Partnership Argues Tax Court Erred in Holding Proceeds Reg Valid

OAKBROOK LAND HOLDINGS, LLC,
WILLIAM DUANE HORTON, TAX MATTERS PARTNER,
Petitioner/Appellant/Cross-Appellee,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent/Appellee/Cross-Appellant.

United States Court of Appeals
for the
Sixth Circuit

APPEAL FROM THE UNITED STATES TAX COURT

(Hon. Mark V. Holmes)

INITIAL BRIEF OF APPELLANT

Michelle Abroms Levin
Sirote & Permutt, P.C.
305 Church Street SW, Ste 800
Huntsville, AL 35801
T: (256) 518-3605

Gregory P. Rhodes
Sirote & Permutt, P.C.
2311 Highland Avenue South
Birmingham, AL 35205
T: (205) 930-5445

Attorneys for Appellant.

DISCLOSURE OF CORPORATE AFFILIATIONS AND FINANCIAL INTEREST

Neither Oakbrook Land Holdings, LLC, the partnership at issue in this proceeding, nor William Duane Horton, Tax Matters Partner, is a subsidiary or affiliate of a publicly owned corporation. There is neither a publicly owned corporation nor a party to the appeal that has a financial interest in the case's outcome.

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TABLE OF CONTENTS

DISCLOSURE OF CORPORATE AFFILIATIONS AND FINANCIAL INTEREST

TABLE OF CONTENTS

TABLE OF AUTHORITIES

STATEMENT IN SUPPORT OF ORAL ARGUMENT

STATEMENT OF JURISDICTION

STATEMENT OF THE ISSUES

STATEMENT OF THE CASE

SUMMARY OF ARGUMENT

ARGUMENT

A The Proceeds Regulation Is Invalid Because Treasury Failed to Comply with the APA's Procedural Requirements

B The Proceeds Regulation Is an Invalid Agency Action Under State Farm and Chevron46

CONCLUSION

CERTIFICATE OF COMPLIANCE

CERTIFICATE OF SERVICE

ADDENDUM

TABLE OF AUTHORITIES

Cases

All. for Cmty. Media v. F.C.C., 529 F.3d 763 (6th Cir. 2008)

Atkinson v. Comm'r, 110 T.C.M. (CCH) 550 (2015)

Atrium Med. Ctr. v. U.S. Dep't of Health and Human Servs., 766 F.3d 560 (6th Cir. 2014)

Auto. Parts & Accessories Assoc. v. Boyd, 407 F.2d 330 (D.C. Cir. 1968)

Barnhart v. Thomas, 520 U.S. 20 (2003)

BC Ranch II, L.P. v. Comm'r, 867 F.3d 547 (5th Cir. 2017)

Butler v. Comm'r, 103 T.C.M. (CCH) 1359 (2012)

Carlson v. Postal Regulatory Comm'n, 938 F.3d 337 (D.C. Cir. 2019)

Carroll v. Comm'r, 146 T.C. 196 (2016)

Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984)

CIC Services, LLC v. I.R.S., 925 F.3d 247 (6th Cir. 2019) (Mem.)

CIC Services, LLC v. I.R.S. 936 F.3d 501 (6th Cir. 2019) (Mem.)

Citizens Coal Council v. EPA, 447 F.3d 879 (6th Cir. 2006)

Comm'r v. Simmons, 646 F.3d 6 (D.C. Cir. 2011)

Dep't of Homeland Sec. v. Regents of the Univ. of Cal., 140 S. Ct. 1891 (2020)

Dominion Res., Inc. v. United States, 681 F.3d 1313 (Fed. Cir. 2012)

Glass v. Comm'r, 471 F.3d 698 (6th Cir. 2006)

Good Fortune Shipping SA v. Comm'r, 897 F.3d 256 (D.C. Cir. 2018)5

Hewitt v. Comm'r, No. 20-13700 (11th Cir. filed Sept. 30, 2020)

Home Box Office, Inc. v. F.C.C., 567 F.2d 9 (D.C. Cir. 1977)

Hospital Corp. of Am. & Subs. v. Comm'r, 348 F.3d 136 (6th Cir. 2003)

Indep. U.S. Tankers Owners Comm. v. Dole, 809 F.2d 847 (D.C. Cir. 1987)

Industrial Union Dep't, AFL-CIO v. Hodgson, 499 F.2d 467 (D.C. Cir. 1974)

Judulang v. Holder, 565 U.S. 42 (2011)

Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012)

Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44 (2011)

Michigan v. EPA, 135 S. Ct. 2699 (2015)

Mid-Am. Care Found. v. N.L.R.B., 148 F.3d 638 (6th Cir. 1998)

Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mut. Auto. Ins., 463 U.S. 29 (1983)

Nichols v. United States, 260 F.3d 637 (6th Cir. 2001)

Oakbrook Land Holdings v. Comm'r, 119 T.C.M. (CCH) 1352 (T.C. 2020)

Oakbrook Land Holdings v. Comm'r, 154 T.C. No. 10 (2020)

Palmer Ranch Holdings, Ltd. v. Comm'r, 812 F.3d 982 (11th Cir. 2016)

PBBM-Rose Hill, Ltd. v. Comm'r, 900 F.3d 193 (5th Cir. 2018)

PBBM-Rose Hill, Ltd. v. Comm'r, No. 026096-14 (T.C. Oct. 11, 2016) (bench opnion) (United States Tax Court Docket Search)

Pine Mountain Preserve, LLLP v. Comm'r, 978 F.3d 1200 (11th Cir. 2020)

PPG Indus., Inc. v. Costle, 630 F.2d 462 (6th Cir. 1980)

Railroad Holdings, LLC v. Comm'r, 119 T.C.M. (CCH) 1136 (2020)

SEC v. Chenery Corp., 332 U.S. 194 (1947)

Simms v. Nat'l Highway Traffic Safety Admin., 45 F.3d 999 (6th Cir. 1995)

Tenn. Hosp. Ass'n v. Azar, 908 F.3d 1029 (6th Cir. 2018)

United States. v. Cain, 583 F.3d 408 (6th Cir. 2009)

United States v. Cartwright, 411 U.S. 546 (1973)

United States v. Nova Scotia Food Prod. Corp., 568 F.2d 240 (2d Cir. 1977)

Village of Barrington v. Surface Transp. Bd., 636 F.3d 650 (D.C. Cir. 2011)

Federal Statutes

5 U.S.C. § 553

5 U.S.C. § 553(c)

5 U.S.C. § 706(2)

I.R.C. § 170(h)

I.R.C. § 170(h)(1)

I.R.C. § 170(h)(1)(C)

I.R.C. § 170(h)(2)(C)

I.R.C. § 170(h)(5)

I.R.C. § 170(h)(5)(A)

I.R.C. § 6234

I.R.C. § 6662

I.R.C. § 7442

I.R.C. § 7482(a)(1)

I.R.C. § 7482(b)

I.R.C. § 7483

Legislative Materials

S. Rep. No. 96-1007 (1980) reprinted in 1980 U.S.C.C.A.N. 6736

Tax Treatment Extension Act of 1980, Pub. L. No. 96-541, §6(b), 94 Stat. 3204, 3206 (1980)

Rules

Tax Court Rule 190(a)

Regulatory Materials

Income Taxes; Qualified Conservation Contributions, 51 Fed. Reg. 1496-98 (Jan. 14, 1986)(to be codified at 26 C.F.R. pt.1); T.D. 8069, 1986-1 C.B. 8951 (included in Addendum)

Qualified Conservation Contribution, 48 Fed. Reg. 22940 (proposed May 23, 1983) (to be codified at 26 C.F.R. pt. 1) (included in Addendum)

Treas. Reg. § 1.170A-14

Treas. Reg. § 1.170A-14(g)(6)

Treas. Reg. §1.170A-14(g)(6)(i)

Treas. Reg. §1.170A-14(g)(6)(ii)

Constitutional Provisions

U.S. Const. amend. V

Other Authorities

Am. Law Inst. Restatement (Third) of Property § 7.11 (2000)

33 Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure §8414 (2d ed. 2020)

Chief Counsel Regulation Handbook, IRM 32.2 (Nov. 12, 2019)

Elizabeth Byers & Karin Marchetti Ponte, Conservation Easement Handbook (2d ed. 2005)

Kristin E. Hickman, Coloring Outside the Lines, Examining Treasury's (Lack of) Compliance with Administrative Procedure Act Rulemaking Requirements, 82 Notre Dame L. Rev. 1727, 1748-50 (2007)

Matthew A. Melone, Light on The Mayo: Recent Developments May Diminish the Impact of Mayo Foundation on Judicial Deference to Tax Regulations, 13 Hastings Bus. L.J. 149, 187 (2017)

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STATEMENT IN SUPPORT OF ORAL ARGUMENT

Oakbrook Land Holdings, LLC (“Oakbrook”) made a charitable donation of a valuable conservation easement to perpetually conserve the ridgeline of White Oak Mountain near Chattanooga, Tennessee (the “Easement”). Oakbrook used well-vetted and standard terms drafted by charitable land trusts that regularly accept and administer easement donations, and its donation complied with all the requirements of Internal Revenue Code § 170(h) (found in Title 26 of the United States Code). Years later, the IRS declared war on conservation easement donations to combat what it perceived as valuation abuses associated with certain “syndicated” conservation easement donations. Oakbrook is not one of the targeted syndicated conservation easement donations; it is a collateral casualty in that war.

