                              T.C. Memo. 2014-159



                        UNITED STATES TAX COURT



       LEROY S. SCHMIDT AND CONNIE M. SCHMIDT, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 1743-12.                          Filed August 6, 2014.



      Larry D. Harvey and Julia R. Prendergast, for petitioners.

      Nancy C. Carver, Miles B. Fuller, and Matthew K. Henderson, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      MARVEL, Judge: Respondent determined deficiencies in petitioners’

Federal income tax of $113,893, $93,581, $144,727, and $149,030 for 2003, 2004,

2005, and 2006, respectively. In the answer respondent asserted that petitioners
                                        -2-

[*2] are liable for accuracy-related penalties under section 6662(a) and (b)(2) and

(3)1 of $22,779, $18,716, $28,945, and $29,806 for 2003, 2004, 2005, and 2006,

respectively. After concessions,2 the issues for decision are: (1) whether

petitioners overstated the value of Leroy S. Schmidt’s conservation easement

donation; and (2) whether petitioners are liable for accuracy-related penalties

under section 6662(a) and (b)(2) and (3) for substantially misstating the value of

Mr. Schmidt’s conservation easement donation or for substantially understating

their Federal income tax liabilities for 2003, 2004, 2005, and 2006, respectively.

                               FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. The stipulations of

facts are incorporated herein by this reference. Petitioners resided in Colorado

when they petitioned this Court.




      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) as amended and in effect for the years at issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure. Some monetary
amounts have been rounded to the nearest dollar.
      2
        Petitioners concede that the period of limitations on assessment for 2003-
06 had not expired before respondent issued the notice of deficiency. Respondent
concedes that Mr. Schmidt’s conservation easement donation met the requirements
of sec. 170 and that the easement was worth at least $480,000.
                                            -3-

[*3] I.         Mr. Schmidt’s Business Background

          Mr. Schmidt graduated from the University of Oregon in 1971. Mr.

Schmidt gained experience in restaurant management, and in 1987 he became a

McDonald’s restaurant franchisee. By June 2000 Mr. Schmidt owned two

McDonald’s franchises and was in the process of buying a third.

          Mr. Schmidt also entertained the notion of becoming a builder, and while

still living in Oregon, he built eight homes in partnership with other builders.

However, he never developed a subdivision from raw land.

II.       The Subject Property

          On May 5, 2000, Mr. Schmidt purchased an approximately 40-acre parcel of

vacant land in northern El Paso County, Colorado, for $525,000 (subject property)

with the intention of subdividing and developing it. The subject property is in

northern El Paso County, west of Interstate 25 and the Town of Monument,

Colorado, and south of the Town of Palmer Lake, Colorado. As of May 5, 2000,

the subject property was raw land with no development entitlements.

          The subject property is near Pike National Forest,3 and it is at the base of

Raspberry Mountain. It is relatively flat, and it has views of rock outcroppings

          3
       The subject property is separated from Pike National Forest by another
parcel. However, an easement on that parcel provides direct access to Pike
National Forest.
                                            -4-

[*4] and mountains. Several locations on the subject property have excellent

views of the Monument area.

III.   Proposed Raspberry Ridge Subdivision

       On June 7, 2000, Mr. Schmidt retained the services of David F. Jones and

Land Resource Associates (LRA) to provide land planning and consulting services

with respect to the development of the subject property. Mr. Jones informed Mr.

Schmidt of the possibility of developing the subject property in conjunction with a

68.8-acre adjoining parcel (adjacent property) along the southern edge of the

subject property.4 Both the subject property and the adjacent property were under

the jurisdiction of El Paso County and zoned RR-3. Under El Paso County’s Land

Development Code (Development Code) as in effect at that time, RR-3 zoning

permitted a density of one lot per five acres. The subject property and the adjacent

property were also subject to the 2000 Tri-Lakes Comprehensive Plan.

       When Mr. Jones informed Mr. Schmidt of the possibility of developing the

subject property in conjunction with the adjacent property, King’s Deer

Development, LLC (King’s Deer Development), was in the process of purchasing

the adjacent property from Red Rock Ranch, Inc. (Red Rock Ranch), and intended

to develop it. On a date that is unclear from the record Mr. Schmidt agreed to

       4
           The adjacent property is also referred to as the Nevins parcel.
                                        -5-

[*5] pursue the development of the subject property along with the adjacent

property as a 108.8-acre residential subdivision with King’s Deer Development

(Raspberry Ridge subdivision).

      Mr. Jones began the entitlement process for both landowners. He obtained a

preliminary ground water investigation report from Wm. Curtis Wells & Co., and

he hired other professionals to prepare reports for the entitlement applications. On

December 12, 2000, Mr. Jones met with El Paso County’s planning department for

a preapplication meeting regarding the proposed Raspberry Ridge subdivision and

filed a preapplication form.

      On February 27, 2001, LRA submitted an application for underground water

rights and plan for augmentation to the State of Colorado Water Court (Colorado

Water Court). The Colorado Water Court approved the application on February

20, 2002.

      On March 23, 2001, Mr. Jones sent to the landowners of properties

adjoining the proposed Raspberry Ridge subdivision a “Notification to Adjoining

Land Owner”, notifying them of the proposed project. On March 26, 2001, LRA

submitted to El Paso County a petition for rezoning of the subject property and the
                                         -6-

[*6] adjacent property and a preliminary plan application with respect to the

Raspberry Ridge subdivision.5

      On April 16, 2001, Elizabeth Hacker of the El Paso County planning

department sent an email to Mike Hrebenar of the El Paso County planning

department providing initial feedback with respect to the Raspberry Ridge

subdivision. In the email Ms. Hacker stated that “[t]he proposed 2.5 acre

subdivision is consistent with the type of subdivisions in” the area.

      During the fall of 2001 El Paso County Development Services and the State

geologist identified seven lots within the proposed Raspberry Ridge subdivision

that required further study because of various topographical and geological issues.

Only one of the seven lots was within the subject property, and LRA prepared

further studies to illustrate the potential development of that site.

      By a fax dated November 2, 2001, Mr. Jones sent to Mr. Schmidt a cost

estimate for the proposed Raspberry Ridge subdivision. In the cover letter Mr.

Jones wrote:

            Attached are the preliminary development cost estimates for
      your portion of the Raspberry Ridge subdivision. Where costs are
      shared of the King’s Deer group, I have assigned 40% to you and
      60% to King’s Deer based upon each owner[’]s lot numbers. Other

      5
       The petition and application requested that the property be rezoned to
permit a density of one lot per each 2-1/2 acres.
                                         -7-

       [*7] costs such as roads, drainage and utilities are based upon
       construction units associated with the development of your specific
       40 acres. In addition, I have included one half of the costs involved
       in extending Red Rock Ranch Road through the Nevins’ parcel to
       your parcel.

              To look at profit potentials, I have utilized a $250,000 average
       lot sales price. Given the current market, this may or may not be a
       realistic number and will probably depend more upon how quickly
       you want to sell your lots.

In the attached cost estimate Mr. Jones estimated development costs of $42,437

per lot.

       At some point during 2002 King’s Deer Development canceled its purchase

contract with Red Rock Ranch and abandoned the proposed Raspberry Ridge

subdivision. Mr. Schmidt subsequently considered developing the Raspberry

Ridge subdivision with a different codeveloper. One of the potential codevelopers

offered to reimburse Mr. Schmidt for his acquisition costs and to give to him a lot

of his choice in the finished project. Mr. Schmidt chose not to develop the

Raspberry Ridge subdivision with any codeveloper.

IV.    Purchase Agreement To Acquire the Adjacent Property

       On April 30, 2003, after an inquiry by Mr. Schmidt, LRA mailed a letter to

him regarding the likelihood of obtaining El Paso County’s approval of the

development applications. In the letter LRA explained that the El Paso County
                                         -8-

[*8] Planning Department concluded in its review of the Raspberry Ridge

subdivision that the zoning change request conformed with the 2000 Tri-lakes

Comprehensive Plan. The letter further explained that relevant agencies had

already signed off on the various studies, plans, and reports submitted by LRA

with respect to the suitability of the subject property for rezoning.

      On May 9, 2003, Mr. Schmidt and Red Rock Ranch executed a purchase

agreement for the sale of the adjacent property to Mr. Schmidt for $1.25 million.

On May 27, 2003, Mr. Schmidt obtained land title insurance on the adjacent

property. On August 5, 2003, Mr. Schmidt terminated the purchase agreement

with Red Rock Ranch.

      When Mr. Schmidt terminated the purchase agreement the zone change and

preliminary plan applications were ready to be forwarded to the El Paso County

Planning Commission and the El Paso County Board of County Commissioners

for public hearing. It is highly probable that the El Paso County Development

Services Department would have endorsed both applications, and approval would

have vested the subdivision’s development entitlements. Following approval, the

proposed subdivision would have entered the final plat phase, in which several

local entities would review the previously approved zoning and preliminary plan

entitlements.
                                       -9-

[*9] Because he was listed on the zone change and preliminary plan applications,

Mr. Schmidt could have severed the subject property from the adjacent property

and pursued rezoning and a preliminary plan for the subject property alone under

the existing applications. However, because the pending applications were

nontransferable, a new owner would have had to submit new applications.

V.    Conservation Easement

      At some point during the development process for the proposed Raspberry

Ridge subdivision, Mr. Schmidt considered granting a conservation easement on

the subject property. Mr. Schmidt engaged the services of W.D. Park of Park &

Associates to value the proposed easement.

