Government Argues Conservation Easement Deduction Properly Denied

OAKBROOK LAND HOLDINGS, LLC; WILLIAM DUANE HORTON, Tax Matters Partner
Petitioners-Appellants
v.
COMMISSIONER OF INTERNAL REVENUE
Respondent-Appellee

IN THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT

ON APPEAL FROM THE DECISION OF THE
UNITED STATES TAX COURT

BRIEF FOR THE APPELLEE

DAVID A. HUBBERT
Acting Assistant Attorney General

FRANCESCA UGOLINI (202) 514-3361
ARTHUR T. CATTERALL (202) 514-2937
NATHANIEL S. POLLOCK (202) 514-3139
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

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Table of contents

Table of authorities

Statement regarding oral argument

Introduction

Jurisdictional statement

Statement of the issue

Statement of the case

Summary of argument

Argument

The Tax Court correctly upheld the IRS's disallowance of the charitable contribution deduction Oakbrook claimed on its 2008 partnership return

Conclusion

Certificate of compliance

Certificate of service

TABLE OF AUTHORITIES

Cases:

Alioto v. Commissioner, 699 F.3d 948 (6th Cir. 2012)

Altera Corp. & Subs. v. Commissioner, 926 F.3d 1061 (9th Cir. 2019)

Belair Woods, LLC v. Commissioner, 120 T.C.M. (CCH) 73 (T.C. 2020)

Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017)

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

Coal Property Holdings, LLC v. Commissioner, 153 T.C. 126 (2019)

Glass v. Commissioner, 471 F.3d 698 (6th Cir. 2006)

Hewitt v. Commissioner, T.C. Memo 2020-89

Hoffman Properties II, LP v. Commissioner, 956 F.3d 832 (6th Cir. 2020)

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

Hussion v. Madigan, 950 F.2d 1546 (11th Cir. 1992)

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

Kuhn v. Washtenaw Cty., 709 F.3d 612 (6th Cir. 2013)

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

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

Nat'l Cable & Telecomms. Ass'n v. Brand X Internet Servs., 545 U.S. 967 (2005)

Nat'l Elec. Mfrs. Ass'n v. U.S. Dept. of Energy, 654 F.3d 496 (4th Cir. 2011)

Navistar Int'l Transp. Corp. v. Environmental Protection Agency, 941 F.2d 1339 (6th Cir. 1991)

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

Perez v. Mortg. Bankers Ass'n, 575 U.S. 92 (2015)

Porter v. Ogden, Newell & Welch, 241 F.3d 1334 (11th Cir. 2001)

SEC v. Chenery Corp., 318 U.S. 80 (1943)

SIH Partners LLLP v. Commissioner, 923 F.3d 296 (3d Cir. 2019), cert. denied, 140 S. Ct. 854 (2020)

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

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

Union Equity Co-op. Exch. v. Commissioner, 481 F.2d 812 (10th Cir. 1973)

United States v. Woods, 571 U.S. 31 (2013)

Vermont Yankee Nuclear Power Corp. v. Nat. Res. Def. Council, Inc., 435 U.S. 519 (1978)

Wachter v. Commissioner, 142 T.C. 140 (2014)

Statutes:

5 U.S.C.:

Internal Revenue Code (26 U.S.C.):

Administrative Procedure Act (5 U.S.C. § 551 et seq.)

Bipartisan Budget Act of 2015, Pub. L. 114-74, Title XI, § 1101, 129 Stat. 630

Miscellaneous:

48 Fed. Reg. 22940 (May 23, 1983)

51 Fed. Reg. 1496 (January 14, 1986)

Black's Law Dictionary (11th ed. 2019)

Nancy A. McLaughlin, Conservation Easements and the Proceeds Regulation, 56 Real Prop. Tr. & Est. L.J. 1 (2021) (forthcoming; copy attached)

Fed. R. App. P. 13(a)

https://www.finance.senate.gov/download/syndicated-conservation-easement-transactions-print-116-44

https://www.neighborhoodscout.com/tn/real-estate

https://www.zillow.com/tn/home-values/

https://www2.census.gov/programsurveys/decennial/tables/time-series/coh-values/values-unadj.txt

IRS Notice 2017-10, 2017-4 I.R.B. 544

Priv. Ltr. Rul. 200836014 (June 3, 2008)

Restatement (Third) of Property: Servitudes (2000)

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

Treas. Reg. (26 C.F.R.):

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STATEMENT REGARDING ORAL ARGUMENT

Under 6th Cir. R. 28(b)(1)(B) and Fed. R. App. P. 34(a), counsel for the Commissioner respectfully inform this Court that they believe holding oral argument for this appeal would be helpful to the Court, given that the appellants have challenged the validity of a Treasury regulation.

