Minnick v. Commissioner of Internal Revenue

U.S. Tax Court, 2012 T.C. Memo 345, December 17, 2012: Conservation easement deduction denied because mortgage not timely subordinated; 20% penalty upheld.

In 2006, Minnick granted a conservation easement to a land trust on a 74-acre parcel of land near Boise, Idaho. The land was subject to a mortgage that was not subordinated to the conservation easement until five years later.  Minnick initially did not claim a deduction for tax year 2006, but later amended his return to do so, and claimed deductions in his 2007 and 2008 returns for the carryover portion of the alleged value of the easement contribution that exceeded his deduction limit for 2006. The IRS disallowed Minnick’s carryover deductions and imposed a 20% accuracy-related penalty under Internal Revenue Code section 6662(a), which they increased to 40% under section 6662(h) for an alleged gross valuation misstatement.

The IRS challenged the deduction on several grounds, but the Court did not address most of them because it decided that the deduction was not allowed because the mortgage was not subordinated at the time of the grant of the conservation easement.  The Court noted that Treasury Regulations sec. 1.170A-14(g)(2) requires that the holder of any mortgage on a donated easement property must “subordinate its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity,” which the Court in Mitchell v. Commissioner, 138 T.C. 324, 332 (2012), held requires that the subordination must be in place at the time that the conservation easement is granted.

Minnick tried to distinguish the Mitchell holding by arguing that his intention to obtain the subordination at the time of the grant (as evidenced by his grantor’s warranty in the easement that there was no unsubordinated mortgage) was sufficient, and that his mortgagee “would have been willing to freely subordinate its mortgage at the time the conservation easement was granted”. The Court rejected these arguments, writing, “Intention and willingness are not what matters.”

Minnick also argued that Mitchell should not apply because in this case, unlike in Mitchell, Idaho law (the Uniform Conservation Easement Act, Idaho Code Ann. secs. 55-2101 to 55-2109 (2012)) imposes the doctrine of cy pres on all conservation easements in Idaho and, they argued, the cy pres doctrine has the effect of subordinating the mortgage.The Court rejected the theory that cy pres subordinates the mortgage.

The Court also rejected Minnick’s attempt to use the “remote possibility” defense, writing that, as in Mitchell, the likelihood of default is irrelevant.

Regarding penalties, the Court found Minnick liable for a 20% accuracy related penalty but not a 40% penalty for gross valuation misstatement. Given the Court’s determination that the deduction failed because of the absence of a timely subordination, without getting to the valuation questions, the IRS dropped its request for the gross valuation misstatement penalty. The Court found Minnick was negligent in his underpayment of taxes (i.e., in claiming the deduction) in that his acts and omissions show a “lack of due care or the failure to do what a reasonably prudent person would do under like circumstances. Hofstetter v. Commissioner, 98 T.C. 695, 704 (1992).”  Minnick’s warranty in the easement that there was no unsubordinated mortgage was held against Minnick as putting him on notice that a subordination was required, thereby demonstrating both his negligence and his ineligibility for the good-faith-and-reasonable-cause defense under code Section 6664(c). The Court gave Minnick the benefit of the doubt that the warranty was not fraudulent, but merely an inadvertent error.

The Court also addressed procedural matters regarding the admissibility of certain evidence for valuation purposes as distinct from the bearing of such evidence on the subordination question.

Decision available at http://www.ustaxcourt.gov/InOpHistoric/MinnickMemo.TCM.WPD.pdf.

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