Tuesday, October 15, 2019
A taxpayer that is engaged in a trade or business can recover the cost of a business asset through depreciation. In other words, an asset is not depreciable unless it is used in the taxpayer’s trade or business or used for the production of income. In essence, the depreciation deduction is to account for the wear-and-tear of the asset as it is used in the business or to produce income for the taxpayer. But, the asset must have a determinable useful life of more than one year. Land, for example, is not depreciable because it does not have a determinable useful life.
But, there are other business and/or income-producing assets that are not eligible for depreciation. For example, natural resources such as sand and gravel deposits, as well as deposits for oil and gas are not depreciated. But don’t these assets wear out? They do and can be eligible for a depletion allowance. The deductible allowance for depletion is computed differently than is the deduction for depreciation. One method of computing it is called “cost depletion.”
The cost depletion method of computing deductions associated with oil, gas and other minerals – it’s the topic of today’s post.
Depletion is the descriptive term for the using of a natural resource by mining, drilling, quarrying or the like. A depletion allowance allows the owner of the resource to recover the cost of the reduction of reserves of the resource as production and sales occur. To be a resource “owner” entitled to a claim depletion, the taxpayer must have an “economic interest” in the natural resource as an owner, and the legal right to the income from the extraction of the minerals. In addition, a depletion deduction is only allowed when there is production and sale activity from the minerals which provides income to the taxpayer for the tax year.
As noted, a taxpayer is entitled to recover the taxpayer’s cost basis in natural resources over the life of the resources. The cost depletion method of computing that cost recovery is tied to the quantity of the resource sold each year. There are unique rules that can apply when determining cost depletion on production payments, advance royalties, bonuses. In addition, sometimes the computational rules are different depending upon the particular natural resource involved. These unique aspects are beyond the scope of today’s post.
Via cost depletion, the taxpayer recovers the taxpayer’s capital investment (i.e., tax basis) in the minerals while the minerals produce income. Thus, with respect to oil and gas, for example, the cost basis of the property must be allocated between the land and the associated capital assets that were acquired with the land purchase – fences; tile lines; buildings; equipment; and the mineral deposit. The use of the cost depletion method is dependent upon having made these allocations.
Under the cost depletion approach, the taxpayer annually deducts a portion of the taxpayer’s capital investment, less prior deductions, that equal the fraction of the estimated remaining recoverable reserves that have been produced and sold during that particular year. Over the life of the deposit, the total cumulative amount recovered under the cost depletion method cannot exceed the taxpayer’s capital investment.
The IRS does not provide a form for computing the cost depletion deduction. However, a formula is utilized to make the computation. Under the formula, the deposit’s adjusted basis is divided by the units of the mineral deposit that remain as of the end of the tax year (i.e., total recoverable units). The result of that is known as the “depletion unit” or a rate per unit. That amount is then multiplied by the units of mineral that were sold within the tax year based on the taxpayer’s accounting method. The taxpayer bears the burden of establishing basis, remaining units and the units sold during the year. Treas. Reg.§1.612-1(b)(1)(i).
With respect to oil and gas, cost depletion is computed with respect to each oil and gas property by reference to the total number of recoverable units that the property is estimated to contain, and the number of units sold from the property during the tax year. Treas. Reg. §1.611-2(a). An account is to be maintained for each property and annually adjusted for units sold and for depletion claimed. Treas. Reg. §1.611-2(a). The total recoverable units is the sum of the number of units that remain at year end plus the number of units of minerals sold during the tax year. The landowner must determine the recoverable units of minerals via industry custom, and can utilize (by election) an IRS safe harbor. See Rev. Proc. 2004-19, 2004-10 IRB 563.
Consider the following example:
Jed buys a tract of land that contains a mineral deposit of sand and gravel. Jed paid $500,000 for the tract, and his accountant allocated $125,000 to the land and $375,000 to the minerals. Jed hired other experts to measure the amount of the marketable minerals via a geological survey and they determined that the deposit contained $100,000 tons of marketable minerals. During the year, 5,000 tons of minerals were mined and sold. Jed’s cost depletion deduction would be computed as follows: $375,000/$100,000 x 5,000 = $18,750.
In the second year (Year 2), another 5,000 tons of the sand and gravel are mined and sold. In Year 2, the property's basis has been reduced to $356,250 by the depletion allowed in the first year. Also, the units remaining as of the tax year have been reduced to 95,000 by the units sold in the first year. The cost depletion deduction in Year 2 would be $18,747.37 ($356,200/95,000 x 5,000).
The Importance of Basis
Clearly, properly computing income tax basis is critical to determining the proper depletion deduction. The basis number only applies to the mineral property. Thus, it doesn’t include non-mineral real estate or non-mineral assets that aren’t used for producing minerals. It also doesn’t include the residual value of land and improvements when operations end. Treas. Reg.§1.612-1(b)(1)(ii). But, it does include capitalized drilling and development costs recoverable through depletion. Treas. Reg.§1.612-1(b)(1).
Adjustments to basis will occur over time and include (as applied to oil and gas) oil and gas drilling and development costs that were capitalized. But, not included in any basis adjustment are any mineral exploration and development expenses that are treated as deferred expenses and any basis of depreciable property that is leased together with depletable mineral property. Treas. Reg. §1.612-1(b)(1).
Deductions for cost depletion stop once the sum of the depletion deductions equals the cost or other basis of the property plus allowable capital additions. Treas. Reg. §1.611-2(b)(2).
Recordkeeping is essential. The basis of the depletable property is to be recorded in a separate account, along with any capital additions and adjustments. Treas. Reg. §1.611-2(b)(1). If that’s not done, the cost depletion deduction may be lost for the tax year and/or upon later disposition of the property. See, e.g., Winifrede Land Company, 12 T.C.M. (CCH) 289 (1953).
Last year, I devoted a post to the issue of depletion of minerals. https://lawprofessors.typepad.com/agriculturallaw/2018/07/the-depletion-deduction-for-oil-and-gas-operations.html. Today’s post took a bit of a closer look at one aspect of depletion – cost depletion. The depletion deduction can be complicated, but when big dollars are involved, getting it right matters.
Wednesday, October 9, 2019
Agricultural law issues in the courts are many. On a daily basis, cases involving farmers, ranchers, rural landowners and agribusinesses are decided. Periodically, on this blog I examine a few of the recent court decisions that are of particular importance and interest. Today’s post is one such post.
Proving water drainage damage; migrating gas and the rule of capture; and suing for Clean Water Act (CWA) – these are the topics of today’s post.
The Case of the Wayward Water
In Kellen v. Pottebaum, 928 N.W.2d 874 (Iowa Ct. App. 2019), the defendant installed a drain pipe that discharged water from the defendant’s land to the plaintiffs’ land. The plaintiff sued alleging that the pipe caused an unnatural flow of water which damaged the plaintiff’s farmland and sought damages and removal of the pipe. The defendant counterclaimed arguing that the plaintiff’s prior acts and/or inaction regarding the flow of the water caused damage to the defendant’s property. The trial court determined that neither party had established their claims and dismissed each claim with prejudice.
The appellate court affirmed. As for the sufficiency of the evidence, the appellate court noted that the defendant owned the dominant estate and the plaintiff owned the servient estate. As such, if the plaintiff could prove that the installation of the pipe considerably increased the volume of water flowing onto the plaintiff’s land or substantially changed the drainage and actual damage resulted, the plaintiff would be entitled to relief. However, most of the evidence presented to the court was the observations of lay witnesses rather than measured water flow. Accordingly, the appellate court agreed with the trial court that the plaintiff did not prove by a preponderance of the evidence that installation of the pipe caused the increased water flow. The appellate court noted that a “reasonable fact finder” could attribute the additional water on the plaintiffs’ property to the increased rain fall during the years at issue. The appellate court also determined that the plaintiffs did not prove by preponderance of the evidence that installation of the pipe substantially changed the drainage. The water did not flow in a different direction on the plaintiff’s property. Rather, the defendant altered the flow of water across his property in a natural direction towards the plaintiff’s drainage, which is permissible under state (IA) law. Thus, the plaintiff did not prove harm by a preponderance of the evidence. The appellate court also concluded that the trial court did not abuse its discretion excluding some of the plaintiff’s evidence.
Ownership of Migrated Gas
In Northern Natural Gas Co. v. ONEOK Field Servs. Co., LLC, No. 118,239, 2019 Kan. LEXIS 324 (Kan. Sup. Ct. Sept. 6, 2019), the plaintiff operated an underground gas storage facility, which was certified by the proper state and federal commissions. The defendants were producers with wells located two to six miles from the edge of the plaintiff’s certified storage area. Stored gas migrated to the defendants’ wells and the defendants captured and sold the gas as their own. The plaintiff sued for lost gas sales and the defendants moved for summary judgment on the grounds that the Kansas common law rule of capture allowed the gas extraction. The trial court granted the defendants’ motion. Two years later, the plaintiff received certification to expand the storage area into the areas with the defendants’ wells. Another dispute arose as to whether the defendants could capture the gas after the plaintiff’s storage area was expanded. The trial court held that the defendants could under the common law rule of capture.
On review, the Kansas Supreme Court reversed and remanded on the basis that the rule of capture did not apply. That rule, the Court noted, allows someone that is acting within their legal rights to capture oil and gas that has migrated from the owner’s property to use the migrated oil and gas for their own purposes. The rule reflects the application of new technology such as injection wells and applies to non-native gas injected into common pools for storage. However, the Court reasoned, the rule does not apply when a party (such as the plaintiff) is authorized to store gas and the storage is identifiable. The Court determined that state statutory law did not override this recognized exception to the application of the rule of capture. The Court remanded the case for a computation of damages for the lost gas.
Jurisdiction Over CWA §404 Permit Violations – Who Can Sue?
A recent case involving a California farmer has raised some eyebrows. In the case, the trial court allowed the U.S. Department of Justice (DOJ) to sue the farmer for an alleged CWA dredge and bill permit violation without a specific recommendation from the Environmental Protection Agency (EPA). The farmer was alleged to have discharged “pollutants” into a “waters of the United States” (WOTUS) as a result of tractor tillage activities on his farmland containing or near to wetlands contiguous to a creek that flowed into a WOTUS. Staff of the U.S. Army Corps of Engineers (COE) saw the tilled ground and investigated. The COE staff then conferred with the EPA and then referred the matter to the U.S. Department of Justice (DOJ). The DOJ sued (during the Obama Administration) for enforcement of a CWA §404 permit “by the authority of the Attorney General, and at the request of the Secretary of the Army acting through the United States Corps of Engineers.” The DOJ alleged that the equipment "constituted a 'point source'" pollutant under the CWA and "resulted in the placement of dredged spoil, biological materials, rock, sand, cellar dirt or other earthen material constituting “pollutants” (within the meaning of 33 U.S.C. § 1362(6) into waters of the United States. The DOJ alleged that the defendant impacted water plants, changed the river bottom and/or replaced Waters of the United States with dry land, and "resulted in the 'discharge of any pollutant' within the meaning of 33 U.S.C. § 1311(a)."
The defendant moved for summary judgment on the basis that the CWA authorizes only the EPA Administrator to file a CWA §404 enforcement action and that the court, therefore, lacked jurisdiction. The court disagreed with the defendant on the basis that 28 U.S.C. §1345 conferred jurisdiction. That statute states, “Except as otherwise provided by Act of Congress, the district courts shall have original jurisdiction of all civil actions, suits or proceedings commenced by the United States or by any agency or officer thereof expressly authorized to sue by Act of Congress. The court rejected the defendant’s claim that 33 U.S.C. §1319(b) and 33 U.S.C. §1344(s)(3) authorized only the EPA to sue for violations of the CWA, thereby limiting the jurisdiction conferred by 28 U.S.C. §1345. Those provisions provide that the EPA Secretary is the party vested with the authority to sue for alleged CWA violations. The court determined that there is a “strong presumption” against implied repeal of federal statutes, especially those granting jurisdiction to federal courts. In addition, the court determined that the defendant failed to show that the general grant of jurisdiction was irreconcilable with either of the statutes the defendant cited. Accordingly, the court determined that the defendant could be sued by the U.S. Department of Justice upon the mere recommendation of the COE and without a specific recommendation from the EPA alleging a CWA violation, and in a situation where the CWA did not determine any CWA jurisdiction and only the COE did. This finding was despite a 1979 Attorney General opinion No. 197 determining that the EPA and not the COE has the ultimate authority to construe what is a navigable WOTUS.
Ultimately, the parties negotiated a settlement. The settlement included $1,750,000 civil penalty. The land which the farmer’s acts occurred will be converted to a conservation reserve and a permanent easement will run with the land to bar any future disturbance. The settlement also specified that the farmer would spend $3,550,000 "to purchase vernal pool establishment, re-establishment, or rehabilitation credits from one or more COE-approved mitigation banks that serve the [applicable] area . . . .". The settlement also included other enforcement stipulations, including fines and the civil penalty for noncompliance. No comments on the settlement were received during the public comment period, after which the settlement was submitted to the court for approval. The court approved the settlement ad consent decree on the basis that it was fair, reasonable, properly negotiated and consistent with governing law. The court also determined that the settlement satisfied the goals of the CWA in that it permanently protected the Conservation Reserve (which contained between 75 and 139 acres of WOTUS); fixed damage caused by unauthorized discharges; applied a long-term pre-clearance injunction; required off-site compensatory mitigation and recouped a significant civil penalty. The case is United States v. Lapant, No. 2:16-CV-01498-KJM-DB, 2019 U.S. Dist. LEXIS 75309 (E.D. Cal. May 3, 2019). United States v. Lapant, No. 2:16-CV-01498-KJM-DB, 2019 U.S. Dist. LEXIS 93590 (E.D. Cal. Jun. 3, 2019).
The three cases summarized today further illustrate the various legal battles that involve farmers, ranchers and rural landowners. They also illustrate the need to legal counsel that is well-versed in agricultural issues. That’s what we are all about in the Rural Law Program at Washburn Law School – providing high-level training in agricultural legal and tax issues and then getting new graduates placed in rural areas to represent farmers and ranchers.
Wednesday, August 28, 2019
One of the most difficult concepts for law students, and practicing lawyers for that matter, is the Rule Against Perpetuities (RAP). The rule bars a person from using a deed or a will (or other legal instrument) to control the ownership of property well beyond their death – known as “control by the dead hand.” It’s an ancient rule of property law that is intended to enhance the marketability of property by limiting the ability to tie-up the ownership of property for too long of a time period. Wedel v. American Elec. Power Service Corp., 681 N.E.2d 1122 (Ind. Ct. App. 1997). The RAP is, essentially, grounded in public policy. See, e.g., Symphony Space, Inc. v. Pergola Properties, Inc., 88 N.Y.2d 466, 669 N.E.2d 799 (N.Y. 1996).
The RAP often comes into play in estate planning situations with respect to wills and trusts, particularly in large estates where the desire is to keep land in the family for many generations into the future. But, it can also be involved when real estate is transferred and oil production is present or might be in the future. But the Rule has been applied to oil, gas, and mineral leases, too. If some future interest in a mineral deed is granted, the RAP requires the interest to vest (the point in time when a person becomes legally entitled to what has been promised) within 21 years of the lifetimes of those living at the time of the grant. If it is possible for the vesting to happen beyond that 21 years, then the Rule voids the contingent future interest.
Indeed, in 2018, the Texas Supreme Court modified the application of the rule in the context of oil and gas, and recently the Kansas Supreme Court refused to apply the RAP to a defeasible term mineral interest (an interest that is capable of being terminated/voided) – a very common form of mineral ownership.
The implications of not applying the RAP to oil and gas interests - that’s the topic of today’s post.
The RAP originated In the late 17th century in England. In the Duke of Norfolk’s Case, 3 Ch. Cas. 1, 22 Eng. Rep. 931 (Ch. 1682), Henry, the 22nd Earl of Arundel, created an estate plan that sought to pass a portion of his property to his oldest son (who was mentally disabled) and then to his second son. Other property would pass to his second son, and then to his fourth son. Henry’s estate plan also contained provisions for shifting property many generations later if certain conditions should occur. When Henry’s second son succeeded to his older brother’s property, he didn’t want the property to pass to his younger brother. The younger brother sued to enforce his interest as created by Henry’s estate plan. The House of Lords held that the shifting condition that the estate plan created could not have an indefinite existence. The Court was of the view that tying up the ability to transfer property for too long of a time period beyond the lives of the persons that were alive at the time of the initial transfer was impermissible. Just how long was too long was not determined until 1833 in Cadell v. Palmer, 1 Cl. & Fin. 372, 6 Eng. Rep. 936 (H.L. 1832, 1833) where the court set the time limit at lives in being plus 21 years.
