548 F. App'x 441, 441 (9th Cir. 2013); Rovakat, LLC v. Comm'r, 529 F. App'x 124, 128 (3d Cir. 2013); Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1381 (Fed. Cir. 2010); see also Kikalos v. Comm'r, 434 F.3d 977, 986-87 (7th Cir. 2006); cf. United States v. Boyle, 469 U.S. 241, 249 n.8 (1985) (Whether the elements that constitute 'reasonable cause' are present in a given situation is a question of fact, but what elements must be present to constitute 'reasonable cause' is a question of law.). Specifically, courts have treated the issue of whether a taxpayer acted in good faith for purposes of the good faith investigation requirement and the reasonable cause and good faith exception as an issue of fact appropriately reviewed for clear error. See Whitehouse Hotel Ltd. P'ship v. Comm'r, 755 F.3d 236, 247-50 (5th Cir. 2014). This makes particularly good sense, including in the context of this case. The Tax Court, which heard firsthand the evidence -- including, importantly, the testimony of the Kaufmans themselves and their accountant -- was in the best position to make the determination of whether the taxpayers acted in good faith. See Frank Sawyer Trust of May 1992 v. Comm'r, 712 F.3d 597, 606 (1st Cir. 2013) ([D]eferential clear error review is especially appropriate when -- as here -- knowledge and intent are pivotal to the Tax Court's ruling and credibility determinations comprise a prime element of the court's ultimate conclusion. -19- (quoting Crowley v. Comm'r, 962 F.2d 1077, 1080 n.4 (1st Cir. 1992)) (internal quotation marks omitted)).
1. The Tax Court's Holding That The Kaufmans Did Not Conduct A Good Faith Investigation After a careful review of the record, we cannot say that the Tax Court's finding that the Kaufmans failed to make a good faith investigation into the value of the easement was clearly erroneous. Indeed, the conclusion was well supported by the evidence. Specifically, it was clearly reasonable for the court to conclude that events after the Kaufmans' receipt of Hanlon's appraisal would have put a reasonable person on notice that further investigation was required to verify the purported value of the donated easement. After receiving Hanlon's appraisal, Gordon, expressly concerned that the donation of the easement to the Trust might hurt the market value of the house, e-mailed Bahar for reassurance, and Bahar unequivocally told him that he did not expect the donation to decrease the value of the residence at all. This should have immediately raised red flags as to whether the value of the easement was zero. Yet the evidence shows Gordon made an immediate decision to press ahead with the donation after Bahar's reassurance that it would not hurt the value of the residence. Moreover, the Kaufmans had signed a letter stating that the restrictions imposed by the PRA were the same as those already -20- in place on the residence by virtue of the South End zoning restrictions. The Tax Court was entitled to reject as not credible Gordon's testimony that he did not put much stock in Bahar's assessment of the effect of the easement donation on the value of the property.8 It was also entitled to reject the Kaufmans' testimony that they did not notice the language about the easement restrictions in the letter they sent to Washington Mutual. And, even accepting that testimony, it was within the Tax Court's purview to find that the Kaufmans should have done further investigation and that they failed to do so. The Kaufmans' protestations that they were unable to critically evaluate the Hanlon appraisal because they were not experts in easement valuation are beside the point. The Tax Court did not suggest that the Kaufmans should have been able to critique the Hanlon appraisal in a vacuum, or that they should have known from the outset that the value of the easement was zero. Rather, 8 Gordon's testimony that he discounted Bahar's analysis because it was not sufficiently statistically rigorous could easily be doubted. It was also striking in its self-contradiction. This statement is belied by Gordon's failure to apply the same statistical rigor to Hanlon's analysis, which was not based on any statistical analysis at all -- just Hanlon's judgment, experience, and common sense. Kaufman IV, 107 T.C.M. (CCH) 1262, slip op. at 26. Indeed, Gordon admitted that he had no basis upon which to accept Hanlon's analysis other than the fact that Hanlon was a professional appraiser, and that he could not judge the accuracy of Hanlon's 10-15% range because to judge its accuracy