INTRODUCTION

To qualify for a charitable contribution deduction, a conservation easement must be granted in perpetuity, I.R.C. § 170(h)(2)(C), and its conservation purpose must be protected in perpetuity, I.R.C. §170(h)(5)(A). But state laws generally allow perpetual conservation easements to be judicially extinguished if continued use of the property for conservation purposes becomes impossible or impractical. And because forever is indeed “a really long time” (Hoffman Properties II, LP v. Commissioner, 956 F.3d 832, 833 (6th Cir. 2020)), it is reasonably likely that a conservation easement may someday be judicially extinguished.

Anticipating this possibility, the Treasury Department issued a regulation providing that the conservation purpose of a perpetual conservation easement will be deemed to be protected in perpetuity if, in the event of a judicial extinguishment of the easement, the donee uses its share of the proceeds from a subsequent sale of the property in a manner consistent with the conservation purpose of the extinguished easement. Treas. Reg. (26 C.F.R.) § 1.170A-14(g)(6)(i). And the regulation further provides that the donee's share of such proceeds must (at a minimum) bear the same ratio to the total amount of proceeds that the date-of-grant value of the easement bears to the date-of-grant value of the property as a whole. Treas. Reg. § 1.170A-14(g)(6)(ii).

Oakbrook Land Holdings LLC granted a conservation easement to a qualified organization and deducted what it claimed to be the value of that easement as a charitable contribution. The IRS disallowed the deduction in full on the ground that Oakbrook's easement deed does not ensure that the donee will receive the minimum share of judicial-extinguishment proceeds described in § 1.170A-14(g)(6)(ii). The Tax Court agreed, and it also rejected Oakbrook's argument that the regulation is procedurally and substantively invalid. But as Judge Toro's concurring opinion persuasively demonstrates, Oakbrook's deed violates the statute itself by limiting the donee's share of extinguishment proceeds to a fixed amount equal to the date-of-grant value of the easement. Accordingly, this Court can affirm the Tax Court's decision without addressing the regulation's validity. If it does reach the regulation, the Court should uphold the Tax Court's conclusion that the regulation is procedurally and substantively valid.

JURISDICTIONAL STATEMENT

A. Tax Court jurisdiction

On December 6, 2012, the Internal Revenue Service (IRS) sent William Duane Horton, the tax matters partner for Oakbrook Land Holdings LLC (Oakbrook) a notice of final partnership administrative adjustment for 2008.¹ (JA17-29, 213-22.) On March 6, 2013, Oakbrook timely petitioned the United States Tax Court for a readjustment of partnership items. (JA8-16, 30.) See I.R.C. (26 U.S.C.) § 6226(a) (2012).² The Tax Court had jurisdiction under I.R.C. §§ 6226(f) (2012) and 7442.

B. Appellate jurisdiction

The Tax Court entered a final decision on July 21, 2020. (JA1222-23.) Oakbrook timely filed a notice of appeal on October 16, 2020. (JA1226.) See I.R.C. § 7483; Fed. R. App. P. 13(a). This Court has jurisdiction under I.R.C. § 7482(a).

STATEMENT OF THE ISSUE

Whether the Tax Court correctly upheld the IRS's disallowance of the charitable contribution deduction Oakbrook reported on its 2008 partnership return.

STATEMENT OF THE CASE

A. Overview of the case and proceedings below

Oakbrook claimed a $9,545,000 deduction on its 2008 tax return based on its donation of a conservation easement on about 100 acres of land in eastern Tennessee. After an audit, the IRS disallowed the claimed deduction in its entirety on the ground that, inter alia, the contribution did not satisfy I.R.C. § 170(h)(5)(A)'s protected-in-perpetuity requirement, as implemented by Treas. Reg. § 1.170A-14(g)(6)(ii). The IRS also asserted the applicability of certain accuracy-related penalties.

