Mitchell v. Commissioner (Mitchell I)

US Tax Court, 138 T.C. No. 16, April 3, 2012: The so-remote-as-to-be-negligible standard of Treasury Regulations cannot be used to excuse the failure to comply with a particular requirement of Treasury Regulations for a qualified conservation contribution. In this case, the taxpayer failed to obtain a subordination of a mortgage to a qualified conservation contribution at the time of grant of the conservation easement, as required by Treasury Regs. sec. 1.170A-14(g)(2).

On December 31, 2003, a family limited partnership granted a conservation easement on land it owned. The partnership claimed a tax deduction for a qualified conservation contribution for that year. The land was subject to a mortgage, but the mortgage was not subordinated to the conservation easement until two years later.

The Internal Revenue Service denied the deduction on the grounds that conservation easement failed the perpetuity test of Code section 170(h), because Treas. Regs. 1.170A-14(g)(2) states that no deduction is permitted for donation of a conservation easement in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the grantee of the easement to enforce the conservation purposes of the gift in perpetuity.

The taxpayer argued that the deduction should be allowed because Treas. Regs. 1.170A-14(g)(3) says that a deduction will not be disallowed merely because on the date of the gift there is the possibility that the interest will be defeated so long as on that date the possibility of defeat is so remote as to be negligible. This is the “so-remote-as-to-be-negligible” standard. The taxpayer presented evidence that during the two-year gap during which there was no subordination, the partnership always had the funds to pay off the mortgage, “there were no lawsuits, potential or otherwise; all bills were paid; payments on the promissory note to [the mortgagee] were current, and casualty insurance was in place”.

The Tax Court first held that the subordination must “be in place at the time of the gift”. It then found, in what the Court said was a case of first impression, that the subordination regulation should not be read in tandem with the so-remote-as-to-be-negligible standard. The Court wrote that this decision is in line with previous Tax court decisions refusing to apply the so-remote-as-to-be-negligible standard to avoid a specific requirement of the regulations, those being  Kaufman v. Commissioner, 136 T.C. 294 (2011) (Kaufman II) (the proceeds requirement of Treas. Regs. section 1.170A-14(g)(6)(ii)) and Carpenter v. Commissioner, T.C. Memo. 2012-1 (the extinguishment by judicial proceeding requirement of Treas. Regs. section 1.170A-14(g)(6)(i)).

Although in Commissioner v. Simmons, 646 F.3d 6, the Court of Appeals for the District of Columbia Circuit found the possibility that the particular donee of the easement in question would actually abandon its rights was so-remote-as-to-be negligible, the Tax Court distinguished that case because the possibility in question was “a general argument made by the Commissioner as to the conservation easement’s grant in perpetuity”, not a Treasury Regulation.

The Court refused to impose an accuracy-related penalty because “given the circumstances, we find that petitioner acted with reasonable cause and in good faith.

The decision is available at http://www.ustaxcourt.gov/InOpHistoric/MitchellRamona.TC.WPD.pdf.

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