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Flawed Appraisal Dooms $20 Million Conservation Easement Charitable Deduction
(Parker Tax Publishing March 2024)
The Tax Court held that the IRS properly disallowed a charitable contribution deduction claimed by a partnership for donating a conservation easement over a tract of land. The court found that the appraisal on which the charitable contribution deduction was based was not a "qualified appraisal" as required by Code Sec. 170(f)(11)(D) because the partnership and the appraisers made an agreement concerning the amount at which the property would be valued and the partnership knew that such amount exceeded the fair market value of the property. Oconee Landing Property, LLC v. Comm'r, T.C. Memo. 2024-25.
Background
James Reynolds III (Jamie) and Mercer Reynolds (the Reynoldses) are third cousins. Members of the Reynolds family have been prominent landowners and developers in Greene County, Georgia, for more than three generations. In 2003, the Reynoldses acquired a 1,130 acre tract of land (i.e., the Parent Tract) in Greene County, roughly 70 miles east/southeast of Atlanta.
Mercer and Jamie developed a plan to develop the Parent Tract as a mixed-use community called Reynoldsboro, consisting of one or more "town centers" surrounded by homes. The Reynoldses marketed the Parent Tract to potential investors. In 2013, they made an offer to TPA Group (TPA), an Atlanta developer, seeking a joint venture partner to develop the property. The Reynoldses valued the Parent Tract at $7.9 million. TPA rejected the Reynoldses' offer. The Reynoldses reduced the value to $6.7 million, but TPA again declined.
In 2014, the Reynoldses formed Carey Station LLC and contributed to it roughly 980 acres of the Parent Tract. The Reynoldses actively marketed the Parent Tract during 2014 and early 2015. They granted Ted Baker, a real estate broker, the right to offer the entire Parent Tract (then consisting of 960 acres) for sale at $7.7 million, or roughly $8,000 per acre. Baker erected a 40-square foot sign on the Parent Tract advertising it for sale as a mixed use development. Baker was contacted by only one potential buyer, but a deal could not be reached due to the buyer's need to complete a like-kind exchange.
In early 2015, the Reynoldses began investigating the possibility of granting a conservation easement over the Parent Tract. In April 2015, Carey Station and the Vola Group, a local real estate company, reached an agreement providing that an easement transaction would be consummated only if Carey Station "decided that the net proceeds from conservation easement are acceptable." Todd Ciavola of the Vola Group contacted Strategic Capital Partners, LLC (SCP), whose principals were Ricky Novak and James Freeman. SCP's business was arranging and helping to market syndicated conservation easement transactions. It performed functions commonly regarded as being performed by a "promoter." The Reynoldses consistently took the view that the proceeds accruing to them would be "acceptable" only if such proceeds exceeded $7 million. In a February 2015 meeting with Ciavola, Novak made clear that in order for the Reynoldses to derive proceeds of $7 million, the Parent Tract would need to have an appraised value of around $60 million.
In July 2015, appraisers Thomas Wingard and Martin Van Sant were retained to appraise the Parent Tract. Ciavola emailed Novak and Freeman a "Market Summary" suggesting a value of $65 million. Novak and Freeman forwarded the document to Wingard and Van Sant. Discussions ensued regarding the Reynoldses' interest in carving out certain parcels and reserving them for future development. SCP estimated that the carveout would decrease the value of the easement by around $5 million. After further discussions, Ciavola sent the Reynoldses a spreadsheet showing an estimated charitable contribution deduction, before carveouts, of $60,608,700. That figure was within one percent of the $60 million projection Novak supplied at his initial meeting with Ciavola. The Reynoldses did, in fact, carve out from the Parent Tract six parcels comprising 82 acres. If the carved-out parcels were removed from the Parent Tract before the granting of the easement, the schedule showed a net "estimated charitable contribution deduction" of $52,873,765.
At this point, Wingard and Van Sant had not yet supplied an appraisal of the Parent Tract. Ciavola told SCP to "call the appraiser" because the Reynoldses needed a "verbal value" in order to proceed with the transaction. Freeman responded: "We all have the window and need to work within that window. The appraisers are pulling the exact figures together. The window you have is within the ballpark of reality."
The Parent Tract was divided into three separate parcels for purposes of marketing the conservation easement deal. These three parcels were transferred to three separate entities, one of which was Oconee Landing Property, LLC (Oconee), which received a 355-acre tract (the Subject Property). On December 31, 2015, Oconee donated to the Georgia-Alabama Land Trust a conservation easement over the Subject Property. Oconee claimed a charitable contribution deduction of $20.67 million on its 2015 partnership tax return. The claimed deduction was premised on the assertion that the tract was worth $59,718 per acre before the granting of the easement. The IRS selected Oconee's return for examination. In a 2019 final partnership administrative adjustment, the IRS disallowed all $20.67 million of the claimed deduction. Oconee and its tax matters partner petitioned the Tax Court for readjustment of partnership items.