A similar property law concept to the RAP is the rule barring unreasonably restraints on alienation. Both concepts are based on the common law’s general distaste of restrictions on the ability to transfer property. See, e,g, Cole v. Peters, 3 S.W.3d 846 (Mo. Ct. App. 1999). But, the concepts are not identical – it is possible for an unreasonable restraint on alienation to occur without triggering the RAP.
2018 Texas Case
In Conoco Phillips Co. v. Koopmann, 547 S.W.3d 858 (Tex. Sup. Ct. 2018), the Texas Supreme Court held that the RAP did not void a 15-year non-participating royalty interest that was reserved in a deed. Accordingly, the Court changed the application of the RAP such that, at least in Texas, it will not void an oil, gas and mineral deed if, regardless of the grant or reservation (it no longer makes a difference whether the interest is created by grant or reservation), the holder of the future remainder interest is at all times ascertainable and the preceding estate was/is certain to terminate. Thus, according to the Texas Supreme Court the RAP will not apply if the future contingent interest is transferable and/or inheritable; the holder of the future interest is known or knowable at all time; and the previous estate is certain to end at some point.
Recent Kansas Case
As noted above, a recent Kansas Supreme Court decision, Jason Oil Company v. Littler, No. 118,387, 2019 Kan. LEXIS 204 (Kan. Sup. Ct. Aug. 16, 2019), involved the application of the RAP to a defeasible term mineral interest. The Court refused to apply the rule.
A defeasible term mineral interest is a durational estate that involves a mineral, royalty or nonexecutive mineral interest for a fixed term of years and for an indefinite period of time thereafter, usually so long as oil or gas is produced. That’s what was it issue in Jason Oil.
In late 1967, a grantor executed two deeds conveying tracts of real estate in the same section of the county. The east half of the section was conveyed to one grantee and the a quarter of the section was conveyed to another grantee. Both deeds stated, “"EXCEPT AND SUBJECT TO: Grantor saves and excepts all oil, gas and other minerals in and under or that may be produced from said land for a period of 20 years or as long thereafter as oil and/or gas and/or other minerals may be produced therefrom and thereunder." The grantor died a few years later and the local probate court distributed set percentages of the residue of the grantor’s estate, including the reserved mineral interest, to the grantor’s descendants.
The 20-year term expired on December 30, 1987. From that time until May 31, 2017, there was no drilling activity on either tract and no gas or mineral production. In 2016, the plaintiff sued to quiet title to both tracts. The plaintiff claimed that it held valid and subsisting oil and gas leases. One set of the grantor’s heirs claimed that they owned an interest in the minerals via the grantor’s will – the grantor owned a fee simple determinable in the mineral rights and that, as a result, they were devised an interest in the minerals. However, another set of the grantor’s heirs claimed that those mineral interests were subject to an invalidated by the RAP because they were “springing executory interests.”
Note: A springing executory interest is an interest in an estate in land created by the conditions of a grant wherein the grantor cuts short the grantor's own interest in the property in favor of the grantee, contingent upon the occurrence of a specific condition. It’s an executory (future) interest that follows an interest that the grantor held upon the happening of a stated event.
If the RAP applied to invalidate their interests, those heirs claimed that their interests should be reformed under the Uniform Statutory RAP contained in Kan. Stat. Ann. §59-3405(b) to conform to the parties’ intent and avoid violating the RAP. The other set of heirs continued to maintain that the RAP invalidated the other heirs’ interest and that the Uniform Statutory RAP was void for violating the Kansas Constitution. As a result, they claimed that they owned the minerals by virtue of the residuary clause of the grantor’s will.
The trial court held that a defeasible term mineral interest is a future estate reserved to the grantor and a reversion. As a reversion remaining to the grantor, the court concluded, it wasn’t subject to the RAP. In addition, the trial court determined that the grantor’s reserved right had not alienated the surface and mineral estates of the tracts.
The Supreme Court agreed with the trial court that the decedent reserved a defeasible term interest. However, the Supreme Court opined that the trial court “…veered off course” by finding (1) the future estate kept by the decedent in the mineral estate was a reversion and (2) the reservation of the defeasible mineral interest was a reversion and not subject to the RAP. However, the Supreme Court declined to apply the RAP concluding that the application of the RAP would be counterproductive to the purpose behind the RAP and create “chaos.” The Supreme Court held that when a grantor (the decedent in this case) creates a defeasible term (plus production) mineral interest by exception that leaves a future interest in an ascertainable person, the future interest in the minerals is not subject to the RAP. In sum, the Supreme Court held that the RAP did not apply because the interest vested during a lifetime, however it reverted back to the surface estate because of the lack of production.
Defeasible term mineral interests are prevalent with oil and gas properties. If the RAP were to apply to these interests, the RAP would invalidate the grantee’s interest. That would often be contrary to the parties’ intent. In fact, had the Kansas court applied the RAP, the future right to the on-half mineral interest upon termination would be void and the landowner (and heirs) would own it forever. Clearly, the parties in Jason Oil did not intend that result. Thus, the Court’s refusal to apply the RAP advanced the underlying public policy of protecting the transferability of interests in land.
The Kansas Supreme Court’s opinion is significant. When application of the RAP would fail to promote transferability of interests in land, it should not be applied. In addition, when a a particular form of property interest (such as a defeasible term mineral interest) has a long history of usage within a particular industry, it is not a good idea to have the RAP apply. In that situation, it would have the serious potential of disrupting titles and impairing commerce in property rights. These points are true even though the Kansas Supreme Court said it was creating a “narrow exception” to the RAP for defeasible term mineral interests. That means the public policy implications of the Court’s decision could apply in future cases.
Thursday, July 11, 2019
My post last fall on what constitutes real estate for purposes of a like-kind exchange under I.R.C. §1031 generated a great deal of interest among readers, lots of good questions and lengthy discussion. https://lawprofessors.typepad.com/agriculturallaw/2018/10/what-is-like-kind-real-estate.html In light of that, it’s worth expanding the topic a bit to address some rather interesting scenarios that can arise in the context of like-kind exchanges.
That’s the topic of today’s post – a deeper dive on like-kind exchanges.
I.R.C. §1031 provides for tax deferred treatment of real property that is exchanged for real property of “like-kind.” Personal property trades were eligible for tax-deferred treatment before 2018, but now the provision only applies to real estate trades. Thus, real estate that is used in the taxpayer’s trade or business or held for investment can be “traded” for any other real estate that the taxpayer will hold for use in the taxpayer’s trade or business or for investment. It’s a broad standard. For example, eligible real estate can be rental properties; farmland; office buildings; retail real estate properties; storage units; bare land held for investment; golf courses; conservation easements; partial interests in property; water rights (in some states (as pointed out in the prior post); and even vacation homes (if certain requirements are satisfied). In addition, the rules don’t require real property trades to be by type. Any type of real estate can be traded with any other type. Treas. Reg. §1.1031(a)-1(b). What matters is the reason the taxpayer held the relinquished property and the replacement property.
What About Property That Doesn’t Produce Income?
A permissible reason for trading real estate is to hold the replacement property on the hopes that it will appreciate in value. Thus, real estate that is held for appreciation purposes without producing income can be traded for other real estate. The replacement real estate can also be held for value-appreciation purposes. Basically, this is a favorable tax rules for those that speculate on a tract of real estate appreciating in value. It also means, for example, that a farmer can defer tax on a trade of farmland that the farmer uses in the farming operation for farmland that is not farmed but used for hunting or fishing purposes, etc. The farmer is deemed to hold the replacement property for investment purposes. But, whenever real estate is traded for real estate that will be held for investment purposes, depending on the real estate market, the replacement property should be held long enough to sufficiently illustrate the investment purpose of holding the replacement property. There is no bright line to determined how long is long enough.
But, there is a distinction to note with respect to property held for investment purposes. I.R.C. §1031 treatment does not apply to real estate that is held for resale or as inventory. This is a rule that is of particular importance to land developers and building contractors. That’s because the real estate that such parties hold constitute inventory. The same result occurs for a taxpayer that acquires an apartment complex with the intent at the time of the acquisition of selling the complex to current occupants as condominiums. The IRS views such deals as a “resale” transaction.
The line between property that is held for investment purposes and property that is held for resale can be rather fine. For example, what about a taxpayer that buys homes, renovates them and then as soon as the home has been renovated (i.e., updated) list the homes for sale at a profit? You may have seen the television shows featuring parties that do this. Rather than being sold, can these homes qualify for I.R.C. §1031 treatment? It’s not likely. In these situations, the IRS has a legitimate claim that the homes were acquired and “held” for the intent and purpose of selling them (resale) and not for investment purposes. To qualify for I.R.C. §1031 treatment at some point in the future, the homes would need to be rented out for a period of time (the longer the better) or be clearly held for appreciation.
Mixed-Use Real Estate
Quite often, the question arises as to how to handle a like-kind exchange of farmland when a personal residence is involved. Indeed, I had this question come up at a tax seminar in Missouri earlier this week. It’s a great question. Many exchanges of farmland involve more than just bare farmland. Buildings, structures, and the farm residence may also be involved in the transaction. As for the personal residence, I.R.C. §121 allows the exclusion of gain of up to $500,000 on a joint return ($250,000 on a single return) if the taxpayer owned the home and used it as the taxpayer’s principal residence for at least two of the immediately previous five years. If the residence gain can qualify for the I.R.C. §121 exclusion, the residence portion of the real estate should be parceled out from the other real estate that will qualify for a like-kind exchange? Keeping in mind that an exclusion from income is better from a tax standpoint than is income tax deferral, as much real estate as possible should be included with the residence. But, how much? The maximum benefit is obtained if enough real estate along with the residence can be combined to “max-out” the $500,000 exclusion. Certainly, land that is adjacent to the residence that is functionally used along with and as part of the residence counts as the “residence” for purposes of the I.R.C. §121 exclusion. The caselaw is all over the board on this issue. It’s a very fact-specific issue with the question being how much land can reasonably be claimed to be used along with the residence. For additional guidance on the matter see Rev. Proc. 2005-14, 2005-1 C.B. 528.
From a transactional and practice standpoint, the documents supporting the exchange (known as the “exchange agreement”) should detail only the real estate that qualifies for tax deferral under I.R.C. §1031. To this end, it may be helpful to include in the documentation a map of the property that distinguishes the property that will be treated as the personal residence for purposes of I.R.C. §121 from the I.R.C. §1031 property with the exchange agreement only listing the I.R.C. §1031 property. A closing statement can then be utilized for the I.R.C. §121 property, and then a separate statement can be used for the I.R.C. §1031 property. Indeed, separate closing statements can be used in any transaction involving mixed-use properties – not just when a principal residence is involved. This is of particular importance post-2017 because personal property involved in a trade of real-property no longer qualifies for I.R.C. §1031 treatment.
Also, the IRS position is that property that is used for both business and personal purposes cannot be treated as two separate properties for purposes of the holding requirement – that the property be held for the productive use in a trade or business or for investment. See, e.g., C.C.A. 201605017 (Jan. 29, 2016).
Do Vacation Homes Qualify?
The upfront answer is, “no” – a vacation home doesn’t qualify for I.R.C. §1031 treatment. It’s not qualifying property unless it is held for the right reason – as trade or business property or for investment purposes. So, while a vacation home wouldn’t normally meet the test, it may be possible to convert the home to a qualified use to eventually allow it to qualify as part of an I.R.C. §1031 exchange. That can be accomplished by the taxpayer renting the vacation home out and either limiting or eliminating personal use. For example, in a case involving the exchange of two vacation houses, Moore, et ux. v. Comr., T.C. Memo. 2007-134, the Tax Court determined that the vacation homes at issue failed to qualify for I.R.C. §1031 treatment because the taxpayer failed to prove that they were held for primarily for investment. Instead, the evidence revealed that the taxpayer basically used the home as a second residence and for personal vacation retreats for family. The Tax Court also pointed out that the taxpayer did not rent or attempt to rent the properties; didn’t offer the replacement property for sale until forced to do so by liquidity needs; spent a great deal of time fixing up the property; kept a boat at the lake for personal use; didn’t claim any deductions for depreciation or maintenance expenses; claimed home mortgage interest deductions; and failed to maintain the relinquished property during the last two years of ownership (i.e., failed to protect the taxpayer’s investment in the property).
But, Moore doesn’t stand for the proposition that a vacation home cannot qualify as part of an I.R.C. §1031 transaction. Under an I.R.S. safe harbor (that was issued after Moore was decided), if the relinquished and/or the replacement property is owned for two years either immediately before or after the exchange; the taxpayer rents out the property at fair market value for 14 days or more during the tax year; and the taxpayer’s personal use of the property does not exceed the greater of 14 days or 10 percent of the number of days during the 12-month period during which the property is rented at fair market rental, the safe harbor applies. See, Rev. Proc. 2008-16, 2008-1 C.B. 547. In addition, the safe harbor is just that – a safe harbor. A transaction involving a vacation home can still qualify under I.R.C. §1031 without being in the safe harbor, but it could be subject to IRS challenge.
Like-kind exchanges are tricky. While the rules presently in place only allow deferred tax treatment on real estate trades, the appropriate reason for holding the properties exchanged must be satisfied. In addition, mixed use properties can present special problems. Again, it’s best to seek out competent counsel. And, one thing I didn’t address, is that often a “qualified intermediary” (Q.I.) must be involved in the exchange to make sure that deferred tax treatment is preserved. One such Q.I. is a firm in Iowa operated by a colleague of mine (and his wife) that were in law school with me. They do a fine job. Let me know if you need assistance on trades and I can point you in the right direction.
Tuesday, July 9, 2019
Agriculture and the law intersect in many ways. Of course, tax and estate/business planning issues predominate for many farmers and ranchers. But, there are many other issues that arise from time-to-time. Outside of tax, leases and fences are issues that seem to come up repeatedly. Other issues are cyclical. Bankruptcy is one of those issues that has increased in importance in recent months. Of course, legal issues associated with the administration of federal farm programs is big too. In addition, legal issues associated with market structure and competition in various sectors of agriculture are of primary importance particularly in the poultry and cattle sectors.
Periodically, I step away from the technical article aspect of this blog and do a survey of some recent ag-related developments in the courts. That’s what today’s post is about – it’s “ag in the courtroom” day today – at least with respect to a couple of recent cases.
Abandoned Rail Lines
One matter that is a big one in ag for those farms and ranches impacted by it involves the legal issues associated with abandoned rail lines. It’s often a contentious matter, and it doesn’t help that the Congress changed the rules several decades ago to, in the view of many impacted adjacent landowners, diminish private property rights.
Recently, another abandoned rail line case was decided. This time the decision was rendered by the Kansas Court of Appeals. In Central Kansas Conservancy, Inc., v. Sides, No.119,605, 2019 Kan. App. LEXIS 29 (Kan. Ct. App. May 17, 2019), the Union Pacific Railroad acquired a right-of-way over a railroad corridor that it abandoned in the mid-1990s. At issue in the case was a 12.6-mile length of the abandoned line between McPherson and Lindsborg, Kansas. A Notice of Interim Trail Use (NITU) was issued in the fall of 1995. The corridor was converted into a trail use easement under the National Trails System Act. In 1997, Union Pacific gave the plaintiff a "Donative Quitclaim Deed" to the railroad’s easement rights over the corridor, with one-quarter mile of it running through the defendant’s property at a width of 66 feet. Pursuant to a separate agreement, the plaintiff agreed to quit claim deed its rights back to the railroad if the railroad needed to operate the line in the future. By virtue of the easement, the plaintiff intended to develop the corridor into a public trail.
In 2013, the plaintiff contacted the defendant about developing the trail through the defendant’s land. The defendant had placed machinery and equipment and fencing in and across the corridor which they refused to remove. In 2015, the plaintiff sued to quiet title to the .75-mile corridor strip and sought an injunction concerning the trail use easement over the defendant’s property. The defendant admitted to blocking the railway with fencing and equipment, but claimed the right to do so via adverse possession or by means of a prescriptive easement. The defendant had farmed, grazed cattle on, and hunted the corridor at issue since the mid-1990s. The defendant also claimed that the plaintiff had lost its rights to the trail because it had failed to complete development of the trail within two years as the Kansas Recreational Trail Act (KRTA) required.
In late 2016, the trial court determined that the two-year development provision was inapplicable because the Interstate Commerce Commission had approved NITU negotiations before the KRTA became effective in 1996. The trial court also rejected the defendant’s adverse possession/prescriptive easement arguments because trail use easements are easements for public use against which adverse possession or easement by prescription does not apply.
During the summer of 2017 the plaintiff attempted work on the trail. When volunteers arrived, the defendant had placed equipment and a mobile home on the corridor preventing any work. The plaintiff sought a "permanent prohibitory injunction and permanent mandatory injunction." The defendant argued that he had not violated the prior court order because "[a]ll the Court ha[d] done [was] issue non-final rulings on partial motions for summary judgments, which [were], by their nature, subject to revision until they [were] made final decisions." Ultimately, the trial court granted the plaintiff’s request for an injunction, determined that the defendant had violated the prior summary judgment order, but also held that the plaintiff had not built or maintained fencing in accordance with state law.
