US Tax Court, T.C. Memo. 2015-130, July 14, 2015: Conservation easement deduction denied; inadequate baseline documentation; Belk violation.
Citing the precedent of the Belk II tax court memo, as affirmed by the Fourth Circuit decision in Belk III, the court denied any tax deduction for twin conservation easements that allowed for the alteration of boundaries between unrestricted house parcels and the property subject to the easements. The tax deductions were also denied because of shortcomings of the baseline reports substantiating conditions at the easement properties. Gross valuation misstatement penalties were imposed. In addition, the court ruled on the tax ramifications of the transfer of the house parcels from the limited partnership to the limited partners, but this Digest report does not discuss that aspect of the case.
Two limited partnerships, Bosque Canyon Resort LP I and Bosque Canyon Resort LP II, granted conservation easements to the North American Land Trust (NALT) on land each entity owned (the 2005 easement and the 2007 easement) and subsequently distributed to each limited partner the fee simple interest in an undeveloped five-acre parcel of property (Homesite parcels). It appears from the court’s opinion that the designated Homesite parcels were not subject to the easements but bordered on the easement land.
The easements provided that the Homesite parcel owners and the NALT could agree, without any further process, to change the boundaries between the Homesite parcels and the property subject to the easements, provided that any modification could not “in the Trust’s reasonable judgment, directly or indirectly result in any material adverse effect on any of the Conservation Purposes” and provided “[t]he area of each Homesite parcel … [could] not be increased.” Thus, land that was subject to the easements could be released from the easements and become Homesite parcels if the parties agreed.
The court said the possibility that the parties could change those boundaries violated the principle set out in Belk II and Belk III, that for an easement to be a qualified conservation contribution entitling the donor to a tax deduction, not only must the easement be enforceable in perpetuity, but also the use of the land originally subject to the easement must be restricted in perpetuity. In other words, land swaps and other boundary changes after the grant of the easement are impermissible (i.e., impermissible without a judicial proceeding extinguishing the easement on land going out of the easement and grant of a qualified easement or amendment to existing qualified easement for land going into the easement). Accordingly, on that basis the claimed deduction was denied.
The court also agreed with the IRS that the deduction should be denied because of improprieties in the baseline documentation prepared by NALT. Treasury Regulations sec. 1.170A-14(g)(5)(i) require that “when the [easement] donor reserves rights the exercise of which may impair the conservation interests associated with the property … the donor must make available to the donee, prior to the time the donation is made, documentation sufficient to establish the condition of the property at the time of the gift.” Under the easements, the BRC easement grantors retained various rights.
For the 2005 easement, the baseline documentation included: maps, a recorded copy of the 2005 deed, photographs taken in 2004, existing conditions reports including a “Site Survey Report” dated March 2007 (15 months after the date of the easement transfer), and a signed owner acknowledgement. The 2007 Site Survey Report was completed using notes taken during an April 2004 site visit, approximately 20 months before the date of transfer. The court noted that construction and development had taken place on the property during that period.
For the 2007 easement, the 2007 baseline documentation included: maps, a recorded copy of the 2007 deed, photographs taken in November 2008 (14 months after the date of transfer of this easement), existing conditions reports including the same 2007 Site Survey Report (based on the 2004 site visit), and a “partially executed” owner acknowledgement which was signed after the date of transfer.
The court characterized these baseline reports as “unreliable, incomplete, and insufficient to establish the condition of the relevant property on the date the respective easements were granted,” and denied a deduction for the easements on this grounds as well.
The court imposed gross valuation misstatement penalties under Internal Revenue Code section 6662(h). Because the court determined the donation did not meet the requirements for a qualified conservation contribution, the actual value of each donation was zero, and any claimed deduction, regardless of how small, would trigger the gross misstatement penalty. Under the law applicable to the 2005 easement, the grantor could assert the defense that it acted reasonably and in good faith. The court rejected that defense because of the extent of flaws in the baseline document. The court said the grantor had not made a reasonable attempt to comply with the substantiation requirement, and therefore they could not make use of this defense. By the time of the 2007 easement, the law had changed and the reasonable cause defense was no longer available for misstatements relating to charitable contribution deductions.
Decision available at http://www.ustaxcourt.gov/InOpHistoric/BosqueCanyonRanchMemo.Foley.TCM.WPD.pdf.