In a split decision, the Fifth Circuit Court of Appeals reversed and remanded the Tax Court’s 2015 opinion in the case of BC Ranch II, LP et al v. Commissioner, Case No. 16-60068 and 16-60069. All the judges on the panel agreed that the Tax Court had erred in deciding that the entire amount paid by limited partners for their interests represented disguised sales and in deciding that a valuation penalty applied. But the panel split on a key question of whether the partnership had complied with the requirements to obtain a charitable contribution for the donation of a conservation easement, with a majority finding the Tax Court had erred in determining the contribution did not qualify for a deduction.

The Tax Court had found that the arrangement in question did not grant the conservation easement in perpetuity, while two of the three judges on the panel found that it did. The arrangement is described as follows in the Fifth Circuit opinion:

BCR I donated a conservation easement to NALT on December 29, 2005. BCR II donated a conservation easement to NALT on September 14, 2007. Both easements contained substantially identical terms. They protected and preserved (1) the habitat for the gold-cheeked warblers and other birds and game, (2) watershed, (3) scenic vistas, and (4) mature forest. The easements “voluntarily, unconditionally, and absolutely” granted NALT, its successors and assigns, “perpetual easement[s] in gross” over the conservation areas, subjecting the property to a series of “covenants and restrictions in perpetuity” that prohibit most residential, commercial, industrial, and agricultural uses. The easements reserved narrow rights to the grantors that NALT and the BCR Partnerships agreed “could be conducted . . . without having an adverse effect on the protected Conservation Purpose.”

The easements could be amended only with NALT’s consent and then only to modify the boundaries of the homesite parcels, but not to increase their areas above five acres. NALT continues to monitor the conservation area and has repeatedly found it to be in good condition and in compliance with the terms of the easements.

The question was whether the reservation of the right to request a modification of the arrangement that would allow for changing the boundaries of the homesite parcels, effectively removing some of the previously protected land and substituting other land for that lost acreage, amounted to a failure to grant the easement in perpetuity.

The Tax Court found that this situation was like that found in the case of Belk v. Commissioner, 140 TC 1, a ruling that was affirmed on appeal by the Fourth Circuit Court of appeals. Certainly, at first glance it appears similar, as Belk involved a grant where the right was reserved to substitute other land for the land initially granted.

But the majority argued that this case was different, ruling:

The easements at issue in this case differ markedly from the easement in Belk. Among other distinctions, the instant easements allow only the homesite parcels’ boundaries to be changed and then only (1) within the tracts that are subject to the easements and (2) without increasing the acreage of the homesite parcel in question. They do not allow any change in the exterior boundaries of the easements or in their acreages. Thus, neither the exterior boundaries nor the total acreage of the instant easements will ever change: Only the lot lines of one or more the five-acre homesite parcels are potentially subject to change and then only (1) within the easements and (2) with NALT’s consent.

Unlike here, the easement in Belk could be moved, lock, stock, and barrel, to a tract or tracts of land entirely different and remote from the property originally covered by that easement. The court in Belk reasoned that, because the donor of the easement could develop the same land that it had promised to protect, simply by lifting the easement and moving it elsewhere, it was not granted in perpetuity. The Belk court also reasoned that such parcel-swapping could undermine the “qualified appraisal of [the] property.”

Those concerns are not present here. Only discrete five-acre residential parcels, entirely within the exterior boundaries of the easement property, could be moved — for example, to account for locations subsequently chosen as nesting sites by the warblers. Even the Commissioner’s own expert confirmed that the unencumbered homesite parcels have roughly the same per-acre value as the rest of the ranch which is encumbered by the easements. Thus, changing the boundaries of some of the homesite parcels would not return any value to the easement donors.

However, the dissenting opinion found that this case was not distinguishable from Belk and that the charitable deduction therefore was properly disallowed by the Tax Court. That opinion reasoned:

Respectfully, I find the attempted distinction unpersuasive. As the majority opinion correctly notes, “[t]he court in Belk reasoned that, because the donor of the easement could develop the same land that it had promised to protect, simply by lifting the easement and moving it elsewhere, it was not granted in perpetuity.” Op. at 9–10. The majority opinion states that the same concern is not implicated in the present case because “[o]nly discrete five-acre residential parcels, entirely within the exterior boundaries of the easement property, could be moved.” Id. at 9–10. I do not see how this distinction obviates the concern expressed by the Belk court: using the modification provision, the BCR Partnerships can lift the easement and swap the previously unprotected five-acre homesites for initially protected land, thereby converting conservation habitat into residential development.

So where does this decision leave us?  At most this decision suggests that if a possibility of substitution exists in the easement granted, it will be a factual determination of whether it “goes too far” (and thus gets disallowed under the Belk analysis) or is sufficiently restricted to not disqualify the contribution. Given it is a split decision where the majority took pains to distinguish the case from Belk rather than take the position that Belk was improperly decided, there is more than a slight risk that other circuits may not be easily taken down the path of allowing the deduction regardless of the facts in a case like this.

From a practical standpoint, having a substitution provision in an easement likely puts the charitable contribution deduction at considerable risk of disallowance, so taxpayers should be advised of the high-risk nature of placing such a provision in an easement for which they are seeking a charitable contribution deduction.