Long-Term Lessee of Historic Buildings Not Entitled to Deduction for Facade Easement
Lessees cannot claim a conservation easement deduction. That is what a partnership with long-term leases on two historic buildings in Massachusetts found out when it tried to take a $4,457,515 charitable contribution deduction for donation of facade easements. The buildings were owned by a nonprofit development association, Executive Development Corp. that leased them for a term of 61 years to Harbor Lofts. In the case of Harbor Lofts Associates, the Court ruled that because Harbor Lofts did not hold a fee interest in the buildings, it was not entitled to deduction for the easements.
Facts of the Case
Under the terms of the lease, Harbor Lofts took on many of the rights and obligations often associated with property ownership. It was required to pay all insurance and utility costs and was allowed to use the buildings for multi-family residential apartments. Harbor Lofts also was given a first right of refusal to purchase the properties and was entitled to a portion of compensation if the properties were taken by eminent domain. The lease required Harbor Lofts to keep and maintain the buildings at its own expense and allowed it to construct improvements and additions.
Harbor Lofts and the Economic Development Corp. later entered into a preservation restriction agreement with Essex National Heritage Commission, Inc., a Massachusetts nonprofit corporation. The restriction granted a facade easement to the Heritage Commission requiring preservation of the buildings’ exterior. Harbor Lofts and the Economic Development Corp. remained responsible for all repairs and were required to maintain the buildings’ facades in their historic condition, as documented in photographs and written descriptions.
No Fee Simple, No Perpetual Easement
Harbor Lofts claimed that its contribution to Heritage Commission was a perpetual conservation restriction and claimed it had the “benefits and burdens of ownership of the property” and was “the equitable owner of the Property and therefore the owner for tax purposes.” The IRS disallowed the deduction and assessed an accuracy-related penalty, finding that Harbor Lofts only had a personal property interest as a lessee of the buildings.
In denying the deduction to Harbor Lofts, the Tax Court found that Economic Development Corp., not Harbor Lofts, was the fee owner of the two buildings. Thus, Harbor Lofts, having only a leasehold interest for a term of years, was incapable of granting a perpetual restriction on the use of the buildings. All Harbor Lofts was giving up with the facade restriction was contractual rights it held under the terms of its lease. A contract right in a long-term lease is not a qualified real property interest, and the waiver of those contract rights does not give rise to a charitable contribution deduction, the Court concluded.
Conservation easements continue to be the subject of many interesting court cases. The IRS aggressively challenges charitable deductions for easement donations, but many taxpayers push back and win their cases. In the Harbor Lofts case, the problem was that the taxpayer did not have ownership of the underlying properties, and a long-term lease was a sufficient property interest to entitle the partnership to a deduction.
Lucia Nasuti Smeal is an attorney and a tax professor with the School of Accountancy at Georgia State University’s J. Mack Robinson College of Business, and the former editor of Tax Notes Today, published by Tax Analysts. Smeal also worked as a legislative analyst for the Congressional Research Service and is a former member of the U.S. House Periodical Press Corps. She is a frequent speaker on current tax developments.