                            142 T.C. No. 16



                   UNITED STATES TAX COURT



 LOGAN M. CHANDLER AND NANETTE AMBROSE-CHANDLER,
Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket No. 16534-08.                      Filed May 14, 2014.



        Ps granted to a qualified organization facade easements on two
 historic homes they owned. They claimed charitable contribution
 deductions for 2004, 2005, and 2006 based on fair market value
 appraisals of the easements. A portion of each of the 2005 and 2006
 deductions resulted from a carryforward of a deduction they first
 claimed for 2004. R disallowed the deductions because he
 determined the easements were valueless. R imposed gross valuation
 misstatement penalties on the underpayments resulting from the
 alleged easement overvaluations.

        Ps sold one of the homes in 2005 and reported capital gain. In
 calculating the gain Ps reported a basis in the home that exceeded
 their purchase price. They claim the basis increase resulted from
 costs they incurred to improve the home. They failed to substantiate
 the full amount of the improvement costs. R disallowed the entire
 basis increase and imposed an accuracy-related penalty on the
 resulting underpayment.
                                  -2-

        Ps contend they had reasonable cause for any underpayments
and thus should not be liable for penalties. R claims that recent
amendments to the gross valuation misstatement penalty preclude Ps
from raising a reasonable cause defense for their 2006 underpayment.
Ps argue that part of that underpayment resulted from a deduction
carried forward from a return they filed before the amended rules took
effect. They argue that applying the amended reasonable cause rules
to their 2006 return would give the penalty amendments retroactive
effect.

      Held: Ps failed to prove their easements had any value and
consequently were not entitled to claim related charitable contribution
deductions.

      Held, further, Ps adequately substantiated a portion of the basis
increase they claimed on the home they sold and were entitled to
reduce their capital gain by the substantiated amount.

      Held, further, Ps are liable for an accuracy-related penalty for
the portion of their 2005 underpayment resulting from
unsubstantiated basis increases they claimed on the home they sold.

      Held, further, Ps are not liable for gross valuation misstatement
penalties for their 2004 and 2005 underpayments, because they
underpaid with reasonable cause and in good faith.

       Held, further, Ps are liable for a gross valuation misstatement
penalty for their 2006 underpayment because the rules in effect when
they filed their 2006 return did not provide a reasonable cause
exception. Denying Ps’ reasonable cause defense does not amount to
retroactive application of the gross valuation misstatement penalty
amendments.
                                         -3-

      Denis J. Conlon, Steven S. Brown, and Mason N. Floyd, for petitioner.

      Carina J. Campobasso, for respondent.



      GOEKE, Judge: Petitioners owned two single-family residences in

Boston’s South End Historic District. They granted a facade easement on each

property to the National Architectural Trust (NAT) and claimed related charitable

contribution deductions for taxable years 2004, 2005, and 2006. In 2005

petitioners sold one of the properties and reported a capital gain. Petitioners

claimed a basis in the property that reflected $245,150 of improvements.

      Respondent disallowed petitioners’ charitable contribution deductions

because he determined the easements had no value. He also found that petitioners

had understated their gain on the property sale because they had overstated their

basis in the property. Finally, respondent determined that petitioners were liable

for accuracy-related penalties under section 6662.1




      1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
                                        -4-

      After concessions,2 the issues remaining for decision are:

      (1) whether the charitable contribution deductions petitioners claimed for

granting conservation easements to NAT exceeded the fair market values of the

easements. We hold they did;

      (2) whether petitioners overstated their basis in the property they sold in

2005. We hold they did, but they were entitled to increase their basis for

improvement costs they properly substantiated; and

      (3) whether petitioners are liable for accuracy-related penalties under

section 6662. We hold they are but in amounts less those respondent determined.

                               FINDINGS OF FACT

      Some facts were stipulated and are so found. Petitioners resided in

Massachusetts when they filed their petition.

A. Background

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

each of the years in issue. Mr. Chandler has a law degree and a master’s in




      2
       Petitioners have conceded their liability for a $1,064.85 addition to tax
under sec. 6651(a)(1) for delinquently filing their 2004 return. Respondent has
conceded that petitioners’ donation of the easements complies with the
requirements for deduction under sec. 170. Respondent disputes only petitioners’
valuation of the easements.
                                         -5-

business administration and works as a business consultant. Mrs. Ambrose-

Chandler owns and operates an interior design company.