While the conservation purposes served by the easement donations under IRS attack are rarely in question, the IRS's recent litigation strategy has been to raise technical arguments seeking wholesale denials of such charitable deductions so that it can avoid the costs of litigating fact-intensive valuation disputes. In furtherance of that strategy, eight years after Oakbrook's donation, the IRS announced, in unrelated litigation, a new interpretation of the requirements imposed by a decades-old regulation — the “Proceeds Regulation”, Treasury Regulation § 1.170A-14(g)(6)(ii). This Regulation addresses a highly unlikely event — how compensation due under the Fifth Amendment, in the event of a government taking of the easement property, should be allocated between the easement donor and donee to ensure the conservation purposes continue to be protected in perpetuity. The IRS's post-donation interpretation now requires that an easement holder (i.e., the land trust) receive proceeds attributable to property interests retained by the landowner. This new interpretation upends, and retroactively disqualifies, generally-accepted provisions in conservation easement deeds that land trusts, states, and even federal agencies (such as the Environmental Protection Agency) have widely-used for decades. As a result, the IRS has disallowed deductions claimed for hundreds of conservation easements, including Oakbrook's, for violating the Proceeds Regulation. These donors are left with no recourse to save a deduction for the undeniably valuable property rights they donated in a manner intended to comply with the IRS's requirements.

In claiming that its Regulation required this specific allocation; which is inconsistent with the standard language developed by the leading experts in conservation, and adopted by dozens of land trusts across the country, several states, and even federal agencies; the IRS brought into question the reasonableness of the Regulation. Oakbrook, in turn, asked that question: Is the Regulation reasonable and is it the product of reasoned decision-making? Turns out, it was not.

The Administrative Record produced by the IRS in the court below unequivocally demonstrates that during the notice and comment period, the Department of Treasury (“Treasury”) received 90 comments on the proposed qualified conservation contribution regulations (found in §1.170A-14 of 26 C.F.R.), over a dozen of which directly addressed proposed Proceeds Regulation. Many of those comments outlined multiple concerns with the formula that Treasury detailed in the proposed regulation and proposed a range of alternatives. Treasury did not respond to, address, or even acknowledge any of those comments.

The Tax Court judge who presided over the trial of the case — Judge Mark V. Holmes — concluded that the Proceeds Regulation is invalid because Treasury entirely failed to respond to comments challenging the proposed regulation or to consider the alternatives proposed. Op. at 118 (Holmes, J., dissenting).¹ The Tax Court majority opinion brushed aside presiding Judge Holmes's concerns, relying on a single throwaway line stating that Treasury finalized the rule “after consideration of all comments.” Id. at 20. As Judge Holmes explained, to permit Treasury to evade the Administrative Procedure Act's (“APA”) requirements in this fashion “would make commenting meaningless.” Op. at 115 (Holmes, J., dissenting) (quoting Home Box Office, Inc. v. F.C.C., 567 F.2d 9, 35 (D.C. Cir. 1977)).

In his dissent, Judge Holmes observed, “[o]ur holding today will likely deny any charitable deduction to hundreds or thousands of taxpayers who donated the conservation easements that protect perhaps millions of acres.” Id. at 82.² The Tax Court's decision has far-reaching implications beyond conservation easement donations. Under the Tax Court's decision, “the Treasury Department gets to ignore basic principles of administrative law that require an agency 'to give reasoned responses to all significant comments in a rulemaking proceeding.'” Id. (quoting PPG Indus., Inc. v. Costle, 630 F.2d 462, 466 (6th Cir. 1980)). Affording Treasury and the IRS such latitude in rulemaking is particularly troubling when the IRS “has begun to regulate an ever-expanding sphere of everyday life — from childcare and charity to healthcare and the environment.” CIC Services, LLC v. I.R.S. 936 F.3d 501, 507 (6th Cir. 2019) (Mem.) (Thapar, J. dissenting), cert. granted, 140 S. Ct. 2737 (May 4, 2020) (No. 19-930). Given the significance of the issues raised and their impact on Treasury's future rulemaking, oral argument is requested.

INITIAL BRIEF OF APPELLANT

STATEMENT OF JURISDICTION

This is an appeal of the July 21, 2020 final decision of the United States Tax Court, which disallowed Oakbrook's charitable contribution deduction for its donation of a qualified conservation contribution solely because the terms of the document conveying the Easement did not comply the IRS's previously unstated and unknown interpretation of Treasury Regulation §1.170A-14(g)(6)(ii), which was issued in violation of the requirements of the APA.

The Tax Court had jurisdiction to review Oakbrook's petition for readjustment of partnership items pursuant to 26 U.S.C. §§6234 and 7442. This Court has jurisdiction to review decisions of the Tax Court pursuant to 26 U.S.C. §7482(a)(1). Venue is proper in the Sixth Circuit pursuant to 26 U.S.C. §7482(b) because Oakbrook's principal place of business was in Tennessee at the time the petition was filed in Tax Court. Oakbrook filed a notice of appeal with the Tax Court on October 16, 2020, within 90 days from the date that the decision was issued in this case. Therefore, this appeal is timely under Tax Court Rule 190(a) and 26 U.S.C. §7483.

STATEMENT OF THE ISSUES

The issue before the Court is whether Treasury violated the APA when it issued the Proceeds Regulation without responding to relevant comments or providing the basis for its decision.³ Judge Holmes, the trial judge in this case, said yes, and he would refuse to penalize well-intentioned taxpayers like Oakbrook, based on an invalid Regulation. In his view, the donation met the Internal Revenue Code's requirements, and the corresponding deduction could not be denied due to an invalid Regulation. The majority of the Tax Court, however, disagreed and issued an opinion that essentially vitiates Treasury's obligation to comply with the APA when issuing new rules or regulations so long as it invokes the magical phrase “after consideration of all comments” when issuing the final regulation. The Tax Court's decision undermines the APA's purposes and gives the IRS carte blanche to ignore comments in the future.

Oakbrook challenges the procedural and substantive validity of the Proceeds Regulation. The grounds for Oakbrook's two challenges overlap to a great degree. The Regulation fails to comply with the APA's procedural requirements because Treasury failed to consider and respond to relevant comments and failed to provide any reason for imposing this regulatory requirement in the basis and purpose statement accompanying the final regulations. See 5 U.S.C. §553(c). Treasury's failure to provide any reason for its rule, or analysis of the comments received, results in its substantive invalidity under 5 U.S.C. §706(2) because Treasury did not meet the reasoned decision-making requirements found in State Farm and Chevron. Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984); Motor Vehicle Mfrs. Ass'n of the U.S. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29 (1983). The Regulation also is substantively invalid because it imposes requirements outside the scope of the relevant statute.

The statute provides that a taxpayer is entitled to a deduction for the donation of a qualified conservation contribution when three requirements are satisfied: (1) the taxpayer donates “a qualified real property interest” (2) to a “qualified organization” (3) that is “exclusively for conservation purposes.” I.R.C. §170(h)(1). A donation is exclusively for conservation purposes if “the conservation purpose is protected in perpetuity.” §170(h)(5). Oakbrook's donation met all three of the statutory requirements.

The Proceeds Regulation was issued in 1986 as part of a larger regulatory project to provide guidance for qualified conservation contributions. The Proceeds Regulation concerns the unlikely event that the protected property is condemned, resulting in the easement's extinguishment. How should the proceeds due under the Fifth Amendment's Takings Clause be allocated between the property owner and the charitable organization that holds the easement to ensure the conservation purposes are protected in perpetuity?

To address this unlikely situation, Treasury's Proceeds Regulation requires that — at the time of donation — the donor and donee agree, inter alia,:

(1) the conservation easement “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;”

(2) the proportionate value of the donee's property right remains constant; and

(3) following the easement's extinguishment by judicial proceedings, “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.”

Treas. Reg. §1.170A-14(g)(6)(i)-(ii).

In response to the proposed Proceeds Regulation, several commenters expressed concerns about whether the requirement that post-extinguishment proceeds be allocated according to the “proportionate value” established at the time of donation was fair, reasonable, or even practical.JA670-72, JA675, JA682, JA685, JA764-66, JA778-79, JA795, JA798. Commenters also expressed concern that, as drafted, the Regulation did not properly account for improvements to the property made by the donor after the donation of the easement, improvements in which the land trust would have no legal or financial interest. JA670-72.

In its final regulations, Treasury neither addressed those comments nor explained whether it had considered or rejected the alternatives proposed and why. See Income Taxes; Qualified Conservation Contributions, 51 Fed. Reg. 1496-98 (Jan. 14, 1986) (to be codified at 26 C.F.R. pt. 1); T.D. 8069, 1986-1 C.B. 8951. In fact, the preamble to the final regulations is silent on the basis or purpose of Treasury Regulation §1.170A-14(g)(6)(ii). Id. In the years that followed, the IRS did not offer any additional explanation or guidance on the purpose or operation of the Proceeds Regulation.

Between 1986 and 2016, the IRS challenged dozens of conservation easement donations with proceeds provisions that operated in the same or similar manner as the provision in Oakbrook's “Conservation Easement and Declaration of Restrictions and Covenants” (the “Deed”). Not once did the IRS challenge the proceeds provision as noncompliant with the Proceeds Regulation. In 2016, eight years after Oakbrook donated the Easement, the IRS reversed course and began to use the Proceeds Regulation as a means to disallow deductions for many significant conservation donations. See, e.g., Carroll v. Comm'r, 146 T.C. 196, 201 n.7, 208-09, 219 (2016) (disallowing in full the taxpayers' deduction for an extensively vetted conservation easement donation to a land trust created by Maryland's legislature to conserve Maryland's critical lands).

Judge Holmes expressed concern with the IRS's “attack on a clause commonly found in easements, particularly in the southeastern part of the country.” Mem. Op.⁴ at *2. Oakbrook argued that the IRS's attack on the generally-accepted proceeds provisions must fail because the IRS did not comply with the administrative law requirements governing the regulation underlying the IRS's attack. The Tax Court majority sided with the IRS, setting the stage for the IRS to forever avoid its APA obligations by merely incorporating “broad statements of purpose . . . coupled with obvious inferences.” Op. at 25.

