Based upon a review of cases decided by the U.S. Tax Court since 2012, the Tax Court’s record reveals that most of its decisions hand an outright victory to the IRS with no charitable deduction allowed for donations by taxpayers of charitable conservation easements.
The Internal Revenue Service designated syndicated conservation easements as listed tax shelters in Notice 2017-10. The IRS has also made conservation easements an audit priority. It is now apparent that the least little deviation by a taxpayer from the extensive statutory and regulatory requirements for conservation easements dooms the easement to fail completely as a charitable donation for the donor. Moreover, the donor is generally liable for substantial penalties for its environmental philanthropy.
An objective review of relevant cases reveals that, arguably, the primary objection may more accurately be the valuation of the easement. The amounts claimed by the syndicated partnerships and partners are frequently many times that of the investments made by the partners. However, the courts rarely analyze whether there are any conservation benefits to these easements. Instead, the primary focus is on the standard language used in the easement deeds, and the easiest way to disallow the charitable deductions. Appellate court decisions have been mixed, but taxpayers have been more successful at the appellate level.
By disallowing conservation easements in total, along with imposing significant penalties, the IRS and the Tax Court are not carrying out the legislative intent behind Congress’ enactment of the legislation that supports conservation easements. While in the earlier years the valuation of the easement was frequently the issue, the IRS now almost always disallows 100% of the charitable deduction attributable to the conservation easement, which the Tax Court almost always upholds. (See case summaries in Appendix) Frequently, the reason for the disallowance is not the lack of a charitable conservation purpose or effect, but a very technical (and fixable) problem with document drafting.
Assuming the presence of a charitable purpose and effect, conservation easements should not be denied in full. Rather, the valuation of the charitable donation of the easement should be the basis for bringing syndicated easements into compliance. The alternate 20% and 40% penalties on valuation overstatements are an effective tool and may be applicable even if the conservation easement is allowed at a reduced value. Tax code Section 6662(h)(2) sets forth the applicable percentages differentiating when the 20% penalty will apply and when the 40% penalty applies. There is no requirement that the revised value be zero, just overstated. If a conservation easement is the result of a syndicated partnership and a promoter selling tax benefits, that arguably should not automatically cancel or disqualify the conservation project as one with no impact. The charitable purpose and the effect of the easements should be analyzed before coming to that conclusion. Improper tax deductions can be dealt with, as appropriate, without destroying the conservation effort. Frequently, the impact of the easement conserving green space and saving threatened plant and animal life is not even considered or mentioned by the IRS or Tax Court.
A charitable conservation easement is defined in Section 170(h) and was added to the Internal Revenue Code in 1980. Extensive Treasury Regulations interpreting Section 170(h) were added in 1986. Depending upon who you talk to, it is either a necessary tax incentive to preserve natural outdoor spaces, or a tax shelter abused by many for inflated charitable deductions. I believe it is a little of both. However, the IRS’s and Tax Court’s current approach that any small deviation from the hyper-technical requirements set forth in the Treasury Regulations cause the conservation easement to completely fail as a charitable donation does not fulfill the Congressional intent of Section 170(h).
Congress enacted a specific carve-out for charitable conservation easements in part to preserve green space. The Senate’s description of the new legislation states: “The committee believes that the preservation of our country’s natural resources and cultural heritage is important, and the committee recognizes that conservation easements now play an important role in preservation efforts.” “Reasons for Change” S.Rep. 96-1007, *6744 (9-30-1980), P.L. 96-541 (emphasis added). The IRS and the Tax Court are impeding Congress’s intent to preserve our country’s natural resources and cultural heritage.
For a conservation easement to be deemed charitable, it must be donated to a Section 501(c)(3) charity or governmental entity and include perpetual use restrictions. The easement must be a recorded property interest that is donated to the charity. Several court decisions of note were released recently, which together merit a review of the status of the law.
Oakbrook Land Holdings
The Tax Court recently issued two opinions regarding a single conservation easement that was donated by a limited partnership to a charitable land conservancy. The IRS argued, in part, that the easement did not comply with the Treasury Regulations’ requirement that the extinguishment clause in the easement document be proportional to the donee and donor. In this case, as in many, the extinguishment provision allows that any improvements on the property (in compliance with the easement) would benefit the donor more than the donee charity upon extinguishment of the easement.
