Whitehouse Hotel Limited Partnership, QHR Holdings-New Orleans, Ltd., Tax Matters Partner, Petitioner v. Commissioner of Internal Revenue, Respondent, 139 T.C. 304

CONTENTS SUPPLEMENTAL OPINION . 306 Discussion . 314 I. Introduction . 314 315 II.Approaches to Valuation A. Cost Approach . co ÜT 1. In General . oo OI 318 2. Comparing Petitioner’s Historic Cost to Mr. Roddewig’s Cost Estimate . 318 3. Terra Cotta Reproduction Cost . 319 4. External Obsolescence . 320 5. Land Value . 321 6. Conclusion ... 321 B. Income Approach . 321 1. Introduction . 321 2. In General . 326 3. Conclusion . 328 C. Comparable-Sales Approach . 328 1. Introduction . 329 2. Disregard of Sales of Nonlocal Comparable Properties 330 3. Highest and Best Use . 332 4. Second-Best Use . 336 5.

Conclusion . III. Effect of the Servitude . 337 A. Introduction . 337 B. The Conveyance . 340 1. Introduction . 340 2. Parties’ Arguments . 342 3. Discussion . 342 C. Conclusion . 347 IV. Valuation of the Servitude . 347 348 V. Valuation Misstatement Penalty A. Introduction . CO 4^ oo B. Discussion . OO cn o 1. Testimony of Mr. Drawbridge . 350 2. Court of Appeals’ Counsel . 351 3. Petitioner’s Burden . 352 4. The Revac Appraisal . 355 5. Form 8283 . 356 6. Investigation . 357 7. Reliance on Advice and Counsel . 359 8. Conclusion . 361 C. Conclusion . 362 VI.

Conclusion . 362 APPENDIX . 362 SUPPLEMENTAL OPINION Halpern, Judge: This case is before us on remand from the U.S. Court of Appeals for the Fifth Circuit (Court of Appeals) for further proceedings in accordance with its opinion in Whitehouse Hotel Ltd. P’ship v. Commissioner, 615 F.3d 321 (5th Cir. 2010) ('Whitehouse II), vacating and remanding 131 T.C. 112 (2008) (Whitehouse I).

The case arose on account of the parties’ disagreement as to the value of the qualified conservation contribution made by Whitehouse Hotel Limited Partnership (partnership) when, in 1997, it conveyed a qualified real property interest, viz, a perpetual conservation restriction, to Preservation Alliance of New Orleans, Inc., d.b.a. Preservation Resource Center of New Orleans (PRC), a Louisiana nonprofit corporation. The Court of Appeals instructed us to reconsider (1) our finding as to the value of the contribution and (2) our determination sustaining an accuracy-related penalty.

At our request, the parties filed supplemental briefs in which they were to address both issues that we had identified and issues that they might identify. Unless otherwise indicated, all

section references are to the Internal Revenue Code in effect for 1997, and all Rule references are to the Tax Court Rules of Practice and Procedure. Background We incorporate herein by this reference the facts that, under the heading FINDINGS OF FACT, we found in Whitehouse I, 131 T.C. at 115-120 (including the stipulation of facts, supplemental stipulation of facts, and second supplemental stipulation of facts), which we do not believe the Court of Appeals disturbed. We summarize pertinent facts and portions of our Opinion in Whitehouse I for the benefit of the reader.

The Partnership, the Maison Blanche and Kress Buildings, the Ritz-Carlton Agreement The partnership is a Louisiana limited partnership formed in 1995. On December 21, 1995, the partnership acquired a parcel of improved real property in New Orleans, Louisiana, on the square (block) bordered by Canal, Burgundy, Iberville, and Dauphine Streets. Principally, the parcel consisted of a historic building, the Maison Blanche Building, built between 1907 and 1909, two annexes, one built in the 1920s and the other built in the 1950s, and the land under all.

At the time the partnership acquired the parcel, the first through third floors of the Maison Blanche Building were under lease to Maison Blanche, Inc., for use as a department store. The lessee had previously prepaid rent for a term ending in 2004. The upper floors of the building were vacant. The partnership agreed to pay $6 million for the parcel plus additional amounts based on the partnership’s “Net Cash Flow” and “Net Capital Proceeds”. In September 1996, the partnership paid an additional $625,000 in cancellation of its obligation to pay those additional amounts and for other things.

In September 1996, the partnership bought out the remaining term of the lease for $3,375,938 and obtained the right to use the Maison Blanche name. The Maison Blanche Building consists of a base level and an eight-level U-shaped tower. Exterior street facades of the Maison Blanche Building consist almost entirely of glazed terra cotta; some interior portions of the building (e.g., interior courtyard areas) are primarily constructed of white glazed brick with less extensive terra cotta ornamentation. The Maison Blanche Building fronts on Canal Street.

The Maison Blanche Building is adjacent to the Vieux Carré (French Quarter) neighborhood of New Orleans. It is in both the Vieux Carré National Historic District and the Canal Street Historic District, which is part of the Central Business District. The Central Business District Historic District Landmark Commission determined that the Maison Blanche Building is a building of major architectural importance.

On February 19, 1997, the partnership and the Ritz-Carlton Hotel Co., L.L.C. (Ritz-Carlton), entered into agreements under which the partnership agreed to renovate the Maison Blanche Building and the as-yet-unacquired neighboring Kress Building and Ritz-Carlton agreed to operate a Ritz-Carlton Hotel in the renovated buildings. Ritz-Carlton was to receive certain fees and expense reimbursements in exchange for its services.

On or about October 30, 1997, the partnership purchased additional property in the same block as the Maison Blanche Building, including the Kress Building, which is adjacent to the Maison Blanche Building, and the Kress parking garage. The Kress Building was built in 1910, consists of six levels, and fronts on Canal Street. The partnership paid $3.4 million for the additional property, $1 million allocable to the Kress Building.

Treating all of the partnership’s expenditures to assemble the Maison Blanche-Kress parcel as having been made in December 1995, the partnership paid $11,000,938 ($6,625,000 + $1,000,000 + $3,375,938) to assemble the parcel. The Maison Blanche Building, its annexes, the Kress Building, and the Kress parking garage were ultimately developed into a 452-room Ritz-Carlton Hotel and into other hotel facilities. The Ritz-Carlton Hotel, and associated facilities, commenced operations on October 6, 2000.

The Servitude On December 29, 1997 (valuation date), the partnership conveyed certain of its rights in the Maison Blanche Building to PRC. The conveyance was by “Act of Donation of Perpetual Real Rights” (conveyance). A copy of the conveyance, excluding exhibits, is appended hereto. In

summary, the conveyance provides that: (1) the owner (i.e., the partnership) intends to convert the Maison Blanche Building (described as the “Improvement” (improvement), to distinguish it from the underlying land) into a hotel; (2) there is no servitude or other encumbrance that would limit the rights conveyed; (3) the rights conveyed (described as the “Servitude” (servitude)) are conveyed in perpetuity; (4) the servitude relates to certain exterior surfaces of the improvement (referred to as the “Facade” (facade)); (5) the owner will maintain the facade in a good and sound state of repair; (6) without permission, the owner will do nothing in or to the facade that would alter its appearance; and

(7) PRC has the right to require the owner to maintain the facade. On December 29, 1997, the conveyance was filed for registry in the conveyance records of the parish of Orleans. La. Rev. Stat. Ann. sec. 9:1252

(2008) Petitioner tax matters partner claims that the servitude was created in accordance with the express statutory provisions of La. Rev. Stat. Ann. sec. 9:1252. La. Rev. Stat. Ann. sec. 9:1252 provides for the creation of a perpetual real right burdening the whole or any part of immovable property, including but not limited to its facade, in favor of an entity formed exclusively for certain public purposes. Pertinent portions of that

section are set out in the margin. The Charitable Contribution and Respondent’s Examination On account of the conveyance of the servitude to PRC, the partnership claimed a charitable contribution deduction of $7,445 million on its 1997 Form 1065, U.S. Partnership Return of Income (1997 Form 1065). Respondent examined the 1997 Form 1065 and determined that the $7,445 million charitable contribution deduction should be reduced by $6,295 million since the partnership had not established that the loss of value on account of the conveyance of the servitude exceeded $1.15 million. On account of the size of his reduction in value, respondent determined that an accuracy-related penalty under

section 6662(

a) is applicable. This proceeding, in which petitioner challenges both respondent’s reduction in value of the charitable contribution deduction and the accuracy-related penalty, followed. Expert Testimony as to the Value of the Servitude The parties agree that the partnership is entitled to a charitable contribution deduction for 1997 on account of its conveying the servitude to PRC. They disagree as to the amount of the deduction because they disagree as to the value of the servitude. The parties relied exclusively on expert testimony to establish the value of the servitude.

