Failure to Get CPAs Advice on Conservation Easement Donation Leads to Penalties for Taxpayer (Parker's Federal Tax Bulletin: December 27, 2012)

Because the mortgage on land for which a conservation easement was granted was not subordinated to the conservation easement when it was granted, no charitable deduction was allowed, and the taxpayer's failure to ask the CPA preparing the return for advice precludes reasonable cause defense for penalty assessment. Minnick v. Comm'r, T.C. Memo. 2012-345 (12/17/12).

On January 25, 2005, Walter Minnick and his wife obtained a mortgage from U.S. Bank on a 74-acre parcel of land they owned. On September 5, 2006, the county in which the land was located permitted Walter to subdivide the land into seven single-family residential lots. Two days later, Walter granted a conservation easement on the land to the charitable organization Land Trust of Treasure Valley, Inc. (i.e., the Land Trust). The terms of the easement prohibited Walter and any subsequent owner from building on or altering the portions of the land outside the areas designated as building envelopes for each lot. The portions of the land thus restricted by the easement constituted 80 percent of the 74-acre parcel. The conservation easement stated: Grantor [i.e. Walter] warrants that * * * [he] owns the Property in fee simple and has conveyed it to no other person, and that there are no outstanding mortgages, tax liens, encumbrances, or other interests in the Property that have not been expressly subordinated to the Easement. Contrary to this warranty provision, U.S. Bank's mortgage was not then subordinated to the conservation easement. The conservation easement also provided that Walter and the Land Trust could amend the terms of the easement if circumstances arose under which an amendment would be appropriate.

When Walter and his wife filed their original 2006 income-tax return, they did not claim a charitable-contribution deduction for the grant of the conservation easement. Walter had not yet received a written appraisal of the easement. On or about December 26, 2007, the Minnicks filed an amended income-tax return for 2006. On the amended return, the Minnicks took a charitable deduction for the grant of the easement of $389,500. They reported that the value of the easement was $941,000, based on an appraisal by G. Joseph Corlett, who had been hired by Walter. The amended return was prepared by a CPA. Both the CPA and Walter intended that Corlett's appraisal be attached to the 2006 tax return, but for some reason the return the IRS received did not have the appraisal attached to it. Minnick never asked the CPA whether he was entitled to the $941,000 deduction, and the CPA did not tell him that he was. Minnick had worked for a few months as a lawyer near the beginning of his career, spending some time in tax law. He later went into the building-supply business. Minnick's wife was uninvolved in determining whether the conservation easement gave rise to a charitable-contribution deduction.

On September 12, 2011, Walter and U.S. Bank executed an agreement under which U.S. Bank subordinated its mortgage to the conservation easement. The effect of this subordination agreement is that the conservation easement will remain in force if U.S. Bank becomes the owner of the land by foreclosure.

The IRS denied the charitable deduction for the following reasons: (1) the grant of the conservation easement was a condition of receiving permission from the county to subdivide the land; (2) the conservation easement was not protected in perpetuity because (a) the terms of the easement allowed Walter and the Land Trust to amend the easement by agreement, (b) U.S. Bank's mortgage on the land was not subordinated at the time of the grant, and (c) the easement failed to provide for the allocation of proceeds to the Land Trust in the event the easement was extinguished; (3) the Minnick's deduction for the contribution of the easement was limited to the basis allocated to the easement; and (4) the easement was overvalued.

The IRS also assessed a penalty, contending that the Minnicks were negligent because they should have known that no deduction would be allowed. The Minnicks argued that they followed a model conservation-easement form given to them by the Land Trust, that Walter discussed with his CPA the legal requirements for a conservation easement, and that he hired an expert appraiser to appraise the conservation easement. Walter also contended that he should not be held to the standard of an experienced tax attorney because he worked only for a few months as an attorney and that he spent only a fraction of his time practicing tax law.

The Tax Court held that, because U.S. Bank's mortgage was not subordinated to the conservation easement when it was granted, the Minnicks could not take a deduction for the grant of the conservation easement. The court rejected the Minnicks argument that the September 2011 subordination agreement with U.S. Bank satisfied the subordination requirement in Reg. Sec. 1.170A-14(g). Citing its decision in Mitchell v. Commissioner, 138 T.C. 324 (2012), the court stated that a subordination agreement must be in place at the time that the conservation easement is granted.

The Tax Court also upheld the penalty assessment. The court concluded that, in determining whether the grant of the conservation easement gave rise to a charitable-contribution deduction, Walter did not exercise reasonable care. The court noted that he did not seek to subordinate U.S. Bank's mortgage to the conservation easement until 2011, and his failure to comply with the subordination requirement found in the regulations appeared to stem from his failure to solicit advice from his CPA about the deductibility of the conservation easement and the failure of the CPA to give such advice. The court noted that while the CPA explained to Walter that the value of a conservation easement was deductible under the Code, he did not tell Walter that the particular conservation easement Walter granted to the Land Trust was deductible. In the absence of such advice, the court said, Walter could not have reasonably relied on the CPA when he claimed a deduction for the conservation easement contribution. According to the court, Walter should have been alerted by the warranty provision in the conservation easement, which stated that there was no unsubordinated mortgage on the land, that there might be a problem with the lack of subordination. While it was true that the form Minnick used to grant the easement was a model, the court said that didn't matter the model easement form was not suited to Minnick's particular parcel of land.

For a discussion of the deductibility of conservation easements, see Parker Tax ¶84,155.

(Staff Editor at Parker Tax Publishing)

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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