Tuesday, June 25, 2013
Belk v. Commissioner - Tax Court Reaffirms its Holding that “Floating” Conservation Easements Are Not Deductible
In Belk v. Comm’r, T.C. Memo 2013-154 (June 19, 2013) (Belk II), the Tax Court denied the taxpayers’ motion for reconsideration, rejecting all three of the taxpayers’ arguments and expanding upon its holding in Belk I.
Tax-Deductible Conservation Easements Must Protect Identifiable, Specific Pieces of Property
The taxpayers first argued that, as long as the taxpayer agreed not to develop 184.627 acres of land, neither the court nor the IRS should be concerned with what land actually comprises the 184.627 acres. The Tax Court disagreed, holding, as it had in Belk I, that a “floating” easement is not eligible for a deduction under § 170(h), and § 170(h)(2)(C) requires that taxpayers donate an interest in an “identifiable, specific piece of real property.”
This holding is consistent with the legislative history of § 170(h), in which Congress indicated its desire to limit the deduction to “the preservation of unique or otherwise significant land areas” (see Senate Report No. 96-1007, Sept. 30, 1980). It also is consistent with the elaborate threshold conservation purposes and other requirements of § 170(h) and the Treasury Regulations. For example, it would make little sense to require that the donee be given baseline documentation establishing the condition of the specific property encumbered by the easement at the time of the donation only to have the parties remove that property from the easement in exchange for the addition of some other property (which may or may not have similar characteristics and for which there is no requirement of a baseline). Similarly, it would make little sense to require that the taxpayer obtain a subordination agreement from a lender holding an outstanding mortgage on the specific property encumbered by the easement at the time of the donation only to have the parties remove that property from the easement in exchange for the addition of some other property (which may or may not itself be subject to a mortgage and for which there is no requirement of subordination).
The Tax Court in Belk II also noted, citing Treasury Regulation § 1.170A-14(c)(2), that the regulations permit substitutions under limited circumstances, and the easement at issue did not limit substitutions to those circumstances. Treasury Regulation § 1.170A-14(c)(2) provides that, to be eligible for a deduction, the instrument of conveyance must prohibit the donee from transferring the easement except to another eligible donee that agrees to continue to enforce the easement. A limited exception to this rule is provided, however, for extinguishments (i.e., transfers) that appear to have to meet the requirements of Treasury Regulation § 1.170A-14(g)(6)(i) and (ii) (the extinguishment and proceeds regulations), which, among other things, require the payment of proceeds to the holder to be used "in a manner consistent with the conservation purposes of the original contribution." In other words, the regulations appear to permit “substitutions” under the limited circumstances described in the extinguishment and proceeds regulations. (Note: although Treasury Regulation § 1.170A-14(c)(2) cross-references to -14(g)(5)(ii), the proper cross-reference is to -14(g)(6)(ii); the Treasury failed to update the cross-references when it finalized the proposed regulations in 1986.)
Limited Amendment Clause Did Not Nullify Substitution Provision
The taxpayers next argued that the conservation easement did not permit substitutions despite the detailed provisions in the deed expressly authorizing substitutions. They pointed to the amendment provision included in the deed, which provides that the holder cannot agree to amendments that would result in the easement failing to qualify for a deduction under § 170(h). The Tax Court again dismissed this argument, finding, as it had in Belk I, that the amendment and substitution provisions were in conflict, and the parties’ intent to permit substitutions controlled. The court also rejected the taxpayers’ argument that, because they intended to make a deductible contribution under § 170(h), the easement deed should be interpreted not to permit substitutions. The court explained that “matters of taxation must be determined in light of what was actually done rather than the declared purpose of the participants.”