      In 2003 petitioners purchased a home at 24 Claremont Park in Boston,

Massachusetts (Claremont property). In 2005 petitioners purchased another home

in Boston at 143 West Newton Street (West Newton property). Both homes are in

Boston’s South End, which the Federal Government has included in the National

Register of Historic Places and designated a National Historic Landmark District.

B. Conservation Easements

      Congress has created the Federal Historic Preservation Tax Incentives

Program to encourage the preservation of historic structures. Under the program,

owners of historic buildings may be entitled to charitable contribution deductions

when they grant conservation easements on their buildings to organizations that

will protect the buildings’ historic character. The National Park Service (NPS)

publicizes the program and assists the IRS in administering it. Mr. Chandler read

about the program in a newspaper, and petitioners decided to grant a facade

easement to NAT on the Claremont property. When they purchased the West

Newton property, they again decided to grant a facade easement to NAT.

      Under the terms of each easement, the property owner must obtain NAT’s

approval before beginning any construction that will alter the exterior of the
                                         -6-

building. NAT periodically sends representatives to inspect properties on which

NAT holds easements. If the inspector determines that a property owner has made

unauthorized changes, NAT can order remediation.

      Boston’s municipal government has formed nine local historic district

commissions to regulate construction within their jurisdictions. The South End

Landmark District Commission (SELDC) has jurisdiction over the properties at

issue here. The SELDC’s powers closely approximate NAT’s powers under the

easement agreements with some exceptions.

      First, the SELDC has no power to regulate construction that is not visible

from a public way and may not require property owners to make repairs. The

easement agreements grant NAT authority to regulate construction and order

repairs on any exterior surface of the home. Second, NAT has staff members who

perform annual site visits, while the SELDC relies on the public to alert it to

potential violations. Finally, NAT has absolute authority to enforce the terms of

its easements, even when doing so would produce substantial economic hardship

for the property owner. Under Massachusetts law, a property owner who faces

significant financial hardship may receive an exemption from the SELDC’s

enforcement. See Mass. Gen. Laws ch. 772, sec. 8 (1975).
                                        -7-

      Petitioners claimed charitable contribution deductions related to the

easements on their 2004, 2005, and 2006 tax returns. Petitioners followed

guidance from the NPS and consulted their easement holding organization to find

an appraiser to value their easements. NAT recommended George Riethof and

George Papulis, who valued the Claremont easement at $191,400 and the West

Newton easement at $371,250. Petitioners consulted with their accountant

concerning the appraisals before claiming deductions on their returns. Because of

relevant limitations, petitioners deducted the values of the easements over several

years. For the years in issue (2004, 2005, and 2006) petitioners claimed

deductions for the easements of $73,059, $83,939, and $296,251 respectively.

      Respondent determined the easements had no value because they did not

meaningfully restrict petitioners’ properties more than local law. Petitioners have

abandoned their original appraisals, but they have presented new expert testimony

supporting the values they claimed on their returns.

C. Gain on Home Sale

      Petitioners purchased the Claremont property for $755,000 in 2003 when it

was in poor condition. They renovated the property and in 2005 sold it for

$1,540,000. On their 2005 return, petitioners reported an adjusted basis in the

property that included $245,150 of improvement costs. During his examination,
                                         -8-

respondent requested documentation substantiating the basis increase, but

petitioners had misplaced their receipts. Later, petitioners produced receipts for

expenses totaling $147,824.

      Respondent’s examiner initially concluded that petitioners had substantiated

$60,000 of renovation costs. However, upon closer review, respondent noticed

that petitioners had claimed larger than average cost of goods sold deductions for

Mrs. Ambrose-Chandler’s interior design business for the years during the

renovations. Respondent believed that petitioners had deducted the renovation

expenses on their Schedules C, Profit or Loss From Business, for 2004 and 2005,

and accordingly respondent disallowed the entire $245,150 basis increase.

Respondent did not seek substantiation for petitioners’ Schedule C deductions

during the audit.

                                     OPINION

I. Conservation Easements

      A. Background

      Congress has provided tax benefits to taxpayers who grant conservation

easements over historic properties they own. A conservation easement allows a

third party, typically a charitable organization, to monitor the owner’s use of
                                         -9-

property. An organization holding an easement may prevent the owner from

changing the property in a way that would destroy its historic character.

