61 York Acquisition, LLC v. Commissioner – $10.7m Facade Easement Deduction Denied For Failure to Restrict Entire Exterior

On December 18, 2006, 61 York Acquisition, LLC (the Partnership) granted a façade easement with respect to a certified historic structure located in the Historic Michigan Boulevard District of Chicago to the National Architectural Trust, or NAT (now known as the Trust for Architectural Easements). Consistent with IRC § 170(h)(4)(B), as amended by the Pension Protection Act of 2006, the easement requires the grantor to obtain prior written consent from NAT before making any change to the “Protected Facades,” which include “the existing facades on the front, sides and rear of the Building and the measured height of the Building.” The Partnership claimed a $10.7 million charitable income tax deduction for the donation on its 2006 partnership tax return. The IRS disallowed the deduction in full and, in 61 York Acquisition, LLC v. Commissioner, T.C. Memo. 2013-266, the Tax Court granted the IRS’s motion for summary judgment sustaining the disallowance.

At the time of the donation of the facade easement, ownership of the structure subject to the easement was divided into two parts: the Partnership owned the first 14 floors (the Office Property), and a third party owned the top 6 floors (the Residential Property). In addition, the two owners had entered into an agreement (the Agreement) pursuant to which:

• the Partnership owned the “Façade,” defined as including only portions of two sides of the building,
• the Partnership reserved the right to grant an easement with respect to the Façade,
• the Partnership was responsible for maintenance of the Façade as well as maintenance of other portions of the facade of the structure, and
• any owner who wished to make an addition, improvement, or alteration that materially altered the Façade had to obtain prior written consent of the other owner.

The IRS disallowed the Partnership’s claimed deduction on the grounds that the Partnership could not have granted a valid easement restricting the entire exterior of the structure (front, sides, rear, and height) because the Partnership did not own the entire exterior of the building. The taxpayer argued that the terms of the easement and the Agreement collectively imposed enforceable restrictions on the entire exterior of the property, and that, under Illinois law, ownership of the entire exterior is not required to grant an easement that imposes enforceable restrictions on the entire exterior.

The Tax Court sided with the IRS. The court first reiterated the well-established rule that, while “[s]tate law determines the nature of property rights, … Federal law determines the appropriate tax treatment of those rights.” Accordingly, to determine whether the easement complied with the federal requirement that a façade easement restrict the entire exterior of a structure, the court looked to state law to determine the effect of the easement.

The court determined that, under Illinois law, “a person can grant only a right which he himself possesses,” Accordingly, the Partnership did not grant an easement in the entire exterior of the structure, as required under federal law, because the Partnership had rights only to the Façade, which was defined to include only portions of two sides of the structure.

The court rejected the taxpayer’s argument that the Partnership had an assignable right in the entire exterior because the Partnership had an obligation under the Agreement to maintain the entire exterior. The court explained that it declined to “find a right [to restrict] in an obligation [to maintain],” and noted that the taxpayer cited no Illinois case law in support of its proposition.

The court also rejected the taxpayer’s argument that the Agreement, which disallowed certain alterations to the property without the prior written consent of the other property owner, gave the Partnership an assignable right to restrict with respect to the entire exterior of the property. The court explained that the Agreement required the altering owner to obtain prior written consent from the other owner only if the alteration would materially alter the Façade. The Partnership thus did not have the right to restrict alterations to the two sides of the structure not covered by the definition of Façade, or to the excluded portions of the other two sides. The Partnership, said the court, could not contribute rights it did not possess.

Even if the Agreement had granted the Partnership rights to restrict alterations with respect to the entire exterior of the structure, it is not clear that the donation of those rights would satisfy the perpetuity or other requirements under § 170(h), or what the value of those rights would be for purposes of § 170(h). Cf. Schwab v. Commissioner, T.C. Memo 1994-232 (the parties stipulated that donation of rights to restrict land the taxpayer did not own was a qualified conservation contribution).

61 York Acquisitions, LLC, is yet another in a string of cases involving challenges to deductions claimed with respect to façade easements donated to NAT. See Herman v. Commissioner, T.C. Memo. 2009-2051982 East LLC v. Commissioner, T.C. Memo. 2011-84Dunlap v. Commissioner, T.C. Memo. 2012-126Rothman v. Commissioner, T.C. Memo. 2012-218Graev v. Commissioner, 140 T.C. No. 17 (2013)Friedberg v. Commissioner, T.C. Memo. 2013-224Gorra v. Commissioner, T.C. Memo. 2013-254. See also Kaufman v. Shulman, 687 F.3d. 21 (1st Cir. 2012) (remanding to the Tax Court on the issue of valuation and noting that, because of local historic preservation laws, the Tax Court might well find that the façade easement donated to NAT was worth little or nothing). NAT also was the subject of a 2011 Department of Justice lawsuit (discussed here) alleging that NAT was engaged in abusive practices. The suit settled with NAT denying the allegations but agreeing to a permanent injunction prohibiting it from engaging in the practices.

Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law