The majority's conclusion that Treasury complied with the APA's procedural requirements was incorrect. As Judge Holmes explained, “if the APA did allow comments to be disregarded with this simple magical phrase as part of a standard form, it would make commenting meaningless.” Id. at 115 (Holmes, J., dissenting). Judge Holmes also criticized the majority's decision to excuse Treasury's failure to provide a reason for its Regulation: “The majority today comes up with as good a set of arguments as possible to justify the reasonableness of the regulatory choices that Treasury made when it was drafting this regulation. But Treasury didn't make them.” Id. at 126. Judge Toro was likewise concerned with the majority's conclusion: “'When an administrative agency sets policy, it must provide a reasoned explanation for its action. That is not a high bar, but it is an unwavering one. Here, . . . [Treasury] has failed to meet it.'” Id. at 80 (Toro, J., concurring) (quoting Judulang v. Holder, 565 U.S. 42, 45 (2011)) (alteration in original).

Under the Tax Court's decision, Oakbrook, and many other donors who relied on generally-accepted deed provisions, will lose their deductions in full, with no opportunity or ability to reform a purportedly problematic provision that likely will never even be utilized. More concerning, the Tax Court's decision lowers the bar for APA compliance to the point where the APA's procedural safeguards become meaningless. Such a determination must not stand in this Court, which recently observed that the IRS does “not have a great history of complying with APA procedures, having claimed for several decades that their rules and regulations are exempt from those requirements.” CIC Services, LLC v. I.R.S., 925 F.3d 247, 258 (6th Cir. 2019) (internal quotations omitted). The questions for this Court, therefore, are as follows:

STATEMENT OF THE CASE

Conservation easement donations have drawn the IRS's ire in recent years due to perceived overvaluations by certain donors of such easements. But instead of addressing valuation issues on a case-by-case basis, as the law requires, the IRS has implemented a strategy to void these deductions en masse by adopting “very contestable readings of what it means for an easement to be perpetual.” Op. at 127 (Holmes, J., dissenting). This blunderbuss approach, which is no doubt designed to save the IRS the administrative hassle of litigating the fact-intensive issue of easement valuation, will deny entire deductions for conservation easement donations that Congress sought to encourage — based on a hypothetical easement extinguishment that is highly unlikely ever to happen. This approach creates vast uncertainty that Congress explicitly sought to prevent.

Oakbrook's members relinquished their rights in perpetuity to develop a valuable mountaintop located in one of Chattanooga's high growth corridors. In exchange, Oakbrook's members are entitled to the tax deduction created by Congress to incentivize this very type of donation. The rights donated will neither revert back to Oakbrook or its members nor did Oakbrook limit the Southeast Regional Land Conservancy's (“SRLC”) ability to enforce the Easement's restrictions in perpetuity. Nevertheless, the IRS disallowed Oakbrook's deduction (and countless others) based on a “very contestable reading” of the Proceeds Regulation that was manufactured by the IRS nearly a decade after Oakbrook's donation.

The IRS cannot deny Oakbrook's deduction based on a regulation that Treasury issued in violation of the APA. The IRS is attempting to leverage its unexplained Regulation into hundreds of disallowed deductions by adopting new interpretations that contravene the engendered reliance interests of taxpayers and land trusts. The APA's procedural safeguards exist to preclude agencies from achieving such inequitable results, and the IRS must be held accountable for failing to meet the APA's requirements.

A Procedural History

In 2008, Oakbrook donated a conservation easement perpetually protecting 106 acres on White Oak Mountain from the growing residential and commercial development in the surrounding area. JA110-11. Oakbrook claimed a charitable contribution deduction resulting from the Easement donation on its 2008 tax return. JA137-38. The IRS selected Oakbrook's 2008 federal tax return for audit. In 2012, the IRS denied Oakbrook's charitable contribution deduction in a Notice of Final Partnership Administrative Adjustment (“FPAA”). JA104. The IRS also asserted accuracy-related penalties under I.R.C. § 6662.Mem. Op. at *9.Oakbrook challenged the IRS's conclusions by timely filing a petition with the United States Tax Court. JA008.

Oakbrook's case was tried before the Honorable Judge Mark V. Holmes on October 6-7, 2016. The IRS argued that (1) the deduction must be disallowed “[b]ecause [SRLC] is not entitled to the proper proportionate share of extinguishment proceeds,” and (2) the Easement's value was overstated by approximately $9 million. JA047, JA050.⁵ The IRS argued that the Deed did not comply with the Proceeds Regulation for two reasons. First, the IRS claimed that the Deed improperly calculated the “proportionate value” based on the Easement's fair market value at the time of donation (i.e., the fair market value of the property right conveyed to the land trust), and that the Regulation requires for a ratio of the Easement's value to the value of the underlying land instead. JA046. Second, the IRS asserted that Oakbrook improperly retained a right, in the unlikely event of easement extinguishment, to compensation proceeds attributable to post-donation improvements built by the landowner. The IRS asserted that land trusts must receive a portion of proceeds attributable to post-donation improvements, despite having no legal interest in (and despite having expended no funds for) those improvements. JA046-47.

During trial and in its post-trial briefs, Oakbrook challenged the IRS's reading of the Proceeds Regulation, the Regulation's validity under the APA, the imposition of accuracy-related penalties, and the IRS's Easement value determination. See, e.g., JA447-83, JA495-542, JA588-601, JA604-30. In response to Oakbrook's challenge to the Proceeds Regulation's validity, Judge Holmes directed the parties to submit additional briefs solely analyzing the Proceeds Regulation's validity. JA632-33. The order also directed the IRS to submit the Administrative Record underlying Treasury Decision 8069 to the Court for review, which included all comments received. JA632-33. Both parties submitted briefs concerning whether Treasury complied with the APA in promulgating the Proceeds Regulation. See JA808, JA1039.

On May 12, 2020, the Tax Court issued two opinions in the case. Judge Holmes issued the Memorandum Opinion containing the Court's factual findings. Judge Holmes explained that two opinions were necessary because there is “a difference of opinion in the Court on the question of the regulation's validity.” Mem. Op. at *3. However, “there is not [a difference of opinion] on the factfinding and application of the regulation to those facts.” Id.

The Memorandum Opinion summarized the IRS's recent onslaught of “sorties” on conservation easement donations “predicated on the requirement that such easements be 'perpetual'” in the hopes of causing “more widespread casualties” to deductions claimed for such donations. Memo Op.. at *2. The “sortie” conducted in Oakbrook is “an attack on a clause commonly found in easements.” Id. These attacks are part of the IRS's ongoing efforts to combat perceived valuation abuse in transactions that the IRS has characterized as “syndicated conservation-easement transactions.” Id. at *13. Oakbrook's Easement “is not a syndicated conservation easement,” just a collateral casualty in the IRS's war. Id. at *13 n.8.

While finding that the language in Oakbrook's Deed violates the IRS's new interpretation of the Regulation announced in 2016 — eight years after Oakbrook donated the Easement — the Memorandum Opinion concluded that this finding does not “necessarily doom Oakbrook's deduction” because “Oakbrook argues in the alternative that this regulation is invalid.” Mem. Op. at *41. The majority of the Tax Court took a different view of the Regulation's validity, necessitating the Regulation Validity Opinion. The Tax Court's Regulation Validity Opinion was binding upon the Tax Court in the Memorandum Opinion.⁶

The Regulation Validity Opinion was authored by Judge Lauber, who concluded that Treasury complied with the APA's procedural requirements. Judge Lauber further concluded that that the Proceeds Regulation was substantively valid under Chevron and State Farm.Judge Holmes penned a lengthy dissent to the Regulation Validity Opinion. Judge Toro concurred in result only. Judge Toro's concurring opinion, joined in relevant part by two Tax Court judges, explained at length why Treasury failed to comply with the APA in promulgating the Proceeds Regulation and why that Regulation, as now interpreted by the IRS, is invalid under Chevron.⁷

Neither the Memorandum Opinion nor the Regulation Validity Opinion reached a determination as to the Easement's value because the deduction was disallowed in full, and the IRS conceded that valuation misstatement penalties do not apply. Mem. Op. at *11 n.6. The Memorandum Opinion concluded that the non-valuation penalties are not applicable because “Oakbrook's position was reasonable” and “taken entirely in good faith.” Id. at *43.

B Rulings Presented for Review

Oakbrook appeals the Regulation Validity Opinion, as adopted by the Memorandum Opinion pursuant to which Oakbrook's deduction was disallowed. Oakbrook donated the Easement to protect White Oak Mountain from development in perpetuity. Oakbrook neither limited the land trust's ability to enforce the Easement's restrictions in perpetuity nor did Oakbrook limit the duration of the Easement's restrictions. Instead, the only issue is whether a commonly-used clause concerning the allocation of proceeds in a hypothetical judicial extinguishment of the Easement dooms Oakbrook's deduction when Treasury failed to provide even a “minimal level of analysis” to support the regulatorily-mandated allocation.

C Facts

(1) Qualified Conservation Contribution Statutory History

In 1980, Congress enacted legislation to encourage the conservation of significant land and vistas. This legislation became I.R.C. §170(h). Tax Treatment Extension Act of 1980, Pub. L. No. 96-541, §6(b), 94 Stat. 3204, 3206 (1980).

The Committee believes that the preservation of our country's natural resources and cultural heritage is important, and the committee recognizes that conservation easements now play an important role in preservation efforts.

S. Rep. No. 96-1007, at 9 (1980), as reprinted in 1980 U.S.C.C.A.N. 6736, 6744. In so doing, “the Committee found it appropriate to expand the types of transfers that will qualify as deductible contributions” to include “easements and other interests in real property that under state property laws have similar attributes (e.g., a restrictive covenant).” Id. at 9-10.

When extending the charitable contribution deduction to conservation easements, Congress noted that it “expects that regulations under this section will be classified among those regulation projects having the highest priority” so that “potential donors [will] be secure in their knowledge that a contemplated contribution will qualify for a deduction.” S. Rep. No. 96-1007, at 13. Forty years later, donors are less confident than ever that their contribution will qualify. See Op. at 127-28 (Holmes, J., dissenting).

