Stefan Nagel, Esq., Of Counsel
Law Office of Stephen J. Small, Esq., P.C.
One Gateway Center, Suite 801
Newton, MA 02458-2804
617-357-4012, ext. 261
Facsimile 617-357-1857
snagel@stevesmall.com
MEMORANDUM
To:
Massachusetts Land Conservation Conference
From:
Stefan Nagel ©
Date:
March 22, 2014
Subject:
Making (Some) Sense of Recent Federal Tax Rulings and Related IRS
Guidance
The following is a summary of recent federal tax rulings and IRS guidance related to
conservation easement (conservation restriction or “CR”) donations. All were released since last
year’s Massachusetts land conservation conference. The rulings and guidance were selected
because they have some unusual or surprising aspects, or offer insights into judicial or IRS
review. This is therefore not a complete compendium of recent rulings but is intended to provide
an understanding of certain key matters that have captured the attention of the national and state
land trust community. The rulings and guidance have been placed into three categories: (1)
valuation, (2) perpetuity/extinguishment, and (3) tax exemption.
VALUATION
Take away: Due to admonitions from the tax court and IRS’ own advisory panel, and because
of a relative lack of success in prevailing on its “strict compliance” donation substantiation
standard, the IRS is re-focusing on donation valuation. Nonetheless, donors’ and land trusts’
adherence to gift and valuation substantiation requirements remains important to offset the
possibility that a valuation challenge may result in a collateral challenge. Valuation is also the
key to the determination of whether accuracy related penalties (20% for “substantial” value
misstatement, or 40% for “gross” value misstatement) may be imposed.
Mountanos v. Commissioner, T.C. Memo 2013-138 (June 3, 2013). Recon. den’d, T.C. Memo
2014-38 (March 6, 2014). Based in part on the fact that the subject ranch property was under
agricultural use value assessment through enrollment under California’s Williamson Act, the tax
court concluded that the taxpayer’s Section 170(h) conservation easement donation did not
diminish the value of the property. MGL Chap. 61 is distinguishable: “Petitioner did not argue
or otherwise show that the Williamson Act contract could be cancelled”, nor that the ten-year
contract was scheduled to terminate for non-renewal. The donor was therefore subject to an
accuracy-related penalty on that portion of underpayment of tax that is attributable to “gross”
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valuation misstatement (at the time, valuation in excess of 400% of the correct amount, under
current law in excess of 200% of the correct amount).
Friedberg v. Commissioner, T.C. Memo 2013-224 (September 23, 2013). Even though the tax
court concluded there were deficiencies in the methodology used to value a façade (historic
preservation) easement, those deficiencies did not render the appraisal report unqualified under
Treas. Reg. Section 1.170A-13(c)(3)(ii). And, interestingly, the court appears to recognize that
the donation and resulting extinguishment of transferable development rights in association with
what would otherwise be a qualified historic preservation easement donation under Section
170(h) may be factored into the valuation of the easement.
Gorra v. Commissioner, T.C. Memo 2013-254 (November 12, 2013). Because the court was
able to find that the subject historic preservation easement and associated monitoring rights were
more restrictive than those imposed under local (NYC) historic preservation laws, the donors of
a historic preservation easement were entitled to a donation deduction. The fact that the
easement grantee could verify that it regularly monitored the easement was a factor in the ruling.
The ruling also confirmed, at least under NY law, that delivery of the document to the recorder’s
office, with receipt acknowledged, constituted recordation in the year of delivery, even though
there was a delay in actual recording until the following year because of a clerical error.
Esgar Corp. v. Commissioner, Ct. of Appeals, 10th Cir., No. 12-9009 (March 7, 2014), appeal of
T.C. Memo 2012-35. In materially upholding the tax court’s determination of value attributed to
the donation of a conservation easement on a ranch, the court rejected the taxpayer’s assertions
that the “highest and best use” of the ranch for valuation purposes was based on gravel mining.
The appeals court noted that the determination of “highest and best use” is “one of objective
probabilities. . .. Valuation does not depend on ‘whether the owner actually has put the property
to its highest and best use’ . . . rather . . . [whether] ‘the property is adaptable and needed or
likely to be needed [for the most profitable use] in the reasonably near future.’”
