It’s been a rough summer for taxpayers attempting to dispute IRS disallowances of charitable contribution deductions for conservation easements under IRC §170(h).  In the most recent case, the plaintiff was coming before the Court for the third time and, as with the last two, the IRS prevailed on the issue in front of the Tax Court.

In this case, the taxpayer in Belair Woods, LLC v. Commissioner, TC Memo 2020-112[1] was disputing the IRS’s position that the easement in question failed the “protected in perpetuity” requirement under IRC §170(h)(5)(A).  That provision and regulations[2] implementing the provision, require that the grant of the easement must, in the event the easement is extinguished, provide the charity with a proportionate share of the proceeds upon a later sale of the property.

Issues Previously Decided by the Court

The deed that was the item being examined in this case provided for the following, as described in the opinion:

The deed recognizes the possibility that the easement might be extinguished at some future date. In the event the property were sold following judicial extinguishment of the easement, paragraph 17 provided that “[t]he amount of the proceeds to which Grantee shall be entitled, after the satisfaction of any and all prior claims, shall be determined, unless otherwise provided by Georgia law at the time, in accordance with the Proceeds paragraph.” Paragraph 19, captioned “Proceeds,” specified that the deed granted the Conservancy “a real property interest, immediately vested in Grantee,” and that this vested property interest entitled the Conservancy to receive, in the event of an extinguishment, a share of any future proceeds determined

by multiplying the fair market value of the Property unencumbered by this Conservation Easement (minus any increase in value after the date of this Conservation Easement attributable to improvements) by the ratio of the value of the Conservation Easement at the time of this conveyance to the value of the Property at the time of this conveyance without deduction for the value of the Conservation Easement. (emphasis was in the original document)[3]

The Court notes that this deed presents issues very similar to ones the Court had decided in the IRS’s favor in prior cases, specifically citing BBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193 (5th Cir. 2018); Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. __ (May 12, 2020); Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126 (2019); and Carroll v. Commissioner, 146 T.C. 196 (2016).[4]

Two particular issues are noted by the Court.  First, the Court notes that the deed does not give the charity a proportionate share of the gross sales proceeds, but rather only the proceeds reduced by any increase in value related to improvements:

First, the regulatory fraction used in the deed to determine the grantee’s proportionate share of post-extinguishment proceeds is applied, not to the full sale proceeds — an amount presumably equivalent to the FMV of the property at the time of sale — but to the proceeds “minus any increase in value after the date of this Conservation Easement attributable to improvements.” Thus, the grantee’s share is improperly reduced on account of (i) appreciation in the value of improvements existing when the easement was granted plus (ii) the FMV of any improvements that the donor or its successors subsequently make to the property. By reducing the grantee’s share in this way, the deed violates the regulatory requirement that the donee receive, in the event the property is sold following extinguishment of the easement, a share of proceeds that is “at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time.” See sec. 1.170A-14(g)(6)(ii), Income Tax Regs.

As we have noted previously, the requirements of this regulation “are strictly construed.” Carroll, 146 T.C. at 212. Because the grantee in this case “is not absolutely entitled to a proportionate share of * * * [the] proceeds” upon a post-extinguishment sale of the Property, the conservation purpose underlying the contribution is not “protected in perpetuity.” Coal Prop. Holdings, LLC, 153 T.C. at 127, 139; accord, Plateau Holdings, LLC v. Commissioner, T.C. Memo. 2020-93, at *23; Oakbrook Land Holdings, LLC v. Commissioner, T.C. Memo. 2020-54. The U.S. Court of Appeals for the Fifth Circuit has likewise sustained the disallowance of a charitable contribution deduction where the judicial extinguishment provision of an easement deed included a carve-out for donor improvements similar to that here. See PBBM-Rose Hill, 900 F.3d at 208.[5]

As well, the Court found the reduction for satisfaction of any and all prior claims also ran afoul of the regulations:

The easement deed here has a second problem, which was also present in Coal Prop. Holdings. The grantee’s tentative share of the proceeds, as determined under paragraph 19 of the deed, is adjusted further by paragraph 17. It provides that the grantee’s share will be determined under the Proceeds paragraph, but only “after the satisfaction of any and all prior claims.” Prior claims against the sale proceeds might be held by various creditors of Belair or its successors.