      In a preliminary development cost analysis dated May 12, 2003 (May 12,

2003, cost estimate), LRA estimated the following development costs and

development costs per lot for the proposed Raspberry Ridge subdivision:

                                     Nevins        Schmidt       Combined
               Costs               (19.5 lots)    (13.5 lots)     (33 lots)

     Development costs             $862,045        $353,339     $1,215,383
     Development costs per lot       44,207          26,173         36,830

The May 12, 2003, cost estimate refers to the Nevins units as “phase 1” and the

Schmidt units as “phase 2” and assumes for other purposes that the Nevins units
                                       - 10 -

[*10] would sell for $225,000 per lot and that the Schmidt units would sell for

$300,000 per lot.6

      On or about May 14, 2003, Mr. Park met with Mr. Schmidt and Mr. Jones to

discuss the valuation of the easement.7 By a fax dated May 29, 2003, Mr. Jones

followed up on the May 14, 2003, meeting by providing to Mr. Park development

cost information from other projects he had worked on.

      On May 30, 2003, Michael G. Figgs, a natural resources planner and the

president of LREP, Inc., inspected the subject property for the purpose of

preparing a baseline report for the proposed conservation easement. In July 2003

Mr. Figgs prepared the baseline report.

      In a letter dated June 10, 2003, Mr. Park notified Mr. Schmidt that his firm

had concluded that the value of the proposed conservation easement would be $1.6

million. Mr. Park stated that, in reaching this conclusion, his firm estimated that

the before value of the subject property was $2 million and the after value was

$400,000. Mr. Park subsequently provided to Mr. Schmidt an appraisal of the


      6
       At trial Mr. Jones testified that the terms “phase 1” and “phase 2” were not
meant to signify that the subdivision would be developed in phases.
      7
       Respondent introduced three pages of Mr. Park’s handwritten notes, at least
one of which was from the May 14, 2003, meeting. An undated page of these
notes anticipates finished lot selling prices of approximately $175,000 per lot and
an easement value of approximately $672,500.
                                      - 11 -

[*11] proposed conservation easement with a valuation date of July 25, 2003

(2003 appraisal), in which he reached the same conclusions as he previously

reached in the June 10, 2003, letter. Mr. Park used a discounted cashflow analysis

to determine a before value for the subject property. He relied on the May 12,

2003, cost estimate for the development cost input in his discounted cashflow

analysis.

      On July 3, 2003, Mr. Schmidt entered into a due diligence agreement with

respect to the proposed conservation easement with El Paso County’s board of

commissioners. Concurrently, El Paso County passed a resolution approving and

accepting the due diligence agreement and the form of the proposed conservation

easement. During July 2003 petitioners began construction of their personal

residence on the subject property. On August 1, 2003, Mr. Schmidt executed an

easement deed, granting a conservation easement on the subject property to El

Paso County. The conservation easement permitted one homesite on the subject

property.

VI.   Red Rock Reserve Project

      On or about August 29, 2003, Red Rock Ranch entered into a contract to

sell the adjacent property to an unrelated developer, Raspberry Ridge

Development, RLLP, a Colorado registered limited liability limited partnership
                                       - 12 -

[*12] (Raspberry Ridge Development), for $1.25 million. On November 13, 2003,

Raspberry Ridge Development purchased the adjacent property for $1.25 million.

      Raspberry Ridge Development did not purchase the pending rezoning and

preliminary plan applications submitted by LRA with respect to the Raspberry

Ridge subdivision. Instead, it submitted new applications for a residential

subdivision called the Red Rock Reserve project. During 2005 El Paso County

approved the rezoning of the adjacent property. Approval of the final plat for the

Red Rock Reserve project was delayed by the presence of the Preble’s meadow

jumping mouse8 on the adjacent property. In early 2006 El Paso County approved

the final plat for the Red Rock Reserve project.

      8
        The Preble’s meadow jumping mouse is currently listed by the U.S. Fish
and Wildlife Service as a threatened species. See U.S. Fish and Wildlife Service,
Endangered Species, Mountain-Prairie Region, Preble’s Meadow Jumping Mouse,
http://www.fws.gov/mountain-prairie/species/mammals/preble/ (last visited July 8,
2014). It

      is a small mammal approximately 9-inches in length with large hind
      feet adapted for jumping, a long bicolor tail (which accounts for 60%
      of its length), and a distinct dark stripe down the middle of its back,
      bordered on either side by gray to orange-brown fur. This largely
      nocturnal mouse lives primarily in heavily vegetated, shrub
      dominated riparian (streamside) habitats and immediately adjacent
      upland habitats along the foothills of southeastern Wyoming south to
      Colorado Springs along the eastern edge of the Front Range of
      Colorado. * * *

Id.
                                       - 13 -

[*13] VII.   Petitioners’ Reporting Position

      Petitioners timely filed Forms 1040, U.S. Individual Income Tax Return

(returns), for 2003, 2004, 2005, and 2006. Petitioners claimed a charitable

contribution deduction of $1.6 million on a Form 8283, Noncash Charitable

Contributions, attached to their 2003 return. The entire $1.6 million deduction

related to the conservation easement that Mr. Schmidt granted to El Paso County

on the subject property. Because of limitations petitioners claimed only $325,407

of the contribution on a Schedule A, Itemized Deductions, attached to their 2003

return. Petitioners carried over the remainder of the charitable contribution

deduction and claimed portions of it on their 2004, 2005, and 2006 returns.

VIII. Notice of Deficiency

      On November 28, 2011, respondent issued to petitioners a notice of

deficiency with respect to petitioners’ 2003, 2004, 2005, and 2006 tax years. In

the notice of deficiency respondent determined that petitioners failed to meet the

requirements of section 170 in claiming a charitable contribution deduction for the

conservation easement on the subject property. Alternatively, respondent

determined that the correct value of the conservation easement was $195,000.
                                        - 14 -

[*14] IX.    Petitioners’ Experts

      A.     Mr. Park

      Petitioners introduced the expert report and testimony of Mr. Park with

respect to the value of the conservation easement on the subject property. Mr.

Park is a real estate appraiser who has practiced for over 37 years. He is certified

as an appraiser by the State of Colorado, and he is a member of the Appraisal

Institute and holds its MAI and SRA designations. He is a certified Appraisal

Institute instructor and has taught classes for the Appraisal Institute on basic and

intermediate appraisal and on the appraisal of conservation easements. He is also

a certified Uniform Standards of Professional Appraisal Practice instructor.

      Mr. Park appraises real estate throughout Colorado. His practice includes

residential and commercial appraisal, eminent domain, valuing tracts of vacant

land for residential development purposes, and appraisal of conservation

easements.

      Mr. Park’s report is substantially derived from his 2003 appraisal. Mr. Park

used the before and after method to determine the value of the conservation

easement. He determined that the highest and best use of the subject property

before the granting of the conservation easement was a residential subdivision,

and he used the subdivision development method to determine the before value of
                                       - 15 -

[*15] the subject property. He also used a method entitled “Direct Sales Analysis”

to determine the before value of the subject property. Mr. Park opined that the

before value of the subject property was $2 million.

      Mr. Park determined that the highest and best use of the subject property

after the granting of the conservation easement was a 40-acre homesite, and he

used the market method to determine an after value for the subject property. Mr.

Park opined that the after value of the subject property was $400,000, and he

therefore opined that the value of the conservation easement was $1.6 million.

      B.     Mr. Jones

      Petitioners introduced the expert report and testimony of Mr. Jones with

respect to the possible subdivision of the subject property and the costs associated

with such development. Mr. Jones is a professional land planner, landscape

architect, and development manager. He has provided development, design,

construction, and management services in El Paso County for over 41 years. Mr.

Jones holds a bachelor’s degree in landscape architecture from Kent State

University College of Architecture and Environmental Design.

      Mr. Jones opined that, if Mr. Schmidt had moved forward with the

Raspberry Ridge subdivision applications the subject and adjacent properties

would have obtained an RR-2 zoning and preliminary plan approval. Mr. Jones
                                       - 16 -

[*16] further opined that the preliminary development cost estimates in the May

12, 2003, cost estimate were accurate and complete.

X.    Respondent’s Expert--Mr. Fellows

      Respondent introduced the expert report and testimony of Thomas Fellows

with respect to the value of the conservation easement on the subject property.

Mr. Fellows is a real estate appraiser who has practiced for over 40 years. He is

certified as an appraiser by the State of Colorado, and he is a member of the

Appraisal Institute and holds its MAI designation. He is experienced in appraising

conservation easements.

      Mr. Fellows used the before and after method to determine the value of the

conservation easement. He determined that the highest and best use of the subject

property before the granting of the conservation easement was a residential

subdivision developed in conjunction with the adjacent property. He used both

the market and subdivision development methods to determine a before value for

the subject property. Mr. Fellows opined that the subject property had a before

value of $750,000.

      Mr. Fellows determined that the highest and best use of the subject property

after the granting of the conservation easement was a 40-acre homesite. He used

the market method to determine an after value for the subject property. He opined
                                         - 17 -

[*17] that the after value of the subject property was $270,000, and he therefore

opined that the value of the conservation easement was $480,000.

      At trial petitioners introduced a supplemental report prepared and submitted

to the Court by respondent’s expert, Mr. Fellows.9 In his supplemental report Mr.

Fellows acknowledges that his original report erroneously stated that new zoning

and preliminary plan applications would have been required to develop the lots on

the subject and adjacent properties in 2003. He explained that he was misled by

an employee of El Paso County Development Services. However, despite

acknowledging this error and that a shorter holding period could result in an

increased value when factored into his discounted cashflow models, Mr. Fellows

concluded that his original report correctly determined the before value of the

subject property.

XI.   Posttrial Stipulations

      After a trial the parties submitted a joint report in which they stipulated

certain areas of agreement and disagreement with respect to the value of the

conservation easement at issue in this case.