Petitioner called as its expert witness Richard J. Roddewig, whom we accepted as an expert with respect to (1) the valuation of conservation easements and (2) the site selection, feasibility, and valuation of hotels. Mr. Roddewig is a real estate appraiser and attorney. He is a member of the Appraisal Institute, and he holds its MAI designation. He conducts his appraisal business from Chicago, Illinois. He obtained a temporary license from the State of Louisiana as a certified general real estate appraiser for the purpose of making his appraisal here under consideration.

Before reaching his conclusion as to the loss in value occasioned by the partnership’s conveyance of the servitude to PRC (sometimes, value of the servitude) he spent four to six days in New Orleans. His staff made additional visits. Mr. Roddewig’s previous appraisal experience in Louisiana consisted of two or three preliminary appraisals made in the early 1980s of preservation easement grants in New Orleans and a market feasibility study for a site in Lafayette, Louisiana. We received his written report, dated August 9, 2005, as his direct testimony.

Respondent called as his expert witness Richard Dunbar Argote, whom we accepted as an expert with respect to commercial real estate appraisal. Mr. Argote is licensed by the State of Louisiana as a certified general real estate appraiser and as a real estate broker. Like Mr. Roddewig, he is a member of the Appraisal Institute and holds its MAI designation. Mr. Argote has been appraising real estate in Louisiana for over 25 years. From 1990 to 2000, he appraised between 50 and 70 buildings in and around New Orleans that were to be used as or converted into hotels.

About 85% of those appraisals were of buildings located within the Central Business District or the Vieux Carré. Over the years, Mr. Argote has appraised every building within the same square as the Maison Blanche Building. He has appraised the Maison Blanche Building on three prior occasions. After addressing objections, we received his written report, dated October 31, 2006, as his direct testimony. Each expert arrived at an opinion as to the fair market value of the servitude by making the before and after comparison contemplated by the applicable regulations. See sec. 1.170A-14(h)(3)(i), Income Tax Regs.

Petitioner’s expert, Mr. Roddewig, determined the requisite before and after values in three different ways. He relied primarily on a reproduction cost approach and an income approach, but he also used, in part, a comparable-sales approach. He determined that the appropriate parcel of property to value was the Maison Blanche Building, the 1920s and 1950s annexes, and the Kress Building (Maison Blanche-Kress parcel).

He determined the following before- and after-restriction values: Before-restriction values Cost approach . $43,000,000 Adjusted income approach . 41,000,000 Comparable-sales approach . 40,000,000 After-restriction values Cost approach . $35,500,000 Adjusted income approach. 28,000,000 Comparable-sales approach He determined no after-restriction comparable-sales-approach value because he found no directly relevant after-restriction sales.

Taking into account his three approaches, but giving significant weight to the adjusted income approach because of the purported uniqueness in New Orleans of the Maison Blanche-Kress parcel, he reached the following ultimate determinations as to the before- and after-restriction values of the Maison Blanche-Kress parcel and the value of the servitude: Value of the servitude Before-restriction value . $41,000,000 After-restriction value. 31,000,000 Difference; i.e., fair market value of the servitude . 10,000,000 Respondent’s expert, Mr. Argote, relied exclusively on a comparable-sales approach.

He concluded that the before-restriction value of the Maison Blanche Building was $10.3 million and the after-restriction value was $10.3 million. He determined that the value of the servitude was zero. Notwithstanding Mr. Argote’s opinion that the value of the servitude was zero, respondent did not ask that we find that the value was any less than the $1.15 million he determined in his examination. Highest and Best Use In Whitehouse I, we acknowledged that the fair market value of property is determined by taking into account the highest and best use of that property on the valuation date.

Whitehouse I, 131 T.C. at 130 (citing Stanley Works v. Commissioner, 87 T.C. 389, 400 (1986)). We explained that the experts differed on whether the conveyance changed the highest and best use of the property each valued. We stated: Mr. Roddewig determined the highest and best use of the Maison Blanche-Kress parcel before the conveyance was a mixed use development, including a Ritz-Carlton Hotel with 512 rooms (60 of them above the Kress Building), an additional all-suites hotel with approximately 268 rooms, and retail use on the first two floors and mezzanine of the Maison Blanche Building.

He determined that the highest and best use of the Maison Blanche-Kress parcel after the conveyance was different in that: “The opportunity to add up to 60 additional hotel rooms [above the Kress Building] * * * [had] been eliminated.” That difference contributed to his conclusion that, under both the cost and income approaches, the fair market value of the Maison Blanche-Kress parcel was reduced on account of the conveyance. Mr.

Argote believes the highest and best use of the Maison Blanche Building both before and after the conveyance was use as a hotel (not necessarily a Ritz-Carlton Hotel) with retail space. [Whitehouse I, 131 T.C. at 130-131.] Essential to Mr. Roddewig’s opinion was his belief that the conveyance eliminated the possibility of constructing 60 hotel rooms above the Kress Building. Considering the question to be one of local (Louisiana) law, we found that, on the evidence before us, the conveyance created no charge on the Kress Building in favor of PRC. Id. at 134.

Therefore, we stated: “Petitioner has failed to show that the highest and best use of the Maison Blanche-Kress parcel after the conveyance differed from its highest and best use before the conveyance on account of the conveyance’s depriving the partnership of the ability to add 60 hotel rooms above the Kress Building.” Id. at 135. We concluded: “Mr. Roddewig erred in his opinion that the highest and best use of the Maison Blanche-Kress parcel differed after the conveyance on account of the partnership’s disability to add 60 hotel rooms above the Kress Building.” Id.

We stated that we would take that error into account in considering his valuation conclusions. Id. Our Analysis of Value Mr. Roddewig failed to persuade us that $43 million and $35.5 million are reliable estimates of the before- and after-restriction reproduction costs, respectively, of the Maison Blanche-Kress parcel, or that the resulting value of the servitude is $7.5 million. We therefore disregarded petitioner’s cost approach in determining the value of the servitude. Id. at 152. Because we believed that (1) that there was a risk of error inherent in the income approach as applied by Mr.

Roddewig and (2) we had reliable alternative evidence of value arrived at by the comparable-sales approach, we also rejected petitioner’s income approach in determining the value of the servitude. Id. at 156. We relied exclusively on the comparable-sales approach to determine the value of the servitude. Id. at 171-172. Of note, we rejected Mr. Roddewig’s use of nonlocal comparables, id. at 158, and his adjustment for the higher room rates expected at a Ritz-Carlton Hotel (price point adjustment), id. at 159.

We found a before-restriction value for the Maison Blanche Building under the comparable-sales approach of $12,092,301. Id. at 168. We accepted Mr. Argote’s determination that the after-restriction value of the Maison Blanche Building under the comparable-sales approach is $10.3 million, and found accordingly. Id. at 171. We found the difference, $1,792,301, to be the fair market value of the servitude on the valuation date. Id. at 172.

Valuation-Misstatement Penalty On the basis of our determination of the value of the servitude, we concluded that the partnership had overstated the value of the servitude on the 1997 Form 1065 by more than 400%, and, therefore, it had made a gross valuation misstatement. Id. at 176. We found no reasonable cause for the misstatement. Id. We therefore sustained application of an accuracy-related penalty under

section 6662(

a) on the basis of a gross valuation misstatement. Id. Discussion I. Introduction “In sum”, the Court of Appeals stated, we erred in declining to consider the Maison Blanche and Kress buildings’ highest and best use in the light of both the reasonable and probable condominium regime and the reasonable and probable combination of those buildings into a single functional unit, both of which foreclosed the realistic possibility, for valuation purposes, that the Kress and Maison Blanche buildings could come under separate ownership.

This combination affected the buildings’ fair market value. [Whitehouse II, 615 F.3d at 340.] It instructed us as follows as to our tasks on remand: The effect of the easement’s impact on the property’s fair market value, such as prohibiting building 60 additional rooms on top of the Kress building, is a question of fact for the tax court to decide on remand. Therefore, we vacate its valuation and remand for reconsideration of the easement’s value.

As discussed supra, in making this valuation on remand, the tax court should, among other things, reconsider the experts’ reports and valuation methods (including, inter alia, using non-local comparables) and their conclusions regarding highest and best use as a luxury or non-luxury hotel. [Id.] It also included among our tasks reconsideration, if necessary, of our penalty determination. Id. at 341. We shall undertake our tasks as follows.

