Lumber Company Disputes Denial of Charitable Contribution

PETITION FOR READJUSTMENT OF PARTNERSHIP ITEMS UNDER I.R.C. SECTION 6226

PETITIONER HEREBY PETITIONS for a readjustment of the partnership items set forth by the Commissioner of Internal Revenue ("Respondent") in the Notice of Final Partnership Administrative Adjustment dated February 29, 2000 (hereafter "FPAA") respecting the tax year ending December 31, 1996. As the basis for its case, Petitioner alleges as follows:

1. Petitioner is Rex Lumber Company ("Rex Lumber") which files this petition by and through Charles Finley McRae whose legal address is 1190 Eighth Avenue, Graceville, Florida 32440, and is the tax matters partner for Rex Lumber.

2. Rex Lumber's employer identification number is [TIN omitted], and its principal place of business is Post Office Box 7, Graceville, Florida. The return for the period involved was filed with the Internal Revenue Service in Atlanta, Georgia.

3. The FPAA purports to have been mailed to Petitioner on February 29, 2000, and was issued by the District Director in Jacksonville, Florida. A copy of the FPAA is attached hereto as Exhibit A. The FPAA asserts two adjustments, the disallowance of a charitable deduction on a bargain sale to the State of Florida in the amount of $7,450,000 and a correlative capital gains adjustment of $835,413 for the taxable year 1996.

4. In the FPAA, Respondent has erred in, inter alia, the following particulars:

a. In reducing the charitable contribution deduction by $7,450,000 for the taxable year 1996; and

b. In failing to increase the charitable contribution to bring it in line with the true fair market value on the date of the contribution.

5. The facts, and mixed points of facts and law, upon which Petitioner relies are, inter alia, as follows: ¹

a. The primary issue in this charitable contribution case is the determination of the fair market value on October 28, 1996 of the property interests Rex Lumber transferred to the State of Florida.

b. The tax treatment of charitable contributions like the part gift/part sale at issue here must be liberally construed to the end of fulfilling the Congressional purpose of encouraging such charitable contributions.

c. Rex Lumber took a conservative approach that it now believes substantially understated the value of that charitable contribution, whereas Respondent discourages all part gift/part sale charitable contributions by insisting that the value cannot exceed the price paid.

d. Rex Lumber simply seeks an accurate determination of the true fair market value of the property it transferred to the State of Florida, without any result-driven compromises of the sort condemned by this Court in Buffalo Tool & Die Manf Co. v. Commissioner, 74 T.C. 441, 452 (1980).

e. Prior to October 28, 1996, Rex Lumber owned a contiguous tract of largely river front property and timberland, consisting of over 37 square miles of land.

f. That tract has land along both sides of over 18 miles of various tributary creeks and over 32 miles of river frontage on the Ochlocknee, Crooked, and New Rivers near Carabelle on the Florida coast.

g. All of the 32 miles of river frontage is along those sections of Ochlocknee, New, and Crooked Rovers [sic] that are navigable down to the nearby Gulf of Mexico.

h. On October 28, 1996 and at all relevant times, the tract has included substantial standing timber and limestone reserves that are unencumbered by any timber cutting or mining contracts. To avoid any confusion in references, the entirety of the river frontage, timberland, unencumbered standing timber, and mineral reserves transferred to the State of Florida are hereinafter referred to as the "23,920 Acre Tract."

i. In 1995, Rex Lumber was contacted by the State of Florida which proposed that Rex Lumber transfer the 23,920 Acre Tract to the State of Florida for which the State would pay for part of the value incident to a part gift/part sale.

j. During the discussions between the State of Florida and Rex Lumber, both parties acknowledged that Rex Lumber would be donating value in excess of the consideration paid.

k. As the negotiator for the State of Florida Department of Environmental Protection explained to Respondent:

(i) In pursuing purchases or part gifts/part sales, the State of Florida is required by statute to obtain and rely upon independent appraisals;