(2) Treasury's Promulgation of Regulations

On May 23, 1983, the IRS issued a notice proposing regulations to clarify the statutory rules put into effect in §170(h). Qualified Conservation Contribution, 48 Fed. Reg. 22940 (proposed May 23, 1983) (to be codified at 26 C.F.R. pt. 1). In response to this notice, “Treasury received approximately 90 comments regarding the substance of the proposed section 170A regulations.” Op. at 89 (Holmes, J., dissenting). Of those 90 comments, 13 directly addressed the proposed regulation that became §1.170A-14(g)(6)(ii).⁸ Id. at 11. Some questioned whether the proposed required allocation “could be enforced against anyone other than the original donor.” Id. at 94 (Holmes, J., dissenting). One commenter cautioned, “[t]he provisions for apportionment of proceeds in the case of extinguishment of a conservation restriction . . . contain problems of policy and practical application so pervasive as to cause us to recommend strongly the deletion of these provisions.” JA670. Moreover, “[t]he question of how to treat donor improvements undertaken after the grant of the easement in the event the property was subsequently sold was put squarely before Treasury during the comment period.” Op. at 70 (Toro, J., concurring). Commenters suggested that existing alternatives would preclude the donor from realizing an improper benefit from an extinguishment, such as the tax benefit rule and the proposed “so-remote-to-as-to-be” negligible rule.JA685, JA795.

In publishing the final regulations, Treasury did not discuss any of the comments made with respect to §1.170A-14(g)(6)(ii), including concerns about the treatment of donor improvements. Qualified Conservation Contributions, 51 Fed. Reg. at 1496-98 (see JA643-45). Treasury did not explain why it rejected specific suggestions, why it altered the Regulation's language, or why it made the decision to require this specific post-extinguishment allocation. In fact, Treasury did not discuss the Proceeds Regulation at all.

In its final form, the Regulation reads as follows:

(ii) Proceeds. In case of a donation made after February 13, 1986, for 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. See §1.170A-14(h)(3)(iii) relating to the allocation of basis. For purposes of this paragraph (g)(6)(ii), that proportionate value of the donee's property rights shall remain constant. Accordingly, when a change in conditions give 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 from the conversion without regard to the terms of the prior perpetual conservation restriction.

Treas. Reg. §1.170A-14(g)(6)(ii).

(3) Absence of IRS Guidance and Taxpayer Reliance

In the 30 years that followed, donors, land trusts, and many federal agencies crafted template language to allocate proceeds in the event of a judicial extinguishment for the purpose of complying with the Proceeds Regulation. Many donors, including Oakbrook, relied on template language drafted and vetted by the land trusts. Such language routinely set aside the value attributable to post-easement improvements when computing the proceeds allocable to the land trust.

In 2005, the Land Trust Alliance (the “Alliance”)⁹ published the second edition of the Conservation Easement Handbook (the “Handbook”). Elizabeth Byers & Karin Marchetti Ponte, Conservation Easement Handbook (2d ed. 2005). The Handbook explains that the regulations do not address “appreciation in value due to improvements, although allocation [consistent with the model deed] . . . is certainly called for as a matter of basic fairness.” Id. at 464. When allocating proceeds, the Handbook's model excludes “any increase in value after the date of this grant attributable to improvements not paid for by holder” from the value of the property on the date of extinguishment. Id. at 463.¹⁰ While recommending that land trusts include post-extinguishment allocation to comply with the Regulation, the Handbook questioned whether such provisions were enforceable: “[T]he mechanics of enforcing this provision may prove complicated, perhaps requiring the imposition, following extinguishment, of a lien.” Id. at 464. This same concern was expressed during the notice and comment period, but Treasury did not address it. Op. at 94-95 (Holmes, J., dissenting).

The land trust community was also tasked with crafting language to properly capture the “proportionate value” of conservation easements for purposes of allocating proceeds following a condemnation. While many land trusts took the view that the language, “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” sets up a formula for a fractional “proportionate value,” other land trusts, including the land trust that drafted Oakbrook's Deed, drafted deeds setting the proportionate value to be the fixed amount of the easement donated. See, e.g., Railroad Holdings, LLC v. Comm'r, 119 T.C.M. (CCH) 1136 at *4 (2020). The preamble to the final regulations provided no clarification as to whether “proportionate value” modifies “fair market value” — which would mean that the amount of the proportionate value is fixed — or whether it modifies “property right,” which would mean that proportionate value is a percentage. In 2018, the Fifth Circuit highlighted this ambiguity but did not disturb the consensus of the parties in that case that the Regulation called for a fraction.¹¹ Rose Hill, 900 F.3d at 205-07. When Oakbrook donated its Easement in 2008, the IRS had never challenged the use of a fixed amount as the “proportionate value” of the conservation easement to be paid in the case of condemnation.

In fact, prior to 2016, the IRS issued no guidance suggesting that removal of value attributable to donor improvements or the use of an easement's fixed fair market value to determine the land trust's allocable share was impermissible. Since 2008, the IRS has challenged several other conservation easement deductions without challenging the proceeds provisions it claims are fatal here. See, e.g., BC Ranch II, 867 F.3d 547; Palmer Ranch Holdings, Ltd. v. Comm'r, 812 F.3d 982 (11th Cir. 2016); Atkinson v. Comm'r, 110 T.C.M. (CCH) 550 (2015); Butler v. Comm'r, 103 T.C.M. (CCH) 1359 (2012).

In 2016, the IRS articulated for the first time — in litigation — its position that §1.170A-14(g)(6)(ii) required an allocation of proceeds attributable to post-donation improvements to the land trust. See PBBM-Rose Hill, Ltd. v. Comm'r, No. 026096-14 (T.C. Oct. 11, 2016) (bench opinion) (United States Tax Court Docket Search). The IRS gave no explanation for its position change. The same year, the IRS — for the first time — challenged Oakbrook and SRLC's use of a fixed amount as the “proportionate value” of the conservation easement. JA044-46. By this time, Oakbrook's Easement had been in place for nearly eight years.

(4) Mr. Horton's Decision to Donate a Conservation Easement

Mr. Horton and his wife discovered the Oakbrook property while searching for a place to build a home. Mem. Op. at *3. They spotted a “briar-covered for-sale sign” on White Oak Mountain offering 143 acres for sale. Id. Though the property “was significantly larger and considerably more overgrown than what they wanted, . . . they thought it could be the diamond in the rough for which they had been prospecting.” Id.

White Oak Mountain is located right outside Chattanooga, Tennessee, the city where Mr. Horton grew up. Mem. Op. at *4. Mr. Horton earned a construction degree at Georgia Tech and started his construction career in Chattanooga in 1998. Id. In 2002, Mr. Horton formed his own construction company which became successful. Id. “In 2007 Horton and a number of his subcontractors, suppliers, and past clients formed a real-estate development company and a real estate investment fund.” Id. The development company worked with larger land tracts “usually in high-growth sectors of the area that may have challenges . . . [such as] lack of infrastructure, access issues, rezoning issues, or topography issues” to unlock the property's potential value. Id. (internal quotations omitted). Due to Mr. Horton's construction background, he was uniquely able to see the overgrown property's potential. Id. As a result of the find, Mr. Horton “quickly contacted various investors to plan how to buy and develop it.” Id.

Mr. Horton and the investors formed Oakbrook in August 2007 and bought the property for $1.7 million in order to develop the property into “higher-end, single-family residences with a commercial service area.” Mem. Op. at *4 (internal quotations omitted). To accomplish such a plan, “Oakbrook had to overcome a number of thorny obstacles.” Id. Oakbrook obtained the necessary, highly-regulated permits to build (and did build) a bridge across Hurricane Creek, which was needed to access approximately 80% of the previously inaccessible property. Id. at *5. Oakbrook also installed a high-pressure sewer pump station, and successfully rezoned a portion of the property to a C-2 Local Business and Commercial District. Id.

While trying to develop the Oakbrook property, Mr. Horton was also proceeding with two other mixed-use development projects near Chattanooga: Hillocks Farm and Brow Wood. JA263, JA289-300. These projects were similar to the planned Oakbrook project in size, scope, and distance from downtown Chattanooga. Id. Mr. Horton originally purchased the Brow Wood property for $10,000 an acre, subdivided it into 1/3 to 1 acre lots, and sold the lots for $185,000-$200,000 each. JA291-92. He also sold three acres to an assisted living group for $166,666 per acre. Id. Mr. Horton's work on these other successful developments limited his ability to devote the necessary attention and time to developing the Oakbrook property.

In early 2008, Mr. Horton learned of a conservation easement placed on property in nearby north Georgia. Mem. Op. at *5. Interested, Mr. Horton researched conservation easements and “started to think about placing a conservation easement on the Oakbrook property.” Id. An easement on the Oakbrook Property would protect the White Oak Mountain ridgeline in perpetuity, in contrast to the ridgeline across the street, which had been heavily developed. See JA264. James Wright, the Executive Director of SRLC, further educated Mr. Horton concerning conservation easements. Mr. Wright assured Mr. Horton that SRLC's attorneys “would draft the legal paperwork should Oakbrook want to give [SRLC] an easement.” Mem. Op. at *5.

When Mr. Horton brought the idea of a conservation easement to Oakbrook's members, they initially balked because they believed that the property would be much more valuable once developed. See JA363-65. However, Mr. Horton eventually persuaded them to agree to conserve 106 acres of the Oakbrook property. See Mem. Op. at *5. In October 2008, Oakbrook transferred thirty-four acres of the Oakbrook property to related entities for development and obtained a $3.2 million bank loan to develop infrastructure on the transferred acres. JA252-261, JA345-48.

On December 30, 2008 Oakbrook donated a conservation easement to SRLC on the 106 acres through the Deed. See JA110. Mr. Horton and all the Oakbrook investors “relied heavily on the Conservancy to draft the Easement Deed.” Mem. Op. at *6. The Tax Court specifically found that “Horton, acting on behalf of Oakbrook, was reasonable in inferring that the Conservancy's experience meant that the deeds it had drafted conformed to the Code and regulations.” Id.