First, we shall reconsider whether the before and after values of the encumbered property are best arrived at under the comparable-sales approach to valuation rather than the cost approach or the income approach. In doing so, we shall explain our reliance in applying the comparable-sales approach on properties in the Vieux Carré and the Central Business District, which implicates our consideration of the highest and best use of the Maison Blanche Building. Second, we shall explain our conclusion that the servitude did not deprive the partnership of the ability to add stories above the Kress Building.

We shall, however, make an additional finding on the bases that, (1) the servitude did so deprive the partnership and, (2) the pending combination of the Maison Blanche and Kress Buildings made unlikely separate ownership of the two buildings. Finally, we shall revisit the penalty. II. Approaches to Valuation A. Cost Approach 1. In General We have reconsidered Mr. Roddewig’s testimony regarding the value of the servitude under the reproduction cost approach and, because we find it unreliable, continue to accord it no weight.

In its supplemental brief, petitioner suggests that in Whitehouse I we may have implied that the reproduction cost “approach should never be used to value historic properties”. That is not our position. In Whitehouse I, 131 T.C. at 147, we stated: We have in the past questioned the suitability of the reproduction cost approach when applied to value older, historic structures. Dorsey v. Commissioner, T.C. Memo. 1990-242; Losch v. Commissioner, T.C. Memo. 1988-230. For example, reproduction cost is of little assistance if no one would think of reproducing the property. United States v.

Toronto, Hamilton & Buffalo Navigation Co., 338 U.S. 396, 403 (1949). * * * With respect to the Maison Blanche Building, we continued: The Maison Blanche Building was built between 1907 and 1909. It is true that the servitude obligates the building’s owner to repair the facade and structural elements of the building if they are damaged. In the case of a total loss or destruction of the building, however, the servitude provides: “Owner shall promptly remove all debris and trash and properly maintain the Land.

Owner must obtain Donee’s written approval of and prior consent to any construction or reconstruction of * * * [the Maison Blanche Building], as provided herein. * * * [Whitehouse I, 131 T.C. at 147.] We concluded: “Petitioner has failed to convince us that, notwithstanding the historic significance of the Maison Blanche Building, the owners of the building would want to, or would be required to, reconstruct that 100-year-old structure if it were destroyed.” Id.

The simple explanation for petitioner’s failure of proof on that score is that it cannot show that it would be a reasonable business venture to reproduce so old a building. Indeed, the reproduction cost approach is in general problematic for determining the value of a historic structure. The problem is described thus in the

section of the Powell treatise on real property dealing with how valuation and appraisal methods vary for conservation easements: The cost approach to valuation encounters substantial difficulties when applied to historic structures (virtually its only application in the conservation easement context). The reproduction cost of an historic building usually bears little relationship to its present economic value.

Such cost is usually far in excess of the cost of construction of a similarly sized modern structure, and may reflect the price of materials and workmanship that are no longer readily available. * * * [Richard R. Powell, Powell on Real Property, sec. 34A.06, at 34A-54 (M. Wolf ed. 2012).] The treatise concludes its discussion of the appropriateness of the reproduction cost approach to valuing historic improvements to land as follows: [T]his method of valuation has substantial disadvantages in the best of circumstances.

Its utility has been questioned and it should be used with care, if it is used at all, in connection with the appraisal of structures subject to conservation easements. In accord with the authority cited by the Powell treatise, the Court of Appeals has said that, for the reproduction cost approach to be appropriate, “there must be a showing that substantial reproduction would be a reasonable business venture”. United States v. Benning Housing Corp., 276 F.2d 248, 250 (5th Cir. 1960).

The Court of Appeals further observed that, where the reproduction cost approach is inapposite, reproduction cost evidence generally should be excluded from jury trials (such as in condemnation proceedings) because such evidence “almost invariably tends to inflate valuation.” Id. (fn. ref. omitted). “This is so”, the court continued, “because the reproduction cost of a structure sets an absolute ceiling on the market price of that structure, a ceiling which may not be, and most frequently is not, even approached in actual market negotiations.” Id. (fn. ref. omitted).

Following that line of reasoning, the Court of Appeals for the Eighth Circuit has stated the rule more generally: “For the reproduction cost appropriately to have an impact on the value equation, the taxpayer must establish ‘a probative correlation between [it] and fair market value.’” Estate of Palmer v. Commissioner, 839 F.2d 420, 424 (8th Cir. 1988) (quoting Rainier Cos. v. Commissioner, T.C. Memo. 1977-351), rev’g and remanding 86 T.C. 66 (1986); see also Crocker v. Commissioner, T.C. Memo. 1998-204 (same with respect to replacement cost, citing Estate of Palmer).

Thus, without a showing by petitioner that reconstruction of the Maison Blanche Building, if destroyed, would be a reasonable business venture, petitioner has failed to convince us that there is a probative correlation between Mr. Roddewig’s estimate of the reproduction cost of the Maison Blanche Building and the fair market value of that property. And while that might be a sufficient basis to disregard Mr. Roddewig’s testimony concerning cost, we believe that there are additional reasons for doing so, which we discussed in Whitehouse I, and which we summarize here. 2. Comparing Petitioner’s Historic Cost to Mr.

Roddewig’s Cost Estimate In Whitehouse I, 131 T.C. at 148-150, we questioned whether Mr. Roddewig’s estimate of a before-restriction value of $43 million for the Maison Blanche-Kress parcel correlated with its market value because of the huge difference between his estimate of its before-restriction reproduction cost — $43 million — and what the partnership actually paid for the parcel no more than two years earlier — slightly more than $11 million. After reviewing his list of reasons for the increase in value of the Maison Blanche Building, we stated: “Simply put, we cannot reconcile Mr.

Roddewig’s report of a New Orleans real estate market enjoying, at best, stable growth with his explanation of 291-percent appreciation in the value of the Maison Blanche-Kress parcel.” Id. at 149-150. We are still of that conclusion. 3. Terra Cotta Reproduction Cost Mr. Roddewig was of the opinion that the reproduction cost of the Maison Blanche Building shell and the Kress Building on the valuation date, before depreciation and obsolescence, was $54.3 million. Of that total estimated cost of reproduction, he attributed $42,025 million to reproducing the terra cotta facade on the Maison Blanche Building.

Because we found that he insufficiently supported his terra cotta reproduction cost estimate (his testimony as to that cost being the only evidence of it in the record), and because that estimate was the major element of his reproduction cost estimate, we gave no weight to his conclusion that the total cost to reproduce the Maison Blanche Building shell and the Kress Building is $54.3 million. Mindful of the fact that, since the conveyance, the partnership has spent $7,792 million repairing and restoring the terra cotta facade, plus $421,000 to repair damage from Hurricane Katrina, we still accord Mr.

Roddewig’s testimony as to the reproduction cost of the Maison Blanche Building shell and the Kress Building no weight because of the inadequacy of his testimony as to the terra cotta reproduction cost. 4. External Obsolescence In both his before- and after-restriction calculations of reproduction cost, Mr. Roddewig deducted an amount to reflect external obsolescence: 15% of the before-restriction depreciated reproduction cost and 30% of the after-restriction depreciated reproduction cost ($6,516,000 and $13,846,500, respectively).

He described the before-restriction external obsolescence as resulting from the designation of the Maison Blanche-Kress parcel as part of the Canal Street Historic District. He described his doubling of that figure to reflect after-restriction external obsolescence as resulting from his judgment of the added burden imposed on the owner of the parcel by the servitude. We refused to rely on his judgment alone that the enforcement of the provisions of the servitude double the cost of external obsolescence.

We explained that our lack of confidence in his judgment was based on our impression that his $43 million estimate of the before-restriction value of the Maison Blanche-Kress parcel defied reason. Whitehouse I, 131 T.C. at 151-152. We added: “We need not rely on the unsupported opinion of an expert witness”, citing Holman v. Commissioner, 130 T.C. 170, 213 (2008), aff’d, 601 F.3d 763 (8th Cir. 2010). Id. at 152. The relevant authority of the Court of Appeals is in accord. E.g., Guile v.

