Ten Twenty Six Investors V. Commissioner

US Tax Court, 2017 TC Memo 115, June 15, 2017: Date of recording conservation easement determines year of eligibility for tax deduction.

The Tax Court agreed with the IRS that a conservation easement donated in 2004 but not recorded until 2006 did not create a qualified conservation contribution in 2004 and therefore did not entitle the donor to a federal tax deduction for 2004.

On December 21, 2004, Ten Twenty Six Investors (partnership) executed an easement deed (deed) granting a facade easement (easement) on a New York warehouse to National Architectural Trust, Inc. (NAT). NAT accepted and signed the deed on December 30, 2004, but it was not recorded until December 14, 2006. The partnership claimed a tax deduction under Internal Revenue Code section 170 for the donation on their 2004 return but the IRS denied it, also hitting the partnership with a 40% gross valuation misstatement penalty under section 6662(a) and (h) or, alternatively, a 20% penalty under section 6662(a) and (b)(1), (2), or (3).

The IRS said the deed created a “conservation easement” under New York State law (N.Y. Envtl. Conserv. Law (NYECL) sec. 49-0303(1) (McKinney Supp. 2017) and that as such the deed had no legal effect until it was recorded (NYECL sec. 49-0305(4) (McKinney Supp. 2017). The IRS therefore concluded there was no legally enforceable restriction as required by section 1.170A-14(g)(1), Income Tax Regs., in 2004: without a legally enforceable restriction in 2004, there could be no deduction for 2004 for an easement donation.

The partnership argued that the easement was not a conservation easement because it was not intended to be such by the parties, that even if the easement created a conservation easement it also created a restrictive covenant at common law (which, the partnership argued, NYECL sec. 49-0309 allows) and that restrictive covenants are generally effective in New York upon delivery of a valid deed. N.Y. Real Prop. Law sec. 244 (McKinney 2006).

The court rejected the partnership’s arguments, saying that in Zarlengo v. Commissioner, T.C. Memo. 2014-161, Rothman v. Commissioner, T.C. Memo. 2012-163, supplemented by T.C. Memo. 2012-218, and Mecox Partners LP v. United States, 117 A.F.T.R.2d (RIA) 2016, substantially identical or similar arguments had been rejected in closely analogous cases.  The court nevertheless went over the partnership’s arguments, “for the sake of completeness.”

First the court addressed whether the deed could be construed as legally effective to convey a property interest in 2004.  The court said that under the plain terms of NYECL sec. 49-0305(4), if the deed was intended to convey a conservation easement, it was not effective until it was recorded. The partnership argued that the subjective intent of the parties was not to create a conservation easement as defined by statute, but the court said subjective intent would only come into play if the deed were ambiguous. The court said there was no ambiguity because the deed was titled “Conservation Deed of Easement,” references itself as such repeatedly throughout the document, purports to do what a conservation easement would do, and grants exactly the mix of easements, restrictions, and affirmative responsibilities that a conservation easement would.

The partnership argued in the alternative that even if the deed created a conservation easement it also created a restriction which was enforceable as a common law interest from the time of delivery.  The court rejected this argument saying precedents support the conclusion that a conservation easement created under title 49 of the NYECL, which that statute says must be recorded to be effective, is separate and distinct from anything created at common law, that if recording were not required for the instrument to take effect the statute’s recording requirement “would have no meaningful effect,” and to avoid finding that a portion of the statute has no meaningful effect, the partnership’s argument must be rejected.

Thus, the court concluded there was no property interest conveyed in 2004.

The court next addressed whether the failure to record the deed in 2004 caused the easement to fail the perpetuity requirements of Code section 170(h)(2)(C) and (5)(A), even if the court were to assume for the sake of argument that the deed effectively created an easement or a restrictive covenant at common law.

The court said it is clear that the perpetuity requirement should be tested as of the date of the alleged transfer (section 1.170A-14(g)(3), Income Tax Regs.), citing, e.g., Graev v. Commissioner, 140 T.C. 377, 393 (2013). If on that date perpetuity could be defeated by possible future events, the perpetuity requirement would not be satisfied. The court said there were two such possible events here:  (1) transfer by NAT of the benefits of the deed to a successor in interest which was not a donee qualified under applicable law to receive a conservation easement eligible for a deduction or which could not enforce a common law easement in gross, and (2) sale (or mortgage) of the property by the partnership to a third party who acquired the property in good faith for value and who did not know of the unrecorded easement (and against whom the instrument could therefore not be enforced). The court judged that the probability of neither of these circumstances was so remote as to be negligible, so the perpetuity requirement was not satisfied.

Accordingly, the court held the partnership was not entitled to a deduction for 2004 for contribution of the easement.

Decision available at http://www.ustaxcourt.gov/UstcInOp/OpinionViewer.aspx?ID=11275.

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