Top-of-market valuation for conservation easement upheld

By James A. Beavers, CPA, CGMA, J.D., LL.M.

The Tax Court held that a real estate development limited liability company (LLC) had not overstated the value of a charitable contribution of a qualified conservation easement and that the charitable deductions taken by two members of the LLC for their passed-through share of the contribution were reasonable.


Ex-NFL player Warren Sapp and a doctor, Kumar Rajagopalan (the taxpayers), were members of SS Mountain LLC (SS Mountain), a North Carolina LLC formed in September 2004. Less than a month before SS Mountain's formation, some of the LLC's future members began buying up mountain land in Haywood County in western North Carolina. They bought seven parcels between August 2004 and July 2005 in arm's-length sales financed by banks that performed their own appraisals of the properties.

At the beginning of 2005, four of the parcels of land were transferred to SS Mountain, and the LLC bought a fifth in its own name in July 2005, resulting in the LLC's owning a 120.233-acre parcel of property (the Haywood property). The total purchase price of the Haywood property was just under $3 million. SS Mountain could have divided all the land into 37 lots for sale. Instead, wishing to preserve the natural beauty of a large portion of the land, the members of the LLC decided to create a 12-lot subdivision on the property and leave the other 25 lots as open space.

To preserve the land as open space, the LLC at the end of November 2006 contributed an easement exclusively for conservation purposes of 89.4 acres of the Haywood property to the North American Land Trust (NALT), a qualified charitable organization. Though a provision in the easement allowed for amendments to it by the parties, under its terms the NALT could not agree to amendments that would disqualify the easement as a valid conservation agreement.

While the conservation easement was being worked out, SS Mountain began selling the 12 home lots reserved for development. In 2006, contracts for three of the lots were signed with parties unrelated to the LLC and a fourth with Kumar Rajagopalan, all for purchase prices of $750,000. That same month, HomeTrust Bank loaned SS Mountain $5 million secured by the 12 home lots. While this was considerably more than what the LLC members and the LLC had paid for the entire Haywood property, before making the loan, HomeTrust had itself completed an appraisal of the lots, which showed each had a value of more than $750,000. In September 2007, Sapp also bought one of the 12 home lots for $1.1 million. HomeTrust loaned him $900,000 for the purchase, based again on its own appraisal, which showed that the lot was worth the loaned amount.

Before the initial sales of the home lots could be closed, the real estate market bubble that had long been building up in the United States started to collapse. The Haywood County real estate market, like the rest of the country's, was hit hard. Some of the sales of the Haywood property home lots ended up not closing.

In July 2007, on its Form 1065, U.S. Return of Partnership Income, SS Mountain reported a noncash charitable contribution of $4,879,000 for the donation of the conservation easement to the NALT and attached a qualified appraisal for the contribution to its return. It reported the members' shares of the charitable contributions to them on their Schedules K-1, Partner's Share of Income, Deductions, Credits, etc., from the LLC.

Kumar Rajagopalan and Warren Sapp, based on the passthrough amounts, claimed noncash charitable deductions, respectively, of more than $190,000 and more than $2.1 million for SS Mountain's donation of the conservation easement on their timely filed 2006 returns. Both attached qualified appraisals to their returns.

The IRS issued notices of deficiency to both taxpayers, asserting tax deficiencies and penalties for tax year 2006. The IRS claimed that either the conservation easement was not a contribution of a qualified property interest for which a charitable contribution could be taken or the value of the easement had been overstated. The taxpayers sought review of the IRS's determinations in the Tax Court.

The Tax Court's decision

The Tax Court held that the taxpayers were entitled to the full amount they claimed as charitable contribution deductions on their individual returns for the donation by SS Mountain of the conservation easement on the Haywood property. The court determined that the easement was a contribution of a qualifying property interest and, due to the unusual circumstances in the real estate market at the time the easement was donated, the fair market value (FMV) of the conservation easement was at least as much as the amount claimed as a charitable contribution by the LLC, and therefore the charitable contribution deductions claimed by the taxpayers for their passthrough shares of the charitable contribution were reasonable.

Contribution of a qualifying property interest: The IRS argued that the easement was not a qualifying property interest because the deed of easement had a clause that allowed certain amendments to be made to it and, thus, the restriction in the deed was not granted in perpetuity as required under Sec. 170(h)(2)(C). The Tax Court found that it had expressly rejected this argument before in Pine Mountain Preserve, LLLP, 151 T.C. 247 (2018), and it was required to follow its precedent from that case. Thus, it found that the contribution of the easement was a contribution of a qualifying property interest.

