Did a fourth appraisal and conditional purchase offers justify increasing the claimed value of a Virginia conservation easement?

Subject

Land Preservation Tax Credit

Plain-English summary

The Tax Commissioner refused to increase the claimed Land Preservation Tax Credit value and upheld the Department's appraisal. The taxpayer's appraisals valued the donated easement far above the Department's appraisal by assuming substantial commercial and residential development potential.

The taxpayer's fourth appraisal valued the two tracts at about $8.9 million before the easement and $0.8 million after, producing an asserted easement value of about $8.1 million. It treated commercial rezoning and residential development as the highest and best uses.

The Department found those assumptions excessive because the taxpayer's appraisals focused mainly on physical suitability and did not adequately analyze economic demand at the donation date. The Department's appraisal addressed falling home prices, reduced sales volume, foreclosures, weak commercial demand, lack of existing utilities and zoning, and the cancellation of a better-located nearby development.

Two 2008 purchase offers did not establish the higher value. They were contingent on commercial rezoning, no rezoning application had been filed, the locality's comprehensive plan did not assure approval, and the taxpayer's own original appraisal anticipated opposition. The Commissioner therefore treated rezoning as speculative.

Result: the earlier determination and the assessments issued to individuals claiming the passed-through credit were upheld. Updated bills would include accrued interest, with payment due within 30 days of the bill date to avoid additional interest.

What this means for you

• A conservation-easement appraisal needs market evidence, not only a physically possible development plan.
• Highest-and-best-use assumptions should account for zoning probability, utilities, demand, comparable locations, and conditions on the valuation date.
• A conditional offer may carry little weight when its price depends on uncertain rezoning or development approvals.
• A new appraisal on reconsideration does not displace the Department's valuation unless it answers the weaknesses in the existing record.

Common questions

Q: What credit percentage did the ruling describe?

A: Virginia Code § 58.1-512 provided a credit equal to 40% of the qualifying donation's fair market value under the law discussed in the ruling.

Q: Why did the Department prefer its appraisal?

A: It analyzed actual commercial and residential market conditions and limited development potential, while the taxpayer's appraisals did not adequately support their assumptions with market evidence.

Q: Did the purchase offers prove the taxpayer's value?

A: No. The offers depended on rezoning, which the Commissioner found speculative at the donation date.

Q: What happened to the assessments?

A: They were upheld, and the Department said it would issue updated bills with accrued interest.

Citations and references

• Va. Code §§ 58.1-512 and 58.1-512.1(A).
• IRC § 170(h).
• Treas. Reg. § 1.170A-13(c)(3)(ii).
• USPAP Standards Rule 1-3, incorporated through the Department's qualified-appraisal guidelines.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 15-234

Original ruling text

December 22, 2015

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek reconsideration of the Department's determination letter, issued as Public Document (P.D.) 14-61 (4/30/2014), to the * (the "Taxpayer"), adjusting the Land Preservation Tax Credit (the "Credit"). I apologize for the delay in responding to your reconsideration request.

FACTS

In P.D. 14-61, the Department concluded that the appraisal performed by a third party appraiser commissioned by the Department provided the most reasonable valuation of the donated easement. The Taxpayer seeks a reconsideration, contending that the Department's appraisal was based on numerous factual inaccuracies and erroneous assumptions. The Taxpayer submitted three appraisals that were evaluated by the Department in P.D. 14-61. The Taxpayer has submitted additional documentation including an additional appraisal (the "Fourth Appraisal").

DETERMINATION

Virginia Code § 58.1-512 provides a Credit for 40% of the fair market value of real property or an interest in real property donated to an eligible charitable organization or instrumentality of the Commonwealth for qualifying land conservation purposes. In order to qualify for the Credit, a donation of an interest in real property must qualify as a charitable deduction under Internal Revenue Code (IRC) § 170(h). Under Treas. Reg. § 1.170A-13(c)(3)(ii), a qualified appraisal must include the appraised fair market value of the property on the date of the contribution.

In P.D. 14-61, the Department found the Taxpayer's appraisers to be overly optimistic about the development potential of the parcels primarily because they lacked access to public water and sewage. The Department also found that the comparables used by its appraiser more accurately reflected the subject property in their size and rural character.

The Taxpayer essentially asserts that the Department's appraiser undervalued the donation because he did not properly address the subject property's development potential. Specifically, the Taxpayer argues that the Department's appraisal did not take into account the property's location in a high growth locality, the ease and affordability to bring water and sewer, and purchase offers on tracts of land within the subject property.