The taxpayer partnership responded by arguing that the Treasury Regulation sub-section at issue, Treas. Reg. 1.170A-14(g)(6)(ii), is invalid. The regulation requires that improvements to the property benefit donor and donee proportionally based upon the fair market value of the easement as compared to the fair market value of the entire property at the time of the donation, regardless of which party funded any improvements. Thus, if an extinguishment of the easement results in a sale of the property, the donee charity retains funds that are proportional to the value of the easement compared to the total value of the property at the time of the donation. If the value of the easement is $3 million at the time of the donation, and the total value of the property is $4 million, the donee charity will keep three-fourths or 75% of the proceeds from the sale of the land if the extinguishment clause applies years later regardless of any improvements funded by either the donee or donor. The donee would not be able to recoup its expenditures.
Judge Mark Holmes, in Oakbrook Land Holdings LLC v. Commissioner, T.C.Memo. 2020-54 held that the easement did not comply with the regulatory requirement, but that the ultimate outcome in the case depended upon whether the Treasury Regulation at issue was valid. In a reviewed opinion issued on the same day: Oakbrook Land Holdings LLC v. Commissioner, 154 T.C. No. 10 (May 12, 2020), the court held that the Treasury Regulation at issue, Treas.Reg. 1.170A-14(g)(6), is valid under the standards set forth in the Administrative Procedures Act and Chevron U.S.A., Inc. v. Nat. Res. Def. Council, Inc., with Judge Holmes responding in a heated dissent. One can only surmise that his original opinion held that although the taxpayer did not comply with a very limited provision of the Treasury Regulations, the regulation sub-section was invalid and thus the easement did qualify as a charitable conservation easement. Judge Holmes would then have undoubtedly analyzed the case as a valuation dispute, because the property was purchased by the taxpayer for $1,700,000 in 2007 and the easement was valued at $9,545,000 in 2008. However, that is not what happened. The en banc review by the Tax Court upheld the regulatory requirements in Treas.Reg. 1.170A-14(g)(6)(ii). Therefore, the easement did not qualify as charitable and the deduction was denied in full. Judge Holmes questioned whether any conservation easements could survive the intense scrutiny. As he stated in his dissent:
“HOLMES, J., dissenting: Our holding today will likely deny any charitable deduction to hundreds or thousands of taxpayers who donated the conservation easements that protect perhaps millions of acres. See Oakbrook Land Holdings, LLC v. Comm’r, T.C. Memo. 2020-54, at *7 n.2. [reason to believe thousands of charitable conservation easements contain the identical extinguishment clause in their easement documents] This is the second time we’ve taken an ax to entire forests of these deductions. In Pine Mountain Preserve, LLLP v. Comm’r, 151 T.C. 247 (2018), appeal filed (11th Cir. May 7,2019), we went ahead and held that reserving a limited right to build on conserved property—unless the site is described with exceptional precision—destroys any deduction for the donation, knowing that we were setting up a conflict with the only circuit court to rule on the issue. See id. at 272-73 (stating that we will not follow BC Ranch II, L.P. v. Comm’r, 867 F.3d 547 (5th Cir. 2017), vacating and remanding Bosque Canyon Ranch, L.P. v. Comm’r, T.C. Memo. 2015-130).”
There is no indication yet whether the taxpayer will appeal either, or both, of these Tax Court opinions but one can surmise that an appeal is likely. The taxpayer is located in Tennessee and so presumably an appeal will be filed in the U.S. Court of Appeals for the Sixth Circuit. The Sixth Circuit has two relevant decisions: Hoffman Properties II, LP v. Commissioner, in which the Tax Court’s decision in favor of the IRS was affirmed. The taxpayer failed to satisfy the “in perpetuity” clause requirement for the donation of a façade conservation easement, although did not rely upon the Treasury Regulations. Perhaps better news for taxpayers is the Sixth Circuit’s opinion in Glass v. Commissioner, in which the Tax Court’s decision in favor of the taxpayers was affirmed. The taxpayers satisfied both courts that their conservation easement was granted in perpetuity, the habitats within the conservation easement were significant, and the easement protected a “relatively natural” habitat of plants and wildlife. It is worth noting that the amounts claimed as charitable deductions in Glass were in the thousands, rather than millions. However, Glass was decided by the Tax Court in 2005 before the proliferation of syndicated partnerships and before the trend discussed herein.