Oakbrook sought a redetermination in the Tax Court, arguing that its contribution complied with the applicable regulation, that the regulation is procedurally and substantively invalid in any event, and that it accurately valued the contribution. The Tax Court upheld the validity of the regulation in an opinion reviewed by the full Tax Court, and it held that the contribution did not comply with the regulation — and that Oakbrook therefore was not entitled to any portion of the claimed deduction — in a memorandum opinion authored by Judge Holmes. Judge Holmes further held that the asserted penalties did not apply. This appeal by Oakbrook followed.³

B. Statutory and regulatory background

Though the Internal Revenue Code generally does not allow deductions for charitable donations of partial interests in property, I.R.C. § 170(f)(3)(A), it does allow a deduction for a “qualified conservation contribution.” I.R.C. § 170(f)(3)(B)(iii). To qualify for the deduction, the property donated must be (1) a “qualified real property interest,” (2) donated to a “qualified organization,” and (3) donated “exclusively for conservation purposes.” I.R.C. § 170(h)(1)(A), (B), and (C); Treas. Reg. § 1.170A-14(a). As relevant here, a “qualified real property interest” is “a restriction (granted in perpetuity) on the use which may be made of the real property.” I.R.C. § 170(h)(2)(C). Under I.R.C. § 170(h)(5)(A), a contribution “shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.”

Treasury Regulations implement the statutory protected-in-perpetuity requirement. The extinguishment regulation, Treas. Reg. §1.170A-14(g)(6)(i), acknowledges that “a subsequent unexpected change in the conditions surrounding the property . . . can make impossible or impractical the continued use of the property for conservation purposes,” but provides that “the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding and all of the donee's proceeds (determined under paragraph (g)(6)(ii) of this section) from a subsequent sale or exchange of the property are used . . . in a manner consistent with the conservation purposes of the original contribution.”

The proceeds regulation, § 1.170A-14(g)(6)(ii), provides that, for a deduction to be allowed, the donee's share of extinguishment proceeds must be determined by reference to the proportionate value of the conservation restriction, i.e., “the proportionate value that [such] restriction at the time of the gift, bears to the value of the property as a whole at that time.” The regulation further provides that this proportionate value (percentage) must remain constant. Id. And it provides that the donee organization “must be entitled to a portion of the [extinguishment] proceeds at least equal to that proportionate value” unless state law requires the donor to receive the full amount of the proceeds. Id. See generally Nancy A. McLaughlin, Conservation Easements and the Proceeds Regulation, 56 Real Prop. Tr. & Est. L.J. 1 (2021) (forthcoming; copy attached).

While the tax deduction allowed under § 170(h) is intended to encourage conservation, see S. Rep. No. 96-1007, at 9 (1980), reprinted in 1980 U.S.C.C.A.N. 6736, 6744-45, the conservation-easement provisions are also widely abused.⁴ In 2016, the IRS issued a notice cautioning that it would be scrutinizing certain “syndicat[ed] conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested.” IRS Notice 2017-10, 2017-4 I.R.B. 544. Although the Tax Court noted that this case does not involve a syndicated conservation easement in the sense that there was no outside “promoter” (JA1189), it does present the type of valuation concerns raised in Notice 2017-10. See pp. 12-13, infra.

C. Oakbrook's easement

In 2007, a real estate developer named Duane Horton discovered a 143-acre piece of undeveloped land on White Oak Mountain, a high-growth area near Chattanooga, Tennessee, and contacted investors about buying the property for both residential and commercial development. (JA1179-80.) Horton and his investors formed Oakbrook Land Holdings, LLC in August 2007 and purchased the property for $1.7 million in December of that year. (JA1180.)

Oakbrook began development by building a bridge, installing a high-pressure sewer-pump station, and getting the property rezoned. (JA1181.) In 2008, Horton began exploring the possibility of granting a conservation easement on part of the property. (Id.) After consulting with the executive director of the Southeast Regional Land Conservancy, Horton took the conservation easement idea to his investors. (Id.) After transferring portions of the land to related entities for unrestricted development, Oakbrook executed a conservation easement deed, granting a conservation easement to the Conservancy with respect to the remaining (approximately 106) acres. (JA1181-82.) The deed identifies numerous conservation purposes, including preserving the scenic beauty of a highly visible ridgeline within the property, preservation of a portion of Hurricane Creek, protecting trees, and preserving a forest habitat for a variety of animals. (JA111-12.)

