US Tax Court, 136 T.C. No. 15, April 5, 2011: Holds transferable Colorado conservation easement tax credits are a capital asset, but the transaction costs to establish the easement are not basis of the asset, and asset holding period began only when the easement donation was complete and the credits were granted by the state.

The Petitioner, the Tempels, donated a conservation easement to a charity. Colorado grants transferable conservation easement income tax credits. Tempel sold most of their tax credits in the same year as they donated the conservation easement. In their federal income tax filing for that year, the Tempels characterized the income from that sale as a capital gain (first as a short-term gain; then at trial as a long-term gain). The IRS asserted in the alternative that the income from the sale was ordinary income, or if a capital gain, without any basis and held short-term.

The Tax Court analyzed the “ordinary income doctrine” exclusion from the definition of capital asset and concluded that the exclusion did not apply. Referring to the possibility of a reduction in Tempels’ taxes owed as a result of the credit, the Court wrote, “A reduction in a tax liability is not an accession to wealth. … A lesser tax detriment to a taxpayer is not an accession to wealth and therefore does not give rise to income.”

As to the basis of the tax credit as a capital asset, the Court reasoned that the transaction fees were incurred to establish a conservation easement donated to an unrelated third party, not to acquire the tax credits by purchase. Accordingly, and also because such expenses are deductible as an itemized deduction as “ordinary and necessary expenses incurred ‘in connection with the determination, collection, or refund of any tax’”, the transaction fees could not be used as the basis of the tax credits.

The Tempels also argued that the tax credits represented a portion of the value of their land subject to the easement, and therefore some of the cost of that land should be accounted as basis for the credits. The Court rejected this idea because it said the tax credits are not an interest in real property. For the same reason, the holding period of the tax credits, as a capital asset, did not begin when the Temples acquired the land, but when the conservation easement was donated, thereby creating only a short-term holding period.

Decision available at http://www.ustaxcourt.gov/InOpHistoric/Tempel.TC.WPD.pdf.