Court Rejects IRS Motion for Summary Judgment in Conservation Easement Case

(Parker Tax Publishing September 2022)

The Tax Court, citing Hewitt v. Comm'r, 2021 PTC 410 (11th Cir. 2021), denied an IRS motion for summary judgement in a case involving a conservation easement donation that the IRS argued did not meet the protected-in-perpetuity requirement in the regulations. However, the Tax Court did agree that the IRS's assessment of penalties in the case received the requisite supervisory approval under Code Sec. 6751(b)(1). Sparta Pink Property, LLC v. Comm'r, T.C. Memo. 2022-88.

Background

Sparta Pink Property, LLC (Sparta) is a Georgia limited liability company (LLC) organized in 2016. It is treated as a TEFRA partnership for federal income tax purposes, and Sparta Pink Manager, LLC, is its tax matters partner. In August 2016, WASCO, LLC, acquired a 99 percent interest in Sparta by contributing to it roughly 286 acres of land (the Property) in Hancock County, Georgia. In December 2016, Sparta granted to the Southern Conservation Trust (grantee) a conservation easement over the Property. The deed of easement was recorded on December 29, 2016. On its 2016 Form 1065, U.S. Return of Partnership Income, Sparta claimed a charitable contribution deduction of $15,632,748 for its donation of the easement. In support of this valuation, Sparta relied on an appraisal prepared by Clayton M. Weibel.

The easement deed recites the conservation purposes and generally prohibits commercial or residential development. But it reserves certain rights to Sparta, including the rights to repair, improve, enlarge, and replace existing improvements on the Property and construct additional improvements. Additional improvements could include agricultural structures such as barns and sheds, as well as roads and utilities to service them. Paragraph 17 expresses the parties' intention that "the Purpose of this Conservation Easement be carried out in perpetuity." However, "[i]f circumstances arise in the future that render the Purpose of this Conservation Easement impossible to accomplish," giving rise to a judicial extinguishment of the easement, then on any subsequent sale or conversion the grantee is entitled to a portion of the proceeds.

Paragraph 19 defines the grantee's share of the proceeds as equal to "the current fair market value" (FMV) of the easement. The FMV of the easement is determined by multiplying the sale proceeds by a fraction specified in the regulations. But before this fraction is applied, the sale proceeds are reduced by "any increase in value after the date of this Conservation Easement attributable to improvements."

The IRS audited Sparta's return and assigned the case to Revenue Agent (RA) Thomas Rikard. He concluded that Sparta had significantly overvalued the easement and that the charitable contribution deduction was only $44,748. In January 2020, as his examination of Sparta neared completion, RA Rikard recommended assessing a penalty for gross valuation misstatement. In the alternative, he recommended assertion of the penalties for substantial valuation misstatement, reportable transaction understatement, negligence, and/or substantial understatement of income tax. His recommendations to this effect were set forth in a civil penalty approval form that he prepared on January 27, 2020. His group manager, Margaret McCarter, submitted a declaration confirming that she supervised RA Rikard's work during the examination and that she approved assertion of the penalties by signing the civil penalty approval form on February 10, 2020.

On July 9, 2020, the IRS issued Sparta a notice of final partnership administrative adjustment (FPAA), including a Form 886 - A, Explanation of Items. The FPAA reduced the allowable charitable contribution deduction by $15,588,000 (i.e., from $15,632,748 to $44,748) and determined the penalties set forth on the penalty approval form.

Code Sec. 170(f)(3)(A) generally restricts a taxpayer's charitable contribution deduction for the donation of an interest in property which consists of less than the taxpayer's entire interest in such property. But there is an exception for a qualified conservation contribution where the conservation purpose is "protected in perpetuity." Under Reg. Sec. 1.170A-14(g)(6)(ii), known as the extinguishment proceeds regulation, the conservation purpose can be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding and the easement deed ensures that the charitable grantee, following sale of the property, will receive a proportionate share of the proceeds and use those proceeds consistently with the conservation purposes underlying the original gift. In effect, the "perpetuity" requirement is deemed satisfied because the sale proceeds replace the easement as an asset deployed by the donee "exclusively for conservation purposes."

Sparta petitioned the Tax Court and the IRS filed a motion for summary judgment. In its motion, the IRS noted that the Tax Court held in Coal Property Holdings, LLC v. Comm'r, 153 T.C. 126 (2019) that a deed of easement failed to satisfy the perpetuity requirement where the grantee's share of post-extinguishment sale proceeds was improperly reduced by carve-outs for donor improvements. The deed in Sparta's case, the IRS argued, has the same defect. Sparta argued that the IRS's motion should be denied in light of the decision in Hewitt v. Comm'r, 2021 PTC 410 (11th Cir. 2021), in which the Eleventh Circuit invalidated the IRS's interpretation of Reg. Sec. 1.170A-14(g)(6)(ii). The Eleventh Circuit found the regulation arbitrary and capricious and said it violated the procedural requirements of the Administrative Procedures Act. Sparta also argued that the penalty assessed against it was not properly approved. According to Sparta, the IRS did not make any effort to authenticate the documents attached to the declarations in the penalty assessment, including the civil penalty approval form and the sworn declarations from McCarter and RA Rikard.

Analysis

The Tax Court denied the IRS's motion relating to the failure of the Sparta deed to meet the perpetuity requirement and held that because an appeal of this case would go before the Eleventh Circuit, it was obligated to follow the law as established by the Eleventh Circuit on this question. The court did note, however, that in Oakbrook Land Holdings, LLC v. Comm'r, the Sixth Circuit disagreed with the Hewitt decision and held that Reg. Sec. 1.170A-14(g)(6)(ii) was valid. The Tax Court thus denied the IRS's motion on this point without prejudice to its re-submission of the arguments set forth in its motion should subsequent developments warrant that action.

With respect to the penalty approval issue, the court concluded that the penalties assessed by the IRS were properly approved. The court found that the IRS supplied documentary evidence confirming that RA Rikard's immediate supervisor approved the assertion of penalties on February 10, 2020, and McCarter supplied the appropriate declaration of her review of RA Rikard's work under penalties of perjury. Citing its decision in Belair Woods, LLC v. Comm'r, 154 T.C. 1 (2020), the court observed that it has repeatedly held that a group manager's signature on the Civil Penalty Approval Form is sufficient to satisfy the statutory requirements.

For a discussion of the rules for deducting a partial interest in property, see Parker Tax ¶84,155. For a discussion of the rules relating to IRS supervisory approval of penalty assessments, see Parker Tax ¶262,195.

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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