Tax Type
Land Preservation Tax Credit
Description
Revaluation of the Credit,/Third Party Appraisal
Topic
Assessment
Land Preservation Tax Credit
Date Issued
01-21-2014
January 21, 2014
Re: § 581-1821 Application: Land Preservation Tax Credit
Dear *****:
This will reply to your letter in which you contest the Department's adjustments to the Land Preservation Tax Credit (the "Credit") application submitted by ***** (the "Taxpayers"). I apologize for the delay in responding to your appeal.
FACTS
In December 2008, the Taxpayers conveyed a conservation easement on two adjacent tracts of land ("Parcel A" and "Parcel B") to the ***** (the "Town"). Pursuant to the conveyance of the easement, the Taxpayers registered their donation with the Department for purposes of the Credit. The Taxpayers requested and were awarded Credit based on an appraisal by an unrelated third party appraiser contracted by the Taxpayers. Subsequently, the Taxpayers transferred the Credit to unrelated individuals.
Under examination, the Department commissioned an appraisal from a third party appraiser. Based on this appraisal, the Credit was revalued and assessments were issued against the individuals that received the transferred Credits. The Taxpayers appeal the revaluation of the Credit, contending their appraiser followed the accepted professional standards and the easement was properly valued in its 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).
Treasury Regulation § 1.170 et seq. governs charitable contributions. 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. Further, Treas. Reg. § 1.170A-1(c)(2) further states the fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the facts. In the Taxpayers' case, the issue is the correct valuation of the easement.
Virginia Code § 58.1-512.1 C provides in pertinent part:
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- The fair market value of any property with respect to a qualified donation shall not exceed the value for the highest and best use (i) that is consistent with existing zoning requirements; (ii) for which the property was adaptable and needed or likely to be needed in the reasonably near future in the immediate area in which the property is located; (iii) that considers factors such as, by way of illustration and not limitation, slopes, flood plains, and soil conditions of the property; and (iv) for which existing roads serving the property are sufficient to support commercial or residential development in the event that is the highest and best use proposed for the property.
Easement Description
The easement was placed on two adjacent parcels of property. Parcel A was zoned commercial and has extensive footage along two roads. A large medical building with associated parking is on the property. ***** (the "Creek") runs through a portion of the property and almost half of the parcel was already encumbered by an easement before the donation. Approximately half of the parcel lies within the floodplain associated with the Creek. This parcel has been under development and has unimproved parcels, the majority of which lie outside of both the flood plain and the easement. In 2010, a fast food facility and associated parking were completed. Because this improvement was made after the date of the donation, it is not considered in the valuation of the easement.
Parcel B had extensive footage along one road, but there are no improvements on the property. The Creek bisects this parcel and there is no access to a portion of the property from the road. Approximately half of the parcel lies within the floodplain associated with the Creek and over half of the parcel was already encumbered by an easement before the donation.
Flood Plains and Setback
The Town's zoning ordinance for commercial property addresses the development of property lying within a floodplain. It also addresses the usage of property that lies adjacent to scenic rivers or major streams. Property located within a floodplain can be used for certain agricultural and recreational activities. However, no structures can be built within a floodplain with the exception of parking, storage and loading areas. Property located within a floodplain can also be used for density calculations for the entire parcel. A portion of Parcel A and Parcel B that was encumbered by the easement lies within a floodplain.
The setback ordinance prohibits the construction of any new buildings, structures, parking lots or other impermeable services within a certain amount of footage of a river or stream. In this case, the Creek was subject to the setback ordinance and ran through both Parcel A and Parcel B.
Appraisals
In the valuation process, the appraisers develop a supportable estimate of market value of the property appraised. This process involves collecting market evidence to support an analysis of value trends, the reactions of buyers and sellers in the marketplace, and a proper interpretation of these facts. Virginia Code § 58.1-512 requires an appraisal to meet USPAP standards in order to be considered valid. See the Guidelines for Qualified Appraisals, issued as Public Document (P.D.) 07-9 (3/12/2007).
