                         T.C. Memo. 2010-151



                       UNITED STATES TAX COURT



      HUDA T. SCHEIDELMAN & ETHAN W. PERRY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15171-08.              Filed July 14, 2010.



     Frank Agostino, Eduardo S. Chung, and Matthew Viera, for

petitioners.

     John V. Cardone, Marc L. Caine, and Marie E. Small, for

respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     COHEN, Judge:    By one statutory notice dated March 21, 2008,

respondent determined deficiencies of $16,873 and $17,537 with

respect to Huda T. Scheidelman’s (petitioner’s) Federal income

taxes for 2004 and 2005, respectively.   Respondent also
                                 - 2 -

determined section 6662(a) penalties of $3,374.60 and $3,507.40

for 2004 and 2005, respectively.    By a second statutory notice of

deficiency dated March 21, 2008, respondent determined a

deficiency of $1,015 with respect to petitioners’ Federal income

tax for 2006 and a section 6662(a) penalty of $203.

     The issues for decision are:    (1) Whether petitioners are

entitled to charitable contribution deductions with respect to a

historic facade easement donation; (2) whether a mandatory cash

payment made to the donee organization is deductible as a

charitable contribution; and (3) whether petitioners are liable

for section 6662(a) penalties.     Unless otherwise indicated, all

section references are to the Internal Revenue Code in effect for

the years in issue.

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.

Petitioners resided in New York at the time that they filed their

petition.   Petitioner is a registered nurse, has no tax

experience, and has not been trained to value real estate.

     On September 24, 1997, petitioner purchased a property on

Vanderbilt Avenue within the Fort Greene Historic District in

Brooklyn, New York, for $255,000 and became the fee simple owner.

The Fort Greene Historic District is designated (1) a “registered

historic district” within the meaning of section 47(c)(3)(B) by
                                - 3 -

the Secretary of the Interior through the National Park Service

(NPS), a bureau within the U.S. Department of the Interior; and

(2) a historic district by New York City and its Landmarks

Preservation Commission.    In New York City it is unlawful to

alter, reconstruct, or demolish a building in a historic district

without the prior consent of the Landmarks Preservation

Commission.    N.Y. City Admin. Code sec. 25-305 (2002).

     Sometime in the fall of 2002, petitioner received a postcard

from the National Architectural Trust (NAT), a section 501(c)(3)

organization (that later became known as the Trust for

Architectural Easements), announcing an upcoming meeting in the

New York City area to provide information regarding the donation

of a facade conservation easement, including possible related tax

benefits.    Petitioner was interested in preserving the historic

facade of her house, particularly because she observed real

estate development increasing in and around Fort Greene.    She

also wanted to obtain the tax benefits suggested by NAT.

     Petitioner called NAT and inquired generally about the

program.    Petitioner also called John Somoza (Somoza), the

accountant who had prepared her tax returns for approximately 10

years before 2004, and asked him about the program because of the

noted tax implications of a donation.    Somoza has a college

degree, has practiced as an accountant for over 40 years, and has

prepared thousands of tax returns during his career.    Somoza
                                - 4 -

informed petitioner that he was not familiar with the donation of

historic facade easements, but he offered to attend NAT’s

upcoming seminar.

     At the seminar attended by Somoza, a representative from NAT

presented information regarding facade easements and distributed

an informational flier that Somoza forwarded to petitioner.

Somoza conducted some additional research and informed petitioner

that the facade easement contribution deduction did exist under

the Internal Revenue Code.    He also cautioned petitioner that

encumbering the property might make it more difficult to sell in

the future.

     On March 24, 2003, petitioner completed a facade

conservation easement application for the Vanderbilt property to

be considered for a facade conservation easement donation to NAT.

On the application, petitioner identified two lenders that held

mortgages on the property.    NAT required a deposit of $1,000 to

be submitted with the application, which was fully refundable if

the necessary approvals for the facade easement donation could

not be obtained.    The application stated that NAT’s “operating

funds come solely from cash donations made by persons donating an

easement.    An agreed upon cash donation of 10% of the easement

value is required at the time the easement donation is accepted

by [NAT]”.
                               - 5 -

     In a letter dated April 2, 2003, the NAT Director of

Operations informed petitioner that her application had been

accepted and that processing would commence.   The letter informed

petitioner that NAT:

     will place significant effort to the processing of your
     application. Processing an application is complex and
     time consuming. It involves obtaining approvals from
     the State and Federal Governments, and your lender.
     * * *

          There is nothing required of you until all
     approvals are received.

NAT sought the approval of petitioner’s mortgage holders

regarding the placement of a preservation restriction agreement

on her Vanderbilt property.   The two mortgage holders executed

lender agreements that were submitted to NAT during the approval

process.

