Retained Surface Mining Rights in Conservation Easement Deeds: CCA 202236010
Introduction: Separating the Surface Estate from the Retained Mineral Interest
As we have discussed in prior posts, conservation easements remain an area of focus for the IRS. The Service has spent significant effort challenging and litigating conservation easements to ensure that only donations that meet the strict standards of section 170(h) of the Code are permitted. In a recent Chief Counsel Advice, CCA 202236010[1] the IRS addressed whether a conservation easement satisfies the requirements of section 170(h) where (i) the easement donor retains a qualified mineral interest, (ii) the ownership of the surface estate and the mineral interest has never been separated, and (iii) under the terms of the deed the donor can use a surface mining method to extract the subsurface materials with the donee’s approval.
As discussed below, the IRS concluded that the conservation easement did not meet the requirements of section 170(h), and in particular, the requirement that the conservation easement was contributed “exclusively for a conservation purpose” because the qualified mineral interest was never separated from the surface estate and the deed retained the possibility of surface mining to extract the subsurface materials. Donors seeking to claim a charitable contribution deduction for a conservation easement should be sure to separate the qualified mineral interest from the surface estate and that the deed to the property permits the owner of the qualified mineral interest to extract or remove the minerals by a surface-mining method.
Qualifying for a Qualified Conservation Contribution Deduction with Retained Mineral Interests
Generally, a taxpayer is not permitted a deduction for a charitable contribution for a gift of a partial interest in property.[2] However, section 170(f)(3)(B)(iii), provides an exception for a qualified conservation contribution. Section 170(h)(1) defines a qualified conservation contribution as a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. Section 170(h)(5)(A) provides that a conservation easement is not treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.
Moreover, section 170(h)(5)(B)(i) provides that if the donor retains a qualified mineral interest (as defined in section 170(h)(6)), the conservation easement is generally not treated as exclusively for conservation purposes if at any time there may be extraction or removal of minerals by any surface-mining method. However, section 170(h)(5)(B)(ii) provides an exception to the general rule and states that if the ownership of the surface estate and the mineral interests has been and remains separated, and the probability of surface mining occurring on such property is so remote as to be negligible, then the contribution may be treated as exclusively for conservation purposes satisfying section 170(h)(5)(A).
Treas. Reg. § 1.170A-14(g)(4)(i) clarifies the rules regarding the retention of qualified mineral interests in conservation contributions and whether those retained interests preclude a charitable contribution deduction. It restates the general statutory rule that no deduction is allowed if there is a retention of a qualified mining interest and the minerals may be extracted or removed by a surface-mining method. It further provides that the perpetuity requirement is not satisfied in the case of a qualified mineral interest gift if any method of mining that is inconsistent with the particular conservation purposes of a contribution is permitted at any time. Finally, the regulation provides a limited exception to the prohibition on mining where the mining method is not surface mining. It provides that the deduction will not be denied in the case of certain mining methods that have limited, localized impact on the real property and are not irremediably destructive of significant conservation interests.
IRS Analysis of the Donation and the Retained Mineral Interests
The IRS stated that unless the exception in section 170(h)(5)(B)(ii) applies, the contribution is not made exclusively for conservation purposes if there is an owner of a qualified mineral interest and the deed permits the owner to extract or remove those minerals by a surface-mining method. Under the facts of the CCA, the exception in section 170(h)(5)(B)(ii) did not apply because the ownership of the surface estate was never separated from the mineral interest. Additionally, the deed permitted the surface mining of the donor’s sub-surface minerals which was contrary to section 170(h)(5)(B)(i) and Treas. Reg. § 1.170A-14(g)(4)(i). The IRS disregarded the fact that the deed only permitted surface mining if the donee approved because if approval was granted, surface mining could occur. Thus, because the contribution did not satisfy the exclusivity requirement, it was not a qualified conservation contribution. Accordingly, because the gift was less than the donor’s entire interest and was not a qualified conservation contribution, a charitable deduction was not allowed under section 170(f)(3)(B)(iii).
The Takeaway
Taxpayers seeking to claim a deduction for a qualified conservation easement and that seek to retain a qualified mineral interest should ensure that the qualified mineral interest is separated from the surface estate. Additionally, taxpayers should ensure that the deed states that if the qualified mineral interest is mined, it will not be mined with a surface mining method, and rather the taxpayer will use a method of mining that has limited, localized impact on the real property and is not irremediably destructive of the conservation interests. Taxpayers that satisfy these two conditions should satisfy the exception in section 170(h)(5)(B)(ii) and Treas. Reg. § 1.170A-14(g)(4)(i) so that the contribution is treated as made “exclusively for conservation purposes” and treated as a qualified conservation contribution for purposes of sections 170(h)(5) and 170(h)(1), respectively.
Expert Tax Attorneys
If you need assistance with conservation easement defense or tax litigation, Freeman Law can help you navigate these complex issues. We have experience with conservation easement tax litigation. We offer value-driven services and provide practical solutions to complex tax issues. Schedule a consultation or call (214) 984-3000 to discuss your tax concerns.
[1] September 9, 2022.
[2] Section 170(f)(3)(A).
