In holding that that Treas. Reg. § 1.170A-14(g)(6)(ii) (Proceeds Regulation) is procedurally invalid under the Administrative Procedure Act (APA),¹ the U.S. Tax Court abandoned its precedent in Oakbrook Land Holdings, LLC v. Commissioner (Oakbrook I), 154 T.C. 180 (2020), aff'd, Oakbrook Land Holdings, LLC v. Commissioner (Oakbrook II), 28 F.4th 700 (6th Cir. 2022), cert. denied, 143 S. Ct. 626 (2023), and followed the U.S. Court of Appeals for the Eleventh Circuit's decision in Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), rev'g and remanding T.C. Memo. 2020-89.

In Oakbrook I, the Tax Court upheld the substantive and procedural validity of the Proceeds Regulation, which provides in part as follows:

[F]or a deduction to be allowed under this section, at the time of the gift the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right, immediately vested in the donee organization, with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time. *** For purposes of this paragraph ***, that proportionate value of the donee's property rights shall remain constant. Accordingly, when a change in conditions give[s] rise to the extinguishment of a perpetual conservation restriction under paragraph (g)(6)(i) of this section, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction, unless state law provides that the donor is entitled to the full proceeds *** .

Oakbrook I at 184-185 (citing Treas. Reg. § 1.170A-14(g)(6)(ii))

The court read that the Proceeds Regulation "requires that the easement deed guarantee the donee 'a proportionate share of extinguishment proceeds.' Carroll v. Commissioner, 146 T.C. 196, 219 (2016) … Further, the regulation does not permit that 'any amount, including that attributable to improvements, may be subtracted out' of the proceeds against which the proportionate value is applied." (Citations Omitted).

Id. at 185

While Oakbrook I was pending on appeal, the Eleventh Circuit in Hewitt held that "the Commissioner's interpretation of § 1.170A-14(g)(6)(ii), to disallow the subtraction of the value of post-donation improvements … , is arbitrary and capricious and therefore invalid under the APA's procedural requirements." 21 F.4th at 1353.

Subsequently, the U.S. Court of Appeals for the Sixth Circuit in Oakbrook II affirmed Oakbrook I and rejected the Eleventh Circuit's rationale in Hewitt.

Valley Park

On its 2016 partnership return, Valley Park Ranch LLC (Valley Park) claimed a $14.8 million deduction under Section 170(h) for the conveyance of a conservation easement. Valley Park reported that it acquired the property in 1998 and that its cost or adjusted basis in the property was $91,610. The IRS disallowed the claimed deduction and alleged that Valley Park did not satisfy all of the requirements of Section 170(h) and corresponding U.S. Department of the Treasury regulations, including the Proceeds Regulation, for deducting a noncash charitable contribution.

The IRS and Valley Park filed cross-motions for partial summary judgment. In its motion for partial summary judgment, the IRS principally argued (presumably consistent with the holdings of Oakbrook I and Oakbrook II) that the conservation purpose of the easement was not "protected in perpetuity" as required by Section 170(h)(5)(A) and, specifically, by operation of the Proceeds Regulation.

In contrast, Valley Park in its motion for partial summary judgment argued that the Proceeds Regulation was procedurally invalid under the APA and that the deed, therefore, need not comply with its requirements.

Majority Opinion

The Tax Court held that the Proceeds Regulation was invalid under the APA and overturned Oakbrook I – a Tax Court ruling from just four years ago. Following the APA, the Tax Court applied the following standard to the regulation:

The APA "prescribes a three-step procedure for so-called 'notice-and-comment rulemaking.'" Perez v. Mortg. Bankers Ass'n, 575 U.S. 92, 96 (2015); accord 5 U.S.C. § 553. First, an agency "must issue a '[g]eneral notice of proposed rule making,' ordinarily by publication in the Federal Register." Mortg. Bankers Ass'n, 575 U.S. at 96 (alteration in original) (quoting 5 U.S.C. § 553(b)). Second, "if 'notice [is] required,' the agency must 'give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments,'" and the agency "must consider and respond to significant comments received during the period for public comment." Id. (alteration in original) (quoting 5 U.S.C. § 553(c))... Third, in promulgating the final rule, the agency must include in its text a "concise general statement of [the rule's] basis and purpose."

Gallegos v. Lyng, 891 F.2d 788, 795 (10th Cir. 1989) (alteration in original) (quoting 5 U.S.C. § 553(c))

A majority of the court found that when the regulations were issued in 1986, the Treasury Department failed to respond to significant comments from New York Landmarks Conservancy (NYLC) and other commentators in the final regulation's "basis and purpose" statement in violation of the APA's procedural requirements.² Because the court found these comments significant (notably from NYLC), it held that the Treasury Department was required to respond.

The Valley Park majority disagreed with the majority opinion in Oakbrook I, which reasoned that the Treasury Department had "clearly considered" the comments made by NYLC and others on the requirement that the donee receive a proportional share of the proceeds, because the Treasury Department substantially revised the text of the Proceeds Regulation in response to those comments. Instead, the court in Valley Park agreed with the Eleventh Circuit's rationale in Hewitt and held that the Proceeds Regulation was procedurally invalid under the APA because the Treasury Department failed to respond to a significant comment.