(ii) Those appraisals are obtained from appraisers on a list approved by the State of Florida for use in these situations;

(iii) The appraisals obtained by the State of Florida in these situations from its approved list of appraisers are generally lower than the appraisals obtained by the landowner;

(iv) Landowners generally do not view the appraisals obtained by the State from its approved list as truly independent;

(v) If the landowner does not agree to transfer the property voluntarily, the State of Florida has the power to take the property by eminent domain;

(vi) In those transactions where the State of Florida obtains more than one appraisal, its policy is to pay up to an "Approved Value"; and

(vii) The State of Florida does not disclose either its appraisals or the "Approved Value" to the landowner until after the transaction is closed.

l. Here, the State of Florida originally determined an "Approved Value" for the Rex Lumber Tract in the amount of $27,330,000. Later, that amount a was increased to $27,400,000.

m. The State of Florida "Approved Value" on the subject property was based on two appraisals relating to valuation dates preceding the actual transfer by roughly two years:

       Date

o. The March 1995 timber inventory obviously did not include the timber growth between March of 1995 and the transfer on October 28, 1996.

p. That omitted period covered two annual growing seasons (March through October of 1995 and March through October of 1996).

q. The transfer was consummated on October 28, 1996.

r. The underlying documents contained clauses confirming that the consideration paid ($24,850,00) did not represent the full fair market value of the 23,920 Acre Tract.

s. As the State of Florida also explained to Respondent, the State of Florida only includes those clauses when it believes the value exceeds the consideration paid.

t. The fair market value of the subject property must be measured on the date of the actual transfer (October 28, 1996) for purposes of determining the amount of the charitable contribution.

u. The calculation of the charitable contribution in the FPAA is based on a revised report by David Elmore, whereas the calculation of the charitable contribution on the original return filed by Rex Lumber for the taxable year 1996 is based primarily on reports by Andrew V. Santangini, Jr., MAI; James H. Gibbs, MAI; and Mr. King.

v. As the experts for both Respondent and Rex Lumber agreed, the original purchase of the 23,920 Acre Tract by Rex Lumber was a distress purchase that does not indicate the price an arm's length buyer would pay an arm's length seller, neither acting under any form of compulsion.

w. The original distress purchase by Rex is therefore not relevant to the determination of value.

x. The appraisers for both Rex Lumber and Respondent identified the same eight transactions as potential comparables, the last of which involves three transactions relating to three parcels sold from a previously aggregated tract covering 23 miles along the New River.

y. Several of those transactions involve transfers to governmental entities or nature conservancies and may or may not also involve a gift element.

z. Messrs. Santangini, Gibbs, and Elmore only addressed the consideration paid in those transactions since the information relating to any gift element was not available. To that extent, the values used by Messrs. Santangini, Gibbs, and Elmore are, if anything, understated.

aa. The eleven transactions (including the resale of the sixth transaction and the three parts of the eighth transaction) addressed by Messrs. Santangini, Gibbs, and Elmore are as follows:

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ac. The time relevant comparables confirm that land by navigable water is more valuable than land without water influence.

                    WATER INFLUENCED COMPARABLES

ae. Moreover, it is navigable down to the Gulf of Mexico.

af. The most comparable transaction for that 32 miles of river frontage and property on both sides of the 18 miles of tributary creeks is Phase III of Transaction 8 at $1,089 per acre of land and $858 per acre of timber.

ag. That value, however, does not reflect the superior navigability, road system, utility access, and vacation housing development of the 23,920 Acre Tract.

ah. The 23,920 Acre Tract has an internal dirt road system.

ai. More importantly, the 23,920 Acre Tract is elongated on a north/south axis and runs along seven miles of C.R. 67, the major north/south paved road out of Carabelle, Florida.

aj. Phase III of Transaction 8 had no internal road system other than the Burnt Bridge dirt road and is not attached at any point to any form of paved road.