     On May 12, 2003, to comply with another component of the

approval process, petitioner executed a National Park Service

Form 10-168, Historic Preservation Certification Application Part

1 – Evaluation of Significance, to request that the NPS certify

the historic significance of the Vanderbilt property.   The NPS

determined that petitioner’s Vanderbilt property contributes to

the significance of the Fort Greene Historic District and is a

“certified historic structure” for a charitable contribution for

conservation purposes in accordance with the Tax Treatment

Extension Act of 1980.
                                - 6 -

       Later in 2003, petitioner informed NAT that she had decided

not to pursue the donation until 2004.    Petitioner needed time to

save the additional required cash due, as outlined in the

application.    By letter dated April 22, 2004, NAT informed

petitioner that all of the necessary approvals had been received

and that she needed to order an appraisal.    NAT provided in the

letter a list of appraisers “qualified to do easement

appraisals”.    Petitioner hired one of the listed appraisers,

Michael Drazner (Drazner), formerly of Mitchell, Maxwell &

Jackson, Inc., to perform an appraisal of the Vanderbilt

property.

       Drazner and James Kearns (Kearns), president of NAT, first

communicated in December 2001 when Kearns contacted Drazner to

inquire whether he would be able to prepare appraisals for

homeowners who were interested in donating facade easements to

NAT.    Kearns sent copies of reports to Drazner that had been

prepared by another appraisal firm outside of the New York City

area along with some information regarding court cases that

involved the charitable contribution of facade easements.

       Drazner completed an appraisal (the Drazner report) for the

subject property on May 20, 2004.    The report states that the

appraisal was completed in accordance with title XI of the

Federal Financial Institutions Reform, Recovery, and Enforcement

Act of 1989 and the Uniform Standards of Professional Appraisal
                               - 7 -

Practice.   Drazner is a qualified expert in the field of real

estate appraisal and valuation.

     Petitioner’s Vanderbilt property was described in the

Drazner report as:

     an attached four story, three family townhouse located
     in the Boerum Hill neighborhood of Kings County. The
     subject is physically and functionally adequate ‘as is’
     * * * [and] features a rear deck, patio, and clean
     tiled subcellar below the garden level. This home also
     includes a wealth of turn of the century details that
     generate strong demand for such homes in the area.
     These include wood mouldings, paneling and
     wainscotting, volume ceilings, exposed brick walls,
     stained glass windows, original wood planking, and
     fireplaces.

     Drazner determined that the estimated market value of the

property was $1,015,000 as of the appraisal date.   The Drazner

report outlined the use of the three classic approaches to value

(sales comparison, cost, and income) that were considered to

determine the market value of the Vanderbilt property.    The

report stated that the sales comparison approach is the “most

applicable and has been given greatest weight in the

determination of the final value * * * [and] the cost approach

was given least weight due to the age of the subject property.”

The stated purpose of the report was “to estimate ‘as is’ value

of the subject property and to estimate the impact on the subject

property if granted an ‘architectural facade easement.’”    The

report explained that

          An easement is a particularly useful historic
     preservation tool in several respects. First, it
                              - 8 -

     allows an individual to retain private ownership of the
     property and obtain potential financial benefits.
     Second, an easement binds not only the current owner,
     but all future owners as well, ensuring that the
     property will be maintained and observed by future
     owners. Third, easements are tailored to meet the
     needs of the property owner, the individual resource,
     and the mission of the protecting organization. * * *

          If certain criteria are met, the owner also may
     receive a Federal income tax deduction equivalent to
     the value of the rights given away to a charitable, or
     governmental organization. * * * The deduction the
     taxpayer is entitled to is equal to the fair market
     value of the easement, which is generally the decrease
     in fair market value of the property caused by the
     restrictions placed on the property because of the
     easement.

     The Drazner report briefly discussed two cases involving

easement valuation, Hilborn v. Commissioner, 85 T.C. 677 (1985),

and Richmond v. United States, 699 F. Supp. 578 (E.D. La. 1988),

and stated that

          As these cases depict, it is extremely difficult
     for appraisers to estimate the probable and possible
     impact on a property’s value by the imposition of a
     facade conservation easement that is granted in
     perpetuity. For most attached row properties in New
     York City, where there are many municipal regulations
     restricting changes to properties located in historic
     districts, the facade easement value tends to be about
     11 - 11.5% of the total value of the property. That
     figure is based on the appraiser’s experience as to
     what the Internal Revenue Service has found acceptable
     (on prior appraisals).

The Drazner report further stated that

          This facade easement can, and often does, have an
     effect on marketability and the market value of a
     property. The measurement of this effect or impact is
     difficult to quantify with any supported precision.
     Articles, periodicals, and books have been written on
     the subject (measurement of the value of the historic
                         - 9 -

easement). However, in this market area, there is no
measure or formula that is applicable for all
properties. The individual properties are so unique
that each case must be evaluated on its own.
Additionally, while there are accepted methods for
measuring this effect, only the market can provide the
true test. Nonetheless, there are market measures that
provide sufficient data with which to bracket and
support a reasonable market indicator.

     Estimating the value of a property after the
donation of a conservation easement is very much like
condemnation appraisal practice where easements or
partial fee interests are taken from property owners by
a sovereign. Attempts must be made to define what
rights have been lost by the property owners and what
elements of damage (or enhancement) are involved in the
loss. Because real estate is not bought and sold in a
vacuum, the appraiser has endeavored to place himself
in the mindset of competent buyers and sellers and to
examine considerations they have actually had, or are
likely to have, in the buying or selling of a property
encumbered by a facade easement.