Oakbrook reserved the right to subdivide one of the tracts into four “Ridge Lots,” each of which would include a 1.5-acre “Building Area” (for a house) that would be carved out of the grant, leaving approximately 100 acres of “Conservation Area.” (JA110-11, 117.) The deed also permits certain development inside the Conservation Area. (JA113-17.) For instance, Oakbrook reserved the right to build in the Conservation Area, inter alia, “limited overnight accommodation facilities,” a community garden, fencing for horse grazing, power lines, water wells, underground water distribution lines, underground septic and sewage systems and lines, barns, sheds, field houses, picnic shelters, and pavilions. (JA113-15.) The deed also allows for limited construction of new roads within the Conservation Area, and it permits Oakbrook to “re-grade, resurface and improve the Existing Roads,” replace culverts and bridges, and maintain roadside ditches. (JA115.) Similarly, the deed allows Oakbrook to “construct and maintain additional walking trails on the Conservation Area,” and Oakbrook can also “install a limited number of outdoor lights” along the trails and roads. (JA116.)

Some of the reserved rights, like location and subdivision of the Ridge Lots and designation of the Building Areas within those lots, require Oakbrook to notify the Conservancy in writing at least 60 days in advance. (JA118.) Before it approves the action, the Conservancy must be satisfied that the proposed exercise of the reserved right “will have no material adverse effect on the Conservation Values or on the significant environmental features of the Conservation Area.” (JA118-19.)

The deed states that it gives rise to a real property right and interest immediately vested in the Conservancy. (JA121.) It provides that the “fair market value” of that right and interest

shall be equal to the 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, (c) less amounts for improvements made by Owner in the Conservation Area subsequent to the date of this Conservation Easement. . . .

(JA121-22.) The deed further provides that the conservation easement can only be extinguished in a judicial proceeding. (JA122.) In the event of any such extinguishment (including by eminent domain), the Conservancy is entitled to extinguishment proceeds “equal to the fair market value of the Conservation Easement as provided above.” (Id.) Finally, the Conservancy must use its share of extinguishment proceeds “in a manner consistent with the conservation purposes” set out in the deed. (Id.)

D. Valuation and audit

Oakbrook hired an appraiser to determine the value of the easement. (JA1184.) Notwithstanding the fact that Oakbrook bought the entire 143-acre property for $1.7 million in December of 2007 (JA1180), the appraiser initially valued the easement on a portion of that property at $19.5 million (JA1184). But some of Oakbrook's consultants and investors were concerned that that valuation was too high, and the same appraiser submitted a second appraisal concluding that the easement was worth $9,545,000. (JA1184 & n.3.) Oakbrook claimed that amount on its 2008 partnership tax return as a charitable contribution deduction. (JA1184-85.) Oakbrook's claimed deduction was, as the Tax Court later observed, predicated upon “the position that the land covered by the easement had appreciated in value by about 700% in a single year during the worst real estate crisis to hit the United States since the Great Depression.” (JA1050-51.)

The IRS audited Oakbrook's 2008 return and issued a notice of final partnership administrative adjustment (FPAA). (JA17-29, 213-22.) In the FPAA, the IRS disallowed Oakbrook's claimed charitable contribution deduction in its entirety. (JA27.) The IRS determined that the deed's extinguishment clause provided for a split of extinguishment proceeds that failed to protect the easement's conservation purposes in perpetuity as the statute and regulations require. (JA1186.) The IRS also asserted a 20% accuracy-related penalty under I.R.C. § 6662 for negligence or disregard of rules or regulations and/or substantial understatement of income tax.⁵ (JA1185-86.)