The appraisal process typically involves three approaches in determining value: the Cost Approach, Sales Comparison Approach, and Income Capitalization Approach. A brief description of each technique follows:
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- The COST APPROACH: An appraisal procedure using depreciated replacement or reproduction costs of improvements, plus land value, as a basis for estimating market value. The underlying assumption is most reliable when the improvements are relatively new and are the highest and best use of the land.
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- The SALES COMPARISON APPROACH: An appraisal procedure using sales prices of whole properties similar to the subject property as a basis for estimating market value. The nature and condition of each sale are analyzed, making adjustments for dissimilar characteristics. The Sales Comparison Approach offers a good indication of value when reliable data exists for a sufficient quantity and quality of sales in the marketplace.
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- The INCOME CAPITALIZATION APPROACH: An appraisal procedure using capitalization of expected future income as a basis for estimating market value. In this approach, there is a direct relationship between the amount of income a property earns and its value. An appropriate capitalization rate is used to estimate value based on the anticipated net operating income of the property. Factors such as risk, time, interest on the capital investment, and recapture of the depreciating asset are considered in deriving an overall rate. The underlying assumption in this approach is that an informed purchaser will pay no more for the subject property than would have to be paid for another property with an income stream of comparable amount, duration, and quality. When analyzing land, the Income Capitalization approach may be presented as a discounted cash flow and is known as the Subdivision Development Approach.
The final step in the appraisal process is the reconciliation of value indications and the final estimate of value. The appraiser considers each approach according to the quantity and quality of information available, as well as the peculiarities of the subject property, and weighs each value estimate. The result is a final conclusion of market value for the subject. An appraiser's opinion of value is based on the property's "highest and best use." According to the Appraisal Institute's Dictionary of Real Estate Appraisal (Third Addition, 1993, p. 171), highest and best use is defined as:
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- The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value. The four criteria the highest and best use must meet are legal permissibility, physical possibility, financial feasibility, and maximum productivity
Taxpayers' Appraisal
The Taxpayers' contracted an engineer to determine the amount of square footage of developable commercial property for both parcels before and after the easement. The Taxpayers' appraiser used these square footage amounts to calculate the value of the easements.
The appraiser appraised Parcel A prior to the easement at approximately $4.9 million and valued it after the easement at approximately $2.9 million. The appraiser appraised the value of Parcel B prior to the easement at approximately $5.3 million and valued it after the easement at approximately $2.9 million. As such, the total value of the easement was appraised at approximately $4.4 million.
The Department's examination shows problems with the Taxpayers' appraisal. The Taxpayers' own engineering study shows that a significant portion of the property encumbered by the easement fell within the floodplain or within the setback area of the Creek. There are also wetlands within both parcels. The Town's zoning ordinance severely limits the amount of improvements permitted to be built within the floodplain and setback area. Part of the land is constrained, which means that only parking and outdoor storage facilities can be added. Other parts of the property cannot be built on at all because of the Creek, wetlands, and setback.
The Taxpayers' appraisal does not appear to address the loss of developable land within the easement. The appraisal describes the floodplain and Creek setback in its description of the easement. However, the floodplain and setback do not appear to reduce the valuation of the easement. The appraisal states that the parcel "needs site work" and it includes costs for water main, sewer main and fill. This seems to indicate that the portion of the lot on which the easement lies was fully developable with improvements, even though the local zoning ordinance prohibited development in this area. In addition, the appraisal also does not appear to account for the lack of access to a portion of Parcel B that is separated from the road by the Creek.
The Taxpayers contend that their appraisal complied with all applicable requirements including the Uniform Standards of Professional Appraisals Practice (USPAP), the Internal Revenue Code (IRS) and related treasury regulations and the Code of Virginia. They assert that the appraiser has significant experience conducting appraisals in the county in which the Town is located, and the appraisal was based on an engineering study by an experienced engineer. The Taxpayers also argue that the Department cannot disregard its appraisal because it failed to prove that it was "false and fraudulent."