The Tax Court has already issued multiple decisions relying upon Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. No. 10 (May 12, 2020) and Treas.Reg. 1.170A-14(g)(6). All of these cases deny the deductions for conservation easements in full, many decided on summary judgment motion, relying upon the easement deed’s extinguishment clause. That is, the easement deed fails to provide the grantee charity with the proportional distributions of the entire proceeds to which it should be entitled in the unlikely event the easement is ever extinguished and sold under court order.
The recent Tax Court cases are the following, with additional cases undoubtedly to be released in the coming months.
- Hewitt v. Commissioner. Charitable deduction of $2.8 million claimed but it was not a syndicated easement. Charitable easement denied due to defective extinguishment/perpetuity clause but no penalties imposed.
- A deduction of $25.5 million was claimed for a syndicated conservation easement. The deduction was denied in full due to the defective extinguishment/perpetuity clause and the 40% penalty was sustained.
- Lumpkin One Five Six v. Commissioner. A deduction of $2.48 million was claimed for a conservation easement. The deduction was denied in full due to the defective extinguishment/perpetuity clause. The case was decided on a partial summary judgment motion.
- Lumpkin HC, LLC v. Commissioner. A deduction of $8.42 million was claimed for a syndicated conservation easement. The deduction was denied in full due to the defective extinguishment/perpetuity clause. The case was decided on a partial summary judgment motion.
- Harris v. Commissioner, Order issued June 30, 2020 by Judge David Gustafson. The IRS’ Motion for Partial Summary Judgment was granted. This was not a syndicated easement. TP claimed a charitable deduction of $1.33 million which was disallowed in full due to defective extinguishment/perpetuity clause. Penalties were not determined due to questions of fact.
- Habitat Green Investments, LLC et al. v. Commissioner, Order issued June 30, 2020, by Judge Gustafson. IRS’s motion for partial summary judgment was granted. Three syndicated conservation easement partnerships were consolidated for trial. The partnerships claimed deductions for the charitable conservation easements in the amounts of $19.1 million, $19.6 million, and $28.5 million, respectively. All deductions were disallowed due to the extinguishment/perpetuity clauses in the easement deeds. Penalties were not determined due to questions of fact.
Champions Retreat Golf Founders v. Commissioner
Another newly issued case is the Eleventh Circuit’s opinion in Champions Retreat Golf Founders, LLC v. Commissioner. The Eleventh Circuit agrees with Judge Holmes’ premise that at least some conservation easements are valid. The Court of Appeals reversed the Tax Court’s opinion (T.C. Memo. 2018-146) in which the Tax Court upheld the IRS’ position and disallowed the easement. The issue was whether there was a valid conservation purpose, rather than an issue regarding the extinguishment clause. The Eleventh Circuit agreed with the taxpayer that the conservation easement qualified as charitable but remanded the case back to the Tax Court for a review of the valuation of the easement.
Champions Retreat is a private property outside of Augusta, Georgia, which includes a private golf course and an undeveloped area of approximately 57 acres. An adjacent portion of the property that is developed with private homesites was not covered by the easement. The IRS and the Tax Court agreed that the property did not satisfy the Section 170(h) requirement that to be charitable, the easement must exclusively be for conservation purposes. On the other hand, the Eleventh Circuit held: “The deduction was proper if the donation was made for “the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem,” or was made for “the preservation of open space … for the scenic enjoyment of the general public. I.R.C. §170(h)(4)(A)(ii) & (iii)(I).” The IRS and the Tax Court disallowed the entire charitable deduction, finding that no part of the easement satisfied the exclusivity requirement of Section 170(h).
The Eleventh Circuit analyzed the various components of the easement and found that at least a portion of the easement was exclusively for conservation purposes. Therefore, the Eleventh Circuit reversed the Tax Court and remanded the case back for a calculation of the correct valuation of the easement. The Court of Appeals also could not understand why the bird count analysis by the Tax Court was dependent upon actual sightings of birds by both expert witnesses. The Eleventh Circuit was mystified by the Tax Court’s disregard of a bird that was heard but not seen and found the misclassification of birds to be clearly erroneous. The court held:
“Despite the abundant bird species, including many of conservation concern, the declining southern fox squirrels, and the rare denseflower knotweed, the Tax Court said Champions had not established the required conservation purpose. To reach this result, the court considered, or at least discussed in its opinion, only birds seen by both Champions experts—ignoring any bird seen by only one Champions expert, even if the bird was also seen by the Commissioner’s expert. The court did this despite explicitly crediting the testimony of both Champions experts. The court offered no explanation for this approach, and we can conceive of none. “
“The court also ignored a bird that was heard but not seen. The court did not explain how a bird could be heard if not present on or at least near the property. The Tax Court’s implicit finding that the only birds on the property were those seen by both Champions experts is clearly erroneous. More importantly, the Tax Court’s conclusion that Champions did not contribute this easement “for the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem”—a conclusion based in part on the clearly erroneous finding of fact—is wrong as a matter of law.”
