Mecox v. U.S—District Court Denies Deduction for Façade Easement Donation; Deed Recorded in Wrong Year and Appraisal Untimely

February 4, 2016

In Mecox Partners LP v. U.S., _ F. Supp. _ (S.D.N.Y. 2016), the U.S. District Court in the Southern District of New York sustained the IRS’s complete disallowance of a $2.21 million deduction that Mecox claimed with regard to a façade easement donated to the National Architectural Trust (NAT). The court determined that the easement had not been contributed in the year for which Mecox claimed the deduction and the appraisal Mecox obtained to substantiate the deduction was untimely. The building subject to the façade easement is a certified historic structure located on Jane Street in New York’s Greenwich Village Historic District.

Background

A representative of each of Mecox and NAT signed the façade easement in December 2004 and Mecox claimed a $2.21 million deduction for the donation on its 2004 partnership tax return. However, the easement was not recorded until November 17^th, 2005, almost one year later. The IRS disallowed the claimed deduction in full, arguing that (i) the contribution was not made until 2005, the year in which the easement was recorded, and (ii) the appraisal was not timely because it was made more than 60 days before the date of the contribution in violation of Treasury Regulation § 1.170A-13(c)(3)(i). The District Court held for the IRS on both counts.

Contribution Not Made Until Easement Recorded

The District Court found that, as a matter of law, Mecox had not made a charitable contribution of the façade easement in 2004 because the easement was not effective until it was recorded in November 2005. The court first noted the fundamental principle that “[i]n a federal tax controversy, state law governs the taxpayer’s interest in the property while federal law determines the tax consequences of that interest.” The court then explained that, under New York law, an instrument purporting to create a conservation easement is not effective unless it is recorded. See N.Y. Envt’l Conservation Law § 49-0305(4) (“An instrument for the purpose of creating … a conservation easement shall not be effective unless recorded”). The court further explained

although “[o]rdinarily, a contribution is made at the time delivery is effected,” … the Deed of Easement had no legal effect when Mecox delivered it to the NAT in 2004. It was not until the Deed was recorded the following year that the Deed became effective, and the Easement was conveyed. Consequently, Mecox erred in taking a deduction for a qualified conservation contribution in 2004.

In support of this holding the District Court referenced two earlier cases involving façade easements donated to NAT with respect to New York properties: Zarlengo v. Comm’r and Rothman v. Comm’r. In each case, the Tax Court determined that the contribution date was the recordation date, not the date on which the easement was signed by the donor and NAT.

The District Court further explained in a footnote that:

Even if the Court were to accept that the contribution date of the Easement was the delivery date of the Deed, regardless of whether the Deed was effective at that point, the Easement still did not satisfy the Code’s definition of a “qualified conservation contribution” … until 2005. This is because a “qualified conservation contribution” must be made “exclusively for conservation purposes.” … This means that the contribution must be “protected in perpetuity,” … and thus “subject to legally enforceable restrictions,” …. But the Easement contribution was not even effective between the parties until it was recorded. Therefore, regardless of when the Easement is considered to have been contributed, the Easement did not meet the [Internal Revenue] Code’s substantive requirements of what constitutes a “qualified conservation contribution” until the Deed of Easement was recorded in 2005.

The District Court’s holding is consistent with the IRS’s position on recordation set forth in the Conservation Easement Audit Techniques Guide. The Guide instructs that the complete deed of conservation easement (including all exhibits or attachments, such as a description of the easement restrictions, diagrams, and lender agreements) must be recorded in the appropriate recordation office in the county where the property is located and, under state law, an easement is not enforceable in perpetuity before it is recorded. The Guide further instructs that the effective date of the gift is the recording date.

Mecox’s Alternative Arguments

Mecox argued in the alternative that, because the easement did not specifically reference the New York conservation easement enabling statute, that statute did not apply and the easement was a common law restrictive covenant that does not require recordation to be effective. The court dismissed that argument, finding that there was “no question” that the easement fell under the New York enabling statute’s definition of a conservation easement. The court explained that the deed repeatedly employed the term “conservation easement,” the deed satisfied the terms of the enabling statute, and the easement described in the deed “fits squarely” within the enabling statute’s definition of a conservation easement. The court noted that nothing in the New York enabling statute suggests that the statute must be explicitly referenced by name in order for the statute to apply. The court also was not aware of a single case in which a conservation easement that satisfied the terms of the enabling statute was interpreted as a common law restrictive covenant. The court concluded that the façade easement reflected “an unambiguous intent by the parties to create a conservation easement, as defined by [New York’s enabling statute]… and… Mecox’s after-the-fact, subjective claims to the contrary are immaterial.”

Mecox also argued that, even if the New York conservation easement enabling statute applied to the façade easement, recordation was not required for the easement conveyance to be effective—i.e., recordation was required only for the easement to be effective against subsequent purchasers of the subject property. The court dismissed this argument as well, noting that such an interpretation was in direct contradiction to the plain text of the enabling statute, which states, without qualification, that (i) “a conservation easement shall be duly recorded” and (ii) an unrecorded conservation easement “shall not be effective.” See N.Y. Envt’l Conservation Law § 49-0305(4). The court explained that conservation easements in New York are subject to special rules, which include, among other things, the benefit of certain defenses not granted to common law easements and a requirement that the conveyance be recorded to be effective.

Even in states other than New York, the donor of a façade (or conservation) easement should see to it that the easement is recorded in the year in which the donor intends to claim the donation was made. Absent recordation of an easement, a purchaser of the subject property who records the purchase deed will generally take the property free of the easement. Thus, until recordation, the property generally will not be “subject to legally enforceable restrictions” as required by Treasury Regulation 1.170A-14(g)(1), and the conservation purpose of the contribution will not be “protected in perpetuity” as required by Internal Revenue Code § 170(h)(5)(A). See Zarlengo v. Comm’r. Cf. Gorra v. Comm’r (façade easement delivered to recorder’s office on December 28, 2006, but not recorded until January 18, 2007, was deemed recorded in 2006; under N.Y. Real Prop. Law § 317, delivery of the deed to the recorder’s office, with receipt acknowledged, constituted recordation, even though there was a delay in the actual recording until the following year because of a cover sheet error).

The date on which an easement contribution is deemed to have been made is also relevant for purposes of ensuring that the appraisal obtained to substantiate the deduction is timely.

Appraisal Untimely

To substantiate the value of a conservation easement for purposes of the federal charitable income deduction, the taxpayer must obtain a “qualified appraisal” of the easement prepared by a “qualified appraiser” no earlier than 60 days before the contribution date of the easement and no later than the extended due date of the tax return claiming the deduction. See Treasury Regulation § 1.170A-13(c)(3). In Mecox, the appraisal of the easement was dated June 13, 2005, and it stated that the value of the easement as of November 1, 2004, was $2.21 million. The court found that the appraisal was “conducted” on June 13, 2005, and the façade easement was not contributed until November 17, 2005, the date on which it was recorded (5 months later). Accordingly, the appraisal “took place” more than 60 days before the contribution date of the easement, and Mecox thus failed to satisfy the substantiation requirements for the deduction.

Mecox is yet another in a line of cases involving challenges to deductions claimed with regard to façade easements donated to NAT:

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