Taxpayer Gets Rare Win on Conservation Easement Deduction.
(Parker Tax Publishing August 25, 2014)

The correct value of a taxpayer's easement contribution was much higher than the amount determined by the IRS and, as a result, the taxpayer did not owe any of the accuracy-related penalties assessed by the IRS. Schmidt v. Comm'r, T.C. Memo. 2014-159 (8/6/14).

In 2000, Leroy Schmidt bought a 40-acre parcel of vacant land in northern El Paso County in Colorado for $525,000 with the intention of subdividing and developing it. The property, which was at the base of Raspberry Mountain, was raw land with no development entitlements. Leroy hired David Jones and Land Resource Associates (LRA) to provide land planning and consulting services. In a preliminary development cost analysis dated May 12, 2003, LRA estimated the development costs per lot for the proposed Raspberry Ridge subdivision. During the development process, Leroy hired W.D. Park of Park & Associates to value a proposed conservation easement. In a letter dated June 10, 2003, Mr. Park notified Leroy that his firm had concluded that the value of the proposed conservation easement would be $1.6 million.

Mr. Park used the before-and-after method to determine the value of the conservation easement. He determined that the highest and best use of the subject property before the granting of the conservation easement was a residential subdivision, and he used the subdivision development method to determine the before value of the subject property. As part of his calculation of the before value, Mr. Park used a discounted cash flow analysis and relied on the LRA May 12, 2003, cost estimate for the development cost input. He opined that the before value was $2 million. He determined that the highest and best use of the subject property after the granting of the conservation easement was a 40-acre homesite, and he used the market method to determine an after value for the subject property. Mr. Park opined that the after value of the subject property was $400,000, and he therefore opined that the value of the conservation easement was $1.6 million. On August 1, 2003, Leroy executed an easement deed, granting a conservation easement on the subject property to El Paso County.

On their Form 1040 for 2003, the Schmidts claimed a charitable contribution deduction of $1.6 million for the conservation easement. Because of limitations, the Schmidts claimed only $325,407 of the contribution on their 2003 return. They carried over the remainder of the charitable contribution deduction and claimed portions of it on their 2004, 2005, and 2006 returns.

The IRS issued notices of deficiency for the Schmidts' 2003, 2004, 2005, and 2006 tax returns. According to the IRS, the correct value of the conservation easement was $195,000, not $1.6 million. In addition, the IRS assessed accuracy-related penalties against the Schmidts under Code Sec. 6662(a) and Code Sec. 6662(b)(2) and (3) for substantially misstating the value of the conservation easement donation or for substantially understating their federal income tax liabilities for 2003 through 2006, respectively.

Code Sec. 6662(a) and (b)(2) and (3) authorize the IRS to impose a 20 percent penalty on an underpayment of tax that is attributable to, among other things, (1) any substantial understatement of income tax and (2) any substantial valuation misstatement. Only one Code Sec. 6662 accuracy-related penalty may be imposed with respect to any given portion of an underpayment. Generally, there is a substantial valuation misstatement if: (1) the value or adjusted basis of any property claimed on a return is 150 percent or more (200 percent or more for a gross valuation misstatement) of the amount determined to be the correct value or adjusted basis.

The Tax Court rejected the IRS's low appraisal value and several of the assumptions made by its expert witness. The court concluded that the value of the conservation easement, and the resulting deduction, was $1,152,445. Thus, while the Tax Court's valuation was lower than the value assigned by the Schmidts, it was much higher than the IRS's valuation. With respect to the testimony of the experts on both sides, the court said neither expert's report was complete and convincing. Thus, after giving appropriate weight to each expert's report, the court drew its own conclusions based on its examination of the evidence in the record. From that evidence, the Tax Court concluded that the before value of the property was $1,422,445 and that the after value of the property was $270,000.

With respect to the assessment of penalties by the IRS, the court noted that the Schmidts relied on Mr. Park's 2003 appraisal, that Mr. Park had the requisite credentials and experience to justify the Schmidts' reliance on his 2003 appraisal, and that the IRS conceded that Mr. Park's appraisal met the requirements to be considered a qualified appraisal. The court said that it sustained, in part, the IRS's deficiency determination because it did not find Mr. Park's report to be complete and convincing in certain respects. However, the court said, it did not think that the problems it found with Mr. Park's report, and by extension with his appraisal of the easement, called into question the reasonableness of the Schmidts' reliance on his appraisal. With respect to the IRS's argument that there were certain facts that supported an inference that Mr. Park intended to secure excessive tax benefits for the Schmidts with his 2003 appraisal, the court said that many of those facts were ambiguous and were also consistent with a good-faith attempt on the part of the Schmidts to reach the right result. The amount the Schmidts claimed on their 2003 return, the court noted, was less than 200 percent (and less than 150 percent) of the amount determined to be the correct amount of the easement donation. Accordingly, the court held that the Schmidts were not liable for a penalty for a substantial valuation misstatement under Code Sec. 6662(a) and (b)(3) for any of the years at issue.

For a discussion of the charitable deduction for conservation easements, see Parker Tax ¶84,155. For a discussion of the penalties for substantial valuation misstatement, see Parker Tax ¶262,120. (Staff Editor 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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