The Tax Court in Brief – October 17th – October 21st, 2022
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Tax Litigation: The Week of October 17th, 2022, through October 21st, 2022
Champions Retreat Golf Founders, LLC v. Comm’r, T.C. Memo. 2022-106 | October 17, 2022 | Pugh, J. | Dkt. No. 4868-15
Summary: This 43-page opinion is another lengthy chapter in over ten years of litigation regarding a charitable contribution deduction for the donation of a conservation easement given in 2010 by Champions Retreat to North American Land Trust (NALT) that covered about 348 acres of a private golf course designed by Gary Player, Arnold Palmer, and Jack Nicklaus. This opinion (we will call Champions III) supplements Champions Retreat Golf Founders, LLC v. Comm’r (Champions I), T.C. Memo. 2018-146, the latter of which was vacated and remanded by the U.S. Court of Appeals for the 11th Circuit in Champions Retreat Golf Founders, LLC v. Comm’r (Champions II), 959 F.3d 1033 (11th Cir. 2020). The focus of Champions III is the determination of the proper amount of the charitable deduction applicable to the charitable contribution, which required that the Tax Court value the conservation easement at the time of the donation.
Champions Retreat and the IRS’s experts agreed that the before and after method applied. However, Champions Retreat claimed a $10,427,435 charitable contribution deduction on its Form 1065, U.S. Return of Partnership Income, for the 2010 taxable year, for its grant of the easement to NALT. Champions Retreat’s claim was supported by an appraisal performed by Claud Clark III, which relied on the “before and after” method to value the easement. See Treas. Reg. § 1.170A-14(h)(3)(i), (ii). Clark concluded that the highest and best use of the property unencumbered by the easement was as a residential subdivision. The IRS, on the other hand, engaged an expert real estate appraiser, David G. Pope, who concluded that the highest and best use of the property before and after the easement grant was the operation of the golf course. Pope opined that the fair market value of the conservation easement was $20,000.
Key Issues:
What is the “highest and best use” of the property in question?
Based on the “highest and best use” and evidence presented, what is the value of the conservation easement made the basis of the $10,427,435 charitable contribution deduction claimed by Champions Retreat?
Primary Holdings:
Siding with Champions Retreat, the Tax Court found that the highest and best use of the property before the easement grant was a residential subdivision with an 18-hole golf course. The Court was not persuaded by the IRS’s expert’s opinion that the underlying deed restrictions would have precluded redevelopment of a portion of the golf course into residential lots.
On the basis of the record presented, the Tax Court concluded that the fair market value of the easement in 2010 was $7,834,091.
Key Points of Law:
Charitable Contribution Deduction. 26 U.S.C. § 170(a)(1) provides that a deduction is allowed for any charitable contribution that is paid within the taxable year. In general, a taxpayer may not claim a deduction for a charitable contribution of property consisting of less than the taxpayer’s entire interest in the property. See id. at § 170(f)(3).
Charitable Contribution Deduction for Conservation Easement. A taxpayer may deduct the value of a contribution of a partial interest in property, if the contribution constitutes a “qualified conservation contribution.” Id. at § 170(f)(3)(B)(iii). The amount of a charitable contribution deduction generally is the fair market value of the contributed property at the time it is contributed. Treas. Reg. § 1.170A-1(a), (c)(1).
Fair Market Valuation, Generally. The fair market value is the price at which the property would change hands between a hypothetical willing buyer and a hypothetical willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts. Treas. Reg. § 1.170A-1(c)(2); see Bank One Corp. v. Commissioner, 120 T.C. 174, 306 (2003), aff’d in part, vacated and remanded in part sub nom. JP Morgan Chase & Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006). Valuation is not a precise science, and the value of property on a given date is a question of fact to be resolved on the basis of the entire record. See Kaplan v. Commissioner, 43 T.C. 663, 665 (1965). Where there is no established market for similar conservation easements and no record exists of sales of easements, the fair market value of the donated easement “is equal to the difference between the fair market value of the property it encumbers before the granting of the restriction and the fair market value of the encumbered property after the granting of the restriction.” Treas. Reg. § 1.170A-14(h)(3)(i); see Browning v. Commissioner, 109 T.C. 303, 315, 320–24 (1997); Hughes v. Commissioner, T.C. Memo. 2009-94, 2009 WL 1227938, at *4. When using the before and after valuation method, any enhancement in the value of a donor’s other property resulting from the easement contribution, or of property owned by certain related persons, reduces the value of the charitable contribution. Treas. Reg. § 1.170A-14(h)(3)(i).
Experts in the Tax Court. An expert’s opinion is admissible if it assists the Tax Court, as the trier of fact, to understand the evidence or to determine a fact in issue. Fed. R. Evid. 702(a); Rule 143(g). The Tax Court evaluates expert opinions in the light of each expert’s demonstrated qualifications and other evidence in the record. See Parker v. Commissioner, 86 T.C. 547, 561 (1986). When experts offer competing estimates of value, the Court determines how to weight those estimates by examining the factors they considered in reaching their conclusions. See Casey v. Commissioner, 38 T.C. 357, 381 (1962). The Court may find that the evidence of value presented by one of the parties is “sufficiently more convincing than that of the other party, so that the final result will produce a significant financial defeat for one or the other, rather than a middle-of-the-road compromise[.]” Buffalo Tool & Die Mfg. Co. v. Commissioner, 74 T.C. 441, 452 (1980); see also Boltar, L.L.C. v. Commissioner, 136 T.C. 326, 333–40 (2011). The Court may accept only those portions of expert opinions that the Court finds reliable. See Parker, 86 T.C. at 561–62. The Court determines value on the basis of the Court’s examination of the record. See Silverman v. Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), aff’g T.C. Memo. 1974-285.