On appeal, the appellate court partially affirmed, partially reversed, and remanded the case. The appellate court determined that the defendant did not obtain rights over the abandoned line via adverse possession or prescriptive easement because such claims cannot be made against land that is held for public use such as a recreational trail created in accordance with the federal rails-to-trails legislation. The appellate court also determined that the plaintiff didn’t lose rights to develop the trail for failing to comply with the two-year timeframe for development under the KRTA. The appellate court held that the KRTA two-year provision was inapplicable because a NITU was issued before the effective date of the KRTA. However, the appellate court determined that the plaintiff did not follow state law concerning its duty to maintain fences. The appellate court held that Kan. Stat. Ann. §58-3212(a) requires the plaintiff to maintain any existing fencing along the corridor and maintain any fence later installed on the corridor. In addition, any fence that is installed on the corridor must match the fencing maintained on the sides of adjacent property. If there is no fencing on adjacent sides of a landowner’s tract that abuts the corridor, the plaintiff and landowner will split the cost of the corridor fence equally. The appellate court remanded the case for a determination of the type and extent of fencing on the defendant’s property, and that the plaintiff has the right to enter the defendant’s property to build a fence along the corridor. Any fence along the corridor is to be located where an existing fence is located. If no existing fence exists along the corridor, the corridor fence is to be located where the plaintiff’s trail easement is separated from the defendant’s property. The appellate court remanded to the trial court for a reconsideration of its ruling on fence issues.
Feasibility of Chapter 12 Plan
As I mentioned at the beginning of the post, bankruptcy is one of those ag legal issues that has increased in relevancy in recent months. In certain parts of the country Chapter 12 (farm) bankruptcy has been on the rise. Once a farmer qualifies for Chapter 12 (not always an easy task), the reorganization plan was be proposed in good faith and be feasible. Those issues were at stake in a recent case from Iowa.
In In re Fuelling, No. 18-00644, 2019 Bankr. LEXIS 1379 (Bankr. N.D. Iowa May 1, 2019), the debtor was a farmer that granted the bank a first priority lien on all farm assets other than a truck and cash proceeds to the 2017 crop. To pay for the 2017 inputs, the debtor secured financing though another creditor (not the bank). The creditor obtained a subordination agreement from the bank, giving the creditor a $151,000 first priority lien in the 2017 crop sale proceeds. However, the proceeds from the 2017 crop were not enough to repay the creditor or continue making payments to the bank. The debtor filed Chapter 12 bankruptcy in May of 2018. The debtor sold the 2017 crops and various equipment to repay secured creditors. The creditor’s remaining claim was $107,506.45, $66,625.37 of which is secured by the remaining 2017 crop sale proceeds that the debtor still held.
The parties agreed that the bank's secured claim was $214,093.86 for purposes of plan confirmation. The creditors filed a motion for relief that would allow them to collect the remainder of the 2017 crop proceeds. The debtor filed a motion to use cash collateral to start a cattle feeding operation and grant the creditor a lien in the cattle and feed. The debtor also proposed to use rental payments from the grain bins on the property to make interest payments to the creditor and the bank for five years. The entire principal of the loans would come due as a balloon payment at the end of the plan period.
The bank, the Chapter 12 Trustee, the Iowa Department of Revenue, and the creditor objected to the debtor’s plan. The bankruptcy court denied the debtor’s proposed plan and motion to use cash collateral. The creditors’ motion for relief of stay was granted due to the court finding that the debtor’s plan was not feasible. The court denied the plan for multiple reasons. First the plan improperly substituted the creditor’s lien in the crop with a lien in cattle. Second the plan impermissibly utilized rental payments covered by the bank lien for payments towards the other creditors. The court also determined that the debtor’s proposed interest rate was not correct. The court agreed with the bank and the creditor that the plan was not feasible based on the information in the record. The debtor’s health issues, overly optimistic rental rates for the grain bins, and the balloon payment all factored in the court’s decision of lack of feasibility, even though the plan was submitted in good faith. Since the debtor’s plan to feed cattle was impermissible and not feasible, the court did not need any additional analysis to deny the debtor’s motion to use cash collateral. The debtor claimed that the remaining proceeds were necessary for reorganization, but the court concluded that the debtor’s proposed use of the proceeds impermissibly substituted the creditors. In the end, the court simply could not find a permissible way for the funds to be utilized in reorganization.
These are just two recent cases involving ag legal issues. There are many more. This all points out the need for well-trained lawyers in the legal issues that face farmers and ranchers.
Wednesday, June 5, 2019
Centuries ago, the seas were viewed as the common property of everyone - they weren’t subject to private use and ownership. This concept was later adopted in English law, the Magna Carta, and became part of the common (non-statutory) law in the United States. Over the years, the doctrine has been primarily applied to access to the seashore and intertidal waters, but it can also be applied with respect to natural resources. A recent case involving seaweed involved the application of the public trust doctrine.
The public trust doctrine and the right to harvest seaweed – that’s the topic of today’s post.
The U.S. Supreme Court’s first application of the public trust doctrine was in 1842 in Martin v. Lessee of Waddell, 41 U.S.367 (1842). In the case, the issue was who had the right to submerged land and oyster harvesting off the coast of New Jersey. The Court, largely based on the language in the charter granted by the King to a Duke to establish a colony and for policy and economic reasons, determined that the land area in issue belonged to the state of New Jersey for the benefit of the people of the state. The Court dealt with the issue again in 1892 in a case involving a railroad that had been granted a large amount of the Chicago harbor. Illinois Central Railroad Company v. Illinois, 146 U.S. 387 (1892). The Court determined that the government cannot alienate (interfere with) the public’s right to access land under waters that are navigable in fact except for situations where the land involved wouldn’t interfere with the public’s ability to access the water or impair navigation.
As generally applied in the United States (although there are differences among the states), an oceanfront property owner can exclude the public below the mean high tide (water) line. See e.g., Gunderson v. State, 90 N.E. 3d 1171 (Ind. 2018). That’s the line of intersection of the land with the water's surface at the maximum height reached by a rising tide (e.g., high water mark). Basically, it’s the debris line or the line where you would find fine shells. However, traceable to the mid-1600s, Massachusetts and Maine recognize private property rights to the mean low tide line even though they do allow the public to have access to the shore between the low and high tide lines for "fishing, fowling and navigation. In addition, in Maine, the public can cross private shoreline property for scuba diving purposes. McGarvey v. Whittredge, 28 A.3d 620 (Me. 2011).
Other applications of the public trust doctrine involve the preservation of oil resources, fish stocks and crustacean beds. Also, many lakes and navigable streams are maintained via the public trust doctrine for purposes of drinking water and recreation.
The public trust doctrine was invoked recently in a Maine case. In Ross v. Acadian Seaplants, Ltd., 2019 ME 45 (2019), the defendants harvest rockweed with skiffs in the intertidal zones of Maine. Rockweed is a perennial plant that attaches to the rocks in the intertidal zones. Rockweed regulates the temperature of the area where it is located and is home to many organisms. Commercially, rockweed is used for fertilizer and feed. To harvest Rockweed, the defendant uses skiffs, rakes, and watercraft without physically stepping foot on the intertidal zone. The defendant annually harvests the statutory maximum 17 percent of eligible harvestable rockweed biomass in Cobscook Bay. The plaintiff, an intertidal landowner, sued seeking (1) a declaratory judgment that the plaintiff is the exclusive owner of the rockweed growing on and affixed to his intertidal property; and (2) injunctive relief that would prohibit the defendant from harvesting rockweed from the plaintiff’s intertidal land without his permission. The defendant sought a judgment declaring that harvesting rockweed from the intertidal water is a public right as a form of "fishing" and "navigation" within the meaning of the Colonial Ordinance. The trial court granted summary judgment for the plaintiff on the declaratory judgment claim, and on the defendants’ counterclaim. The trial court denied the defendant’s counterclaim.
On appeal, the state Supreme Court affirmed, holding that rockweed that is attached to and growing on rocks in the intertidal zone is private property owned by the adjacent landowner. The Court noted that the English common law tradition vested both “title” to and “dominion” over the intertidal zone in the crown. While title belonged to the crown, however, it was held subject to the public’s rights of “navigation,” “commerce,” and “fishing.” After the American colonies gained independence, the ownership of intertidal land devolved to the particular state where the intertidal area was located. See, e.g., Phillips Petroleum Co. v. Mississippi, 484 U.S. 469 (1988). But, the Court noted the uniqueness of rockweed. It takes specialized equipment and skills to harvest it, and harvesting didn’t “look like” the usual activities in the water of fishing and navigation. Instead, it was more like the other uses in the intertidal zone that have been held to be outside the public trust doctrine. Thus, the Court concluded that the harvesting of rockweed was not within the collection of rights held by the State for use by its citizens – the public couldn’t engage in rockweed harvest as a matter of right. The Court stated that, "rockweed in the intertidal zone belongs to the upland property owner and therefore is not public property, is not held in trust by the State for public use, and cannot be harvested by members of the public as a matter of right."
The application of the public trust doctrine has the potential to be quite broad. Environmental activists and others opposed to various agricultural activities often attempt to get courts to apply the doctrine in an expansive manner well beyond public access to that of preservation in general. The potential application of the doctrine can be rather expansive – nonpoint source pollution from farm field runoff; wetlands; dry sand areas; cattle ranching in areas of the West, etc. See, e.g., Mathews v. Bay Head Improvement Association, 471 A.2d 355 (N.J. 1984). The issue is acute in California where a private party can bring an independent action against a state agency under the public trust doctrine when that agency allegedly doesn’t follow the public trust in the conduct of its duties. See Citizens for Biological Diversity, Inc. v. FPL Group, Inc., 83 Cal. Rptr. 3d 588 (Cal Ct. App. 2008); San Francisco Baykeeper, Inc. v. State Lands Commission, 29 Cal. App. 5th 562, 240 Cal. Rptr. 3d 510 (2018).
In the recent Maine case, the public trust doctrine was not used to unnecessarily erode private property rights. The Court balanced the public’s rights against those of private property owners. It wasn’t enough for the plaintiff to simply assert the public trust doctrine.
Maybe there’s hope that the public trust doctrine will be properly balanced against the rights of private landowners. The recent Maine case weighs in on that side of the scale.
Monday, May 20, 2019
For farmers and ranchers (and other rural landowners) owning agricultural land adjacent to railroads, the abandonment of an active rail line presents a number of real property issues. What is the legal effect of the abandonment? Does state or federal law apply? What about fencing? These (and others) are all important questions when a railroad abandons a line.
Abandoned rail lines and legal issues – that’s the topic of today’s post.
Legal Effect of Abandonment
During the nineteenth century, many railroad companies acquired easements from adjoining landowners to operate rail lines. In some instances, railroads acquired a fee simple interest in rights-of-way and in those situations, can sell or otherwise dispose of the property. In most situations, however, a railroad was granted an easement for railroad purposes, usually acquired from adjacent property owners. The general rule is that a right-of-way for a railroad is classified as a limited fee with a right of reverter if received from Congress on or before 1871, but is classified as an exclusive use easement if the right of way is received after 1871.
If the railroad held an easement, the abandonment of the line automatically terminates the railroad's easement interest, and the interest generally reverts to the owners of the adjacent land owning the fee simple interest from which the easement was granted. See, e.g., Penn. Central Corp. v. United States Railroad Vest Corp., 955 F.2d 1158 (7th Cir. 1992).
After abandonment, state law controls the property interests involved. Once abandonment occurs, federal law does not control the property law questions involved. The only exception is if the United States retained a right of reverter in the abandoned railway. Under the Abandoned Railroad Right of Way Act (43 U.S.C. § 912), land given by the United States for use as a railroad right-of-way in which the United States retained a right of reverter had to be turned into a public highway within one year of the railroad company’s abandonment or be given to adjacent landowners. Later, the Congress enacted the National Trails System Improvement Act of 1988 under which those lands not converted to public highways within one year of abandonment would revert back to the United States, not adjacent private landowners.
What About Recreational Trails?
In 1976, the Congress passed the Railroad Revitalization and Regulatory Reform Act in an effort to promote the conversion of abandoned lines to trails. Under the Act, the Secretary of Transportation is authorized to prepare a report on alternate uses for abandoned right-of-ways. The Secretary of the Interior can offer financial, educational and technical assistance to local, state and federal agencies. In addition, the Interstate Commerce Commission (ICC) was authorized to delay disposition of railroad property for up to 180 days after an order of abandonment, unless the property was first offered for sale on reasonable terms for public purposes including recreational use. The National Trails System Act amendments of 1983 authorized the ICC to preserve for possible future railroad use, rights-of-way not currently in service and to allow interim use of land by a qualified organization as recreational trails. Effective January 1, 1996, the Congress replaced the ICC with the Surface Transportation Board (STB), and gave the STB authority to address rail abandonment and trail conversion issues. The organizations operating the corridors as trails assume all legal and financial responsibility for the corridors. This is known as railbanking.
Under the 1983 amendments, a railroad must follow a certain procedure if it desires to abandon a line. A potential trail operator must agree to manage the trail, take legal responsibility for the trail and pay any taxes on the trail. The STB engages in a three-stage process for railroad abandonment. First, a railroad must file an application with the STB and notify certain persons of its planned abandonment. The application must state whether the right-of-way is suitable for recreational use. In addition, the application must notify government agencies and must be posted in train stations and newspapers giving the public a right to comment. Second,the STB then determines whether “present or future public convenience and necessity” permit the railroad to abandon. A trail organization then must submit a map and agreement to assume financial responsibility and the STB will then determine whether the railroad intends to negotiate a trail agreement. Third, if such a determination is made, the STB will issue a “certificate of interim trail use” or a certificate of abandonment. The parties have 180 days to reach this agreement. If no agreement is reached, the line is abandoned. Abandonment of a railroad right-of-way cannot occur without the prior authorization of the STB. See, e.g., Phillips Company v. Southern Pacific Rail Corp., 902 F. Supp. 1310 (D. Colo. 1995). But, once abandonment occurs, the STB no longer has any jurisdiction over the issue. See, e.g., Preseault v. Interstate Commerce Commission, 494 U.S. 1 (1990).
Before passage of the 1983 amendments, it was clear that when a railroad ceased line operation and abandoned the railway, the easement interest of the railroad in the line reverted to the adjacent landowners of the fee simple. See, e.g., Consolidated Rail Corp. Inc. v. Lewellen, 682 N.E.2d 779 (Ind. 1997). However, as noted, the 1983 amendments established a more detailed process for railroad abandonment and gave trail organizations the ability to operate an abandoned line. While most railroads hold a right-of-way to operate their lines by easement specifying that the easement reverts to the landowner upon abandonment, after passage of the 1983 amendments, a significant question is when, if ever, abandonment occurs. One court has held that the public use condition on abandonment does not prevent the abandonment from being consummated, at which time STB jurisdiction ends, federal law no longer pre-empts state law, and state property law may cause the extinguishment of the railroad's rights and interests. See, e.g., Fritsch v. Interstate Commerce Commission, 59 F.3d 248 (D.C. Cir. 1995), cert. denied sub. nom. CSX Transportation v. Fritsch, 516 U.S. 1171 (1996).
A more fundamental issue is whether a preclusion of reversion to the owner of the adjacent fee simple is an unconstitutional taking of private property. I will analyze the constitutional takings issue is a subsequent post. Suffice it to say, however, in 1990 the U.S. Supreme Court upheld the 1983 amendments as constitutional. Preseault v. Interstate Commerce Commission, 494 U.S. 1 (1990). But see Swisher v. United States, 176 F. Supp.2d 1100 (D. Kan. 2001).
Numerous issues (including issues associated with fencing) involving the abandonment of a rail line were front and center in a recent court decision from Kansas. In, Central Kansas Conservancy, Inc., v. Sides, No.119,605, 2019 Kan. App. LEXIS 29 (Kan. Ct. App. May 17, 2019), the Union Pacific Railroad acquired a right-of-way over a railroad corridor that it abandoned in the mid-1990s. At issue in the case was a 12.6-mile length of the abandoned line between the towns of McPherson and Lindsborg in central Kansas. A Notice of Interim Trail Use (NITU) was issued in the fall of 1995. The corridor was converted into a trail use easement under the National Trails System Act.
In 1997, Union Pacific gave the plaintiff a "Donative Quitclaim Deed" to the railroad’s easement rights over the corridor, with three-quarters of a mile of it running through the defendant’s property at a width of 66 feet. Pursuant to a separate agreement, the plaintiff agreed to quitclaim deed its rights back to the railroad if the railroad needed to operate the line in the future. By virtue of the easement, the plaintiff intended to develop the corridor into a public trail. In 2013, the plaintiff contacted the defendant about developing the trail through the defendant’s land. The defendant had placed machinery and equipment and fencing in and across the corridor which they refused to remove.