you would have to see the sample data on which it was based. Id. at 79. -21- the court found that the Kaufmans should have recognized obvious warning signs indicating that the appraisal's validity was subject to serious question, and should have undertaken further analysis in response. The Kaufmans also miss the mark in arguing that it was conventional wisdom during the tax years in question that a conservation easement, in general, would decrease the value of a piece of property. The IRS regulations themselves reject any notion that the grant of a conservation easement itself affects the fair market value. As the Scheidelman court observed, [t]o the contrary, the regulations provide that an easement that has no material effect on the obligations of the property owner or the uses to which the property may be put may have no material effect on the value of the property. And sometimes an easement may in fact serve to enhance, rather than reduce, the value of the property. In such instances no deduction would be allowable. Scheidelman, 755 F.3d at 152 (footnote omitted) (quoting 26 C.F.R. § 170A-14(h)(3)(ii)); see also id. at 152 n.1 (noting that [t]his is especially true if only a simple facade easement has been granted over a property that has substantial market value because of its historic character (alterations, citation, and internal quotation marks omitted)). Moreover, neither the Tax Court nor any Circuit Court of Appeals has held that the grant of a conservation easement effects a per se reduction in the fair market value. Id. at 152 (alteration in original) (citations and -22- internal quotation marks omitted); see also Nicoladis v. Comm'r, 55 T.C.M. (CCH) 624 (1988) (disclaiming adoption of any general '10-percent rule' . . . with respect to facade donations). The Tax Court did not purport to equate good faith investigation with exhaustive investigation. It merely required that the Kaufmans do some basic inquiry into the validity of an appraisal whose result was squarely contradicted by other available evidence glaringly in front of them. There was no clear error in such reasoning. The Kaufmans also argue that they must be found to have acted in good faith because they reasonably relied on their accountant, Cohen, who reviewed the Hanlon appraisal and expressed no reservations about the Kaufmans taking the easement deduction. But Cohen testified that he offered the Kaufmans no opinion on whether the easement valuation was reasonable or not.9 And so, reliance on Cohen could not, by definition, constitute a good faith investigation of the value of the contributed property, 26 U.S.C. § 6664(c)(2)(B) (emphasis added), particularly given the other information available to the Kaufmans that cast doubt on the validity of the appraisal. 9 Gordon testified that Cohen said the results of the Hanlon appraisal were reasonable. But the Tax Court, as factfinder, was entitled to weigh the credibility of the conflicting testimony, and to credit Cohen's testimony over Gordon's. See Frank Sawyer Trust, 712 F.3d at 606. -23- The Fifth Circuit's decision in Whitehouse, upon which the Kaufmans rely, is not to the contrary and is consistent with our conclusions. There, the taxpayer had relied on two appraisals, and moreover, the valuations were much more complicated because many issues were in dispute, including the property's boundaries, its highest and best use, and how the donation of the easement would affect the highest and best use. See Whitehouse, 755 F.3d at 239-41, 247-48, 250. Most importantly, there is no indication that the taxpayer in Whitehouse encountered red flags suggesting that the easement had no value. The Kaufmans mistakenly attempt to rely on the Tax Court's decision in Chandler v. Commissioner, 142 T.C. 279 (2014). It is also distinguishable. There, as here, the taxpayers relied on an appraisal and the advice of their accountant. Id. at 295. Unlike in this case, there were no red flags analogous to the Bahar e-mail or the Washington Mutual letter. Indeed, the Chandler court expressly distinguished this case on that precise basis. See id. (noting that Kaufman involved different circumstances, namely, [t]he taxpayers' continued reliance on the initial appraisal in the face of [Bahar]'s comments). Such red flags were likewise missing from the other cases cited by the Kaufmans. See Zarlengo v. Comm'r, 108 T.C.M. (CCH) 155 (2014); Scheidelman v. -24- Comm'r, 100 T.C.M. (CCH) 24 (2010), vacated and remanded, 682 F.3d 189 (2d Cir. 2012).10 2. The Tax Court's Alternate Holding That The Kaufmans Did Not Act With Reasonable Cause And In Good Faith The Tax Court also did not clearly err in finding, as an alternate holding, that the Kaufmans did not satisfy the reasonable cause and good faith exception, for the same reasons already discussed. Generally, the most important factor in the reasonable cause and good faith determination is the extent of the taxpayer's effort to assess the taxpayer's proper tax liability. 