The provision in the Easement Deed relevant to this appeal is Article VI, Section B(2) (the “Extinguishment Provision”). Id. The Extinguishment Provision follows the Proceeds Regulation, providing “[t]his Conservation Easement gives rise to a real property right and interest immediately vested in SRLC.” JA121. The fair market value of that property right is:

[T]he difference between (a) the fair market value of the Conservation Area as if not burdened by this Conservation Easement and (b) the fair market value of the Conservation Area burdened by this Conservation Easement, as such values are determined as of the date of this Conservation Easement.

JA121-22. The Extinguishment Provision reduces the value of SRLC's property right by:

[A]mounts for improvements made by Owner in the Conservation Area subsequent to the date of this Conservation Easement, the amount of which will be determined by the value specified for these improvements in a condemnation award in the event all or part of the Conservation Area is taken in exercise of eminent domain.

JA121-22.

SRLC drafted this Extinguishment Provision to provide SRLC with what it was entitled to receive under the Proceeds Regulation and more.JA394-95. “According to Wright, the above language is standard among the Conservancy's conservation easements.” Mem. Op. at *7.Wright was also “'pretty sure' the language was adopted from numerous other model agreements, including those produced by the Land Trust Alliance.”¹² Id.

Wright explained that the Extinguishment Provision defines the Easement's fair market value “as the difference between the property's value without the easement and the property's value with the easement.” Id. at *7-8. Wright understood that the language was consistent with Regulation's language and “secur[ed] a fixed amount” for SRLC. Id. at *8. The Tax Court found that “Wright credibly testified” that SRLC “did not pay for those improvements and shouldn't have a property interest in those improvements.” Id. (internal quotations omitted).

(5) Oakbrook's Charitable Contribution Deduction

Oakbrook claimed a deduction of $9,545,000 on its Form 1065, a number that matched the Easement value set forth in the qualified appraisal that Oakbrook procured to value the Easement. Id. Oakbrook's deduction amount was consistent with the values that Mr. Horton was seeing in his other projects, including the Brow Wood project and the Hillocks Farm project, where Mr. Horton made an offer of $85,000 per acre for land in December 2008. JA244-49, JA294-95.

Mr. Horton hired the accounting firm Henderson Hutcherson & McCullough, PLLC to prepare Oakbrook's 2008 Form 1065. Mem. Op. at *9. The Tax Court determined that “Horton was unfamiliar with conservation easements and under intense scrutiny by Oakbrook's investors, so he discussed Oakbrook's 2008 tax return with Oakbrook's accountants multiple times” since they were familiar with the requirements for conservation easement donations. Id. Both Mr. Horton and another Oakbrook member, Ryan Crimmins, testified that they viewed the deduction amount as reasonable, if not less than the actual value that they might have realized if the Oakbrook property were developed. See JA334, JA365-66. The value determined in the qualified appraisal was consistent with the bank's willingness to lend Oakbrook's related entity $3.2 million to develop a much smaller portion of the Oakbrook Property. See JA252-60.

SUMMARY OF ARGUMENT

When extending the charitable contribution deduction to include donations of partial interests in real property that further conservation (i.e., conservation easements), Congress intended to incentivize such donations. Over the last several years, the IRS has thwarted this intent by conjuring new technical requirements to disallow a great number of conservation easement deductions and upset reasonable taxpayer reliance interests. The IRS's hyper-technical interpretation and application of §170(h), and the regulations issued thereunder, have been rejected by several Courts of Appeals, including this one. See Pine Mountain, 978 F.3d 1200; BC Ranch II, 867 F.3d 547; Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012); Comm'r v. Simmons, 646 F.3d 6 (D.C. Cir. 2011); Glass v. Comm'r, 471 F.3d 698 (6th Cir. 2006). The IRS's disallowance of Oakbrook's deduction must likewise be rejected because it is based on a newly proffered interpretation of an invalid Regulation.

The two key facts about the regulatory history are not in dispute. First, the Administrative Record reveals that 13 of the 90 comments received by Treasury explicitly addressed the proposed Proceeds Regulation. Op. at 11; See JA657-700, JA712-61, 764-79, 782-801. Second, the final regulations' preamble makes no reference to those comments and contains no discussion of the issues raised concerning the proposed allocation of post-extinguishment proceeds. See Qualified Conservation Contributions, 51 Fed. Reg. at 1496-98. As a result, “the six Federal Register columns that Treasury offered fail to provide 'that minimal level of analysis' required by the APA.” Op. at 69-70 (Toro, J., concurring) (quoting Encino, 136 S. Ct. at 2125). Judge Holmes explained:

Treasury didn't even acknowledge the relevant comments or expressly state its disagreement with them. Instead it just ignored them. There is not even 'a minimal level of analysis' as the Supreme Court, just a couple of years ago, insisted an agency must show if it hopes to avoid its regulation's being held procedurally invalid.

Id. at 110 (Holmes, J., dissenting) (quoting Encino, 136 S. Ct. at 2125) (emphasis added).

Because Treasury failed to offer any basis — let alone a reasonable one — for its decision concerning the post-extinguishment allocation of proceeds, the Proceeds Regulation is also substantively invalid. See 5 U.S.C. §706(2); Chevron, 467 U.S. at 844. Moreover, the required allocation of post-extinguishment proceeds under the Tax Court's interpretation of the Regulation is inconsistent with the rights donated under §170(h). “Requiring the donor to promise to turn over to the donee proceeds in excess of the fair market value of [the donee's qualified real property] interest is inconsistent with the statutory framework, and nothing in the 'statutory purposes' compels a different conclusion.” Op. at 56-57 (Toro, J., concurring) (citations omitted). Treasury cannot demonstrate that such requirement is the product of reasoned decision-making because Treasury offered no reason for the decision. Id. at 126 (Holmes, J., dissenting).

These errors require a reversal of the Tax Court's decision and reinstatement of Oakbrook's deduction.

ARGUMENT

A The Proceeds Regulation Is Invalid Because Treasury Failed to Comply with the APA's Procedural Requirements

Tax Court legal decisions concerning Internal Revenue Code provisions and Treasury regulations, including Treasury regulations challenged under the APA, are reviewed de novo. See Hospital Corp. of Am. & Subsidiaries v. Comm'r, 348 F.3d 136, 140 (6th Cir. 2003); Nichols v. United States, 260 F.3d 637, 642 (6th Cir. 2001) (holding that questions of law about regulations are subject to de novo review).

The Supreme Court recently affirmed the important role served by the APA in curbing agency overreach: “Justice Holmes famously wrote that [m]en must turn square corners when they deal with the Government. But it is also true . . . that the Government should turn square corners in dealing with the people.” Dep't of Homeland Sec. v. Regents of the Univ. of Cal., 140 S. Ct. 1891, 1909 (2020) (internal quotations omitted). Here, the IRS has denied Oakbrook's deduction for failing to comply with Treasury's rule, though Treasury failed to take the proper steps in issuing that rule.

The APA sets forth the applicable requirements for agency rulemaking. 5 U.S.C. §553.¹³ Relevant here is the APA's requirement that:

After notice . . . the agency shall give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments . . . After consideration of the relevant matter presented, the agency shall incorporate in the rules adopted a concise general statement of their basis and purpose.

§553(c). These requirements serve an important role in agency rulemaking. “'The primary purpose of Congress in imposing notice and comment requirements for rulemaking' is 'to get public input so as to get the wisest rules.'” United States. v. Cain, 583 F.3d 408, 420 (6th Cir. 2009) (quoting Dismas Charities, Inc. v. U.S. Dep't of Justice, 401 F.3d 666, 680 (6th Cir. 2005)). These requirements also “ensure fair treatment for persons affected by the regulation.” Id.

This Court has explained that the statement should clearly and fully explain the factual and legal basis for a rule, enabling a reviewing court “to see what major issues of policy were ventilated by the informal proceeding and why the agency reacted to them as it did.” Simms v. Nat'l Highway Traffic Safety Admin., 45 F.3d 999, 1005 (6th Cir. 1995). A court should avoid rubber-stamping an agency action, and instead, should ensure that the agency has taken a “hard look” at relevant issues and reasonable alternatives. Id. at 1004; 33 Charles Alan Wright & Arthur R. Miller, Federal Practice and Procedure §8414 (2d ed. 2020) (stating that “courts made clear that they expected agencies to provide exhaustive explanations for their rules in the 'concise general statements of . . . basis and purpose' required by the APA . . . [a]nd the courts then took 'hard looks' at these explanations to ensure their rationality”).

Here, Treasury was required to use the basis and purpose statement to “give reasoned responses to all significant comments in a rulemaking proceeding.” PPG Indus., 630 F.2d at 466.Treasury's response to significant comments on the Proceeds Regulation, however, was nothing more than the “chirping of crickets.” Op. at 95 (Holmes, J., dissenting). Such silence is a blatant violation of the APA. As Judge Thapar recently observed: “In recent years, [the IRS] has begun to regulate an ever-expanding sphere of everyday life — from childcare to charity to healthcare and the environment. That might be okay if the IRS followed the basic rules of administrative law. But it doesn't.”¹⁴ CIC Services, 936 F.3d at 507 (Thapar, J., dissenting).

(1) The Basis and Purpose Statement Fails to Explain the Proceeds Regulation

Basis and purpose statements provide courts with a mechanism to ensure that the agency has examined “the relevant data and articulate[d] a satisfactory explanation for its action including a rational connection between the facts found and the choice made.”Encino, 136 S. Ct at 2125 (internal quotations omitted). When an agency fails “to provide even that minimal level of analysis, its action is arbitrary and capricious and so cannot carry the force of law.” Id.

Treasury received approximately ninety comments.Op. at 11.Thirteen commenters directly addressed the Proceeds Regulation.¹⁵ Id.; see JA657-700, JA712-61, JA764-79, JA782-801. And in response, Treasury added only two pages (six columns) addressing these eight hundred pages of comments and two hundred pages of public testimony. See Qualified Conservation Contributions, 51 Fed. Reg. at 1496-98.

