BC Ranch II, LP v. Commissioner (Bosque Canyon II)

U.S. Court of Appeals, Fifth Circuit, No. 16-60068, Cons. w/16-60069, August 11, 2017: Conservation easement may OK boundary changes.

The Bosque Ranch’s two conservation easements were disallowed as charitable deductions by the Tax Court in 2015 because that Court held the conservation easements failed the perpetuity requirements of the Tax Code, § 170(h)(2)(C). Bosque Canyon Ranch LP v. Commissioner, T.C. Memo. 2015-130 (Bosque I). Disqualification was based on the easements’ provision allowing the grantor a limited right, exercisable only with the grantee’s consent, to change the boundaries of land protected by the easements to the extent needed to modify the boundaries of reserved five-acre homesite parcels, if there would be no increase in the homesite parcels above five acres. The Tax Court held that an easement fails the perpetuity requirements if the boundaries of the property subject to the easement may be modified; not only must the easement purposes be enforceable in perpetuity but the particular property protected by the easement must be protected in perpetuity. (The Tax Court also held sales of certain limited partnership interests were actually disguised sales of partnership property, and the gross valuation misstatement penalty was applicable, but the decision of the Court of Appeals on those subjects is not reviewed in this post.)

BC Ranch I, L.P. and B.C. Ranch II, L.P. appealed the Tax Court decision. The Appeals Court vacated it and remanded the case back to consider the IRS challenges to the easements not previously addressed by the Tax Court.

Perpetuity of Place:

The Bosque I Tax Court decision had been based on Belk v. Commissioner, 140 T.C. 1, (2013) (Belk I), aff’d, 774 F.3d 221 (4th Cir. 2014) (Belk III).  The Belk easement allowed the parties to amend the easement to remove land from the original defined real property and substitute other land of “equal or greater value.” Code § 170(h)(2)(C)  says, “…the term ‘qualified real property interest’ means [inter alia]… (C) a restriction (granted in perpetuity) on the use which may be made of the real property.” (Emphasis added.) The Fourth Circuit Court of Appeals reasoned in Belk that the word “the” before “real property” “makes clear that a perpetual use restriction must attach to a defined parcel of real property rather than simply some or any (or interchangeable parcels of) real property.”  The Belk Court also felt the need to distinguish two other decisions from other federal circuits: Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012) and Commissioner v. Simmons, 646 F.3d 6 (D.C. Cir. 2011)(regarding historic preservation façade easements).  Those decisions were distinguishable, the Belk Court said, because they were about whether the easements satisfied the requirement of a different section of the Code about perpetuity of conservation purpose, not perpetuity of “the parcel.” (“A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.” § 170(h)(5)(A))

In the Bosque appeal, the Fifth Circuit said the Bosque easements and the configuration of the protected land were different enough from Belk to make Belk III inapplicable. The Bosque easements, unlike the Belk easement, allow only the homesite parcels’ boundaries to be changed, the court said, and then only (1) within the tracts that are subject to the easements and (2) without increasing the acreage of the homesite parcel in question, plus they do not allow any change in the exterior boundaries of the easements or in their acreages. In Belk, by contrast, the easement “could be moved, lock, stock, and barrel, to a tract or tracts of land entirely different and remote from the property originally covered by that easement.” The Bosque court also found it significant that the Belk court had also reasoned that such parcel-swapping could undermine the “qualified appraisal of [the] property.”

The court considered the physical configuration of the property (the original protected land and the homesites) important enough to attach a plan, prepared as an exhibit in the trial. The court wrote, “Given this subdivision-like layout and the homesites’ contiguity or close proximity to each other and to the only interior road providing ingress and egress to and from the public roads, the Conservation Easement Plan of the ranch visually eschews any realistic likelihood of significant future changes in homesite location — at most, only theoretical or hypothetical changes…. We are satisfied that any potential future tweaking of the boundaries of one or a few homesite locations cannot conceivably detract from the conservation purposes [emphasis added] for which these easements were granted….” This conclusion seems to be based on “the facts that (1) the vast majority of the homesites are tightly clustered, largely contiguous…; (2) together, they closely resemble a typical suburban subdivision; (3) almost every homesite shares one or two common side line boundaries with one or more other homesites; and (4) most homesites are located on or in close proximity to the only road inside the easements, which road provides the sole access to the nearest public roads (Route 22 and County Road 1070).”

The Bosque court, like the Belk court, compared the case at hand with the Simmons and Kaufman decisions, but for the purpose of likening Bosque to those cases.   The court dismissed the distinction between the Code section at issue in Belk (§ 170(h)(2)) versus that in Simmons and Kaufman (§ 170(h)(5(A)), saying the latter two cases stand for the “common sense” proposition that an easement may be modified to promote the underlying conservation interests, reflecting “[t]he need for flexibility to address changing or unforeseen conditions on or under property subject to a conservation easement….”

The court also justified its analysis of tax deductions for the grant of conservation easements under the “ordinary standard” of statutory construction, rather than strict construction usual for intentionally adopted “tax loopholes”.  It justified this on the basis of what it saw as the adoption of Code §170(h) “at the behest of conservation activists, not property-owning, potential-donor taxpayers … by an overwhelming majority of Congress … in the hope of adding untold thousands of acres of primarily rural property for various conservation purposes….”

Baseline Documentation:

The Bosque Tax Court had also agreed with the IRS that the deduction should be denied because of improprieties in the baseline documentation prepared by the grantee. (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.”) On appeal the court found “the Tax Court failed to consider significant information contained in the record” and characterized the Tax Court’s analysis as “hyper-technical requirements” that “would create uncertainty by imposing ambiguous and subjective standards for such documentation and are contrary to the very purpose of the statute.” The Tax Court’s holding regarding the baseline documentation was thus also vacated.

Dissent:

One Judge (James L. Dennis) filed a separate opinion, dissenting in part and concurring in part. After rejecting the majority’s “impermissibly lax standard” for statutory interpretation, the dissent opined that the Bosque easement allowed for more than de minimis changes as to which property was protected and therefore failed the Belk test that “a conservation easement must govern a defined and static parcel.” (Belk III at 774 F.3d 227.)

Decision available at http://www.ca5.uscourts.gov/opinions/pub/16/16-60068-CV0.pdf.

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