United States, 422 F.3d 221, 227 (5th Cir. 2005) (“An expert’s opinion must be supported to provide substantial evidence; * * * ‘A claim cannot stand or fall on the mere ipse dixit of a credentialed witness.’” (quoting Archer v. Warren, 118 S.W.3d 779, 782 (Tex. Ct. App. 2003))). We have reconsidered and do not believe we erred in questioning, and refusing to rely on, Mr. Roddewig’s judgment that the enforcement of the provisions of the servitude doubles the cost of external obsolescence. 5. Land Value In moving from his before- to his after-restriction value, Mr.

Roddewig reduced his estimate of the cost of land by $2.5 million because the conveyance had reduced the partnership’s interest in the Maison Blanche-Kress parcel to less than a fee simple interest and, he believed, the partnership had lost the right to construct 60 rooms above the Kress Building. We shall address his second reason infra. In Whitehouse I, 131 T.C. at 152, we conceded for the sake of argument that a servitude requiring maintenance of a building’s facade would survive and affect the value of the underlying land if that land were wiped clean of the building. Id.

His testimony that the price of each comparable should be adjusted down by 10% to reflect the effect of the servitude was supported only by his opinion, which we did not find persuasive and did not accept. Id. Here, we again cited Holman v. Commissioner, 130 T.C. at 213, signifying that we need not rely on the unsupported testimony of an expert witness. Accord Guile, 422 F.3d at 227.

Additionally, as with our consideration of his testimony with respect to external obsolescence, we lack confidence in his judgment on account of what we consider to be his overvaluation of the before-restriction value of the Maison Blanche-Kress parcel. We continue not to accept his 10% downward adjustments. 6. Conclusion We reject Mr.

Roddewig’s testimony regarding the value of the servitude under the reproduction cost approach not only because that approach is in general problematic for determining the value of a historic structure (and, in particular, problematic here, where petitioner has failed to show that reconstruction, if the Maison Blanche Building were destroyed, would be a reasonable business venture) but also because we lack confidence in some of Mr. Roddewig’s unsupported conclusions.

Moreover, we need not (and should not) rely on a substantially flawed and inappropriate valuation method where we have another method that provides a more accurate valuation of the servitude, as discussed infra. B. Income Approach 1. Introduction In Whitehouse I, 131 T.C. at 156, we summed up our grounds for rejecting petitioner’s income approach to valuing the servitude as follows: “The risk of error inherent in the income approach as applied by Mr.

Roddewig in this case, together with the fact that we have reliable alternative evidence of value arrived at by the comparable sales approach, is sufficient grounds for us to reject the income approach, and we do.” We have reconsidered and come to the same conclusion. 2. In General While on the valuation date the partnership and Ritz-Carlton had entered into agreements under which (1) the partnership agreed to renovate the Maison Blanche and Kress Buildings and

(2) Ritz-Carlton agreed to operate a hotel therein, on that date there had been no renovation and there was no hotel. Indeed, all that was valuable with respect to the Maison Blanche Building was its shell, since the rehabilitation plan for the building was to remove all interior partitions as well as mechanical and electrical systems. Id. at 136 n.ll. The income approach to valuation is based on the premise that the subject property’s market value is measured by the present value of the future income its owners can expect to realize. E.g., Marine v.

Commissioner, 92 T.C. 958, 983 (1989), aff’d without published opinion, 921 F.2d 280 (9th Cir. 1991). The subject property’s future cashflows are estimated, and the present value of those cashflows is determined on the basis of an appropriate risk-adjusted rate of return. See, e.g., Estate of Heck v. Commissioner, T.C. Memo. 2002-34. Mr. Roddewig described the process as follows: In our Income Approach “before” considering the preservation and conservation easement, the rehabilitation costs have been based upon the actual proposed rehabilitation costs as of December of 1997.

Operating revenues, operating costs and expenses, and profits associated with the proposed Ritz-Carlton Hotel project have been determined based upon analysis of the actual real estate marketplace in the New Orleans CBD [Central Business District], and elsewhere, and then inserted into a computerized discounted cash flow model.

The resulting discounted present value is the price that could be paid for the Maison Blanche Building, the 1950s Addition, and the Kress Building in their deteriorated condition prior to rehabilitation as of December of 1997, and before considering the preservation and conservation easement. The result is the most probable price that a purchaser would be willing to pay for the unrehabilitated Maison Blanche complex prior to considering the impact of the preservation easement. In short, Mr.

Roddewig input data to his computer model, and the output, he represents, is the “most probable price” that a willing buyer would be willing to pay for the Maison Blanche-Kress parcel sans the servitude. The seemingly mechanical nature of the process should not obscure the fact that Mr. Roddewig’s estimate of “the most probable price” is a probabilistic expression (a point estimate) of value resulting from an analysis of a considerable number of underlying data.

Even if we accept that, according to his analysis of the data, the model has generated the most probable price that a willing buyer would pay, how much confidence should we place in that estimate? How confident should we be that the most probable price that a willing buyer would pay is not substantially less (or more) than the price indicated by Mr. Roddewig’s model? Many of the data Mr. Roddewig relied on (e.g., occupancy rates) were as yet unknown. He relied on industry data for many of his inputs (e.g., room revenues, food and beverage revenue, telephone revenue).

Some risks are obvious: e.g., the hotel might not be finished on schedule; occupancy might be less than expected; the hotel might not fetch $123,942,500 at the end of 2002 (ignoring the servitude). Moreover, in estimating construction costs and hotel receipts and expenses alone, Mr. Roddewig made hundreds of assumptions, involving amounts both large ($9,904,936 in construction period interest) and small ($4.50-a-night telephone revenue from occupied rooms), each carrying with it some risk of error.

He has provided us with no measure of the overall risk of error in his conclusion of the most probable price that a willing buyer would pay. Our own calculations, see Whitehouse I, 131 T.C. at 154-156, show that relatively minor changes in only a few of his assumptions would have large bottom-line effects.

Without some measure of the overall risk attendant to his model’s output that we might examine, and with our own conclusions as to the sensitivity of his model’s output to relatively minor changes, we were (and remain) hesitant to attach any weight to that output (i.e., most probable price that a willing buyer would pay), especially in the light of the availability of comparable-sales data as to value. Mr. Argote did not use the income approach. He testified that, as applied to the Maison Blanche Building, the income approach relied upon too many assumptions, thus making it prone to error.

He believes (as we determined) that even a small change in estimated construction costs, the timing of those costs, the length of time to complete construction, estimated income, estimated expenses, capitalization rate, or discount rate could substantially affect the present value arrived at using a discounted cashflow analysis. Petitioner in its supplemental brief points us to cases in which we approved the income approach to valuing income-generating properties. E.g., Gross v. Commissioner, T.C.

Memo. 1999-254 (“When properly applied, a discounted cash-flow analysis is a reliable tool for financial analysis.”), aff’d, 272 F.3d 333 (6th Cir. 2001). Two of the cases that petitioner refers us to are cases in which we actually ignored the income approach (applied by at least one appraiser in each case) in determining the fair market value of an encumbrance: Dorsey v. Commissioner, T.C.

Memo. 1990-242 (preferring acquisition cost to establish the pre-encumbrance value of the building and reducing it by 10% to reflect the loss in value attributable to the encumbrance; illustrating in an appendix how our result was approximately the same as under the taxpayer’s expert’s income approach), and Hilborn v. Commissioner, 85 T.C. 677, 698—700 (1985) (relying, in part, on each expert’s testimony but not placing any weight on the value arrived at under the income method).

It is true that we have used the income approach (the subdivision method) to account for the loss of development potential resulting from the restrictions imposed by a conservation easement. E.g., Symington v. Commissioner, 87 T.C. 892 (1986); Trout Ranch, LLC v. Commissioner, T.C. Memo. 2010-283, aff’d, 493 Fed. Appx. 944 (10th Cir. 2012); Clemens v. Commissioner, T.C. Memo. 1992-436.

In those instances, we found that the loss in value due to imposition of the conservation restriction stemmed from the change in the number of lots that could be sold, with the number and value of those lots (determined by the comparable-sales approach) being the principal points of disagreement. We had sufficient information from the experts that we were comfortable in evaluating and adjusting their analyses to produce valuations in which we had confidence. See, e.g., Symington v. Commissioner, 87 T.C. at 903—904.

Certainly, we are not hostile to the income approach to determining value, and we have accepted (and applied) it in determining the value of conservation easements, see, e.g., id. (subdivision method), although it is not favored if comparable-sales data are available, see, e.g., Chertkof v. Commissioner, 72 T.C. 1113, 1122 (1979), aff’d, 649 F.2d 264 (4th Cir. 1981). As we said in Whitehouse I, 131 T.C. at 153: “The usefulness of the income approach diminishes * * * as the quality of the evidence of the income-producing potential of the property (usually' evidence of its past performance) diminishes.

