The Tax Court disallowed charitable deductions for a taxpayer's donations of two conservation easements on a tract of land to a qualified land trust because the easements did not constitute a "qualified real property interest" that could give rise to a charitable contribution deduction under Sec. 170(h)(1)(A); however, it found that a third easement on the same property was a qualified real property interest and the taxpayer was entitled to a charitable deduction for its donation.
Background
Pine Mountain Preserve LLLP (PMP) acquired a tract of land (the Pine Mountain property) near Birmingham, Ala. In 2005, 2006, and 2007, PMP conveyed easements covering relatively small portions of the Pine Mountain property to the North American Land Trust (NALT), a qualified land trust. Each of the easements defined a conservation area that was to be restricted in perpetuity from commercial and residential development. While each easement differed in some ways, all three contained a provision that allowed PMP and NALT "in their sole discretion, to agree to amendments to this Conservation Easement which are not inconsistent with the Conservation Purposes."
The stated conservation purpose in the 2005 easement was the preservation of the conservation area "as a relatively natural habitat of fish, wildlife, or plants" and "as open space which provides scenic enjoyment to the general public and yields a significant public benefit." However, the easement reserved a host of rights to PMP and its successors, including the right to 10 building areas inside the conservation area. In each of the building areas, the PMP or its successors (including individual homeowners) could construct one single-family dwelling, as well as a shed, garage, gazebo, vehicle parking area, and pool. The location of the building areas was set out in an appendix to the easement, but under the terms of the easement, the building areas could be moved to other locations within the conservation area with NALT's consent. The easement also allowed the future homeowners to construct other things in the conservation area, including certain buildings, roads, trails, walkways, ponds, and boat launches, and it reserved for the homeowners certain hunting and fishing rights in the conservation area.
The conservation purpose in the 2006 easement was the same as that in the 2005 easement, except that it added another purpose: preservation of the 2006 conservation area "as open space that will advance a clearly delineated Federal, State, or local government conservation policy." Like the 2005 easement, it included a carve-out for building areas, but only for six such areas. The easement reserved similar rights to PMP and individual homeowners within the building areas and the overall conservation area. However, the easement did not specify the location of the building areas and placed no limitation on the location of the areas, except that the location of the areas required NALT's approval. Also, the easement allowed for the construction of a water tower in the conservation area but did not allow for the construction of most of the other structures that the 2005 conservation easement allowed the future homeowners to construct.
The 2007 easement included the same conservation purposes for the conservation area as the 2005 easement. It did not, however, designate any building areas and permitted no residential construction in the conservation area. The easement permitted PMP to construct a water tower and related pipelines in the conservation area, as well as the construction of fences, trails, service roads, etc., in the area. It also granted PMP hunting and fishing rights like those in the 2005 and 2006 easements.
PMP timely filed Forms 1065, U.S. Return of Partnership Income, for tax years 2005, 2006, and 2007. On these returns it claimed charitable contribution deductions of $16,550,000, $12,726,000, and $4,100,000, respectively, for its donation of the 2005, 2006, and 2007 easements. The IRS selected these returns for examination and issued a final partnership administrative adjustment for each year, each of which disallowed the claimed charitable contribution deduction for the respective year in its entirety. The IRS contended that the grants of the easements did not meet the Sec. 170 requirements for a deduction because the easements were not qualified real property interests under Sec. 170(h)(1)(A) and they were not made "exclusively for conservation purposes" under Sec. 170(h)(1)(C).
The statutory framework
Sec. 170(a)(1) allows a deduction for any charitable contribution made within the tax year. Regs. Sec. 1.170A-1(c)(1) states that if the taxpayer makes a charitable contribution of property other than money, the amount of the contribution is generally equal to the fair market value of the property at the time the gift is made.
Generally, under Sec. 170(f)(3)(A), a taxpayer's charitable contribution deduction for the donation of a partial interest in property is restricted. An exception to this rule is made for a qualified conservation contribution in Sec. 170(f)(3)(B)(iii). Under Sec. 170(h)(1), a contribution is a qualified conservation contribution if (1) the interest contributed is a qualified real property interest, (2) the donee is a qualified organization, and (3) the contribution is exclusively for conservation purposes.