The Department has not disregarded the Taxpayers' appraisal. Under Virginia Code § 58.1-512, the fair market value of a Credit must be substantiated by a qualified appraisal performed by a qualified appraiser. As such, the Department has a duty to ensure that any donated conservation easements are valued at fair market value. Virginia Code § 58.1-512 D 6 allows the Department to conduct audits in order to verify the value of any credits issued. In order to properly confirm an easement's fair market value, the Department will commission an appraisal by an independent third party appraiser. In this case, the Department reviewed the Taxpayers' appraisal and found issues with its valuation methodology. As such, it commissioned an appraisal by an independent third party in order to determine the fair market value of the easement.
Third Party Appraisal
As mentioned above, the Department commissioned an independent third party appraisal subsequent to the Taxpayer's appeal. After reviewing this appraisal, it is my determination that the appraisal prepared by ***** (the "Third Party Appraiser") most accurately reflects the value of the subject easement.
The Third Party Appraiser valued the entire property prior to the easement at approximately $3.3 million and valued it after the easement at approximately $2.8 million, resulting in the easement being valued at approximately $500,000.
The appraiser used the sales comparison approach with five comparables with adjustments based on the location, size and physical characteristics of these properties. The appraiser then calculated the value per square foot of each comparable and calculated the approximate midpoint of value per square footage. The appraiser then took the entire acreage of the easement and multiplied it by this midpoint to get the before value. The appraiser calculated the value of the property after the easement by multiplying the price of undeveloped land per square foot of building area by the amount of developable land left after the easement.
The Taxpayers contend that the Department's appraiser was not competent as required by USPAP because the appraiser did not have experience performing appraisals in the county where the Town is located and lacked knowledge of the market and geographic area. USPAP requires that when an appraiser conducts an appraisal in an unfamiliar locality, they must spend sufficient time to understand the market and locations involved. In this case, the Third Party Appraiser had performed appraisals of conservation easements throughout the state of Virginia. The appraiser made several trips to the Town to familiarize themselves with the area and met with their Town's zoning administrator several times. Thus, the Third party Appraiser fulfilled their obligation to understand the market and location of Parcel A and Parcel B under USPAP.
The Taxpayers further argue that the comparables chosen by the appraiser were not valid because more suitable comparable sales were available. The appraiser used larger sites with some development potential rather than small lots that had already been developed. Because of the unique nature of the parcels at issue, and the relative absence of sales of large parcels around the time of the donations, identifying comparables was a challenge for both appraisers. The Third Party Appraiser's comparables adequately support their conclusion.
The Taxpayers assert that the appraiser did not take into account the sales price of a lot on Parcel A that significantly exceeded the appraiser's sales price estimate. This estimate of sales price was made as of the date of the appraisal. The sale, identified by the Taxpayer, occurred approximately three and one-half years after the date of the easement donation. Market conditions change over time, and the Taxpayers provided no documentation to show the present value of the sale as of the time of the donation.
The Department's review of the appraisal it commissioned indicates that the appraiser took into account the restrictions on developing property within the easement due to the setback, wetlands, floodplain, and lack of access. After analyzing the appraisal commissioned by the Taxpayer and the appraisal the Department commissioned, it is my determination that the appraisal the Department commissioned most accurately reflects the value of the subject easement. This appraisal's value of the property before the easement addresses the encumbrances inherent with developing the subject properties. The value after the easement is supported by the Third Party Appraiser's assumptions. The percentage of diminution appears reasonable. Accordingly, the Department finds that the Third Party Appraisal represents the most accurate valuation of the easement.
CONCLUSION
The assessments issued against the individuals claiming the Credit passed through from the Taxpayers 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 cited are available on-line at www.tax.virginia.gov in the Laws, Rulings and Decisions section of the Department's website. If you have any questions about this determination, you may contact ***** in the Department's Office of Tax Policy, Appeals and Rulings, at *****.
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- Sincerely,
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Craig M. Burns
Tax Commissioner
AR/1-5064976828.B
Rulings of the Tax Commissioner