      9
          Respondent did not offer the supplemental report into evidence.
                                        - 18 -

[*18]                    ULTIMATE FINDINGS OF FACT

        Before Mr. Schmidt granted the conservation easement the subject property

could have been developed as a 13-lot subdivision either separately or in

conjunction with the development and subdivision of the adjacent property. The

mean lot selling price for the finished lots on the subject property would have been

$220,000 and would have appreciated at a rate of 6% per annum. A prospective

buyer could have developed the subject property and begun selling lots within 12

months from the easement grant date. It is likely that all 13 lots on the subject

property would have sold within two years of being offered for sale. Development

costs for a hypothetical subdivision of the subject property would have been

$580,416. Marketing/administrative costs for a hypothetical subdivision of the

subject property would have been 10% of gross sales. The appropriate discount

rate is 22%.

        The before value of the subject property is $1,422,445. The after value of

the subject property is $270,000. Accordingly, the value of the conservation

easement is $1,152,445.
                                         - 19 -

[*19]                                 OPINION

I.      Burden of Proof

        Generally, the taxpayer bears the burden of proving that he is entitled to any

claimed deduction. See Rule 142(a)(1); INDOPCO, Inc. v. Commissioner, 503

U.S. 79, 84 (1992). However, if a taxpayer produces credible evidence10 with

respect to any factual issue relevant to ascertaining the taxpayer’s tax liability for

any tax imposed by subtitle A or B of the Code and satisfies the requirements of

section 7491(a)(2), the burden of proof on any such issue shifts to the

Commissioner. Sec. 7491(a)(1). Section 7491(a)(2) requires a taxpayer to

demonstrate that he or she (1) complied with requirements under the Code to

substantiate any item, (2) maintained all records required under the Code, and (3)

cooperated with reasonable requests by the Secretary11 for witnesses, information,

documents, meetings, and interviews. See Higbee v. Commissioner, 116 T.C. 438,

440-441 (2001). The taxpayer bears the burden of proving that all of the


        10
        “‘Credible evidence is the quality of evidence which, after critical
analysis, the court would find sufficient upon which to base a decision on the issue
if no contrary evidence were submitted (without regard to the judicial presumption
of IRS correctness).’” Higbee v. Commissioner, 116 T.C. 438, 442 (2001)
(quoting H.R. Conf. Rept. No. 105-599, at 240-241 (1998), 1998-3 C.B. 747,
994-995).
        11
       The term “Secretary” means the Secretary of the Treasury or his delegate.
Sec. 7701(a)(11)(B).
                                        - 20 -

[*20] requirements of section 7491(a) have been satisfied. See Rolfs v.

Commissioner, 135 T.C. 471, 483 (2010), aff’d, 668 F.3d 888 (7th Cir. 2012).

      Petitioners contend that the burden of proof should shift to respondent

pursuant to section 7491(a) because they introduced credible evidence and

cooperated with respondent. Respondent contends that petitioners have not

satisfied the requirements of section 7491(a)(1) and (2).

      Petitioners point to stipulated exhibits that show that they voluntarily agreed

to extend the period of limitations for four years during the audit and to the fact

that respondent has not filed a motion to compel discovery in this case. Both of

these points, however, fail to carry petitioners’ burden of showing that they

cooperated with respondent. To meet their burden petitioners were required to

produce evidence showing that they “cooperated with reasonable requests by the

Secretary for witnesses, information, documents, meetings, and interviews”. Sec.

7491(a)(2)(B). The limited evidence that petitioners introduced regarding their

conduct during the examination falls short of demonstrating that they cooperated

with respondent’s reasonable requests during the examination. Accordingly, the

burden of proof remains with petitioners with respect to the deficiencies at issue in

this case.
                                         - 21 -

[*21] II.    Conservation Easements Generally

      Section 170(a)(1) provides that a deduction is allowed for any charitable

contribution that is paid within the taxable year. “The sine qua non of a charitable

contribution is a transfer of money or property without adequate consideration.”

United States v. Am. Bar Endowment, 477 U.S. 105, 118 (1986). If a taxpayer

makes a charitable contribution of property other than money, in general, the

amount of the contribution is equal to the fair market value of the property at the

time of the contribution. See sec. 1.170A-1(c)(1), Income Tax Regs.

      Generally, a taxpayer may not deduct the value of a contribution of property

that consists of less than the taxpayer’s entire interest in that property. See sec.

170(f)(3). However, a taxpayer is allowed a charitable contribution deduction for

a qualified conservation contribution. See sec. 170(f)(3)(B)(iii). “A qualified

conservation contribution is the contribution of a qualified real property interest to

a qualified organization exclusively for conservation purposes.” Sec.

1.170A-14(a), Income Tax Regs. “A perpetual conservation restriction is a

qualified real property interest”, sec. 1.170A-14(b)(2), Income Tax Regs., that is

defined as “a restriction granted in perpetuity on the use which may be made of

real property--including, an easement or other interest in real property that under
                                        - 22 -

[*22] [S]tate law has attributes similar to an easement (e.g., a restrictive covenant

or equitable servitude)”12, id.

      Section 1.170A-14(h)(3)(i), Income Tax Regs., states in relevant part:

      The value of the contribution under section 170 in the case of a
      charitable contribution of a perpetual conservation restriction is the
      fair market value of the perpetual conservation restriction at the time
      of the contribution. See § 1.170A-7(c). If there is a substantial
      record of sales of easements comparable to the donated easement
      (such as purchases pursuant to a governmental program), the fair
      market value of the donated easement is based on the sales prices of
      such comparable easements. If no substantial record of market-place
      sales is available to use as a meaningful or valid comparison, as a
      general rule (but not necessarily in all cases) the fair market value of
      a perpetual conservation restriction is equal to the difference between
      the fair market value of the property it encumbers before the granting
      of the restriction and the fair market value of the encumbered
      property after the granting of the restriction. * * *

See generally Hilborn v. Commissioner, 85 T.C. 677, 688-689 (1985). Because a

market for the purchase and sale of conservation easements rarely exists, see

Symington v. Commissioner, 87 T.C. 892, 895 (1986), a conservation easement’s

value is ordinarily determined by measuring the diminution in value of the

affected property resulting from the creation of the easement (before and after

method), see sec. 1.170A-14(h)(3)(i) and (ii), Income Tax Regs.

      12
         “For purposes of this section, the terms ‘easement’, ‘conservation
restriction’, and ‘perpetual conservation restriction’ have the same meaning.” Sec.
1.170A-14(b)(2), Income Tax Regs. We will use the term “conservation
easement” to describe that common meaning.
                                       - 23 -

[*23] Generally, the fair market value of property is determined by taking into

account the highest and best use of that property on the relevant valuation date.

See, e.g., Stanley Works & Subs. v. Commissioner, 87 T.C. 389, 400 (1986); sec.

1.170A-1(c)(2), Income Tax Regs. With respect to the valuation of conservation

easements using the before and after method, the regulations further provide that

      the fair market value of the property before contribution of the
      conservation restriction must take into account not only the current
      use of the property but also an objective assessment of how
      immediate or remote the likelihood is that the property, absent the
      restriction, would in fact be developed, as well as any effect from
      zoning, conservation, or historic preservation laws that already
      restrict the property’s potential highest and best use. * * *

Sec. 1.170A-14(h)(3)(ii), Income Tax Regs.

      A determination of fair market value is largely a factual inquiry in which the

trier of fact must weigh all relevant evidence of value and draw appropriate

inferences. See Commissioner v. Scottish Am. Inv. Co., 323 U.S. 119, 123-125

(1944); Helvering v. Nat’l Grocery Co., 304 U.S. 282, 294 (1938); Symington v.

Commissioner, 87 T.C. at 896. Three methods are generally employed to measure

the fair market value of property: (1) the market method, (2) the income method,

and (3) the replacement cost method. The question of which method to apply in a

particular case is a question of law. See Chapman Glen Ltd. v. Commissioner, 140

T.C. 294, 325-326 (2013).
                                       - 24 -

[*24] The market method values a property by comparing the property to similar

properties sold in arm’s-length transactions in or about the same period. See

Estate of Spruill v. Commissioner, 88 T.C. 1197, 1229 n.24 (1987); Wolfsen Land

& Cattle Co. v. Commissioner, 72 T.C. 1, 19 (1979). The prices of comparable

properties are adjusted to create parity between those properties and the property

being valued for comparative purposes. The reliability of the market method

depends upon the comparability of the property selected and the reasonableness of

the adjustments made to establish comparability. See Wolfsen Land & Cattle Co.

v. Commissioner, 72 T.C. at 19-20.

      The income method values a property by capitalizing or discounting

expected cashflow from the property. Property value is determined under this

method by adding the sum of the present value of the expected cashflow and the

present value of the residual value of the property. See Crimi v. Commissioner,

T.C. Memo. 2013-51, at *64. The subdivision development method is a variation

of the income method previously recognized by this Court. See, e.g., Consol.

Investors Grp. v. Commissioner, T.C. Memo. 2009-290, 98 T.C.M. (CCH) 601,

610 (2009); Glick v. Commissioner, T.C. Memo. 1997-65, 73 T.C.M. (CCH)

1925, 1929 (1997). The subdivision development method values undeveloped
                                         - 25 -

[*25] land by treating the property as if it were subdivided, developed, and sold.13

See Consol. Investors Grp. v. Commissioner, 98 T.C.M. (CCH) at 610 (citing

Glick v. Commissioner, T.C. Memo. 1997-65).

       The replacement cost method values a property by determining the cost to

reproduce it less applicable depreciation or amortization. See Chapman Glen Ltd.

v. Commissioner, 140 T.C. at 327. The parties agree that the replacement cost

method is not a reliable method for determining the fair market value of the

subject property.

