The federal government is aggressively trying to halt the abuse of an obscure tax break by examining the tax returns of hundreds of Washington area property owners and seeking the identities of hundreds more in an attempt to reclaim hundreds of millions of dollars.
The Justice Department also is asking a federal judge to order a local historic preservationist to stop advising homeowners that they can claim huge tax deductions. The department is demanding the names and Social Security numbers of an estimated 800 property owners who used the tax break — known as a facade easement donation — on their homes.
In recent years, the Internal Revenue Service has denied 70 percent of facade easement deductions, court filings show. Since 2002, the Justice Department estimates that inflated easement deductions have totaled $1.2 billion.
“These are very wealthy people taking a massive deduction on their taxes, for plenty of nothing,” said Dean Zerbe, who investigated abusive tax shelters while legal counsel for the Senate Finance Committee. “The request for the client list will give the IRS a road map for additional doors to knock on.”
Under the donation system, property owners promise they will not change the outward appearance of their historic homes and office buildings without permission. They “donate” the promises — in the form of easements — to preservation organizations and deduct an amount estimated to represent the gifts’ cash value from their income taxes as a charitable contribution, just as though they had given an armful of old coats to a neighborhood thrift shop. Some property owners have claimed tax deductions exceeding $1 million.
But preservation laws in the District and many other cities already forbid unapproved changes to the exterior of historic homes, meaning the property owners are promising not to alter something they cannot legally change anyway.
“It’s money for nothing,” Zerbe said.
In a civil complaint filed last month, the Justice Department asked a D.C. federal judge to order Steven McClain and the nonprofit organization he heads to stop telling homeowners that they were entitled to deductions of up to 15 percent of the value of their property.
The complaint contends that reforms that McClain and his associates claim to have made in 2005, after The Washington Post raised questions about their operations, were “cosmetic” and created “the illusion that they took seriously criticisms of their practices.” Behind the scenes, however, they hired a team of lobbyists, political consultants and public relations specialists, and abuse continued, the complaint says.
The IRS estimates that, between 2002 and 2006, such deductions cost the Treasury revenue totaling more than $250 million.
In return for help arranging the donations, the property owners have contributed millions of dollars to a handful of nonprofit organizations and private businesses associated with McClain that made the transactions possible, the Justice Department said.
Most of those property owners live in Washington, where McClain’s operation started and is based. Other cities targeted by the nonprofits include New York, Baltimore and Boston.
Hundreds of the homeowners in those cities are already facing examination by the IRS, and some individual property owners have been assessed additional taxes and penalties exceeding $300,000.
The tax write-offs are supposed to represent the decline in the property’s worth attributable to the restriction on altering the facade. But market studies show that the easements generally do not hurt resale, making the tax breaks unwarranted, the complaint says.
The nonprofit organizations typically ask homeowners to donate 10 percent of their potential tax write-offs to the trusts as a charitable contribution.
Jeffrey Tenenbaum, a lawyer for the Trust for Architectural Easements, which McClain co-founded, denied the allegations but said the nonprofit group has reached a settlement with the government.
The agreement, which has not been made public, neither concedes wrongdoing nor agrees to damages, Tenenbaum said. Instead, it “pretty much requires the trust to do what it’s already been doing,” he said.
Tenenbaum emphasized that, in some cases, property owners have won court approval for sizable tax deductions. He said that some of the practices highlighted in the complaint were discontinued years ago and that no one at the trust had a financial motive.
“There has been absolutely no personal enrichment of Steve McClain in any manner,” Tenenbaum said. “The trust looks forward to putting this matter behind it.”
Justice Department spokesman Charles Miller said the proposed settlement would establish an independent monitor to ensure that the trust complies with terms and allows the IRS to assess financial penalties.
Many tax experts applauded the government crackdown as welcome news at a time the federal deficit is ballooning.
“They basically took an easement on their home that didn’t have any real limitation on its value; the rest of us are having to shoulder the tax burden,” Zerbe said. Property owners who took such deductions “should be sprinting to the phone” to contact the IRS, because “you want to call the IRS before they call you,” Zerbe added.
McClain’s rise in the historic preservation field, and the questionable nature of the deductions, were first described in “Rich with History,” a 2004 Washington Post investigative series. Brass plaques identifying homes with facade easements are common in historic neighborhoods in Georgetown, Capitol Hill and Dupont Circle. Property owners who have donated easements include nationally known political figures, celebrities, lobbyists and journalists.
After the series was published, McClain’s operation was the subject of a Senate investigation and a House hearing. The IRS announced a crackdown and added easement donations to its annual “Dirty Dozen” list of tax abuses. Congress in 2006 passed legislation tightening tax laws governing appraisal standards.
The Justice Department complaint lists McClain as a defendant, along with the Trust for Architectural Easements, a Washington-based tax-exempt organization formerly known as the National Architectural Trust.
The complaint says McClain and his trusts designed the scheme to “grossly overstate the amount of charitable contribution deductions” that participants could claim. McClain “repeatedly made false and fraudulent statements to donors” regarding the financial windfall they could expect, and he guided participants to a hand-picked group of appraisers who helped manipulate estimates of an easement’s value, the complaint says.
McClain and his organizations are accused of wrongly asserting that the IRS had effectively approved a standard deduction of up to 15 percent of the value of a piece of real estate, and of “coaching appraisers.”
“The IRS has generally disallowed in whole or in part amounts claimed by taxpayers for the value of the facade easements donated,” the complaint says.
The scheme has already created headaches for hundreds of area homeowners. Since The Post’s investigative series, the IRS has initiated more than 300 examinations of tax returns claiming facade easement deductions.
Of the 51 examinations completed, 70 percent have resulted in the deductions being denied. In individual cases, the complaint says, taxpayers have been assessed taxes and penalties exceeding $330,000.