Conservation Easement Deduction Fails Due to Donor's Retained Development Rights

(Parker Tax Publishing February 2020)

The Tax Court held that the IRS properly denied a taxpayer's deduction for the donation of a conservation easement because the court found that certain restrictions on the use of the property at issue were antithetical to the easement's conservation purposes and did not meet the perpetual restriction requirement in Code Sec. 170(h)(2). However, the Tax Court found that the IRS failed to comply with the supervisory approval requirement in Code Sec. 6751(b)(1) with respect to the gross valuation misstatement penalty it imposed because the initial determination of the penalty was not approved in writing by the supervisor of the agent making the initial determination. Carter v. Comm'r, T.C. Memo. 2020-21.

Background

In 2005, Dover Hall Plantation, LLC (DHP), a partnership, purchased a 5,245-acre tract of land in Glynn County, Georgia, known as Dover Hall. Nathaniel Carter and Ralph Evans were 50 percent partners in DHP.

In 2011, DHP conveyed to the North American Land Trust (NALT) an easement of over 500 acres of Dover Hall. The deed of easement restricts the use of the covered property and, among other things, generally prohibits the construction or occupancy of any dwellings. The deed lists as the easement's conservation purposes the preservation of the covered property as relatively natural habitat and open space. Notwithstanding the general restriction on development of the property, DHP retained the right to build a single-family dwelling on each of 11 "building areas" of no more than two acres, the locations of which were to be determined, subject to NALT's approval. Evans and Carter claimed that these building areas were just for family usage, not for subsequent development and sale. However, nothing in the deed or the taxpayers' valuation report limited the permitted building of residences to family members.

On its 2011 tax return, DHP claimed a charitable contribution deduction for the donation of the easement to NALT. Evans reported his share of the deduction on his 2011 return. Carter and his wife reported their share as an itemized deduction on their 2011 return and carried the unused portion forward to 2012 and 2013.

On May 8, 2015, IRS Revenue Agent Christopher Dickerson sent Evans and the Carters Letters 5153 and accompanying examination reports (RAR). The reports proposed to disallow their deductions for DHP's contribution and to impose penalties for each year. The Letters 5153 instructed the taxpayers to respond either by paying the tax, calling to discuss payment options, or agreeing to extend the period of limitations on assessment to allow time for their case to be considered by the IRS Appeals Office (Appeals). The Letters 5153 also advised that, if there was no response, their cases would be processed on the basis of the proposed changes and notices of deficiency would be sent. Neither Evans nor the Carters agreed to extend the period of limitations on assessment. On May 19, 2015, Dickerson's immediate supervisor, Donald Maclennan, approved the proposed penalties in writing. In August of 2015, the IRS sent notices of deficiency, and Evans and the Carters took their cases to the Tax Court.

Although charitable deductions are not permitted for donations of partial interests in property, Code Sec. 170(f)(3)(B)(iii) provides a limited exception for a qualified conservation contribution. A qualified conservation contribution is the contribution of a (1) a qualified real property interest to (2) a qualified organization (3) exclusively for conservation purposes. Under Code Sec. 170(h)(2)(C), a qualified real property interest includes a use restriction that is granted in perpetuity. Under Code Sec. 170(h)(5)(A), the contribution is exclusively for conservation purposes only if the conservation purpose is in perpetuity.

In Belk v. Comm'r, 140 T.C. No. 1 (2013), aff'd 2014 PTC 614 (4th Cir. 2014), the Tax Court held a conservation easement deed that allows the donor to change what property is subject to the conservation easement does not meet the perpetual use restriction in Code Sec. 170(h)(2)(C). The Tax Court reasoned that both Code Sec. 170(h)(2)(C) and Code Sec. 170(h)(5)(A) must be satisfied; protecting the conservation purpose in perpetuity is separate from the requirement that there be real property subject to a use restriction in perpetuity. However, in BC Ranch II, L.P. v. Comm'r, 2017 PTC 367 (5th Cir. 2017), the Fifth Circuit reversed a Tax Court decision that followed Belk. The Fifth Circuit held that the perpetual use restriction requirement in Code Sec. 170(h)(2)(C) is not violated if an easement allows the location of building areas within an easement to be modified after the contribution, as long as the exterior boundaries and total acreage of the easement cannot be changed. In a dissenting opinion, one Fifth Circuit judge accepted the Tax Court's analysis in Belk and said that if an easement does not govern a defined and static parcel of land, it does not constitute a qualified conservation contribution. In Pine Mountain Preserve, LLLP v. Comm'r, 151 T.C. No. 14 (2018), the Tax Court followed its decision in Belk, and expressed its agreement with the analysis of the Fourth Circuit and the dissenting judge in the Fifth Circuit's Bosque Canyon decision.

Evans and the Carters argued that Pine Mountain did not apply because the properties in that case were in different states, and thus subject to different laws, from the property in this case. They also pointed out that the easements in Pine Mountain allowed commercial development while theirs permitted only single-family homes. According to Evans and the Carters, the full exercise of DHP's retained rights would not impair the easement's conservation purposes.

Tax Court's Analysis

The Tax Court followed its decision in Pine Mountain and held that the easement did not meet the perpetual restriction requirement of Code Sec. 170(h)(2).The court reasoned that the restrictions provided in the easement that would remain applicable to any selected building areas would not prevent the development of single-family homes, meaning that those areas would not be preserved as open spaces, and any natural habitats within them would not be protected. Consequently, the easement at issue was not a qualified real property interest. The Tax Court noted that its holding conflicted with the Fifth Circuit's conclusion in BC Ranch II. But because this case was appealable to the Eleventh Circuit, the court said that it did not have reason to depart from its own precedent and follow the Fifth Circuit's position. The Tax Court rejected the taxpayers' arguments, finding that Pine Mountain did not depend on state law or on the character of the development within the easement area. The court reasoned that under Pine Mountain, even if the donor's retained rights do not impair the conservation purposes of the easement as a whole, they may nevertheless violate the perpetual use restriction requirement within each building area.

However, the Tax Court did not uphold the imposition of penalties because it found that the IRS did not satisfy the supervisory approval requirement in Code Sec. 6751(b)(1). The court found that the RARs communicated Dickinson's initial determination of the penalties and, because written approval occurred only after Dickinson sent the RARs to the taxpayers, that approval was not timely. The court found that the fact that Dickinson did not send 30-day letters informing the taxpayers of their appeal rights did not change this outcome. In the court's view, the fact that the RARs were sent with Letters 5153 rather than 30-day letters was attributable solely to the taxpayers' unwillingness to provide Appeals sufficient time to consider their cases. Thus, under the circumstances, the court did not consider the absence of 30-day letters to indicate a lack of formality or finality in Dickerson's determination.

For a discussion of the rules for contributions of partial interests in property, see Parker Tax ¶84,155. For a discussion of the procedural requirements for computing penalties, 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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