Code Sec. 170(f)(11) disallows a deduction for certain noncash charitable contributions unless the specified substantiation and documentation requirements are met. In the case of a contribution of property valued in excess of $500,000, Code Sec. 170(f)(11)(D) provides that the taxpayer must obtain and attach to his return "a qualified appraisal of such property." Under Code Sec. 170(f)(11)(E)(i), an appraisal is "qualified" if it is "conducted by a qualified appraiser in accordance with generally accepted appraisal standards" and meets requirements set forth in "regulations or other guidance prescribed by the Secretary."
The IRS acknowledged that Wingard and Van Sant met the general requirements for qualified appraisers set forth in Code Sec. 170(f)(11)(E) at the time they prepared the final appraisal. However, the IRS contended that Wingard were not qualified appraisers by virtue of the "Exception" set forth in Reg. Sec. 1.170A-13(c)(5)(ii). It provides that an individual is not a qualified appraiser with respect to a particular donation "if the donor had knowledge of facts that would cause a reasonable person to expect the appraiser falsely to overstate the value of the donated property." This will be true, for example, if "the donor and the appraiser make an agreement concerning the amount at which the property will be valued and the donor knows that such amount exceeds the fair market value of the property." In gauging a partnership's "knowledge" for this purpose, the court looks to the knowledge of the person(s) with ultimate authority to manage the partnership. Thus, in determining what facts were "known" by Oconee, the court had to determine what facts were known - actually or constructively - by the Reynoldses.
Oconee argued that the Reynoldses could not have had "knowledge of facts that would cause a reasonable person to expect the appraiser[s] falsely to overstate the value" because there was "no communication" between them and Wingard and Van Sant. Mercer testified that he put a "Chinese Wall" in place to ensure that he and Jamie never communicated with the appraisers directly. Oconee likewise asserted that no advance agreement could have existed because the IRS "was unable to elicit any testimony from any witness that anyone instructed the appraisers as to value." To the contrary, Oconee said, the evidence was that all parties were awaiting value determinations by the appraisers before other numbers could be finalized.
Analysis
The Tax Court held that Oconee was entitled to a charitable deduction of zero for 2015 because it failed to secure a qualified appraisal as required by Code Sec. 170(f)(11)(D).
The court found that the Reynoldses regarded the conservation easement transaction as a substitute for sale of the Parent Tract. The agreement they executed with the Vola Group, the court noted, stated explicitly that an easement transaction would be consummated only if the Reynoldses decided that the net proceeds from the transaction were "acceptable." The court further found that the Reynoldses, acting through their intermediaries, reached a meeting of the minds with Wingard and Van Sant that the Parent Tract would be appraised at roughly $60 million (before carve-outs) and fairly close to $52.8 million (after carve-outs).
The court found that the Reynoldses knew that the Parent Tract in 2015 was worth considerably less than $10 million after their unsuccessful efforts to market the property based on valuations of $7.9 million and $ 6.7 million. In the court's view, because the Reynoldses knew that the Parent Tract was not worth $51.7 million, but rather was worth less than $10 million, they "had knowledge of facts that would cause a reasonable person to expect the appraiser falsely to overstate the value of the donated property" under Reg. Sec. 1.170A-13(c)(5)(ii).
In the court's view, when Freeman referred to "the window we all have," he was referring to the easement numbers that were discussed with the Reynoldses in November 2015, i.e., an estimated charitable contribution deduction of $60.6 million, reduced to $52.8 million after the 82-acre carveout. In stating this window "is within the ballpark of reality," the court found that Freeman was assuring the Reynoldses that the appraisal would come in fairly close to the latter number. The court was not persuaded by Oconee's argument that the Reynoldses could not have had communication with the appraisers. Even if the Reynoldses never communicated directly with Wingard and Van Sant, the court found that there was a "daisy chain" of intermediaries who ensured that all critical information was passed back and forth across the chain. In the court's view, testimony that someone instructed the appraisers as to value was not required.
The court also found that the Reynoldses did not have reasonable cause for failure to secure a qualified appraisal based on good faith reliance on professional advice under Code Sec. 170(f)(11)(A)(ii)(II). According to the court, the appraisal was nonqualified not due to some minor defect or technical flaw (a matter about which a taxpayer might sensibly trust professional advice) but rather because the Reynoldses "had knowledge of facts that would cause a reasonable person to expect the appraiser falsely to overstate the value of the donated property" under Reg. Sec. 1.170A-13(c)(5)(ii). The court reasoned that a person who achieves an advance agreement with an appraiser that property will be overvalued - knowing that it is being overvalued - cannot establish good faith reliance on professional advice that the appraisal is acceptable.
As a separate ground for disallowing the deduction, the court found that the Reynoldses held their interests in the Parent Tract for sale to customers in the ordinary court of their real estate business. Therefore, the Subject Property was "ordinary income property" under Code Sec. 724(b) and any deduction attributable to Oconee's grant of a conservation easement was thus limited under Code Sec. 170(e)(1) to Oconee's basis in the Subject Property. The court concluded that Oconee failed prove that its basis in the property exceeded zero and therefore, its charitable contribution deduction was zero.
For a discussion of appraisals for charitable contributions, see Parker Tax ¶84,198.
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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