Not an Impossible or Impractical Requirement
The taxpayers’ final argument was that the court imposed an impossible and impractical requirement on donors and donees because the parties purportedly could change the property subject to the easement under state law and, thus, should not be penalized for including substitution provision in the easement deed. The IRS disagreed, stating that the taxpayers’ interpretation of state law “as giving parties unfettered ability to modify contracts is nonsensical and would make all conservation easements meaningless.” The court held against the taxpayer, noting that “we do not consider whether the parties could have substituted property by mutual agreement without a substitution provision but simply look to the fact that the conservation easement agreement contained such a provision.” Because the easement contained a substitution provision, the court found that the taxpayers “did not agree to restrict their use of the golf course in perpetuity.”
The taxpayers in Belk II also argued, citing to Comm’r v. Simmons, 646 F.3d 6 (D.C. Cir., June 21, 2011), aff’g Simmons v. Comm’r, T.C. Memo. 2009-208 (Sept. 15, 2009), that the Tax Court in Belk I failed to consider “that an element of trust and confidence is placed in a qualified organization that it will continue to carry out its mission to protect and conserve property.” The Tax Court responded that, while the taxpayers were correct that courts trust qualified organizations to fulfill their responsibilities, that trust is based on the requirements imposed on the qualified organization by the conservation easement and local law. The court pointed out that, in Simmons, although the conservation easement deed contained a clause granting the holder the right to consent to changes or abandon its rights under the easement, the Court of Appeals found that both the easement deed and local historic preservation laws prevented the donee from consenting to any changes that were inconsistent with the conservation purposes of the easement. Moreover, if the donee dissolved (thereby abandoning the easement), the easement would be transferred to the District of Columbia to be reassigned to similar organization. Accordingly, “the conservation purpose was protected at all times.” The same was not true in Belk, where the easement granted the parties the right to agree to substitutions and, thus, “there is no restriction on the golf course in perpetuity that we can trust [the holder] to enforce.”
Although not at issue in Belk, charities and government entities that solicit and accept charitable gifts to be used for specific purposes are obligated under state law to administer those gifts consistent with their terms and purposes, and the state attorney general can generally call a holder to account for failing to do so. In Carpenter v. Commissioner, T.C. Memo 2012-1 the Tax Court held, in part, that the tax-deductible conservation easements at issue in that case were restricted charitable gifts, or “contributions conditioned on the use of the gift in accordance with the donor’s precise directions and limitations.” Accordingly, the holder of a tax-deductible perpetual conservation easement, whether a government entity or nonprofit, should be required under state law to administer the easement consistent with its terms and charitable conservation purpose, including the terms included in the deed to satisfy federal tax law requirements.
Finally, the holding in Simmons regarding the grant to the holder of the right to consent to changes to two façade easements should be confined to its facts because it was based, in part, on (i) a regulation applicable only to historic preservation easements (see Treasury Regulation § 1.170A-14(d)(5)(i)), (ii) the presence of “appropriate” federal, state, and local historic preservation laws, and (iii) the provisions of the deeds at issue, which (consistent with the regulation) specifically required that any work done on the properties had to comply with applicable federal, state, and local historic preservation laws, whether the holder consented or not. As the Tax Court in Simmons explained, although the easements grant the holder the right to consent to changes, they also require that any rehabilitative work or new construction on the facades comply with the requirements of all applicable federal, state, and local government laws and regulations, and Treasury Regulation § 1.170A-14(d)(5)(i) specifically allows a donation to satisfy the conservation purposes test even if future development is allowed, as long as that development is subject to appropriate local, state, and federal laws and regulations. The D.C. Circuit in Simmons similarly explained, in part, that “any change in the façade to which [the holder] might consent would have to comply with all applicable laws and regulations, including the District's historic preservation laws” and, thus, “the donated easements will prevent in perpetuity any changes to the properties inconsistent with conservation purposes.” The backstop of “appropriate local, state, or Federal standards” for development is generally not present in the context of conservation easements encumbering land donated for outdoor recreation or education, open space, or habitat protection conservation purposes because such easements typically do not merely duplicate or supplement federal, state, or local zoning or other laws. Moreover, the regulations interpreting the outdoor recreation or education, open space, and habitat conservation purposes do not similarly provide that a deduction will be allowed provided the terms of the easement require that future development conform with appropriate local, state, or federal standards.