It has been judged an unsatisfactory valuation method for property that does not have a track record of earnings.” See Duncan Indus., Inc. v. Commissioner, 73 T.C. 266, 280 n.13 (1979) (rejecting capitalization-of-income approach where corporation had just come into existence); Pittsburgh Terminal Corp. v. Commissioner, 60 T.C. 80, 89 (1973) (rejecting capitalization-of-income approach where coal fields were not yet developed and operational on date for valuation), aff’d without published opinion, 500 F.2d 1400 (3d Cir. 1974); Ambassador Apartments, Inc. v.

Commissioner, 50 T.C. 236, 243-244 (1968) (rejecting real estate valuation based on capitalization-of-income approach in favor of market value established by recent sales), aff’d, 406 F.2d 288 (2d Cir. 1969); see also, e.g., Allison v. Ticor Title Ins. Co., 979 F.2d 1187, 1200 (7th Cir. 1992) (“[T]he law is clear in Wisconsin that when comparable-sales evidence is available, income evidence should not be admitted. * * * Income evidence is generally considered too speculative as it depends upon too many contingencies to be reliable for determining fair market value.”); Winooski Hydroelectric Co. v.

Five Acres of Land, 769 F.2d 79, 82 (2d Cir. 1985) (“On the most basic level, the future income calculations were too speculative, since Green Mountain had not operated any business at Montpelier #4 for over a decade.”). The Court of Appeals has also approved a trial court’s excluding income-generating proposals from the consideration of value where the evidence showed that the proposals were too speculative to contribute to market value. United States v. Land, 62.50 Acres of Land More or Less, 953 F.2d 886, 891, 893 (5th Cir. 1992).

What these cases establish is that the reliability of the income approach depends on the underlying facts (e.g., whether there is an ongoing business on the valuation date), the quality of the evidence, and whether evidence of comparable sales was available. We have explained our general hesitancy with respect to Mr. Roddewig’s model on the basis of his failure to quantify the risk inherent in the conclusion he draws from it. Moreover, he did not capitalize the income of an ongoing business.

He identified the property that he was to value as the shell of the Maison Blanche Building, and, for that property, comparable-sales data were available. We felt, and still do, that there is simply too much uncertainty and unquantified risk associated with Mr. Roddewig’s application of the income approach for us to accept at face value his value conclusions resulting from that approach. We do not intend to write a rule for facade cases in general, nor do we rule out the income approach in some of those cases; we deal here only with the facts (testimony) before us. One significant problem with respect to Mr.

Roddewig’s income approach that is specific to the facts before us is that a large portion of the change in annual operating costs that he projected is attributable to annual additions to a “facade replacement reserve” on the basis of an estimate of terra cotta replacement costs that we found to be unreliable. Whitehouse I, 131 T.C. at 150-151, 155. We also faulted Mr.

Roddewig for inadequately explaining, among other costs, an almost $3 million architect’s fee, approximately $4 million for a development fee, interest, real estate taxes, “Etc.”, a project management fee of approximately $2.6 million, and a financing fee of approximately $4.7 million. Finally, we had a major problem with his failure adequately to explain the change in his assumed capitalization and discount rates. Id. at 155.

We pointed out that, if we reduce his 0.5% increase in both his capitalization and discount rates by 0.1% (a 20% reduction), the value he calculated for the servitude would be reduced by close to $1 million. Id. 3. Conclusion To sum up, Mr. Roddewig used a computer model employing a discounted cashflow analysis to arrive at both before- and after-restriction present values for the Maison Blanche-Kress parcel (the difference being his estimate under the income approach of the value of the servitude). We have no difficulty with the process.

Where we have difficulty is with petitioner’s call to trust on their face Mr. Roddewig’s judgments as to values to be input to his model. Certainly there are risks associated with those values, but we are not informed as to the magnitude of those risks, either individually or in total. We have also described specific concerns that we have with certain of the values Mr. Roddewig input to his model. Together, we think those factors are sufficient that we need give no weight to his income approach in determining the value of the servitude.

Finally, there is the fact that, during the trial, petitioner asked us to take judicial notice of the pending bankruptcy of the partnership on July 25, 2003, the date the petition was filed. The bankruptcy proceeding commenced on January 3, 2002, and it was brought under

chapter 11 of the U.S. Bankruptcy Code in the U.S. Bankruptcy Court for the Eastern District of Louisiana (case No. 02-10061). Petitioner referenced the bankruptcy in support of its claim that, pursuant to

section 7491, the partnership lacked sufficient net worth such that petitioner was not excluded from shifting the burden of proof to respondent. See sec. 7491(a)(2)(C). And while subsequent events generally are not considered in fixing fair market value, they may be considered to the extent that they were reasonably foreseeable on the date as of which the value is fixed. E.g., Estate of Gifford v. Commissioner, 88 T.C. 38, 52 (1987). Mr.

Argote testified that, “based upon what * * * [he] knew in 1997 * * * y * * * development of the Ritz-Carlton was not feasible.” That opinion, he added, was borne out by the fact that full-service hotel projects that went ahead in the 1990s and up to the mid-2000s “have generally gone into bankruptcy”. While we have no additional information concerning the partnership’s bankruptcy, the risk inherent in the Maison Blanche development was, on the valuation date, apparent to Mr. Argote. The partnership’s bankruptcy and Mr. Argote’s testimony stand in sharp contrast to the rosy pictures generated by Mr.

Roddewig’s model, which showed a positive worth for the Maison Blanche-Kress parcel both before and after conveyance of the servitude (and a terminal value of over $100 million on the hypothetical sale of the parcel after conveyance of the servitude, in 2003). As stated, we reject Mr. Roddewig’s testimony valuing the Maison Blanche-Kress parcel under the income approach because we judge that testimony to be unreliable. C. Comparable-Sales Approach 1.

Introduction In Whitehouse I, relying exclusively on the comparable-sales approach, we found the value of the servitude to be $1,792,301, calculated as follows: Value of the servitude under comparable-sales approach Before-restriction value . $12,092,301 Less after-restriction value. 10,300,000 Value of the servitude . 1,792,301 Putting aside for the moment the question of the effect of the servitude on the value of the Kress Building, we discern from petitioner’s supplemental brief two principal concerns with our application of the comparable-sales approach; viz, that we rejected Mr.

Roddewig’s sales of nonlocal comparable properties and that we disregarded his determination of the value of the Maison Blanche-Kress parcel based on dollars paid per hotel guest room for comparable properties. The more important of those concerns is the first, because, if we are right on the first, the second is of no consequence to petitioner, since, considering only local sales, Mr. Roddewig’s per-room analysis produces a lower value for the Maison Blanche Building than does his per-square-foot analysis. 2. Disregard of Sales of Nonlocal Comparable Properties Mr.

Roddewig testified that he included nonlocal comparables because none of the buildings that he found in downtown New Orleans were similar to the Maison Blanche-Kress parcel in size or luxury hotel market orientation. He added: “‘Buildings purchased for rehabilitation into first class luxury hotels trade in a national marketplace, so it is appropriate to analyze sales in other cities for purposes of establishing the value of the Maison Blanche Hotel Complex by the Sales Comparison Approach.’” Whitehouse I, 131 T.C. at 157. Mr. Argote saw no need for nonlocal comparables.

While he agreed that, occasionally, if there are insufficient local sales, an appraiser has to look outside the location of the subject property for comparables, he thought there was an adequate number of local comparable properties. Id. And, indeed, Mr. Roddewig did identify five local sales of comparable properties; Mr. Argote believed that there were nine that Mr. Roddewig should have considered. Id. at 158. We rejected Mr. Roddewig’s nonlocal comparables for a number of reasons.

First, we expressed our preference for local comparables, stating: “The reason is simply that location plays a huge role in determining the desirability, and, thus, the value of real estate. We reduce substantially the risk of error in employing the comparable-sales approach if, on account of proximity, we can eliminate (or reduce the significance of) location as a distinguishing factor.” Id. at 157-158.

The Court of Appeals has also recognized the link between proximity and probative value: “The more comparable a sale is in characteristics, proximity, and time, the more probative it is of value.” Estate of Jameson v. Commissioner, 267 F.3d 366, 373 (5th Cir. 2001) (emphasis added), vacating and remanding T.C. Memo. 1999-43. We found the risk of relying on Mr.