      Under section 170, if taxpayers meet certain criteria, they may claim

charitable contribution deductions for the fair market value of conservation

easements they donate to certain organizations. See sec. 170(f)(3)(B)(iii); sec.

1.170A-1(c)(1), Income Tax Regs. Respondent concedes that petitioners have

satisfied the technical requirements for the deductions, but he disputes their

valuations of the easements. Petitioners bear the burden of proving their

deductions reflected the easements’ fair market values. See Rule 142(a)(1).

      Easements are usually transferred by gift; consequently, we rarely have an

established market on which to rely in determining their value. Simmons v.

Commissioner, T.C. Memo. 2009-208, aff’d, 646 F.3d 6 (D.C. Cir. 2011); see also

Hilborn v. Commissioner, 85 T.C. 677, 688 (1985). We have often used the

“before and after” approach to value restrictive easements for which taxpayers

have claimed deductions. See, e.g., Hilborn v. Commissioner, 85 T.C. at 688-689;

Simmons v. Commissioner, T.C. Memo. 2009-208; Griffin v. Commissioner, T.C.

Memo. 1989-130, aff’d, 911 F.2d 1124 (5th Cir. 1990). Under this approach the

fair market value of the restriction is equal to the difference (if any) between the

fair market value of the property without the restriction (before value) and its fair
                                        -10-

market value with the restriction (after value). Sec. 1.170A-14(h)(3)(I), Income

Tax Regs. When a conservation easement enhances or does not materially affect

the property’s value, the taxpayer may not claim a deduction. Sec. 1.170A-

14(h)(3)(ii), Income Tax Regs.

      An appraiser may use the comparable sales method or another accepted

method to estimate the before and after values of the property. Hilborn v.

Commissioner, 85 T.C. at 689-690. An appraiser using the comparable sales

method identifies property sales that meet three criteria: (1) the properties

themselves are similar to the subject property; (2) the sales are arm’s-length

transactions; and (3) the sales have occurred within a reasonable time of the

valuation date. Wolfsen Land & Cattle Co. v. Commissioner, 72 T.C. 1, 19

(1979). The appraiser uses the sale prices of the comparable properties to estimate

the value of the subject property.

      Both parties submitted expert reports concerning the values of petitioners’

easements. Petitioners’ expert was Michael Ehrmann, and respondent’s expert

was John C. Bowman III.
                                        -11-

      B. The Ehrmann Report

      Using the comparable sales approach Mr. Ehrmann calculated before values

for the Claremont property and the West Newton property of $1,385,000 and

$2,950,000 respectively.

      To estimate the properties’ after values, he attempted to quantify the effect

of petitioners’ easements. Mr. Ehrmann analyzed sales of seven properties

encumbered with easements similar to petitioners’. He compared those sales with

sales of comparable unencumbered properties to determine whether the easements

diminished property values. Of the seven encumbered properties he chose, four

were in Boston and three were in New York City. Accounting for Mr. Ehrmann’s

adjustments, the encumbered properties in the sample sold for an average of

18.5% less than the unencumbered properties.3

      Mr. Ehrmann also included in his report information concerning a

settlement agreement arising from the sale of encumbered property in New

Orleans. The property’s seller did not disclose an existing conservation easement


      3
        Mr. Ehrmann’s report contains procedural errors. He calculated the
easement values by dividing the difference in sale prices by the encumbered
property’s price. He then applied that percentage to the before value of
petitioners’ properties to calculate the easement values. He should have divided
the difference in sale prices by the unencumbered property’s sale price. We have
adjusted the data in his report to account for this error.
                                        -12-

to the buyer. After the buyer bought the property, he discovered the easement and

sued the seller. The parties settled the dispute for 14.6% of the sale price. Mr.

Ehrmann claims that the settlement represents direct market valuation of the

easement restriction on the property.

      On the basis of his data, Mr. Ehrmann estimated that petitioners’ easements

diminished their property values by 16%. Accordingly, he valued the easements at

about 16% of their before values--$220,000 for the Claremont easement and

$470,000 for the West Newton easement.