A qualified real property interest includes "a restriction (granted in perpetuity) on the use which may be made of the real property" (Sec. 170(h)(2)(C)). Regs. Sec. 1.170A-14(b)(2) provides that a "perpetual conservation restriction" is a restriction — including an easement, restrictive covenant, or equitable servitude — "granted in perpetuity on the use which may be made of real property" and that "[a]ny rights reserved by the donor in the donation of a perpetual conservation restriction must conform to the requirements" of Sec. 170(h) and the regulations thereunder.
Belk cases: The Tax Court's first foray into Sec. 170(h)(2)(C) and the substitution of property in conservation easements was in Belk, 140 T.C. 1 (2013), supplemented by Belk, T.C. Memo. 2013-154, aff'd, Belk, 774 F.3d 221 (4th Cir. 2014). In the Belk cases, the taxpayer had granted a conservation easement on a golf course. Under the terms of the easement, the taxpayer, with the approval of the donee trust, could remove land from the conservation area specified in the easement and replace it with land of equal size and quality outside but contiguous to the conservation area. The taxpayer argued that because the conservation purpose of the easement was protected in perpetuity as required by Sec. 170(h)(5)(A), the perpetuity requirement in Sec. 170(h)(2)(C) was also satisfied.
The Tax Court disagreed, finding that the perpetuity requirements in Secs. 170(h)(5)(A) and 170(h)(2)(C) were separate and distinct requirements and that nothing in the statute and its legislative history suggested that the perpetuity requirement in Sec. 170(h)(2)(C) was necessarily satisfied if the conservation purpose of an easement satisfied the perpetuity requirement in Sec. 170(h)(5)(A). To satisfy the perpetuity requirement of Sec. 170(h)(2)(C), the Tax Court averred that a perpetual use restriction must attach to an interest in an identifiable, specific piece of real property. Because the taxpayer in Belk could replace portions of the land protected under the easement and replace them with property that was not protected by easement, the court determined that the taxpayer had not donated an interest in an identifiable, specific piece of real property subject to a use restriction granted in perpetuity.
The taxpayer appealed the case to the Fourth Circuit, which affirmed the Tax Court. The taxpayer contended that Sec. 170(h)(2)(C) requires only a perpetual restriction on some real property, rather than the real property governed by the original easement. Rejecting this contention, the Fourth Circuit stated that the language of the statute made 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."
Bosque Canyon Ranch cases: The Sec. 170(h)(2)(C) perpetuity requirement again arose in Bosque Canyon Ranch, L.P., T.C. Memo. 2015-130, vacated and remanded sub nom. BC Ranch II, L.P., 867 F.3d 547 (5th Cir. 2017). In that case, the taxpayer donated easements to NALT that allowed it to place homesites within the conservation area and allowed the taxpayer at a later date to move the homesites to other locations within the conservation area. The taxpayer argued that the easements differed from the ones donated by the taxpayer in Belk, because under each easement, only the boundaries of the homesites within the easement could be changed and the outer boundaries of the conservation area could not be changed. Thus, because the overall conservation area would remain the same, it had donated an easement that restricted an identifiable, specific piece of real property, thereby meeting the perpetuity requirement of Sec. 170(h)(2)(C).
The Tax Court, however, did not find the differences between the taxpayer's easements and the Belk easements meaningful and held that the easements did not satisfy Sec. 170(h)(2)(C). While the overall conservation area remained the same under the easements, because the location of the homesites could be changed, some of the property protected by the original easements could end up being unprotected. Thus, the court determined that the easements still failed to put a use restriction on a specific, identifiable piece of real property.
The taxpayer appealed the decision to the Fifth Circuit, which reversed the Tax Court's decision. The Fifth Circuit concluded that the potential movement of the homesites could not "conceivably detract from the conservation purposes" for which the easement was granted, and consequently, the perpetuity requirement of Sec. 170(h)(2)(C) was met.
The Tax Court's decision
The Tax Court, sitting en banc, held that PMP could take a charitable contribution deduction for the 2007 easement but not for the 2005 and 2006 easements. The court found that the easements did not restrict a specific, identifiable piece of property because they allowed supposedly conserved land to be taken back and used for residential development. Consequently, the Tax Court determined that the easements were not qualified real property interests that gave rise to a qualified charitable conservation deduction.