Roddewig’s nonlocal comparables to be significant because the adjusted values he determined for his nonlocal properties were significantly higher than the adjusted values he determined for his local properties, “64 percent higher on a square footage basis and at least double on a per room basis”. Whitehouse I, 131 T.C. at 158. Those large variances from the local real estate market underscore the lack of comparability of the nonlocal properties that Mr. Roddewig chose. Moreover, there were at least five (in Mr. Roddewig’s opinion) and as many as nine (in Mr.

Argote’s opinion) local sales of comparable properties for which the risk of proximity disparity was low, and the addition of Mr. Roddewig’s nonlocal comparables would, by increasing the risk of proximity disparity, only decrease the probability of an accurate valuation of the Maison Blanche Building, unless some characteristic of those nonlocal sales sufficiently increased that probability.

We did not believe that it did, adding: Nor are we convinced that it was appropriate to take nonlocal sales into account because of his claim that buildings purchased for rehabilitation into first class luxury hotels trade in a national marketplace. He [Mr. Roddewig] had no statistics supporting that claim, nor did he have evidence of any competition for the Maison Blanche Building, which, 2 years before the valuation date, was purchased for the relatively moderate price of $6,625 million. [Id.; fn. ref. omitted.] 3. Highest and Best Use Mr.

Roddewig looked to nonlocal comparables, and he made price point adjustments for his comparables (adjusting for the higher room rates expected at a Ritz-Carlton Hotel), because he determined that the highest and best use of the Maison Blanche-Kress parcel before the conveyance was a mixed use development, including a Ritz-Carlton Hotel with 512 rooms (60 of them above the Kress Building), an additional all-suites hotel with approximately 268 rooms, and retail use on the first two floors and mezzanine of the Maison Blanche Building (for short, luxury hotel development). Id. at 130-131. Mr.

Argote determined that the highest and best use of the Maison Blanche Building both before and after the conveyance was as a hotel (not necessarily a Ritz-Carlton Hotel) with retail space (for short, a nonluxury hotel development). Id. The Court of Appeals found inadequate our findings with respect to highest and best use: As stated, Whitehouse contends the highest and best use of the Maison Blanche and Kress buildings was as a Ritz-Carlton (per Roddewig’s opinion), not as a non-luxury hotel (per Argote’s opinion).

The tax court did not explicitly rule on this issue, but it did not accept Roddewig’s opinion on highest and best use. Accordingly, on this issue, the tax court’s decision can be construed in two ways: even if the highest and best use was as a Ritz-Carlton, that had no effect on the property’s value; or, a non-luxury hotel was the highest and best use. * * * [Whitehouse II, 615 F.3d at 335-336.] The Court of Appeals is correct that we did not explicitly decide whether the highest and best use of the Maison Blanche-Kress parcel was as a luxury hotel or as a nonluxury hotel. What we did decide was that Mr.

Roddewig erred in his opinion that the highest and best use of the Maison Blanche-Kress parcel differed after the conveyance because the servitude prevented the partnership from adding stories to the Kress Building. Whitehouse I, 131 T.C. at 135. We address that conclusion infra in

section III. of this report. We of course agree with the Court of Appeals that finding a property’s highest and best use is critical for determining its fair market value. Whitehouse II, 615 F.3d at 335 (citing Olson v. United States, 292 U.S. 246, 255 (1934)). Indeed, we have said: “The realistic, objective potential uses for property control the valuation thereof.” Stanley Works v. Commissioner, 87 T.C. at 400. Nevertheless, we are not compelled to choose between Messrs.

Roddewig’s and Argote’s competing opinions as to highest and best use of the Maison Blanche Building either as a luxury or as a nonluxury hotel. The term “highest and best use” may be defined as “[t]he reasonably probable and legal use of vacant land or an improved property that is physically possible, appropriately supported, and financially feasible and that results in the highest value.” Appraisal Institute, The Appraisal of Real Estate 277-278 (13th ed. 2008).

But, and this is very important, the highest and best use of property does not itself identify the fair market value of the property: It “forms the foundation for the opinion of value.” Id. at 295. As the Supreme Court explained, the determination of fair market value incorporates the highest and best use of a piece of property only if the demand for that use will affect the market price: [M]arket value fairly determined * * * does not depend upon the uses to which * * * [the owner] has devoted his land but is to be arrived at upon just consideration of all the uses for which it is suitable.

The highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future is to be considered, not necessarily as the measure of value, but to the full extent that the prospect of demand for such use affects the market value * * * [Olson, 292 U.S. at 255; emphasis added.] Accordingly, as the Court of Appeals has explained: “Even if * * * a potential use is profitable and * * * the property is adaptable for that use, that use is not necessarily the measure of the value of the property.

Instead, it is to be considered to the extent the prospect of demand for the use affects market value.” Land, 62.50 Acres of Land More or Less, 953 F.2d at 890 (citing Olson, 292 U.S. at 255); see also Boltar, LLC v. Commissioner, 136 T.C. 326, 336 (2011) (“The concept of ‘highest and best use’ is an element in the determination of fair market value, but it does not eliminate the requirement that a hypothetical willing buyer would purchase the subject property for this indicated value.”). 4. Second-Best Use .

The point to be taken is that, although the highest and best use of property may determine a ceiling on how much a willing buyer would pay for the property, it does not necessarily determine a floor on how little a willing seller would accept. In other words, the hypothetical willing buyer and the hypothetical willing seller who populate our standard definition of fair market value will not invariably conclude their negotiation over price at a price reflecting the value of the property at its highest and best use. In Van Zelst v. Commissioner, 100 F.3d 1259 (7th Cir. 1996), aff’g T.C.

Memo. 1995-396, Judge Easterbrook, writing for the court, explained this commonsense point by reference to auction theory. He rejected as “nonsense on its own terms” an appraisal, used to support a substantial charitable contribution deduction for the contribution to the United States of lands in the Alaskan wilderness, that was based on the theory that the property might be developed as a luxury resort lodge. Id. at 1262.

He explained: “It should not have required the award of the 1996 Nobel Prize in Economics to William Vickrey, a pioneer of auction theory, to remind people that the market price of an asset depends on the second-most-productive use to which it can be put.” Id. (citing R. Preston McFee & John McMillan, “Auctions and Bidding”, 25 J. Econ. Lit. 699 (1987)).

He further explained that the equilibrium price at which the willing buyer and the willing seller would meet would be somewhere between the value of the property taking into account its most productive use (i.e., its highest and best use) and the value of the property taking into account its second most profitable use. Id. at 1262-1263.

If there are many potential buyers in the market for the property, the equilibrium price would be closer to the price determined by taking into account its most productive use, and, if there are few potential buyers in the market for the property, it would be closer to the price determined by taking into account its second most productive use. Id.

Judge Easterbrook’s discussion of the value of land in Alaska— which, as here, the taxpayer claimed, could be used for the development of a luxury hotel — is helpful in resolving the problem before us; viz, the value of a property in New Orleans that might be used to develop a luxury hotel: Suppose three parcels of private land in the Park are equally suitable to be the site of a resort that will bring its developer $2 million after costs of construction and operation. How much will the developer pay for the land?

That depends on what else the owners can do with their land, as the developer will shop for the lowest price. Suppose Parcel A has a vein of ore with a present value of $650,000, and Parcels B and C, which lack minerals, are suitable only for subsistence hunting and fishing (value $10,000). The owner of Parcel A will not sell for less than $650,000, but the owners of Parcels B and C will sell for anything over $10,000. The developer will not pay $650,000 to the owner of Parcel A, when he can get land for so much less elsewhere, so Parcel A is worth only $650,000 as the value of its second-best-use, a mine.

If there were no Parcel C, the developer and the owner of Parcel B would reach a deal in the range between $10,000 and $650,000: the developer never pays more than $650,000 (for he can turn to Parcel A), and the owner never takes less than $10,000 (for he can keep the land in its current use). When there is a Parcel C, a threat to buy it instead of Parcel B helps the developer chisel the price down, unless the owners collude. As the number of available sites rises, the possibility of collusion declines.

When there are hundreds of potential sites (as there are in the Park and Preserve), the price the developer must pay falls to the competitive level. To put this otherwise, land is not a scarce resource in these mountains; financing and entrepreneurship are the scarce ingredients, so they will capture the economic return of resort development. Yet the Hawley Group’s appraisal attributed to the Nelson Mine 100 percent of the (potential) economic profit of a resort development. It did not offer a rationale for that allocation.