     *       *       *       *       *      *       *

It is now generally recognized by the Internal Revenue
Service that the donation of a facade easement of a
property results in a loss of value * * * between 10%
and 15%. The donation of a commercial property results
in a loss of value of between 10% or 12% or higher if
development rights are lost. The inclusive data
support at least these ranges, depending on how
extensive the facade area is in relation to the land
parcel.

     It is our opinion that the presence of the facade
conservation easement would alter the market value of
the subject property. In the subject’s market area,
the appraiser cannot precisely estimate the extent to
which this “loss in value” will result from the facade
easement due to the lack of market data. In this
situation it is the appraiser’s conclusion that the
value of the facade conservation easement * * * on the
subject property would be estimated at $115,000, which
is approximately 11.33% of the fee simple value of
$1,015,000. This conclusion is based on consideration
of range of value that the I.R.S. has historically
                              - 10 -

     found to be acceptable as well as historical
     precedents. Therefore, the presence of the historic
     facade easement would decrease the fair market value of
     the property rights held by the homeowner of the
     subject property to $900,000.

     An article entitled “Facade Easement Contributions” was

prepared by Mark Primoli of the Internal Revenue Service (IRS)

sometime before 2002 and was included as a part of the IRS’ 1994

Market Segment Specialization Program Audit Technique Guide on

the Rehabilitation Tax Credit--used to assist in training IRS

personnel.   The article stated that

     Internal Revenue Service Engineers have concluded that
     the proper valuation of a facade easement should range
     from approximately 10% to 15% of the value of the
     property. Once fair market values have been
     determined, the same ratios are used to allocate the
     basis of the building and the underlying land to the
     facade easement for both rehabilitation tax credit and
     depreciation purposes. See Treasury Regulation 1.170A-
     14(h).

An excerpt from this article was posted on the NPS’ Web site

until early 2003 but was revised in 2003 to remove the first

sentence quoted above.   The Drazner report does not cite this

article.

     By letter dated June 7, 2004, NAT informed petitioner that

it was in receipt of the Drazner report valuing the Vanderbilt

property facade easement at $115,000.   In the letter, NAT also

informed petitioner that if she closed on the facade easement

contribution transaction by June 30, 2004, the cash payment due

would be $9,275 (applying a 15-percent discount to 10 percent of
                               - 11 -

the easement value and deducting a processing fee of $500 that

one of the lenders charged from the initial $1,000 deposit).

     Petitioner sent a check for $9,275 to NAT dated June 18,

2004, and NAT confirmed receipt of the moneys by letter dated

July 2, 2004.    The letter also stated that NAT “certifies that

you have received no goods or services in return for your gifts”,

and informed petitioner that attached was a Form 8283, Noncash

Charitable Contributions, executed by the appraiser and NAT.

     On June 23, 2004, Kearns signed the conservation deed on

behalf of NAT.    On September 21, 2004, the City of New York

recorded the conservation deed of easement for the Vanderbilt

property.   The deed of easement for the subject property is

considered to be only an architectural facade conservation

easement.

     Petitioner attached Form 8283 to her 2004 Form 1040, U.S.

Individual Income Tax Return, and reported a $115,000 gift to

charity on line 16 of Schedule A, Itemized Deductions.    The Form

8283 filed had two versions of page 2, with one signed by the

appraiser and president of NAT and the other lacking these

signatures.   Both reported essentially the same information:   (1)

A description of the donated property as a facade easement with

respect to the Vanderbilt property; (2) the overall physical

condition being a “Historic Preservation Easement Donation”; and

(3) a stated appraised fair market value of $115,000 for the
                              - 12 -

donated property.   On the executed page 2, Drazner signed the

declaration of appraiser section and identified the appraisal

date as May 20, 2004, and Kearns, as president of NAT, signed an

acknowledgement of receipt of the contribution by NAT, as donee,

on June 23, 2004.

     On her 2004 tax return, petitioner did not claim a deduction

for the full $115,000 because of limitations provided under

section 170(b).   Petitioner carried over $63,083 of the reported

contribution to her 2005 tax return and claimed a deduction of

$59,959 according to section 170(d)(1).   The remaining $3,124 was

carried over and claimed as a deduction on petitioners’ jointly

filed 2006 tax return.   No charitable contribution deduction for

the cash payment to NAT was claimed on the tax return filed for

2004, 2005, or 2006.

     Somoza prepared petitioner’s tax returns for 2004 and 2005

and petitioners’ joint tax return for 2006 using information

supplied by petitioners.

     In the notice of deficiency sent to petitioner for 2004 and

2005, petitioner’s deduction for a charitable contribution of

property was not allowed because:

          The contribution of property to a qualifying
     organization is measured by the fair market value of
     that property at the time the gift is made. Based upon
     all available information, you have not established the
     fair market value. Therefore, we have disallowed your
     charitable contribution deduction of property in full.
                               - 13 -

The carryovers claimed for 2005 and 2006 were accordingly

disallowed.

