Friday, August 30, 2013
Mitchell v. Commissioner Revisited – 170(h) Requires Perpetuation of Conservation Easement Itself, Not Just Conservation Purposes
In Mitchell v. Commissioner, T.C. Memo. 2013-204 (Mitchell II), the Tax Court denied the taxpayer’s motion for reconsideration and supplemented its opinion in Mitchell v. Commissioner, 138 T.C. No 16 (2012) (Mitchell I). In Mitchell I, the court sustained the IRS's disallowance of a charitable income tax deduction claimed with regard to a conservation easement donation because the taxpayer failed to satisfy the mortgage subordination requirement of Treasury Regulation § 1.170A-14(g)(2).
To be eligible for a deduction under IRC § 170(h) for the donation of a conservation easement, the easement must, among other things, be “granted in perpetuity” and its conservation purpose must be “protected in perpetuity.” IRC § 170(h)(2)(C), (h)(5)(A).
To satisfy the "protected in perpetuity" requirement:
(1) the easement must be granted to an “eligible donee” as defined in Treasury Regulation § 1.170A-14(c)(1) (i.e., a qualified organization that has “a commitment to protect the conservation purposes of the donation” and “the resources to enforce the restrictions”),
(2) the easement must prohibit the donee from transferring the easement, whether or not for consideration, except for transfers to other eligible donees that agree to continue to carry out the conservation purposes of the easement as provided in Treasury Regulation § 1.170A-14(c)(2),
(3) the easement must not permit “inconsistent uses” as specified in Treasury Regulation § 1.170A-14(e) (i.e., uses that would injure or destroy significant conservation interests), and
(4) the various “enforceable in perpetuity” requirements of Treasury Regulation § 1.170A-14(g) must be satisfied, namely
- the general enforceable in perpetuity requirement ((g)(1)),
- the mortgage subordination requirement ((g)(2)),
- the mining restrictions requirement ((g)(4)),
- the baseline documentation requirement ((g)(5)(i)),
- the donee notice, access, and enforcement rights requirements (g)(5)(ii)), and
- the extinguishment and division of proceeds requirements ((g)(6)(i) and (ii)).
See Treas. Reg. § 1.170A-14(e)(1); S. Rep. No. 96-1007, 1980-2 C.B. 599 (explaining the protected in perpetuity requirement). Each of these requirements plays an important role in ensuring that the conservation purpose of a tax-deductible easement will be "protected in perpetuity" as Congress intended.
Treasury Regulation § 1.170A1-4(g)(2) – the mortgage subordination requirement – provides that, in the case of a contribution made after February 13, 1986, of an interest in property that is subject to a mortgage, no deduction is permitted unless the lender subordinates its rights in the property “to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.” In Mitchell I, a partnership of which the taxpayer was a partner donated a conservation easement but did not obtain a subordination agreement from the lender holding an outstanding mortgage on the subject property until two years after the date of the gift. The Tax Court sustained the IRS's disallowance of the taxpayer's claimed deduction for the donation, finding that "the regulation requires that a subordination agreement be in place at the time of the gift.” The court explained that, had the partnership defaulted on the mortgage before the date of the subordination, the lender could have instituted foreclosure proceedings and eliminated the conservation easement. Accordingly, the conservation easement was not protected in perpetuity at the time of the gift as is required by IRC § 170(h).
In Mitchell I the taxpayer argued that the conservation purpose of the easement had been protected in perpetuity at the time of the gift even without a subordination agreement because the probability that the partnership would have defaulted on the mortgage was so remote as to be negligible. The Tax Court rejected that argument, holding that a taxpayer cannot avoid meeting the strict requirement of the subordination regulation by making a showing that the possibility of foreclosure is so remote as to be negligible. The court explained that “[t]he requirements of the subordination regulation are strict requirements that may not be avoided by use of the so-remote-as-to-be-negligible standard” of Treasury Regulation § 1.170A-14(g)(3).
In Mitchell II, the taxpayer argued that the First Circuit’s decision in Kaufman v. Commissioner, 687 F.3d 21 (1st Cir. 2012) (Kaufman III), was an intervening change in the law that required the Tax Court to reconsider its opinion in Mitchell I. The Tax Court disagreed, explaining that not only is Kaufman III not binding in Mitchell, Kaufman III addressed legal issues different from the one present in Mitchell. Kaufman III, explained the court, "addressed the proper interpretation of the proceeds regulation and, in particular, the breadth of the donee organization’s entitlement to proceeds from the sale, exchange, or involuntary conversion of property following the judicial extinguishment of a [conservation easement].” Mitchell, on the other hand, addressed interpretation of the mortgage subordination regulation.
The Tax Court also rejected all three of the taxpayer’s specific arguments in Mitchell II.
- The taxpayer argued that the partnership's financial ability to discharge the mortgage at any time before the date on which the lender agreed to the subordination “was the functional equivalent of a subordination.” The Tax Court summarily dismissed that argument, explaining “There is no functional subordination contemplated in [Treasury Regulation § 1.170A-14(g)(2)], nor do we intend to create such a rule.”
- The taxpayer argued that the Tax Court had held in Carpenter v. Commissioner, T.C. Memo 2012-1, that Treasury Regulation 1.170A-14(g)(6) "merely creates a safe harbor,” and given the opinions in Kaufman III and Commissioner v. Simmons, 646 F.3d 6 (D.C. Cir., June 21, 2011), “the entire regulation could and should be read as a safe harbor.” The Tax Court explained that it had rejected a similar argument in Carpenter v. Commissioner, T.C. Memo. 2013-172 (Carpenter II), and reiterated that the specific provisions of Treasury Regulation § 1.170A-14(g), including paragraph (g)(6) and (g)(2) "are mandatory and may not be ignored." For a discussion of Carpenter II, see Carpenter v. Commissioner Revisited: Federally-Deductible Conservation Easements Must be Extinguishable Only in a Judicial Proceeding.
- The taxpayer further argued that the court should "draw a general rule" with respect to the in-perpetuity requirement of IRC § 170(h)(5)(A) and Treasury Regulation § 1.170A-14(g) from the analysis in Kaufman III. In particular, the taxpayer argued that “The regulation emphasizes perpetuating an easement’s purpose as opposed to the conservation easement itself. The proceeds are protected which is the goal of the law.” The Tax Court rejected that argument, stating “Nowhere in Kaufman III did the Court of Appeals for the First Circuit state a general rule that protecting the proceeds from an extinguishment of a conservation easement would satisfy the in-perpetuity requirements of section § 1.170A-14(g) ... generally.”
The Tax Court has distinguished the holdings in Kaufman III and Simmons in three cases, Belk v. Commissioner, T.C. Memo. 2013-154, Carpenter II, and Mitchell. This was appropriate. Among other things, Kaufman III and Simmons did not address the specific statutory or regulatory requirements at issue in Belk, Carpenter, or Mitchell, and the holdings in Kaufman III and Simmons were based on the specifics facts of those facade easement donation cases. For a discussion of this latter point, see Belk v. Commissioner - Tax Court Reaffirms its Holding that “Floating” Conservation Easements Are Not Deductible