III.   Expert Reports Generally

       An expert’s opinion is admissible if it assists the trier of fact to understand

the evidence or to determine a fact in issue. Fed. R. Evid. 702. We evaluate

expert opinions in light of each expert’s qualifications and the evidence in the

       13
         The subdivision development method consists of six primary steps. See
Crimi v. Commissioner, T.C. Memo. 2013-51, at *64 n.28 (citing Appraisal
Institute, The Appraisal of Real Estate 370-376 (13th ed. 2008)). First, the
property’s highest and best use is determined. Second, the market method is used
to identify comparable finished (developed) lots and a per-lot value is derived.
Third, anticipated gross proceeds from the sale of the developed lots are calculated
by multiplying the per-lot value by the total number of estimated finished lots.
Fourth, expected net proceeds are calculated by reducing the expected gross
proceeds by direct and indirect costs and entrepreneurial profit. Fifth, net sales
proceeds are discounted to present value at a market-derived rate over the
development and market absorption period. Sixth, appropriate discounts for lack
of marketability, partition, and market absorption are applied where appropriate.
The resulting figure equals the indicated value of the undeveloped land.
                                        - 26 -

[*26] record. See Parker v. Commissioner, 86 T.C. 547, 561 (1986). Where

experts offer competing estimates of fair market value, we decide how to weigh

those estimates by, inter alia, examining the factors they considered in reaching

their conclusions. See Casey v. Commissioner, 38 T.C. 357, 381 (1962). We are

not bound by an expert’s opinion and may accept or reject an expert opinion in full

or in part in the exercise of sound judgment. See Helvering v. Nat’l Grocery Co.,

304 U.S. at 295; Parker v. Commissioner, 86 T.C. at 561-562. We may also reach

a decision as to value based on our own examination of the evidence in the record.

See Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), aff’g T.C.

Memo. 1974-285.

      Before we turn to the valuation of the conservation easement at issue, we

first address two preliminary issues that the parties raised on brief.

IV.   Mr. Park’s Credibility

      Respondent argues that we should discount Mr. Park’s report because of

various misrepresentations in his report and his testimony at trial. First,

respondent criticizes Mr. Park for assuming in his report that “[t]he development

had been approved for final platting” whereas the record shows that the

development applications were still pending. Second, respondent criticizes Mr.

Park for significantly increasing his valuation of the conservation easement in his
                                       - 27 -

[*27] valuation report from the initial estimate he made in his handwritten notes.

Third, respondent criticizes Mr. Park for stating that no one provided him any

assistance in preparing his report even though he copied an introductory portion of

his report from an amicus brief in another case that petitioners’ counsel provided

to him.

      We do not agree with respondent that Mr. Park’s report should be

significantly discounted for these reasons. First, although Mr. Park appears to

have misstated or misunderstood the status of the pending development

applications, this error does not seem to have significantly affected his conclusion

regarding the before value of the subject property because his discounted cashflow

analysis assumes that none of the finished lots would be sold during the first year.

Second, it is unclear when the handwritten notes were prepared and for what

purpose.14 It is possible that Mr. Park prepared these handwritten notes before he

began his research into the before value of the subject property. Third, we

understand Mr. Park’s testimony that he received no assistance in preparing the

report to refer to the technical aspects of the report. Respondent has not shown




      14
       The discounted cashflow analysis is on ruled paper whereas the page dated
May 14, 2003, is on plain paper. We infer from this that the various handwritten
notes may not have been prepared at the same time.
                                        - 28 -

[*28] that Mr. Park’s report is not his own; indeed, it is substantially the same as

his 2003 appraisal.

      That said, we are mindful of the “cottage industry of experts who function

primarily in the market for tax benefits”. Boltar, L.L.C. v. Commissioner, 136

T.C. 326, 335 (2011). Accordingly, the credibility of both parties’ experts largely

depends on the extent to which their reports are supported by relevant and reliable

data and reflect sound and objective reasoning.

V.    Mr. Schmidt’s Opinion Testimony

      At trial Mr. Schmidt testified that he agreed with Mr. Park’s 2003 appraisal

and disagreed with Mr. Fellows’ report. Petitioners contend that Mr. Schmidt’s

testimony should be given significant weight.

      Under rule 702 of the Federal Rules of Evidence a landowner is competent

to offer opinion testimony with respect to the value of his or her property. See

Fed. R. Evid. 702 Advisory Committee Note (“[W]ithin the scope of the rule are

not only experts in the strictest sense of the word * * * but also the large group

sometimes called ‘skilled’ witnesses, such as bankers or landowners testifying to

land values.”); LaCombe v. A-T-O, Inc., 679 F.2d 431, 434 n.4 (5th Cir. 1982);

Estate of Dunia v. Commissioner, T.C. Memo. 2004-123, 87 T.C.M. (CCH) 1353,

1355 (2004). Although petitioners failed to list Mr. Schmidt in their pretrial
                                       - 29 -

[*29] memorandum as an expert witness and he did not submit an expert report as

required under Rule 143(g), see Estate of McCampbell v. Commissioner, T.C.

Memo. 1991-141, 61 T.C.M. (CCH) 2263, 2270 (1991), respondent did not object

to Mr. Schmidt’s testimony and we allowed his opinion testimony.

      In agreeing with Mr. Park’s 2003 appraisal Mr. Schmidt offered no

independent analysis other than to agree to the comparables that Mr. Park used in

his 2003 appraisal. Mr. Schmidt also criticized the comparables that Mr. Fellows

used in his report. Because Mr. Schmidt’s opinion as to the value of the

conservation easement is based on and is supported only by Mr. Park’s 2003

appraisal, we give it weight only to the extent that we find Mr. Park’s report--

which is substantially the same as his 2003 appraisal--to be reliable. See Sanborn

v. Commissioner, T.C. Memo. 1983-579, 46 T.C.M. (CCH) 1435, 1147 (1983)

(citing Kestenbaum v. Falstaff Brewing Corp., 514 F.2d 690, 699 (5th Cir. 1975)).

However, to the extent that Mr. Schmidt explained why he disagreed with the

comparables that Mr. Fellows selected, we give Mr. Schmidt’s testimony

appropriate weight.

      We turn now to the valuation of the conservation easement at issue. We do

so using the before and after method. See sec. 1.170A-14(h)(3)(i) and (ii), Income

Tax Regs.
                                        - 30 -

[*30] VI.    Before Value of the Subject Property

      With respect to the before value of the subject property, the parties agree

that both the market and subdivision development methods are appropriate, but the

parties disagree with respect to which one of these methods is more appropriate in

this case.

      A.     Market Method

      The parties disagree about the use of the market method for determining a

before value for the subject property. Petitioners contend there is insufficient data

available to use the market method. Respondent disagrees.

      Mr. Park did not use the market method to determine a before value for the

subject property because he could not find adequate sales of comparable

properties.15 By contrast, Mr. Fellows used the market method to determine a

before value for the subject property. In his rebuttal report Mr. Park explained that

he rejected the comparables that Mr. Fellows used because he thought that they

lacked the development entitlements that Mr. Schmidt had secured for the subject

property.

      15
        Mr. Park prepared an alternative analysis that he called a “direct sales
analysis”. This analysis purports to measure the difference in value between
comparable properties before and after they obtain entitlements. We do not find
this analysis to be relevant or helpful because the subject property had not yet
obtained development entitlements by the conservation easement grant date.
                                        - 31 -

[*31] Mr. Fellows identified four sales of raw land that he determined to be

comparable to a hypothetical sale of the subject property before the granting of the

conservation easement. Those sales are: (1) the prior sale of the subject property

to Mr. Schmidt in May 2000; (2) the sale of the adjacent property to Raspberry

Ridge Development in November 2003; (3) the sale of a property in the South

Black Forest area, east of Interstate 25, in May 2001; and (4) a second sale of a

property in the South Black Forest area in April 2004. Mr. Fellows adjusted the

first and third property sales to account for market conditions using a factor of 5%

per annum. The approximate dates, selling prices, areas in acres, prices per acre,

and adjusted prices per acre of the sales are as follows:

                                                            Price per     Adjusted
       Property         Date    Selling price    Acres        acre      price per acre

  Subject property       5/00      $525,000      40.00      $13,125        $15,094
  Adjacent property     11/03      1,250,000     67.90       18,409         18,409
  Black Forest 1         5/01        805,000     81.80        9,841         10,825
  Black Forest 2         4/04        560,000     44.35       12,627         12,627

      After comparing the physical characteristics of the comparable sale

properties Mr. Fellows concluded that the prior sale of the subject property and the

subsequent sale of the adjacent property were most relevant in determining a

before value for the subject property. Consequently, Mr. Fellows concluded that
                                        - 32 -

[*32] the subject property had a before value of $18,000 to $19,000 per acre and

that it therefore had an estimated before value of $700,000 to $800,000.

      Respondent contends that Mr. Park wrongly rejected Mr. Fellows’

comparables because the subject property had no development entitlements when

Mr. Schmidt granted the conservation easement. Respondent notes that

petitioners’ land-use expert, Mr. Jones, stated in his report that the rezoning and

preliminary plan applications for the subject property were “ready to be forwarded

to the El Paso County Planning Commission and the El Paso County Board of

County Commissioners for public hearing.” Respondent further contends that the

fact that the rezoning and preliminary plan applications were still pending and

likely to be granted does not distinguish the subject property from the comparables

that Mr. Fellows selected because the pending applications were nontransferable.

We disagree.

      Even though the pending applications were nontransferable, the record

establishes that the applicants had been able to address all relevant issues that

could have prevented or delayed the granting of development entitlements for the

subject property16 and that the proposed development of the subject property was


      16
       By contrast, development of the adjacent property was delayed by the
presence of the Preble’s meadow jumping mouse.
                                       - 33 -

[*33] consistent with the 2000 Tri-lakes Comprehensive Plan. Moreover, as Mr.

Fellows recognized but did not fully account for, much of the work that LRA had

done was transferable even if the applications themselves were not. Finally, as

petitioners note in their answering brief, Mr. Schmidt could have sold the subject

property subject to his first securing the development entitlements with the

pending applications.