                               OPINION

     Section 170(a)(1) allows as a deduction any charitable

contribution verified under regulations prescribed by the

Secretary.    Generally, an individual claiming a noncash

charitable contribution of more than $5,000 is required to:

(1) Obtain a qualified appraisal of such property, (2) attach a

fully completed appraisal summary (i.e., Form 8283) to the tax

return on which the deduction is claimed, and (3) maintain

records pertaining to the claimed deduction in accordance with

section 1.170A-13(b)(2)(ii), Income Tax Regs.   Sec. 1.170A-

13(c)(2), Income Tax Regs.

     Section 170(f)(11), added as part of the American Jobs

Creation Act of 2004, Pub. L. 108-357, sec. 883, 118 Stat. 1631,

is effective for contributions made after June 3, 2004.      Section

170(f)(11)(E) provides that the term “qualified appraisal” means

an appraisal that is treated as a qualified appraisal under

regulations or other guidance prescribed by the Secretary.

Section 170(f)(11)(H) gives the Secretary authority to prescribe

regulations to carry out the purposes of this section.      For

appraisals prepared with respect to returns filed on or before

August 17, 2006, the requirements under section 1.170A-13(c),
                              - 14 -

Income Tax Regs., related to a qualified appraisal and qualified

appraiser, apply.   See Notice 2006-96, 2006-2 C.B. 902.

     The regulations state, among other things, that a qualified

appraisal is made not earlier than 60 days before the date of

contribution of the appraised property nor later than the due

date of the tax return on which a deduction is first claimed; is

prepared, signed, and dated by a qualified appraiser; and

includes the following information:

          (A) A description of the property in sufficient
     detail for a person who is not generally familiar with
     the type of property to ascertain that the property
     that was appraised is the property that was (or will
     be) contributed;

          (B) In the case of tangible property, the physical
     condition of the property;

          (C) The date (or expected date) of contribution to
     the donee;

           (D) The terms of any agreement or understanding
     entered into (or expected to be entered into) by or on
     behalf of the donor or donee that relates to the use,
     sale, or other disposition of the property contributed,
     * * *

          (E) The name, address, and * * * identifying
     number of the qualified appraiser; * * *

          (F) The qualifications of the qualified appraiser
     who signs the appraisal, including the appraiser’s
     background, experience, education, and membership, if
     any, in professional appraisal associations;

          (G) A statement that the appraisal was prepared
     for income tax purposes;

          (H) The date (or dates) on which the property was
     appraised;
                              - 15 -

          (I) The appraised fair market value (within the
     meaning of §1.170A-1(c)(2)), of the property on the
     date (or expected date) of contribution;

          (J) The method of valuation used to determine the
     fair market value, such as the income approach, the
     market-data approach, and the replacement-cost-less-
     depreciation approach; and

          (K) The specific basis for the valuation, such as
     specific comparable sales transactions or statistical
     sampling, including a justification for using sampling
     and an explanation of the sampling procedure employed.

Sec. 1.170A-13(c)(3)(ii), Income Tax Regs.

     The appraisal summary must include, among other things, a

description of the property in sufficient detail for a person who

is not generally familiar with the type of property to ascertain

that the property appraised is the property that was contributed,

a brief summary of the property’s physical condition, the manner

and date of acquisition, and the cost or other basis of the

property.   See sec. 1.170A-13(c)(4)(ii), Income Tax Regs.

     Respondent argues that the Form 8283 attached to

petitioner’s 2004 tax return did not satisfy the requirements

outlined in section 1.170A-13(c)(4), Income Tax Regs.

Petitioners assert that the Form 8283 included all the required

information.

     The Form 8283 attached to petitioner’s 2004 tax return did

not include the date and manner of acquisition of the property

purportedly contributed or the cost or other basis of the

property purportedly contributed, adjusted as provided by section
                              - 16 -

1016.   These defects alone demonstrate that there has not been

strict compliance with the regulation requirements.

     Respondent contends further that petitioners did not satisfy

the requirements of section 1.170A-13(c), Income Tax Regs.,

regarding obtaining a qualified appraisal because the Drazner

report did not describe the property contributed; did not include

the terms of the deed of easement; did not include a statement

that it was prepared for income tax purposes; and did not provide

the method and specific basis for valuing the easement.

Petitioners assert that these requirements were satisfied.

     The evidence at trial, notably conflicting expert testimony,

and the arguments of the parties, deal in large part with

valuation of the facade easement by traditional fair market

analysis.   Because we conclude that the Drazner report is not a

qualified appraisal, we do not discuss this evidence or reach a

conclusion as to the value of the easement.