      C. Ehrmann Report Analysis

      Although Mr. Ehrmann used an appropriate methodology to isolate the

easements’ effects on property values, certain factors undermine its

persuasiveness. The locations of the sample properties are our first concern. Mr.

Ehrmann chose seven encumbered properties to measure against comparable

unencumbered properties. Of those seven properties, only four are in Boston; the

other three are in New York City. He also provided information concerning a

property settlement in New Orleans. We find Mr. Ehrmann’s analysis of the

properties outside Boston unpersuasive. The values of easements in other markets

tell us little about easement values in Boston’s unique market.
                                       -13-

      Our second concern is the size of Mr. Ehrmann’s sample. We recognize

that the lack of encumbered property sales in petitioners’ neighborhood limited the

depth of Mr. Ehrmann’s analysis. Nevertheless, we must adjust our confidence in

his estimates accordingly. Although Mr. Ehrmann reviewed four encumbered

property sales in Boston, only one, “Easement Encumbered Sale #1”, is not

obviously flawed. “Easement Encumbered Sales #s 2 and 4” are flawed because

the “comparable” unencumbered property sales Mr. Ehrmann chose were not

actually comparable. “Easement Encumbered Sale #3” is flawed because one of

the comparable “unencumbered” properties was not actually unencumbered.

            1. Easement Encumbered Sale # 1

      “Easement Encumbered Sale #1” refers to the sale of the encumbered

Claremont property. Mr. Ehrmann compared this sale to the sale of unencumbered

property at 30 Claremont Park. Mr. Ehrmann determined the properties were in

the same condition and adjusted the comparable property’s sale price by only 1.3%

for other minor differences. The encumbered property sold for 12.5% less than the

unencumbered property.

            2. Easement Encumbered Sales #s 2 and 4

      “Easement Encumbered Sale #2” refers to the sale of the encumbered West

Newton property. Mr. Ehrmann compared this sale to sales of unencumbered
                                       -14-

properties at 118 West Newton Street and 176 West Canton Street. “Easement

Encumbered Sale #4” refers to the sale of encumbered property at 306

Marlborough Street. Mr. Ehrmann compared this sale to sales of unencumbered

properties at 285 Marlborough Street and 381 Beacon Street. Mr. Ehrmann

significantly adjusted the sale prices of the “comparables” before he compared

them to the encumbered property’s sale price. The adjustments ranged from

11.2% to 20.3% and included significant adjustments based on Mr. Ehrmann’s

subjective evaluation of the properties’ “condition”.4 Because of these significant

subjective adjustments, Mr. Ehrmann’s conclusions flowing from these

comparisons largely reflect his opinion rather than the objective market values of

the easements. When an appraiser makes numerous adjustments to a subject

property’s comparables, the subject property’s valuation becomes less reliable.

See Gorra v. Commissioner T.C. Memo. 2013-254, at *59. Accordingly, we give

these two comparisons little weight.

            3. Easement Encumbered Sale #3

      “Easement Encumbered Sale #3” refers to the sale of encumbered property

at 3 Cazenove Street. Mr. Ehrmann compared this sale to sales of comparable


      4
      The “condition” adjustments were: 5% for 118 West Newton, 15% for 176
West Canton, 20% for 285 Marlborough, and 10% for 381 Beacon.
                                        -15-

“unencumbered” properties at 6 St. Charles Street and 139 Appleton Street. After

adjustments, Mr. Ehrmann concluded that the Cazenove Street property sold for

12.8% and 18.5% less than the St. Charles Street and Appleton Street properties

respectively. He attributed these differences to the encumbrance on the Cazenove

Street property. However, the St. Charles Street property’s deed contains

restrictions that are substantially the same as those the Cazenove Street property’s

easement imposes. This indicates that the difference in price resulted from some

other factor that Mr. Ehrmann did not consider. This error undermines Mr.

Ehrmann’s credibility concerning not only this comparison, but the entire report.

      D. The Bowman Report

      Mr. Bowman did not independently evaluate the properties’ before values,

but he reviewed the appraisals petitioners relied on for their return. Those

appraisals included comparable sales analyses for each property. Mr. Bowman

determined that the appraisals were reasonable aside from one minor error that

resulted in a 10% undervaluation of the Claremont property. Mr. Bowman

corrected that error and assigned before values to the Claremont and West Newton

properties of $1,450,000 and $2,750,000 respectively.