ak. Further, the 23,920 Acre Tract has a power line running its length with C.R. 67, whereas Phase III of Transaction 8 has no power beyond Burnt Bridge.

al. Unlike the absence of any development adjacent to Phase III of Transaction 8, vacation homes have been built adjacent to the 23,920 Acre Tract along the Ochlocknee, New, and Crooked Rivers.

am. With its superior access to power, seven miles of frontage on C.R. 67, AND-32 plus miles of navigable waters, the potential for vacation development was greater on the 23,920 Acre Tract before the transfer to the State of Florida, than development of the Transaction 8 Phase III tract ever was.

an. Commercially recoverable mineral reserves are located on the 23,920 Acre Tract.

ao. One limestone mining operation was already underway prior to October 28, 1996 and another reserve had been proven.

ap. Mr. King, with the assistance of a Ph.D and geologists who actually make their living mining limestone, valued the limestone reserve transferred to the State of Florida at $2,900,000 as of August 1995, with an updated value of $3,470,000 as of October 28, 1996.

aq. Respondent relies upon Messrs. Elmore and Hoover as to the value of the mineral rights. Mr. Elmore, with the assistance of Mr. Hoover, relied on alleged discounted amounts the State of Florida paid for other mineral rights appraised by Mr. King.

ar. The report by Messrs. Elmore and Hoover does not consider the gift element of those transactions.

as. Respondent, through Messrs. Elmore and Hoover, "concluded that the $24,850,000 purchase price paid by the State of Florida represented the full and complete fair market value of the subject" and, of that amount, "$2,726,000 [was] allocated and paid by the State of Florida" for the mineral rights. Revised IRS Engineering and Valuation Report dated October 19, 1998, pp. 20, 23.

at. As a result, the FPAA raises the issue of whether the value of the mineral rights was $2,726,000 as Respondent determined or was at least $3,470,000 as Petitioner urges.

au. As Respondent recognized, the conveyance of mineral rights to the State of Florida has a value separate and apart from the mineral rights because it conveys perpetual protection against the property being disturbed by that mining.

av. The mineral rights on the 23,920 Acre Tract had a fair market value of at least $3,470,000 as of the valuation date.

aw. Due to the passage of time, Rex Lumber obtained an updated timber inventory/valuation from Mr. King, the appraiser/forester chosen by the State of Florida to inventory/value the standing timber in the beginning.

ax. That updated timber inventory and valuation was completed on February 24, 1997, only four months after the valuation date of October 28, 1996.

ay. Mr. King adjusted the overall timber inventory by applying a one-year growth factor obtained from a GAPPS program from a biometrician with the leading forestry experts in the South.

az. Mr. King was too conservative in asking for a one-year growth factor because the interim actually covered two growth seasons (March-October 1995 and March-October 1996).

ba. In his original timber inventory and appraisal, Mr. King also excluded Stands 15 and 16 because they were under a timber contract to a third party.

bb. By October 28, 1996, the timber on Stands 15 and 16 had not been cut and was passing to the State.

bc. Therefore, Mr. King properly added 2,500 cords to his updated timber inventory/valuation for Stands 15 and 16.

bd. During the interim between the original March 1995 inventory and the October 28, 1996 valuation date, the timber on Stand 17 moved from a classification of pre-merchantable to merchantable timer.

be. That reclassification results in a measurable jump in value from at least $35.61 per cord to at least $45 per cord.

bf. As recognized by Mr. Elmore, the timber on Stand 18 had a greater diameter than some of the merchantable stands even though the timber on Stand 18 was less than 15 years old.

bg. Due to its rapid growth, the timber on Stand 18 that was conveyed to the State of Florida should also be treated as merchantable, with a corresponding increase in value of at least $52,371.