      Respondent contends that all of this is irrelevant because the before and

after method is concerned only with what a hypothetical purchaser would have

paid for the subject property. However, the regulations look to the before and

after method to value conservation easements only where there is no substantial

record of comparable easement sales, see sec. 1.170A-14(h)(3)(i), Income Tax

Regs., and even then, the before and after value method is not always conclusive,

see id. Rather, what the before and after method is trying to measure is the price

that a hypothetical purchaser of a conservation easement would have to pay a

hypothetical seller for the easement. Because a hypothetical seller of a

conservation easement on the subject property would agree to sell the easement

only for an amount that adequately accounted for the value of the development

work that had been accomplished to that date, we find that the comparables

selected by Mr. Fellows are insufficiently comparable to the subject property and
                                          - 34 -

[*34] that the market method is not the appropriate method to use to determine the

before value of the subject property. See, e.g., Estate of Andrews v.

Commissioner, 79 T.C. 938, 956 (1982) (“Certainly, the hypothetical sale should

not be constructed in a vacuum isolated from the actual facts[.]”).

      B.     Subdivision Development Method

      The parties agree that, if the subdivision development method is used, the

following factors are relevant to the preparation of the discounted cashflow

analysis that would be required to determine the before value of the subject

property: (1) the number of lots; (2) the retail lot selling prices; (3) the retail lot

selling price appreciation rate, (4) the time required to obtain entitlements, (5) the

absorption rate of the lots, (6) development costs, (7) marketing/administrative

costs, and (8) the discount rate.

             1.     Number of Lots

      The parties agree that, if the subject property was developed as a stand-

alone, 40-acre subdivision, the subject property would yield thirteen 2.5-acre lots.

The parties further agree that, if the subject property was developed as part of the

originally proposed 108-acre subdivision, the development as a whole would yield

thirty-five 2.5-acre lots, 13 of which would be on the subject property.
                                          - 35 -

[*35]         2.     Retail Lot Selling Prices

        The parties disagree with respect to the ultimate retail lot selling prices for

lots developed on the subject property. Petitioners contend that the retail lots

would sell for $250,000 to $300,000 per lot. Respondent contends that the retail

lots would sell for no more than $220,000 per lot.

                     a.     Mr. Park’s Report

        Mr. Park prepared an analysis of the selling prices of comparable finished

lots (finished lot sales analysis). Mr. Park identified sales of five specific

comparable lots with addresses on the following streets: (1) Colonial Park Drive,

(2) Embassy Court, (3) High Forest Road, (4) Willow Stone Height, and (5)

Stratton Woods View. Mr. Park adjusted the sale prices for these lots to account

for differences in location, density, topography, view, and whether the lot is in a

gated community as follows:
                                         - 36 -

 [*36]                  Colonial                    High         Willow        Stratton
                         Park        Embassy        Forest       Stone         Woods
                         Drive        Court         Road         Height         View

 Sale price             $210,000      $225,000    $295,000       $360,000     $480,000
 Sale date               3/22/02       5/28/03     3/31/03        5/15/02      4/15/03

    Adjustments

 Location                  .00           .00         .10           (.10)        (.10)
 Density                   .00           .00         .00            .05          .00
 Topography                .10           .10         .10            .00          .00
 View                      .30           .20         .10            .10          .10
 Gated community           .00           .00        (.20)          (.20)        (.20)
  Total adjustments        .40           .30         .10           (.15)        (.20)
  Indicated value       $294,000      $292,500    $324,500       $306,000     $384,000

The first two of these lots are in the Bent Tree subdivision; the third lot is in the

High Forest Ranch subdivision; the fourth lot is in the Broadmoor Resort

Community subdivision; and the fifth lot is in the Stratton Forest subdivision. The

Bent Tree and High Forest Ranch subdivisions are in northern El Paso County,

and the Broadmoor Resort Community and Stratton Forest subdivisions are in the

southwestern quadrant of Colorado Springs, where some of the more expensive

lots in the region are located.

      In his report Mr. Park stated as follows: “The lots created by the

subdivision would have above average to excellent views, would be heavily
                                         - 37 -

[*37] wooded and would have considerable market value after the completion of

the subdivision process.”

                    b.      Mr. Fellows’ Report

      Mr. Fellows also prepared a finished lot sales analysis. In his finished lot

sales analysis Mr. Fellows collected sales data from numerous subdivisions in the

northern El Paso County market. Mr. Fellows then selected a sample of the data

that he considered to be representative.17 The sample that Mr. Fellows selected

comprised lot sales during 2002-03 in the following subdivisions: (1) Forest View

3; (2) Wissler; (3) Kings Deer; (4) Bent Tree; and (5) Tall Pines. With the

exception of the Forest View 3 subdivision, all of the subdivisions are east of

Monument and Interstate 25. The number of lot sales, low price, high price, and

mean price for these subdivisions are as follows:




      17
         In his rebuttal report Mr. Fellows noted that he also obtained sales data for
2002-03 with respect to High Forest Ranch subdivision but chose not to include it
because he considered it to be superior to the subject property. The number of lot
sales, low price, high price, and mean price for the subdivision are as follows:

                                No. of                               Mean
                                sales    Low price    High price     price

           High Forest Ranch      17     $155,000      $320,000    $223,700
                                       - 38 -

          [*38]            No. of                                 Mean
                           sales     Low price    High price      price

          Forest View 3      11      $154,000      $160,000     $156,545
          Wissler            12       122,500       156,000      141,269
                                      1
          Kings Deer         24         95,000      200,000      139,978
          Bent Tree          11       108,000       250,000      159,091
          Tall Pines          5       145,500       180,000      177,500

               1
                 Mr. Fellows’ report erroneously states that the low price
         for the Kings Deer subdivision was $170,000. However, an
         addendum to his report contains a table that shows that the
         lowest lot sale price for the Kings Deer subdivision was
         $95,000.

      Mr. Fellows determined the mean selling price of the lots in each of the

comparable subdivisions and adjusted that price to account for differences

between the hypothetical subdivision on the subject property and the subdivisions

included in his data set. However, Mr. Fellows did not specify what factors he

considered in adjusting the mean prices. Mr. Fellows concluded that the average

selling price for the 13 finished lots on the subject property would be between

$175,000 and $200,000 as of the valuation date. In two of his three models he

assumed a mean lot selling price for the subject property of $200,000.

      In his rebuttal report Mr. Fellows explained the difference between his and

Mr. Park’s conclusions as follows:

      [Mr. Park] gives significant weight to views and trees. I agree that
      these are significant amenities. However, both are highly subjective.
                                       - 39 -

      [*39] There is a difference between city views and views of Pike’s
      Peak. There are differences between Colorado Springs city views and
      Monument city views. Again, the issue is subjective.

             During my inspection of subject property, I noted several
      locations that offer excellent views of the Monument area. I also
      noted interior and westerly lots that had ordinary views. Also, tree
      cover is not uniform over the property.

                   c.     Analysis

      We do not find the analysis of either expert report with respect to the retail

lot selling prices to be complete and convincing. Mr. Park’s finished lot sales

analysis included lot sales from the High Forest Ranch, Broadmoor Resort

Community, and Stratton Woods View subdivisions. All of these subdivisions are

part of gated communities and have numerous amenities that would not be present

in the subdivision contemplated by Mr. Park’s report. Additionally, both the

Broadmoor Resort Community and the Stratton Woods View subdivisions are in

Colorado Springs. See Whitehouse Hotel Ltd. P’ship v. Commissioner, 139 T.C.

304, 329 (2012) (rejecting the use of nonlocal comparables), aff’d in part, vacated

in part on another issue and remanded, ___ F.3d ___, 2014 WL 2609866 (5th Cir.

June 11, 2014); Whitehouse Hotel Ltd. P’ship v. Commissioner, 131 T.C. 112, 157

& n.19 (2008) (same), vacated on another issue, 615 F.3d 321 (5th Cir. 2010).

Although Mr. Park adjusted the selling prices of these lots to account for some of
                                        - 40 -

[*40] these amenities and distinctions, his inclusion of such dissimilar

comparables calls into question the reliability of his conclusions.

      Mr. Fellows’ finished lot sales analysis included only lot sales from

subdivisions that he considered to be inferior to a hypothetical subdivision on the

subject property. Although Mr. Fellows adjusted for the quality of the

comparables that he used, he did not specify the factors he considered in adjusting

the mean lot selling prices for these subdivisions. Additionally, Mr. Fellows’

analysis included mean lot sales from subdivisions with significant variations in

finished lot selling prices. However, his report does not compare hypothetical

individual finished lots on the subject property to any of the individual lots in any

of his comparable subdivisions. Although Mr. Fellows explained that some of the

finished lots on the subject property would not have excellent views and that tree

cover was not uniform over the subject property, other factors suggest that the

finished lots would not be subject to extreme price variations. For example, the

subject property was relatively flat, and only 1 of the 13 proposed lots on the

subject property was flagged as having a potential topographical or geological

issue. Moreover, the interior and westerly lots that Mr. Fellows considered to

have ordinary views had other amenities, such as more significant tree cover and

closer proximity to Pike National Forest. Significantly, Mr. Fellows’ rebuttal
                                        - 41 -

[*41] report does not suggest that any of the finished lots on the subject property

would be inferior to the two Bent Tree subdivision lots that Mr. Park identified in

his report or that any of the finished lots on the subject property would be

comparable to any of the lower priced lots in the Bent Tree subdivision.

      Respondent contends that Mr. Fellows’ analysis is supported by our

approval of a statistical approach in Crimi v. Commissioner, at *76. However, in

Crimi, the taxpayers’ expert “developed a statistical model using polynomial

regression to correlate a relationship between the number of lots into which an

undeveloped parcel of land may be subdivided and the sale price per lot.” Id. at

*74. Here, by contrast, Mr. Fellows did not develop a statistical model to derive

useful data from dissimilar comparables. Rather, his approach served only to

allow him to include many inferior lots in his analysis.

