Conservation Deeds and Consistency with Treasury Regulations
Morgan Run Partners, LLC, Overflow Marketing, LLC, Tax Matters Partner v. Comm’r, T.C. Memo. 2022-61 | June 14, 2022 | Lauber, J. | Docket No. 8669-20
Short Summary: Morgan Run Partners, LLC (“Morgan” or “Petitioner”) petitioned the Tax Court for readjustment of partnership items after the IRS disallowed a deduction and assessed penalties. The IRS disallowed Morgan’s charitable contribution deduction for a syndicated conservation easement, which it claimed on a timely Form 1065 and supported with an appraisal.
Morgan granted to the National Farmer’s Trust (the “Trust”) a conservation easement over 232 acres of land. Petitioner timely filed a return and for 2016 and a deduction of $26 million for donation of the easement. The IRS then selected Morgan’s return for an examination. The Revenue Agent (RA) recommended assessing penalties under IRC sections 6662 and 6662A. Her manager agreed and signed an approval form in September of 2019. In late October the RA mailed petitioner documents detailing the proposed adjustments and penalties. Then in January 2020, the IRS sent a notice of final partnership administrative adjustment (FPAA), including a Form 886–A, Explanation of Items.
In a Motion for Summary Judgment, the IRS asked the Court to find that procedure was properly followed and attacked various aspects of the easement deed, arguing that certain of its terms did not comply with the requirement that a conservation easement’s purpose must be “protected in perpetuity” to be deductible. See IRC §§ 170(f)(3)(A), 170(f)(B)(iii), (h)(1), (5)(A); see TOT Prop. Holdings, LLC v. Commissioner, 1 F.4th 1354, 1362 (11th Cir. 2021); PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 201 (5th Cir. 2018). The Tax Court’s opinion evaluated whether:
- disallowing the deduction was appropriate because the easement’s conservation purpose was not “protected in perpetuity” as required by IRC section 170(h)(5)(A); and
- the IRS secured timely supervisory approval of the penalties in compliance with section 6751(b)(1).
- Despite apparent failures to formally provide certain legal provisions required in the relevant Treasury Regulations, Morgan’s easement deed did not conclusively fail to comply with the statutory requirement that a conservation easement be “protected in perpetuity” as interpreted under the Treasury Regulations such that the court would grant summary judgment.
- Petitioner’s speculative assertions that the RA may have communicated information regarding an assessment to the partnership, and that this must be determined at trial, failed to introduce a genuine issue of material fact given that the IRS’s documentary evidence, including declarations of personnel, confirmed written supervisory approval well in advance of the FPAA, the first formal written communication to the Petitioner.
Key Point of Law:
- To qualify for a charitable conservation deduction, a deed donating a conservation easement must give rise to a property right at least equal to the proportionate value of the easement to the unrestricted property at the time of the gift. Treas. Reg. § 1.170A-14(g)(6).
- Because unexpected circumstances can ruin the conservation purpose of an easement, the Treasury Regulations deem easements to meet the “protected in perpetuity.” standard if their granting deeds provide that the donor and done proportionally divide proceeds in the event the underlying property is sold following judicial extinguishment of the easement.” See Reg. § 1.170A-14(g)(6).
- Treasury Regulation § 1.170A-14(g)(6)(i) sets forth a formula for determining the proportionate share the grantee must receive upon any extinguishment of the easement. The rules further stipulate that upon judicial extinguishment, the Trust must receive a share of the proceeds that is proportional to the easement’s value in relation to the property.
- IRC section 6751(b)(1) requires written approval of an assessment by the RA’s immediate supervisor which, in a TEFRA case must be in advance of the FPAA. See Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152 T.C. 75, 83 (2019). If an RA obtains approval by that date, to challenge whether approval was obtained prior to assessment, a partnership must prove there was a formal communication of the penalty prior to approval. See Frost v. Commissioner, 154 T.C. 23, 35 (2020).
- If a Petitioner does not assert any evidence of a prior communication of a penalty prior to an initial formal written communication from the IRS, the Petitioner fails to introduce a genuine issue of material fact with respect to the existence of prior communications.
Insights: From the Tax Court’s review of the Petitioner’s deed, it appears that the deed failed to track all of the requirements in the relevant Treasury Regulations. For instance, the deed does not address judicial extinguishment. Rather, it expresses the parties’ intention that changed conditions would not result in extinguishment of any the deed’s provisions. Also, it defined the fair market value of the Trust’s right and interest as equal to the value of the easement but did not specify a valuation date. Further, the deed requires collaboration for the parties to recover the full value of the damages if the easement’s purpose were to be voided by eminent domain and for the rights of each to a “Proportionate Share” of the proceeds, but it failed to define that term. The Court noted, however, that the deed referenced the relevant rules, suggesting that the deed may evince the parties’ intent for the deed to comply with rules governing the deduction, even if it lacked the express formalities demanded.
In general, this is good news for taxpayers interested in taking deductions based on conservation easements. Notwithstanding, this case also serves as a lesson to taxpayers and their counsel to spend the time to ensure formalistic compliance with regulatory requirements when seeking deductions. It is good to prevail in court, but in situations like these having to litigate in the first place is losing.