United States Court of Appeals, District of Columbia Circuit
Jeff Blau, Tax Matters Partner of RERI Holdings I, LLC, Appellant
Commissioner of Internal Revenue Service, Appellee
November 9, 2018
Appeal from the Decision of the United States Tax Court
Kathleen Pakenham argued the cause for appellant. With her on
the briefs were Stephen D. Gardner, Adriana Lofaro Wirtz, and
Earl Christensen, Attorney, U.S. Department of Justice,
argued the cause for appellee. With him on the brief was
Richard Farber, Attorney.
Before: Rogers and Millett, Circuit Judges, and Ginsburg,
Senior Circuit Judge.
GINSBURG, SENIOR CIRCUIT JUDGE
Holdings, LLC (RERI) claimed a charitable contribution
deduction of $33 million on its 2003 federal tax return. The
Internal Revenue Service determined that RERI was not
entitled to this deduction and imposed a 40% penalty for
underpayment of tax. RERI unsuccessfully challenged both
rulings before the Tax Court, and now appeals to this court
on a variety of grounds. For the reasons set forth below, we
affirm the judgment of the Tax Court.
high level of generality, the facts of this case are simple:
RERI acquired and donated a future interest in a piece of
commercial property to the University of Michigan. RERI
maintains the donation is a bona fide deduction that it
valued reasonably at $33 million. The IRS says RERI
artificially inflated the value of the donated property in
order to offset the tax liability of its owners.
corporate arrangements and transactions involved in this case
are fairly complicated. For the sake of clarity, we lay them
out in some detail.
February 7, 2002, RS Hawthorne, LLC - a shell company, whose
only member was RS Hawthorne Holdings, LLC (RSHH), the only
member of which was Red Sea Tech I, Inc. - purchased a 288,
000 square-foot web-hosting facility located in Hawthorne,
California for $42, 350, 000. At the time of the purchase,
the Hawthorne Property was leased to AT&T. The lease had
an initial term of 15.5 years, ending in May 2016; AT&T
then had the option to renew it three times for periods of
five years each. The rent for each year during the initial
term was spelled out in the lease; if AT&T renewed the
lease, then the rent would be re-set at the then-market rate
but not less than $14 per square foot per year.
Hawthorne financed its purchase with a mortgage loan from
BB&T Bank. In connection with the loan, BB&T had the
Hawthorne Property appraised by Bonz/REA, Inc. The appraisal
"concluded that the Hawthorne property was worth $47
million as of August 16, 2001." RERI Holdings I, LLC
v. Comm'r, 149 T.C. 1, 4(2017).
February 7, 2002, Red Sea divided its member interest in RSHH
into two temporal interests: (1) a Term of Years (TOYS)
interest lasting until December 31, 2020 and (2) the
remainder, which the Tax Court refers to as the
"successor member interest" (SMI). The SMI in RSHH
is the donated property at issue in this case. Red Sea
assigned the TOYS interest to PVP-RSG Partnership and sold
the SMI to a company called RJS Realty Corporation for $1,
610, 000. The agreement assigning the SMI to RJS imposes
several conditions on Red Sea's TOYS interest, which the
Tax Court assumed would also bind subsequent assignees.
Id. at 6 n.4. First, the TOYS holder is prohibited
from "causing or permitting any transfer of the
Hawthorne property or the member interest in [RS] Hawthorne
or the imposition of any lien or encumbrance on either"
and is obligated to "take all reasonable actions
necessary" to prevent waste of the Hawthorne property.
Id. at 5. Of particular relevance to this appeal,
the assignment also contained a non-recourse provision:
In the event of any Breach of the provisions of this
Assignment on the part of Assignor or any of its successors
in interest hereunder, the recourse of Assignee or any of its
successors in interest hereunder shall be strictly limited to
the [TOYS interest]. In no event may any relief be granted
that imposes on the owner from time to time of the [TOYS
interest] any personal liability, it being understood that
any and all remedies for any breach of the provisions hereof
shall be limited to such owner's right, title and
interest in and to the [TOYS interest].
March 2002 RERI purchased the SMI from RJS for $2, 950, 000.
RERI was a limited liability company that was formed on March
4, 2002 and dissolved on May 11, 2004. RERI Holdings I,
LLC v. Comm'r, 107 T.C.M. (CCH) 1488, 1489 (2014).
August 2003 Stephen M. Ross, one of RERI's members,
pledged a gift of $4 million to the University of Michigan;
he later increased the pledge to $5 million. In partial
fulfillment of Ross's pledge, RERI assigned the SMI to
the University pursuant to a Gift Agreement dated August 27,
2003. The Gift Agreement provided, among other things, that
the University "shall hold the Remainder Estate for a
minimum of two years, after which the University shall sell
the Remainder Estate in a manner and to a buyer of its
December 2005 the University sold the SMI to HRK Real Estate
Holdings, LLC for $1, 940, 000 although it had had the
property appraised at $6.5 million earlier that year. The
parties have stipulated that the sale price did not represent
the fair market value of the SMI. The buyer, HRK, was
indirectly owned in part by Harold Levine, one of RERI's
members. The proceeds of the sale were credited toward
RERI is treated as a partnership for federal income tax
purposes, it filed a 2003 federal income tax return for
informational purposes only; the actual taxpayers are the
owners of shares in the LLC. RERI claimed a charitable
contribution deduction of $33, 019, 000 for the transfer of a
noncash asset, $32, 935, 000 of which represented the
purported value of the donated SMI. (The remaining $84, 000
was for appraisal and professional fees.) The valuation of
approximately $33 million derives from an appraisal conducted
by Howard Gelbtuch of Greenwich Realty Advisors, dated
September 2003. As required by Treasury regulations, RERI
attached the Gelbtuch appraisal to its return. RERI also
completed a Form 8283 for Noncash Charitable Contributions;
however, RERI left blank the space for "Donor's cost
or adjusted basis." It did not provide any explanation
for the omission.
thereafter selected RERI for audit and in March 2008 issued a
Notice of Final Partnership Administrative Adjustment (FPAA).