IRS Chief Counsel Advice 201334039 (released August 23, 2013). This advice, which is
intended to assist IRS personnel in administering their programs (i.e., audits), provides guidance
in the application of the “contiguous parcel” and “enhancement” CR valuation rules under Treas.
Reg. Section 1.170A-14(h)(3)(i). In addition to the expected clarifications, the Advice also
concluded that the contiguous parcel rule is applied when the adjacent parcel is owned by a
“disregarded” LLC or partnership of which the donor or a family member (vertical) is the sole
member. Similary, the enhancement rule is applied when the adjacent property is owned by an
LLC, partnership or corporation that is NOT “disregarded”, even if the donor or vertical family
members are sole or majority member(s) or shareholder(s).
PERPETUITY/EXTINGUISHMENT
Take away: Termination of a CR must be by judicial extinguishment to satisfy the requirements
of Section 170(h). To provide otherwise in the CR or by statute will disqualify the CR from the
federal tax benefits for failure to meet the federal statutory “perpetuity” requirement and the
express provisions of Treas. Reg. Section 1.170A-14(g)(6). Recent related rulings, particularly
Carpenter II and Wachter, below, may nor may not influence proposed legislation in Vermont
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and Kansas.
Graev v. Commissioner, 140 T.C. No. 17 (June 24, 2013)). A side letter between the donor of a
historic preservation restriction and the restriction grantee assured the donor that the donee
organization would join with the donor to release the restriction in the event the promised
favorable charitable deduction was denied. The court ruled that the gift was conditional and
therefore not complete. Also, because recent litigation developments made the likelihood that a
deduction would be denied more than “remote” – resulting in possible termination under the
terms of the letter - the tax court determined that the donation was disallowed as a charitable
deduction.
Carpenter v. Commissioner, T. C. Memo 2013-172 (July 25, 2013) (Carpenter II). The tax court
clarified its ruling in Carpenter I (T.C. Memo 2012-1) by stating unequivocally:
“extinguishment by judicial proceedings is mandatory” for the contribution of a conservation
restriction to be deemed “qualified” under Section 170(h). The ruling also affirmed, at least with
respect to Colorado law, that the charitable trust doctrine does not apply to the donation of a
conservation restriction.
Wachter v. Commissioner, 142 T.C. No. 7 (March 11, 2014). Because North Dakota law limits
conservation restrictions granted since 1977 to a term that may not exceed 99 years, donors of
conservation restrictions in North Dakota may not receive federal donation deductions.
Conservation restrictions in the state cannot be granted in perpetuity, as required under Section
170(h). The effect of the statutory limitation cannot be eliminated through the application of the
“so remote as to be negligible” exclusion under Treas. Reg. Section 1.170A-14(g)(3).
TAX EXEMPTION
Take away: A charity, even one that has been previously determined by the IRS to be “publicly
supported” and operating “exclusively” for exempt purposes, cannot allow itself to be held
hostage to the fulfillment of private interests and achievement of personal financial gain. This
does not, however, preclude the charity from the pursuit of financial reward that is substantially
related to its exempt purposes.
Private Letter Ruling 201405018 (January 31, 2014). The IRS has ruled that the president, a
CPA, of a publicly supported, tax exempt conservation organization used the organization to
help his clients obtain significant charitable deductions through their donations to the
organization of sparsely documented, inadequate conservation easements. While the details of
the ruling are quite specific to the situation being evaluated, the ruling serves as an important
reminder that charitable organizations must be run in the public interest, and not for private gain.
Private Letter Ruling 201408031 (February 21, 2014). At best, unrelated trade or business
activities may generate unrelated business income tax or, at worst, justify the IRS’ revocation of
an organization’s tax exemption. IRC Sections 512 - 513. Based on the specific facts and
circumstances of this particular matter, the IRS ruled that a land trust’s stream mitigation
activities, which generated marketable mitigation credits, did not constitute unrelated trade or
business activities.
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