      To analyze the impact of petitioners’ easements, Mr. Bowman selected nine

recently encumbered Boston properties that sold between 2005 and 2011. He
                                        -16-

compared their prices in the sales immediately preceding and succeeding the

imposition of their easements. Each property had sold for more after it had been

encumbered. Mr. Bowman annualized the appreciation rates between the sales

and compared them to city wide appreciation rates for upper-tier properties. He

found that the properties in his sample appreciated at a higher-than-average rate.

On the basis of his analysis, he concluded that easements like petitioners’ do not

diminish the values of the properties they restrict and thus have no value. Mr.

Bowman acknowledged that many of the homes in his sample had been

significantly renovated, but he did not try to remove the renovations’ effect on

appreciation from his analysis.

      E. Bowman Report Analysis

      Mr. Bowman’s sales analysis is not persuasive, because it does not isolate

the effect of easements on the properties in his sample. The properties in his

sample appreciated in spite of their restrictions. However, many of the properties

had been significantly renovated, and Mr. Bowman’s report does not account for

the renovations’ effects on the property values. The report demonstrates that,

combined, the renovations and easements positively affected value, but the report

does not isolate the effect of the easements. To measure one variable’s effect, one
                                       -17-

must hold all other variables constant. Mr. Bowman’s report does not measure

easements’ effect on value, because he has not held other variables constant.

      F. Conclusion

      We do not find Mr. Ehrmann’s report credible and therefore reject his

conclusion that petitioners’ easements diminished their property values by 16%.

However, Mr. Ehrmann’s failure to persuasively value the easements does not

necessarily mean they had no value. Petitioners cite several cases in which we

have upheld valuations similar to theirs. See, e.g., Whitehouse Hotel Ltd. P’ship

v. Commissioner, 139 T.C. 304 (2012); Dorsey v. Commissioner, T.C. Memo.

1990-242; Griffin v. Commissioner, T.C. Memo. 1989-130; Losch v.

Commissioner, T.C. Memo. 1988-230. However, each of those cases involved

commercial property. Restrictions on construction impair the value of commercial

property more tangibly than they impair the value of residential property.

Commercial property derives its value from its ability to generate cashflows. For

commercial property, development generally correlates with increased future

cashflows. More retail space, more space for tenants, and more room for

customers generally increase profitability. Restrictions on the development of

commercial property reduce potential for increased future cashflows and thus

diminish value.
                                        -18-

      Construction restrictions affect residential property values more subtly.

People do not buy homes primarily to make money, and personal rather than

business reasons usually motivate any construction on their homes. The loss of

freedom to make changes to the exterior of one’s home has a price, but it is

difficult to quantify. The task becomes even more difficult when we consider the

already existing restrictions on the property. Even if petitioners had not granted

the easements, local law would have prevented them from freely altering their

homes. The easements had value only to the extent their unique restrictions

diminished petitioners’ property values.

      Petitioners have identified several differences between the easement

provisions and local law. The differences concern the scope, monitoring, and

enforcement of the construction restrictions.

      The easements have a broader scope than local law because they restrict

construction on the entire exterior of the home and require property owners to

make repairs. Local law restricts construction only on portions of the property

visible from a public way, and local law does not require property owners to make

repairs.

      Petitioners also were subject to different monitoring procedures under the

easement agreements. NAT inspects each of its properties annually for
                                       -19-

compliance with applicable standards. The SELDC relies on the public to report

violations. NAT’s historical compliance standards are also slightly different from

the SELDC’s.

      Finally, NAT has greater power to enforce the terms of its easements than

the SELDC has to enforce local law. Unlike the SELDC, NAT has a right to enter

property to inspect for compliance, and NAT can require corrective action. NAT

can also enforce its easement terms even when doing so would impose substantial

economic hardship on the property owner. Under State law an owner may obtain

an exemption from local standards if compliance would cause a substantial

economic burden.

      We must determine the value diminution resulting from these additional

restrictions. We recently performed this analysis under identical circumstances.