Because PMP had its principal place of business in Alabama, the appeal of the case would lie to the Eleventh Circuit, which has not addressed the issue presented. Therefore, although PMP's facts were very similar to the facts in BC Ranch II, L.P., the Tax Court was under no obligation to follow the Fifth Circuit's opinion from that case. Not surprisingly, the Tax Court thought the approach that it and the Fourth Circuit took in the Belk cases (which it also followed in Bosque Canyon Ranch, L.L.P.) was correct and chose to apply the same approach to PMP's case.
2005 and 2006 easements: Under the 2006 easement, the court explained, PMP was free to locate its six reserved building areas anywhere within the conservation area. According to the court, "it was impossible to define, when the 2006 easement was granted, what 'real property' would actually be restricted from development." Thus, the restriction in the easement did not attach at the outset to a defined parcel of real property, so the easement could not be a qualified real property interest.
With regard to the 2005 easement, the Tax Court noted that while the building areas in the 2005 easement conservation area were defined in the easement, they could be moved within the conservation area with the consent of NALT and there was no limit on the number of homesites that could be moved, how often they could be moved, or when they could be moved. The court also found that the right reserved to PMP to construct numerous additional buildings for the use of homeowners and guests in the conservation area also effectively expanded the potential area subject to residential development well beyond the 10 acres reserved in the original easement for the building areas. Therefore, the court concluded that, like the 2006 easement, the 2005 easement did not attach at the outset to a defined parcel of real property and could not be qualified real property.
The Tax Court also addressed the argument that PMP's right to take back conserved land by relocating the building areas was permissible because any relocated building areas would still be within the boundaries of the conservation area set out in the easements. The court explained that while the building areas are within the conservation area, they are not subject to the easements in any meaningful sense. As the court pointed out, the stated purpose of the easements was to conserve natural fish and wildlife habitats and preserve open spaces, and accordingly the easements forbid all residential development and the erection of structures in the conservation area. As the building areas were to be used specifically for residential development, the court found that they were exempt from the easements because they permit uses antithetical to the easements' conservation purposes.
2007 easement: The Tax Court looked favorably upon the 2007 easement because, unlike the other two, it did not designate any building areas or permit any residential construction in the conservation area and did not reserve to PMP the right to build auxiliary structures other than a water tower and related underground pipes and hunting blinds. The court found that these would have no effect on whether the perpetuity requirement under Sec. 170(h)(2)(C) was met, so the court found that the 2007 easement met the perpetuity requirements of Sec. 170(h)(2)(C) and was a qualified real property interest and that PMP was entitled to a charitable deduction for the donation of the easement.
Other arguments against the 2007 easement: The IRS also attacked the 2007 easement based on a general amendment provision allowing PMP and NALT to agree to amendments to the easement that were not inconsistent with their conservation purposes. The IRS argued that this provision could enable PMP and NALT to amend the easement in ways that would violate the statutory perpetuity requirements. Therefore, the restrictions in the easement should be regarded as not being restrictions in perpetuity.
The court stated that it had found no support for the IRS's position in the statute, regulations, decided cases, or legislative policy underlying the statute, and that if this position were generally adopted, it would prevent any donor of an easement that permitted amendments from qualifying for a charitable contribution. Accordingly, it rejected the argument.
The IRS also argued that while the 2007 easement protected a valid conservation purpose, the easement was not made exclusively for conservation purposes as required by Sec. 170(h)(1)(C) because the conservation purpose was not protected in perpetuity. While PMP presented testimony from an NALT biologist in its defense on this point, the IRS produced no evidence at all, so the Tax Court rejected this argument.
Reflections
PMP will undoubtedly appeal this case to the Eleventh Circuit, and, regardless of how it decides, the court's decision will be ripe for review by the Supreme Court because of the circuit split on the issue. However, given the Supreme Court's reluctance to hear tax cases, and the limited number of situations that involve the issue, it seems unlikely that it would take the case. Thus, how a conservation easement like PMP's is treated for tax purposes will probably continue to depend on the federal circuit in which the land is located.
Pine Mountain Preserve, LLLP, 151 T.C. No. 14 (2018)
