Tax Court in Brief | Sparta Pink Property, LLC v. Comm’r | Conservation Easement and Additional Fodder for Circuit Split

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The Tax Court in Brief – August 29th – September 2nd, 2022

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Tax Litigation:  The Week of August 29th, 2022, through September 2nd, 2022

Sparta Pink Property, LLC v. Comm’r, T.C. Memo. 2022-88 | August 29, 2022 | Lauber, J. | Dkt. No. 12114-20

SummaryThis case involves a charitable contribution deduction claimed by Sparta Pink Property, LLC (Sparta), for the donation of a conservation easement. In August 2016 WASCO, LLC, acquired a 99% interest in Sparta by contributing to it roughly 286 acres of land (Property). In December 2016 Sparta granted to the Southern Conservation Trust (grantee) a conservation easement over the Property. On its 2016 Form 1065, U.S. Return of Partnership Income, Sparta claimed a charitable contribution deduction of $15,632,748 (appraised value) for its donation of the easement. The easement deed recited the conservation purposes and generally prohibits commercial or residential development. But it reserved certain rights to Sparta, including the rights to repair, improve, enlarge, and replace existing improvements on the Property. The deed also provided that, “[i]f circumstances arise in the future that render the Purpose of this Conservation Easement impossible to accomplish,” giving rise to a judicial extinguishment of the easement, then on any subsequent sale or conversion the grantee is entitled to its fair market value (FMV) portion of the proceeds, defined as equal to the current FMV of the easement determined by multiplying the sale proceeds by a fraction specified in the regulations. But before this fraction is applied, the sale proceeds were to be reduced by “any increase in value after the date of this Conservation Easement attributable to improvements.” The IRS disallowed most (all but $44,748) of the deduction claimed by Sparta because, according to the IRS, the easement’s conservation purpose was not “protected in perpetuity,” see 26 U.S.C. § 170(h)(5)(A), and the IRS determined penalties for gross valuation misstatement. Id. at §§ 6662(e), (h), 6662(b)(1)-(3), (c)-(e), 6662A(b). Sparta challenged the IRS’s decision on the deduction and contended that the IRS did not comply with supervisory approval for the penalties determined.

Key Issues:

Whether, as a matter of law: (1) the easement’s conservation purpose was not “protected in perpetuity” due to the FMV calculation formula in the underlying deed; and (2) the IRS proved it proved its compliance with determination procedures for penalty assessment.

Primary Holdings:

No and Yes. The Court denied the Motion on the section 170(h)(5)(A) question but granted it with respect to section 6751(b)(1).

Following Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), rev’g and remanding T.C. Memo. 2020-89, the Tax Court denied the IRS’s motion as to section 170(h)(5)(A). As for statutory compliance with determination procedures, the IRS presented sworn declarations in support of compliance with assessment determination procedures, and that was sufficient for summary judgment on that issue.

Key Points of Law:

Summary Judgment Standard – The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). The Tax Court may grant partial summary judgment regarding an issue as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. See Rule 121(b). In deciding whether to grant partial summary judgment, the Court construes factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Where the moving party properly makes and supports a motion for summary judgment, “an adverse party may not rest upon the mere allegations or denials of such party’s pleading” but must set forth specific facts, by affidavit or otherwise, showing that there is a genuine dispute for trial. Rule 121(d).

“Protected in Perpetuity”. The Internal Revenue Code generally restricts a taxpayer’s charitable contribution deduction for the donation of “an interest in property which consists of less than the taxpayer’s entire interest in such property.” § 170(f)(3)(A). But there is an exception for a “qualified conservation contribution.” § 170(f)(3)(B)(iii), (h)(1). For the donation of an easement to be a “qualified conservation contribution,” the conservation purpose must be “protected in perpetuity.” § 170(h)(1)(C), (5)(A).

Hewitt v. Commissioner and Mandatory Division of Proceeds. The Treasury Regulations recognize that “a subsequent unexpected change in the conditions surrounding the [donated] property . . . can make impossible or impractical the continued use of the property for conservation purposes.” See Treas. Reg. § 1.170A-14(g)(6)(i).

“[T]he conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding” and the easement deed ensures that the charitable grantee, following sale of the property, will receive a proportionate share of the proceeds and use those proceeds consistently with the conservation purposes underlying the original gift. Id.see 26 U.S.C. § 170(h)(5)(A). In Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), rev’g and remanding T.C. Memo. 2020-89, the U.S. Court of Appeals for the Eleventh Circuit held that “the Commissioner’s interpretation of § 1.170A-14(g)(6)(ii), to disallow the subtraction of the value of post-donation improvements . . . , is arbitrary and capricious and therefore invalid under the [Administrative Procedure Act’s] procedural requirements.” Id. at 1353. Contra Oakbrook Land Holdings, LLC v. Commissioner, 28 F.4th 700, 717–18 (6th Cir. 2022) (disagreeing with Hewitt), aff’g 154 T.C. 180 (2020).

Appeal of this Sparta case would lie to the Eleventh Circuit; thus, the Tax Court was obligated to follow the law as established by the Eleventh Circuit on this question. Therefore, the IRS’s motion on this issue was denied.

Penalty Approval, § 6751(b)(1). “No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination.” In a TEFRA case such as this, supervisory approval generally must be obtained before the IRS issues an FPAA to the partnership. See Palmolive Bldg. Invs., LLC v. Commissioner, 152 T.C. 75, 83 (2019).

Once the IRS introduces evidence sufficient to show that written supervisory approval was obtained by that date, the partnership must establish that the approval was untimely, i.e., “that there was a formal communication of the penalty before the proffered approval” was secured. See Frost v. Commissioner, 154 T.C. 23, 35 (2020). “The written supervisory approval requirement . . . requires just that: written supervisory approval.” See Pickens Decorative Stone, LLC v. Commissioner, T.C. Memo. 2022-22, at *7. And, the penalty approval form or similar document need not demonstrate the depth or comprehensiveness of the supervisor’s review.

A group manager’s signature on a civil penalty approval form, without more, is sufficient to satisfy the statutory requirements. Sworn declarations submitted to the Tax Court in support of compliance with assessment determination procedures is sufficient to entitle the IRS to summary judgment on statutory compliance with determinations procedure. Examining agents and their supervisors are not required to be subjected to cross-examination. See Thompson v. Commissioner, T.C. Memo. 2022- 80, at *8; Raifman v. Commissioner, T.C. Memo. 2018-101, 116 T.C.M. (CCH) 13, 27–28.

Insights: Sparta is an additional U.S. Tax Court opinion that should help set the stage for the eventual (or potential) United States Supreme Court evaluation of the split among various U.S. Circuit Courts of Appeals on the application and interpretation of 26 C.F.R. § 1.170A-14(g)(6)(ii). See and compare Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), rev’g and remanding T.C. Memo. 2020-89, with Oakbrook Land Holdings, LLC v. Commissioner, 28 F.4th 700, 717–18 (6th Cir. 2022) (disagreeing with Hewitt on this issue), aff’g 154 T.C. 180 (2020).