Thursday, July 11, 2013

Pesky v. U.S. – Deduction for Conservation Easement Donation Not Fraudulent

Pesky copyUnderstanding the District Court’s rulings in Pesky v. United States, No. Civ. 1:10-186 WBS (July 8, 2013) (Pesky II), requires a bit of background.

On or around September 29, 1993, the Peskys and The Nature Conservancy (TNC) entered into a series of agreements relating to a certain parcel of property located in Ketchum, Idaho (the Ketchum Property), which was adjacent to property TNC owned (the Hemingway Property).

Pursuant to the Assignment Agreement, the Peskys paid $50,000 to TNC and agreed to limit the height of structures on the Ketchum Property to twenty-five feet and TNC (i) assigned an option to purchase the Ketchum Property for $1.6 million to the Peskys, (ii) agreed to grant the Peskys an easement over the Hemingway Property to provide access to the Ketchum Property, and (iii) agreed to support the Peskys’ application for driveway approval with the City of Ketchum and the County in which the properties were located.

Pursuant to the Pledge Agreement, the Peskys agreed to pay $400,000 to TNC for a new office building and convey to TNC at a later date all rights to develop or improve the Ketchum Property except for one single-family residence. The parties also agreed that the Pledge Agreement would be kept confidential.

The Peskys exercised the option and purchased the Ketchum Property for $1.6 million on the same day, September 29, 1993. A few months later, the Peskys marketed the property for a price between $6.5 and $9.5 million. They also requested the local planning commission's approval of the driveway over the Hemingway Property and TNC allegedly supported this request.

More than eight years later, around March 7, 2002, the Peskys granted TNC a conservation easement limiting development on the Ketchum Property to one single-family residence and a guest house. Five days later, the Peskys sold the Ketchum Property for approximately $6.9 million.

The Peskys claimed charitable income tax deductions for the $3 million appraised value of the conservation easement on their 2002, 2003 and 2004 tax returns. The IRS issued a notice of deficiency and the Pesky’s paid the assessments and brought suit in District Court seeking recovery of the assessments.

Fraud Penalty

In Pesky v. United States, 2013 WL 97752 (D. Idaho, Jan. 7, 2013) (Pesky I), the District Court held that the government adequately pled a counterclaim for a civil fraud penalty under IRC § 6663 based on the Peskys’ allegedly fraudulently claimed charitable deduction for the conveyance of the easement. The court did not determine that the Peskys were liable for the fraud penalty; it decided only that the case could proceed on the merits.

In Pesky II, in an opinion authored by the same Judge who wrote the Pesky I opinion, the District Court addressed the fraud issue on its merits. The court explained that “fraud is intentional wrongdoing on the part of the taxpayer with the specific intent to avoid a tax known to be owing,” and that the government must prove fraud by clear and convincing evidence.

The government rested its fraud counterclaim on Mr. Pesky’s alleged role in failing to disclose or provide a copy of the Pledge Agreement to the IRS and City of Ketchum officials. The District Court found, however, that the primary actors regarding nondisclosure of the Pledge Agreement to the IRS were Mr. Pesky’s attorneys and those attorneys “had good faith reasons for their decisions, separate from any intent to conceal the Pledge Agreement from the IRS.” The court found similarly with regard to the decision to limit disclosure of the agreement to the City of Ketchum. Accordingly, even assuming Mr. Pesky had agreed with his attorneys’ decision regarding nondisclosure of the Pledge Agreement, the court could not conclude that a reasonable jury could find it “highly likely” that Mr. Pesky’s deduction was due to fraud. Because the government did not produce sufficient evidence to meet its heightened burden of showing fraud by clear and convincing evidence, the court granted Mr. Pesky’s motion for summary judgment on the fraud penalty issue.

Other Issues

In Pesky II the government also moved for summary judgment on a number of issues relating to whether Peskys are entitled to a deduction for the conveyance of the conservation easement.

Quid Pro Quo

The government first contended that the easement conveyance was part of a larger quid pro quo transaction between the Peskys and TNC and that the parties attempted to mask the nature of the transaction by (i) breaking it into multiple documents, (ii) keeping the Pledge Agreement secret, and (iii) recording the easement long after TNC had conferred the benefits of the Assignment Agreement on the Peskys.

The District Court found that, while the government had produced evidence that the conservation easement was part of a quid pro quo transaction, that evidence was not so convincing as to compel summary judgment in its favor. The court explained that, “[l]ooking to the external features of how the transaction was structured, there is a genuine issue of material fact as to whether the Peskys provided the Conservation Easement ‘without the receipt or expectation of receipt of adequate consideration.’” In other words, the court found that there was a genuine issue of material fact as to whether the Assignment Agreement and Pledge Agreement were separate transactions or one integrated transaction. Accordingly, the court denied both parties’ motions for summary judgment on this issue.

Contemporaneous Written Acknowledgement

The government next argued that Mr. Pesky failed to disclose the goods and services TNC had provided in consideration for the conservation easement in a contemporaneous written acknowledgment as required by IRC § 170(f)(8)(B)(ii). TNC had sent the Peskys a contemporaneous written acknowledgment in connection with the conservation easement conveyance stating that TNC “provided no goods or services in exchange for [the] gift.” The government did not object to the form or timing of this letter. Rather, the government’s “claim appear[ed] to rely on the court finding that a good or service was received in consideration for the Conservation Easement.”

Because the court determined that a genuine issue of material fact exists as to whether TNC provided any goods or services in exchange for the Conservation Easement (i.e., as to whether the Pledge Agreement was separate from the Assignment Agreement), the court denied the government’s motion for summary judgment on this issue.

Qualified Appraisal

The government also argued that the conservation easement was not appraised in accordance with the requirements of Treasury Regulation § 1.170A-13(c)(3)(ii) and, thus, the deductions should be disallowed. The court noted, however, that pursuant to IRC § 170(f)(11)(A)(ii)(II), a deduction will not be denied for failure to meet the regulatory requirements if it is shown that such failure "is due to reasonable cause and not to willful neglect.” The court determined that “whether the Peskys are excused from the requirements regarding submission of a qualified appraisal due to reasonable cause is a genuine issue of material fact.” Accordingly, the government’s motion for summary judgment on this ground was also denied.

While the issue of fraud was decided in Mr. Pesky’s favor, the other issues addressed in Pesky II may be decided on their merits in future litigation.


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