26 C.F.R. § 1.6664-4(b)(1). Courts should tak[e] into account all pertinent facts and circumstances, including the experience, knowledge, and education of the taxpayer. Id. The Kaufmans were highly intelligent, very well-educated people, and the Tax Court reasonably found that developments casting doubt on the Hanlon appraisal should have alerted them that they needed to take further steps to assess their proper tax liability. Moreover, and importantly for our purposes, 10 We also note that, because of the applicable standard of review, the cases cited by the Kaufmans in which the Tax Court found that the taxpayer acted in good faith are of limited help to the Kaufmans. Even if the Kaufmans were identically situated to the taxpayers in those cases (and they are not), and even if the Tax Court's findings on the good faith issue in those cases would have been affirmed on appeal as not clearly erroneous, it would not logically follow that the Tax Court clearly erred in finding a lack of good faith in this case. -25- [r]easonable cause and good faith ordinarily is not indicated by the mere fact that there is an appraisal of the value of property. Other factors to consider include the methodology and assumptions underlying the appraisal, the appraised value, the relationship between appraised value and purchase price, the circumstances under which the appraisal was obtained, and the appraiser's relationship to the taxpayer or to the activity in which the property is used. 26 C.F.R. § 1.6664-4(b)(1). Hanlon's assumptions and methodology were questionable at best, and the appraisal value was suspiciously high in view of other evidence available to the Kaufmans. Further, Hanlon at least arguably had an incentive to calculate a high value for the easement, given that he performed appraisals for the Trust and the Trust received cash donations corresponding to a set percentage of the assessed value of the donated easements, see Kaufman III, 687 F.3d at 32. In view of these facts, the Tax Court did not clearly err in concluding that the Kaufmans' reliance on Hanlon's appraisal was not sufficient to satisfy the reasonable cause and good faith exception. 3. The Kaufmans' Remaining Arguments The Kaufmans advance three additional arguments in an effort to show that the Tax Court's analysis was infected by legal error. We address and reject each in turn. First, the Kaufmans argue that the IRS did not meet its burden of production to impose any penalty. Not so. In addition to the basic underlying facts, the IRS submitted the expert -26- testimony of Bowman, who concluded, based on market research and a comparison of the South End zoning restrictions with the restrictions imposed by the PRA, that the value of the easement was zero. The Kaufmans criticize Bowman for not relying on contemporary comparable sales data to determine the 'after' value, but they concede elsewhere that this sort of data was nonexistent and that accordingly it was reasonable to compare the South End zoning restrictions with the PRA restrictions to arrive at a valuation of the easement. Bowman's testimony, while not compelling a finding that the value of the easement was zero, certainly heavily supported such a finding -- a point the Kaufmans seem to have implicitly conceded by their decision not to challenge the Tax Court's valuation of the easement. Second, the Kaufmans argue that the Tax Court employed an erroneous definition of the term good faith. The court used the phrase honesty in belief and required the Kaufmans to demonstrate how they honestly came to believe that, beyond being simply the amount determined in the Hanlon appraisal, the value of the facade easement was $220,800. Kaufman IV, 107 T.C.M. (CCH) 1262, slip op. at 72. The Kaufmans contend that this is an impossibly high standard of proof and that [a] more suitable definition for good faith . . . would be the absence of 'bad' faith -- that is, the absence of 'dishonesty of belief or purpose.' At oral argument, counsel for the Kaufmans framed this argument -27- somewhat differently, asserting that the Tax Court employed an overly subjective standard in evaluating the Kaufmans' good faith. The Kaufmans' proposed objective/subjective distinction is unhelpful and not supported by the text of the regulations. The inquiry must necessarily be somewhat subjective, since courts must consider the experience, knowledge, and education of the taxpayer. 