In 2015, the plaintiff sued to quiet title to the .75-mile corridor strip and sought an injunction concerning the trail use easement over the defendant’s property. The defendant admitted to blocking the railway with fencing and equipment, but claimed the right to do so via adverse possession or by means of a prescriptive easement. The defendant had farmed, grazed cattle on, and hunted the corridor at issue since the mid-1990s. The defendant also claimed that the plaintiff had lost its rights to the trail because it had failed to complete development of the trail within two years as the Kansas Recreational Trail Act (KRTA) required.
In late 2016, the trial court determined that the two-year development provision was inapplicable because the ICC had approved NITU negotiations before the KRTA became effective in 1996. The trial court also rejected the defendant’s adverse possession/prescriptive easement arguments because trail use easements are easements for public use against which adverse possession or easement by prescription does not apply. During the summer of 2017 the plaintiff attempted to work on the trail. When volunteers arrived, the defendant had placed equipment and a mobile home on the corridor preventing any work. The plaintiff sought a "permanent prohibitory injunction and permanent mandatory injunction." The defendant argued that he had not violated the prior court order because "[a]ll the Court ha[d] done [was] issue non-final rulings on partial motions for summary judgments, which [were], by their nature, subject to revision until they [were] made final decisions." Ultimately, the trial court granted the plaintiff’s request for an injunction, and determined that the defendant had violated the prior summary judgment order. The trial court also held that the plaintiff had not built or maintained fencing in accordance with state law.
On appeal, the appellate court partially affirmed, partially reversed, and remanded the case. The appellate court determined that the defendant did not obtain rights over the abandoned line via adverse possession or prescriptive easement because those claims cannot be made against land that is held for public use such as a recreational trail created in accordance with the federal rails-to-trails legislation. The appellate court also determined that the plaintiff didn’t lose rights to develop the trail for failing to comply with the two-year timeframe for development under the KRTA. The appellate court held that the KRTA two-year provision was inapplicable because a NITU was issued before the effective date of the KRTA.
However, the appellate court determined that the plaintiff did not follow state law concerning its duty to maintain fences. The appellate court held that Kan. Stat. Ann. §58-3212(a) requires the plaintiff to maintain any existing fencing along the corridor and maintain any fence later installed on the corridor. In addition, any fence that is installed on the corridor must match the fencing maintained on the sides of adjacent property. If there is no fencing on adjacent sides of a landowner’s tract that abuts the corridor, the plaintiff and landowner are to split the cost of the corridor fence equally. The appellate court remanded the case for a determination of the type and extent of fencing on the defendant’s property, and that the plaintiff has the right to enter the defendant’s property to build a fence along the corridor. Any fence along the corridor is to be located where an existing fence is located. If no existing fence exists along the corridor, the corridor fence is to be located where the plaintiff’s trail easement is separated from the defendant’s property. The appellate court remanded to the trial court for a reconsideration of its ruling on fence issues.
Abandoned rail lines create numerous legal issues for adjacent landowners, including a mix of federal and state law. In addition, fencing issues get involved and those may be handled not under the general fence laws of the particular state, but in accordance with fencing provisions specific to the conversion of abandoned rail lines to trails. In any event, for those that believe they have been negatively impacted by a rail line abandonment, seeking good legal counsel is a must to protect whatever landowner rights remain.
Monday, February 11, 2019
The Founders understood that governments can often be the biggest obstacle to individual, inalienable rights – those rights that cannot be revoked by some outside (governmental) force. While a representative form of government can be the best protector of individual rights, it can become the “tyranny of the majority” as noted by John Adams and Alexis De Tocqueville.
The matter of inalienable rights is important to farmers and ranchers. Land ownership and the rights associated with land ownership is of primary importance to agricultural businesses and families. One of those rights involves the right to hunt (and fish) the property that an individual owns.
That’s the topic of today’s post – an individual’s rights to hunt (and fish) their own property.
State Regulation of Hunting Rights
All states have an elaborate set of statutes and regulations governing the hunting of wildlife in that particular state. The rules govern hunting on state-owned public land as well as privately owned land. In addition, the hunting rules vary depending on the type of game – big game; small game; fur-bearing or fowl. The state rules also depend on whether the hunter is a resident of the particular state or a nonresident. The rules tend to be less restrictive for residents, particularly those in certain age ranges, than they are for nonresidents. The fees for licenses and/or permits are also much lower for residents than nonresidents, with typical exceptions for full-time students and service members.
As for non-resident landowners, the state rules vary from state-to-state. Kansas, for example, requires a nonresident “hunt-on-your-own-land” deer permit. That permit is available to either a resident or nonresident who actively farms a tract of 80-acres or more in the state. The property must be owned in fee simple. The name on the deed must be denoted in a particular manner.
The Iowa approach is different. Hunting rights in Iowa don’t follow ownership. A nonresident landowner has no inalienable right to hunt their own property – property for which they pay taxes to the state of Iowa. The portion of the Iowa hunting laws defining “resident” and “owner” were the subject of a recent case.
Iowa hunting law allows a resident landowner to obtain annually up to two deer hunting licenses - one antlered or any sex deer hunting license and one antlerless deer free of charge. Iowa Code §483A. A resident landowner may also buy two antlerless deer hunting licenses. “Owner” is defined as the owner of a farm unit who is a resident of Iowa. Iowa Code §483A.24(2)(a)(3). A “resident” is defined as including a person with a principle or primary residence or domicile in Iowa, a full-time student, a non-resident under age 18 who has a parent that is an Iowa resident or a member of the military that claims Iowa residency either by filing Iowa taxes or being stationed in Iowa. Iowa Code §483A.1A(10). Nonresident landowners must apply for antlered licensing. The state allots 6,000 antlered or any sex deer hunting licenses to nonresidents via a lottery system for a fee. If a nonresident landowner does not receive an antlered license through the lottery system, "the landowner shall be given preference for one of the antlerless deer only nonresident deer hunting licenses."
The plaintiff owned 650 acres in southcentral Iowa, but was not domiciled in Iowa. Over the prior six-year period, the plaintiff received nonresident antlered deer hunting licenses through the lottery four times. The other two years the plaintiff obtained a nonresident antlerless deer hunting license. The plaintiff has been able to hunt every year on his property, but as a nonresident landowner and by paying the higher fees associated with being a “nonresident.”
In 2016, the plaintiff, in Carter v. Iowa Department of Natural Resources, No. 18-0087, 2019 Iowa App. LEXIS 119 (Iowa Ct. App. Feb. 6, 2019), filed a declaratory action against the state requesting a ruling establishing him as an "owner" under for purposes of Iowa deer hunting laws. He claimed that not treating him as an “owner” violated his inalienable rights and his equal protection rights under the Iowa Constitution. The state did not respond within 60 days and the action was treated as having been denied. The plaintiff sought judicial review.
The trial court rules for the state. On further review, the appellate court affirmed. While the plaintiff claimed that he had an inalienable right to hunt the property that he owned and paid taxes on to the state of Iowa, the appellate court held that the state’s differential treatment between residents and non-residents for obtaining hunting licenses for antlered deer was reasonable, not arbitrary, and constituted an appropriate use of the state’s police power. The appellate court also determined that the different treatment of residents and non-residents served a legitimate governmental interest in conserving and protecting wildlife that was rationally related to that legitimate governmental interest. The court, citing Democko v. Iowa Department of Natural Resources, 840 N.W.2d 281 (Iowa 2013), noted that 2013 decision held that landownership in Iowa does not give the landowner the right to hunt the land because the landowner has no interest in or title to wildlife on the owner’s property. That wildlife, the Supreme Court had determined in 2013, is owned by the state of Iowa. Thus, there is no common law right to hunt based on ownership. The legislature, as the Iowa Supreme Court noted in 2013, established extensive hunting laws (and the subsequent underlying regulations) that had eliminated that right in a manner consistent with the legitimate state interest of wildlife preservation.
What About Private Farm Ponds?
As noted, the Iowa Supreme Court, in 2013, removed from the “bundle of sticks” of private property ownership, the common law right to hunt wildlife on one’s own property. But what about fish in a pond on privately owned property? Does the landowner have a right to fish their own pond without going through the state? The answer may not be as obvious as it seems it should be. It’s also an issue that is currently being debated in Iowa. Current Iowa law says that the Iowa Natural Resource Commission (Commission) can’t stock private water unless the owner agrees that the private water is opened to the public for fishing. Iowa Code §481A.78. In other words, if the state stocks a private pond, the landowner must make the pond available for public fishing. However, the law allows the Commission to investigate a private pond to determine if the “living conditions” of the fish in the private pond are suitable and then provide breeding stock on the owner’s request. In that instance, the private pond need not be opened for public fishing. Id.
However, this fishing provision of Iowa law has become contentious. Legislation is presently being worked up in the Iowa legislature that would strike that law entirely and replace it with a new provision specifying that the Commission “shall not stock a private pond or lake.” SF 203. The new legislation would allow the Commission to stock a creek or stream flowing through private property. Id. The legislation also specifies that a fishing license is not required to fish on an entirely land-locked private pond so long as it is not located on a natural stream channel or connected via surface water to waters of Iowa. Id.
Apparently, there is no “resident” requirement in the law governing the fishing of private ponds in Iowa. So, a nonresident can fish their own pond even though living out of state, but a nonresident has no common law right to hunt their own property in Iowa. “Wildlife,” however, belong to the state of Iowa while they are present there. That is, of course, unless a resident (or nonresident) collides with wildlife on an Iowa public roadway and incurs damage and/or injury in the collision. Hmmm…. That might be the topic of a future post.
Do you know the rules in your state?
Thursday, February 7, 2019
The law sets forth particular requirements that a real estate deed must satisfy to be effective to convey title in the manner in which the parties to the transaction desire. Those requirements, for example, might concern particular deed language, recordation, or even the manner in which the deed is executed.
But, just how technical are those requirements? Is a failure to precisely follow all of the rules fatal to the conveyance of the property involved? Can a party to a real estate transaction use a minor “foot-fault” by the other party as a means of getting out of what is discovered to be a bad deal? What if the “defect” isn’t discovered until several years after the deed is executed and title conveyed? Does the passage of time matter?
That’s the topic of today’s post – the impact of the passage of time on deed defects.
All states have all curative statutes designed to address various types of errors associated with real estate deeds. The statutes vary greatly from state-to-state, and deal with various possible defects. However, they all have one purpose – to cure defects following the passage of a certain amount of time. The goal is to allow title examiners to rely upon recorded documents that may have some minor defect once an appropriate length of time has passed. If execution and recording of the deed is defective, that generally does not impact the validity of the conveyances between the parties to the conveyance. It only impacts whether constructive notice to the world was effective.
Recent Case. A recent decision by the U.S Court of Appeals for the Eleventh Circuit dealt with the Florida curative statute and how it applied to a alleged deed defect in a case involving an IRS attempt to foreclose on the real estate. In Saccullo v. United States, No. 17-14546, 2019 U.S. App. LEXIS 1056 (11th Cir. Jan. 11, 2019), a father executed a deed in 1988 that conveyed a tract of real estate to a trust for the benefit of his son. But, the deed was witnessed by only one person rather than two as Florida law required. The father died in 2005, and the IRS asserted that the estate owed $1.4 million in delinquent federal estate tax. In 2015, the IRS filed a tax lien against the property on the basis that it was property that was included in the decedent’s estate.
The son sued, claiming that the lien was inapplicable. He claimed that the property was not included in the father’s estate because it had been transferred to the trust before the father’s death. The IRS acknowledged that there had been an attempted transfer to the trust before death, but claimed that the properly had not actually been conveyed to the trust because the deed execution was not properly witnessed. As a result, the IRS claimed, the property was included in the father’s estate at death and was subject to the IRS lien for unpaid taxes. The IRS motioned for summary judgment and the trial court agreed, granting the motion.
On appeal, the appellate court reversed noting that Florida law (Fla. Stat.§95.231) specifies that an improperly executed deed is considered valid five years after recordation. While the IRS claimed that this “curative” statute required “some form of formal adjudication” before it cured a deed and that, even if it did apply automatically, the statute essentially constituted a statute of limitations. As a statute of limitations, the IRS claimed, it couldn’t apply in a manner that bound the United States. The IRS cited an old U.S. Supreme Court opinion for that proposition. See United States v. Summerlin, 310 U.S. 414 (1940).
The appellate court disagreed with the IRS. The appellate court noted that while the Florida Supreme Court had not squarely addressed this particular issue, the clear weight of Florida authority favored applying the curative statute automatically five years after a deed is recorded and did not require any adjudication. The appellate court also held that Summerlin did not apply because the deed had been cured before the father died (the deed was executed and recorded 17 years before the father died) and, at the time of curing, was deemed to be effectively conveyed to the trust. As a result, there was no statute of limitations issue because the IRS claim failed to accrue. The result was that, upon the father’s death, the real estate was not included in his estate and the IRS lien couldn’t attach to it.
The “take-home” from the case is that the Florida statute was drafted precisely enough to cure what is probably a commonly-overlooked defect in Florida. The statute also triggered the running of the five-year period from the date the deed was recorded. In other words, the act of recording the deed had to occur to start the five-year timeframe running. Five years was also a long-enough period of time to ensure that no bona fide purchasers would be impacted. The statute of limitations issue was also not problematic because the IRS lien for unpaid federal estate tax couldn’t arise until after the father had died. By that time, much more time than five years had passed since the deed had been executed and recorded.
Where a defect associated with a real estate deed prevents the conveyance from being effective, a curative statute would not help unless it clearly provides that something that was defective because of a statutory requirement is deemed effective with the passage of time. That’s a lesson for practitioners to keep in mind. Real estate deeds are often a big part of the business of agriculture. It’s also a lesson for legislator’s drafting curative statutes to remember to draft carefully. If drafted carefully, the passage of time will cure defects.
Wednesday, January 30, 2019
Over the past three years, I have written on a couple of occasions about the accommodation doctrine – a mineral owner’s right to use the surface estate to drill for and produce minerals. The doctrine requires a balancing of the interests of the surface and mineral owner. But, at least one court has also applied the doctrine to groundwater. Now, a federal appellate court has applied the doctrine to find that vertical drilling on farmland may constitute a trespass.
An update on the accommodation doctrine in the courts – that’s the topic of today’s post.
Land ownership includes two separate estates in land – the surface estate and the mineral estate. The mineral estate can be severed from the surface estate with the result that ownership of the separate estates is in different parties. In some states, the mineral estate is dominant. That means that the mineral estate owner can freely use the surface estate to the extent reasonably necessary for the exploration, development and production of the minerals beneath the surface. If the owner of the mineral estate has only a single method for developing the minerals, many courts will allow that method to be utilized without consideration of its impact on the activities of the surface estate owner. See., e.g., Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013).
But, under the accommodation doctrine, if alternative means of development are reasonably available that would not disrupt existing activities on the surface those alternative means must be utilized. In other words, the accommodation doctrine applies if the surface owner must establish that the lessee’s surface use precludes (or substantially impairs) the existing surface use, and that the surface owner doesn’t have any reasonable alternative means to continue the current use of the surface estate. For example, in Getty Oil co. v. Jones, 470 S.W.2d 618 (Tex. 1971), a surface estate owner claimed that the mineral estate owner did not accommodate existing surface use. To prevail on that claim, the Getty court determined that the surface owner must prove that the mineral estate owner’s use precluded or substantially impaired the existing surface use, that the surface estate owner had no reasonable alternative method for continuing the existing surface use, and that the mineral estate owner has reasonable development alternatives that would not disrupt the surface use.
Accommodation Doctrine and Water
A question left unanswered in the 1971 decision was whether the accommodation doctrine applied beyond subsurface mineral use to the exercise of groundwater rights. In 2016, the Texas Supreme Court, in Coyote Lake Ranch, LLC v. City of Lubbock, 498 S.W.3d 53 (Tex. Sup. Ct. 2016), held that it did. Thus, according to the Court, the doctrine applies in situations where the owner of the groundwater impairs an existing surface use, the surface owner has no reasonable alternative to continue surface use, and the groundwater owner has a reasonable way to access and produce water while simultaneously allowing the surface owner to use the surface.
The Court held that the language of the deed for the land involved in the litigation governed the rights of the parties, but that the deed didn’t address the core issues presented in the case. For example, the Court determined that the deed was silent on the issue of where drilling could occur and the usage of overhead power lines and facilities associated with water development. The Court determined that water and minerals were sufficiently similar such that the accommodation doctrine should also apply to water – both disappear, can be severed, and are subject to the rule of capture, etc. The Court also concluded that a groundwater estate severed from the surface estate enjoys an implied right to use as much of the surface as is reasonably necessary for the production of groundwater. Thus, unless the parties have a written agreement detailing all of the associated rights and responsibilities of the parties, the accommodation doctrine would apply to resolve disputes and sort out rights.