bh. Mr. King's pricing of the different lumber classes (sawtimber, chip-and-saw, and hardwood pulpwood) in the updated report was too conservative. Most of the timber was second and third generation natural/virgin growth, much of it was suitable for poles, and these characteristics, as well as other features, bring a premium.

bi. Therefore, Mr. King was overly conservative when he applied the following straight market-driven pricing:

(i) Pine Sawtimber. Mr. King's appraised value of $400 per mbf includes second and third generation timber from natural stands and pine poles which can carry values of up to $500 per thousand. Negotiated sales for sawtimber in the area ranged from $375 to $450. Mr. King used the mean value of $400 per mbf because the pole quality timber is included in this category. The average haul for Rex Lumber's sawtimber is less than 80 miles. Thus, Mr. King's pricing is, if anything, too low.

(ii) CNS. Mr. King was conservative as to price ($90 per cord) and volume. North Florida Lumber regularly defines pines between 8- 11 inches in diameter as CNS and logs in the 9.6 to 13 inch range as sawtimber. Without recognizing that much of Rex Lumber's CNS can be sold as sawtimber, Messrs. King and Elmore understated the CNS values.

(iii) Hardwood Pulpwood. The mean negotiated sales value of hardwood pulpwood is $23 per cord. Mr. Elmore ignores that price on the apparent belief no market exists. Markets for this hardwood are Stone Container in Panama City and Perry, Florida, both located 100 miles from the property, and Georgia Pacific in Cedar Springs, Florida, 110 miles away. In addition, paper mills give zone pricing particularly for large tracts of timber. A large tract provides a paper mill with a continuing supply of pulpwood for which they are willing to pay a premium. This offsets the cost of the longer haul for the timber grower and gives the paper mill a much wider supply base.

bj. Mr. King understated the overall fair market value of the timber on October 28, 1996 by, inter alia:

(i) Omitting the growth factor for the second growing season;

(ii) Failing to adjust for the superior growth of Stand 18; and

(iii) Applying an excessively conservative pricing schedule.

bk. Similarly, if the valuation by Messrs. Santangini and Gibbs deviates from accuracy at all, it fails to fully measure, inter alia:

(i) The market value influence of water;

(ii) The market value influence of navigable water with ready access to the Gulf of Mexico;

(iii) The market value influence of available electricity;

(iv) The market value influence of an adjacent State Road;

(v) The market value influence of an internal road system; and

(vi) The market value influence of adjacent vacation home development.

bl. Petitioner is awaiting confirmation of the impact of fully considering these various factors but believes it may well have mistakenly understated the true value of the 23,920 Acre Tract on its original return.

6. The FPAA is excessive, erroneous, arbitrary, capricious, and unjustified. Respondent should, therefore, bear the burden of proof.

7. The true fair market value of the 23,920 Acre Tract appears to be greater than Rex Lumber originally believed. Therefore, Petitioner hereby claims any greater amount determined by the Court and preserves on behalf of its constituent partners their distributive share of that increased charitable contribution together with a refund of any resulting overpayment of tax (plus interest as provided by law).

WHEREFORE, Petitioner prays that after due proceedings are had it be redetermined that:

(i) Respondent erred in adjusting the Partnership's reported income, gain, and charitable contribution deduction for the taxable year 1996;

(ii) Petitioner is actually entitled to a greater charitable contribution than originally claimed and its partners are therefore entitled to the increased deduction and refund of any overpayment (with interest as provided by law) resulting from an accurate determination of fair market value;

(iii) Respondent should bear the burden of proof as to all issues; and

(iv) The Court grant such other and further relief as it deems appropriate.

Respectfully submitted,

² Petitioner questions this allocation between land and timber.

³ The three phases of Transaction 8 cover 23 miles of the New River in the aggregate.

⁴ As noted, Petitioner questions this allocation between land and timber.

[Editor's Note: The attachment has been omitted. However, this document in its entirety can be obtained through our Tax Analysts' Access Service as Doc 2000-18582 (26 pages).]