Service Focuses on Conservation Purpose Test and Division of Proceeds Clause in PBBM-Rose Hill, Belair Woods, and Champions Retreat Golf Founders
The IRS has been busy this year challenging conservation easement deductions, particularly conservation easements protecting golf courses and conservation easements providing overinflated syndicated tax deductions.
This blog, the Land Trust Alliance, the IRS, the Wall Street Journal, Forbes, and Pro Publica have all previously described in detail the abusive syndication shelters proliferating in the conservation easement realm, which are threatening the viability of legitimate conservation donations. Two cases in the past couple of months highlight the jurisprudential damage these transactions have caused: PBBM-Rose Hill, LLC v. Commissioner, No. 17-60276 (5th Cir., Aug. 14, 2018) and Champions Retreat Golf Founders, T.C. Memo. 2018-146 (Sept. 10, 2018). A follow-on case, Belair Woods, LLC v. Commissioner, T.C. Memo 2018-159 (Sept. 20, 2018), didn’t create any precedential damage, but does provide a good example of a syndicated easement shelter and the IRS and courts’ continued avoidance of valuation disputes.
Take away points from these cases:
Golf course easements are particularly vulnerable right now
Taxpayers and easement holders must ensure that the conservation purposes of the easement are substantiated and, in the case of a golf course easement, that real public access is provided
The IRS continues to focus on the extinguishment proceeds clause in easements – both with respect to the valuation formula itself and with respect to the exclusion of improvements from the formula
Taxpayers must complete the Form 8283 properly and fill in the owner’s basis
Nitty gritty details below for tax, real property, and/or conservation easements wonks:
Unfortunately, this dreadful opinion came down from the Fifth Circuit and is the current law throughout that circuit, although an en banc hearing has been requested with a supporting amicus brief from the Land Trust Alliance. It is a policy disaster and, put simply, bad law.
In PBBM-Rose Hill v. Commissioner, No. 17-60276 (5th Cir. August 14, 2018), the taxpayer purchased a failing golf course property out of bankruptcy for $2.3 million, donated a conservation easement, and claimed an easement donation worth $13 million the same year. Immediately prior to the easement donation, the property was involved in a messy bankruptcy and litigation, in part revolving around a prior open space restriction.
Instead of looking too closely at the questionable valuation or digging into the prior open space restriction, at the IRS’s behest, the court zeroed in on an arcane provision of the Treasury Regulations: 26 C.F.R. § 1.170A-14(g)(6) or the “Extinguishment Proceeds Requirement.”
The Treasury Department promulgated the Extinguishment Proceeds Requirement to ensure that a tax-deductible conservation easement will continue to fulfill its conservation purposes in perpetuity, as required by Internal Revenue Code § 170(h)(5)(A), and thus preserve the public’s investment in that conservation easement. In the unlikely event that the conservation easement is terminated by judicial proceeding either because of condemnation or impossibility / impracticability of purpose, the Extinguishment Proceeds Requirement provides that the property owner must pay the easement holder the value of the easement, defined as 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.”
The IRS successfully argued that a conservation easement’s extinguishment clause must strictly copy the regulations’ precise formulaic language in the 2016 Tax Court case, Carroll v. Commissioner. More detail regarding the argument and its policy implications can be found here.
In PBBM-Rose Hill, the IRS went one step further with its extinguishment proceeds attack strategy and successfully argued that an easement is not perpetual if it excludes any post-easement improvements built by the landowner (where permitted by the easement) from the calculation of the value to go to the easement holder upon extinguishment.
This argument is senseless and it is embarrassing that the IRS and a circuit court judge failed to thoughtfully apply basic real property law principles to the matter. If the landowner has reserved the right to build improvements, then that right has not been conveyed to the easement holder and should not be included as part of the easement’s value. Indeed, any appraisal of the easement will have reduced the easement value by the value of retained development rights and the resulting tax deduction accordingly will exclude the retained development rights.
For example, say Daisy Donor donates an easement valued at $3 million over property worth $6 million (a 50% reduction in value). Daisy reserves the right to build a house within a particular building envelope and does so at the cost of $1 million the following year. The easement terminates one year later due to condemnation of the property and the condemning agency pays $7 million in condemnation proceeds: $6 million attributable to the underlying fee title and $1 million for the residence. Should the land trust’s share in these proceeds be $3 million (50% of the fee value) or $3.5 million (50% of the fee value and 50% of the new residence value)? Clearly, the proceeds to the land trust should be $3 million and Daisy should not have to share the $1 million attributable to the house that she built at her own expense. Otherwise, Daisy will have lost half of the expense she put into the house and a windfall will be created for the easement holder, which in no way reflects the tax deduction or appraised value of the easement. If a landowner’s expense in building new improvements is to be shared with the easement holder in the future, then arguably an additional tax deduction should be available for that expense.
The relevance of this most recent holding in PBBM-Rose Hill is that the IRS’s focus on the exclusion of improvements from the proceeds clause has found circuit-level approval, which does not bode well for any of the easements in the Fifth Circuit, or thousands of easements across the country, since similar challenges will be made in other circuits. The proceeds language disapproved by the IRS and the Fifth Circuit has been used in most land trust forms for the past several decades. Hopefully, the en banc hearing by the Fifth Circuit will result in better news for conservationists.
Champions Retreat is both a golf course easement and a syndicated easement with 39 investors, so it was ripe for challenge by the IRS as low hanging fruit. Rather than focusing on the proceeds clause or the syndication aspect of the easement, this is one of the few Tax Court opinions that delves into whether the easement protected any of the required conservation purposes found in Internal Revenue Code § 170(h)(4). The court held that the easement did not protect any of the required conservation purposes, because (1) there was an insufficient number of important species on the property, (2) if there had been a sufficient number, the pesticides on the property would undermine conservation of those species, (3) there was little to no public access on the property, and (4) the golf course was not a “natural area” and could not qualify as contributing to the ecological viability of nearby national parkland. It is obvious that the Internal Revenue Service and the Tax Court have it out for golf course easements.
Another syndicated easement came down last month, but at least this one doesn’t create any new foot faults in the easement documents or identify new, unsuspected vulnerabilities. The court did circumvent messy valuation arguments again, however, instead finding that the taxpayer should always disclose its basis in the underlying donated property in the IRS Form 8283, which is the form required to be attached to the tax return when a taxpayer claims a charitable deduction.
In Belair Woods, the taxpayer participated in a syndicated conservation easement transaction, claimed a $4.8 million charitable deduction, and, following the advice of its syndicator’s legal counsel, failed to provide its basis in Section B, Part I, Box F of Form 8283.
The court held that (1) the Form 8283 must be properly completed (including basis) because that information is necessary for the 8283 to achieve its intended purpose of highlighting disparities for the IRS to investigate, and (2) permitting the taxpayer to correct its exclusion by providing the missing information following review or audit would defeat the purpose of flagging issues for the IRS on review of the tax return.
The court’s reasoning is sound, particularly in this case, where the taxpayer claimed that the property had appreciated in value by “1,128% during the previous 2-1/2 years among the worst real estate crisis since the Great Depression.” The case is still active and open issues under review by the court include whether the taxpayer has a “reasonable cause” defense, whether the syndicator qualifies as a tax professional, and whether the taxpayer can rely on indirect advice provided to the syndicator by the syndicator’s legal counsel. The syndicator and its counsel will likely face some fallout from the taxpayer, regardless of the outcome.
These cases evidence the reluctance of the IRS and the tax and circuit benches to wade into valuation disputes and their willingness instead to use any argument to defeat a syndicated easement and, worst of all worlds, a syndicated golf course easement.