      Because we do not find either expert’s report with respect to the finished lot

selling prices to be complete and convincing, we adopt the conclusions of neither

report. Instead, after giving appropriate weight to each expert’s report, we draw

our own conclusions based on our examination of the evidence in the record. The

sales of the two Bent Tree subdivision lots on which Mr. Park relied, which we

find to be sales of the most comparable lots in the record, had selling prices of

$210,000 and $225,000, respectively. Because of the small sample size and the
                                        - 42 -

[*42] subjective nature of Mr. Park’s adjustments to these lot sale prices we

decline to adopt Mr. Park’s adjustments. Placing slightly more weight on the sale

of the second of the Bent Tree subdivision lots because it occurred closer in time

to the conservation easement grant date, we estimate that the mean lot selling price

for the finished lots on the subject property would have been $220,000.

            3.     Retail Lot Price Appreciation Rate

      The parties agree that the selling prices for the retail lots would appreciate at

a rate of 6% per annum.

            4.     Timing To Obtain Entitlements

      The parties disagree with respect to how long it would take to obtain

entitlements to develop the subject property and whether to take into account the

zone change and preliminary plan approval applications associated with the

proposed Raspberry Ridge subdivision. Petitioners contend that Mr. Schmidt

would have obtained preliminary approval of the proposed Raspberry Ridge

subdivision applications within three to four months from the easement grant date.

Respondent contends that a hypothetical buyer would have obtained final approval

of a subdivision on the subject and adjacent properties in approximately 24

months. Accordingly, respondent contends that it would have taken at least 24

months for a hypothetical buyer to begin selling developed lots.
                                       - 43 -

[*43] Mr. Park assumed in his report that the time required for development of the

lots was 12 months. Mr. Jones estimated in his rebuttal report that Mr. Schmidt

could have secured final plat approvals by February 2004 and begun selling

developed lots on the subject and adjacent properties by March 2004.

      Respondent agrees that Mr. Schmidt could have obtained preliminary

approval for a subdivision on the subject and adjacent properties on the basis of

the applications for the proposed Raspberry Ridge subdivision but contends that

this is irrelevant because the zone change and preliminary plan applications were

nontransferable. However, we concluded above, see supra part VI.A, that the

pending applications are relevant in determining the price that a hypothetical

buyer of the conservation easement would have to pay to a hypothetical seller for

the easement and that much of the work that had been done was transferable even

if the entitlement applications themselves were not. We conclude that a

prospective buyer could have developed the subject property and begun selling

lots within 12 months from the conservation easement grant date.

             5.    Lot Absorption

      The parties disagree with respect to the amount of time it would take for the

market to absorb the retail lots. Petitioners contend that the 13 lots would have
                                        - 44 -

[*44] sold within 12 months. Respondent contends that the lots would have sold

at a rate of approximately 5 to 6 per annum.

      Mr. Jones credibly testified that Mr. Schmidt could have developed the 13

lots on the subject property in a first phase and the 22 lots on the adjacent property

in a second phase. Mr. Jones further testified that, to develop the lots on the

subject property before the lots on the adjacent property, a prospective buyer

would have had to secure access for the subject property to the road that was

accessible from the adjacent property.18 Mr. Fellows’ report also recognized that

access was an issue that would need to be resolved, but he noted that “[t]his is a

common character of real estate”. Respondent contends that developing the lots

on the subject property separately would subject a hypothetical purchaser to

increased development costs. However, as discussed below, see infra part VI.B.6,

petitioners concede the development costs issue. Accordingly, because Mr.

Fellows considered the access issue in his report, no further adjustment for any

increased development costs for developing the lots on the subject property before

the lots on the adjacent property is necessary.




      18
        Mr. Jones testified that, under local ordinances, the owner of the adjacent
property would have to provide road access to the subject property before being
allowed to subdivide the adjacent property.
                                          - 45 -

[*45]                a.    Mr. Park’s Report

        Mr. Park determined that all of the finished lots on the subject property

would sell within 12 months. Mr. Park relied on an absorption study and on sales

data from a representative subdivision.

        Mr. Park’s absorption study identified 140 comparable lots in the same

market as the subject property that were listed for sale during 2002-03. During

that time 105 of the lots sold.

        Mr. Park also relied on sales data from the Walters Commons subdivision in

the Woodmor area in northern El Paso County. The Walters Commons

subdivision contains 174 lots. They were sold from December 2003 to July 2008

at a rate of approximately 3.22 sales per month. Mr. Park concluded that the rate

of sales in the Walters Commons subdivision supported his estimate of a 12-month

absorption period.

                     b.    Mr. Fellows’ Report

        Mr. Fellows determined that the finished lots on the subject property would

sell at a rate of five per annum. His determination was based on a survey of the

sales rates of five subdivisions during 2002 and 2003 and on a housing market

study for El Paso County during this time.
                                        - 46 -

[*46] Mr. Fellows relied on sales data from the following subdivisions: Forest

View 3, Wissler, Kings Deer, Bent Tree, and Tall Pines. Mr. Fellows summarized

the sales data as follows:

                  Forest View 3     Wissler Kings Deer     Bent Tree     Tall Pines
                      1
 No. of sales             11.0       12.0        24.0          11.0           5.0
 Annual avg.
                          1
  no. of sales                5.5     6.0        12.0           5.5           2.5

             1
             Respondent concedes that Forest View 3 in fact had 13 sales
      during 2002 and 2003. However, respondent contends that this error
      does not materially affect Mr. Fellows’ conclusions.

      Mr. Fellows also relied on a report entitled “Colorado Springs Single

Family Housing Market--April 2003” (Bamberger Report). The Bamberger

Report reported that there was a 2.4 year supply of upper-end residential lots (i.e.,

lots that sold for more than $128,000). After combining his lot absorption

estimate with his estimate for the time to obtain entitlements, see supra part

VI.B.4, Mr. Fellows estimated a five-year holding period in his discounted

cashflow models. He assumed that five lots would be sold in each of years 3 and 4

and that three lots would be sold in year 5.

             c.     Analysis

      We do not find the analysis of either expert report with respect to the

absorption rate to be complete and convincing. Mr. Park’s absorption study does
                                        - 47 -

[*47] not support his conclusion that all 13 lots on the subject property would sell

in one year. Instead, the absorption study indicates that approximately 75% of the

lots placed on the market during 2002-03 sold during that period. Mr. Park’s

analysis of the sales data from the Walters Commons subdivision is similarly

unconvincing because it does not follow from the fact that the lots on a 174-lot

subdivision sold at a rate of 3.22 per month that a 13-lot subdivision would

experience a similar rate of monthly sales. Moreover, the sales data from the

Walters Commons subdivision is particularly unconvincing because the Walter

Commons subdivision is a high-density townhome development in Monument.

      Mr. Fellows’ survey of the sales data from the five subdivisions is

unconvincing because a closer look at the underlying data shows that all of the lots

in each of the five subdivisions sold in less than a year and a half. The sales data

for the five subdivisions that Mr. Fellows relied upon shows as follows:
                                         - 48 -

           [*48]             No. of                                  No. of
                            lots sold    First sale    Last sale     months

           Forest View 31      11        8/14/2002    12/31/2003        16
           Wissler             12        8/15/2002     9/12/2003        13
           Kings Deer          24        7/11/2002    11/12/2003        16
           Bent Tree           11       10/15/2002    12/29/2003        14
           Tall Pines           5         9/3/2002     7/23/2003        10

                   1
                  As discussed later in this paragraph, the sales data with
           respect to Forest View 3 is inconsistent with other evidence in
           the record, including copies of patents for each of the lots in
           Forest View 3. Mr. Fellows testified that he was unaware of the
           patents when he prepared his report and instead relied on other
           data.

Although respondent contends that the lots in the Forest View 3 subdivision were

offered for sale throughout 2002 and 2003, he cites no evidence in the record to

support this contention. In fact, the record shows that the final plat for Forest

View 3 was approved by various boards and commissions between February 21

and April 18, 2002, the final plat for the subdivision was recorded on May 24,

2002, and patents for 13 of the 14 platted lots in the subdivision were made

between August 9, 2002, and August 22, 2003.19 This indicates that all of the lots

in the Forest View 3 subdivision sold within 17 months of final plat approval.




      19
        The 14th lot was pulled off the market and not sold until 2006 because of
an issue that arose with respect to that lot.
                                          - 49 -

[*49] Because we do not find either expert’s report with respect to the lot

absorption rate to be complete and convincing, we adopt the estimates of neither

report. Instead, after giving appropriate weight to each expert’s report, we draw

our own conclusions based on our examination of the evidence in the record. The

sales data from the five subdivisions on which Mr. Fellows relied shows that,

measuring from the date of the first sale to the date of the last sale, all of the lots in

each of the five subdivisions sold in less than a year and a half. Although the

record does not show when the lots in the five subdivisions discussed in Mr.

Fellows’ survey were initially offered for sale, the record does show that less than

five months passed between the approval of the final plat for Forest View 3 and

the first lot sale in that subdivision. Accordingly, we estimate that all 13 lots on

the subject property would have sold within two years of being offered for sale.

             6.     Development Costs

      The parties agree that development costs for the combined 108-acre

subdivision would have totaled approximately $1,485,295. Respondent contends

that the amount of the development costs allocable to the subject property is

between $40,000 and $45,000 per lot. At trial petitioners relied on Mr. Jones’

expert report. Mr. Jones’ report opines that the amount of the development costs

allocable to the subject property is $26,173 per lot. On brief, however, petitioners
                                       - 50 -

[*50] concede that the amount of the development costs allocable to the subject

property is $580,416, or $44,647 per lot. We conclude that the development costs

for a hypothetical subdivision of the subject property would have been $580,416.