26 C.F.R. § 1.6664-4(b)(1); see also id. (providing that an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances may be indicative of reasonable cause and good faith (emphasis added)). At the same time, the inquiry is not entirely subjective, as the regulations instruct courts to consider whether the taxpayer would know or have reason to know that information on which he or she relied was incorrect. Id. (emphasis added). The more helpful framing of the issue is that set forth in the regulations: whether, taking into account all pertinent facts and circumstances, the taxpayer acted in good faith. Id. That is the standard the Tax Court used. Turning to the argument in the Kaufmans' brief, the contention that the honesty in belief standard is impossibly high is undercut by the fact that the Tax Court has in fact recently applied that definition of good faith in a case in which it found in favor of the taxpayers. See Zarlengo, 108 T.C.M. (CCH) 155, slip op. at 57-58. Importantly, Black's Law Dictionary -28- seemingly treats both definitions as paths to reach a finding. It defines good faith as having several components: [a] state of mind consisting in (1) honesty in belief or purpose, (2) faithfulness to one's duty or obligation, (3) observance of reasonable commercial standards of fair dealing in a given trade or business, or (4) absence of intent to defraud or to seek unconscionable advantage. Black's Law Dictionary 808 (10th ed. 2014) (emphases added).11 Third, the Kaufmans make an argument that obtaining a qualified appraisal made by a qualified appraiser [a]utomatically constitutes a good-faith investigation. This interpretation of the statute cannot be correct. Section 6664(c)(2) sets forth two separate requirements that must be met in order for the reasonable cause exception to apply to a gross valuation overstatement: (A) the claimed value of the property was based on a qualified appraisal made by a qualified appraiser, and (B) in addition to obtaining such appraisal, the taxpayer made a good faith investigation of the value of the contributed property. The 11 Insofar as the Kaufmans mean to argue that it would be error to require them to determine that the easement was worth precisely $220,800 -- as opposed to, say, $215,000 (or $220,799) -- we do not understand the Tax Court's opinion to require that level of precision. The court's analysis, considered as a whole, suggests that it merely required that the Kaufmans, after a goodfaith investigation of the value of the easement, believe that Hanlon's appraisal was reasonably accurate. Cf. Fire & Police Pension Ass'n of Colo. v. Simon, 778 F.3d 228, 241 n.5 (1st Cir. 2015) (citing Connor B ex rel. Vigurs v. Patrick, 774 F.3d 45, 54 n.9 (1st Cir. 2014)). -29- Kaufmans' reading would render the second requirement meaningless, in violation of the rule that a statute ought, upon the whole, to be so construed that, if it can be prevented, no clause is rendered superfluous, void, or insignificant. Young v. United Parcel Serv., Inc., 135 S. Ct. 1338, 1352 (2015) (citations and internal quotation marks omitted) (declining to read the second clause of the Pregnancy Discrimination Act as simply defin[ing] sex discrimination to include pregnancy discrimination because [t]he first clause accomplishes that objective). Simply obtaining an appraisal is not the same as reasonably relying on that appraisal. The Kaufmans concede as much in their reply brief, acknowledging that 'obtaining' a qualified appraisal alone will not satisfy the good-faith investigation requirement, nor will 'unreasonable' reliance. There may well be situations in which the taxpayer need do little more than read an appraisal and note that there is no other evidence that reasonably casts doubt on the accuracy of the appraisal. Here, however, the Tax Court supportably found that the Kaufmans obtained a qualified appraisal from a qualified appraiser, but that other facts available to the Kaufmans should have alerted them that it was not reasonable to rely on that appraisal. The Tax Court's analysis with respect to the accuracyrelated penalties was sound as a legal matter and not clearly erroneous as a factual matter. -30-