Tax Court Rejects Charitable Deduction for Purported Bargain Sale of Land

(Parker Tax Publishing August 2023)

The Tax Court held that the shareholders of an S corporation that operated a mining company were not entitled to take charitable deductions for a purported bargain sale of property following litigation with a town over a 2004 zoning change which ended with a settlement in which the town bought a portion of the property and rezoned the remainder to its pre-2004 designation. The court found that the taxpayers failed to establish the value of all consideration the S corporation received as part of the purported bargain sale because they did not take into account the value of the reversion of the zoning designation, which in the court's view was an integral part of the sale transaction. Braen et al. v. Comm'r, T.C. Memo. 2023-85.

Background

Braen Commercial Holdings Corp. (Holdings) is a family-owned S corporation founded in 1904. Holdings' business centered on mining, growing over time to include four quarries in New Jersey, two asphalt plants, and masonry yards. As part of its operations, the company processed the materials that it mined for a variety of end uses, including asphalt, ready mix concrete, paving stones, and housing veneers.

In 1996, Holdings entered into an option agreement to purchase property for $3.5 million. The property consisted of a 445.5-acre lot in an unincorporated portion of Ramapo, New York, and a 58.5-acre lot in the Village of Hillburn, an incorporated village within Ramapo. To the Braens' trained eyes, the property bore all the indications of having significant deposits of granite and other minerals. A mix of industry and parkland neighbored the property. The property was located near Torne Valley Road, a rugged region marked by thick woods, steep inclines, and rocky outcroppings. The area is home to spring-fed streams that feed into the Ramapo River, a significant source for the major local aquifer. Timber rattlesnakes, a threatened species protected in New York, have taken up their abode in the area.

When Holdings signed the option agreement, the Ramapo portion of the property was zoned as "planned industrial," as it had been for the previous 25 years, while the Hillburn portion fell within that village's "R-60" rural residential zoning district. Quarrying was prohibited by law in Ramapo. Holdings understood that various governmental authorizations were needed to establish a quarry on the property. Specifically, quarrying required an amendment to Ramapo's zoning law removing it as a prohibited use, as well as a conditional use permit that would affirmatively allow a quarry. A state mining permit was another important prerequisite. And a quarry demanded a host of other permits and approvals relating to concerns about water protection, air pollution, stormwater runoff, and wetlands.

Holdings began the process of obtaining the necessary approvals in 1997. At a February 1998 public hearing, Holdings learned that five villages near the proposed quarry site had passed resolutions against it. Concerns were raised about the quarry's effects on a nearby capped landfill that was a recently remediated Superfund site. Multiple speakers worried about traffic, the effects on the aquifer, and the quarry's proximity to parkland. Undaunted by either the regulatory requirements or the public hearing, Holdings exercised its option to purchase the property in July 1998 for $3.5 million.

In 2004, Ramapo passed a new zoning law that changed the zoning of the Ramapo portion of the property from planned industrial to low-density rural residential. In an accompanying impact statement, Ramapo observed that the area contained critical natural resources, such as the aquifer, and that additional industrial development could cause significant harm to these resources. Holdings filed a lawsuit opposing the zoning change. During court-ordered settlement negotiations, Holdings asked for Ramapo to purchase the property for $12 million as a "bargain sale," grant Holdings a right to grade and remove material, and guarantee an additional payment of $5.5 million if it were not able to remove sufficient material within a fixed period. Ramapo countered with a price of $5 million, which it said was somewhat in excess of recent purchases of undeveloped property in the area.

Eventually, the parties agreed that Ramapo would buy 425 acres of the property for $5,250,000, with the zoning on the remaining 80 acres reverting to its former industrial designation. Ramapo twice passed resolutions authorizing the purchase of this land, with the second resolution describing the purchase "as part of a court ordered settlement of an action challenging the rezoning" of the property. The purchase agreement stated that Ramapo was "aware that the transfer of the property was being undertaken by [Holdings] as a bargain sale."

