In a recent ruling from Judge Halpern of the United States Tax Court, a deduction claimed by RERI Holdings I, LLC for a 2003 donation to the University of Michigan was denied, with the Court upholding penalties for a gross valuation misstatement.

The asset that RERI donated was a remainder interest in a holding company that owned a web-hosting facility in southern California that was leased through 2016. The remainder interest entitled the holder to the cash flows from the facility after 2020. It was purchased by RERI for $2.95 million in March 2002 and donated to the University in August 2003, when RERI claimed the value was $33 million and took a tax deduction in that amount.

Brattle Chairman Michael Cragg testified for the IRS regarding the value of the remainder interest. He opined that when RERI purchased the interest, it was worth no more than $1.65 million, and when it was donated in August 2003, it was worth $2.09 million. Dr. Cragg’s analysis took into account the varying levels of risk associated with the cash flows in the short term, when the facility was leased to a massive telecommunications provider, and in the long term, when there was no assurance of the property generating cash flows. This led to different discount rates before and after the lease expired, and was the primary difference in Dr. Cragg’s valuation and the valuation put forward by RERI’s expert.

The Court largely agreed with Dr. Cragg’s discount rate analysis, finding “Dr. Cragg’s determination of the rate at which to discount post-2020 cashflows to be more credible than [RERI’s expert], primarily because Dr. Cragg’s analysis gives more account to the difference in risk between the expected cashflows during and after the initial period of [the lease].” Judge Halpern largely rejected RERI’s criticisms of Dr. Cragg’s analysis, and ultimately concluded the appropriate value to be $3.46 million, much closer to Dr. Cragg’s analysis than RERI’s expert’s analysis, and on that basis upheld the gross valuation misstatement penalty.

The Brattle team was led by Principal Evan Cohen, Senior Associate David Hutchings, and Associate Chi Cheng. The team worked closely with the IRS in all phases of case and trial preparation over a period of several years, including fact witness depositions, developing expert testimony, consulting support during trial, and assistance with post-trial briefs.

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