In the case of Rutkoske, Sr. et al v. Commissioner, 149 TC No. 6, the Tax Court was asked to consider what types of income counted as “gross income from the trade or business of farming” for purposes of gaining access to the increased deduction for qualified conservation easements of property used in agriculture or livestock production under IRC §170(b)(1)(E)(iv).

Normally a deduction for a qualified conservation easement is limited to 50% of the taxpayer’s income after reduction for other charitable contributions.[1]  However, that limit rise to 100% for the contribution of property used in agriculture or livestock production by a qualified farmer or rancher.[2]

To be a “qualified farmer or rancher” under this provision, the taxpayer’s gross income from the trade or business of farming must exceed 50% of the taxpayer’s gross income for the taxable year.[3]  What constitutes the trade or business of farming for this purpose is defined at IRC §2032A(e)(5).[4]

In this case the taxpayers engaged in a bargain sale of land that included a grant of conservation easement.  As the Court explains the transactions:

On June 5, 2009, Browning Creek conveyed a conservation easement to Eastern Shore Land Conservancy, Inc.,4 restricting the development rights attached to the property in exchange for $1,504,960. In connection with the granting of the easement, Browning Creek obtained an appraisal which set forth the fair market value of the unencumbered property as of June 5, 2009, as $4,970,000 and the fair market value of the property after the granting of the conservation easement as $2,130,000. After conveying the conservation easement, later on June 5, 2009, Browning Creek sold its interest in the property to Quiet Acre Farm, Inc. (Quiet Acre), for $1,995,040.

Browning Creek reported that its total basis in the property was $1,745,885. Browning Creek allocated $240,828 of this amount to the conservation easement and $1,505,057 to its remaining interest in the property. Browning Creek reported a capital gain of $1,754,115 from the sale of the property: $1,264,132 from the sale of the conservation easement, and $489,983 from the sale of its remaining property interest. Browning Creek also reported a noncash charitable contribution for the conservation easement of $1,335,040 — the difference between the purported value of the property before the conveyance of the conservation easement, i.e., $4,970,000, and the purported value of the property after the conveyance of the easement, i.e., $2,130,000, minus the $1,504,960 Browning Creek received from the sale of the conservation easement.

The taxpayers asserted that the income derived from the sale of the conservation easement counts as income from the trade or business of farming or ranching, while the IRS argued that such amounts are not part of gross income from that activity.

IRC §2032A(e)(5)’s definition of farming and ranching contains a list of various activities that give rise to income from the trade or business of farming.  The activities are:

(A) cultivating the soil or raising or harvesting any agricultural or horticultural commodity (including the raising, shearing, feeding, caring for, training, and management of animals) on a farm;

(B) handling, drying, packing, grading, or storing on a farm any agricultural or horticultural commodity in its unmanufactured state, but only if the owner, tenant, or operator of the farm regularly produces more than one-half of the commodity so treated; and

(C) (i) the planting, cultivating, caring for, or cutting of trees, or

(ii) the preparation (other than milling) of trees for market.

The taxpayers argue the sales proceeds should be included based on the following rationale:

Petitioners maintain that the business of farming requires monetary capital and investment in tangible physical capital, including land, buildings and structures, and machinery and equipment. Hence they posit:

proceeds from a sale of an asset used in the business of farming constitute income from the business of farming. Accordingly, the proceeds of sale of a tractor used in the business of farming would be characterized as income from the business of farming. Proceeds from a sale of real estate used in the business of farming likewise generates income from the business of farming.

Petitioners argue that the sale of the property falls under the strictures of section 2032A(e)(5) in that “farm real estate is an asset integral to raising, harvesting and/or producing saleable agricultural or horticultural commodities as well as the handling, drying, packing, grading, and or storing the agricultural and/or horticultural commodities produced for sale.” Thus petitioners assert that proceeds from the sale of real estate used in the business of farming generates income from the trade of business of farming.

The IRS, on the other hand, argue that to qualify for the special 100% rate, the income must come exclusively from the listed activities and can’t be “expanded” to include other income that does not represent the specifically enumerated activities.

The Tax Court sided with the IRS in this case.  The Court held:

We do not agree with petitioners’ assertion that the disposal of property (and the development rights attached thereto) constitutes cultivating the soil, raising agricultural or horticultural commodities, the handling of such commodities, or tree farming. To cultivate means “[t]o prepare and improve (land), as by fertilizing or plowing, for raising crops”. Webster’s II New Riverside University Dictionary 335 (1988); to “raise” in the context of agriculture means “[t]o grow or breed”; id. at 972; and to “harvest” means “[t]he act or process of gathering a crop”; id. at 566. For the contribution of the conservation easement to qualify for the special rule of section 170(b)(1)(E)(iv), we look to the income derived from the sale of the agricultural and/or horticultural products created when engaging in these activities, not from the sale of the land on which the agricultural and/or horticultural products are grown.

Of course, if such sales do not count as part of the farming income, then this additional “abnormal” income could easily serve to disqualify an otherwise qualified farmer solely for that year of sale.  The opinion recognizes that but notes:

We recognize that the statute makes it difficult for a farmer to receive a maximum charitable contribution deduction by disposing of a portion of property in a year in which he/she donates a conservation easement, especially in a State with high land values. But it is not our task to rewrite a statute.

Or, to put more simply, if this is a problem it is one that Congress must solve.

[1] IRC §170(b)(1)(E)(i)

[2] IRC §170(b)(1)(E)(iv)

[3] IRC §170(b)(1)(E)(v)

[4] IRC §170(b)(1)(E)(v)