Ninth Circuit Denies Easement Deduction Where Mortgage on Property Was Not Subordinated to Easement.

(Parker Tax Publishing September 4, 2015)

For a taxpayer to take a charitable deduction for the donation of a conservation easement, any mortgage on the property must be subordinated to the easement at the time of the donation. Minnick v. Comm'r, 2015 PTC 280 (9th Cir. 2015).

In 2005, Walter Minnick took out a $400,000 loan from a bank, secured by an undeveloped plot of land Minnick already owned in Idaho. Minnick intended to use the funds to develop that land. After Minnick received preliminary approval to develop parts of the land, the loan amount was increased to $1.5 million. Subsequently, in September 2006, Minnick received final approval of the development plans. Two days later, he donated to the Land Trust of Treasure Valley, a qualified organization, a conservation easement on parts of the land that would not be developed.

Minnick did not inform the bank of the easement. An appraiser hired by Minnick valued the easement at $941,000, and Minnick and his wife claimed a charitable deduction of approximately $390,000 on their 2006 tax return and carried over the remainder to their 2007 and 2008 returns. The IRS issued a notice of deficiency, disallowing the charitable contribution carryovers to 2007 and 2008. According to the IRS, the couple could not deduct the conservation easement as a gift because Minnick did not subordinate his rights in the property to the rights of the Land Trust of Treasure Valley to enforce the conservation purposes of the gift in perpetuity.

Under Code Sec. 170(h)(5)(A), a deduction for the donation of a conservation easement is allowed only if the easement's conservation purpose is protected in perpetuity. Reg. Sec. 1.170A-14(g)(2) interprets this provision to mean that, that when a piece of property is subject to a mortgage, no deduction is allowed unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.

Minnick and his wife contested the IRS deficiency in Tax Court. In December 2012, the Tax Court, citing its recent decision in Mitchell v. Comm'r, 138 T.C. No. 16 (2012), affirmed the IRS's disallowance of the charitable deduction for 2007 and 2008 because of the couple's failure to ensure the subordination of the mortgage held by the bank at the time of the gift. Minnick and his wife appealed to the Ninth Circuit, arguing that the requirement to subordinate a mortgage need not be met at the time of the gift. While the appeal was pending, the Tenth Circuit affirmed the Tax Court's earlier decision on the issue in Mitchell v. Comm'r, 2015 PTC 1 (10th Cir. 2015).

The Ninth Circuit affirmed the Tax Court and held that Reg. Sec. 1.170A-14(g)(2) requires that a mortgage be subordinated at the time of the gift of an easement for the gift to be deductible. The court looked at whether the plain language of the regulation supported the Tax Court's interpretation. When the meaning of a regulation is clear, the court said, the regulation is enforced according to its plain meaning. The court found that the plain language of the regulation supported the Tax Court's interpretation because the regulation specifies that "no deduction will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property." Strictly construed, the court said, this language makes clear that subordination is a prerequisite to allowing a deduction.

The Ninth Circuit noted that, in 2006, when Minnick and his wife made the donation and requested a deduction, there was no dispute that the bank had not subordinated its rights in the property. Thus, under the plain meaning of the regulation, the court said, no deduction is allowed. Further, the court found that the IRS's interpretation was reasonable and not plainly erroneous or inconsistent with the regulation.

The Ninth Circuit cited the Tenth Circuit's holding in Mitchell and said that, because a conservation easement subject to a prior mortgage obligation is at risk of extinguishment upon foreclosure, requiring subordination at the time of the donation is consistent with the Code's requirement that the conservation purpose be protected in perpetuity. An easement can hardly be said to be protected in perpetuity, the court observed, if it is subject to extinguishment at essentially any time by a mortgage holder who was not a party to, and indeed (as in the instant case) may not even have been aware of, the agreement between the taxpayers and a conservation trust.

For a discussion of the rules for deducting a conservation easement, see Parker Tax ¶84,155. (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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