Obligation to Repay Government Entities Upon Extinguishment of Easement Does Not Preclude Deduction (Parker's Federal Tax Bulletin: November 21, 2012)

In an issue of first impression relating to the perpetuity requirement of conservation easement donations, an obligation to repay governmental entities does not mean the donee failed to receive its proportionate share of any extinguishment proceeds. Irby v. Comm'r, 139 T.C. No. 14 (10/25/12).

Charles and Irene Irby are members of Irby Ranches, an LLC taxed as a partnership. The LLC conveyed conservation easements encumbering two parcels of land to Colorado Open Lands (COL), a qualified charitable organization, in bargain sale transactions. The purchase portion of the transactions was funded with grants from three governmental agencies that were established to assist in the conservation of open land: (1) the Farm and Ranchland Protection Program (FRPP) of the National Resources Conservation Service (NRCS), an agency of the U.S. Department of Agriculture (USDA); (2) Great Outdoors Colorado (GOCO), a voter-created trust fund organization of the State of Colorado; and (3) the Gunnison County Land Preservation Board. One of the provisions of the deeds conveying the properties was that if the land should be condemned or the easement otherwise extinguished, the three governmental agencies that funded the bargain purchase would be reimbursed a certain amount of the proceeds relating to such condemnation or extinguishment and COL would retain the remaining amount.

The LLC reported gain with respect to the sale portion and a charitable contribution with respect to the remaining portion (the bargain portion) of the transactions. The Irbys reported their respective shares of the gain and deducted their share of the charitable contributions on their respective individual tax returns for years 2003 and 2004.

Under Code Sec. 170(h)(5)(A), a contribution is not treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. Reg. Sec. 1.170A-14(g)(1) provides that, in general, for the conservation purpose of the donation to be enforceable in perpetuity, the interest in the property retained by the donor must be subject to legally enforceable restrictions that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation. Even with the strictest protections, the possibility exists that an unexpected change in the conditions surrounding the property may make it impossible or impractical to continue the use of the property for conservation purposes. Thus, Reg. Sec. 1.170A-14(g)(6)(i) provides that the conservation purposes will continue to be treated as protected in perpetuity if the restrictions limiting the use of the property for conservation purposes are extinguished by judicial proceeding and all of the donee's proceeds from a subsequent sale or exchange of the property are used by the donee organization in a manner consistent with the conservation purposes of the original contribution.

Upon auditing the Irbys' tax return, the IRS disallowed the charitable contribution deductions they claimed for the bargain portion of the transactions. According to the IRS, (1) the conservation purpose for the easements was not protected in perpetuity because COL was required to reimburse the funding government agencies in the event it received proceeds should the land to which the easements related be condemned and the easements extinguished; (2) the Irbys' appraisal report was not a qualified appraisal because the report did not include statements that the appraisal was prepared for income tax purposes; and (3) the Irbys did not obtain contemporaneous written acknowledgments from COL indicating the amount of goods or services that the Irbys received for the contribution.

The Tax Court held that the conservation purpose of the easements was protected in perpetuity, the appraisal report met the requirements of a qualified appraisal, and the Irbys obtained the contemporaneous written acknowledgment of the transactions as required by law. The Tax Court noted that the case presented an issue of first impression: whether COL's obligation to repay the governmental entities meant that COL failed to receive its proportionate share of any extinguishment proceeds. The court rejected the IRS's argument that COLs' obligation to repay the grant money upon the extinguishment or condemnations of the easements meant that COL's entitlement to the proceeds was merely superficial. With respect to the IRS's concern as to whether all the extinguishment proceeds would be used by COL in a manner consistent with the conservation purposes of the original contribution, the court said it was mindful that while some conservation easements are gratuitously donated, others, such as the ones at issue, were acquired through bargain sale transactions. Because the Irbys required some cash consideration for the easements, the court said, COL would not have been able to further the desired conservation purpose derived by its obtaining and holding the Irby parcel easements were it unable to receive government funding.

Nor did the court share the IRS's fear that the policies and intentions do not require either the parties or their successors in interest to use the proceeds for the conservation purposes of the West and East Parcel Easements. The court said it was convinced that these institutions and their respective employees would fulfill their obligations under federal, state, and local laws. Indeed, the court noted, reimbursement under the terms of the deeds of conservation easement would enhance the ability of the NRCS, GOCO, and the Gunnison County Land Preservation Board to conserve and protect more land, since the reimbursed funds would be used to do just that.

With respect to the IRS's argument that none of the documents individually contained sufficient information to constitute a contemporaneous written acknowledgment, the court found no authority to indicate that the contemporaneous written acknowledgment may not be made up of a series of documents.