At oral argument Van Zelst’s lawyer tried to supply one by saying that the number of potential resort-mine combinations in the vicinity is small, but for reasons we have already explained even a “small” number of rivals allows the developer to capture the returns * * *. [Van Zelst v. Commissioner, 100 F.3d at 1262—1263.] See also Caracci v. Commissioner, 456 F.3d 444, 459 (5th Cir. 2006) (citing with approval that discussion of comparable properties), rev’g 118 T.C. 379 (2002). Even if Mr.

Roddewig is right that the highest and best use of the Maison Blanche-Kress parcel before the conveyance to PRC was a luxury hotel development and that “[b]uildings purchased for rehabilitation into first class luxury hotels trade in a national marketplace”, that does not necessarily lead to the conclusion that the fair market value of the parcel is much (if indeed any) greater than the price that would be predicted for the parcel taking into account its second best use; i.e., development as a nonluxury hotel. By his own admission, what Mr.

Roddewig valued was the shell of a building, which he thought could profitably be developed into a hotel: “We have concluded that the highest and best use of the Maison Blanche Building * * * [before conveyance] is rehabilitation of the 'shell’ structure for hotel use with retailing on the first and second floor[s]”.

He identified as comparables five local buildings which he described as “downtown New Orleans buildings purchased as shells for adaptive reuse as hotels.” He cautioned, however, that “none were similar to the Maison Blanche hotel complex in size and luxury hotel market orientation.” The size dissimilarity is easily adjusted for. The second dissimilarity appears inappropriate, however, since, admittedly, he was comparing building shells, and, for the shell of a building, similarity is determined by development potential, not by actual development.

To reflect an after-development dissimilarity between the Maison Blanche-Kress parcel and the comparables, he made his so-called hotel price point adjustments, whereby he adjusted (upward) the reported sale price of each comparable building to reflect the higher room rates expected at a Ritz-Carlton Hotel over the actual rates quoted for rooms at the comparable buildings, after their development into hotels.

While apparently none of the comparables was developed into a luxury hotel, petitioner makes no argument that, when considered in their shell-state condition, luxury hotel development was precluded for any of the comparables. The hotel price point adjustments therefore are beside the point. So long as the comparables when considered as shell buildings had a potential for hotel development (luxury or not) similar to that of the Maison Blanche Building when considered as a shell building, the comparables’ actual development as nonluxury hotels is irrelevant.

Petitioner wants to ascribe to the shell of the Maison Blanche Building some difference (“luxury hotel market orientation”) that it has not shown exists. Luxury versus nonluxury might be a relevant distinction when applying the comparable-sales approach to valuing renovated properties (or when applying the income approach to valuing improved or unimproved real property), but even in those circumstances there is a hotel business whose value must be differentiated from the value of the real property.

Moreover, petitioner has failed to show that, on the valuation date, there was any scarcity of buildings in New Orleans suitable for development as luxury hotels. Only if there were sufficient scarcity would the partnership, considering it as the landlord of the Maison Blanche Building, capture a piece of the economic return to luxury hotel development of the building’s shell. But, as Judge Easterbrook points out, even a small number of rivals allows the developer (and not the property owner) to capture the return. Van Zelst v. Commissioner, 100 F.3d at 1263. Mr.

Roddewig identified five local comparables, while Mr. Argote believed that there were nine. Local rivals, therefore, were not scarce, and, as to the intensity of demand, Mr. Roddewig had no “evidence of any competition for the Maison Blanche Building, which, 2 years before the valuation date, was purchased for the relatively moderate price of $6,625 million.” Whitehouse I, 131 T.C. at 158. Since it was petitioner’s burden to establish otherwise, and since petitioner did not do so, we assume that, on the valuation date, demand also was weak. Finally, Mr.

Roddewig did not justify his use of nonlocal comparables and his price point adjustments on competitive grounds (i.e., that, on the valuation date, it was a seller’s market for properties comparable to the Maison Blanche Building) but on the ground that buyers in the marketplace for shell buildings suitable for development into luxury hotels “will pay a premium without trying to think about what the local buyers will pay.” Whitehouse I, 131 T.C. at 160.

Even in the absence of competing bids, that is, he testified that developers of luxury hotels will leave money on the table by paying more than the local market would demand for the property. Id. Put simply, that defies common sense. Moreover, it contradicts a basic tenet of the fair market value paradigm; viz, that, with respect to both the hypothetical buyer and the hypothetical seller, “each is a rational economic actor, that is, each seeks to maximize his advantage in the context of the market that exists at the date of valuation.” Estate of Jameson v.

Commissioner, 267 F.3d at 370; see also Estate of Newhouse v. Commissioner, 94 T.C. 193, 217-218 (1990). The rational economic buyer’s advantage is that the sellers’ properties are worth more to him than they are to the sellers, and he maximizes that advantage by acquiring a seller’s property at the lowest cost that seller will accept. 5.

Conclusion The highest and best use of the Maison Blanche-Kress parcel on the valuation date may have been luxury hotel development; but even if we were to accept that as a fact, it does not rule out the possibility that the value of the parcel on that date was dictated by its second best use (which, we assume, is as a nonluxury hotel). We have Mr. Roddewig’s testimony that, on the valuation date, the market for the parcel was national and that luxury hotel developers have deep pockets and do not stoop to bargain, but we have rejected that.

While the fair market value of the parcel may have fallen somewhere between its value determined by its highest and best use and its value determined by its second best use, we have no evidence, or the tools, to determine what that might be. In Whitehouse I, 131 T.C. at 158-160, we disregarded Mr. Roddewig’s nonlocal comparables and his price point adjustments, and we determined the value of the Maison Blanche Building on the basis of only local comparables, without any price point adjustments. We continue to believe that that was the proper course. In effect, then, we are accepting Mr.

Argote’s methodology and his view that the value of the subject property under the comparable-sales approach is to be determined on the basis of sales of buildings suitable for conversion into hotels — luxury or not. The properties that both expert witnesses chose represent the market value of shell buildings of comparable age, character, and quality that were suitable for conversion to hotels. They are, therefore, representative of how the market would have valued the Maison Blanche Building at the time of the donation.

We do not need to choose between the two experts’ opinions of highest and best use, since, even if we were to agree with Mr. Roddewig, it would make no difference. III. Effect of the Servitude A. Introduction We have summarized the terms of the conveyance above and have set it out in full (excluding exhibits) in the appendix. The six-story Kress Building is adjacent to the Maison Blanche Building on Canal Street.

According to petitioner, in order to protect that portion of a common wall rising above the Kress Building, the conveyance prevents the partnership “from building additional stories atop the Kress Building and from selling the Kress Building unencumbered.” In Whitehouse I, 131 T.C. at 132, we began our discussion of the conveyance by noting that petitioner described the partnership’s risk from building above the Kress Building or selling the Kress Building “unencumbered” as the risk of being sued by PRC for breach of contract.

Petitioner conceded that no portion of the protected facade is actually located on the Kress Building. Moreover, neither the definition of “improvement” nor the definition of “property” in the conveyance includes the Kress Building. Id. We found that the conveyance creates no charge on (i.e., does not burden) the Kress Building, id. at 134, and the Court of Appeals agreed with us that the conveyance does not burden the Kress Building, Whitehouse II, 615 F.3d at 337. We continued: Petitioner has therefore failed to prove that, by the conveyance, and pursuant to La. Rev. Stat.

Ann. sec. 9:1252 (1991), the partnership granted PRC a perpetual real right (servitude) of any extent in the Kress Building.

While the partnership may have obligated itself personally to maintain a view of the Maison Blanche Building, petitioner has failed to show how that promise binds anyone who does not undertake it * * * [Whitehouse I, 131 T.C. at 134-135; emphasis added.] Implicit in the emphasized language is our conclusion that, not only did the servitude not burden the Kress Building, but it did not impose any obligation on the partnership not to build atop it so as to block views of the Maison Blanche Building’s facade.

That is not to say that the partnership had not personally obligated itself not to do so, but we did not read the servitude to include that obligation. And that is an important distinction. All agree that the servitude constitutes a perpetual conservation restriction. The Louisiana statute pursuant to which the servitude was created, La. Rev. Stat. Ann. sec. 9:1252, specifies that a real right created pursuant to the

section “shall be effective against third parties when filed for registry in the conveyance records of the parish in which the immovable property is located.” La. Rev. Stat. Ann. sec. 9:1252, C.

