Tax Court Declines to Follow First Circuit Ruling on Mortgage Subordinations & Conservation Easements

by Coblentz Patch Duffy & Bass

This month, the Tax Court revived a method to defeat conservation deductions with its October 10 opinion published as Palmolive Building Investors LLC et al. v. Commissioner, No. 23444-14; 149 T.C. No. 18 (Oct. 10, 2017), holding that if a taxpayer donates a conservation easement, the Tax Code’s requirement that any mortgage must be subordinated to the conservation easement includes subordination of the mortgagee’s rights to insurance and condemnation proceeds.

Palmolive Building is in direct contravention of the First Circuit appellate court’s 2012 ruling in Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012)(Kaufman III), affirming in part, vacating in part, and remanding in part Kaufman v. Commissioner, 136 T.C. 294 (2011)(Kaufman II), and 134 T.C. 182 (2010)(Kaufman I). Under the Golsen rule, where a tax case is appealable to an appellate court and the appellate court has already ruled on the issue, the Tax Court must follow the appellate decision in that circuit. Because the Palmolive Building decision is appealable to the Seventh Circuit, the Tax Court has signaled that it declines to follow Kaufman III outside of the First Circuit.

Why does this matter?

The decision means that if a taxpayer donates a conservation easement outside of the First Circuit (comprising Maine, Massachusetts, New Hampshire, Puerto Rico, and Rhode Island), then the taxpayer must ensure that any existing mortgage on the property is properly subordinated to the easement and that the mortgagee does not retain any rights to be senior to the easement holder with regard to any insurance or condemnation proceeds. Otherwise, the deduction could be disallowed by the Tax Court.

In both Palmolive Building and Kaufman III, the taxpayer donated a façade easement and subordinated existing mortgages to the easement as required by the applicable Treasury Regulations, 26 C.F.R. 170A-14(g)(2). However, the subordinations were subject to the condition that the mortgagee would have first claim on insurance or condemnation proceeds, prior to the easement holder’s claim. The IRS argued that this condition violated the requirement of 26 C.F.R. 170A-14(g)(6)(ii) that, on extinguishment of the easement, the easement holder must be entitled to its share of the resultant proceeds. The First Circuit disagreed in Kaufman III and held that, to qualify as the “entitlement” required by -14(g)(6)(ii), the easement holder’s claim to the proceeds need only be senior to the property owner, not the mortgagee.

Interestingly, in the IRS’s 2012 Conservation Easement Audit Techniques Guide, the IRS warned several times that any subordination by a lender must include subordination to the division of proceeds clause required by 26 C.F.R. 170A-14(g)(6)(ii), but in the next edition of the Conservation Easement Audit Techniques Guide, which was published after Kaufman III, the IRS removed these warnings, presumably in acknowledgment of Kaufman III.

It looks like the Audit Guide needs to be dusted off and updated again. The Tax Court in Palmolive Building explicitly declined to follow Kaufman III and reaffirmed its own holdings in Kaufman I and Kaufman II. Outside of the First Circuit, a conservation easement deduction will be disallowed by the Tax Court where a mortgagee has retained a right to insurance and condemnation proceeds senior to the easement holder— unless the Seventh Circuit overturns Palmolive Building if it is appealed by the taxpayer.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Coblentz Patch Duffy & Bass | Attorney Advertising

Written by:

Coblentz Patch Duffy & Bass

Coblentz Patch Duffy & Bass on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.