It disallowed $29 million of RERI's deduction, based upon
its determination that the SMI was worth only $3.9 million.
Accordingly, it also imposed a penalty equal to 20% of the
tax underpayment for a substantial valuation misstatement,
pursuant to IRC § 6662(e)(1).
April 2008 RERI filed a petition in the Tax Court challenging
the FPAA. In its answer, the IRS revised its determinations,
asserting RERI was entitled to no deduction for a charitable
contribution on the ground that the transaction giving rise
to the deduction was "a sham for tax purposes or lacks
economic substance." It argued in the alternative that
the deduction should be limited to $1, 940, 000, the amount
the University had realized from the sale of the SMI.
Finally, the IRS claimed the valuation misstatement was
"gross" rather than merely "substantial,"
triggering a penalty equal to 40% of the tax underpayment.
See IRC § 6662(h)(1).
four-day trial, the Tax Court issued a judgment sustaining
both the IRS's determination that RERI was not entitled
to any charitable contribution deduction and its assessment
of the 40% penalty. The Tax Court, however, did not base its
decision upon the "lack of economic substance"
theory advanced by the IRS; instead, it concluded that RERI
had failed to substantiate the value of the donated property
as required by Treasury regulations. 149 T.C. at 17. Nonetheless,
on its way to affirming the penalty for a gross valuation
misstatement, the Tax Court found the SMI was worth $3, 462,
886 on the date of the donation. The court also held RERI did
not qualify for the "reasonable cause" exception to
accuracy-related penalties. See IRC § 6664(c).
The Charitable Contribution Deduction
first challenges the Tax Court's ruling that it was not
entitled to a charitable contribution deduction.
170 of the Internal Revenue Code permits a taxpayer to claim
a deduction for a contribution to a charitable organization.
This deduction can be abused by a taxpayer who inflates the
valuation of the donated property. For that reason, IRC
§ 170(a)(1) provides that "[a] charitable
contribution shall be allowable as a deduction only if
verified under regulations prescribed by the Secretary."
Deficit Reduction Act of 1984 (DRA), the Congress directed
the Secretary of the Treasury to increase the stringency of
its requirements for verification. Pub. L. No. 983-69, §
155(a)(1), 98 Stat. 494, 691. Specifically, the DRA instructs
the Secretary to promulgate regulations that require a
taxpayer claiming a deduction for a noncash charitable
A. to obtain a qualified appraisal for the property
B. to attach an appraisal summary to the return on which such
deduction is first claimed for such contribution, and
C. to include on such return such additional information
(including the cost basis and acquisition date of the
contributed property) as the Secretary may prescribe in such
fulfillment of this mandate, the Secretary promulgated 26
C.F.R. § 1.170A-13, subsection (c) of which is most
relevant to this case. Paragraph (c)(2) instantiates the
three statutory requirements: The donor must (A)
"[o]btain a qualified appraisal"; (B)
"[a]ttach a fully completed appraisal summary ... to the
tax return"; and (C) "[m]aintain records"
containing specified information. Paragraph (c)(3) defines a
"qualified appraisal" and paragraph (c)(4) details
the necessary elements of an "appraisal summary,"
one of which is "[t]he cost or other basis of the
property." § 1.170A-13(c)(4)(ii)(E). The taxpayer
must provide the appraisal summary on IRS Form 8283. §
deduction is typically disallowed if these requirements are
not met. There is an exception, however, "[i]f a
taxpayer has reasonable cause for being unable to provide the
information ... relating to the manner of acquisition and
basis of the contributed property" in the appraisal
summary. § 1.170A-13(c)(4)(iv)(C)(1). In that case, the
deduction will still be allowed if the donor attaches
"an appropriate explanation" to the appraisal
Court disallowed RERI's charitable donation deduction on
the ground that it failed to comply with the substantiation
requirements. First, the Tax Court held "the reporting
requirements of section 1.170A-13, Income Tax Regs., are
directory and not mandatory," such that a taxpayer who
"substantially complies" with the requirements is
entitled to the claimed deduction. 149 T.C. at 15 (citing
Bond v. Comm'r, 100 T.C. 32, 40-41 (1993))
(cleaned up). The court went on to conclude that RERI failed
substantially to comply because it did not disclose its basis
in the donated property.
urges this court to affirm the Tax Court on the alternative
theory that substantial compliance with the regulation does
not suffice, so that RERI's failure to include the basis
on Form 8283 was automatically fatal. RERI, for its part,
does not dispute that it failed to supply its basis in the
SMI and to provide an explanation for the omission. Instead,
RERI maintains that the substantial compliance doctrine does
apply here, and that providing its basis in the donated
property is not necessary for compliance. It emphasizes that
both the Second Circuit and the Tax Court have concluded the