Recent Tax Court Conservation Easement Decision Demonstrates Continued IRS Enforcement Efforts and Penalty Defenses
The Tax Court’s recent decision in Sells shows that the IRS is continuing to aggressively pursue conservation easement deductions where it believes the transaction is overly aggressive. However, the case also demonstrates potential defenses against proposed penalties.
Sells v. Comm’r, T.C. Memo. 2021-12, January 28, 2021 | Holmes, J. | Dkt. Nos. 6267-12, 6801-12, 6835-12, 6836-12, 6837-12, 6838-12, 19246-12, 13553-13
Short Summary: In August 2002, Burnish Bush Farms, LLC was formed with eight members—each a 12.5% owner. Later, Mr. and Mrs. Moses sold mountainous land to Burnish Bush for $1.4 million. In 2003, Burnish Bush deeded a conservation easement on the acres that it owned to Chattoawah Open Land Trust, Inc. The conservation deed contained various provisions, including an extinguishment-proceeds clause.
Burnish Bush filed a Form 1065, U.S. Return of Partnership Income. Attached to the Form 1065 was Form 8283, Noncash Charitable Contributions. On page 2 of this form Burnish Bush reported the donation of the conservation easement to COLT as a noncash charitable contribution with a value of less than $5.4 million. Burnish Bush attached a “qualified appraisal” to the return. The IRS audited the return, disallowed the charitable contribution, and proposed penalties.
Key Issues: Whether the taxpayers are entitled to a charitable conservation easement deduction and whether they are liable for penalties?
Primary Holdings: The taxpayers are not entitled to the charitable conservation easement deductions. Moreover, with respect to some taxpayers, the IRS failed to comply with Section 6751(b) with respect to certain proposed penalties—accordingly, those penalties are waived. Moreover, some taxpayers are not liable for penalties due to reasonable cause.
Key Points of Law:
- Section 170 sets the rules for the deductibility of charitable contributions, and there are regulations that go into much greater detail. Reg. § 1.170A-13. Those regulations distinguish between cash and noncash contributions. See id.
- One type of noncash charitable contribution is the donation of a partial interest in real estate. The Code generally disallows a charitable contribution deduction for a gift of real property that consists of less than the taxpayer’s entire interest in such property. 170(f)(3)(A). But there is an exception for the donation of conservation easements. Sec. 170(f)(3)(B)(iii).
- A qualified conservation contribution is a contribution: (A) of a qualified real property interest; (B) to a qualified organization; (C) exclusively for conservation purposes. 170(h)(1).
- A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. 170(h)(5)(A).
- As the Tax Court held in Oakbrook, a conservation easement must be protected in perpetuity. C. Memo. at *10. Part of this protection must be the allocation of proceeds to the donee if the easement is condemned or otherwise extinguished. Treas. Reg. § 1.170A-14(g)(6)(i).
- Proportionate value” demands the creation of a fraction, the numerator of which is the fair market value (FMV) of the easement and the denominator of which is the FMV of the contributed property unburdened by the easement, both on the date of donation. We followed the Fifth Circuit’s lead in holding that this section of the regulations requires that the donee be entitled to receive this fraction multiplied by the gross proceeds of any extinguishment. PBBM Rose Hill, Ltd. v. Comm’r, 900 F.3d 193, 207-208 (5th2018). And in Oakbrook v. Comm’r, 154 T.C. 180, we held that this regulation was valid. That opinion binds us.
- Section 6662(b)(1) penalizes understatements due to negligence or disregard of rules or regulations; Section 6662(b)(2) penalizes substantial understatements of tax due; and Section 6662(b)(3) penalizes substantial valuation misstatements. All of these carry a 20% penalty.
- Section 6662(h) imposes a 40% penalty for gross misstatements of value on a return. In Palmolive Bldg. Inv’rs, LLC v. Comm’r, 152 T.C. 75, 79 n. 3 (2019), we concluded that the substantial and gross misvaluation penalties were distinct with each requiring supervisory approval under Section 6751(b).
Insight: The decision in Sells shows that the IRS will continue to aggressively go after perceived, abusive conservation easement deductions. It also shows the potential use of Section 6751(b) as a defense against proposed penalties.