     Section 1.170A-13(c)(3)(ii)(J), Income Tax Regs., provides

that the qualified appraisal is to include the method of

valuation used to determine the fair market value, such as the

income approach, the market-data approach, and the replacement-

cost-less-depreciation approach.   These methods are suggested,

but not mandatory.   Further, other valuation methods were

contemplated in the legislative history of the Act of Dec. 17,

1980, Pub. L. 96-541, 94 Stat. 3204, regarding the deduction for
                              - 17 -

charitable contributions of real property for conservation

purposes under section 170:

          In general, a deduction is allowed for a
     charitable contribution in the amount of the fair
     market value of the contributed property, defined as
     the price at which the property would change hands
     between a willing buyer and a willing seller. Thus,
     the amount of the deduction for the contribution of a
     conservation easement or other restriction is the fair
     market value of the interest conveyed to the recipient.
     However, because markets generally are not well
     established for easements or similar restrictions, the
     willing buyer/willing seller test may be difficult to
     apply * * *. As a consequence, conservation easements
     are typically (but not necessarily) valued indirectly
     as the difference between the fair market value of the
     property involved before and after the grant of the
     easement. (See Rev. Rul. 73-339, 1973-2 C.B. 68 and
     Rev. Rul. 76-376, 1976-2 C.B. 53). Where this test is
     used, however, the committee believes it should not be
     applied mechanically. [S. Rept. 96-1007, at 14-15
     (1980), 1980-2 C.B. 599, at 606.]

     As the Drazner report states, and we have previously noted,

comparable sales transactions involving real estate with similar

facade easements are not always available.   See Hilborn v.

Commissioner, 85 T.C. at 688; Simmons v. Commissioner, T.C. Memo.

2009-208.   The “before and after” approach has been used on

numerous occasions to determine the fair market values of

restrictive easements with respect to which charitable

contribution deductions are claimed.   See, e.g., Hilborn v.

Commissioner, supra; Simmons v. Commissioner, supra; Griffin v.

Commissioner, T.C. Memo. 1989-130, affd. 911 F.2d 1124 (5th Cir.

1990).
                              - 18 -

     As we outlined in Hilborn v. Commissioner, supra at 689-690:

          “Before” value (before value) is arrived at by
     first determining the highest and best use of the
     property in its current condition unrestricted by the
     easement. At this stage, the suitability of the
     property’s current use under existing zoning and market
     conditions and realistic alternative uses are examined.
     Any suggested use higher than current use requires both
     “closeness in time” and “reasonable probability.”
     Next, to the extent possible, the three commonly
     recognized methods of valuing property (capitalized net
     operating income, replacement cost, and comparable
     sales) are used, but are modified to take into account
     any peculiarities of the property which impact on the
     relative weight to be afforded each respective method.

          “After” value (after value) is arrived at by first
     determining the highest and best use of the property as
     encumbered by the easement. At this stage the
     easement’s terms and covenants are examined,
     individually and collectively, and compared to existing
     zoning regulations and other controls (such as local
     historic preservation ordinances) to estimate whether,
     and the extent to which, the easement will affect
     current and alternate future uses of the property.
     Next, the above-mentioned three approaches to valuing
     property are again utilized to estimate the value of
     the property as encumbered by the easement.

     The Drazner report purportedly employed the before and after

method.   To determine the “before” market value of the Vanderbilt

property, Drazner considered the three approaches to value (sales

comparison, cost, and income).   Drazner’s determination of the

“after” value stated that it was “based on consideration of a

range of value that the I.R.S. has historically found to be

acceptable as well as historical precedents.”   Petitioners

contend that this satisfies the requirements of section 1.170A-

13(c)(3)(ii)(J) and (K), Income Tax Regs., by identifying:
                              - 19 -

     (a) the method of valuation used to determine the fair
     market value (i.e., the appraiser’s comparison of the
     Primoli Memorandum’s accepted range of values as
     narrowed down according to the appraiser’s judgment);
     and (b) the specific basis for the valuation (i.e., the
     lack of market data, IRS publications and case law).

     We have previously held that such information as the

valuation method used or the basis for the appraised value is

essential because “‘Without any reasoned analysis, * * * [the

appraiser’s] report is useless.’”   Friedman v. Commissioner, T.C.

Memo. 2010-45 (quoting Jacobson v. Commissioner, T.C. Memo. 1999-

401).   In Nicoladis v. Commissioner, T.C. Memo. 1988-163, we

found that the facade easement did result in a 10-percent

decrease in value under the facts and circumstances of the case,

but further stated that

     we do not mean to imply that a general “10-percent
     rule” has been established with respect to facade
     donations. There was a fair amount of discussion by
     the parties at trial about whether the Court had
     established a “10-percent rule” in Hilborn. We did not
     there and do not here. Hilborn establishes as
     acceptable the before and after method of valuation,
     and while under the circumstances of that case a 10-
     percent figure was relied upon, valuation itself is
     still a question of facts and circumstances. * * *

     There have been additional cases in which percentage

reductions have been accepted to determine an easement’s value

based on qualitative factors that suggest such a value.    See,

e.g., Griffin v. Commissioner, supra; Losch v. Commissioner, T.C.