The Internal Revenue Code states that a taxpayer may satisfy the conservation purpose requirement if its contribution protects “a relatively natural habitat of fish, wildlife, or plants, or a similar ecosystem.” Section 170(h)(4)(A)(ii). However, the Treasury Regulations interpreting this tax code section added the word “significant” to the statutory language: The habitat must be a “significant relatively natural habitat in which a fish, wildlife, or plant community, or similar ecosystem normally lives.” Treas. Reg. 1.170A-14(d)(3)(i). The validity of this provision of the regulation, in which the word “significant” is added to the statutory language, has not been challenged, but clearly the Tax Court relied upon that language in its decision. The legislative history uses language of a “significant natural habitat”, and the statutory language is a “relatively natural habitat”. While this is a substantial change to the statutory meaning, it appears to be within legislative intent. ” S.Rep. 96-1007, *6745 (9-30-1980), P.L. 96-541. See also, Glass v. Commissioner, 124 T.C. 258 (2005), aff’d 471 F.3d 698 (6th Cir. 2006)Both the Tax Court and the Sixth Circuit found the conservation easement to be a significant relatively natural habitat, and thus held that the taxpayer’s charitable deduction is sustained. However, since the IRS and Tax Court are ignoring the more general legislative intent behind conservation easements in general, it is curious that the addition of the word “significant” to the statutory requirements through regulatory fiat has been upheld without comment.
IR-2020-130: IRS’ Settlement Option
The IRS recently issued IR-2020-130 (June 25, 2020) offering a settlement option for those taxpayers with syndicated charitable conservation easement cases pending in the Tax Court. The settlement requires all partners to agree to concede all deductions, pay 100% of the tax, interest, and penalties, and accept a 40% penalty for any partners who provided services in connection with the easement scheme, with 10% to 20% penalties for investment partners. One concession made by the IRS is that investment partners may deduct the costs of acquiring their partnership interests. This is a “time-limited” offer and taxpayers eligible will be notified by the IRS by mail. One unstated concession by taxpayers is that they forfeit their ability to appeal to the more forgiving Courts of Appeal. A settlement cannot be appealed, while the inevitable adverse Tax Court decision is most definitely appealable.
Due to the plethora of cases decided in reliance on Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. No. 10 (May 12, 2020), which is a new case not yet tested by an appellate court, it may be advisable for taxpayers with conservation easement issues to wait to take further actions until the landscape is more settled. Whether the various appellate courts to which these cases could be, and probably will be, appealed will uphold the validity of the Treasury Regulation has yet to be determined. If taxpayers settle their cases in reliance on Oakbrook Land Holdings, there may be regrets if any of the above cited cases relying on Oakbrook Land Holdings are reversed on appeal, depending upon the taxpayer’s applicable Circuit. If these multiple cases are eventually decided on conservation purpose and valuation issues instead of an obscure Treasury Regulation, the outcome could be much different both for taxpayers and for the environment.
It is unknown whether conservation easements that are disallowed as charitable easements remain with the charity, or whether they are clawed back in some manner by the donor. It is possible that due to court opinions declaring easement clauses defective, the donors could declare the entire easement deed defective and seek to render said agreement null and void. If so, as Judge Holmes stated, many forests of trees will be lost and disappearing species will likely disappear, all because of a tax law that is not being enforced by the IRS and Tax Court in a manner consistent with legislative intent.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Nancy Ortmeyer Kuhn is a director at Jackson & Campbell, P.C. in Washington, D.C., and is chair of the Tax Group. Nancy’s legal practice focuses on litigation and federal tax matters. She was a law clerk at the U.S. Tax Court for two years and then a litigator in Chief Counsel’s office of the IRS for approximately nine years. Nancy then switched sides and represent taxpayers before the IRS, the Tax Court, and District Courts. In addition, she handles general litigation matters in various state and federal courts. She is an active member of the Women’s Bar Association of the District of Columbia and is a founding board member of 131 & Counting, a nonprofit organization celebrating women in elective office.