It is not necessarily unreasonable for a deed to provide that prior claims may be paid from sale proceeds. What is unreasonable is the requirement that all prior claims be paid out of the grantee’s share of the proceeds, even if those claims represent liabilities of Belair or its successors. See Coal Prop. Holdings, LLC, 153 T.C. at 145 n.5. Because the grantee’s share of the proceeds is improperly reduced by carve-outs both for donor improvements and for claims against the donor, the deed’s judicial extinguishment provisions do not satisfy the regulatory requirements.[6]

But, the Court noted, the taxpayer raised other arguments that had not been dealt with before in this situation.[7]

The IRS Was Taking a Position Inconsistent with One Taken in Prior Cases

On June 27 we had looked at a taxpayer’s unsuccessful attempt to hold the IRS to a position the IRS had previously conceded in earlier years in the case of Audio Technica U.S., Inc. v. United States, CA6, Case No. 19-3469.[8] The Court there held that the IRS’s concessions in prior years as part of a settlement of those earlier year cases did not bar the IRS from asserting a different position in an examination of a later year that did proceed to trial.

In this case the taxpayer was not asserting the IRS had previously taken an inconsistent position with this taxpayer, but rather had accepted that such deed terms were acceptable via a stipulation in another unrelated taxpayer’s case.

The decision describes the facts as follows:

Petitioner contends that judicial estoppel should prevent the IRS from disallowing Belair's deduction because, in an unrelated case, the Government stipulated that a deed with an analogous extinguishment clause satisfied the regulations. Petitioner directs our attention to DMB Realco LLC v. United States, Civil No. 16-1585-NVW (D. Ariz. filed May 23, 2016), where the IRS had disallowed a $26.44 million charitable contribution deduction for a conservation easement. The parties filed a “joint stipulation of facts for purposes of summary judgment” in which they stipulated that the easement deed, originally conveyed in 2006, satisfied the “judicial extinguishment” regulation after the deed was amended in 2012. The Government concurrently filed a motion for summary judgment contending that the original, unamended deed controlled as to whether the taxpayer was entitled to a deduction. Before the court could hear argument on that motion, the parties reached a settlement that allowed the taxpayer a deduction of $6.61 million.[9]

The Court notes that the concept of judicial estoppel is applicable in Tax Court cases, but only if particular conditions are met.  Those conditions are stricter under the holdings of the Eleventh Circuit Court of Appeals if the matter involves a case to which the taxpayer was not a party, such as in this situation:

Judicial estoppel applies in the Tax Court. See Huddleston v. Commission- er, 100 T.C. 17, 28 (1993). Generally, three non-exhaustive factors guide our analysis when asked to invoke this doctrine. We consider whether: (1) “a party’s later position * * * [is] ‘clearly inconsistent’ with its earlier position,” (2) “the party has succeeded in persuading a court to accept that party’s earlier position,” and (3) “the party seeking to assert an inconsistent position would derive an unfair advantage.” New Hampshire v. Maine, 532 U.S. 742, 750-751 (2001). Where (as here) a party seeks to invoke judicial estoppel on the basis of a prior proceeding to which it was not a party, the Court of Appeals for the Eleventh Circuit — to which an appeal of this case would appear to lie — instructs trial courts to apply a stricter, two-factor test. That test asks whether: “(1) the party took an inconsistent position under oath in a separate proceeding, and (2) the inconsistent positions were ‘calculated to make a mockery of the judicial system.’” Slater v. U.S. Steel Corp., 871 F.3d 1174, 1181 (11th Cir. 2017) (quoting Burnes v. Pemco Aeroplex, Inc., 291 F.3d 1282, 1285 (11th Cir. 2002)).[10]

The Tax Court found the taxpayers failed to meet this rather hefty burden:

None of these conditions is met here. The Government’s “earlier position” was simply a concession, and it evidently made that concession for the purpose of facilitating summary judgment on another theory that it deemed meritorious. Parties to litigation make concessions for all sorts of reasons unrelated to the underlying merits, and the Government’s action in the Arizona case was not “clearly inconsistent” with respondent’s current position. Ibid. (quoting New Hampshire, 532 U.S. at 750-751). Nor did the Government “persuad[e] a court to accept * * * [its] earlier position.” Ibid. Because the Government made a tactical stipulation and ultimately settled the case, the District Court had no occasion either to accept or to reject the Government’s position. See Kaplan v. Commissioner, 795 F.3d 808, 813 (8th Cir. 2015), aff’g T.C. Memo. 2014-43. Finally, petitioner has not shown how the Government’s concession in the earlier case would allow it to derive “an unfair advantage,” see New Hampshire, 532 U.S. at 751, much less that it was “calculated to make a mockery of the judicial system,” see Slater, 871 F.3d at 1181; Smith Lake, LLC v. Commissioner, T.C. Memo. 2020-107.[11]

Improvements Weren’t Part of the Donation

The taxpayer next argued that the clause in the deed related to the improvements should be ignored as the “‘property that is the subject of [the] donation’ is simply ‘the underlying land’” and thus the value of the improvements can be ignored if a later sale took place.

