Wednesday, December 17, 2014
In Belk v. Commissioner, No. 13-2161 (Dec. 16, 2014), the 4th Circuit affirmed a Tax Court ruling that a conservation easement that authorized the parties to agree to “substitutions” or “swaps” (i.e., to remove some or all of the original protected land from the easement in exchange for the protection of other land) was not eligible for a federal charitable income tax deduction because it was not “a restriction (granted in perpetuity) on the use which may be made of the real property” as required under § 170(h)(2)(C). The 4th Circuit agreed with the Tax Court that, to be eligible for a deduction under § 170(h), a donor must grant an easement with regard to a “single, immutable” or “defined and static” parcel.
The Belks purchased 410 acres near Charlotte, North Carolina, and developed a 402-lot residential community along with a 184-acre golf course (pictured above) on the land. In 2004, the Belks donated a conservation easement on the golf course to a land trust and claimed a deduction of $10.5 million.
The conservation easement authorizes the landowner to remove land from the easement in exchange for adding an equal or greater amount of contiguous land, provided that, in the opinion of the grantee:
- the substitute property is of the same or better ecological stability,
- the substitution shall have no adverse effect on the conservation purposes of the easement, and
- the fair market value of the “easement interest” on the substitute land will be at least equal to or greater than the fair market value of the “easement interest” encumbering the land to be removed.
This substitution provision, explained the 4th Circuit, permits the landowner “to swap land in and out of the Easement” with the agreement of the land trust.
In affirming the Tax Court’s holding that the Belks were not eligible for a federal deduction for the donation of the easement, the 4th Circuit first noted that the “Treasury Regulations offer a single -- and exceedingly narrow -- exception to the requirement that a conservation easement impose a perpetual use restriction”—i.e.:
[if a] subsequent unexpected change in the conditions surrounding the property . . . make[s] impossible or impractical the continued use of the property for conservation purposes, the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding and all of the donee’s proceeds . . . from a subsequent sale or exchange of the property are used by the donee organization in a manner consistent with the conservation purposes of the original contribution. Treas. Reg. § 1.170A-14(g)(6)(i) (emphasis added by the court).
“[A]bsent these ‘unexpected’ and extraordinary circumstances,” explained the 4th Circuit, “real property placed under easement must remain there in perpetuity in order for the donor of the easement to claim a charitable deduction.”
The 4th Circuit then proceeded to reject each of the Belks’ specific arguments.
Plain Language of the Code
The Belks argued that § 170(h) “requires only a restriction in perpetuity on some real property, rather than [on] the real property governed by the original easement." The 4th Circuit noted that the plain language of § 170(h) belies this contention. The court explained that § 170(h) expressly defines a “qualified property interest” to include “a restriction (granted in perpetuity) on the use which may be made of the real property” and placement of the article “the” before “real property” makes clear that a perpetual use restriction must attach to a defined parcel of real property rather than simply some or any (or interchangeable parcels of) real property.
The 4th Circuit further explained that, although the easement purports to restrict development rights in perpetuity for a defined parcel of land, upon satisfying the conditions in the substitution provision the taxpayers may remove land from that defined parcel and substitute other land. Accordingly, “while the restriction may be perpetual, the restriction on ‘the real property’ is not.” For this reason, the easement donation did not constitute a “qualified conservation contribution” under § 170(h) and the Belks were not entitled to claim a deduction for the contribution.
The 4th Circuit explained that permitting a deduction for the donation of the Belk easement would enable taxpayers to bypass several requirements critical to the statutory and regulatory schemes governing deductions for charitable contributions.
For example, permitting the Belks to change the boundaries of the easement would render “meaningless” the requirement that an easement donor obtain a qualified appraisal because the appraisal would no longer be an accurate reflection of the value of the easement, parts of which could be clawed back. “It matters not,” said the court, “that the Easement requires that the removed property be replaced with property of ‘equal or greater value,’ because the purpose of the appraisal requirement is to enable the Commissioner, not the donee or donor, to verify the value of a donation. The Easement’s substitution provision places the Belks beyond the reach of the Commissioner in this regard.”
Similarly, the baseline documentation requirement (i.e., the requirement that a conservation easement donor make available to the donee documentation sufficient to establish the condition of the property at the time of the donation) “would also be skirted if the borders of an easement could shift.” “Not only does this regulation confirm that a conservation easement must govern a defined and static parcel,” explained the court, “it also makes clear that holding otherwise would deprive donees of the ability to ensure protection of conservation interests by, for instance, examination of maps and photographs of ‘the protected property.’”