In 2018, however, the Texas Court of Appeals, refused to further expand the accommodation doctrine. Harrison v. Rosetta Res. Operating, LP, No. 08-15-00318-CV 2018 Tex. App. LEXIS 6208 (Tex Ct. App. Aug. 8, 2018), involved a water-use dispute between an oil and gas lessee and the surface owner. The plaintiff owned the surface of a 320-acre tract. The surface estate had been severed from the mineral estate, with the minerals being owned by the State of Texas. The plaintiff executed an oil and gas lease on behalf of the State that allowed the lessee to use water from the land necessary for operations except water from wells or tanks of the landowner.
To settle a lawsuit with the plaintiff, the lessee agreed to buy 120,000 barrels of water. The lessee built a frac pit to store the water that it would use in drilling operations and drilled two wells. The lessee then assigned the lease to the defendant. The defendant drilled a third well and had plans to drill additional wells. However, the defendant did not buy water from the plaintiff as the lessee had. Instead, the defendant pumped water from a neighbor and brought temporary waterlines onto the plaintiff’s property to fill storage tanks.
The plaintiff claimed that the defendant (via an employee) orally agreed to continue the existing arrangement that the plaintiff had with lessee and was in violation with an alleged industry custom in Texas – that an oil and gas lessee would only buy water from the surface owner of the tract it was operating. The plaintiff claimed that it wasn’t necessary for the defendant to bring in hoses and equipment because the defendant should have bought the plaintiff’s water from the plaintiff, Not doing so violated the accommodation doctrine. The trial court rejected the plaintiff’s arguments.
The appellate court determined that the plaintiff’s accommodation doctrine arguments appeared to rest on his proposition that because a frac pit was built on his land for use by the former lessee, it unified the use of the land with the oil and gas operations, and when the defendant chose not buy his water it substantially interfered with his existing use of the land as a source of water for drilling operations. Thus, the substantial interference complained of was that the frac pit was no longer profitable because the defendant is not using it to supply water for its operations. The appellate court held that categorizing a refusal to buy goods produced from the land as interference with the land for purposes of the accommodation doctrine would stretch the doctrine beyond recognition. Therefore, because the defendant’s use did not impair the plaintiff’s existing surface use in any way, except in the sense that not buying the water had precluded the plaintiff from realizing potential revenue from selling its water to the defendant, the inconvenience to the surface estate was not evidence that the owner had no reasonable alternative to maintain the existing use. Lastly, the court determined that if it were to hold for the plaintiff on these facts they would, in effect, be holding that all mineral lessees must use and purchase water from the surface owner under the accommodation doctrine if his water is available for use. Accordingly, the appellate court affirmed.
In, Bay v. Anadarko E&P Onshore LLC, No. 17-1374, 2018 U.S. App. LEXIS 36454 (10th Cir. Dec. 26, 2018), the plaintiffs, a married couple, operate a farm in Weld, County, CO. In 1907, the Union Pacific Railroad acquired large swaths of land and sold off surface rights to others, ultimately selling subsurface rights to mineral deposits to the defendant, an oil and gas company. The 1907 deed reserved the following: “First. All coal and other minerals within or underlying said lands. Second. The exclusive right to prospect in and upon said land for coal and other minerals therein, or which may be supposed to be therein, and to mine for and remove, from said land, all coal and other minerals which may be found thereon by anyone. Third. The right of ingress, egress and regress upon said land to prospect for, mine and remove any and all such coal or other minerals; and the right to use so much of said land as may be convenient or necessary for the right-of-way to and from such prospect places or mines, and for the convenient and proper operation of such prospect places, mines, and for roads and approaches thereto or for removal therefrom of coal, mineral, machinery or other material” [emphasis added].
The plaintiffs’ farm was above a large oil and gas deposit. Before 2000, the railroad entered into agreements with surface owners before drilling for oil or gas. Those agreements often included payments to surface owners and provided that the railroad would pay for surface property damages, including crop damages. In 2000, the defendant bought the railroad’s mineral rights in the oil and gas deposit underlying the plaintiffs’ property. In 2004, the defendant leased the mineral rights under the plaintiffs’ farms to an exploration company which drilled three vertical wells on a part of the plaintiffs’ farm. An energy company bought the exploration company in 2006 and drilled four more vertical wells on another part of the plaintiffs’ farm between 2007 and 2011. In an attempt to have fewer wells drilled on their farm and minimize the impact to their farmland, the plaintiffs asked the energy company to drill directionally. The energy company requested $100,000 per directional well. The plaintiffs refused, and the energy company continued to drill vertically. The plaintiffs sued, claiming that the energy company’s surface use constituted a trespass because directional drilling would have resulted in two wells on their property rather than seven. Directional drilling is the norm in the county with one drill site per pad serving 12-36 wells.
The trial court granted a judgment as a matter of law to the defendant on the basis that the defendant had presented sufficient evidence that vertical drilling was the only commercially reasonable practice; that this practice was afforded in the additional rights granted in the original deed; and that the plaintiffs could not establish trespass. On appeal, the appellate court reversed. The appellate court noted that state law held that deeds containing language identical to the “convenient and necessary” language of the deed at issue does not grant mineral owners more rights than what state common law provides. The appellate court also expressed doubt as to whether a mineral reservation in a deed can expand surface or mineral ownership rights unless those rights are clearly defined in accordance with Gerrity Oil and Gas Corp. v. Magness, 946 P.2d 913 (Colo. 1997). The appellate court concluded that the deed at issue in the case was insufficient to expand mineral or surface rights beyond those recognized in state common law. The appellate court also held that the trial court erred by requiring the plaintiffs to show that vertical drilling wasn’t commercially reasonable. Under Gerrity, the appellate court noted, a surface owner can introduce evidence that "reasonable alternatives were available." Once that evidence is introduced, the appellate court determined that it is then up to a judge or jury to "balance the competing interests of the operator and surface owner and objectively determine whether ... the operator's surface use was both reasonable and necessary."
The accommodation doctrine sounds reasonable. But, defining what a reasonable use can be difficult to determine, and if new uses can be asserted the mineral owner’s rights can be diminished. From an economic standpoint, it would seem that the owner of the surface estate as the accommodated party should pay for the extra expense associated with the accommodation. In other words, when the mineral estate owner must accommodate, but at the expense of the surface estate owner, both parties benefit and the surface estate owner can’t get rights back for nothing that it sold when the original grant was created. Some states, such as Kansas, follow this approach.
Monday, January 28, 2019
Last fall, I wrote a blog post where I took a look at a handful of recent court developments involving agricultural law. Since then I have received numerous requests to do another post surveying more court developments involving legal issues that farmers, ranchers, rural landowners and agribusinesses face.
Recent court opinions involving ag law issues – that’s the topic of today’s post.
Each state, even though differences exist in state law, recognize that if an individual possesses someone else's land in an open and notorious fashion with an intent to take it away from them, such person (known as an adverse possessor) becomes the true property owner after the statutory time-period (anywhere from 10 to 21 years) has expired. If use is by permission, the adverse possession statute is never tolled. See, e.g., Engel v. Carlson, No. A-07-016, 2008 Neb. App. LEXIS 94 (Neb. Ct. App. May 13, 2008).
The requirements that the use of the land must be “adverse” and under a “claim of right” are sometimes combined under the requirement that the use of the land be “hostile” to the true owner’s use. For example, in Cannon v. Day, 165 N.C. App. 302, 598 S.E.2d 207 (2004), rev. den., 604 S.E.2d 309 (N.C. 2004), the original owners never granted permission to use a lane, and the neighbor had used the lane for more than 20 years adverse to the true owners. The court determined that the neighbor had adversely possessed the lane and the ownership of it passed to the neighbor’s successors in interest.
The hostility requirement is designed to put the true owner on notice that another party is using the land adversely to the true owner. See, e.g., Groves v. Applen, No. 31241-7-II, 2005 Wash. App. LEXIS 1460 (Wash. Ct. App. Jun. 14, 2005). However, in Kansas, the adverse possession statute does not contain a “hostility” requirement, and the doctrine can be asserted against an undisclosed co-tenant. Buchanan v. Rediger, 26 Kan. App.2d 59, 975 P.2d 1235 (1999).
Recent case. In Collier v. Gilmore, 2018 Ark. App. 549 (Ark. Ct. App. 2018), the Arkansas Court of Appeals held that farming to a cultivation line constituted adverse possession. The parties each gained title to their respective tracts from the same predecessor. In 1972, the plaintiff purchased his tract and believed that he purchased up to the fence where his predecessor had farmed. However, the deed did not include a strip of land up to the fence. Since the 1980’s, the plaintiff farmed up to where the fence was in 1972 believing that to be the property line. Sometime during the 1980’s the defendant received title to the other portion of the predecessor’s original property. The plaintiff sued claiming adverse possession of the strip of land not in the 1972 deed. The trial court agreed.
On appeal, the appellate court affirmed. The appellate court held that the plaintiff’s farming of the disputed strip for several decades was sufficient to establish an intent to hold against the true owner’s rights. The appellate court also determined that the plaintiff’s possession was also hostile because it was greater than the deed anticipated and was without permission of the true owner. While the strip had never been enclosed by a fence or other enclosure, the property line was the cultivation line which had been clearly identified for decades via the plaintiff’s conduct.
In certain situations, one person may be held liable for the tortious acts of another person based on a special relationship between the two. Such liability (called vicarious liability) exists even though the person held liable not have personally committed the act. Often this issue arises in employment situations. An employer may be held vicariously liable for the tortious acts (usually negligent ones) committed by an employee. Thus, if an employee commits a tort during the “scope of employment”, the employer will (jointly with the employee) be liable.
This rule is often described as the doctrine of “respondeat superior”, which means “let the person higher up answer.” Vicarious liability applies to torts committed by employees and generally not to those committed by independent contractors. Therefore, it is critical to determine whether a particular individual was an employee or an independent contractor. While no single factor is dispositive in all cases, an employee is generally one who works subject to the control of the employer concerning the manner and means of performance.
Recent case. In Moreno v. Visser Ranch, Inc., No. F075822, 2018 Cal. App. LEXIS 1194 (Cal. Ct. App. Dec. 20, 2018), at issue was a dairy farm’s liability for a worker involving in an accident. The dairy employed a worker to be on call around the clock to repair equipment at the dairy. The worker was involved in his work vehicle when he was involved in a single vehicle accident. The plaintiff was riding with the worker at the time of the accident. The plaintiff was employed by a third party to perform various services at the dairy and other local farms. On the night of the accident, the worker and plaintiff attended a family function (they were related) not located on the dairy’s property. On the way home after the function, the vehicle they were in left the road and rolled over. The plaintiff was not wearing a seat belt and was seriously injured. The plaintiff sued the driver, dairy farm and the auto manufacturer for negligence. The plaintiff also sued the State and the County based on the dangerous condition of the road where the accident occurred (the road was under construction). The dairy moved for summary judgment on the plaintiff’s respondeat superior claim on the basis that the driver was not acting within the scope of employment when the accident occurred. The trial court granted the motion. The trial court also granted summary judgment for the diary on the issue of liability arising from ownership of the vehicle. The plaintiff was, however, able to recover statutory damages from the driver.
On appeal, the appellate court determined that fact issues remained on the respondeat superior claim. Though the worker and the plaintiff were returning from a family function, the driver was on call 24/7 to respond to issues at the dairy farm. In addition, the appellate court determined that a fact issue remained as to whether the worker was acting within the scope of his employment and benefiting the dairy farm at the time of the accident. The appellate court remanded the case.
Inherently Dangerous Activities
Another aspect of respondeat superior involves activities that the law deems to be inherently dangerous. In this instance, the person making the hire can be held vicariously liable even if the person hired is an independent contractor. For example, in some states, aerial crop spraying is considered evidence of negligence. In these situations, a plaintiff only needs to establish that aerial spraying occurred and damage resulted. A showing of negligence on the part of the individual spraying the crops is not necessary. However, the majority of states still require a showing of negligence before damages can be recovered. In the states not requiring a showing of negligence, the practical effect is to apply a strict liability rule. In these jurisdictions, delegation of the spraying task to an independent contractor does not eliminate a farmer's liability. This problem is so severe that most farm liability policies do not cover the aerial spraying or dusting of crops. The damage award in a crop dusting case is calculated on the basis of the difference between the crop yield that would have normally resulted and the yield actually obtained after the damage, adjusted for any reduction in costs, such as drying or hauling costs. Yield is based on the best evidence available.
Recent case. In Keller Farms, Inc. v. Stewart, No. 1:16 CV 265 ACL, 2018 U.S. Dist. LEXIS 210209 (E.D. Mo. Dec. 13, 2018), the court held that the aerial application of ag chemicals is not an inherently dangerous activity. The case involved a dispute involving damage to the plaintiffs’ trees caused by chemicals that allegedly drifted during aerial application. The plaintiffs attempted to hold both the aerial applicator and the landowner that hired the applicator. The plaintiffs claimed the landowner was vicariously liable for the applicator’s actions because aerial spraying of burndown chemicals is an "inherently dangerous activity."
The trial court granted the defendants’ motion for judgment as a matter of law on the plaintiff's trespass claim, but the remaining issues were left for the jury to resolve. The jury returned a verdict in favor of the defendants on the negligence and negligence per se claims. The plaintiffs filed a motion for a new trial, arguing the verdict was against the weight of the evidence; that the trial court erred in excluding evidence; and that the trial court erred in granting the defendants’ motion for judgment as a matter of law. The trial court, however, denied the plaintiff’s motion for a new trial.
On appeal, the appellate court affirmed. The appellate court determined that the jury’s verdict was not against the weight of the evidence, and that the aerial application of herbicides was commonplace and not inherently dangerous. In addition, the appellate court noted that the defendants’ evidence was that the herbicides did not actually drift onto the plaintiff’s property and that the applicator complied with all label requirements and sprayed during optimal conditions. The appellate court also determined that the trial court had ruled properly on evidentiary matters and that the plaintiff had not proven the alleged monetary damages to the trees properly. The appellate court also upheld the trial court’s denial of the plaintiff’s motion for a new trial.
The legal issues that farmers and ranchers deal with are potentially very large. Today’s post examined just a small slice. It’s always helpful to know what the rules are when the issue arises.
Friday, January 18, 2019
Presently, over 300,000 cell/wireless towers have been erected in the United States. Some of those are on farm and ranch land with the landowners having been presented an agreement to sign allowing the wireless carrier to use of some of the land. But, not all agreements are created equally.
What makes a cell/wireless tower agreement a good one? What are the key elements of a good agreement? What should or should not be included in an agreement from the landowner’s perspective? These questions are the topic of today’s post.
The Battle of the Forms
A key point for a landowner to understand is that when presented with an agreement to sign, the standard form of the wireless carrier is one-sided. It is one-sided in the favor of the wireless carrier. That’s to be expected. After all, a maxim of contract law is that the party who drafts a contract drafts the contract in their favor. So, a wireless carrier, via a landowner agreement, will attempt to take as much advantage of a naïve landowner as possible. That means a landowner presented with a wireless carrier’s boilerplate form could incur substantial legal fees to have the form edited in the negotiation process to reach a more balanced agreement that protects the landowner’s property rights.
A better approach might be for attorneys that represent landowners to develop their own standard form that thoroughly protects a landowner’s property rights while also ensuring that the wireless carrier can still experience an economic benefit from the placement of the tower on the landowner’s property.
There are a couple of basic points to be made when drafting a cell/wireless tower agreement. These are: 1) clearly identify the premises that is subject to the agreement; and 2) clearly identify the grant of authority. An exhibit should be included with the agreement that contains the legal description of the subject property along with drawings and/or photos. The more detail that is provided, the easier it will be to police the agreement. That’s particularly true with respect to unauthorized collocations (the placement of additional electronic devices on a tower) and subleases. In addition, any standard agreement should address the usage of common areas and access points. Similarly, the landowner will want the retained right to control signage, conduct and look. Nobody wants an eyesore on their property.
The grant of authority to the carrier involves the property rights that are given to the company. The grant of authority should be either a license or a lease. An easement should not be granted. The grant of an easement may result in granting others access to the same property. Instead, a license is all the legal authority that a wireless company needs. A license simply gives the wireless company exclusive permission to enter the property to establish the tower and perform necessary maintenance activities. A lease can also be utilized if it grants exclusive use to the wireless company and not shared use. In addition, a lease may provide more protection to the landowner in the event of the bankruptcy of the wireless company.
Whether a license or a lease is utilized, some basic elements should be included in the document.
Term. The term of the agreement and any renewal options should be clearly specified. For larger installations of wireless towers, the term is typically a series of five-year terms totaling somewhere between 20 and 30 years. For smaller installations that are placed in a right-of-way, a shorter term is generally better because of uncertainly that may exist due to governmental regulatory authority. Each particular situation will be different in terms of that the optimal term will be, whether an automatic renewal clause should be included and whether actual affirmative notice should be required of renewals.
