A partnership was denied charitable contribution deduction because it had entered in an conservation easement that violated the perpetuity requirement of Code Sec. 170(h)(5) and the regulations. The Tax Court held that if there is a judicial extinguishment of an easement the donee receives a proportionate value of any proceeds.
The Easement DeedThe taxpayer had donated a conservation easement to a land trust and claimed a charitable contribution deduction under Code Sec. 170(a). The easement deed provided that, if the conservation restriction were extinguished at some future date, the donee would receive a share of the proceeds equal to the fair market value (FMV) of the easement on the date the contribution was made. The deed further provided that the donee’s share as thus determined would be reduced by the value of any improvements made by the donor after granting the easement.
The taxpayer argued that Reg. §1.170A-14(g)(6) does not say that the donee is entitled to a proportionate share of any proceeds upon extinguishment of the easement but proportionate value. It argued this means fixed value and because the regulation requires that the value be fixed as of the donation date, the donee was not entitled to any proceeds attributable to the value of post-donation improvements.
Windfall for Donees?The IRS disallowed the deduction, contending that the extinguishment clause violated the requirements of Reg. §1.170A-14(g)(6). The Tax Court concurred with the Service’s reasoning and held that the easement deed violated the "protected in perpetuity" requirement of Code Sec. 170(h)(5), as interpreted in Reg. §1.170A-14(g)(6).
The Court held that the donee’s share of the "proportionate value" as used in the regulation means a fraction of the proceeds from a judicial extinguishment, and not a fixed value.
The taxpayer argued that it was unfair for a donee to receive extinguishment proceeds attributable to the value of improvements made solely by the donor because it would amount to an unintended charitable contribution for which it received no deduction. However, the Tax Court found that the purpose of the regulation is to avoid any windfalls to donors, not donees, if an easement was extinguished. The easement deed violated the regulation because the donee must be entitled to any proceeds from extinguishment or condemnation that were at least equal to the total proceeds multiplied by a fraction defined by the ratio of the FMV of the easement to the FMV of the unencumbered property determined as of the date of the easement deed.
The taxpayers were not held liable for accuracy-related penalties because the taxpayer acted reasonably and in good-faith. The partner was unfamiliar with the nuances of setting up a conservation easement and had relied on public letter rulings.
The Validity of the RegulationThe taxpayer challenged the validity of Reg. §1.170A-14(g)(6) which was addressed by the Tax Court in a concurrent opinion. The taxpayer contended the "proportionate value" approach to division of proceeds from a judicial extinguishment of the easement does not take into account for the possibility of donor improvements. The Tax Court held that the regulation was properly promulgated as it substantially revised the text regarding the proportionate value in response to comments and had only received one comment on the possibility of improvements. It therefore found that the regulation was valid under the Administrative Procedure Act, 5 U.S.C. Section 553.
The Tax Court further relied on the two-part test given in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc. 467 U.S. 837 (1984) and held that the construction of Code Sec. 170(h)(5) as set forth in Reg. §1.170A-14(g)(6) was valid. The Treasury exercised reasoned judgment by adhering to a simple rule that split sale proceeds in a direct proportional manner on the basis of a fraction determined as of the date the gift was made. Because the regulation as drafted ensures satisfaction of the statutory mandate that the conservation purpose be "protected in perpetuity", the regulation was not arbitrary, capricious, or manifestly contrary to the Code.
Wilson Tax Law Group APLC (www.wilsontaxlaw.com) is a boutique Orange County tax controversy law firm that specializes in representation of individuals and businesses before federal and state tax authorities with audits, appeals, FBAR, offshore compliance, litigation and criminal defense. The firm was founded in 2014 by Joseph P. Wilson, a former Federal tax prosecutor, trial attorney for the IRS and trial attorney for the Franchise Tax Board.