For a discussion of the rules relating to contributions of partial interests, such as easement contributions, see Parker Tax ?84,155. (Staff Editor at Parker Tax Publishing)

Additional Insights From Our Guest Contributor:

Mr. K. Chin, CPA, CFF, FCPA, CITP

This Tax court decision goes into tax annul with historic proportion for the filing preparer community, when we pull our hair out deciding on how to evaluate adequacy for claiming certain donations. The important focus is not about the donation deductible or not, but about documentation requirements FOR the donation.

In a rare favorable case to taxpayer Irby, (previously donating the Irby Ranch 2003) now during Thanksgiving season for their generosity, UC Irvine website jumps out a couple of days before official case publication date 11/25/12, with more details disputing several of the IRS Treasury Regulation interpretations. The filing community can now be guided by Tax Court Judge Jacob’s decision upholding Irby’s' appraisal report despite lacking tax purpose conformity. It still met the requirements of a qualified appraisal as required by sec. 1.170A-13(c)(3)(ii)(G), IRS Income Tax Regs.

1. Terms and conditions of the deeds of conservation easement (deeds) complies and determines that conservation easement is protected in perpetuity within section 170(h)(5) and section 1.170A-14(g)(6), Income Tax Regs.,
2. Taxpayer’s appraisal remains qualified report even though few details missing, as required by section 1.170A-13(c)(3), Income Tax Regs. and did not fail to meet certain recordkeeping requirements, and
3. Contemporaneous paperwork remains adequate despite few details missing and complies with the substantiation requirements of section 170(f)(8).

IRS argued unsuccessfully that none of the documents individually contains sufficient information to constitute a contemporaneous written acknowledgment, but Judge Jacob disagreed and found no authority to indicate, that the contemporaneous written acknowledgment may not be made up of a series of documents. The Tax Court found that the documents petitioners Irby provided constituted a contemporaneous written acknowledgment when taken together collectively.

When Bush signed Preparer Penalty Provisions of the Small Business and Work Opportunity Tax Act of 2007, tax practitioners around the country constantly struggled with advocating client’s interests but for few minor details and omissions in record keeping for which IRS not simply disallows client’s tax deductions, but threatens preparer conduct penalties if tax advice apparently based on unreasonable basis. AICPA submitted many letters to Congress, the Treasury and the IRS since amending IRC 6694 in May 2007 on tax services to clients with one of the most significant problems is the potential for a conflict of interest between a preparer and a taxpayer/client, which would arise if a return were to contain inconsistent position:

1. That satisfies the taxpayer standard (substantial authority) under IRC 6662(d),
2. But not the higher preparer standard more likely than not (MLTN) under IRC 6694.

The IRS then issued Notice 2008-13 addressing the concerns regarding both: (1) the potential for a conflict of interest between a preparer and a taxpayer/client; and (2) the difficulty in determining if the MLTN standard is satisfied, but we continued to pull out our hair in complying with the confusing tax laws. The Irby tax case is a welcome relief.

With Judge Jacob’s articulated decision, the preparer community can now cite the Irby case when asserting MLTN standard for undisclosed positions which continuously created several problems for return preparers and for taxpayers claiming an otherwise legitimate donation. Now tax practitioners have a position with a reasonable basis for which would more likely than not be sustained on its merits. The United States Tax Court case: Charles R. Irby et ux. et al. v. Commissioner; 139 T.C. No. 14; Nos. 7559-10, 7561-10, 7562-10.

Sources: 1.http://www.plannedgiving.uci.edu 2. http://www.law.cornell.edu/uscode/text/26/6694 3. http://www.aicpa.org/Advocacy/Tax/Pages/IRS
%20Issues%20Interim%20Relief%20on%20More-Likely-Than-Not%20Penalties.aspx 4. http://www.irs.gov/irb/2008-03_IRB/ar17.html

Mr. Chin, CPA, CFF, FCPA, CITP is the Senior Consulting Manager at Chin Consulting Associates LLC in the Philadelphia Area. His skills include mediation and managing, planning, performing audits and special financial investigations of Fortune 1000 companies, midsize corporations, smaller special purpose partnerships and related pass-through entities. He also has experience for 5+ years in forensic investigations and 10+ years supervision of audit and anti-fraud programs of white collar crimes: bribery, kickbacks, misfeasance, malfeasance, consumer fraud, ponzi schemes, asset misappropriation, money laundering etc. Expertise in project management, corporate governance, shareholder disputes, IRS audit defense including tax planning, compliance, research, resolution and litigation support. Experience on both sides of the isle – Defense and Prosecution, plaintiff and respondent, civil complaints and criminal charges. Personal Motto as Truth Advocate: Focused in discovering the compelling evidence separating smoke and confusion – the secret of clarity, eloquence, virtue, art and business reality. Mr Chin speaks 2 Chinese languages: Cantonese and Toishanese.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com