The preamble contains no discussion of (1) the Proceeds Regulation's purpose, (2) Treasury's goal in issuing the Proceeds Regulation, (3) the negative comments received, or (4) Treasury's responses to those comments. Id. Conversely, the final regulations contain an extensive discussion about negative comments received regarding the proposed methods of determining whether preserved open space meets the Code's requirements and the IRS's position with respect to those comments. Id. at 1497-98. The absence of Treasury's discussion of comments relating to the distribution of post-extinguishment proceeds is stark. See Atrium Med. Ctr. v. U.S. Dep't of Health and Human Servs., 766 F.3d 560, 568 (6th Cir. 2014). Judge Toro observed that Treasury is more than capable of providing meaningful responses to comments received. Op. at 69 n.17 (Toro, J., concurring). Treasury simply failed to do so here.

Judge Holmes found that the basis and purpose statement failed to comply with the APA for multiple reasons. First “[t]he Final Rule's statement of basis and purpose shows absolutely no mention of the extinguishment-proceeds clause at all, much less any mention of the proportionate-share or improvements problems.” Op. at 95 (Holmes, J., dissenting) (emphasis added). Second, the preamble contains “no reasoned response to any of the public's comments on those provisions.” Id. at 95-96 (emphasis added). Finally, he observed, “we aren't even the first court to notice: In Kaufman . . . the First Circuit was forced to guess at the apparent purpose of the section 1.170A-14(g)(6)(ii), Income Tax Regs., after noting that it 'was unexplained when first promulgated.'” Id. at 96.

Judge Toro likewise concluded that the lack of any discussion or explanation concerning “the donor improvements interpretation” advanced by the IRS “fail[s] to provide 'that minimum level of analysis' required by the APA.” Id. at 69-70 (Toro, J., concurring) (quoting Encino, 136 S. Ct. at 2125). In sum, Treasury failed “to respond to 'significant points' and consider 'all relevant factors' raised by the public comments.” Id. at 62 (quoting Carlson v. Postal Regulatory Comm'n, 938 F.3d 337, 344 (D.C. Cir. 2019) (quoting Home Box Office, 567 F.2d at 35-36)).

In Simms, the appellants claimed that the agency ignored significant facts in the record when choosing static over dynamic testing in a new regulation, especially considering that most commenters preferred dynamic testing. 45 F.3d at 1005. This Court looked to whether the agency explained the evidence available and made “a rational connection between the facts found and the choice made.” Id. (internal quotations omitted). Importantly, this Court noted that, in the preamble to the final rules, the agency explained the benefits of using static testing and discussed the agency's rationale for rejecting dynamic testing, acknowledging the commenters' preference for dynamic testing. Id. at 1005-06. As a result, this Court upheld the regulation's procedural validity under the APA. Id. at 1006.

Treasury's shortcomings here are glaring in comparison the agency's actions in Simms. Treasury never even mentioned the Proceeds Regulation. There is no mention of concerns received or alternatives proposed by the 13 commenters, such as the “so-remote-as-to-be negligible” rule, the tax benefit rule, or allowing the donor and donee to negotiate an appropriate allocation on a “property by property basis.” JA685, JA779, JA795. Without any discussion of the comments received, there cannot be a rational connection between the “facts found and the choice made.”

In PPG Industries, this Court refused to affirm the EPA's “perfunctory treatment” of comments when the EPA simply stated that it “reanalyzed” the data, resulting in an administrative record from which it was “impossible to determine whether the agency's . . . designation was arbitrary and capricious.” 630 F.2d at 466. Here, it is likewise impossible for the Court to take a “hard look” at Treasury's response to comments on the Proceeds Regulation and consideration of alternatives due to Treasury's complete omission of any discussion concerning those comments. As such, Treasury failed to supply the required statement of basis and purpose for its Regulation.

(2) The Comments Addressing the Proceeds Regulation Are Relevant and Significant

The comments that Treasury received about the Proceeds Regulation are significant, and Treasury was required to address them. While the measure of a “significant” comment varies by Circuit, the comments on the Proceeds Regulation are significant under any standard.

Some courts held that an agency should address why alternative measures were rejected in the basis and purpose statement. See, e.g., Indep. U.S. Tankers Owners Comm. v. Dole, 809 F.2d 847, 852 (D.C. Cir. 1987). Other courts held that an agency should address significant issues of policy and explain why it chose one course over another. See, e.g., United States v. Nova Scotia Food Prod. Corp., 568 F.2d 240, 252 (2d Cir. 1977) (holding that “[t]he agencies certainly have a good deal of discretion in expressing the basis of a rule, but the agencies do not have quite the prerogative of obscurantism reserved to legislatures[;] . . . [w]e cannot discharge our role adequately unless we hold [the agency] to a high standard of articulation”) (internal quotations omitted); Industrial Union Dep't, AFL-CIO v. Hodgson, 499 F.2d 467, 475-76 (D.C. Cir. 1974); Auto. Parts & Accessories Assoc. v. Boyd, 407 F.2d 330, 338 (D.C. Cir. 1968). Last, some courts held that comments are significant when, if adopted, they require a change in an agency regulation. See, e.g., Home Box Office, 567 F.2d at 35 n.58. In other words, a comment is significant if it addresses an issue and identifies why the issue is troublesome. Op. at 102-03 (Holmes, J., dissenting).

This Court has explained that a basis and purpose statement should enable a reviewing court to “see what major issues of policy were ventilated by the informal proceedings and why the agency reacted to them as it did.” Simms, 45 F.3d at 1005 (citing Boyd, 407 F.2d at 338). Further, the agency must “give reasoned responses to all significant comments in a rulemaking proceeding.” Atrium Medical, 766 F.3d at 568; PPG Indus., 630 F.2d at 465-66. Even a single comment, if it is relevant and significant, can require an agency response. See, e.g., Carlson, 938 F.3d at 346 (holding that the Commission should have addressed the public comments of a single commenter, Douglas Carlson, because the comments were relevant and significant).

Seven of the thirteen commenters that addressed the Proceeds Regulation expressed concern that the proposed Proceeds Regulation was unworkable, did not reflect reality, or could result in an unfair loss to the property owner and a corresponding windfall for the donee. See Op. at 90-95 (Holmes, J., dissenting).

For example, the New York Landmarks Conservancy (“NYLC”) identified the following problems with the proposed Proceeds Regulation:

• it would deter prospective donors from donating conservation easements due to potential inequitable allocations (JA670-71);

• there was a potential conflict with the provision and state condemnation law (JA671-72); and

• the ratio fails to take into account improvements made by the landowner after donation, and it is unexplained whether those alter the ratio. (JA671-72)

Thus, NYLC suggested the Regulation's deletion due to its potential adverse effect on donations. JA670-71.

The Landmarks Preservation Council of Illinois (“LPCI”) explained that the Proceeds Regulation “create[s] a potential disincentive to the donation of easements” because the Proceeds Regulation could leave a building owner in a situation where the proceeds he receives from a subsequent sale are insufficient to pay the donee and third parties, such as lenders. JA778-79. As an alternative, the LPCI suggested that the issue of post-extinguishment proceeds “should not be treated in the regulations, but should be negotiated, defined, and incorporated by the donor and donee into the conservation right document.” JA779.

The Land Trust Exchange's comments identified similar problems and observed that “[t]his section may result in donors and donees having to pay real estate transfer taxes.” JA685. As an alternative, the Land Trust Exchange suggested “the tax benefit rule and the remote future event rule should make this section unnecessary.” JA685.

The Trust for Public Land stated “[w]e have serious doubts whether the provision for the allocation of the proceeds of a sale following extinguishment of an easement could be enforced against anyone other than the original donor of the easement, if that is what is intended.” JA795. This commenter also suggested:

[W]e think this provision goes further than the regulations need to go. The remote future event rule of §1.170A-13(g)(2) should suffice. The possibility that a conservation gift will become obsolete, although certain to be realized in some cases, must be negligible at the time a particular gift is made in order for it to qualify under the rule.

JA795 In sum, multiple commenters raised concerns that the proposed Proceeds Regulation was unfair, imposed a potentially unenforceable obligation, and could be substituted with better, alternative measures. Treasury offered no response to these concerns or proposed alternatives.

Treasury could not simply ignore these comments: “Commenters didn't just say, 'Delete the regulation, we don't like it.' They wrote in to propose other alternatives to achieve the Code's requirement that the conservation purpose of a donated easement be preserved 'in perpetuity.'” Op. at 104 (Holmes, J., dissenting). Even the Nature Conservancy, the Maine Coast Heritage Trust, and the Brandywine Conservancy, “thought the provision needed to be clearer.” Id. Altogether, the comments “identified inequities with the regulation, suggested alternatives, identified potential negative effects on the willingness of donors to make donations, uncovered potential conflicts with state law, and simply asked for more clarity.” Id. at 105. These comments are “significant” within the meaning of APA jurisprudence.

This Court made it clear that it will take a “hard look” to ensure an agency looked at all relevant issues raised by the comments, responded to significant comments, and “considered reasonable alternatives.” Simms, 45 F.3d at 1004-05; PPG Indus., 630 F.2d at 465-66. Here, Treasury failed to show any sign that it considered the significant issues raised concerning the Proceeds Regulation or the reasonable alternatives proposed by several commenters. Particularly relevant is Treasury's failure to respond to comments raising questions about how the Proceeds Regulation would impact donor improvements, an issue that is impacting hundreds, if not thousands, of deductions now targeted by the IRS. As Judge Toro observed, “the Commissioner's actions belie any claim that the comment did not raise a significant issue.” See Op. at 77 (Toro, J., concurring).

