WHITEHOUSE HOTEL LIMITED PARTNERSHIP; QHR HOLDINGS -- NEW ORLEANS LIMITED, Tax Matters Partner, Petitioners -- Appellants
COMMISSIONER OF INTERNAL REVENUE, Respondent -- Appellee
Appeal from the Decision of the United States Tax Court.
For Whitehouse Hotel Limited Partnership, QHR HOLDINGS - NEW ORLEANS LIMITED, Tax Matters Partner, Petitioners - Appellants: Gary J. Elkins, Thomas Matthew Beh, Counsel, Yvonne Chalker, Elkins, P.L.C., New Orleans, LA.
For Commissioner of Internal Revenue, Respondent - Appellee: Bethany Buck Hauser, Esq., U.S. Department of Justice, Washington, DC; Robert R. Di Trolio, U.S. Tax Court, Washington, DC; Kenneth L. Greene, Esq., Supervisory Attorney, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC; Kathryn Keneally, U.S. Department of Justice, Tax Division, Washington, DC; William J. Wilkins, Internal Revenue Service, Washington, DC.
For National Trust For Historic Preservation in The United States, Amicus Curiae: Elizabeth Sherrill Merritt, Esq., Deputy General Counsel, National Trust for Historic Preservation, Washington, DC.
Before STEWART, Chief Judge, and GARZA and SOUTHWICK, Circuit Judges.
LESLIE H. SOUTHWICK, Circuit Judge:
This appeal marks the second time Whitehouse Hotel Limited Partnership appeals from a ruling of the United States Tax Court disallowing a significant portion of a tax deduction claimed for a historic conservation easement. Whitehouse also appeals the tax court's enforcement of a 40 percent gross overstatement penalty. We AFFIRM the determination of the amount of the deduction but VACATE the penalty.
FACTUAL AND PROCEDURAL BACKGROUND
Whitehouse was formed in 1995 to purchase the Maison Blanche building in New Orleans, renovate it, and reopen it as a Ritz-Carlton hotel and condominium complex with retail space. Built between 1907 and 1909, the Maison Blanche is located on Canal Street in the city's Central Business District. The building was listed on the National Register of Historic Places in
1966 and designated a City of New Orleans landmark in 1980. Whitehouse's development plan included combining the Maison Blanche with the contiguous Kress building. Whitehouse also owned a parking garage in the immediate vicinity which would be utilized in the new complex.
On December 29, 1997, Whitehouse conveyed a conservation easement to the Preservation Alliance of New Orleans, d/b/a Preservation Resource Center (PRC), a Louisiana nonprofit corporation dedicated to historical preservation. The easement burdens the Maison Blanche with a number of restrictions and affirmative obligations, all revolving around maintaining the appearance of the ornate terracotta faç ade.
In its 1997 tax return, Whitehouse claimed a $7.445 million charitable contribution deduction for the easement. In 2003, the Commissioner issued Whitehouse a Notice of Final Partnership Administrative Adjustment, which allowed a deduction of only $1.15 million for the easement. The Commissioner further assessed a gross undervaluation penalty of 40% of the portion of underpayment of tax that year. See 26 U.S.C. § 6662(h)(2).
Whitehouse challenged both the valuation of the easement as well as the gross undervaluation penalty in the tax court. See Whitehouse Hotel Ltd. P'ship v. Comm'r, 131 T.C. 112 (2008). The 2006 trial focused on the pre- and post-easement valuation of the Maison Blanche building. The difference in value represents the value of the conservation easement and therefore the amount of the permissible deduction in the year of conveyance. See 26 C.F.R. 1.170A-14(h)(3).
At trial, Whitehouse presented the expert testimony of Richard Roddewig, while the Commissioner proffered that of Dunbar Argote. As we held in our 2010 decision reviewing that decision, both Roddewig and Argote were well-qualified to evaluate, appraise, and testify about commercial real estate. Whitehouse Hotel Ltd. P'ship v. Comm'r, 615 F.3d 321, 326 (5th Cir. 2010). The expert reports, testimony, and cross-examination of Roddewig and Argote are at the center of this controversy. The two appraisers reached widely varying conclusions regarding the proper parameters and valuation methods to use in their valuations. They arrived at vastly different pre- and post-easement valuations.
The two appraisers did not agree even on what property they were to evaluate. Roddewig included the adjacent Kress building in his valuation because it was to be brought under common ownership the day after creation of the easement. Argote determined the relevant property was the Maison Blanche by itself. The two appraisers further disagreed over the " highest and best use"  of the Maison Blanche building and complex, even to the point of disagreement over how the easement itself would affect the highest and
best use of the parcel. Roddewig concluded the highest and best use of the complex would be a 780-room, all-suite luxury hotel, 60 of those rooms being in a nine-story addition that would be constructed atop the Kress to bring its height nearer to that of the taller Maison Blanche, and ground-level retail space. As discussed more thoroughly later, Roddewig believed the conservation easement prohibited the 60-room addition to the Kress because the new floors would impair sightlines for the faç ade. Therefore, the post-easement highest and best use would be limited to 720 rooms. Conversely, Argote found that the easement did not limit an addition to the Kress building. He also determined the building's highest and best use was as a mixed-room, non-luxury hotel.