The Court rejected this view of the donation:

We disagree. The donation of a conservation easement gives rise to a deduction only if it imposes “a restriction (granted in perpetuity) on the use which may be made of the real property.” Sec. 170(h)(2)(c). The “donation under this paragraph” thus consists of the use restrictions that are imposed in perpetuity by the easement deed. See sec. 1.170A-14(g)(6)(i), Income Tax Regs. The restrictions imposed by the easement deed necessarily apply, not only to the land, but also to any improvements made by the grantor pursuant to its reserved rights.

Here, the deed reserves to Belair the right to conduct forestry and agricultural activities, but it restricts the scale of those activities and the manner in which they may be performed. Para. 4(a) and (b). The deed reserves to Belair the right to “construct a limited number of new improvements,” but restricts that right in various ways. The deed specifies the permissible location of residential driveways and utility lines, including water, septic, and power lines. Para. 4(e)(i). Utility lines must be buried if possible “so as to minimize interference with the scenic nature” of the conserved area. Ibid. The installation of any irrigation system must not “interfere with the Conservation Values protected herein.” Para. 4(e)(ii).

“Utility and driveway placement and any construction performed shall be done in such a manner as to minimize damage to the environment and the Conservation Values.” Para. 4(e)(iii). “Roads, the driveway and utilities shall not be placed in locations which significantly interfere with the Conservation Values.” Ibid. Any ponds constructed may not exceed four acres in toto, may not “impact the ecological integrity of any wetlands [or] creek,” and are conditioned on the Conservancy’s approval as to location. Para. 4(f).

In short, the deed’s restrictions are imposed on the entirety of the conserved area — both the land and any improvements Belair makes to it. The “property that is the subject of * * * [the] donation” thus includes both the land and its improvements. Sec. 1.170A-14(g)(6)(i), Income Tax Regs.; see Hewitt v. Commissioner, T.C. Memo. 2020-89, at *18 (“The subject property refers to the property that is sold that generates the proceeds after the easement is extinguished.”). The proceeds that the Conservancy must receive upon a post-extinguishment sale of the subject property thus include the Conservancy’s proportionate share of proceeds attributable to improvements.[12]

Improvements Are Worthless

The final argument we’ll look at posits that any future improvements would not materially increase the value of the property, so this is a case of, as the Court puts it, “no harm, no foul.”[13]

The Court doesn’t accept this argument.  One problem with such an argument is understanding why, if this would never matter, such a clause was put into the deed in the first place:

To start, petitioner’s contention rests uneasily with the terms of the deed. Paragraph 4(a) reserves to Belair the right to “construct a limited number of new improvements” and enumerates the types of improvements that Belair may make. Paragraph 19 explicitly subtracts from the sale proceeds, and reserves to Belair, “any increase in value after the date of this Conservation Easement attributable to improvements.” It is hard to understand why the draftsperson would have included this language if Belair had believed that its anticipated improvements would not enhance the property’s value. And it seems entirely plausible that they would do so: Roads, driveways, irrigation systems, water pipes, electric cables, and septic systems have value intrinsically and as furnishing essential services to Belair’s adjoining residential parcels.[14]

Also, the language simply is at odds with the requirements of the regulations:

Deductions are a matter of legislative grace, and a taxpayer must prove its entitlement to the deductions it claims. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). To be entitled to a deduction for the donation of a conservation easement, the donor must ensure that the donation “gives rise to a property right, immediately vested in the donee organization,” to receive a proportionate share of the proceeds of any post-extinguishment sale. Sec. 1.170A-14(g)(6)(ii), Income Tax Regs. The deed here does not meet this test because it reserves to Belair the right to make “improvements” of obvious value and to retain all proceeds attributable to those improvements.[15]

[1] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, July 22, 2020, https://www.ustaxcourt.gov/UstcInOp2/OpinionViewer.aspx?ID=12291 (retrieved July 24, 2020)

[2] Reg. §1.170A-14(g)(6)

[3] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, p. 5

[4] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp. 2-3

[5] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp. 9-10

[6] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp. 10-11

[7] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, p. 2

[8] Ed Zollars, CPA, “IRS Not Barred From Challenging Item Agreed to in Prior Settlements,” Current Federal Tax Developments website, June 27, 2020, https://www.currentfederaltaxdevelopments.com/blog/2020/6/27/irs-not-barred-from-challenging-item-agreed-to-in-prior-settlements (retrieved July 24, 2020)

[9] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, p. 12

[10] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp. 12-13

[11] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp. 13-14

[12] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp. 15-16

[13] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, p. 16

[14] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, p. 17

[15] Belair Woods, LLC v. Commissioner, TC Memo 2020-112, pp.17-18