Memo. 1988-230.   However, Drazner’s report failed to outline and

analyze qualitative factors for the Vanderbilt property.
                              - 20 -

     Petitioners argue that the Drazner report outlined the

methodology set forth to determine the “after” fair market value

and assert that Drazner explained at trial that his appraisal was

“not mechanical, it was reasoned.”     However, the application of a

percentage to the fair market value before conveyance of the

facade easement, without explanation, cannot constitute a method

of valuation as contemplated under section 1.170A-13(c)(3)(ii),

Income Tax Regs.   Drazner’s report applied mechanically a

percentage with no demonstrated support as to its derivation,

other than acceptance of similar percentages in prior

controversies.   Further, no meaningful analysis was provided in

the Drazner report to explain why Drazner applied 11.33 percent

to the before fair market value of the property to calculate the

facade easement value other than his statement:

     For most attached row properties in New York City,
     where there are many municipal regulations restricting
     changes to properties located in historic districts,
     the facade easement value tends to be about 11 - 11.5%
     of the total value of the property. That figure is
     based on the appraiser’s experience as to what the
     Internal Revenue Service has found acceptable (on prior
     appraisals).

This assertion fails to explain how the specific attributes of

the subject property led to the value determined in the Drazner

report.

     The Drazner report indicated that estimating the value of a

property after the donation of a facade conservation easement is

much like condemnation appraisal practice that includes attempts
                                   - 21 -

to define what rights have been lost by the property owners and

what elements of damage (or enhancement) are involved in the

loss.   Such an analysis was not included in the Drazner report

for the Vanderbilt property.

     At trial, when asked by respondent’s counsel to explain how

he determined the after value of the property and how he measured

the effect of the facade easement on the property, Drazner

testified:

          A: Based on prior legal cases in summaries that
     the facade easement donations were between 10 and 15
     percent. So, I applied the fee simple value and I
     multiplied them by a factor of 11 percent to arrive at
     the effect of the easement donation as to that would be
     the deduction of the fee simple value, the deduction
     from the before value.

          Q: Did you round the value at all after you
     applied 11 percent, round the value of the effect of
     the easement?

            A:   I usually did.

          Q:     What was the number approximately that you did
     round?

            A:   I would say the closest $5,000.

          Q: Now, did you use this process for any other
     easements * * * ?

            A:   Yes, I did.

            *        *         *       *     *      *       *

            Q:   Did your methodology or process change in any
     way?

          A: In some cases I would use a different
     percentage factor.
                                 - 22 -

             Q:   What was that based on?

          A: Whether the property * * * [was] attached,
     semi-attached, or detached on all sides.

             Q:   Did you base it on anything else?

          A: No. In general I based it on between the 10
     and 15 percent standard, and within that range I would
     use a lower number if the property * * * [was] attached
     on both sides, as in the case of * * * [petitioner’s]
     property. In other cases if the property were
     detached, I would use a slightly higher percentage.

Petitioners’ counsel questioned Drazner about the number of sales

of easement-encumbered properties that he was aware of at the

time he conducted the appraisal for petitioner, with Drazner

testifying that

             A:   I believe that I only knew of one.

          Q:      The one that you knew of, was that on Willow
     Street?

             A:   Yes, it was.

             Q:   Did you personally appraise that property?

          A: I believe that I appraised it for the easement
     donation purpose.

          Q: How did you come to the conclusion that your
     appraisal was correct?

             A:   Which appraisal are you referring to?

             Q:   The subsequent sale of the property was less
     than.

          A: I had done many appraisals in that
     neighborhood, and based on sales of properties similar
     to that property on Willow Street in records to lot
     size and the building square footage, their property
     sold for a lower price than I believe it would have
     sold without the easement encumbrance.
                               - 23 -

     No further information regarding the details or

specifications of the Willow Street property was supplied, and it

was not a part of the Drazner report.    Drazner testified that he

had performed many appraisals in the neighborhood of the Willow

Street property, and on the basis of sales of similar properties

in the area, he was able to determine that the property sold for

a lower price than the property’s market value without the

easement encumbrance.    Drazner stated that he believed this sale

confirmed that an easement encumbrance reduces the fair market

value of a property.    Further information regarding the Willow

Street property, such as the fair market value assumed by Drazner

at the time of the sale, had it been sold without the encumbering

easement, compared to the actual sale price; terms of the

easement; and whether the property is within a recognizable

historic district would be necessary to assess the reliability of

the Drazner analysis.

     Petitioners rely on a quotation from Simmons v.

Commissioner, T.C. Memo. 2009-208, that “appraisals also include

discussions of IRS practice and cases of this Court concerning

facade easements”, to assert that the Drazner methodology is

sufficient to satisfy the qualified appraisal reporting

requirements.   However, in Simmons, the appraisals included

statistics gathered by the donee organizations that the appraiser

took into account; and each appraisal identified the method of
                              - 24 -

valuation used and the basis for the valuations reached.   The

Drazner report used only estimates based on prior cases and

displayed no independent or reliable methodology applied to the

subject property as the basis for the valuation reached.   Thus,

we conclude that petitioners have failed to comply with the

substantiation requirements under section 170(f) and section

1.170A-13, Income Tax Regs.