That, the pertinent regulations recognize, is sufficient to conclude that the servitude is enforceable in perpetuity: In the case of any donation under this section, any interest in the property retained by the donor (and the donor’s successors in interest) must be subject to legally enforceable restrictions (for example, by recordation in the land records of the jurisdiction in which the property is located) that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation. * * * [Sec. 1.170A-14(g)(l), Income Tax Regs, (general rule under heading “Enforceable in perpetuity”).} Thus, if the partnership’s supposed obligation with respect to the Kress Building is not within the burdens or obligations constituting the servitude, then, unless petitioner can otherwise show us that the obligation is enforceable in perpetuity, it fails as a perpetual conservation restriction, and it cannot be taken into account in determining the amount of the partnership’s charitable contribution deduction on account of its December 29, 1997, conveyance of certain rights in the Maison Blanche Building to PRC.

That is not to say, of course, that the burden of the supposed obligation, which has no apparent enforceability against successors in ownership to the building, did not reduce the value of the contiguous Maison Blanche and Kress Buildings; but unless the obligation is, or constitutes part of, a perpetual conservation restriction, that reduction in value cannot be counted as part of qualified conservation contribution. See sec. 1.170A-14(h)(3), Income Tax Regs.

Because petitioner failed to show us that the partnership’s supposed obligation not to build atop the Kress Building is enforceable against any successor in interest, we concluded in Whitehouse I that the supposed obligation, if enforceable, is not enforceable in perpetuity. See sec. 1.170A-14(g)(l), Income Tax Regs. Therefore, we disregarded it in determining the value of the servitude and, consequently, the amount of the partnership’s charitable contribution deduction.

We are aware that, in Whitehouse II, 615 F.3d at 337, the Court of Appeals stated: “[B]ecause of the easement, Whitehouse could not build on top of the Kress building”. We are also mindful that, once a case has been decided on appeal and a mandate issued, a lower court is not free to alter the mandate of the appellate court, although it is free to decide matters that are left open by the mandate. Barrett v. Thomas, 809 F.2d 1151, 1154 (5th Cir. 1987) (citing In re Sanford Fork & Tool Co., 160 U.S. 247, 255 (1895)).

Because the distinction we have drawn between the partnership’s personal obligation not to block views of the Maison Blanche Building and its burdens and obligations undertaken pursuant to the real right created by the servitude was not considered by the Court of Appeals, we see some daylight to again examine the conveyance to see whether it imposes an obligation on the partnership not to block views of the Maison Blanche Building. We believe that type of analysis is what the Court of Appeals intended when it directed this Court to reconsider the effect of the servitude on the fair market value.

Whitehouse II, 615 F.3d at 340. If we overstep our authority, we apologize. We shall recalculate the value of the servitude on the assumptions that, in fact, it does obligate the partnership not to build atop the Kress Building and that separate ownership of the Maison Blanche and Kress Buildings is unlikely. B. The Conveyance 1. Introduction We look to Louisiana law in interpreting the conveyance. Id. at 329 (citing Adams v.

United States, 218 F.3d 383, 386 (5th Cir. 2000) (“To arrive at a reasonable conclusion regarding the value of the property at issue * * *, one must first determine the rights afforded to the owner of such property by the applicable state law.”)). By its terms, and pursuant to La. Rev. Stat. Ann. sec. 9:1252, the conveyance purports to transfer a perpetual real right “in and to certain exterior surfaces of the * * * [Maison Blanche Building]” to PRC. La. Rev. Stat.

Ann. sec. 9:1252, A. provides for the creation of a perpetual real right burdening the whole or any part of immovable property, including its facade, in favor of an entity formed exclusively for certain public purposes. While the provision is found in the statute among provisions headed “Predial Servitudes” (La. Rev. Stat. Ann. title 9, code book II, code title IV), the perpetual real right created by the provision has aspects of a right of use, a form of personal servitude. See Whitehouse I, 131 T.C. at 132-133. Petitioner argues that, in enacting La. Rev. Stat.

Ann. sec. 9:1252, the legislature intended to create a special type of predial servitude, one that has characteristics of both predial and personal servitudes. As we discussed in Whitehouse I, 131 T.C. at 133-134, whether most resembling a right of use or a predial servitude, the perpetual real right created by the provision is subject to the interpretive rules applicable to predial servitudes. Thus, for instance: “Doubt as to the existence, extent, or manner of exercise of a predial servitude shall be resolved in favor of the servient estate.” La. Civ. Code Ann. art. 730 (2008). “[T]he proper

interpretation of an ambiguous instrument is that which least restricts the ownership of the land”. Id. cmt. b. (Revision Comments— 1977) (noting that Louisiana courts have applied this rule “in a variety of contexts”). One illustrative case cited in the comment is Whitehall Oil Co. v. Heard, 197 So. 2d 672 (La. Ct. App. 1967). There, the court was faced with construing a partition agreement to determine whether it created separate servitudes over each of several contiguous tracts or whether it created a single servitude over all of them. Id. at 676.

The court stated that the answer depended on the intent of the parties to the agreement determined under principles of contract construction. Id. The court apparently found no role for parol evidence, stating: “[T]his determinative question is to be decided by the intention of the parties as reflected by the partition agreement.” Id.; see also Robert Inv. Co., Inc. v. Eastbank, Inc., 496 So. 2d 465, 472 (La. Ct. App. 1986) (“Parol evidence is not admissible to modify a written instrument pertaining to the establishment of a predial servitude.”). With these rules in mind, we approach the conveyance. 2.

Parties’ Arguments Because language prohibiting the partnership from building atop the Kress Building is not apparent to us, we asked the parties to identify language in the conveyance either prohibiting the owner of the Maison Blanche Building from building atop the Kress Building or otherwise obscuring a view of the Maison Blanche Building. Respondent could identify no such language. Petitioner did not directly answer our request.

Rather, petitioner first references language in the first numbered paragraph of the conveyance identifying a portion of the facade: exterior walls of the Lower Stories which are visible from. Canal and Dau-phine Streets, the exterior portion of the Improvement above the Lower Stories which is not covered by the Upper Stories, the exterior walls of the Upper Stories which are visible from Canal, Burgundy, Iberville, and Dau-phine Streets!.] * * * Petitioner then references the eleventh “whereas” clause in the

preamble of the conveyance, in which the partnership states its “desire[] to donate, grant, transfer and convey to * * * [PRC] * * * a scenic, open space and architectural facade servitude”. Conflating those two provisions, petitioner argues that the combined language “creates a servitude of view.” Petitioner then refers us to La. Civ. Code Ann. art. 701, Servitude of view (2008), which provides: “The servitude of view is the i;ight by which the owner of the dominant estate enjoys a view; this includes the right to prevent the raising of constructions on the servient estate that would obstruct the view.” 3. Discussion Petitioner’s reliance on the

preamble of the conveyance is misplaced. “Generally, a

preamble does not create rights beyond those conveyed by the contract’s operative terms.” Chevron U.S.A., Inc. v. Santa Fe Snyder Corp., 69 Fed. Appx. 658 (5th Cir. 2003) (citing Grynberg v. FERC, 71 F.3d 413, 416 (D.C. Cir. 1995) (“[I]t is standard contract law that a Whereas clause, while sometimes useful as an aid to

interpretation, ‘cannot create any right beyond those arising from the operative terms of the document.’”)); see also Succession of Ramp, 212 So. 2d 419, 423 (La. 1968). We shall, therefore, first set aside the portion of the

preamble that petitioner relies on and consider the operative terms of the conveyance. The conveyance (set out in the appendix) establishes in PRC a real right (i.e., the servitude) “in and to certain exterior surfaces of the Improvement [i.e., the improvement being the Maison Blanche Building and referenced exterior surfaces constituting the building’s facade]”. In furtherance of the servitude, the partnership agrees “to do (and refrain from doing)” each of certain listed things.

The first paragraph following that prefatory language describes the facade and, as highlighted, is the object of petitioner’s claimed servitude of view: 1. The exterior surfaces of the Improvement subject to this Servitude are the exterior walls of the Lower Stories which are visible from Canal and Dauphine Streets, the exterior portion of the Improvement above the Lower Stories which is not covered by the Upper Stories, the exterior walls of the Upper Stories which are visible from Canal, Burgundy, Iberville, and Dau-phine Streets, and the roof of the Upper Stories * * * (the “Facade”).

In the event of uncertainty, the exterior surfaces of the Improvement visible in the photographs in Exhibit C shall control. Other operative provisions of the conveyance referenced by petitioner in passing that may be relevant to establishing the partnership’s claimed duty not to build atop the Kress Building are as follows: 2. Donee acknowledges that Owner has provided to Donee Pl

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