In sum, the comments concerning the Proceeds Regulation are significant comments because each of them addresses an issue and identifies why the issue is problematic. Treasury failed to address any of the vital questions raised by the comments or explain why it chose one course over another. Such omissions fail the APA's procedural requirements.

(3) Treasury's Cursory Statement that It Considered “All Comments” Is Insufficient to Demonstrate Compliance with the APA

Agencies must give “reasons for their actions” in a basis and purpose statement. PPG Indus., 630 F.2d at 465. Courts “are not required to take the agency's word that it considered all relevant matters.” Id. at 466.

Treasury was on notice of the APA's procedural requirements prior to the Regulation's final promulgation in 1986 because the above case (and multiple cases in other circuits) was decided prior to 1986. Yet, Treasury still gave no explanations.

Instead, Treasury summarily stated it “consider[ed] all [ ] comments regarding the proposed amendments,” which the majority found sufficient. Op. at 20.

Judge Holmes explained why such a phrase is insufficient. “The APA . . . has no provision for agencies to use ritual incantations to ward off judicial review.” Op. at 115 (Holmes, J., dissenting) (citing Dominion Res., Inc. v. United States, 681 F.3d 1313, 1319 (Fed. Cir. 2012)). With good reason, “because if the APA did allow comments to be disregarded with this simple magical phrase as part of a standard form, it would make commenting meaningless.” Id.; see Encino, 136 S. Ct. at 2126-27 (concluding that the Secretary of Labor's use of such phrase was insufficient to establish APA compliance). The APA is not concerned with talismanic phrases, but instead, is meant to promote substantive and thoughtful analysis in promulgating rules. See Regents of the Univ. of Cal., 140 S. Ct. at 1909.

In Dominion Resources, the Federal Circuit invalidated Treasury's regulation where the only rationale provided was “the general statement that regulations are intended to implement the avoided-cost method.” 681 F.3d at 1319. This general phrase “is not sufficient to satisfy the State Farm requirement that the regulation must articulate a satisfactory or cogent explanation.” Id. Likewise, here, Treasury's comment in the preamble that it considered “all comments” and that it was “providing necessary guidance” concerning “contributions . . . of partial interests in property for conservation purposes” is insufficient to meet the APA's procedural requirements or to satisfy its obligation to offer a satisfactory explanation under State Farm. See Qualified Conservation Contributions, 51 Fed. Reg. at 1496.

(4) Minor Changes to the Proposed Regulation Are Insufficient to Demonstrate Compliance with the APA

The Tax Court also erred when it found that Treasury meaningfully responded to comments by making minor alterations to the proposed Proceeds Regulation's text before it became final. Op. at 14-15, 21. The proposed Proceeds Regulation before notice and comment reads:

“immediately vested in the donee organization, with a fair market value that is a minimum ascertainable proportion of the fair market value to the entire property. See §1.170-13(h)(3)(iii). For purposes of this paragraph (g)(5)(ii), that original minimum proportionate value of the donee's property rights shall remain constant.”

Qualified Conservation Contribution; Proposed Rulemaking 48 Fed. Reg. at 22946 (emphasis added). The final Proceeds Regulation reads:

“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. See §1.170A-14(h)(3)(iii) relating to the allocation of basis. For purposes of this paragraph (g)(6)(ii), that proportionate value of the donee's property rights shall remain constant.”

Treas. Reg. §1.170A-14(g)(6)(ii) (emphasis added). Treasury did not explain why it made these changes.Concluding that these changes responded to significant comments is simply not supported.

While the majority claims the Proceeds Regulation was “substantially revised,” a comparison of the proposed regulation to the final Proceeds Regulation shows that both provisions intend to communicate the same substantive message. See Op. at 21. The changes were made, from all appearances, to “increase editorial clarity.” Id. at 117 (Holmes, J., dissenting). As Judge Holmes observed, “one would be hard pressed to think of any set of facts in which the changed language would change the outcome in any particular case.” Id. at 118.

Moreover, speculating that “Treasury clearly considered the comments” because it “substantially revised the text” of the Proceeds Regulation is not the proper standard for evaluating agency action. Id. at 21. Without an agency statement explaining the reason for its regulatory changes and choices, the court may not speculate as to the reasons for agency action “that the agency itself has not given.” State Farm, 463 U.S. 29, 43 (1983) (internal quotations omitted); see Encino, 136 S. Ct. at 2127. In short, Treasury failed to explain the changes it made as required under the APA.¹⁶

In Nova Scotia, the court held that a basis and purpose statement failed to satisfy the APA procedural requirements due to its silence about important comments even though the agency made minor changes to the proposed regulation and stated it considered all comments in the preamble. 568 F.2d at 244-45, 253.¹⁷ The minor revisions here fail to show “discernable and defensible reasoning” regarding the Proceeds Regulation. See Atrium Medical, 766 F.3d at 568. These minor changes show minimal effort that render it impossible to see from the Proceeds Regulation whether the Regulation is arbitrary and capricious. See PPG Indus., 630 F.2d at 465-66. Thus, Treasury's failure to identify any objections to the Proceeds Regulations and failure to respond to such objections is fatal to the Regulation's validity.

The Tax Court's decision essentially renders a basis and purpose statement superfluous and unnecessary if Treasury makes even a small change to the proposed regulation. The dissent wholly rejected this notion. Op. at 116-18 (Holmes, J., dissenting) (citing Dominion, 681 F.3d at 1319; Nova Scotia, 568 F.2d at 253; and Hodgson, 499 F.2d at 476 for support that an agency needs to at least identify considerations it found persuasive). Slight revisions to a proposed regulation's text cannot rescue a regulation from the agency's noncompliance with the APA's requirement that the agency explain its decision.

B The Proceeds Regulation Is an Invalid Agency Action Under State Farm and Chevron

The Proceeds Regulation is an arbitrary and capricious exercise of agency rulemaking under 5 U.S.C. §706(2) because it fails to comply with the second step of Chevron and cannot meet the reasoned decision-making requirement in State Farm. Tax Court legal decisions concerning Treasury regulations, including Treasury regulations challenged under the APA and Chevron, are reviewed de novo. See Hospital Corp., 348 F.3d at 140; Nichols, 260 F.3d at 642.

Courts follow a two-step analysis in reviewing an agency's regulatory interpretation of a statute it enforces. First, the court determines whether Congress has “directly spoken to the precise question at issue.” Chevron, 467 U.S. at 842. If so, the inquiry ends there, and the court must give effect to Congress's expressed and unambiguous intent. Id. If not, the court must defer to the agency's interpretation if it is “reasonable.” Id. at 843-44. Specifically, the court considers whether the interpretation is “arbitrary or capricious in substance, or manifestly contrary to statute.” Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44, 53 (2011) (applying the Chevron standard to Treasury regulations). A determination of whether an interpretation is arbitrary or capricious requires the court to analyze “whether the [agency] has reasonably explained how the permissible interpretation it chose is 'rationally related to the goals of' the statute.” Village of Barrington v. Surface Transp. Bd., 636 F.3d 650, 665 (D.C. Cir. 2011) (quoting AT&T Corp. v. Iowa Utils. Bd., 525 U.S. 366, 388 (1999)); All. for Cmty. Media v. F.C.C., 529 F.3d 763, 786 (6th Cir. 2008).

The record before the Tax Court demonstrates that the Proceeds Regulation is arbitrary, capricious, and manifestly contrary to statute. Treasury failed to establish that the Proceeds Regulation was the product of reasoned decision-making and supplied no grounds upon which a court could affirm the propriety of that Regulation. Further, it imposes requirements on taxpayers that are beyond the requirements imposed by Congress. As a result, the Proceeds Regulation must be set aside as an invalid exercise of Treasury's rule-making authority.

(1) The Proceeds Regulation Is Not the Product of Reasoned Decision-Making

When applying the arbitrary and capricious standard found in step two of Chevron, the court “must assess, among other matters, 'whether the decision was based on a consideration of the relevant factors and whether there has been a clear error of judgment.'” Judulang, 565 U.S. at 53 (quoting State Farm, 463 U.S. at 43). Put another way, the court is required to “examine[ ] the reasons for agency decisions — or, as the case may be, the absence of such reasons.” Id. Agency action is the product of reasoned decision-making if the agency “examine[d] the relevant data and articulate[d] a satisfactory explanation for its action, including a rational connection between the facts found and the choices made.” Simms, 45 F.3d at 1004 (internal quotations omitted).On the flipside, an agency action is arbitrary and capricious if:

[T]he agency has relied on factors which Congress has not intended it to consider, entirely failed to consider an important aspect of the problem, offered an explanation for its decision that runs counter to the evidence before the agency, or is so implausible that it could not be ascribed to a difference in view.

State Farm, 463 U.S. at 43. In such case, the agency action will be invalidated by the Court under the APA. 5 U.S.C. §706(2).

In Judulang, the Supreme Court confirmed that its analysis of the reasonableness of the agency's action under State Farm “would be the same” under Chevron step two because “we ask whether an agency interpretation is arbitrary or capricious in substance.” 565 U.S. at 52 n.7 (internal quotations omitted). This Court recognized that the State Farm analysis is incorporated into Chevron, explaining that “there is support that in review of rulemaking the second step of Chevron indeed amounts to the same inquiry as arbitrary or capricious review under the APA.” Citizens Coal Council v. EPA, 447 F.3d 879, 889 n.10 (6th Cir. 2006).¹⁸

Here, where no explanation is offered, the agency's decision cannot be the product of reasoned decision-making.The reviewing court “may not supply a reasoned basis for the agency's action that the agency itself has not given.” State Farm, 463 U.S. at 43; SEC v. Chenery Corp., 332 U.S. 194, 196 (1947) (holding that “a reviewing court, in dealing with a determination or judgment which an administrative agency alone is authorized to make, must judge the propriety of such action solely by the grounds invoked by the agency. If those grounds are inadequate or improper, the court is powerless to affirm the administrative action”); Dominon, 681 F.3d at 1319 (invalidating a Treasury regulation under State Farm's arbitrary and capricious standard when the final regulation provided no rationale for the regulation, and the IRS's only guidance “provided no rationale other than a general statement that the regulations are intended to implement the avoided-cost method”); cf. Tenn. Hosp. Ass'n v. Azar, 908 F.3d 1029, 1044 (6th Cir. 2018) (holding that “[w]hen a regulation is ambiguous, [courts] consult the preamble of the final rule as evidence of context of intent of the agency promulgating the regulations”) (internal quotations omitted).