             7.     Marketing/Administrative Costs

      The parties disagree as to the proper amount of marketing/administrative

costs. Both Mr. Park and Mr. Fellows included inputs for cost of sales (marketing).

Mr. Park included marketing costs equal to 10% of gross sales. Mr. Fellows

included marketing and closing costs equal to 7% of gross sales. The 3%

difference between Mr. Park’s and Mr. Fellows’ estimates is partially offset by the

“administrative expense” of $10,000 per annum included by Mr. Fellows to

account for administrative expenses, taxes, and other miscellaneous holding costs.20

Paradoxically, Mr. Fellows’ estimate supports a lower combined cost for

marketing/administrative costs for a subdivision on the subject property--and thus a

higher before value for the subject property. Petitioners have not shown that Mr.

Fellows’ lower estimate is more reliable. See Rule 142(a)(1). We conclude that




       20
        In the joint status report the parties purported to disagree with respect to
the proper amount of carrying/holding costs. Although the parties fail to explicitly
address these costs on brief, it appears from Mr. Fellows’ report that these are the
administrative holding costs that Mr. Fellows included but Mr. Park did not.
                                       - 51 -

[*51] the marketing/administrative costs for a hypothetical subdivision of the

subject property would have been 10% of gross sales.

             8.    Discount Rate

      The parties agree that the appropriate discount rate is 22%. This rate

includes a 10% entrepreneurial-profit factor.

      C.     Conclusion

      Having determined the respective values of the various inputs that the parties

agree are relevant in determining the before value of the subject property using the

subdivision development method, we can now recalculate the before value of the

subject property using a discounted cashflow model that is similar to the

discounted cashflow models used by the parties’ experts. Before we do so,

however, we address the proper application of the discounted cashflow method in

this case.

      It is not clear from Mr. Park’s report how he calculated the present value of

the income and expenses from the hypothetical subdivision of the subject

property.21 Mr. Fellows assumed that a hypothetical developer would receive all

income at yearend. However, Mr. Fellows also assumed that the hypothetical


       21
       Indeed, Mr. Park admitted at trial that his discounted cashflow analysis
model contained a significant error.
                                        - 52 -

[*52] developer would pay the development costs at the beginning of the first year.

Besides being inconsistent, Mr. Fellows’ adoption of a yearend convention is

questionable with respect to the facts in this case. In Estate of Heck v.

Commissioner, T.C. Memo. 2002-34, 83 T.C.M. (CCH) 1181, 1190 (2002), we

adopted a yearend convention because the cashflow being discounted was from the

sale of champagne and was therefore more heavily weighted toward the end of the

year. See also Estate of Adams v. Commissioner, T.C. Memo. 2002-80, 83 T.C.M.

(CCH) 1421, 1424 (2002) (adopting a yearend convention because the

Commissioner failed to introduce evidence showing that the corporation “would

pay its investors at the middle of the year rather than at the end of the year”). Here,

the more reasonable assumption is that the lot sales, and other income and

expenses, would occur evenly throughout the year in which they are expected to

occur. See John A. Bogdanski, Federal Tax Valuation, para. 3.05[5][b][vi], at

3-135 (2012) (noting that the mid-year convention “better reflects the fact that

operating revenues are often received throughout the year”). Accordingly, we

adopt a midyear convention in this case.

      The following represents our reconstruction of the discounted cashflow

analysis of the income and expenses relating to the hypothetical subdivision of the

subject property:
                                        - 53 -

         [*53]                            Year 1       Year 2       Year 3

         Lot sale price1                $226,504 $240,094          $254,500
         Lot sales                          -0-          6.5             6.5
          Gross sales                       -0-   1,560,611       1,654,250
         Marketing costs (10%)              -0-     156,061         165,425
         Development costs               580,416      -0-             -0-
          Net                           (580,416) 1,404,550       1,488,825
         Present value factor (PVF)2    0.905357 0.742096          0.608276
          Discounted value              (525,484) 1,042,312         905,617

                 1
                  We estimated that the finished lot sale price as of the
         conservation easement grant date would have been $220,000.
         See supra part VI.B.2.c. The parties stipulated that the lot sale
         price appreciation rate is 6% per annum. See supra part VI.B.3.
         Because we adopt a midyear convention, the lot sale price is
         $220,000 * 1.06n - 1/2 where n is the year.
                2
                  A PVF is used to calculate the present value of each dollar
         received or expended in the future. In general, PVF = 1 / (1 + r)n
         where r is the discount rate and n is the year. The parties
         stipulated that the appropriate discount rate is 22% per annum.
         See supra part VI.B.8. Because we adopt a midyear convention,
         PVF = 1 / (1 + 0.22)n - 1/2.

The total discounted value of the cashflow from the hypothetical subdivision of the

subject property is $1,422,445. After a hypothetical subdivision of the subject

property there would be no residual value to the subject property, all the lots

having been sold off. Accordingly, the before value of the subject property is

$1,422,445.
                                        - 54 -

[*54] VII.   After Value of the Subject Property

      The parties agree that the after value of the subject property should be based

on sales of other comparable properties with restrictions similar to those imposed

by the conservation easement at issue in this case. The parties disagree, however,

with respect to the ultimate after value of the subject property.

      A.     Mr. Park’s Report

      Mr. Park prepared an analysis of the selling prices of comparable, similarly

sized lots. Mr. Park identified comparable lot sales with addresses on the

following streets: (1) Hardy Road; (2) Crowfoot Springs Road; (3) East Jones

Road; and (4) Goodson Road. Mr. Park chose these lots because they lacked

development entitlements. Mr. Park adjusted the sale prices per acre for these lots

to account for differences in location, access, density, and topography/view as

follows:
                                         - 55 -

 [*55]                                     Crowfoot
                               Hardy        Springs     East Jones   Goodson
                               Road          Road         Road        Road

 Sale price                  $300,000       $300,000     $335,000    $320,000
 Sale date                    5/30/03        4/29/03      2/28/03     3/15/02
 Acres                          40.00          42.87        52.84       40.00
 Sale price per acre           $7,500         $7,000       $6,300      $8,000

         Adjustments

 Location                       .10           .10          .20         .00
 Access/visibility              .10           .10          .10         .00
 Topography/view                .30           .30          .30         .30
  Total adjustments             .50           .50          .60         .30
  Indicated value per acre     $11,250       $10,500      $10,080     $10,400

Mr. Park determined that the estimated after value of the subject property is

$10,500 per acre, or approximately $400,000 in total.

      B.     Mr. Fellows’ Report

      Mr. Fellows identified property sales in two subdivisions that contained real

property platted as 35- to 40-acre lots. These subdivisions are the Highlands

Turkey Canyon subdivision near Colorado Springs and the Majestic Park

subdivision near Woodland Park. In eight lot sales between July 2001 and

November 2004 in the Highlands Turkey Canyon subdivision the mean lot sale

price was $4,199 per acre. In 10 lot sales between May 2000 and June 2006 in the

Majestic Park subdivision the mean lot sale price was $8,439 per acre. Mr.
                                         - 56 -

[*56] Fellows chose these subdivisions because the 35-40 acre platting made

further subdivision unlikely.

      Mr. Fellows considered the Highlands Turkey Canyon lots to be inferior and

the Majestic Park lots to be superior to the subject property. However, he

considered the subject property to be more comparable to the Majestic Park lots.

Consequently, Mr. Fellows determined that the after value of the subject property is

$6,500 to $7,000 per acre, or between $260,000 and $280,000 in total. In Mr.

Fellows’ opinion, the after value of the subject property is $270,000.

      C.     Analysis

      The most significant methodological difference between Mr. Park’s report

and Mr. Fellows’ report with respect to the after value of the subject property is

that Mr. Park selected sales of properties that were not platted and Mr. Fellows

selected sales of properties that were platted for use as a 35-40 acre residential

building site. Mr. Fellows’ method seems to more accurately value the subject

property after the granting of the conservation easement because the sales of the

unplatted lots selected by Mr. Park were still subject to possible rezoning and

development as a multilot subdivision. Consistent with Mr. Fellows’ conclusion

on this issue, we find that the after value of the subject property is $270,000.
                                        - 57 -

[*57] VIII. Value of the Conservation Easement

      We have found that the before value of the subject property is $1,422,445

and that the after value of the subject property is $270,000. Accordingly, the value

of Mr. Schmidt’s conservation easement is $1,152,445.

IX.   Penalties

      A.     Burden of Proof

      Generally, the Commissioner bears the burden of production with respect to

the taxpayer’s liability for a section 6662(a) penalty and must produce sufficient

evidence indicating that it is appropriate to impose the penalty. See sec. 7491(c);

Higbee v. Commissioner, 116 T.C. at 446-447. Once the Commissioner meets his

burden of production, the taxpayer must come forward with persuasive evidence

that the Commissioner’s determination is incorrect or that the taxpayer had

reasonable cause or substantial authority for the position. See Higbee v.

Commissioner, 116 T.C. at 447. However, if the Commissioner first asserts

penalties in the answer, the Commissioner has the burden of proof as to the new

matter. See Rule 142(a)(1).

      Petitioners contend that the burden of proof with respect to the penalties

asserted in this case should be on respondent because they were not included in the

notice of deficiency and are therefore new matters. Respondent concedes that
                                        - 58 -

[*58] he bears the burden of proof with respect to the penalties but contends that

petitioners bear the burden of proof with respect to any affirmative defenses to the

penalties.

      We agree with petitioners that the penalties asserted in this case are new

matters, pleaded in the answer. Accordingly, the burden of proof with respect to

the penalties, both as to the production of evidence and as to persuasion, is on

respondent. See Rule 142(a)(1); Bruner Woolen Co. v. Commissioner, 6 B.T.A.

