If you happen to own a historic building, you could be sitting on a tax deduction gold mine. If you meet various strict IRS requirements, you may be able to donate a facade easement to a charity and reap a substantial charitable tax deduction.
However, you need to be careful. Due to past abuses by some property owners, the IRS tends to be very suspicious of facade easement deductions.
A facade easement is a legally binding agreement that the owner of a historic structure enters into with a charity whose mission includes historic preservation. The owner gives up the right to demolish or make other destructive alternations to the exterior of the building.
The easement, which must run with the title to the property forever, gives the nonprofit the right to review and preapprove any changes to the building exterior.
All other rights and obligations of ownership, such as the right to sell or lease the property, and the duty to maintain it, remain with the owner. The owner may also make any changes he or she desires to the building interior.
Why would a homeowner want to grant a facade easement? Two reasons: (1) it ensures that the historic character of the exterior of their structure will be preserved; and (2) it may result in a tax deduction — a deduction that could be substantial.
Contributions of property to qualified charitable organizations are tax deductible. A facade easement is property, and if the charity granted the easement is a qualified charitable organization, the easement may qualify as a tax-deductible, charitable contribution.
However, as you might expect, you have to satisfy some strict IRS rules to get this deduction.
First of all, your building (which may be a residential or business structure) must be a “certified historic structure.” Under Internal Revenue Code Section 170(h)(4)(C), this includes any building, structure or land area listed in the National Register, or any building located in a registered historic district and certified by the Secretary of Interior as being of historic significance to the district. (IRC Sec. 170(h)(4)(C).)
In addition, you need to obtain an appraisal by a qualified appraiser. The IRS has many detailed requirements concerning the appraisal. You then need to file the appraisal, easement agreement and other paperwork with the IRS and pay a special fee. IRS engineers may review your filing.
How much do you get to deduct? That’s the key question.
The rule is that your are allowed to deduct as a charitable contribution only the decline in the property’s fair market value caused by the restrictions placed on the use of the property by the easement. This can be difficult to determine.
IRS engineers have concluded that, as a general rule, the value of a facade easement should range from 10 to 15 percent of the value of the property as a whole. Thus, for example, if you own a historic building with a fair market value of $1 million, a facade easement could result in a $100,000 to $150,000 charitable contribution deduction.
However, there’s a fly in the ointment. Many facade easements are worth much less than 10 to 15 percent of the property’s fair market value. Indeed, the IRS says that many facade easements are worth nothing at all.
The fact is that many historic structures are already subject to local zoning ordinances or historic preservation laws that greatly restrict how they may be altered. As a result, a facade easement may have no practical effect and not reduce the value of the property at all. Hence, the property owner is entitled to a zero deduction.
Facade easements have aided in the preservation of hundreds of historic buildings throughout the country. Unfortunately, over the years, many owners of historic structures have taken improperly large facade easement deductions. The IRS has fought against many of these deductions tooth and nail, and has even listed facade easements as one of its “dirty dozen tax scams.” If you own a historic building, talk to a professional before you try to take advantage of this complex deduction.
The National Park Services’ division of Technical Preservation Services offers a brochure on issues surrounding the potential tax benefits of facade easements and other historic preservation measures through its website, www.nps.gov/tps/.
Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors, Freelancers and Consultants,” “Deduct It,” “Working as an Independent Contractor” and “Working with Independent Contractors.