On its 2010 tax return, Holdings claimed a charitable contribution deduction of $5,222,000 arising out of the sale of the transferred property to Ramapo. Holdings attached a "charitable contribution deduction explanation," which asserted a fair market value of $17,472,000 based on a mineral value of $14,554,000 for 175 acres and a land value of $2,918,263 for 212.5 acres on which no mining would be performed. The explanation stated that, although Holdings "would be entitled to a charitable contribution deduction of $12,222,000," it "is only claiming a charitable contribution of $5,222,000" to avoid a dispute with the IRS over the value of the transferred property and a potential substantial or gross valuation misstatement penalty.

The IRS audited Holdings' return. In a December 2013 email, the assigned revenue agent informed Holdings' attorney, Rachel Votto, that "[t]he issues including penalties are complete" but that he had to review "the RAR and 30 day letter before [he] send[s] that out." He further explained that he "wrote the entire penalties 886-A today so do need to review that before sending." He also offered the opportunity to "discuss it with [him] after [she had] a chance to read it." In January 2014, the revenue agent faxed Votto a Form 5701, Notice of Proposed Adjustment, which included a Form 886-A, Explanation of Items, addressing penalties. The form explained that an accuracy-related penalty would apply based either on a substantial valuation misstatement, negligence, or a substantial understatement of tax. In March 2015, the IRS sent Holdings' shareholders 30-day letters. The letters proposed changes to the shareholders' tax but did not assert penalties or additions to tax.

The shareholders petitioned the Tax Court. The IRS filed an answer in each of the consolidated cases, asserting various penalties under Code Sec. 6662. and alleging that, in compliance with Code Sec. 6751(b), those penalty determinations had been approved by Julia Cannarozzi, the immediate supervisor of Clare Darcy, the IRS's counsel in the cases. The answers were all signed by both Darcy and Cannarozzi.

Analysis

The Tax Court held that the Braens were not entitled to the claimed charitable contribution deductions because they failed to establish the value of all consideration Holdings received as part of the purported bargain sale.

In the court's view, the land purchase agreement and the settlement of the zoning litigation had to be considered together as parts of an inseparable package. The land purchase agreement expressly stated that the zoning litigation was settled "as part of the conveyance of the property." The court also noted that the settlement agreement referenced the land purchase agreement, which was included as an attachment. Thus, examining both parts of the "integrated transaction," the court found that Holdings received two types of consideration: (1) $5,250,000 and (2) reversion of the zoning designation over the portion of the property Holdings retained to its prior designation of planned industrial. The court rejected the Braens' argument that Holdings was entitled to the zoning reversion as a matter of law and that the zoning litigation would have vindicated its entitlement. Whether or not Holdings would have been able to prevail in litigation, the court said that Holdings gained the significant benefit of a change to its zoning designation as part of the coordinated settlement and land purchase agreement.

The court also found that the Braens were liable for substantial valuation misstatement penalties under Code Sec. 6662(b)(3) and (e). First, the court determined that the IRS satisfied the Code Sec. 6751(b)(1) supervisor approval requirement after finding that the initial determination of penalties occurred when the IRS filed its answers in the Tax Court, and the answers were signed by Cannarozzi. Next, the court considered the property's fair market value. In the court's view, residential development, not quarrying, was the property's highest and best use because, as of September 2010, no reasonable probability existed that Holdings would be able to procure within a reasonable time the approvals, zoning changes, and permits required for quarrying. The court then determined that the fair market value of the property was $5,227,060, and therefore Holdings' $10,472,000 value on its 2010 tax return constituted a substantial valuation misstatement as it exceeded 150 percent of the value determined by the court. In addition, the court also found that the Braens did not qualify for the reasonable cause exception under Code Sec. 6664(c)(3). To establish reasonable cause, the Braens would have had to show that they relied on a qualified appraisal, and the court found that the Braens' appraisals failed to include the terms the settlement agreement and therefore were not qualified appraisals.

For a discussion of charitable contributions resulting from bargain sales, see Parker Tax ¶84,170.

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.

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