Appraisals

The Fourth Appraisal appraised Tract A prior to the easement at approximately $7.0 million and Tract B for $1.9 million for a total before value of $8.9 million. The appraiser valued the subject property after the easement at approximately $0.8 million. As such the total value of the easement was appraised at approximately $8.1 million. The appraiser concluded that the highest and best use for Tract A was to rezone and develop for commercial use. It concluded that the highest and best use for Tract B was to develop for residential use.

The Taxpayer contends its appraisals accurately reflect the value of the donated easement. It asserts that the Department's appraisal did not correctly analyze the commercial potential of the subject properties. The Taxpayer argues that the Department erroneously concluded that the development of the subject property would be impeded by the lack of public water and sewer, as well as the poor soil characteristics. The Taxpayer also states that the locality supported the rezoning of Tract A from agricultural to commercial.

Virginia Code § 58.1-512.1 A provides that "[e]ach appraisal estimating the value of any donation upon which credits are to be based shall employ proper methodology and be appropriately supported by market evidence ." [Emphasis Added.] Under P.D. 07-9 (3/12/2007), the Guidelines for Qualified Appraisals, the Uniform Standards of Professional Appraisal Practice (USPAP) were incorporated into the Guidelines by reference. USPAP Standards Rule 1-3 states that an appraiser must analyze land use regulations, economic supply and demand and market area trends.

The two appraisals that the Taxpayer submitted with its Credit applications merely discussed the subject property's physical suitability for commercial and residential development. They did not discuss the economic conditions and demands for property development in the subject property's area. The Fourth Appraisal primarily discussed the site's physical characteristics. The only reference it made to the real property development potential at the time of the donation was a "slight softening in the market" for residential sales and that the "both residential and commercial activity diminished significantly." However, it went on to state that "the commercial data did not indicate a precipitous downturn in the market."

The Department's appraisal analyzed both the commercial and residential markets at the time of the donation. It observed that the demand for commercial property in the subject property's vicinity had evaporated and the only commercial or industrial construction near the subject property was an old light industrial building and a mini-storage facility. The analysis stated that commercial development would have first occurred closer to existing development in areas with existing utilities and proper zoning before moving to the subject property. In fact, a major commercial and residential project planned near the subject property was cancelled in 2007 even though the developers had invested significant time and money. This project was located in a more desirable location than the subject property because utilities and the proper zoning were already in place.

The Department's appraisal took notice of the economic downturn for residential property at the time of the donation. It reported that home prices were falling and that the volume of sales had decreased by almost half from its peak. It also referenced the marked increase in foreclosures and short sales. The statistical information showed the decrease in the number and price of houses sold and the increase in the number of days houses were on the market.

Other Documentation

In addition to the Fourth Appraisal, the Taxpayer provided documents showing that the subject property was marketed to various non-profit and conservation organizations. This marketing effort shows the Taxpayer's desire to develop the property, but is irrelevant in the valuation of the donation. However, in 2008 the Taxpayer received and turned down two offers to purchase portions of Tract A at a price per square foot comparable to the before value opined by the Fourth Appraisal.

The purchase of the property would have been contingent on Tract A being rezoned from agricultural to commercial. Tract A was identified as potentially rezoned according the locality's comprehensive plan. The comprehensive plan states that "[t]his identification of potential growth areas in the [f]uture [I]and [u]se [p]lan is neither an assurance of community acceptance nor a commitment to develop by the County".

The Taxpayer's original appraisal states that rezoning would be unlikely because there would be considerable opposition to development of the site from Civil War preservationists. In addition, there was a decreased demand for commercial property in more developed locations, where water and sewer were readily available, if not already on site. At the time of the donation, no application for rezoning had been submitted to the locality. As such, the rezoning of the subject property was speculative at best and likely reflective of the development potential of the property. Accordingly, the offer prices on the Tract A of the subject property cannot be considered for valuing the donation.

CONCLUSION

After reviewing all of the information provided, I find that the development potential of the subject property was more limited prior to the easement than proposed by the Taxpayer's appraisers because of the weak economic conditions for real estate at the time of the donation and the uncertainty of rezoning. As such, it is my determination that the valuations of the subject property before being encumbered by the easement as stated in the Taxpayer's appraisals were excessive. Moreover, I find that the Department's appraiser based his analysis on the limited development potential of the subject property at the time of the donation. As such, my determination in P.D. 14-61 is upheld.

Based on this determination, the assessments issued to the individuals claiming the Credit passed through from the Taxpayer are upheld. The Department will issue updated bills with accrued interest. The individuals must pay the outstanding balance within 30 days of the bill date to avoid the accrual of additional interest.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department's web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns
Tax Commissioner

AR/1-5773578500.B