The 4th Circuit also rejected the Belks’ argument that the provision in the Treasury Regulations permitting a tax-deductible conservation easement to be extinguished “in one limited instance” (i.e., in a judicial proceeding upon a finding of impossibility or impracticality) “would be invalid” if the Tax Court’s holding were upheld. The court explained that the regulation permitting extinguishment by court order if an easement can no longer further its conservation purpose does nothing to undercut the correctness of the Tax Court’s holding that § 170(h) requires a donor to grant an easement with regard to “a single, immutable parcel” to qualify for a charitable deduction.
Simmons and Kaufman Distinguishable
The Belks argued that Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012) and Commissioner v. Simmons, 646 F.3d 6 (D.C. Cir. 2011) support the notion that § 170(h) does not require that restrictions attach to a single, defined parcel. The 4th Circuit rejected that argument, explaining that these “out-of-circuit” cases:
plausibly stand only for the proposition that a donation will not be rendered ineligible simply because the donee reserves its right not to enforce the easement. They do not support the Belks’ view that the grant of a conservation easement qualifies for a charitable deduction even if the easement may be relocated. Indeed, as we have explained, such a holding would violate the plain meaning of § 170(h)(2)(C).
Federal Law Controls Eligibility for Deduction
The Belks argued that, because North Carolina law permits parties to amend an easement, the Tax Court’s logic would render all conservation easements in North Carolina ineligible for a deduction under § 170(h). The 4th Circuit found this argument “equally unpersuasive,” explaining:
whether state property and contract law permits a substitution in an easement is irrelevant to the question of whether federal tax law permits a charitable deduction for the donation of such an easement . . . § 170(h)(2)(C) requires that the gift of a conservation easement on a specific parcel of land be granted in perpetuity to qualify for a federal charitable deduction, notwithstanding the fact that state law may permit an easement to govern for some shorter period of time. Thus, an easement that, like the one at hand, grants a restriction for less than a perpetual term, may be a valid conveyance under state law, but is still ineligible for a charitable deduction under federal law.
Savings Clause Does not Save Deduction
The Belk conservation easement provides that substitutions become final when they are reflected in a formal recorded “amendment.” The easement also provides that the land trust cannot agree to any amendment that would result in the easement failing to qualify for a deduction under § 170(h). The Belks referred to this latter provision as a “savings clause.” They argued that if the 4th Circuit found that the substitution provision violated the requirements of § 170(h), the savings clause would operate to void the offending provision, thus rendering the easement eligible for the deduction. In other words, explained the 4th Circuit, the Belks argued that the savings clause would operate to negate a right clearly articulated in the easement (the right to substitute property), but only if triggered by an adverse determination by the court.
The 4th Circuit declined to give the savings clause that effect. Citing to Commissioner v. Procter, 142 F.2d 824 (4th Cir. 1944), the court explained that “the IRS and the courts have rejected ‘condition subsequent’ savings clauses, which revoke or alter a gift following an adverse determination by the IRS or a court.” The court further noted that the Belks were asking the court to employ the savings clause to rewrite the easement in response to the court’s holding and “[t]his we will not do.”
The 4th Circuit also rejected the Belks’ “last-ditch” argument—that the savings clause is designed “to accommodate evolving … interpretation of Section 170(h)”—explaining
the statutory language of § 170(h)(2)(C) has not “evolved” since the provision was enacted in 1980…. The simple truth is this: the Easement was never consistent with § 170(h), a fact that brings with it adverse tax consequences. The Belks cannot now simply reform the Easement because they do not wish to suffer those consequences.
The 4th Circuit concluded by noting:
were we to apply the savings clause as the Belks suggest, we would be providing an opinion sanctioning the very same “trifling with the judicial process” we condemned in Procter…. Moreover, providing such an opinion would dramatically hamper the Commissioner’s enforcement power. If every taxpayer could rely on a savings clause to void, after the fact, a disqualifying deduction (or credit), enforcement of the Internal Revenue Code would grind to a halt.
The 4th Circuit’s opinion in Belk complements Carpenter v. Commissioner, T.C. Memo. 2013-172, denying motion for reconsideration and supplementing T.C. Memo. 2012-1, in which the Tax Court held that conservation easements extinguishable by mutual agreement of the parties, even if only in the event of “impossibility,” were not eligible for the charitable deduction under § 170(h). Rather, extinguishment of a tax-deductible easement requires a judicial proceeding and there are no alternatives.
Finally, it is noteworthy that, while Belk involved a conservation easement encumbering a golf course (and golf course easements have been subject to much criticism), nothing in the 4th Circuit’s opinion turned on that fact.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law