Tax Law Update 2011-05-01 (1)Tax Law Update 2011-05-01 (1)

Tax Court holds residence isn't includible in decedent's estate under Internal Revenue Code Section 2036 — In Estate of Riese, T.C. Memo 2011-60 (March 15, 2011), Sylvia Riese of Kings Point, N.Y., inherited her husband's fortune, which he had accumulated over the years as co-founder of the popular Riese restaurant chain. In 2000, Sylvia discussed transferring her New York residence to a qualified personal residence trust (QPRT), with one of her daughters, her son-in-law (who provided financial advice to Sylvia) and an estate-planning attorney. In these conversations and in written correspondence, the estate-planning attorney stated that after the term of the QPRT ended, Sylvia would no longer own the residence and would have to pay rent to continue to reside there.

Sylvia funded a 3-year QPRT with her New York residence in April 2000. At the end of the term, the property was to be transferred to two trusts for the benefit of Sylvia's daughters. Sylvia survived the term of the QPRT, which ended on April 19, 2003. Sylvia's daughter didn't discuss rent with Sylvia at that time but called the estate-planning attorney to inquire about how to establish the amount of rent charged. The estate-planning attorney told her that by the end of the year, she should contact a local real estate broker to determine the rent. Sylvia unexpectedly died in October, before she signed a lease or paid any rent. In addition, the title to the property had never been transferred to the two trusts. Sylvia's estate paid all property taxes, insurance, upkeep and maintenance on the residence until it was sold a year later.

The estate didn't include the value of the residence in the calculation of Sylvia's gross estate. It also claimed deductions of (1) the net fair market rent of $7,500 per month from the QPRT's termination until Sylvia's death as a claim against the estate under IRC Section 2053, and (2) the net fair market rent of $7,500 per month from the day after Sylvia's death through April 30, 2004 as administration expenses under IRC Section 2053. The Internal Revenue Service examined the estate's tax return and included the value of the residence, which was alleged to be $6,138,000, in Sylvia's gross estate. It also denied the deductions for pre- and post-death rent.

IRC Section 2036 includes “the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money's worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.” Under Treasury Regulations Section 20.2036-1(a)(ii), “an interest or right is treated as having been retained or reserved if at the time of the transfer there was an understanding, express or implied, that the interest or right would later be conferred.”

Based on the testimony of Sylvia's daughters and the estate-planning attorney, the court found that the parties had agreed that Sylvia would start paying fair market rent by the end of 2003 at a to-be-determined amount. The express (although unwritten) agreement among the parties for the payment of rent negated any implied agreement that Sylvia would have the right to continue using the residence. Therefore, there was no retained life estate in the residence that would cause the residence to be included in her gross estate.

The court allowed the estate's deduction under IRC Section 2053(a)(3) for the rent that accrued prior to Sylvia's death, explaining that Sylvia's occupation of the residence constituted a tenancy at will under New York law, which created a personal obligation for Sylvia to pay rent. But it didn't allow the deduction under IRC Section 2053(a)(2) for the rent accrued after Sylvia's death because there was no formal lease and no tenancy at will for the estate.

Taxpayer denied charitable deduction for contribution of façade easement — In Schrimsher v. Commissioner, TC Memo 2011-071 (March 28, 2011), the Tax Court granted partial summary judgment to the IRS, holding that taxpayers had failed to obtain a contemporaneous written acknowledgement for a charitable donation of a façade easement.

In 2004, Randall Schrimsher executed an agreement granting a façade easement to the Alabama Historical Commission (the Commission) with respect to property in Huntsville, Ala., known as the Times Building. The introductory language of the agreement provided that “for and in consideration of the sum of TEN DOLLARS, plus other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Grantor [Schrimsher] does hereby irrevocably GRANT, BARGAIN, SELL, AND CONVEY unto the Grantee [the Commission], its successors and assigns, a preservation and conservation easement to have and hold in perpetuity …”

Randall listed the appraised fair market value of the façade easement as $705,000 on a Form 8283 (Noncash Charitable Contributions), attached to his 2004 federal income tax return. However, the “Appraisal Summary” on the Form 8283 omitted various required items of information and wasn't signed or dated by Randall, the appraiser or any representative of the donee. Nor was any written appraisal of the façade easement attached to the tax return.

The IRS issued a notice of deficiency and disallowed the charitable contribution deduction on the alternative grounds that (1) Randall failed to obtain a contemporaneous written acknowledgement of the façade easement from the Commission as required under IRC Section 170(f)(8), and (2) Randall had failed to obtain a qualified appraisal and attach it to the tax return as required by IRC Section 170(f)(11). Under IRC Section 170(f)(8)(A), a charitable contribution of $250 or more must be substantiated with a contemporaneous written acknowledgment from the donee organization. The contemporaneous written acknowledgment doesn't need to be in any particular form but must include: (1) the amount of cash and a description (but not value) of any property other than cash contributed, (2) whether the donee organization provided any goods or services in consideration, in whole or in part, for any property described in clause (1), and (3) a description and good faith estimate of the value of any goods or services referred to in clause (2).

The IRS contended that while the agreement regarding the façade easement was an acknowledgment that was contemporaneous, it failed to describe whether any goods or services were exchanged for the easement, and the Tax Court agreed. The court noted that if no goods or services were exchanged, the acknowledgment was required to explicitly state so. The only statement in the agreement concerning consideration was the introductory language stating that the Commission provided $10 plus other good and valuable consideration. The court explained that even if the introductory language was simply boilerplate, it still didn't confirm that the Commission provided no goods or services. And if the introductory language was interpreted literally to mean that the Commission did provide consideration, there was still no description and good faith estimate of the value of the “other good and valuable consideration.”