Roddewig's appraisal considered three methods to evaluate the pre- and post-easement value of the Maison Blanche: replacement cost, income, and comparable sales. These methods yielded pre-easement values of $43 million, $29.5 million, and $40 million, respectively. Post-easement, the values were $35 million and $18 million for the first two methods, and, after deciding there were no comparable sales of encumbered historic buildings, he made no valuation under that method. Roddewig estimated a value pre-easement of $41 million and post-easement of $31 million, leaving an easement value of $10 million. Argote used only the comparable sales method in his valuation. He concluded the Maison Blanche was worth $10.3 million pre- and post- easement. Consequently, he valued the easement at zero dollars, a conclusion which we in 2010 labeled " rather extraordinar[y]." Id. at 327.
In a 94-page opinion issued on October 30, 2008, a little over two years after the trial, the tax court blended analysis from the expert reports. In weighing the two reports, it reached several conclusions regarding the parameters, assumptions, and valuation methods used by the two appraisers.
First, the tax court concluded there was no difference in the highest and best use before and after the conveyance of the easement because the easement did not prevent building rooms atop the Kress. Whitehouse Hotel, 131 T.C. at 133-35. Second, it held that use of the reproduction cost approach was inappropriate because the building or faç ade would not be rebuilt if destroyed. Id. at 147-48, 152. Third, it concluded the income approach was inappropriate because it rested upon a number of assumptions about income and expenses and did not contain any measure of overall risk of error in his income model. Id. at 154-55. Ultimately, the tax court determined a pre-easement value of $12,092,301 and a post-easement value of $10.3 million. The value of the easement, then, was $1,792,301. That valuation meant that Whitehouse overstated its deduction by $5,652,699, the difference between $7,445,000 and $1,792,301. The overstated deduction meant that Whitehouse had claimed a deduction roughly 415% higher than its proper value ($7,445,000 / $1,792,301 = 4.15). Id. at 172. If a taxpayer misstates a deduction by 400% or more, a penalty of 40% of the underpayment may be charged as a penalty for a " gross valuation misstatement." I.R.C. § 6662(h)(2)(A)(i). A taxpayer may be relieved of this penalty if the taxpayer shows the misstatement falls into the " reasonable
cause exception." I.R.C. § 6664(c)(1). To qualify for this exception, the taxpayer must show the claimed value was based on a qualified appraisal by a qualified appraiser and that the taxpayer made a good faith investigation of the value of the property. I.R.C. § 6664(c)(3). Concluding Whitehouse had presented no evidence to show it had undertaken the steps required in Section 6664(c)(3), the tax court determined that the requirements of the good faith exception had not been met. Whitehouse Hotel, 131 T.C. at 175.
Whitehouse appealed to this court. We rejected several arguments but remanded for further consideration on three valuation issues and the denial of the good faith exception. Whitehouse Hotel, 615 F.3d at 330-31. We were concerned that the tax court did not make an explicit determination of the parcel's highest and best use, id. 336-37, and that it failed to consider the effect of the easement on the Kress. Id. at 339-40. Thus, our instructions on remand were these: (1) reconsider all valuation methods, not just the comparable sales method; (2) determine the parcel's " highest and best use" for the purposes of its valuation; and (3) consider the effect of the easement on the Kress building, even if the easement itself did not specifically burden that building under relevant Louisiana law. Having vacated the tax court's valuation of the easement, we also vacated the gross undervaluation penalty. Id. at 343. We discussed relevant legal principles to guide the tax court on imposing a penalty should it decide again the incorrect valuation of the easement gave rise to one. Id. at 340-41. Though we did not hold that the proper frame of valuation was to be what the property would be following its renovation, we did direct the tax court to determine whether the highest and best use would be as the luxury hotel actually being built or instead as a non-luxury hotel. Id. at 336-37.
On remand, the tax court again analyzed the easement's effect on the Kress building. It quoted our decision that " because of the easement, Whitehouse could not build on top of the Kress building." Id. at 337. That conclusion had rejected the 2008 tax court determination on the effect of the easement on the Kress. Nonetheless, the tax court judge (the same judge wrote both the 2008 and 2012 opinions) discussed Louisiana's law of servitudes at length and concluded we had been in error: any restriction on development that is not expressly contained in an easement cannot be used in valuation of that easement. Whitehouse Hotel Ltd. P'ship v. Comm'r, 139 T.C. 304, 339-40 (2012). Having confirmed its continuing disagreement, the court then enforced our contrary holding that some effect on the valuation of the entire parcel must occur as a ...