                                           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 con-
                                               tribution 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 value-
                                               less. R imposed gross valuation misstatement penalties on the
                                               underpayments resulting from the alleged easement overvalu-
                                               ations. 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 under-
                                               payment. 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

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                                               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, fur-
                                               ther, 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 underpay-
                                               ments, 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.

                                       Denis J. Conlon, Steven S. Brown, and Mason N. Floyd, for
                                     petitioners.
                                       Carina J. Campobasso, for respondent.
                                        GOEKE, Judge: Petitioners owned two single-family resi-
                                     dences in Boston’s South End Historic District. They granted
                                     a facade easement on each property to the National Architec-
                                     tural Trust (NAT) and claimed related charitable contribu-
                                     tion 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.




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                                     (279)                          CHANDLER v. COMMISSIONER                                       281


                                        After concessions, 2 the issues remaining for decision are:
                                        (1) whether the charitable contribution deductions peti-
                                     tioners 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 prop-
                                     erty they sold in 2005. We hold they did, but they were enti-
                                     tled to increase their basis for improvement costs they prop-
                                     erly substantiated; and
                                        (3) whether petitioners are liable for accuracy-related pen-
                                     alties 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 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 des-
                                     ignated a National Historic Landmark District.
                                     B. Conservation Easements
                                       Congress has created the Federal Historic Preservation
                                     Tax Incentives Program to encourage the preservation of his-
                                     toric structures. Under the program, owners of historic
                                     buildings may be entitled to charitable contribution deduc-
                                           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 peti-
                                     tioners’ valuation of the easements.




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                                     tions when they grant conservation easements on their
                                     buildings to organizations that will protect the buildings’ his-
                                     toric 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 peti-
                                     tioners 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 construc-
                                     tion that will alter the exterior of the building. NAT periodi-
                                     cally 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 his-
                                     toric 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 excep-
                                     tions.
                                        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 Massachu-
                                     setts 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).
                                        Petitioners claimed charitable contribution deductions
                                     related to the easements on their 2004, 2005, and 2006 tax
                                     returns. Petitioners followed guidance from the NPS and con-
                                     sulted their easement holding organization to find an
                                     appraiser to value their easements. NAT recommended
                                     George Riethof and George Papulis, who valued the Clare-




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                                     (279)                         CHANDLER v. COMMISSIONER                                       283


                                     mont easement at $191,400 and the West Newton easement
                                     at $371,250. Petitioners consulted with their accountant con-
                                     cerning 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 deduc-
                                     tions 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’ prop-
                                     erties more than local law. Petitioners have abandoned their
                                     original appraisals, but they have presented new expert testi-
                                     mony 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, respondent requested documentation substan-
                                     tiating 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 peti-
                                     tioners had deducted the renovation expenses on their Sched-
                                     ules 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 peti-
                                     tioners’ Schedule C deductions during the audit.




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                                     284                 142 UNITED STATES TAX COURT REPORTS                                    (279)


                                                                                  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 chari-
                                     table organization, to monitor the owner’s use of 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 cer-
                                     tain organizations. See sec. 170(f)(3)(B)(iii); sec. 1.170A–
                                     1(c)(1), Income Tax Regs. Respondent concedes that peti-
                                     tioners have satisfied the technical requirements for the
                                     deductions, but he disputes their valuations of the ease-
                                     ments. Petitioners bear the burden of proving their deduc-
                                     tions 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 restric-
                                     tive easements for which taxpayers have claimed deductions.
                                     See, e.g., Hilborn v. Commissioner, 85 T.C. at 688–689; Sim-
                                     mons 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 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




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                                     (279)                         CHANDLER v. COMMISSIONER                                       285


                                     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.
                                           B. The Ehrmann Report
                                        Using the comparable sales approach Mr. Ehrmann cal-
                                     culated before values for the Claremont property and the
                                     West Newton property of $1,385,000 and $2,950,000 respec-
                                     tively.
                                        To estimate the properties’ after values, he attempted to
                                     quantify the effect of petitioners’ easements. Mr. Ehrmann
                                     analyzed sales of seven properties encumbered with ease-
                                     ments 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 con-
                                     cerning a settlement agreement arising from the sale of
                                     encumbered property in New Orleans. The property’s seller
                                     did not disclose an existing conservation easement to the
                                     buyer. After the buyer bought the property, he discovered the
                                     easement and sued the seller. The parties settled the dispute
                                       3 Mr. Ehrmann’s report contains procedural errors. He calculated the

                                     easement values by dividing the difference in sale prices by the encum-
                                     bered 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.




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                                     for 14.6% of the sale price. Mr. Ehrmann claims that the
                                     settlement represents direct market valuation of the ease-
                                     ment restriction on the property.
                                        On the basis of his data, Mr. Ehrmann estimated that peti-
                                     tioners’ 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 ease-
                                     ments in other markets tell us little about easement values
                                     in Boston’s unique market.
                                       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 ‘‘com-
                                     parable’’ 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 Clare-
                                     mont 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




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                                     (279)                         CHANDLER v. COMMISSIONER                                       287