In Kaufman v. Commissioner, T.C. Memo. 2014-52, we reviewed a NAT

easement on a property in the South End Historic District. There we determined

that the differences outlined above do not affect property values, because buyers

do not perceive any difference between the competing sets of restrictions. Id. at

*57. We see no reason to break with that result here. Mr. Ehrmann’s report,

which petitioners exclusively rely on to demonstrate their easements’ values, was

not credible. Respondent has persuasively argued that a typical buyer would
                                        -20-

perceive no difference between the two sets of applicable restrictions here. We

recognize technical differences between the easements and local law, but we agree

with respondent’s conclusion that the restrictions were practically the same.

Because petitioners have not proved that the easements they donated had value,

we sustain respondent’s disallowance of the charitable contribution deductions

they claimed.

II. Gain on Home Sale

      Taxpayers must recognize gain when they sell property for more than its

adjusted basis. Sec. 1001(a); sec. 1.61-6(a), Income Tax Regs. Taxpayers may

increase their adjusted basis in property for costs they incur to improve the

property, but they generally bear the burden of proving basis increases they claim.

See sec. 1016(a); Rule 142(a); sec. 1.1016-2(a), Income Tax Regs. The burden

may shift to the Commissioner if the taxpayer introduces credible evidence

supporting a basis increase. See sec. 7491(a)(1). If taxpayers cannot produce

records of actual expenditures, we may estimate the amounts of expenses if they

provide credible evidence that provides a factual basis for the estimate. See

Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

      Petitioners increased their basis in the Claremont property by $245,150 for

improvement costs they claim they incurred. Petitioners concede that they bear
                                         -21-

the burden of proving they were entitled to the basis increase. They have

presented documentary evidence that proves they incurred costs of at least

$147,824 in improving the property. They have also submitted before and after

photos of the home that demonstrate they made significant renovations.

      Respondent acknowledges that petitioners made improvements to the home.

However, he contends petitioners had likely already received tax benefits for the

improvement expenses. In particular respondent notes that for the years during the

renovations (2004 and 2005), petitioners reported unusually high costs of goods

sold on their Schedules C for Mrs. Ambrose-Chandler’s interior design business.

Respondent believes that petitioners included their renovation expenses in the

business’ costs of goods sold, which would have prevented them from also

increasing their basis in the property. See Thrifty Oil Co. v. Commissioner, 139

T.C. 198, 205, 217 (2012) (holding that taxpayer was not entitled to a double

deduction for the same economic loss).

      Petitioners have presented credible documentary evidence supporting

$147,824 of their basis increase. Respondent contends that petitioners may have

included the improvement costs in their Schedule C costs of goods sold for 2004

and 2005. This argument, first made at trial, raises a new matter for which

respondent bears the burden of proof. See Rule 142(a)(1). Respondent cites the
                                         -22-

abnormally high costs of goods sold petitioners reported for those years, but he

has presented no evidence concerning the expenses underlying the total. Without

more specific evidence, we cannot conclude that petitioners included the

renovation expenses in their costs of goods sold. Respondent had ample

opportunity to investigate petitioners’ costs of goods sold during the examination,

but he chose not to. He has failed to persuade us that petitioners included

renovation expenses on their 2004 and 2005 Schedules C. Accordingly, we hold

that petitioners were entitled to increase their basis in the Claremont property by

$147,824.

      Petitioners urge us to allow the full $245,150 basis increase they claimed

despite their inability to produce documentary evidence for the full amount. They

claim that pictures of the home before and after the renovations demonstrate that

they made improvements beyond those for which they could produce receipts.

The pictures indicate that petitioners made significant renovations, but we cannot

say for sure that they cost more than $147,824. Accordingly, we decline to

estimate further basis increases. Petitioners have failed to prove their entitlement

to basis increases beyond those for which they produced documentary evidence.

Petitioners’ claim that they had receipts but lost them does not affect our result,

because they have not shown that the loss was beyond their control. We hold that
                                        -23-

petitioners were not entitled to basis increases beyond the $147,824 they

substantiated.

III. Accuracy-Related Penalties

        Under section 6662, taxpayers may be liable for penalties for underpaying

their income tax. A 20% penalty applies when the underpayment resulted from

certain causes including negligence, a substantial understatement of income tax, or

a substantial valuation misstatement. Sec. 6662(a) and (b)(1), (2), and (3). A 40%

penalty applies when the underpayment resulted from a gross valuation

misstatement. Sec. 6662(h). Although an underpayment may trigger the penalty

for more than one reason, the Commissioner may not impose more than one

penalty on a single portion of the underpayment. Sec. 1.6662-2(c), Income Tax

Regs.