881, 882 (1927); Derby v. Commissioner, T.C. Memo. 2008-45, 95 T.C.M. (CCH)

1177, 1194 (2008); Arnold v. Commissioner, T.C. Memo. 2003-259, 86 T.C.M.

(CCH) 341, 344 (2003).

      B.     Section 6662(a) Penalties Generally

      Section 6662(a) and (b)(2) and (3) authorizes the Commissioner to impose a

20% penalty on an underpayment of tax that is attributable to, among other things,

(1) any substantial understatement of income tax and (2) any substantial valuation

misstatement. Only one section 6662 accuracy-related penalty may be imposed

with respect to any given portion of an underpayment. See New Phoenix Sunrise

Corp. v. Commissioner, 132 T.C. 161, 187 (2009), aff’d, 408 Fed. Appx. 908 (6th

Cir. 2010); sec. 1.6662-2(c), Income Tax Regs.
                                         - 59 -

[*59] An understatement is substantial in the case of an individual if the amount of

the understatement for the taxable year exceeds the greater of 10% of the tax

required to be shown on the return or $5,000. See sec. 6662(d)(1)(A). With

respect to returns filed on or before August 17, 2006, there is a substantial

valuation misstatement where the value of any property claimed on any return of

tax imposed by chapter 1 is 200% or more of the amount determined to be the

correct amount. See sec. 6662(e)(1)(A); Pension Protection Act of 2006 (PPA),

Pub. L. No. 109-280, sec. 1219(a)(1)(A), (e)(1), 120 Stat. at 1083, 1085. With

respect to returns filed after August 17, 2006,22 there is a substantial valuation

misstatement where the value of any property claimed on any return of tax imposed

by chapter 1 is 150% or more of the amount determined to be the correct amount.23


       22
         With respect to valuation misstatements relating to charitable
contributions of facade easements PPA’s effective date is July 25, 2006. See
Pension Protection Act of 2006 (PPA), Pub. L. No. 109-280, sec. 1219(e)(3), 120
Stat. at 1086.
       23
        In Chandler v. Commissioner, 142 T.C. ___, ___ (slip op. at 24-25) (May
14, 2014), we held that provisions of the PPA that removed the reasonable cause
defense for gross valuation misstatements under sec. 6662(h) applied to a
carryover that the taxpayer claimed on a return filed after PPA’s effective date
even though the carryover related to a deduction that arose on a return that the
taxpayer filed before that date. However, Chandler did not decide whether the
pre- or post-PPA rules apply with respect to the determination of whether a
substantial or gross valuation misstatement penalty applies in the case of a post-
PPA carryover that arose from a deduction claimed on a return before PPA’s
                                                                       (continued...)
                                         - 60 -

[*60] PPA sec. 1219(a)(1)(A), (e)(1), 120 Stat. at 1083, 1085. In the case of an

individual the substantial valuation misstatement penalty applies only where the

portion of the underpayment for the taxable year attributable to the substantial

valuation misstatement exceeds $5,000. See sec. 6662(e)(2).

      Generally, the accuracy-related penalty does not apply with respect to any

portion of the underpayment for which the taxpayer shows that there was

reasonable cause and that he or she acted in good faith. See sec. 6664(c)(1). The

decision as to whether a taxpayer acted with reasonable cause and in good faith is

made on a case-by-case basis, taking into account all of the pertinent facts and

circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. “Circumstances that

may indicate reasonable cause and good faith include an honest misunderstanding

of fact or law that is reasonable in light of all of the facts and circumstances,

including the experience, knowledge, and education of the taxpayer.” Id.




      23
        (...continued)
effective date. Cf. sec. 1.6662-5(c), Income Tax Regs. (providing that the
substantial or gross valuation misstatement penalty applies with respect to a
carryover if there is an underpayment for the carryover year and the valuation
misstatement was substantial or gross in the year in which the valuation
misstatement arises). Because petitioners will not be liable for a substantial
valuation misstatement penalty regardless of whether the pre- or post-PPA rules
apply with respect to petitioners’ 2006 carryover, see infra part IX.C.1, we do not
decide this issue in this case.
                                        - 61 -

[*61] In the case of a substantial valuation misstatement with respect to charitable

deduction property,24 however, the reasonable-cause-and-good-faith defense does

not apply unless the taxpayer can show that (1) “the claimed value of the property

was based on a qualified appraisal made by a qualified appraiser”, sec.

6664(c)(2)(A); and (2) “in addition to obtaining such appraisal, the taxpayer made

a good faith investigation of the value of the contributed property”, sec.

6664(c)(2)(B).

      C.     Whether Petitioners Are Liable for a Section 6662(a) Penalty

      Because the reasonable cause defense for a substantial valuation

misstatement penalty has more requirements than a reasonable cause defense for a

substantial understatement of income tax penalty, we first consider whether

petitioners are liable for a substantial valuation misstatement penalty.

             1.    Substantial Valuation Misstatement Penalty

      On their 2003 return petitioners claimed a $1.6 million charitable

contribution deduction for Mr. Schmidt’s donation of a conservation easement on

the subject property to El Paso County. A portion of that deduction was carried




       24
       Charitable deduction property “means any property contributed by the
taxpayer in a contribution for which a deduction was claimed under section 170.”
Sec. 6664(c)(3)(A).
                                        - 62 -

[*62] over to each of petitioners’ 2004, 2005, and 2006 returns.25 We have

concluded that the value of the conservation easement, and the amount of the

resulting deduction, was $1,152,445. See supra part VIII. The amount petitioners

claimed on their 2003 return is less than 200% (and less than 150%) of the amount

we determined to be the correct amount. Accordingly, petitioners are not liable for

a penalty for a substantial valuation misstatement pursuant to section 6662(a) and

(b)(3) for any of the years at issue. See sec. 6662(e)(1)(A).

             2.    Substantial Understatement Penalty

      We shall assume for purposes of this analysis that petitioners understated

their Federal income tax liability by an amount exceeding the greater of at least

10% of the amount required to be shown on their return for at least one of the

taxable years at issue or $5,000, see sec. 6662(d)(1)(A), and consider whether


       25
       With respect to carryovers, section 1.6662-5(c), Income Tax Regs.,
provides that

       [t]he penalty for a substantial or gross valuation misstatement applies
       to any portion of an underpayment for a year to which a loss,
       deduction or credit is carried that is attributable to a substantial or
       gross valuation misstatement for the year in which the carryback or
       carryover of the loss, deduction or credit arises (the “loss or credit
       year”), provided that the applicable dollar limitation set forth in
       section 6662(e)(2) is satisfied in the carryback or carryover year.
                                        - 63 -

[*63] petitioners had reasonable cause for the understatement and whether they

acted in good faith, see sec. 6664(c)(1). We conclude that they did.

      In claiming a charitable contribution deduction for the conservation

easement at issue, petitioners relied on Mr. Park’s 2003 appraisal. Mr. Park had the

requisite credentials and experience to justify petitioners’ reliance on the 2003

appraisal, and respondent concedes that it was a qualified appraisal. Although we

have sustained in part respondent’s deficiency determination, we have done so

because we did not find Mr. Park’s report to be complete and convincing in certain

respects. However, we do not think that the problems that we found with Mr.

Park’s report, and by extension with the 2003 appraisal, call into question the

reasonableness of petitioners’ reliance on the 2003 appraisal.

      Respondent contends that there are certain facts that support an inference

that Mr. Park intended to secure excessive tax benefits for petitioners with his

2003 appraisal. However, many of these facts are ambiguous and are also

consistent with a good-faith attempt on the part of petitioners to reach the right

result. For example, we found that Mr. Park’s reliance on dissimilar comparables

undermined the reliability of his finished lot sales analysis. See supra part

VI.B.2.c. However, it is possible that Mr. Park--and petitioners--reasonably
                                        - 64 -

[*64] believed that the analysis was accurate and reliable.26 Similarly, Mr. Park’s

handwritten notes contained a finished lot sale price that was significantly below

the price that he used in the 2003 appraisal. However, the notes are undated and it

is possible that the finished lot sale price estimate in Mr. Park’s handwritten notes

was a preliminary, uninformed guess. See supra part IV.

      Respondent points to other facts, and inferences that he would like to draw

from those facts, in support of his argument that Mr. Schmidt lacked good faith in

accepting Mr. Park’s 2003 appraisal, but we are unpersuaded. For example,

respondent contends that Mr. Schmidt acquired the option to purchase the adjacent

property only for the purpose of including the pending preliminary plan and zone

change applications in Mr. Park’s appraisal of the subject property. Respondent,

however, does not explain why this is inconsistent with a good-faith attempt on the

part of petitioners to achieve the right result. Similarly, respondent contends that

Mr. Schmidt’s decision not to purchase and develop the adjacent property shows

that he did not believe that the 2003 appraisal was accurate or correct. We reject

respondent’s argument because the record shows that the adjacent property

       26
        We note that Mr. Jones’ November 2, 2001, cost estimate--which was not
prepared in anticipation of Mr. Schmidt’s granting of the conservation easement--
assumed average finished lot sale prices of $250,000 for the lots on the subject
property. After adjusting for market conditions, this is close to the average
finished lot sale price that Mr. Park determined in the 2003 appraisal.
                                         - 65 -

[*65] was more difficult to develop than the subject property and Mr. Schmidt had

other businesses to manage.

      Because the record establishes--without regard to the burden of proof--that

petitioners had reasonable cause for the underpayment and acted in good faith, we

hold that petitioners are not liable for a penalty for a substantial understatement of

Federal income tax pursuant to section 6662(a) and (b)(2). See sec. 6664(c)(1).

      We have considered the parties’ remaining arguments, and to the extent not

discussed above, conclude those arguments are irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                  Decision will be entered

                                        under Rule 155.