Care should be given, however, to the use of a clause that gives the wireless company the “option to lease” or a clause that provides for a long “due diligence” period. The problem with those clauses are that they can tie up the site for a set amount of time with no guarantee of rent flowing to the landowner. Relatedly, a landowner should not allow the wireless company to have a long delivery or construction period for obtaining the necessary permits without requiring additional compensation. Ideally, the term of the agreement should begin immediately with a construction period of 30-60 days being added to the overall term.
If the wireless company desires either an option to lease or a due diligence clause, such a clause should be negotiated as an addition to the basic agreement for additional compensation. For instance, a “due diligence” period is a timeframe that the wireless company is given to obtain the necessary legal clearances and ensure that the location works for the company. This landowner should not give this time period away without additional compensation, even if the underlying agreement is not yet in force. Likewise, during this due diligence period, the landowner should consider requiring the wireless to carry insurance for any activities on the site by the company or consultants (and require copies of consultant reports be provided to the landowner), require prior written consent for any borings, and require the wireless company to indemnify the landowner for liability arising from the conduct of the company or consultants, etc.
Rent. The amount of rent or license fee paid to the landowner will depend on whether the installation is inside or outside the existing right-of-way. If it is inside the right-of way, the amount should be a reasonable approximation of cost. If it is outside the right-of-way, it will likely be tied to the market rate. In either event, a landowner should do the necessary “homework” to determine what an appropriate level of compensation should be, but the landowner’s compensation should be comprised of a base amount with additional compensation for collocation (additional devices added to the existing structure). In addition, a provision for late fees, interest and the possibility of holdover should be included in the agreement. Late fees are essentially whatever the landowner is able to negotiate, with interest on late fees typically limited by state law. A “savings” clause should be included to ensure that a state law barring usury won’t be violated. The hold-over rent amount will likely be in the range of 125 percent to 150 percent of the rent amount at the time the hold-over began.
Assignment. Often, the wireless company will desire to assign the lease to another related (affiliate) company, such as a “tower operating company.” Any assignment should require the landowner’s written approval. One option for a landowner to consider is to execute a property management agreement. But, in no event should the landowner agree to release the original wireless company from responsibility for liability associated with hazardous chemicals (battery leakage, etc.) and insurance.
Relatedly, a landowner should not allow the wireless company to sublicense or sublease without the landowner’s prior written approval. In addition, the landowner should retain the ability to consent to any proposed sublicense or sublease involving the placement of another carrier’s equipment (“facilities”) on the existing tower (or other structure). If additional equipment is desired to be placed on the existing tower or structure, additional rent or fees should be paid to the landowner.
Interference. The landowner is legally obligated to provide the tenant with “peaceable possession” of the premises. “Peaceable possession” means that the landowner will provide the premises to the tenant in a condition that will serve the intended purpose(s) of the tenant’s use. As applied to cell/wireless tower license or lease situations, that means that the landowner should not cause any interference problems for the existing tenant or licensee. For facilities and structures that are outside of a right-of-way and entirely on the landowner’s property, the landowner should ensure that subsequent tenants/licensees (collocators) do not cause interference. While the legal burden is on a newcomer to cure interference issues that are caused by the subsequent placement of a facility on an existing tower/structure, the landlord should take steps to ensure the landlord’s non-responsibility for interference or curing the problem. Also, the landlord should ensure that no rights have been granted that could lead to an interference.
Improvements. A significant area of concern for landowners is how to deal with improvements that the wireless company may desire to place on the tower/structure after the initial installation. Any proposed improvement should require detailed plans with prior approval and, of course, additional compensation for the landowner. The landowner should not agree to clause language such as, “approval not to be unreasonably withheld, delayed or conditioned…”. Also, the landowner should control the appearance of any improvements, and require that any improvement by the licensee/tenant be performed in compliance with applicable laws, codes and ordinances. In addition, the licensee/landlord should not be authorized to contract for or on behalf of the licensor or impose any additional expense (such as utilities) on the landowner.
The landowner should ensure that improvements will be maintained and upgraded to continuously be in compliance with applicable laws, and that any new installations will not be heavier, or exceed capacity or space than the original grant permitted. Similarly, the agreement should specify that the wireless company pay for utilities and that the landlord is not responsible for any interruptions in cell/wireless service. Concerning an operational issue, the landowner should not allow the wireless company to use the landowner’s electric connection with a submeter.
Access. The landowner should make sure that the agreement provides sufficient protection related to access to the property. In general, it is advisable to require the landowner to be given 24-hour notice when access to the property is desired or will be occurring. In addition, access to the property should be limited to just what is necessary to accomplish the purpose of gaining access. Also, some provision should be included in the agreement for emergency access to the property. If the wireless facilities are installed on the roof of a building, access to the facilities should be limited to just those areas that the wireless company needs. In addition, if the facility is placed on the top of a commercial building the roof contractor should approve of the access and roof penetrations should be avoided that could possibility invalidate roof warranties. Relatedly, the size, weight and frequency of roof access should be limited. If the installation of the cell/wireless facility is on private land (such as farmland), access should similarly be limited, and provisions included to protect fencing and animals, for example. The burden of maintaining secure fencing should be on the wireless company.
Default. The agreement should provide for events of default and termination by the landlord. Common events of default would be the non-payment of rent by the wireless company or habitual late payments. Likewise, default could be triggered on the violation of any term of the agreement, including non-permitted collocations and the bankruptcy of the wireless company. Consideration may need to be given as to whether a clause should be included that allows default to be cured by a monetary payment provision.
Care should be taken to clearly specify how and when the wireless company can terminate the agreement. Commonly, wireless carriers want a provision included in the agreement that allows them to terminate the agreement for “technological, economic, or environmental” reasons. A landowner should not accept this clause. It is a “get out of jail free” clause for the wireless company. From the landowner’s perspective, the agreement should either bar terminations by the wireless company or allow it for an additional payment (such as rent for the balance of the then-existing term or an amount of rent equal to a year or two).
Decommissioning. Thought should be given in the agreement concerning the ultimate removal of the tower and related improvements. Removal should also apply to improvements that have been made beneath the surface of the property. The manner of removal may depend on the type of facility that has been erected. If possible, the agreement should provide for immediate ownership of the facility/improvement in the landowner (although this likely won’t work if the structure has been added to a light pole that is on the landowner’s property located in a right-of-way). Alternatively, an option can be included in the agreement for the landowner to retain improvements or require removal of structures, footings and foundations.
Miscellaneous provisions. A well-drafted agreement should contain provisions dealing with numerous other issues. The following is a breakdown of the major “miscellaneous” provisions:
- Insurance provisions should apply to contractors and subsidiaries without reciprocal indemnity (which may be banned by state and/or local law). It’s a good idea to have insurance professionals review the insurance provisions.
- A tax provision should clearly state that taxes due are in addition to the rent amount due under the agreement. Likewise, the agreement should make the wireless company pay any increase in any property tax or insurance as a result of the installation and associated improvements.
- A “notice” provision should require that all notices, requests, demands and other communications be in writing and delivered to a specific address, and have multiple government entities copied (such as the city/county clerk; county/township/city engineer, etc.).
- Clause language should be included to limit the ability of the wireless company to store items on the property. This is an environmental concern. Stored batteries and generators can leach, and diesel fuel can leak.
- A provision should be included for attorney fees.
- Give thought as to whether a severability provision should be included as well as a clause providing that the landlord is not liable for brokerage or agent fees.
- A governing law provision should specify that the governing law is where the premises subject to the agreement is located and that jurisdiction is in the state rather than federal court.
- Other clauses to consider include a mortgage subordination provision; a clause providing for the limitation of liability; no relocation assistance (condemnation payments need to go to the landlord); and that time is of the essence.
- A provision addressing the sale of the agreement.
- It might be a good idea to include a provision addressing the possible sale of the agreement.
Perhaps the biggest key for a landowner in achieving a good agreement with a cell/wireless company is to control the drafting process. A good agreement can produce a good economic result for a landowner. A bad agreement that is not put together well can result in undesireable situations for the landowner. Good legal counsel is a must in getting a good agreement that will provide long-term benefits.
Monday, December 31, 2018
2018 was a big year for developments in law and tax that impact farmers, ranchers, agribusinesses and the professionals that provide professional services to them. It was also a big year in other key areas which are important to agricultural production and the provision of food and energy to the public. For example, carbon emissions in the U.S. fell to the lowest point since WWII while they rose in the European Union. Poverty in the U.S. dropped to the lowest point in the past decade, and the unemployment rate became the lowest since 1969 with some sectors reporting the lowest unemployment rate ever. The Tax Cuts and Jobs Act (TCJA) doubles the standard deduction in 2018 compared to 2017, which will result additional persons having no federal income tax liability and other taxpayers (those without a Schedule C or F business, in particular) having a simplified return. Wages continued to rise through 2018, increasing over three percent during the third quarter of 2018. This all bodes well for the ability of more people to buy food products and, in turn, increase demand for agricultural crop and livestock products. That’s good news to U.S. agriculture after another difficult year for many commodity prices.
On the worldwide front, China made trade concessions and pledged to eliminate its “Made in China 2025” program that was intended to put China in a position of dominating world economic production. The North-Korea/South Korea relationship also appears to be improving, and during 2018 the U.S. became a net exporter of oil for the first time since WWII. While trade issues with China remain, they did appear to improve as 2018 progressed, and the USDA issued market facilitation payments (yes, they are taxed in the year of receipt and, no, they are not deferable as is crop insurance) to producers to provide relief from commodity price drops as a result of the tariff battle.
So, on an economic and policy front, 2019 appears to bode well for agriculture. But, looking back on 2018, of the many ag law and tax developments of 2018, which ones were important to the ag sector but just not quite of big enough significance nationally to make the “Top Ten”? The almost Top Ten – that’s the topic of today’s post.
The “Almost Top Ten” - No Particular Order
Syngenta litigation settles. Of importance to many corn farmers, during 2018 the class action litigation that had been filed a few years ago against Syngenta settled. The litigation generally related to Syngenta's commercialization of genetically-modified corn seed products known as Viptera and Duracade (containing the trait MIR 162) without approval of such corn by China, an export market. The farmer plaintiffs (corn producers), who did not use Syngenta's products, claimed that Syngenta's commercialization of its products caused the genetically-modified corn to be commingled throughout the corn supply in the United States; that China rejected imports of all corn from the United States because of the presence of MIR 162; that the rejection caused corn prices to drop in the United States; and that corn farmers were harmed by that market effect. In April of 2018, the Kansas federal judge handling the multi-district litigation preliminarily approved a nationwide settlement of claims for farmers, grain elevators and ethanol plants. The proposed settlement involved Syngenta paying $1.5 billion to the class. The class included, in addition to corn farmers selling corn between September of 2013 and April of 2018, grain elevators and ethanol plants that met certain definition requirements. Those not opting out of the class at that point are barred from filing any future claims against Syngenta arising from the presence of the MIR 162 trait in the corn supply. Parties opting out of the class can't receive any settlement proceeds, but can still file private actions against Syngenta. Parties remaining in the class had to file claim forms by October of 2018. The court approved the settlement in December of 2018, and payments to the class members could begin as early as April of 2019.
Checkoff programs. In 2018, legal challenges to ag “checkoff” programs continued. In 2017, a federal court in Montana enjoined the Montana Beef Checkoff. In that case, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV-16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017), the plaintiff claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was unconstitutional. The Beef Checkoff imposes a $1.00/head fee at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision was finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. On further review by the federal trial court, the court adopted the magistrate judge’s decision in full. The trial court determined that the plaintiff had standing on the basis that the plaintiff would have a viable First Amendment claim if the Montana Beef Council’s advertising involves private speech, and the plaintiff did not have the ability to influence the advertising of the Montana Beef Council. The trial court rejected the defendant’s motion to dismiss for failure to state a claim on the basis that the court could not conclude, as a matter of law, that the Montana Beef Council’s advertisements qualify as government speech. The trial court also determined that the plaintiff satisfied its burden to show that a preliminary injunction would be appropriate.
The USDA appealed the trial court’s decision, but the U.S. Court of Appeals for the Ninth Circuit affirmed the trial court in 2018. Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018). Later in 2018, as part of the 2018 Farm Bill debate, a provision was proposed that would have changed the structure of federal ag checkoff programs. It did not pass, but did receive forty percent favorable votes.
GIPSA rules withdrawn. In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) an interim final rule and two proposed regulations setting forth the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The proposals generated thousands of comments, with ag groups and producers split in their support. The proposals concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim.
The interim final rule and the two proposed regulations stemmed from 2010. In that year, the Obama administration’s USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA. 75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010). Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It included, but was not limited to, situations in which a packer, swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) was stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically noted that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations also specified that a PSA violation could occur without a finding of harm or likely harm to competition, contrary to numerous court opinions on the issue.
On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017, with the due date for public comment set at June 12, 2017. However, on October 17, 2017, the USDA withdrew the interim rule. The withdrawal of the interim final rule and two proposed regulations was challenged in court. On December 21, 2018, the U.S. Court of Appeals for the Eighth Circuit denied review of the USDA decision. In Organization for Competitive Markets v. United States Department of Agriculture, No. 17-3723, 2018 U.S. App. LEXIS 36093 (8th Cir. Dec. 21, 2018), the court noted that the USDA had declined to withdraw the rule and regulations because the proposal would have generated protracted litigation, adopted vague and ambiguous terms, and potentially bar innovation and stimulate vertical integration in the livestock industry that would disincentivize market entrants. Those concerns, the court determined, were legitimate and substantive. The court also rejected the plaintiff’s argument that the court had to compel agency action. The matter, the court concluded, was not an extraordinary situation. Thus, the USDA did not unlawfully withhold action.
No ”clawback.” In a notice of proposed rulemaking, the U.S Treasury Department eliminated concerns about the imposition of an increase in federal estate tax for decedents dying in the future at a time when the unified credit applicable exclusion amount is lower than its present level and some (or all) of the higher exclusion amount had been previously used. The Treasury addressed four primary questions. On the question of whether pre-2018 gifts on which gift tax was paid will absorb some or all of the 2018-2025 increase in the applicable exclusion amount (and thereby decrease the amount of the credit available for offsetting gift taxes on 2018-2025 gifts), the Treasury indicated that it does not. As such, the Treasury indicated that no regulations were necessary to address the issue. Similarly, the Treasury said that pre-2018 gift taxes will not reduce the applicable exclusion amount for estates of decedents dying in years 2018-2025.
The Treasury also stated that federal gift tax on gifts made after 2025 will not be increased by inclusion in the tax computation a tax on gifts made between 2018 and 2015 that were sheltered from tax by the increased applicable exclusion amount under the TCJA. The Treasury concluded that this is the outcome under current law and needed no regulatory “fix.” As for gifts that are made between 2018-2025 that are sheltered by the applicable exclusion amount, the Treasury said that those amounts will not be subject to federal estate tax in estates of decedents dying in 2026 and later if the applicable exclusion amount is lower than the level it was at when the gifts were made. To accomplish this result, the Treasury will amend Treas. Reg. §20.2010-1 to allow for a basic exclusion amount at death that can be applied against the hypothetical gift tax portion of the estate tax computation that is equal to the higher of the otherwise applicable basic exclusion amount and the basic exclusion amount applied against prior gifts.
The Treasury stated that it had the authority to draft regulations governing these questions based on I.R.C. §2001(g)(2). The Treasury, in the Notice, did not address the generation-skipping tax exemption and its temporary increase under the TCJA through 2025 and whether there would be any adverse consequences from a possible small exemption post-2025. Written and electronic comments must be received by February 21, 2019. A public hearing on the proposed regulations is scheduled for March 13, 2019. IRS Notice of Proposed Rulemaking, REG-106706-18, 83 FR 59343 (Nov. 23, 2018).
These were significant developments in the ag law and tax arena in 2018, but just not quite big enough in terms of their impact sector-wide to make the “Top Ten” list. Wednesday’s post this week will examine the “bottom five” of the “Top Ten” developments for 2018.
December 31, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Tuesday, November 27, 2018
Easements are a commonly encountered in agricultural settings. An easement does not give the holder of the easement a right of possession, but a right to use or to take something from someone else's land. To the holder of the easement, the easement is a right or interest in land, but to the owner of the real estate subject to the easement, the easement is an encumbrance upon that person's estate.
Easements may take several forms. Most easements are affirmative that entitle the holder to do certain things upon the land subject to the easement. A negative easement gives its holder a right to require the owner of the land subject to the easement to do or not to do specified things with respect to that land. For example, a negative easement could be a right-of-way, a riparian right, a right to lateral and subjacent support (see, e.g., Ohio Rev. Code. §§723.49-.50), a surface water flowage easement, a manure easement, a soil retention easement or an easement to be free from nuisances, just to name a few.