Dissenting Opinion

The dissent raised three points in objection:

1. First, the dissent reasoned that the cross-motions for partial summary judgment could be decided without addressing the validity of the Proceeds Regulation.³
2. Second, the four dissenting judges were part of the majority opinion in Oakbrook I, which was upheld by the Sixth Circuit in Oakbrook II – after the Eleventh Circuit issued Hewitt. The dissent found "no compelling reason" to change position.
3. Third, the dissenting opinion argued that the majority opinion violated the longstanding principle of stare decisis by failing to follow its own precedent established just four years earlier in Oakbrook I.

The majority explained that the "Golsen rule"⁴ did not apply and that as a result of Hewitt, it could "reconsider" its opinion in Oakbrook I. The court stated:

In light of the reversal by the Eleventh Circuit, we reconsider our holding in Oakbrook I. See Lawrence v. Commissioner, 27 T.C. 713, 716–17 (1957) (observing that when one of our decisions is reversed by an appellate court, we must "thoroughly reconsider the problem in the light of the reasoning of the reversing appellate court and, if convinced thereby, … follow the higher court"), rev'd on other grounds, 258 F.2d 562 (9th Cir. 1958); see also, e.g., Tice v. Commissioner, No. 24983-15, 160 T.C., slip op. at 10–11 (Apr. 10, 2023); Peat Oil & Gas Assocs. v. Commissioner, 100 T.C. 271, 274 (1993), aff'd per curiam sub nom. Ferguson v. Commissioner, 29 F.3d 98 (2d Cir. 1994).

The dissent disagreed with the majority and raised the concern that the opinion will result in instability of the law in the area of conservation easements. The dissent also worried that the court "would be constantly faced with" additional challenges to regulations that have been in existence for decades (in this case, over 40 years) in order to determine "whether comments are significant and whether the agency responded appropriately to them."

Observations

• The U.S. Supreme Court's decision in Mayo⁵ continues to reverberate through the once impenetrable fortress known as the IRS regulations. Regulations that were implemented arguably under a different standard⁶ are now clearly subject to APA review. The Treasury Department should take heed of the dissent's concerns as practitioners will focus on the Treasury Department's regulations that were issued under the National Muffler standard, such as Abbott Laboratories v. Commissioner, No. 20227-23.
• The judicial composition of the Tax Court appears to have had a significant impact on the decision. Only one judge was part of the majority in both Valley Park and Oakbrook I. New judges may be swinging the pendulum in a new direction with respect to compliance with the APA.⁷
• The concurring and dissenting opinions submitted that the statute itself resolved the issue (i.e., that the statute is clear an on its face). If so, did their respective opinions offer a new line of attack that the regulation was invalid under Chevron?⁸
• Valley Park will likely be appealed due to the various conflicting opinions, with another U.S. circuit court of appeals inevitably weighing in differently than one of the circuits that have already opined on the Proceeds Regulation.

The dissenting opinion raises policy concerns regarding pre-Mayo tax regulations, an issue Congress may decide to address through legislation.

Notes

¹ Unless otherwise indicated, all "Section" references are to the Internal Revenue Code of 1986, as amended (the Code), and all "Reg. §" references are to the Treasury Department regulations promulgated thereunder.

² In fact, the Tax Court noted that the Treasury Department's decision consisted of approximately 12 pages, about 10 of which were devoted to the actual text of the regulations and a little over two pages for the department's responses to comments and other administrative matters.

³ The concurring opinion agreed with this point.

⁴ "To effect 'efficient and harmonious judicial administration,' this Court will follow a court of appeals decision that is 'squarely in point where appeal from our decision lies to that Court of Appeals and to that court alone.'" Valley Park, at 9 (quoting Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971)). As noted, Hewitt was issued by the Eleventh Circuit, and Oakbrook II by the Sixth; Valley Park is appealable to the U.S. Court of Appeals for the Tenth Circuit.

⁵ In Mayo Foundation for Medical Education and Research v. United States, 562 U.S. 44 (2011), the IRS urged the Supreme Court that Treasury Department regulations should be entitled to the same standard in Chevron U.S.A. Inc. v. Natural Resources Defense Council Inc., 467 U.S. 837 (1984) (Chevron deference) as other agency regulations. The Supreme Court agreed with the IRS that the same deferential standard of review applicable to other agency rules should "apply with full force in the tax context." Essential to the Supreme Court's decision was the fact that the regulation had been issued through the notice and comment process, which the Supreme Court found was "a very good indicator of delegation meriting Chevron treatment" and a "significant sign that a rule merits Chevron deference." Thus, the price of Chevron deference is that the IRS and Treasury Department must comply with the APA.

⁶ See National Muffler Dealers Association v. United States, 440 U.S. 472 (1979), in which the Supreme Court implied that a special administrative standard of review applies for tax law only.

⁷ It is important to note that Tax Court judges have terms of 15 years. Section 7443(e).

⁸ In footnote 12 of the Valley Park opinion, the majority stated that Chevron was not to be considered as it was "beyond the scope of the briefing requested."