E. Proceedings in the Tax Court

Oakbrook challenged the IRS's disallowance of its charitable contribution deduction (and the IRS's assertion of the 20% penalty) in the Tax Court. During the Tax Court proceedings, the Commissioner asserted an increased penalty of 40% based on a determination that Oakbrook's claimed value of the easement was at least 200% of the easement's correct value. (JA50, 94-95.) See I.R.C. § 6662(h). The Commissioner based that determination on an expert opinion concluding that the easement was worth $545,000. (JA50.) On the basis of post-trial developments in the case law, however, the Commissioner ultimately conceded the valuation-misstatement penalty on procedural grounds. (Doc. 66.) See Chai v. Commissioner, 851 F.3d 190 (2d Cir. 2017) (construing the supervisory-approval requirement of I.R.C. § 6751(b) that applies to most tax penalties). The Tax Court therefore did not address the valuation issue.

The Tax Court's resolution of the case focused on the proceeds regulation, Treas. Reg. § 1.170A-14(g)(6)(ii). Oakbrook argued that its easement deed satisfied the regulation and that, even if it did not, the regulation is invalid. (JA1053.)

The Tax Court issued two opinions concurrently. The first, an opinion reviewed by the full Tax Court, held that the proceeds regulation is procedurally and substantively valid.⁶ The second opinion, a memorandum opinion authored by the judge who presided over the trial (Judge Holmes), held that Oakbrook's conservation easement deed violated the proceeds regulation and that Oakbrook therefore did not qualify for the charitable contribution deduction it claimed in 2008. The memorandum opinion also held that the asserted 20% penalty under I.R.C. § 6662 did not apply because Oakbrook qualified for the reasonable-cause exception to that penalty. (JA1218-19.) See I.R.C. §6664(c)(1).

1. The Tax Court's majority opinion upholding the validity of the proceeds regulation

The Tax Court's opinion upholding the validity of the proceeds regulation was authored by Judge Lauber and joined in full by eleven other Tax Court judges. The court explained that, per the concurrently issued memorandum opinion, the easement deed violated I.R.C. §170(h)(5)(A)'s protected-in-perpetuity requirement and the proceeds regulation because

the donee's share of the proceeds, in the event the property were sold following a judicial extinguishment of the easement, would be (1) determined according to a fixed historical value rather than a proportionate share of the proceeds and (2) reduced by the value of any improvements made by the donor.

(JA1051.)

The Tax Court further explained that, under the proceeds regulation, a conservation easement deed must “guarantee the donee 'a proportionate share of extinguishment proceeds'” in order to qualify for a charitable contribution deduction. (JA1057 (citations omitted).) The court noted in that regard that the proceeds regulation “does not permit . . . 'any amount, including that attributable to improvements, [to] be subtracted out' of the proceeds against which the proportionate value is applied.” (Id. (citations omitted) (alteration added).)

The Tax Court then rejected Oakbrook's argument that the Treasury Department's promulgation of the regulation at issue violated the Administrative Procedure Act's notice-and-comment-rulemaking procedures set forth in 5 U.S.C. § 553. (JA1065-73.) In particular, the court rejected Oakbrook's argument that Treasury failed to consider relevant comments to the proposed extinguishment rule and failed to provide “a concise general statement of [its] basis and purpose” in the preamble to the final conservation easement regulations. 5 U.S.C. §553(c). The court explained that, in response to comments from 90 organizations and individuals, Treasury made numerous changes to the proposed conservation easement regulations and highlighted the most important of those changes in the preamble to the final regulations. (JA1068.) The court also noted Treasury's statement in the preamble that it had considered all of the submitted comments. (Id.)

The Tax Court then focused on Oakbrook's specific objections to the regulations: “the requirement that the donee receive a proportional share of the [extinguishment] proceeds and the fact that the 'proportionate share' formula does not account for the possibility of donor improvements.” (JA1069.) The court concluded that Treasury “clearly considered” comments about the proportionate-share rule because it “substantially revised” the proceeds regulation “in response to those comments.” (Id.) Commenters “urged that 'the proportionate value, not the absolute value, * * * is the important figure,' and that 'the proportionate value assigned to an easement at the time of gift is the minimum that a grantee organization should receive in the event of an extinguishment and sale.'” (JA1063.) As the court explained, Treasury responded by adopting the term “proportionate value” in the final rule and otherwise clarifying that the donee must receive a proportionate share of extinguishment proceeds rather than any absolute value. (JA1062-63.) The court also noted that only one comment mentioned the improvements issue (in a single paragraph), and that the comment was directed to façade easements on historic structures, see I.R.C. § 170(h)(4)(A)(iv), rather than the natural conservation easements “with which Treasury was chiefly concerned.” (JA1069.) Accordingly, the court found that Treasury “may reasonably have discounted” the stated concern that the proposed rule's failure to account for improvements would likely discourage donations of façade easements. (JA1070.) The court further noted that, in any event, the comment did not offer any alternative except deletion of the proceeds regulation. (Id.)