        The Commissioner bears the burden of production with respect to penalties.

Sec. 7491(c). To meet this burden, he must produce evidence regarding the

appropriateness of imposing the penalty. Higbee v. Commissioner, 116 T.C. 438,

446 (2001); Raeber v. Commissioner, T.C. Memo. 2011-39. Once the

Commissioner carries his burden, the taxpayer bears the burden of proving the

penalties are inappropriate because of reasonable cause or otherwise. Higbee v.

Commissioner, 116 T.C. at 446.
                                         -24-

      A. Underpayments Resulting From Easement Misvaluations

      The Pension Protection Act of 2006 (PPA), Pub. L. No. 109-280, sec.

1219(a)(2)(B), 120 Stat. at 1083, amended the rules for the 40% gross valuation

misstatement penalty. Before the PPA the penalty applied when taxpayers

misstated the value of their property by 400% or more, and taxpayers could avoid

the penalty under certain circumstances if they made the misstatement in good

faith and with reasonable cause. The PPA lowered the threshold to 200% and

eliminated the reasonable cause exception for gross valuation misstatements of

charitable contribution property. See secs. 6662(h), 6664(c). The new rules apply

to all returns filed after July 25, 2006.5 PPA sec. 1219(e)(3), 120 Stat. at 1086.

The years in issue here straddle the PPA’s effective date--petitioners filed their

2004 and 2005 returns before July 25, 2006, but they filed their 2006 return after.

      Petitioners misvalued their easements. They claimed deductions of

$191,400 and $371,250, but they have failed to prove the easements had any

value. Under either version of section 6662(h) the valuation misstatements are

“gross” and trigger the 40% penalty. However, the facts raise a novel issue

concerning petitioners’ right to raise a reasonable cause defense for their 2006


      5
        For charitable contributions of property other than facade easements, the
effective date is August 17, 2006.
                                         -25-

underpayment. Petitioners note that a portion of the underpayment resulted from

the carryover of charitable contribution deductions they first claimed on their 2004

return, which they filed before the PPA’s effective date. Accordingly, they argue,

denying their right to raise a reasonable cause defense would amount to

retroactively applying the PPA.

      Petitioners acknowledge that, by its plain language, the statute applies for

their 2006 return, but they urge us to look beyond the plain language because of its

retroactive effect. We disagree with petitioners that applying the amended

reasonable cause rules for their 2006 return amounts to retroactively applying the

PPA. Accordingly, we need not look beyond the statute’s plain language, and we

apply the amended reasonable cause rules to petitioners’ 2006 underpayment.

      When taxpayers file a return that includes carryforward information, they

essentially reaffirm that information. The amended reasonable cause rules were in

effect when petitioners filed their 2006 return, which reaffirmed the Claremont

easement’s grossly misstated value. Applying those rules does not amount to

retroactive application. The plain language of the statute makes the rules

applicable for all returns filed after July 25, 2006. Petitioners filed their 2006

return after that date and consequently may not raise a reasonable cause defense
                                        -26-

for their 2006 underpayment, which resulted exclusively from gross valuation

misstatements.

      We evaluate petitioners’ reasonable cause defense for their 2004 and 2005

underpayments under the pre-PPA rules. Even before Congress enacted the PPA,

more rigorous reasonable cause rules applied to taxpayers who substantially or

grossly misvalued charitable contribution property. Under pre-PPA rules such

taxpayers could raise a reasonable cause defense only if: (1) the property value

they claimed on their return was based on a qualified appraiser’s qualified

appraisal and (2) they made a good-faith investigation of the property’s value.

Sec. 6664(c). Respondent concedes the appraisal requirement but argues that

petitioners have not met the good-faith investigation requirement. We disagree.