Highest and Best Use. In determining the fair market value of property, the Tax Court first determines its highest and best use. See Stanley Works & Subs. v. Commissioner, 87 T.C. 389, 400 (1986); Treas. Reg. § 1.170A-14(h)(3)(i) and (ii). To do so, the Court considers the highest and most profitable use for which it is adaptable and needed or likely to be needed in the reasonably near future. Olson v. United States, 292 U.S. 246, 255 (1934). The highest and best use can be any realistic, objective, potential use of the property. Symington v. Commissioner, 87 T.C. 892, 896 (1986). When the before and after method is used, the appraisal of the property before the easement grant “must take into account . . . any effect from zoning, conservation, or historic preservation laws that already restrict the property’s potential highest and best use.” Treas. Reg. § 1.170A-14(h)(3)(ii).
Fair Market Value. Three methods are commonly used to determine fair market value: (1) the market (sales comparison) method, (2) the income method, and (3) the asset-based (replacement cost) method. See Chapman Glen Ltd. v. Commissioner, 140 T.C. 294, 325 (2013). The question of which method to apply in a particular case is a question of law. Id. at 325–26.
Sales Comparison Method. The sales comparison method values a property by comparing it to similar properties sold in arm’s-length transactions in or about the same period. See Estate of Spruill, 88 T.C. at 1229 n.24; Wolfsen Land & Cattle Co. v. Commissioner, 72 T.C. 1, 19 (1979). No two properties are ever identical. Thus, the appraiser considers aspects of the comparable properties such as time of sale, size, or other significant features and makes appropriate adjustments for each to approximate the qualities of the property. See, e.g., Wolfsen Land & Cattle Co., 72 T.C. at 19. The reliability of the sales comparison method depends upon the comparability of the property selected and the reasonableness of adjustments made to establish comparability. Id. at 19–20.
Income Method. The income method values a property by discounting expected cashflow from the property. See, e.g., Marine v. Commissioner, 92 T.C. 958, 983 (1989), aff’d without published opinion, 921 F.2d 280 (9th Cir. 1991). Property value is determined under this method by adding the sum of the present values of the expected cashflows from the property to the present value of the residual value of the property. See Chapman Glen Ltd., 140 T.C. at 327; see also Crimi v. Commissioner, T.C. Memo. 2013-51, at *64. The theory is that an investor would be willing to pay no more than the present value of a property’s anticipated future net income. See Trout Ranch, LLC v. Commissioner, T.C. Memo. 2010-283, 2010 WL 5395108, at *4, aff’d, 493 F. App’x 944 (10th Cir. 2012).
Subdivision Developed Method. The subdivision development method is a variation of the income method. See, e.g., Crimi, T.C. Memo. 2013-51, at *64–65; Consol. Invs. Grp. v. Commissioner, T.C. Memo. 2009-290, 2009 WL 4840246, at *15; Glick v. Commissioner, T.C. Memo. 1997-65, 1997 WL 42357, at *5. It values undeveloped land by treating the property as if it were subdivided, developed, and sold. Glick v. Commissioner, 1997 WL 42357, at *5. The subdivision development method consists of six primary steps: (1) the subdivided property’s highest and best use is determined. (2) the comparable sales method is used to identify comparable finished (developed) lots and derive a per-lot value. (3) anticipated gross proceeds from the sale of the developed lots are calculated by multiplying the per-lot value by the total number of estimated finished lots. (4) expected net proceeds are calculated by reducing the expected gross proceeds by direct and indirect costs and entrepreneurial profit. (5) net sale proceeds are discounted to present value at a market-derived rate over the development and absorption period. (6) appropriate discounts for lack of marketability, partition, and market absorption are applied where appropriate. The resulting figure equals the indicated value of the undeveloped subdivision. The same process is repeated for all of the subdivisions. The sum of the values for all subdivisions is the value of the entire property. The replacement cost method values a property by determining the cost to replace it less depreciation or amortization. See Crimi, T.C. Memo. 2013-51, at *64 n.28; Chapman Glen Ltd., 140 T.C. at 327.
Insight: This opinion provides an excellent roadmap of the various valuation methods to use in determining the fair market value of a conservation easement. The Court provides easy (fairly easy) to understand definitions and processes for use of (1) the market (sales comparison) method, (2) the income method, and (3) the asset-based (replacement cost) method. And, the Court threw in a sub-method for the income method, that being the subdivision development method. Ultimately, the Court sided with Champions Retreat as to the “highest and best” use of the property in issue before and after the grant. And, the Court found that the value of the easement in issue was $7,834,091, not the $10,427,435 as claimed by Champions Retreat or the measly $20,000 claimed by the IRS.