     Petitioners argue that their compliance with the

substantiation requirements should be excused on the ground of

reasonable cause.   Section 170(f)(11)(A)(ii)(II) provides that

the requirement to obtain a qualified appraisal under section

170(f)(11)(C) will not apply if it is shown that the failure to

meet the requirement is due to reasonable cause and not due to

willful neglect.

     Petitioner obtained an appraisal that we have concluded is

not a qualified appraisal under section 170(f)(11).   Although the

regulations do not require that a specific method of valuation

be used to determine the fair market value for noncash

contributions of more than $5,000, the appraisal must still

include the method of valuation used and the specific basis for

the valuation.   See sec. 1.170A-13(c)(3)(ii)(J) and (K), Income

Tax Regs.   Petitioners have not persuaded us that reasonable

cause existed and excuses the failure to comply with the

requirements for obtaining a qualified appraisal.
                               - 25 -

      Petitioners next assert that they are entitled to a

deduction for the charitable contribution of the facade easement

because they substantially complied with the regulations.

      Under the substantial compliance doctrine, the critical

question is whether the requirements relate “‘to the substance or

essence of the statute.’”    Bond v. Commissioner, 100 T.C. 32, 40-

41 (1993) (quoting Sperapani v. Commissioner, 42 T.C. 308, 331

(1964)).    If so, strict adherence to all statutory and regulatory

requirements is mandatory.   See Dunavant v. Commissioner, 63 T.C.

316, 319-320 (1974).   However, if the requirements are procedural

or directory in that they are not of the essence of the things to

be done but are given with a view to the orderly conduct of

business, then they may be fulfilled by substantial compliance.

See id.    We have previously held that the reporting requirements

of section 1.170A-13, Income Tax Regs., are directory and require

only substantial compliance.    Bond v. Commissioner, supra at 41-

42.

      In Bond, the taxpayers donated two blimps to a charitable

organization and obtained a professional appraisal of the blimps

in that same month.    The appraiser completed an appraisal summary

for inclusion with the taxpayers’ tax return but did not provide

a separate written report of the appraisal.   The appraisal

summary contained most of the information required for a

qualified appraisal, and the taxpayers promptly furnished the IRS
                               - 26 -

with a letter outlining the appraiser’s qualifications and the

appraisal methodology used shortly after the audit of their tax

return commenced.   Id. at 34-35.

     In Simmons v. Commissioner, supra, we found that the

taxpayer had substantially complied with the substantiation

requirements of section 170 because she “included all of the

required information in the appraisals attached to her returns or

on the face of the returns.”

     Petitioners claim they substantially complied with the

substantiation requirements of section 170 because, as in Bond

and Simmons, the documents that they submitted included the

information required for a qualified appraisal and appraisal

summary.   We disagree.   In this case the lack of a recognized

methodology or specific basis for the calculated after-donation

value is too significant for us to ignore under the guise of

substantial compliance.

     When a qualified appraisal has not been submitted, we have

not applied the doctrine of substantial compliance to excuse a

taxpayer’s failure to meet the qualified appraisal requirement.

See, e.g., Hewitt v. Commissioner, 109 T.C. 258, 264-266 (1997),

affd. without published opinion 166 F.3d 332 (4th Cir. 1998);

D’Arcangelo v. Commissioner, T.C. Memo. 1994-572.    We cannot

accept the Drazner report as a qualified appraisal complying with

the substantiation requirements of section 170.
                                - 27 -

     We conclude that petitioners did not substantially comply

with section 1.170A-13(c), Income Tax Regs.   Accordingly,

petitioners are not entitled to the claimed noncash charitable

contribution deduction.

     Respondent argues in the alternative that petitioner’s

contribution of the easement failed to meet the section 170(h)

requirements for a qualified conservation contribution because it

was not exclusively for conservation purposes and is not

protected in perpetuity according to section 1.170A-14(g)(6),

Income Tax Regs.    See, e.g., Kaufman v. Commissioner, 134 T.C.

___ (2010).    We do not reach the contentions that the easement

does meet the requirements of section 170(h) because we conclude

that petitioners did not satisfy the requirement of obtaining a

qualified appraisal.

Deductibility of Cash Payment

     Petitioner did not claim a charitable contribution deduction

on her 2004 tax return for the $9,275 check dated June 18, 2004,

paid to NAT.   Petitioners noted this in their pretrial memorandum

and raised the deductibility of this payment at trial. Respondent

initially objected to trying this issue, but subsequently

conceded that this issue was tried by consent.

     Respondent asserts that petitioner’s cash payment to NAT was

not a “contribution or gift” under section 170(a) and that the

payment was made as a quid pro quo because NAT accepted the
                               - 28 -

facade easement and assisted petitioner in claiming a tax

deduction in return for petitioner’s cash payment, calculated as

a percentage of petitioner’s valuation of the facade easement.

       A payment of cash to a qualified organization may be

deductible under section 170 if the payment is a “contribution or

gift”.    A payment of money or transfer of property generally

cannot constitute a charitable contribution if the contributor

expects a substantial benefit in return.    See United States v.

