Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
REFORM BUT PRESERVE THE FEDERAL TAX DEDUCTION FOR CHARITABLE CONTRIBUTIONS
OF HISTORIC FAÇADE EASEMENTS
Federal law encourages historic preservation by allowing property owners to take a tax deduction after donating an easement of an historic building’s façade to an organization that will restrict its alteration or demolition.1 Recently, façade easement deductions have been closely scrutinized by the media, the Service, and Congress.2 The Service has revealed that overvaluation of façade easement contributions is rampant, especially in districts where strict historic preservation laws already prohibit alteration of historic homes’ façades.3 Even if an easement places additional restrictions on changes to a building’s façade, some organizations lack the resources to monitor and enforce the easement terms; others simply allow property owners to make any requested alterations. The Service found these problems so troublesome and pervasive that worthless and overvalued façade easements made its “Dirty Dozen” of 2005.4 The staff of the Congressional Joint Committee on Taxation responded to these concerns in January 2005 with a proposal to eliminate the charitable deduction for contributions of façade easements on personal residences (the “Staff Proposal”).5 The Staff Proposal also recommended tightening the rules for nonresidential properties and providing stricter rules for appraisals.6 Many historic preservation advocates, including the National Trust for Historic Preservation, support congressional efforts to tighten rules to prevent abuse.7 Yet, the Staff Proposal would severely restrict the tax incentives for preservation without addressing the inherent problem of valuation and the untrustworthy preservation organizations that facilitate abuse. The Senate chose not to adopt the Joint Committee Staff Proposal. Instead, in the Tax Relief Act of 2005 (the “Senate Bill”), it provided several alternative reforms.8 Section 314 of the Senate Bill would create stricter eligibility rules for the deduction, require the donee to affirm in writing that it has the resources and commitment to enforce the easement terms, and demand greater substantiation by taxpayers claiming the deduction. The Senate Bill also would impose stricter penalties for overvaluation. Section 320 would make it easier to hold a taxpayer liable for overstating a façade easement’s value and section 505 would stiffen the penalties against appraisers and others who assist taxpayers in understating tax liability. The tax laws, as currently written, include numerous provisions to protect against the problems criticized in the press, but they can be strengthened. Between the two existing legislative proposals, the Senate Bill, rather than the Joint Committee Staff Proposal, should be adopted. The Senate Bill more appropriately balances the important goals of limiting abuse and maintaining incentives to preserve our nation’s most precious historic properties. Part I of this paper provides a general background on historic façade easements and reviews how charitable contributions of these easements are treated under current federal tax law. Part II argues that federal tax incentives are an important tool for historic preservation. Tax benefits not only encourage protection of properties in areas with very permissive historic preservation laws, but also reduce the burden on property owners by spreading the cost of historic preservation across society. Part III outlines the changes proposed by the Joint Committee staff and the Senate. It critiques the Staff Proposal as unresponsive to the challenges of accurate valuation and easement enforcement and also unduly restrictive on federal involvement in historic preservation. Part III then explains why the Senate’s proposed changes better respond to these challenges and, thus, recommends that the Senate Bill pass into law. Part IV proposes two additional ways for the Service to improve valuation: audit more of the tax returns that claim the deduction, and expand its Art Appraisal Services division and Art Advisory Panel to cover historic façade easements.