But, does the law recognize a negative easement for light, air or view? It’s an interesting question, and the issue comes up in ag settings more often than would be suspected. It’s also the topic of today’s post – whether the law recognizes a negative easement for light, air or view.
General rule. Negative easements are synonymous with covenantal land restrictions and are similar to certain “natural rights” that are incidents of land ownership. However, most American courts reject the English “ancient lights” doctrine. That means that American courts typically refuse to recognize a negative easement for light, air and view. This was the result, for example, in Fontainebleau Hotel Corp. v. Forty-Five Twenty-Five, Inc., 114 So.2d 357 (Fla. App. 1959). In the case, a hotel’s additional floors added to the top of the existing building cast a shadow over an adjacent hotel’s beach frontage. The complaining hotel asserted that the other hotel couldn’t add the additional floors to its building because the adjacent hotel had a negative easement over the other hotel’s property for light, air and view. The court rejected the claim on the basis that American law does not recognize a negative easement for light, air or view.
Exception. However, if light, air or view is obstructed out of spite or malice, an American court might determine that a negative easement exists. In other words, if a property owner's interference with a neighboring owner's light, air or view is done maliciously, the court may enjoin the activity as a nuisance. For example, in Coty v. Ramsey Associates, Inc., 149 Vt. 451, 546 A.2d 196 (1988), the court enjoined the defendant's “spite farm” on the basis that it constituted a nuisance. There was no question that the hog “farm” at issue was created purely out of maliciousness against an adjoining landowner. Thus, the court held that the adjoining landowner that had been harmed held a negative easement over the hog “farm” for light, air and view. In addition to the actual damages that the hog farm created, the court imposed substantial punitive damages. The conduct of the hog farm owner was incredibly egregious.
In Rattigan v. Wile, 445 Mass. 850, 841 N.E.2d 680 (2006), the parties were adjoining property owners. The defendant had outbid the plaintiff for the tract that the defendant purchased. That fact upset the plaintiff and the plaintiff then successfully challenged the defendant’s building permit. The result was that the defendant could not build on his tract as desired without being in violation of applicable zoning bylaws. The defendant retaliated against the plaintiff by flying his helicopter near the plaintiff’s property and otherwise harassing the plaintiff. The plaintiff sued, and the court entered an injunction against the defendant that also barred the defendant from putting portable toilets on the property line between the parties. The defendant appealed, claiming (in essence) that the plaintiff did not have any negative easement for light, air or view over the defendant’s property. However, the appellate court affirmed the trial court’s order of injunctive relief on the basis that the defendant’s conduct constituted a nuisance. The appellate court also determined that the proper measure of damages was the loss of rental value ($318,000 plus some additional out-of-pocket costs) attributable to the plaintiff’s property. The appellate court, however, modified the trial court’s permanent injunction so as to not limit the defendant’s legitimate uses of his property.
The issue of maliciousness or “spite” often arises with respect to fences. In 1887, Massachusetts enacted one of the earliest “spite fence” statutes in the United States which declared such a fence to be a private nuisance. Mass. Gen. Laws Ch. 348, §1 (1887); presently codified as Mass. Ann. Laws Ch. 49, §21. A “spite” fence is one that is an overly tall structure that is constructed with no legitimate purpose other than to obstruct an adjoining landowner’s light, air or view. For example, in Rice v. Cook, 115 A.3d 86 (Maine 2015), the parties disagreed over the boundary to their adjoining tracts. Neither party knew where the actual boundary was until a survey was completed in 2008, but the survey result upset the defendant and he erected what the court deemed to be a “spite fence” under Maine law which specifies that “[a]ny fence or other structure in the nature of a fence, unnecessarily exceeding 6 feet in height, maliciously kept and maintained for the purpose of annoying the owners or occupants of adjoining property, shall be deemed a private nuisance.” Me. Rev. Stat. Ann. Tit. 17, §2801. The court noted that the evidence clearly demonstrated that the defendant built the fence with the intent to annoy the plaintiff and interfere with the plaintiffs’ use of their property.
A row of trees can also be a “spite fence.” Unless there is some good reason to plant tall trees on a property line with the knowledge that the trees will block a neighbor’s view, the trees could be deemed to be a malicious spite fence and the trees ordered removed. For example, in Wilson v. Handley, 97 Cal. App. 4th 1301 (2002), the plaintiff built a second story addition to her log cabin. The defendant, a neighbor, then planted a row of evergreen trees parallel with the property line. When the trees became mature in the future, they would block the plaintiff’s mountain view from the second story addition. Because the evidence disclosed that the trees were planted to purposely block the view, they were deemed to be a “spite fence” and a private nuisance in violation of California law. Under California law, any fence or other structure in the nature of a fence (such as trees) that exceeds 10 feet in height and is maliciously erected or maintained for the purpose of annoying the owner or occupant of adjoining property is a private nuisance. See, Cal. Civ. Code §6-10 841.4. See also Vanderpol v. Starr, 194 Cal. App. 4th 385 (2011).
The California case is interesting for the fact that the court determined a “spite fence” existed even though the trees at issue would not obscure the view until some future date, if at all. The court noted that some varieties of trees can grow quickly Normally there can be no claim for an “anticipatory nuisance.” In other words, the law does not recognize an action for a nuisance until the nuisance actually occurs. For example, in Blackwell v. Lucas, No. 2017-CA-01492-COA, 2018 Miss. App. LEXIS 582 (Miss. Ct. App. Nov. 20, 2018), the defendants planted some plants and shrubs in the front yard of their home. Their neighbors, the plaintiffs, sued on the basis that the plants and shrubs caused them “mental pain and suffering.” Their complaint sought damages and preliminary and permanent injunctive relief requiring the removal of the plants and shrubs or to restrict their growth and height so that the plaintiffs’ view of the ocean and surrounding areas was not blocked. The defendants motioned to dismiss the case on the basis that the complaint failed to allege a violation of any legally cognizable right. The trial court dismissed the case.
On appeal, the appellate court noted that the plaintiffs’ only allegation of harm was that, if allowed to grow, the plants and shrubs would obstruct their view across the defendants’ property at some undetermined future date. The plaintiffs claimed that this potential future “harm” gave them a viable cause of action for a “spite fence” or nuisance. The appellate court stated that the plaintiffs had no common law or statutory right to an unobstructed view across their neighbors’ property. Nor did they have a right to dictate the type or placement of the defendants’ shrubs. In support of their claim, the plaintiffs cited the only reported Mississippi case concerning a “spite fence.” In that case, the court ordered the removal of a fourteen-foot-high "spite fence." That court relied on a treatise that defined a "spite fence" as "a structure of no beneficial use to the erecting owner or occupant of the premises but erected or maintained by him solely for the purpose of annoying the owner or occupier of adjoining property.” In this case, however, the appellate court pointed out that because the prior opinion was a 5-5 decision there remained no precedent for a “spite fence” claim under Mississippi law. Moreover, the appellate court declined to recognize a new cause of action for a “spite fence” in a case that did not even involve a traditional fence. The appellate court also pointed out that the plaintiffs’ complaint failed to state a claim for the additional reason that it failed to allege that the “plants and shrubs” actually obstructed their view. The complaint merely asserted that, if allowed to grow, the shrubbery would obstruct their view at some unspecified point in the future. Thus, the appellate court held that the plaintiffs’ complaint failed to state a claim upon which relief could be granted and affirmed the trial court’s decision.
American law generally does not recognize a negative easement for light, air or view. But, if the facts of a situation reveal that light, air or view has been obstructed with the intent to cause harm to an adjoining landowner, then a legal right may be impacted. The obstruction can take the form of a traditional fence, trees and shrubs, or the deliberately improper operation of a farm. If whatever is done, is done with malicious intent, a negative easement may be found to exist.
Friday, October 26, 2018
The TCJA eliminated tax-deferred like-kind exchanges of personal property for exchanges completed after 2017. However, exchanges of real estate can still qualify for tax-deferred treatment if the exchange involves real estate that is “like-kind.” But, what does that mean?
Real estate tax-deferred trades and what counts as “like-kind” – that’s the focus of today’s post.
Definition of “Real Estate”
Broad definition. Under the former rules governing trades of personal property, such as farm machinery, the Treasury Regulations determined if property was like-kind by reference to being within the same product class. See Treas. Reg. §1.1031-2(b)(2). Also, property was of a like-kind to property that was of the same nature or character. See Temp. Treas. Reg. §1.1031(a)-2T(d). However, like-kind property personal property did not necessarily have to be of the same grade or quality. In addition, for intangible assets, the determination of like-kind had to be made on an asset-by-asset basis. Thus, a like-kind trade could involve a bull for a bull, a combine for a combine, but not a combine for a sports car or a farm or ranch for publicly traded stock.
With respect to real estate, a much broader definition of like-kind applies. Virtually any real estate used for business or investment can be exchanged for any other real estate if the taxpayer continues to use the replacement property for business or investment. The regulations define “like-kind” in terms of reference to the nature or character of the replacement property rather than its grade or quality. Treas. Reg. §1.1031(a)-1(b); see also C.C.M. 201238027
In addition, it doesn’t matter whether the real estate involved in a tax-deferred exchange is improved or unimproved. Treas. Reg. §1.1031(a)-1(b), (c). Thus, agricultural real estate may be traded for residential real estate. However, if bare farmland is traded for farmland with depreciable structures on it, tax issues can arise. Many farm depreciable buildings and structures are “I.R.C. §1245 property.” For example, commodity storage facilities and single-purpose agricultural structures are I.R.C. §1245 property, as are irrigation systems, drainage tile, and other improvements to farm real estate. If property with an I.R.C. §1245 depreciation recapture attribute is disposed of in an I.R.C. §1031 exchange, the I.R.C. §1245 depreciation recapture must be recognized to the extent that the replacement property has insufficient I.R.C. §1245 property. IRS Form 8824 provides a location for reporting the I.R.C. §1245 depreciation recapture if non-I.R.C. §1245 property is received in the exchange.
Unique situations. While the definition of real estate is rather broad, some distinctions are present. For example, a leasehold interest can be exchanged for fee interests if the leasehold interest has at least 30 years to run at the time the exchange is entered into. Treas. Reg. §1.1031(a)-1(c). Case law also indicates that, at the time the transaction is entered into, the lease must have at least 30 years remaining. See, e.g., VIP Industries Inc. & Subsidiaries v. Comm’r, T.C. Memo. 2013-357.
That 30-year rule is important. The IRS has, apparently, taken the position that an exchange of a remainder interest in a tract of real estate for a life estate (where the life expectancy of the life tenant exceeds 30 years) for another tract of real estate can qualify for like-kind exchange treatment. Rev. Rul. 72-601, 1977-2 C.B. 467. Likewise, a remainder interest in real estate can qualify for like-kind exchange treatment when it is exchanged for a remainder interest (or, probably, a reversionary interest) in a different tract of farmland. Rev. Rul. 78-4, 1978-1 C.B. 256. Also, real estate owned in fee simple can qualify for like-kind exchange treatment when traded for real estate subject to 99-year leases. See, e.g. Koch v. Comr., 71 T.C. 54 (1978).
Also, a sale followed by a leaseback involving terms of 30 years or more has been deemed to be like-kind. Rev. Rul. 60-43, 1960-1 C.B. 687; Jordan Marsh Company v. Comr., 269 F.2d 453 (2d Cir. 1959).
As for land that is being sold under an installment land contract, the buyer’s rights under the contract have been held to be the same as a fee simple interest in the real estate. See, e.g., Starker v. Comr., 602 F.2d 1341 (9th Cir. 1979).
In Peabody Natural Resources Co. v. Comr., 126 T.C. 261 (2006), the Tax Court determined that under New Mexico law, coal supply contract constituted real property interests and were like-kind to gold mine. The case involved the exchange of an operating gold mine, including real estate, for operating coal mines which were subject to coal supply contracts obligating the owner to provide electric utilities with coal. The IRS denied like-kind exchange treatment on the basis that the coal supply contracts weren’t real property. However, the Tax Court determined that under New Mexico law (the state where the coal mines were located) the coal contracts were servitudes (an interest on the underlying land) under New Mexico law. As for the nature and character of the contracts, the Tax Court determined that they couldn’t be separated from the ownership of the coal reserves. They were ancillary to the ownership of the coal reserves. As a result, the contracts were like-kind to the gold mining property.
Perpetual water rights are like-kind to land. Rev. Rul. 55-749, 1955-2 C.B. 295. However, water rights that are limited in duration are not considered like-kind to a fee interest in land. Wiechens v. United States, 228 F. Supp. 2d 1080 (D. Ariz. 2002). But, there can be an exception to that outcome. If the water rights are limited only as to annual use the IRS has ruled that they are of sufficient like-kind to a fee interest in land to qualify the transaction for like-kind exchange treatment. Priv. Ltr. Rul. 200404044 (Oct. 23, 2003).
Impact of State Law
It could be concluded from a read of the above cases and rulings that state law plays a predominant role in determining whether a property interest is an interest in real property that can potentially be eligible for like-kind exchange treatment. That was certainly the case in the early cases dealing with the issue. See, e.g., Morgan v. Comr., 309 U.S. 78 (1940); Aguilino v. United States, 363 U.S. 509 (1960); Comr. v. Crichton, 122 F.2d 181 (5th Cir. 1941); Priv. Ltr. Rul. 200424001 (Dec. 8, 2003). But, other cases indicate that the like-kind determination is a matter of federal law rather than state law. See, e.g., Fleming v. Comr., 24 T.C. 818 (1955), rev’d., 241 F.2d 78 (5th Cir. 1957).
In 2012, the IRS clarified its position on the impact of state law in determining whether a property interest is in interest in real property. In C.C.A. 201238027 (Sept. 21, 2012), the IRS determined that federal income tax law, not state law, controls whether exchanged properties are of like kind for I.R.C. §1031 purposes. While the IRS stated that state law property classifications are relevant for determining if property is real or personal, they aren't determinative of whether properties are of the same nature and character. Instead, that determination is to be made by considering all of the facts and circumstances of the particular transaction and the property interests involved. Id.
The TCJA eliminated the ability to treat personal property trades under the I.R.C. §1031 rules. However, real estate can still be traded in a tax deferred exchange transaction. What constitutes “real estate” is an important first determination. The nature and character of the properties involved in the transaction is the next determination. If those hurdles are successfully cleared, the I.R.C. §1031 rules can provide a preferential tax result.
Thursday, October 18, 2018
For the Spring 2019 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of next spring’s online Ag Law course – that’s the topic of today’s post.
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate. A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course is available here:
You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in January!
Checkout the postcard (401 KB PDF) containing more information about the course and instructor.
October 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Thursday, September 20, 2018
Land ownership includes two separate estates in land – the surface estate and the mineral estate. The mineral estate can be severed from the surface estate with the result that ownership of the separate estates is in different parties. In some states, the mineral estate is dominant. That means that the mineral estate owner can freely use the surface estate to the extent reasonably necessary for the exploration, development and production of the minerals beneath the surface.
The “accommodation doctrine” is a court-made doctrine relating to the mineral owner's right to use the surface estate to drill for and produce minerals. ... The doctrine requires a balancing of the interests of the surface and mineral owner. How that balancing works was at issue in a recent case.
The accommodation doctrine – that’s the topic of today’s post.
The Accommodation Doctrine
If the owner of the mineral estate has only a single method for developing the minerals, many courts will allow that method to be utilized without consideration of its impact on the activities of the surface estate owner. See., e.g., Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013). But, under the accommodation doctrine, if alternative means of development are reasonably available that would not disrupt existing activities on the surface those alternative means must be utilized. For example, in Getty Oil co. v. Jones, 470 S.W.2d 618 (Tex. 1971), a surface estate owner claimed that the mineral estate owner did not accommodate existing surface use.
To prevail on that claim, the Texas Supreme Court, determined that the surface owner must prove that the mineral estate owner’s use precluded or substantially impaired the existing surface use, that the surface estate owner had no reasonable alternative method for continuing the existing surface use, and that the mineral estate owner has reasonable development alternatives that would not disrupt the surface use. A question left unanswered in the 1971 decision was whether the accommodation doctrine applied beyond subsurface mineral use to the exercise of groundwater rights. But, in 2016, the court said that the doctrine said the doctrine applied to groundwater. Coyote Lake Ranch, LLC v. City of Lubbock, No. 14-0572, 2016 Tex. LEXIS 415 (Tex. Sup. Ct. May 27, 2016).