Am. Bar Endowment, 477 U.S. 105, 116 (1986).

       If a transaction is structured in the form of a quid
       pro quo, where it is understood that the taxpayer’s
       money will not pass to the charitable organization
       unless the taxpayer receives a specific benefit in
       return, and where the taxpayer cannot receive the
       benefit unless he pays the required price, then the
       transaction does not qualify for the deduction under
       section 170.

Graham v. Commissioner, 822 F.2d 844, 849 (9th Cir. 1987), affd.

sub nom. Hernandez v. Commissioner, 490 U.S. 680 (1989).

       A taxpayer who receives or expects to receive a benefit in

return for a purported contribution may nonetheless be allowed a

deduction if the money or property transferred clearly exceeds

the benefit received and the excess is given with the intent to

make a gift.    See United States v. Am. Bar Endowment, supra at

117.    A taxpayer claiming a charitable contribution deduction

under this “dual character” theory, however, “must at a minimum

demonstrate that * * * [she] purposely contributed money or
                                - 29 -

property in excess of the value of any benefit * * * [she]

received in return.”   Id. at 117-118.

     Petitioners failed to provide evidence necessary for us to

determine that in return for the payment of cash to NAT they

received nothing of substantial value or, if they did receive

something of substantial value, that they are entitled to a

partial charitable contribution deduction because the payment

exceeded the value of the benefits received.    Accordingly, we

hold that petitioners have not sustained their burden of proving

that they are entitled to deduct any portion of the amount paid

to NAT as a charitable contribution under section 170.

Section 6662 Accuracy-Related Penalty

     Petitioners contest the imposition of an accuracy-related

penalty under section 6662(a).    Section 6662(a) and (b)(1) and

(2) imposes a 20-percent accuracy-related penalty on any

underpayment of Federal income tax attributable to a taxpayer’s

negligence or disregard of rules or regulations, or a substantial

understatement of income tax.    Section 6662(d)(1)(A) defines

“substantial understatement of income tax” as an amount exceeding

the greater of 10 percent of the tax required to be shown on the

return or $5,000.

     Under section 7491(c), the Commissioner bears the burden of

production with regard to penalties and must come forward with

sufficient evidence indicating that it is proper to impose
                              - 30 -

penalties.   Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

However, once the Commissioner has met the burden of production,

the burden of proof remains with the taxpayer, including the

burden of proving that the penalties are inappropriate because of

reasonable cause or substantial authority.    Id. at 446-447.

      Respondent asserts that substantial understatements of

income tax exist for 2004 and 2005.    Each of the deficiencies,

after disallowance of the charitable contribution deductions

attributable to the easements, is greater than $5,000 and greater

than 10 percent of the amount of tax required to be shown on the

return.   Respondent’s burden of production has been met for 2004

and 2005.

      The accuracy-related penalty under section 6662(a) is not

imposed with respect to any portion of the underpayment as to

which the taxpayer acted with reasonable cause and in good faith.

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, including the taxpayer’s experience, knowledge,

and education.   Sec. 1.6664-4(b)(1), Income Tax Regs.

“Generally, the most important factor is the extent of the

taxpayer’s effort to assess the taxpayer’s proper tax liability.”

Id.   Reliance on professional advice may constitute reasonable

cause and good faith, but only if, under all the circumstances,
                                - 31 -

such reliance was reasonable.     Freytag v. Commissioner, 89 T.C.

849, 888 (1987), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501

U.S. 868 (1991); sec. 1.6664-4(b)(1), Income Tax Regs.

Reasonable cause exists where a taxpayer relies in good faith on

the advice of a qualified tax adviser where the following three

elements are present:   “(1) The adviser was a competent

professional who had sufficient expertise to justify reliance,

(2) the taxpayer provided necessary and accurate information to

the adviser, and (3) the taxpayer actually relied in good faith

on the adviser’s judgment.”     Neonatology Associates, P.A. v.

Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir.

2002).

     Petitioner credibly testified that she was not a tax expert

and hired Somoza to ensure that her tax returns were properly

filed.   Somoza was a competent tax professional, though not

knowledgeable about facade easement donations.     As petitioner’s

return preparer of many years, he was involved with petitioner’s

facade easement contribution from the beginning and had access to

all the information needed to properly evaluate the tax treatment

of the facade conservation easement.     Somoza relied in turn on

Drazner, whom the parties agree is a qualified appraiser for

purposes of section 170, regarding the value of the noncash

charitable contribution.
                             - 32 -

     We conclude that petitioner had reasonable cause and acted

in good faith as to any underpayment for 2004 and therefore is

not liable for the penalty for that year.   The 2005 and 2006

underpayments resulted from carryovers from 2004, so the

penalties for those years also will not be sustained.

     We have considered the other arguments of the parties but do

not reach them because of our conclusion on a decisive issue.

To reflect the foregoing,


                                        Decision will be entered

                                   for respondent as to the

                                   deficiencies and for

                                   petitioners as to the

                                   penalties.