      Respondent’s chief criticism of petitioners’ efforts appears to be their

failure to independently assess the easements’ values. Respondent contends that

because Mr. Chandler had a law degree and worked as a business consultant, he

should have known his appraiser had overvalued the easements. Petitioners are

well educated, but they have no experience valuing easements. Even experienced

appraisers find valuing conservation easements difficult because they are not

bought and sold in established markets. Average taxpayers would not know where

to start to value a conservation easement, and even well-educated taxpayers like
                                        -27-

petitioners must rely heavily on the opinions of professionals. Petitioners retained

an appraiser to value their easements. To choose the appraiser, petitioners relied

on the National Park Service’s advice and consulted their easement holding

organization, NAT. We have identified flaws in the initial appraisals, but they

would not have been evident to petitioners. Although petitioners could not rely

exclusively on the appraisals, they were entitled to give them substantial weight.

Petitioners corroborated the appraisals with advice from an experienced

accountant. We think these actions represent a good-faith attempt to determine the

easements’ values. Accordingly, petitioners may raise a reasonable cause defense

for their 2004 and 2005 underpayments resulting from gross valuation

misstatements.

      In Kaufman v. Commissioner, at *72-*75, we held that taxpayers whose

investigation approximated petitioners’ had not established reasonable cause for

their gross misvaluation of a conservation easement. However, the taxpayers’

investigation of value in Kaufman took place under different circumstances. In

Kaufman, after the taxpayers had received their initial appraisal they became

worried that the easement would devalue their home too much. They expressed

their concern to a representative of NAT, and he assured them that the easement

would have no effect on the resale value of their home. The taxpayers’ continued
                                         -28-

reliance on the initial appraisal in the face of the representative’s comments led in

part to our conclusion that the taxpayers’ investigation of value was in bad faith.

Here there is no evidence that petitioners relied on the appraisals in bad faith, and

we hold that their investigation was sufficient to allow them to raise a reasonable

cause defense.

      Taxpayers can establish reasonable cause by demonstrating they reasonably

and in good faith relied on the advice of a tax professional or appraiser. Sec.

1.6664-4(b), Income Tax Regs. To determine whether a taxpayer’s reliance on

professional advice was reasonable and in good faith we consider all facts and

circumstances, including “the taxpayer’s education, sophistication and business

experience”. Sec. 1.6664-4(c), Income Tax Regs.

      Petitioners have established reasonable cause for misvaluing their

easements. Mr. Chandler has a law degree and significant business experience,

but he has no valuation experience. Even without valuation experience most

taxpayers can evaluate the reasonableness of an appraisal for most forms of real

property. But easements are different because most taxpayers have never bought

or sold an easement. Petitioners followed the NPS’s suggestion for choosing an

appraiser and relied on his report. The report was not so deficient on its face that

petitioners should have reasonably discounted it. They obtained their accountant’s
                                        -29-

assurances before they claimed the easement deductions. On these facts we

believe petitioners have established reasonable cause, and we hold they are not

liable for accuracy-related penalties on the portions of their 2004 and 2005

underpayments that resulted from misvaluing their easements.

      B. Underpayments Resulting From Unsubstantiated Basis Increases

      Respondent imposed a 20% accuracy-related penalty on the portion of

petitioners’ 2005 underpayment resulting from unsubstantiated basis increases in

the Claremont property. Respondent argues that the penalty applies because that

portion of the underpayment resulted both from a “substantial understatement” of

income tax and from petitioners’ negligence. We hold that petitioners are liable

for the 20% accuracy-related penalty because this portion of the underpayment

resulted from their negligence.

      “Negligence * * * includes any failure by the taxpayer to keep adequate

books and records or to substantiate items properly.” Sec. 1.6662-3(b)(1), Income

Tax Regs. Petitioners have not retained records supporting the full amount of the

basis increase they claimed for the Claremont property. They have failed to

properly substantiate $97,326 of the basis increase they reported. The reasonable

cause exception applies to penalties for negligence, but petitioners have not

established reasonable cause. They claim they kept records but that some were
                                         -30-

lost when they moved from the Claremont property to the West Newton property.

They have not proved that the loss resulted from circumstances beyond their

control, and they have failed to offer a reasonable reconstruction of the lost

records. Cf. Mears v. Commissioner, T.C. Memo. 2013-52. Section 6001 requires

taxpayers to keep records long enough to properly substantiate items they claim on

their returns. Petitioners have failed to do so and are accordingly liable for the

20% penalty on the portion of their 2005 underpayment resulting from the

unsubstantiated basis increase.

      To reflect the foregoing,

                                                     Decision will be entered under

                                                Rule 155.