The Tax Court's “review of the administrative record” left it “with no doubt that Treasury considered the relevant matter presented to it.” (JA1071.) Noting that the preamble to the final regulations emphasized the perpetuity requirement, the court found it “plain on its face” that the purpose of the judicial-extinguishment rule was to “to provide a mechanism to ensure that the conservation purpose can be deemed 'protected in perpetuity' notwithstanding the possibility that the easement might later be extinguished.” (JA1071-72.) The court rejected the notion that Treasury has to separately discuss every provision of regulations it issues, finding that the “broad statements of purpose contained in the preambles” to the proposed and final conservation easement regulations, “coupled with obvious inferences drawn from the regulations themselves,” provided a “more than adequate” basis for judicial review under the APA. (JA1072-73.) Because “Treasury's rationale for the judicial extinguishment rule 'can reasonably be discerned,'” the court held that Treasury “satisfied all applicable APA requirements when promulgating this rule.” (JA1073.)

The Tax Court next evaluated the substantive validity of the regulation at issue under the two-step framework set out in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). The court concluded (at step one) that the statute did not directly address the prospect of judicial extinguishment of conservation easements and, therefore, that its task was to determine whether the regulation at issue reflected a reasonable interpretation of the statute (step two). (JA1074-75.)

Regarding the proportionate-value approach to the division of extinguishment proceeds, the court concluded that it “cannot say” that this approach “is 'arbitrary, capricious, or manifestly contrary to the statute.'” (JA1076 (quoting Chevron, 467 U.S. at 844).) The court explained that, because the extinguishment could occur many years after the easement is granted, with considerable inflation in the interim, the donee's “property right could be eviscerated in real dollar terms” if the donee's share of sale proceeds were limited to the easement's date-of-grant value (the approach advocated by Oakbrook). (JA1076.) The court concluded that this outcome would thwart the purpose of the protected-in-perpetuity requirement. (Id.)

Regarding donor improvements, the Tax Court likewise concluded that it “cannot say that the absence of a provision addressing donor improvements renders the regulation 'arbitrary, capricious, or manifestly contrary to the statute.'” (JA1077 (quoting Chevron, 467 U.S. at 844).) The court concluded that, in the situation where local land values had decreased over time, “reducing the donee's [extinguishment] proceeds on account of donor improvements could frustrate” the goal of the statutory protected-in-perpetuity requirement by failing to preserve (to the extent possible) the quantum of value committed to conservation purposes. (JA1077.) The court reiterated that only one commenter had mentioned the issue of donor improvements and “[ha]d not suggest[ed] any text” to address the issue. (JA1078.) And it reasoned that, inasmuch as addressing the issue specifically “would have raised a host of questions,” the determination not to take that approach “was a policy decision for Treasury, not this Court, to make.” (Id.)

Summarizing its analysis, the Tax Court found that “Treasury exercised reasoned judgment by adhering to a simple rule that splits sale proceeds in a direct proportional manner on the basis of a fraction determined as of the date the gift was made.” (JA1079.) The court added that, because that rule “ensures satisfaction of the statutory mandate that the conservation purpose be 'protected in perpetuity,'” the regulation was substantively valid under Chevron. (Id. (quoting I.R.C. § 170(h)(5)(A).)

As a final point, the Tax Court opined that “the age of this regulation gives weight to the presumption of reasonableness.” (JA1079.) It explained that the proceeds regulation was issued in 1986, that it has never been amended, and that Congress has since amended I.R.C. § 170 more than 30 times without suggesting “any disagreement with the construction of the statute that Treasury adopted” in that regulation. (JA1080-81.)

