Friday, June 7, 2013
In a June 3, 2013, memorandum opinion, Mountanos v. Commissioner, T.C. Memo. 2013-138, the Tax Court sustained the IRS’s disallowance of a $4.6 million deduction claimed for the 2005 donation of a conservation easement encumbering 882 acres of undeveloped land in Lake County, California. The land is almost completely surrounded by federal land and, at the time of the donation, was accessible only through neighboring properties (the Bureau of Land Management had granted the taxpayer limited access to the property for single-family use) and was subject to a Williamson Act contract under California law that limited the land’s use and development. In addition, a permit was required to divert water for private use from the creek flowing through the property.
The IRS disputed the value of the conservation easement and the court found that the taxpayer failed to show that the easement reduced the value of the land.
The Tax Court agreed with the taxpayer’s valuation experts that the highest and best use (HBU) of the land after the easement donation was for recreation. However, the Tax Court found that the taxpayer failed to show that the HBU of the land before the donation was, in part, a vineyard and, in part, either a 22-lot residential development or a subdivision for unspecified uses.
With regard to use as a vineyard, the taxpayer failed to show that there was the necessary legal access or water supply, that there was demand for vineyard-suitable property in the county, or that vineyard use was economically feasible.
With regard to use as a residential development or a subdivision (i) the taxpayer’s valuation experts failed to take into account the restrictions imposed by the Williamson Act, (ii) neither the taxpayer nor the IRS provided the court with the Williamson Act contract relating to the land or a description of the contract’s terms, and (iii) the taxpayer failed to provide any evidence that the Williamson contract was scheduled to terminate for non-renewal or that it could be cancelled. Accordingly, the court looked to the purpose of the Williamson Act, which is to preserve agricultural and open space land and discourage premature urban development, and the general terms of Williamson Act contracts, which limit land to agricultural and compatible uses for ten or more years and automatically renew each year absent notice of non-renewal. The court found that the taxpayer, who had the burden of proof, failed to establish that vineyard use, residential development, or unspecified subdivision were permitted or probable uses of the land at the time of the easement’s donation. Thus, the taxpayer failed to prove that the HBU of the land before and after the easement donation differed, and it followed that the taxpayer failed to show that the easement reduced the value of the land. The court also found that the taxpayer was liable for a gross valuation misstatement penalty.
It is not uncommon for property to be subject to temporary development and use restrictions under state law provisions similar to the Williamson Act at the time of the donation of a conservation easement (numerous states have similar temporary agricultural land protection programs). In situations where property is subject to such temporary restrictions, the estimate of the “before” value of the property for purposes of valuing the easement should take into account the remaining tenure of the restrictions and any penalties or other conditions imposed on termination of the restrictions. The best evidence of such before value would be the sales price of land subject to similar temporary restrictions. In some cases, the before value of the property, even considering the temporary restrictions, may exceed the after value, and the donor would be entitled to a deduction for the difference. In Mountanos, the taxpayer failed to provide any evidence of the Williamson contract terms, the remaining tenure of the restrictions, or the conditions or limitations imposed on termination of those restrictions. Moreover, even if such evidence had been provided, the limited acess and water supply issues may have prohibited or limited vineyard use, a 22-lot residential development, or subdivision in any event.