Treasury gave neither a reason for its decision to require that the donor and donee determine proportionate value in this manner, nor a reason why this proportionate value must remain constant despite the fact that Treasury knew that the relative value of their interests could change, such as when the donor makes post-donation improvements. As outlined above, several commenters expressed concerns with the proposed regulation's requirements. See supra Argument, Part A Section 2. Moreover, commenters proposed several alternatives. In addition, Treasury had information concerning how other entities allocated post-condemnation proceeds. See, e.g., JA742 (Maryland statute providing that when property underlying an easement held by the Maryland Agricultural Land Preservation Fund (“Fund”) is condemned, the amount of proceeds due to the Fund is the amount paid by the Fund for the easement and not a percentage). Why Treasury chose to impose this specific allocation remains unknown.

The Restatement of Property outlines the amounts due to a conservation easement holder after extinguishment in a manner that is wholly different from the formula in the Regulation. Restatement (Third) of Property §7.11 (Am. Law. Inst. 2000). The Restatement explains that the amount of compensation owed to a conservation easement holder varies based on the circumstances. “Damages should ordinarily be calculated to compensate the public for loss of the servitude.” Id. However, “if the servient owner is not responsible for the changes that have made the servitude useless” i.e., a state or federal entity condemns the property, “damages sufficient to replace the servitude may be unfair. In that case, restitution, without more, may be appropriate.” Id. Such restitution may be comprised of “tax and other governmental benefits received by the servient owner as a result of creation of the servitude.” Id. There is no indication that Treasury considered these varying circumstances or how they should impact the allocation of proceeds.

SRLC's Executive Director testified that he believed the allocation in Oakbrook's Deed would provide the land trust with more proceeds than what it would receive under the Regulation and that the allocation certainly guarantees that the public is repaid what it invested in the conservation easement. JA405-08. No reason was provided, either by Treasury during the Regulation's promulgation, or by the IRS at trial, as to why the Regulation's formula better protects the conservation purposes than the provision in Oakbrook's Deed. By contrast, the record is clear that there are several alternative methods for allocating proceeds to the easement holder in order to carry out the conservation purposes in perpetuity. A one-size-fits-all approach in the Regulation in unworkable given the wide range of properties and conservation values protected.

It is not clear whether Treasury considered these alternatives or examined any relevant data when deciding that the Regulation's formula must be used in all circumstances. But it is clear that, when imposing this requirement, Treasury gave no explanation for the agency's action, and provided no evidence of a rational connection between the facts found and decision made. See Qualified Conservation Contributions, 51 Fed. Reg. at 1496-98. In sum, Treasury offered no reason for its decision for this Court to affirm.

(2) The Tax Court Erred in Supplying a Reason for Treasury's Decision Where None Was Given

Finding no relevant factors or explanation in the record to support Treasury's decision, the Tax Court simply assumed that “Treasury's overarching goal was to guarantee that the donee, upon judicial extinguishment, would receive the full share of proceeds to which it was entitled.” Op. at 31. This statement is erroneous in two respects. First, nothing in the record demonstrates that this was Treasury's goal. The judicial extinguishment provisions are not discussed in the preamble. Second, even if Treasury had stated its goal was to guarantee the donee proceeds “to which it was entitled,” the Regulation does not align with that goal. As now interpreted by the IRS, the Regulation requires the donee to receive proceeds to which the donee is not entitled, i.e., proceeds attributable to the donor's interest in post-donation improvements. See id. at 29-31.

The Tax Court also erred in assuming that Treasury's failure to examine relevant data or explain its decision was simply “a policy decision for Treasury . . . to make.” Id. at 30. In Dominion, the Federal Circuit concluded that Treasury's lack of investigation or explanation could not be chalked up to “policy choice.” 681 F.3d at 1318 (holding that the Court of Federal Claims erred in concluding that Treasury's unexplained regulatory requirements were “a 'policy choice' . . . and thus permissible”). When no investigation is undertaken, the ultimate decision cannot be rationally related to the facts considered. In such cases, the agency's rule is arbitrary, capricious, and must be set aside.

In sum, Treasury could have engaged in reasoned decision-making with respect to the Proceeds Regulation's requirements, but it chose not to. The Tax Court concedes that “Treasury could have drafted a regulation that addressed the possibility of donor improvements,” Op. at 30, but it failed to address those improvements in any way — either through a revision to the Regulation or by explanation in the preamble. This failure, given the specific comments concerning donor improvements and the problems with the Regulation's formula, means that Treasury did not consider important aspects of the problem its rule was to address. As such, the Proceeds Regulation fails the reasoned decision-making standard of State Farm, as well as the second step of Chevron, and constitutes an arbitrary, capricious, and invalid statutory interpretation.

(3) The Tax Court's Interpretation of the Proceeds Regulation Is Contrary to the Statute Because It Requires Donors to Relinquish Interests that They Are Permitted to Retain Under I.R.C. § 170(h).

The Proceeds Regulation is also invalid because, as now interpreted by the Tax Court, it is manifestly contrary to the statute.Judge Toro explained this deviation from the statutory scheme in his concurrence:

Although the statute makes clear that there can be no deduction unless the conservation purposes are “protected in perpetuity,” one cannot lose track of the fact that the deduction is predicated on a “qualified real property interest” being contributed to a qualified organization. Thus, the most that a qualified organization can be entitled to receive if its “qualified real property interest” is extinguished in the future is the full value of that interest. Whatever the purpose of a contribution, that purpose may not be invoked to require the donor to give the donee, as a precondition to receiving a deduction . . . a right to receive compensation properly attributed to the real property interest that the Code permits the donor to retain. A regulation interpreted to require otherwise cannot be a permissible interpretation of the statutory text before us.

Id. at 56 (Toro, J., concurring) (emphasis added).

Deviating from the statutory bounds requires a regulatory invalidation even if the statute left some ambiguity to be filled. Michigan v. EPA, 135 S. Ct. 2699, 2707 (2015) (explaining that even under the deferential standard of Chevron, “agencies must operate within the bounds of reasonable interpretation”); Mid-Am. Care Found. v. N.L.R.B., 148 F.3d 638, 642 (6th Cir. 1998) (holding that “when an agency's application of statutory interpretation . . . frustrates judicial review by 'subtly and obliquely' revising the stated interpretation to impose a more stringent definition or a higher standard of compliance in certain factual contexts, Chevron deference is inappropriate”). Treasury regulations, like other regulations, are invalid if they impose requirements beyond the statutory text. Good Fortune Shipping SA v. Comm'r, 897 F.3d 256, 263 (D.C. Cir. 2018).

The statute requires the donation of a “qualified real property interest,” which is a restriction on the use of property. §170(h)(2)(C). The statute further requires that such interest be conveyed “exclusively for conservation purposes.” §170(h)(1)(C). A qualified real property interest is exclusively for conservation purposes if “the conservation purpose is protected in perpetuity.” §170(h)(5)(A).

Nothing in §170(h) suggests that a qualified organization must be compensated above the value of its qualified real property interest in the event the easement is extinguished. However, the Proceeds Regulation, as interpreted by the Tax Court, requires the donor to agree to give the easement holder compensation in excess of the interest conveyed to the easement holder under §170(h).

By imposing additional regulatory obligations in 2016 with respect to post-donation improvements, the IRS has “rewritten the statutory terms” to obligate the donor to give property to the land trust beyond the interest conveyance that §170(h) requires be conveyed. As Judge Toro noted, “a rule interpreted to require the deed to allocate to the donee not only the proceeds attributable to its own real property interest but also a share of the proceeds attributable to the interest the Code permits the donor to retain does not 'fit' with the statutory language and is unreasonable.” Op. at 57-58 (Toro, J., concurring) (quoting Good Fortune, 897 F.3d at 262) (internal quotations omitted).

It is not clear whether Treasury wanted conservation easement donors to agree to forgo their rights to just compensation for condemned post-donation improvements. However, it is clear that Congress did not impose such a requirement, nor did Congress leave a gap for Treasury to fill with that requirement. Rather, Congress permitted donors to reserve an interest in the underlying property, including the right to improve that property. “The contribution must involve legally enforceable restrictions on the interest in the property retained by the donor.” S. Rep. No. 96-1007, at 13 (emphasis added). Nothing in the text of the statute itself or the legislative history suggests, in order to protect conservation purposes in perpetuity, a landowner must agree to relinquish compensation for his interest in the property. See United States v. Cartwright, 411 U.S. 546, 557 (1973) (invaliding a Treasury regulation that “is manifestly inconsistent with the most elementary provisions” of the statute). Because the Proceeds Regulation is contrary the statute, it is arbitrary, capricious, and invalid.

CONCLUSION

Administrative law jurisprudence is clear. When an agency fails to consider relevant comments or address viable alternatives proposed by the regulated individuals and entities, its rules cannot have the force of law. That is exactly what happened in this case. Oakbrook's deduction cannot be doomed by an invalid rule. Therefore, the decision of the Tax Court is due to be reversed.

Respectfully submitted,

SIROTE & PERMUTT, P.C.

Michelle Abroms Levin
Sirote & Permutt, P.C.
305 Church Street SW, Suite 800
Huntsville, AL 35801
205-518-3605 (telephone)
205-518-3681 (facsimile)
mlevin@sirote.com

Gregory P. Rhodes
Sirote & Permutt, P.C.
2311 Highland Avenue South
Birmingham, AL 35205
205-930-5445 (telephone)
205-212-2933 (facsimile)
grhodes@sirote.com