Harrison v. Rosetta Res. Operating, LP, No. 08-15-00318-CV 2018 Tex. App. LEXIS 6208 (Tex Ct. App. Aug. 8, 2018), involved a water-use dispute between an oil and gas lessee and the surface owner. The plaintiff owned the surface of a 320-acre tract. The surface estate had been severed from the mineral estate, with the minerals being owned by the State of Texas. In October 2009, the plaintiff executed an oil and gas lease on behalf of the State with Eagle Oil & Gas Co. Eagle began its drilling operations, but before completing its first well it assigned the lease to Comstock Oil & Gas, L.P., subject to an agreement to indemnify Eagle against claims arising from its operations to that point. Within a few months, the plaintiff and several other plaintiffs sued Eagle for negligently destroying the plaintiff’s irrigation ditch as well as damage resulting from road construction, among other claims. Comstock defended Eagle in the lawsuit and settled a few months later. According to the settlement agreement, Comstock would make repairs to a water well on the plaintiff’s land and purchase 120,000 barrels of water from the plaintiff at a rate of fifty cents per barrel. A plastic-lined “frac pit” was also built on the property to store water produced from the well, although the pit was not a requirement of the settlement agreement. Comstock complied with the agreement and purchased the required amounts of water from the plaintiff at the agreed price. Comstock completed two oil wells on the property that year and began constructing a third well the following year. Before completing the third well, however, Comstock assigned the least to Rosetta Resources Operating, LP, the defendant in this case, who continued construction of the third well and began construction of several more. Unlike Comstock, the defendant did not purchase its water from the plaintiff, choosing instead to pump in water from an adjacent property, a neighbor of the plaintiff.
After learning that the defendant was importing his neighbor’s water, the plaintiff filed suit in his individual capacity and as trustee against the defendant for breach of contract, claiming an employee of the defendant had orally agreed to continue the same arrangement the plaintiff had enjoyed with Comstock. He also sought to permanently enjoin the defendant from using his neighbor’s water and sought cancellation of the State’s oil and gas lease. The defendant filed three motions for summary judgment that collectively challenged all of the plaintiff’s claims. In response, the plaintiff filed an amended petition asserting that the defendant had violated the “accommodation doctrine” by not purchasing his water, thus rendering his well and frac pit useless and unnecessarily causing damage to his property. The trial court granted the defendant’s motions for summary judgment in their entirety. The plaintiff appealed.
The appellate court determined that the plaintiff’s accommodation doctrine arguments appeared to rest on his proposition that because a frac pit was built on his land for use by the former lessee, it unified the use of the land with the oil and gas operations, and when the defendant chose not buy his water it substantially interfered with his existing use of the land as a source of water for drilling operations. Thus, the substantial interference complained of was that the frac pit was no longer profitable because the defendant is not using it to supply water for its operations. The appellate court held that categorizing a refusal to buy goods produced from the land as interference with the land for purposes of the accommodation doctrine would stretch the doctrine beyond recognition. Therefore, because the defendant’s use did not impair the plaintiff’s existing surface use in any way, except in the sense that not buying the water had precluded the plaintiff from realizing potential revenue from selling its water to the defendant, the inconvenience to the surface estate was not evidence that the owner had no reasonable alternative to maintain the existing use. Lastly, the court determined that if it were to hold for the plaintiff on these facts they would, in effect, be holding that all mineral lessees must use and purchase water from the surface owner under the accommodation doctrine if his water is available for use. Accordingly, the appellate court affirmed.
The accommodation doctrine is not designed to substitute for common sense reasonableness when the dominant estate owner has two clear options for doing something that involve the same cost. If one option is more disruptive to the surface owner, inherent limits of reasonable use dictate use of the less disruptive option. The recent Texas case is just another illustration of how courts wrestle with the application of the doctrine.
Thursday, July 26, 2018
Financial distress in the farm sector continues to be a real problem. Low prices in recent years has added to the problem, as have increased debt levels as a result of financed asset purchases during the economic upswing in the ag economy in earlier years. As an example, the level of working capital in the farm sector has fallen sharply since 2012. Working capital for the farm sector as a whole (current assets less current liabilities) is at its lowest level in 10 years, presently at 36 percent of its 2012 peak. In the past year alone, working capital dropped by 18 percent. It has also declined precipitously as a percentage of gross revenue. This means that many farmers have a diminished ability to reinvest in their farming operations. It also means that there is an increased likelihood that a farmer may experience the repossession of farm personal property and real estate. When that happens, the sellers of the assets that repossess have tax consequences to worry about.
Sometimes a Chapter 12 bankruptcy might be filed – and those filings are up in parts of the Midwest and the Great Plains. Other times, farmland might be repossessed.
Tax issues upon repossession of farmland – that’s the topic of today’s post.
Repossession of Farmland
Special exception. A special exception exists under I.R.C. § 1038 that is very favorable to sellers repossessing land under an installment sale – the seller need not recognize gain or loss upon the repossession in either full or partial satisfaction of the debt. It doesn’t matter what method of accounting the seller used in reporting gain or loss from the sale or whether at the time of reacquisition the property has increased or decreased in value since the time of the original sale. However, the rules do not apply if the disposition constitutes a tax-free exchange of the property, and a special problem can be created if related parties are involved. See I.R.C. §453B(f)(2). In addition, for the special rules to apply, the debt must be secured by the real property.
When real property is repossessed, whether the repossession is voluntary or involuntary, the amount of gain recognized is the lesser of - (1) the amount of cash and the fair market value of other property received before the reacquisition (but only to the extent such money and other property exceeds the amount of gain reported before the reacquisition); or (2) the amount of gain realized on the original sale (adjusted sales price less adjusted income tax basis) in excess of the gain previously recognized before the reacquisition and the money or other property transferred by the seller in connection with the reacquisition.
Handling interest. Amounts of interest received, stated or unstated, are excluded from the computation of gain. Because the provision is applicable only when the seller reacquires the property to satisfy the purchaser's debt, it is generally inapplicable where the seller repurchases the property by paying the buyer an extra sum in addition to cancelling the debt. However, if the parties are related, the seller (according to the statute) must report interest debt that is canceled as ordinary income. I.R.C. §453B(f)(2). But, a question exists as to whether that provision applies in financial distress situations.
The rules generally are applicable, however, if the seller reacquires the property when the purchaser has defaulted or when default is imminent even if the seller pays additional amounts.
Debt secured by the real property. The provisions on repossession of real property do not apply except where the indebtedness was secured by the real property. Therefore, reconveyance of property by the obligor under a private annuity to the annuitant would appear not to come within the rules.
Character of gain. The character of the gain from reacquisition is determined by the character of the gain from the original sale. For an original sale reported on the installment method, the character of the reacquisition gain is determined as though there had been a disposition of the installment obligation. If the sale was reported on the deferred payment method, and there was voluntary repossession of the property, the seller reports the gain as ordinary income. If the debts satisfied were securities issued by a corporation, government or political subdivision, the gain would be capital gain.
Basis issues. Once the seller has reacquired the property, it is important to determine the seller's basis in the reacquired property. The adjusted income tax basis for the property in the hands of the reacquiring seller is the sum of three amounts - (1) the adjusted income tax basis to the seller of the indebtedness, determined as of the date of reacquisition; (2) the taxable gain resulting from reacquisition; and (3) the money and other property (at fair market value) paid by the seller as reacquisition costs.
The holding period of the reacquired property, for purposes of subsequent disposition, includes the holding period during which the seller held the property before the original sale plus the period after reacquisition. However, the holding period does not include the time between the original sale and the date of reacquisition.
Is the personal residence involved? The provisions on reacquisition of property generally apply to residences or the residence part of the transaction. However, the repossession rules do not apply if - (1) an election is in effect for an exclusion on the residence (I.R.C. §121) and; (2) the property is resold within one year after the date of reacquisition. See, e.g., Debough v. Comm’r, 142 T.C. No. 297 (2014), aff’d, 799 F.3d 1210 (8th Cir. 2015). If those conditions are met, the resale is essentially disregarded and the resale is considered to constitute a sale of the property as of the original sale. In general, the resale is treated as having occurred on the date of the original sale. An adjustment is made to the sales price of the old residence and the basis of the new residence. If not resold within one year, gain is recognized under the rules for repossession of real property. An exclusion election is considered to be in effect if an election has been made and not revoked as of the last day for making such an election. The exclusion can, therefore, be made after reacquisition. An election can be made at any time within three years after the due date of the return.
No bad debt deduction is permitted for a worthless or a partially worthless debt secured by a reacquired personal residence, and the income tax basis of any debt not discharged by repossession is zero. Losses are not deductible on sale or repossession of a personal residence. When gain is not deferred or excluded, the repossession of a personal residence is treated under the general rule as a repossession of real property. Adjustment is made to the income tax basis of the reacquired residence.
Special situations. In 1969, the IRS ruled that the special provisions on income tax treatment of reacquisition of property did not apply to reacquisition by the estate of a deceased taxpayer. Rev. Rul. 69-83, 1969-1 C.B. 202. A decedent's estate was not permitted to succeed to the income treatment that would have been accorded a reacquisition by the decedent. However, the Installment Sales Revision Act of 1980 changed that result. The provision is effective for “acquisitions of real property by the taxpayer” after October 19, 1980. Presumably, that means acquisitions by the estate or beneficiary. Under the 1980 amendments, the estate or beneficiary of a deceased seller is entitled to the same nonrecognition treatment upon the acquisition of real property in partial or full satisfaction of secured purchase money debt as the deceased seller would have been. The income tax basis of the property acquired is the same as if the original seller had reacquired the property except that the basis is increased by the amount of the deduction for federal estate tax which would have been allowable had the repossession been taxable.
The IRS ruled in 1986 that the nonrecognition provision on repossessions of land does not apply to a former shareholder of a corporation who receives an installment obligation from the corporation in a liquidation when that shareholder, upon default by the buyer, subsequently receives the real property used to secure the obligation. Rev. Rul. 86-120, 1986-2 C.B. 145.
Tax planning is important for farmers that are in financial distress and for creditors of those farmers. As usual, having good tax counsel at the ready is critical. Tax issues can become complex quickly.
Wednesday, July 18, 2018
Next month, Washburn Law School and Kansas State University (KSU) will team up for its annual symposium on agricultural law and the business of agriculture. The event will be held in Manhattan at the Kansas Farm Bureau headquarters. The symposium will be the first day of three days of continuing education on matters involving agricultural law and economics. The other two days will be the annual Risk and Profit Conference conducted by the KSU Department of Agricultural Economics. That event will be on the KSU campus in Manhattan. The three days provide an excellent opportunity for lawyers, CPAs, farmers and ranchers, agribusiness professionals and rural landowners to obtain continuing education on matters regarding agricultural law and economics.
This year’s symposium on August 15 will feature discussion and analysis of the new tax law, the Tax Cuts and Jobs Act, and its impact on individuals and businesses engaged in agriculture; farm and ranch financial distress legal issues and the procedures involved in resolving debtor/creditor disputes, including the use of mediation and Chapter 12 bankruptcy; farm policy issues at the state and federal level (including a discussion of the status of the 2018 Farm Bill); the leasing of water rights; an update on significant legal (and tax) developments in agricultural law (both federal and state); and an hour of ethics that will test participant’s negotiation skills.
The symposium can also be attended online. For a complete description of the sessions and how to register for either in-person or online attendance, click here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/continuingeducation/businessofagriculture/index.html
Risk and Profit Conference
On August 16 and 17, the KSU Department of Agricultural Economics will conduct its annual Risk and Profit campus. The event will be held at the alumni center on the KSU campus, and will involve a day and a half of discussion of various topics related to the economics of the business of agriculture. One of the keynote speakers at the conference will be Ambassador Richard T. Crowder, an ag negotiator on a worldwide basis. The conference includes 22 breakout sessions on a wide range of topics, including two separate breakout sessions that I will be doing with Mark Dikeman of the KSU Farm Management Association on the new tax law. For a complete run down of the conference, click here: https://www.agmanager.info/risk-and-profit-conference
The two and one-half days of instruction is an opportunity is a great chance to gain insight into making your ag-related business more profitable from various aspects – legal, tax and economic. If you are a producer, agribusiness professional, or a professional in a service business (lawyer; tax professional; financial planner; or other related service business) you won’t want to miss these events in Manhattan. See you there, or online for Day 1.
July 18, 2018 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Wednesday, May 9, 2018
Under the typical Conservation Reserve Program (CRP) contract, farmland is placed in the CRP for a ten-year period. Contract extensions are available, and the landowner must maintain a grass cover on the ground which may involve planting appropriate wild grasses and other vegetation and to perform mid-contract maintenance of the enrolled land in accordance with USDA/FSA specifications.
But, what happens if the CRP land is sold even though several years remain on the contract? This is particularly the case when crop prices are relatively high and there is an economic incentive to put the CRP-enrolled land back into production.
The possible penalties and tax consequences of not keeping land in the CRP for the duration of the contract – that the topic of today’s post.
Consequences of Early Termination
When a landowner doesn’t keep land in the CRP for the full length of the contract, the landowner of the former CRP-enrolled land must pay back to the USDA all CRP rents already received, plus interest, and liquidated damages (which might be waived). That’s synonymous with a lessee’s termination of a lease when the obligations under the lease exceed the benefits. When that happens, and the lessee pays a cancellation fee to get out from underneath the lease, the lessee is generally allowed a deduction. The rationale for allowing a deduction is that the lessee does not receive a future benefit, as long as the lease cancellation payment is not integrated in some manner with the acquisition of another property right. If, however, the termination payment is part of a single overall plan involving the acquisition of an affirmative benefit, the taxpayer must capitalize the payment. See Priv. Ltr. Rul. 9607016 (Nov. 20, 1995). That would be the case, for instance, when a lessee terminates a lease by buying the leased property. I.R.C. §167(c)(2) bars an allocation of a portion of the cost to the leasehold interest. Thus, allocations to lease contracts by real estate purchasers of real estate are not effective. The taxpayer must allocate the entire adjusted basis to the underlying capital asset.
Sale Price Allocation To CRP Contract
The IRS has ruled that a taxpayer who sold the right to 90 percent of the revenue from three CRP contracts that had approximately 11 years remaining was required to report the lump sum payment as ordinary gross income in the year of receipt. C.C.A. 200519048 (Jan. 27, 2005). The taxpayer agreed to comply will all of the provisions of the CRP contract, with damage provisions applying if he failed to comply. The taxpayer’s return for the year of sale reported the entire amount received for the sale on Form 4835. On the following year’s return, the taxpayer included the annual CRP payment from the remaining 10 percent on Form 4835 and claimed a deduction for the part which sold the prior year. On the next year’s return, the taxpayer included the total CRP payment and did not offset it with the amount he received from the buyer. The taxpayer later filed amended returns to remove the amount reported as income on Form 4835 in the year of sale, and to remove the expense deduction that was claimed on the following year’s return. The taxpayer claimed that the lump-sum was not income in the year of sale because he did not have the unrestricted right to the funds (due to the damage clause applying in the event of noncompliance), and only held them as a conduit. The IRS disagreed, noting that the taxpayer had received the proceeds from the sale of the CRP contracts, with the risk of nonpayment by the USDA shifted to the purchaser. The IRS also stated that amounts received under a claim of right are includable in income, even though the taxpayer may have to repay some portion at a later date. In addition, the IRS noted that a lump sum payment for the right to future ordinary income generally results in ordinary income in the year of receipt. See, e.g., Cotlow v. Comr., 22 T.C. 1019 (1954), aff’d., 228 F.2d 186 (2nd Cir. 1955).
The acquiring farmer may pay the early termination costs. In such case, the payment should be considered part of the land, as an additional cost incurred to acquire full rights in the property (i.e., a payment made to eliminate an impediment to full use of the property).
Early Termination Payments
Generally. A lessor’s payment to the lessee to obtain cancelation of a lease that is not considered an amount paid to renew or renegotiate a lease is considered a capital expenditure subject to amortization by the lessor. Treas. Reg. §1.263(a)-4(d)(7). The amortization period depends on the intended use of the property subject to the canceled lease.
If the lessor pays a tenant for early termination to regain possession of the land, the termination costs should be capitalized and amortized over the lease’s remaining term. Rev. Rul. 71-283. However, if early termination costs are incurred solely to allow the sale of the farm, the costs should be added to the basis of the farmland and deducted as part of the sale.
As applied to CRP contracts. A landlord paying early CRP termination costs to enter into a new lease of farmland with another farmer will capitalize and amortize the costs over the remaining term of the CRP contract that is being terminated. That’s the case where a lease cancelation is not tied to substantial improvements that are to be made to the property. However, the IRS might claim that such costs should be amortized over the term of the new lease if the new lease is for a longer period that the remaining term of the CRP contract. However, the U.S. Court of Appeals for the Ninth Circuit has questioned this position, noting that the Tax Court decision seeming to bolster the IRS position relied on court cases that seemed to alternate between using the unexpired lease term versus the new lease term. Handlery Hotels, Inc. v. United States, 663 F.2d 892 (9th Cir. 1981). Thus, the general rule that lease cancelation costs should typically be written off over the unexpired term of the canceled lease.
The early disposition of a CRP contract carries with it some substantial consequences, both financial and tax. It’s important to understand what might happen if early termination is a possibility.