Carroll, (2016) 146 TC No. 13
The Tax Court has held that a clause in an easement, which provided for the amount the donee would receive if conditions caused an extinguishment of the perpetual conservation restriction, did not meet the requirements of a reg under the charitable deduction Code section that requires that a conservation purpose be protected in perpetuity. As a result, the taxpayer received no tax deduction for the easement. Click here for the Opinion of the Court.
Background. In general, Code Sec. 170(f)(3) bars a charitable contribution deduction for a contribution of an interest in property that is less than the taxpayer’s entire interest in the property, but an exception is made for a qualified conservation contribution, i.e., the contribution of a qualified real property interest exclusively for conservation purposes. The interest in property conveyed by an easement must be protected in perpetuity for the contribution of the easement to be a qualified conservation contribution. (Code Sec. 170(h), Reg. § 1.170A-14(b)(2))
Regs provide a rule with respect to the perpetuity requirement. At the time of the gift, the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right, immediately vested in the donee organization, with a fair market value that, at the time of the gift, is at least equal to the proportionate value that the perpetual conservation restriction bears to the value of the property as a whole. When a change in conditions results in the extinguishment of a perpetual conservation restriction, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction, unless state law provides that the donor is entitled to the full proceeds from the conversion without regard to the terms of the prior perpetual conservation restriction. (Reg. § 1.170A-14(g)(6)(ii))
Reg. § 1.170A-14(g)(3) provides that a charitable deduction is not disallowed merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event if, on the date of the gift, it appears that the possibility that such act or event will occur is so remote as to be negligible.
Facts. The taxpayer, Mr. Carroll, granted a conservation easement to two Maryland qualified organizations, MET and LPT. A clause in the conservation easement (the clause) provided that, in the event that the conservation purpose was extinguished because of an unexpected change in circumstances surrounding the donated property, the donee organizations would be entitled to a proportionate share of extinguishment proceed, based on a fraction equal to (1) the amount allowable as a deduction for Federal income tax purposes, over (2) the fair market value of the property at the time of the contribution.
No deduction allowed. The Court held that the clause does not comply with the requirement of Reg. § 1.170A-14(g)(6)(ii) that the proportionate share of extinguishment proceeds be based on a fraction equal to the fair market value of the easement on the date of the gift over the fair market value of the whole property on the date of the gift.
The Court said that Reg. § 1.170A-14(g)(6)(ii) was designed to prevent taxpayers from reaping a windfall if encumbered property was subsequently destroyed or condemned. Inconsistent with this purpose, the taxpayer’s easement violates Reg. § 1.170A-14(g)(6)(ii) by providing Carroll with a potential windfall in the event that a change of conditions extinguishes the conservation easement. For example, if IRS denied Carroll’s charitable contribution deduction for Federal income tax purposes for reasons other than valuation, and the easement was extinguished in a subsequent judicial proceeding, the numerator used in the clause would be zero, and MET and LPT would not receive a proportionate share of extinguishment proceeds.
Carroll argued that IRS ignored the Reg. § 1.170A-14(g)(6)(ii) language which provides an exception to the proportionality requirement if “state law provides that the donor is entitled to the full proceeds from the conversion without regard to the terms of the prior perpetual conservation restriction.” According to Carroll, Maryland law requires that extinguishment proceeds be distributed to easement donors without regard to the conservation easement.
But the relevant Maryland law, Md. Code Ann., Real Prop. sec. 12-104(g), only applies to specific donees, and, while MET was one such donee, LPT was not. And that law only applied with respect to condemnation proceeds. Thus, although Maryland law would apply to MET in a condemnation proceeding, it would not apply to either MET or LPT in a extinguishment proceeding that was not based on condemnation (e.g., the destruction of the subject property or where the characteristics of the neighborhood render the conservation purpose impractical).
Carroll also argued that IRS’s rationale is “circular in nature,” arguing that the disallowance of their charitable contribution deduction under Reg. § 1.170A-14(g)(6)(ii) hinges on the possibility that IRS may disallow Carroll’s deduction on another ground. The Court rejected this argument, saying that it was obligated to apply statutes as written and follow accompanying regs when consistent therewith.
Finally, Carroll argued that IRS ignored the safe harbor regarding unlikely events in Reg. § 1.170A-14(g)(3). The Court said that accepting that argument would effectively nullify the proportionality requirement of Reg. § 1.170A-14(g)(6)(ii), because, by its own terms, the reg applies to “unexpected” changes in conditions, which likely encompass events that are “so remote as to be negligible” under Reg. § 1.170A-14(g)(3).