The Tax Court held that a taxpayer was not entitled to a charitable deduction for a contribution of a conservation easement on land subject to a mortgage because the mortgagee’s rights in the land had not been subordinated to the rights of the charitable organization that received the easement.
Charles and Ramona Mitchell purchased a large tract of ranchland in Mancos, Colo., in two separate transactions from a rancher, Clyde Sheek. In the second transaction (which comprised the bulk of the land) the Mitchells made a down payment to Sheek and executed a promissory note for the remaining amount of the purchase price secured by a deed of trust on the land. The Mitchells later transferred all the land to a family limited partnership in which they were equal partners.
On Dec. 31, 2003, the partnership granted a conservation easement on 180 acres of unimproved land in the tract to a qualified organization. At the time the easement was granted, the deed of trust securing the debt to Sheek was not subordinated to the easement. From 2003 to 2005, the partnership had the money to pay off the promissory note, which the deed of trust secured, at any time. There were no lawsuits, potential or otherwise; all bills were paid; payments on the promissory note to Sheek were current; and casualty insurance was in place. Two years after the partnership granted the conservation easement, Sheek agreed to subordinate his deed of trust to the conservation easement but received no consideration for the subordination. On Dec. 22, 2005, Sheek signed a subordination agreement.
In 2004, the Mitchells had the conservation easement appraised as of Dec. 31, 2003. The appraiser determined the conservation easement’s fair market value was $504,000. The partnership claimed a $504,000 charitable contribution deduction, which flowed through to Charles and Ramona equally. The couple claimed a $504,000 charitable contribution deduction on their 2003 joint federal income tax return.
The IRS disallowed the 2003 charitable contribution deduction in 2010 with respect to Ramona Mitchell (Charles had died in 2006). It disallowed the deduction on the grounds that the transfer of the easement had not met the requirements of Sec. 170 because the mortgage on the land was not subordinated to the right of the organization that received the easement to enforce the conservation purposes of the easement in perpetuity as required by Regs. Sec. 1.170A-14(g)(2). Mrs. Mitchell challenged the IRS’s determination in Tax Court.
The Tax Court’s Decision
The Tax Court held that the IRS had properly disallowed the deduction for the contribution of the conservation easement because the mortgage on the land had not been subordinated to the rights of the easement’s holder as required under the regulations. Mrs. Mitchell had argued to the court that the mortgage was subordinated by virtue of the subordination agreement signed by the mortgagee, Clyde Sheek, in 2005. In the alternative, she argued that Regs. Sec. 1.170A-14(g)(2) should be read together with Regs. Sec. 1.170A-14(g)(3), which states that a deduction should not be disallowed because of the possibility of a remote event. Because, according to Mitchell, the possibility of her defaulting on the mortgage was so remote as to be negligible, the fact that the easement might be defeated due to a lack of subordination of the mortgage should be disregarded.
The Tax Court found that the subordination requirement had not been met with respect to contribution of the easement because it was not met at the time Mitchell gave the easement to the charitable organization. Sheek did not subordinate the mortgage until December 2005, and had Mitchell defaulted between the date of the gift and that time, Sheek could have foreclosed on the mortgage and eliminated the conservation easement. Thus, at the time of the gift in 2003, the conservation easement was not protected in perpetuity.
The Tax Court also rejected the idea that Regs. Sec. 1.170A-14(g)(3) should be read together with Regs. Sec. 1.170A-14(g)(2). The Tax Court found that the drafters of Regs. Sec. 1.170A-14(g)(2) “saw taxpayers defaulting on their mortgages as more than a remote possibility. Therefore they drafted a specific provision which would absolutely prevent a default from destroying a conservation easement’s grant in perpetuity.” Thus, the Tax Court concluded that it would not read Regs. Sec. 1.170A-14(g)(3) to overrule the strict requirement of subordination in Regs. Sec. 1.170A-14(g)(2).
In its opinion, the Tax Court discussed Simmons , 646 F.3d 6 (D.C. Cir. 2011), in which the court held that the so-remote-as-to-be-negligible rule from Regs. Sec. 1.170A-14(g)(3) applied to save a deduction for a contribution of a conservation easement from IRS challenge. The key difference in Simmons was that in that case, the taxpayer raised the rule to defeat a general argument made by the IRS that a conservation easement was not made for perpetuity, rather than to attempt to excuse noncompliance with one of the several specific requirements in Regs. Sec. 1.170A-14(g) that an easement must meet for the taxpayer to qualify for a charitable contribution deduction.
Mitchell, 138 T.C. No. 16 (2012)