Accordingly, the Tax Court granted the IRS' motion for summary judgment on the issue of the contemporaneous written acknowledgment. The court didn't address the IRS' alternative argument that Randall had failed to attach a qualified appraisal to the tax return as required by IRC Section 170(f)(11). This case is a good reminder of the severe consequences of failing to obtain a complete acknowledgement of a charitable donation. (For more information on the importance of acknowledgement letters, see Laura H. Peebles, “No Job's Over 'til the Paperwork is Done,” in the February 2011 issue of Trusts & Estates, at p. 14.)

Ninth Circuit holds that appraisal of conservation easement isn't protected by attorney-client privilege or work-product doctrine — In United States v. Richey, 107 A.F.T.R.2d 2011-573 (Jan. 21, 2011), the U.S. Court of Appeals for the Ninth Circuit reversed a district court's holding that an appraiser's work file relating to an appraisal attached to an income tax return was protected by the attorney-client privilege and the work-product doctrine. Alan and Wendy Pesky owned general and limited partnership interests in FAWPEAS, an Idaho limited partnership that owned a 50 percent interest in real property located in Ketchum, Idaho. On March 7, 2002, the Peskys caused FAWPEAS to grant a conservation easement for the property in favor of the Nature Conservancy.

The Peskys claimed a charitable contribution deduction of approximately $200,000 on their 2002 federal income tax return, due to the proportionate share of the alleged value of the easement. The Peskys' attorney retained an MAI-certified appraiser, Mark Richey, who prepared an appraisal report that was filed with the taxpayers' 2002 federal income tax return. The appraisal report noted: “[T]his report may not include full discussion of the data, reasoning, and analyses that were used in the appraisal process to develop Richey's opinion of value. Supporting documentation concerning the data, reasoning, and analyses is retained in Richey's file.” Further deductions (approximately $1.3 million) based on the easement were carried forward on the Peskys' 2003 and 2004 federal income tax returns.

In July 2008, the IRS mailed a summons to Richey instructing him to appear before an IRS agent to provide testimony, documents, books, records and information related to the appraisal. The Peskys' attorney directed Richey not to comply with the summons based on the attorney-client privilege and work-product doctrine. In October 2008, the government filed a petition to enforce the summons, explaining that the agent was investigating the Peskys' 2003 and 2004 federal income tax returns, had summoned Richey to inquire about the valuation of the easement and needed further information to determine the Peskys' tax liability.

In December 2008, the IRS issued a notice of deficiency to the Peskys, disallowing the charitable deductions for the 2003 and 2004 federal income tax returns. The Peskys paid the amount due under the notice and then filed a motion to intervene in the government's summons enforcement action. The district court agreed with the Peskys and issued a memorandum order quashing the summons. The IRS appealed.

The Peskys and the IRS agreed that the summons was issued in good faith initially. However, the court held that the burden shifted to the Peskys to establish that the continued enforcement of the summons was in bad faith once the Peskys paid the amount due under the notice of deficiency. The court followed the rulings of the Second and Seventh Circuits and held that the continued enforcement of the summons was proper because the Peskys' liability hadn't been finally determined (even though the audit was closed, the time period for the Peskys to file a petition with the Tax Court hadn't expired when the IRS sought enforcement of the summons), and there was no other evidence in the record that the summons was issued for an improper purpose.

The court also held that the district court erroneously concluded that the entire appraisal work file was protected by the attorney-client privilege. The attorney-client privilege protects confidential communications between attorneys and clients, which are made for the purpose of giving legal advice. The privilege may extend to communications with third parties who have been engaged to assist the attorney in providing legal advice. But, if the advice sought isn't legal advice, then the privilege doesn't exist.

The court held that any communications related to the preparation and drafting of the appraisal for submission to the IRS wasn't made for the purpose of providing legal advice, but instead, for the purpose of determining the value of the easement. In addition, the attorney-client privilege shouldn't protect documents in the files that weren't communications.

The court also held that the district court erred by concluding that the entire work file was protected by the work-product doctrine. The work-product doctrine protects documents prepared by a party or his representative in anticipation of litigation. The court found that regardless of whether the IRS examined the return, the Peskys would still have been required to attach the appraisal to the income tax return. Therefore, the appraisal wasn't prepared in anticipation of litigation and wasn't protected under the work-product doctrine.

Treasury Department and IRS extended April 18 filing deadline for Form 8939 — In a news release, IR-2011-33, the Treasury Department and the IRS announced that they had extended the April 18 deadline for filing Form 8939 (Allocation of Increase in Basis for Property Acquired from a Decedent). Executors shouldn't file the form with the final Form 1040 for decedents who died in 2010.

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, enacted in December 2010, reinstated the estate tax for decedents who died in 2010, but allows executors of the estates of such decedents to elect out of paying estate tax and to apply modified carryover basis rules. The executors of the estates of such decedents must file the Form 8939, an informational return used to establish basis for income tax purposes. Originally, the filing deadline for the form was the date of the decedent's final Form 1040 (April 18 for this filing season) or a later date specified in the Treasury regulations.

A final version of the form wasn't available at press time. The Treasury Department and the IRS plan to issue future guidance that will provide a deadline for filing Form 8939. The news release says that there will be a reasonable period of time for preparation and filing between issuance of the guidance and the filing deadline. The IRS will make both the future guidance and new form available on www.IRS.gov.