                                     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 properties at 118 West
                                     Newton Street and 176 West Canton Street. ‘‘Easement
                                     Encumbered Sale #4’’ refers to the sale of encumbered prop-
                                     erty 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 com-
                                     pared 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 conclu-
                                     sions flowing from these comparisons largely reflect his
                                     opinion rather than the objective market values of the ease-
                                     ments. When an appraiser makes numerous adjustments to
                                     a subject property’s comparables, the subject property’s valu-
                                     ation 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 ‘‘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 respec-
                                     tively. He attributed these differences to the encumbrance on
                                     the Cazenove Street property. However, the St. Charles
                                     Street property’s deed contains restrictions that are substan-
                                     tially the same as those the Cazenove Street property’s ease-
                                     ment imposes. This indicates that the difference in price
                                       4 The ‘‘condition’’ adjustments were: 5% for 118 West Newton, 15% for

                                     176 West Canton, 20% for 285 Marlborough, and 10% for 381 Beacon.




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                                     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 prop-
                                     erties’ before values, but he reviewed the appraisals peti-
                                     tioners 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. Bow-
                                     man selected nine recently encumbered Boston properties
                                     that sold between 2005 and 2011. He 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 renova-
                                     tions and easements positively affected value, but the report
                                     does not isolate the effect of the easements. To measure one
                                     variable’s effect, one must hold all other variables constant.




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                                     (279)                         CHANDLER v. COMMISSIONER                                       289


                                     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 there-
                                     fore reject his conclusion that petitioners’ easements dimin-
                                     ished their property values by 16%. However, Mr. Ehrmann’s
                                     failure to persuasively value the easements does not nec-
                                     essarily 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 construc-
                                     tion impair the value of commercial property more tangibly
                                     than they impair the value of residential property. Commer-
                                     cial 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 gen-
                                     erally increase profitability. Restrictions on the development
                                     of commercial property reduce potential for increased future
                                     cashflows and thus diminish value.
                                        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 restric-
                                     tions 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’ prop-
                                     erty 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




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                                     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 proce-
                                     dures under the easement agreements. NAT inspects each of
                                     its properties annually for compliance with applicable stand-
                                     ards. The SELDC relies on the public to report violations.
                                     NAT’s historical compliance standards are also slightly dif-
                                     ferent 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 eco-
                                     nomic 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 perceive no difference between the two sets of
                                     applicable restrictions here. We recognize technical dif-
                                     ferences between the easements and local law, but we agree
                                     with respondent’s conclusion that the restrictions were prac-
                                     tically the same. Because petitioners have not proved that
                                     the easements they donated had value, we sustain respond-
                                     ent’s disallowance of the charitable contribution deductions
                                     they claimed.




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                                     (279)                         CHANDLER v. COMMISSIONER                                       291


                                     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 prop-
                                     erty, 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 esti-
                                     mate the amounts of expenses if they provide credible evi-
                                     dence 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 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 dem-
                                     onstrate they made significant renovations.
                                        Respondent acknowledges that petitioners made improve-
                                     ments 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 Sched-
                                     ules C for Mrs. Ambrose-Chandler’s interior design business.
                                     Respondent believes that petitioners included their renova-
                                     tion 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 con-
                                     tends 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




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                                     142(a)(1). Respondent cites the 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 exam-
                                     ination, 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 prop-
                                     erty by $147,824.
                                        Petitioners urge us to allow the full $245,150 basis
                                     increase they claimed despite their inability to produce docu-
                                     mentary evidence for the full amount. They claim that pic-
                                     tures of the home before and after the renovations dem-
                                     onstrate 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. Peti-
                                     tioners’ 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 petitioners were not
                                     entitled to basis increases beyond the $147,824 they substan-
                                     tiated.
                                     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.




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                                     (279)                         CHANDLER v. COMMISSIONER                                       293


                                       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. Commis-
                                     sioner, 116 T.C. at 446.
                                           A. Underpayments Resulting From Easement Misvalua-
                                              tions
                                        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 mis-
                                     stated the value of their property by 400% or more, and tax-
                                     payers could avoid the penalty under certain circumstances
                                     if they made the misstatement in good faith and with reason-
                                     able 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 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
                                       5 For charitable contributions of property other than facade easements,

                                     the effective date is August 17, 2006.




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                                     294                 142 UNITED STATES TAX COURT REPORTS                                    (279)


                                     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 under-
                                     payment.
                                        When taxpayers file a return that includes carryforward
                                     information, they essentially reaffirm that information. The
                                     amended reasonable cause rules were in effect when peti-
                                     tioners filed their 2006 return, which reaffirmed the Clare-
                                     mont 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 for their 2006 under-
                                     payment, 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 substan-
                                     tially 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




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                                     (279)                         CHANDLER v. COMMISSIONER                                       295


                                     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 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’ inves-
                                     tigation of value in Kaufman took place under different cir-
                                     cumstances. In Kaufman, after the taxpayers had received
                                     their initial appraisal they became worried that the ease-
                                     ment 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 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 peti-
                                     tioners 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 dem-
                                     onstrating 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 reli-
                                     ance on professional advice was reasonable and in good faith
                                     we consider all facts and circumstances, including ‘‘the tax-




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                                     296                 142 UNITED STATES TAX COURT REPORTS                                    (279)


                                     payer’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 tax-
                                     payers 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 ease-
                                     ment. Petitioners followed the NPS’ 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 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 por-
                                     tion of the underpayment resulted both from a ‘‘substantial
                                     understatement’’ of income tax and from petitioners’ neg-
                                     ligence. We hold that petitioners are liable for the 20%
                                     accuracy-related penalty because this portion of the under-
                                     payment 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 lost when they moved from the Clare-
                                     mont property to the West Newton property. They have not
                                     proved that the loss resulted from circumstances beyond




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                                     (279)                         CHANDLER v. COMMISSIONER                                       297


                                     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.

                                                                               f




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