Whitehouse Hotel v. Commissioner (Again)—5th Circuit Affirms Tax Court’s Façade Easement Valuation But Vacates on Penalties
In the first case, Whitehouse Hotel Limited Partnership v. Comm’r, 131 T.C. No. 10 (2008), the Tax Court, in a lengthy and detailed opinion, held that the partnership had overstated the value of the easement by more than 415% and was liable for a gross valuation misstatement penalty. The partnership had claimed the easement had a value of $7.445 million and the Tax Court determined that the value was only $1.792 million.
On appeal, in Whitehouse Hotel Limited Partnership v. Comm’r, 625 F.3d 321 (5th Cir. 2010), the 5th Circuit vacated and remanded on the issue of the easement’s value and, by extension, the penalty. The 5th Circuit held, in part, that the Tax Court had erred in failing to value the entire contiguous property owned by the taxpayer (i.e., the Maison Blanche building, which was encumbered by the easement, and the adjacent Kress building, which was not) as required by Treas. Reg. § 1.170A-14(h)(3)(i). The 5th Circuit found that the Tax Court had erred in declining to consider the highest and best use of the two properties in light of a pending agreement to consolidate the properties into a single ownership, which would preclude the building of sixty additional rooms on top of the Kress building because it would violate the easement encumbering the Maison Blanche building. The 5th Circuit opined that any hypothetical buyer would have assumed consolidation of the buildings and elimination of the right to build the sixty additional rooms, and this should have been taken into account in determining the value of the easement.
On remand, in Whitehouse Hotel Limited Partnership v. Comm’r, 139 T.C. No. 13 (2012), the Tax Court reiterated its original conclusion that the façade easement did not deprive the partnership or a successor owner of the ability to add stories to the Kress Building. Consistent with the 5th Circuit’s instructions, however, the Tax Court reconsidered the value of the easement assuming that it precluded the partnership from building atop the Kress building. The Tax Court ultimately concluded that the easement had a value of $1.857 million (or only approximately $65,000 more than the value it had ascribed to the easement in its first opinion). This meant, interestingly, that the partnership’s claimed value for the easement exceeded the actual value by approximately 401%, just barely triggering the gross valuation misstatement penalty (which kicked in at 400%). The court also found that the partnership was not eligible for the reasonable cause and good faith exception, in part because it relied on an appraisal estimating that the Maison Blanche had appreciated in value in less than 3 years by approximately 970% (i.e., from the partnership’s approximate $9 purchase price to an estimated value of $96 million). This dramatic asserted appreciation in value, said the court, must have left the partnership “thunderstruck,” and a reasonably prudent taxpayer attempting to assess its proper tax liability would have further investigated.
The partnership appealed again. This time, in Whitehouse IV, the 5th Circuit upheld the Tax Court’s valuation of the easement. The partnership argued that Judge Halpern’s rehearsal of his analysis that the easement did not preclude building atop the Kress building was evidence of “judicial insubordination” that “infected” the entire remand opinion (Judge Halpern wrote both Tax Court opinions in Whitehouse). The 5th Circuit disagreed. While acknowledging that the Tax Court went out of its way to state its continuing disagreement with parts of the 5th Circuit’s analysis, the 5th Circuit found that the Tax Court did not ignore its instructions. Begrudging compliance with our mandate, said the 5th Circuit, is nonetheless compliance.
The 5th Circuit did, however, vacate the Tax Court’s imposition of the gross valuation misstatement penalty. The 5th Circuit noted that it shared Tax Court’s skepticism regarding the taxpayer’s assertion that the Maison Blanche had appreciated in value by approximately 970% in less than 3 years. The 5th Circuit also noted, however, that 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, especially with regard to such a complex valuation task that involved so many uncertainties. The 5th Circuit noted that it was particularly persuaded by Whitehouse’s argument that the IRS, the IRS’s expert, and the Tax Court all reached different conclusions regarding value. Ultimately, the 5th Circuit concluded that, although reasonable cause must be determined on a case-by-case basis, in this case, obtaining a qualified appraisal, analyzing that appraisal, commissioning another appraisal, and submitting a professionally-prepared tax return was sufficient to show the taxpayer engaged in a good faith investigation as required by law.
The Pension Protection Act of 2006 eliminated the reasonable cause exception for gross valuation misstatements relating to charitable contribution property. The new “strict liability” penalty applies with respect to tax returns involving façade easement donations filed after July 25, 2006. See Chandler v. Commissioner, 142 T.C. No. 16 (2014).
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law