Schmidt v. Commissioner

U.S. Tax Court, 2014 TC Memo 159, August 6, 2014: Court makes its own valuation of conservation easement contribution.

At issue was the valuation of a conservation easement for the purposes of a federal income tax deduction for a “qualified conservation contribution.”  Both the taxpayer/petitioner and the IRS (respondent) introduced expert testimony and questioned the credibility of each other’s experts. The parties and court agreed the valuation should be done using the “before and after method” and the primary focus of the court’s opinion was on the “before” valuation. In various respects, the court found neither side’s experts entirely convincing, and came up with its own appraisal of the before value.

The parties agreed that it would be appropriate to use both the “market” and “subdivision development” methods to determine the before value. The court, however, rejected the market method in this case. The market method looks at comparable sales, and the subdivision development method analyzes the income potential of a property based on creation and sale of subdivision lots, and then capitalizing or discounting the expected cash flow from the property. The court rejected the market method because it determined there were not sufficient sales of properties comparable to the before condition of the property.

The parties agree, and the court accepted, that the following factors are relevant to the subdivision development method to determine the before value of a property: (1) the number of lots; (2) the retail lot selling prices; (3) the retail lot selling price appreciation rate, (4) the time required to obtain entitlements (i.e., development approvals), (5) the absorption rate of the lots, (6) development costs, (7) marketing/administrative costs, and (8) the discount rate. The court accepted the parties’ conclusions on some of these factors but on others rejected the experts’ analysis and substituted its own analysis and conclusions.

In doing its analysis, the court did its own “proper application” of the discounted cash flow method in this case. The decision itself should be read for the court’s technical analysis.

Among other things, the court accepted the parties’ agreement that the appropriate discount rate was 22%, including a 10% entrepreneurial-profit factor.

The court thus determined the before value itself. As to the after value, the court accepted the agreement of the parties that the after value should be based on comparable sales of properties subject to conservation easements. The taxpayer’s and IRS’ experts disagreement on the after value was based primarily, the court said, on whether sales of properties that were not platted were comparable or sales of platted properties. The court came down on the side of using platted properties. The court, having made its own determination of the before value and accepting the IRS’ expert’s after value, was able to find what it said was the appropriate value of the conservation easement donation.

Because the value claimed by the taxpayer was substantially greater than the value determined by the court, the IRS sought a substantial underpayment penalty. The court found the taxpayer had reasonable cause and acted in good faith, and so rejected the penalty.

Decision available at

My appreciation to Leslie Rately-Beach for first bringing this case to my attention.

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