Value of the easement: The value of a conservation easement donated under Sec. 170 is its FMV at the time of the contribution. In determining the FMV, the regulations require the use of sales of property with easements comparable to the donated easement if there is a substantial record of such sales. If there is no substantial record of comparable sales, the FMV of the easement is the difference between the FMV of the property it encumbers before the granting of the restriction and the FMV of the encumbered property after the granting of the restriction, commonly known as the before-and-after test. In making its determination, a court must consider the properties' highest and best use before and after the easement grant.

The parties and the Tax Court agreed that, after the easement, the highest and best use of the Haywood property was for a 12-home lot subdivision, with the conserved area under the easement as open space. The court thus valued the Haywood property in two parts — one consisting of the 12 home lots that were to be developed after the easement and the other consisting of the 25 lots, the development of which was forgone due to the easement.

In determining the before and after values for the property, generally either the comparable-sales method or the income method is used. The comparable-sales method looks at transactions that involve properties similar to the subject property, completed at arm's length, and sold within a reasonable time of the valuation date. The income approach projects the future cash flows the property will generate at its highest and best use, under the assumption that an investor would pay no more than the present value of the property's anticipated future income.

The parties hired experts for the trial. The taxpayers' expert used the comparable-sales and the income methods in determining the before and after values of the property. The IRS's expert used the comparable-sales method in his analysis. The taxpayers' expert found the before FMV of the easement was $4.15 million, and the IRS's expert found it was $1.28 million, both well below the amount needed to support the value for the easement SS Mountain claimed on its return.

The Tax Court, however, found deficiencies in the methods of both experts and went in a different direction in valuing the conservation easement. Finding that the property had a recent and reliable, and therefore relevant, transactional history, it abandoned the use of sales of nearby comparable properties in its determination of the FMV of the easement and instead relied entirely on the transactional history of the Haywood property itself to determine the FMV. The items it considered included the sales transactions of the home lots, the various bank loans related to the properties and the appraisals completed for the loans, and the county tax records.

On its return, SS Mountain had reported a value for the conservation easement of $4.879 million. The Tax Court, for purposes of its analysis, assumed that the value of the land encumbered by the easement (the land in the conserved area) was $560,000 (as was claimed by the IRS's expert). Accordingly, under the before-and-after test, in order for SS Mountain's valuation of the easement (and by extension, the taxpayers' valuation of their share of the easement) to be correct, the land encumbered by the easement must have had an FMV of at least $5.439 million before the easement donation.

The Tax Court, looking at the problem from two different perspectives, found that the value of the land in the conserved area was at least, if not more than, $5.439 million under the prevailing market conditions at the time the easement was donated. Thus, the charitable deductions claimed by the taxpayers on their individual returns for the contribution of the easement on the Haywood property were reasonable.

First, looking at the conserved area on a lot-by-lot basis, the court explained that in order for the total before value of the land in the conserved area (which consisted of 25 lots) to meet the required value of $5.439 million, each lot would need a before value of $217,560. Based on its analysis of the transactional history of the 12 lots that were being developed, the court determined that these lots were worth a minimum of $750,000. Given their proximity to the similar lots being developed, the court therefore found that it was reasonable to believe that, at the time the easement was donated (which was during the pre-2008 real estate bubble), the lots in the conserved area were worth in excess of the $217,560 needed to support the charitable contribution claimed by SS Mountain and the charitable deductions claimed by the taxpayers.

The court also looked at the problem from a view of the price per acre. At trial, the IRS's expert testified that land prices were increasing at a rate of 2.5% per month. If the necessary before value of the land in the conserved area of $5.439 million was divided by the number of acres contained in the conserved area, the price per acre was $60,584. The price per acre of the last parcel of land that was part of the Haywood property that SS Mountain purchased in July 2005 was $57,328.

Thus, based on the value per acre of the land in the conserved area established by this last transaction, and taking into account price inflation over 16 months at a rate the IRS's own expert said was reasonable, the court found that the price per acre of land at the time the easement was donated was $85,104. Again, under this view, the value of the land was substantially higher than what was needed to support the value of the charitable contribution of the easement SS Mountain claimed and the charitable deductions for it that the taxpayers claimed.


As the Tax Court notes, based on the evidence before it of the conditions in the frothy real estate market in Haywood County at the time SS Mountain made the easement donation, the large charitable deductions claimed by the taxpayers were not excessive. Interestingly, the taxpayers early in the litigation had petitioned the court to direct the IRS to engage in settlement discussions, saying the IRS was unreasonably refusing to settle. The court noted that it does not force parties to settle lawsuits, and in this case, the taxpayers no doubt ended up in a better position than if they had gotten the IRS to settle.

Rajagopalan, T.C. Memo. 2020-159

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