2. Judge Toro's concurring opinion

Judge Toro (joined in full by Judge Urda and in part by Judges Gustafson and Jones) concurred in the result reached by the majority, but not in its analysis. Judge Toro would have ruled that Oakbrook's easement deed violates the plain terms of the statute, thus obviating the need to address the validity of the proceeds regulation. (JA1083.) He pointed out that I.R.C. § 170(h)(2) requires the donor to “grant to a donee an 'interest[ ] in real property,'” and he explained that “[o]ne of the rights inherent in a real property interest . . . is the property holder's right to be compensated at fair market value upon a subsequent transfer or taking.” (JA1089 (citing Tennessee law).) In Judge Toro's view, because the extinguishment-proceeds clause of the deed “fails to account for any market-based appreciation that may have occurred after the grant of the easement,” the Conservancy never received the type of real property interest “contemplated by section 170(h)(2)(C) and further protected by section 170(h)(5)(A).” (JA1091.)

Judge Toro further opined that, for similar reasons, the extinguishment-proceeds clause of the deed “also affects Oakbrook's compliance with [the protected-in-perpetuity requirement of] section 170(h)(5)(A).” (JA1092.) In short, Judge Toro concluded that the statute's protected-in-perpetuity requirement cannot be reasonably construed to “bless the donee receiving an amount that is less than” the (appreciated) present value of the donee's interest in the property. (Id.)

Judge Toro also disagreed with the majority's analysis concerning the validity of “the portion of the regulation addressing donor improvements.” (JA1094.) In his view, the IRS's (and the majority's) interpretation of the proceeds regulation as applied to donor improvements is not a reasonable interpretation of the statute and thus is substantively invalid under Chevron step two.⁷ (JA1102.) He reasoned that their interpretation requires “a donor to turn over to the donee a portion of the proceeds attributable to its own permissible retained real property interest,” which “cannot be a reasonable interpretation of the statutory text.”⁸ (JA1103, 1104.)

Judge Toro next concluded that the IRS's interpretation of the proceeds regulation as applied to donor improvements would not pass muster under the Administrative Procedure Act's notice-and-comment requirements. Noting that the New York Landmarks Conservancy had raised the improvements issue in its written comment, Judge Toro concluded that the comment was both relevant and significant, thus requiring a response by Treasury. (JA1118, 1121-25.)

3. Judge Holmes's dissenting opinion

Judge Holmes filed a dissenting opinion. He concluded that Treasury violated the APA because the statement of basis and purpose in the preamble to the final regulations failed to discuss the proceeds regulation or mention “the proportionate-share or improvements problems” and thus failed to include any “reasoned response” to the “'significant' comments” that Treasury had received. (JA1143-44.) He further opined that even if the proceeds regulation were procedurally valid, “it might well be substantively invalid.” (JA1166.) In particular, while Judge Holmes found “perfectly plausible” the reasons cited by the majority for holding that the proceeds regulation represents a reasonable construction of the statute, he remarked that “they are not the ones that Treasury itself offered when it issued the regulation.” (JA1173 (citing SEC v. Chenery Corp., 318 U.S. 80, 87 (1943).) In other words, Judge Holmes posited that, as part of the rulemaking process, an agency must provide a legal analysis explaining why the rule represents a reasonable construction of the statute. Contra Nat'l Elec. Mfrs. Ass'n v. U.S. Dept. of Energy, 654 F.3d 496, 515 (4th Cir. 2011) (Chenery “does not oblige the agency to provide exhaustive, contemporaneous legal arguments to preemptively defend its action” under the Chevron framework).

4. The Tax Court's memorandum opinion holding that Oakbrook's deed violates the proceeds regulation

Judge Holmes also authored the memorandum opinion of the Tax Court that applied the proceeds regulation to Oakbrook's easement deed. After describing the statutory requirements, the court explained that it had previously held that the proceeds regulation requires the donee's share of extinguishment proceeds to be a proportionate share, meaning that it is equal to a percentage based on the date-of-grant values of the easement and of the property as a whole. (JA1196 (citing Coal Property Holdings, LLC v. Commissioner, 153 T.C. 126 (2019).) The court concluded that Oakbrook's deed did not comply with the proceeds regulation because it provided the Conservancy with a fixed amount of extinguishment proceeds rather than a proportionate share. (JA1213-14; see also JA1216-17.) The court further explained that “the regulation prohibits any scenario in which [the donor] gets to recover compensation other than [that] proportionate share of the proceeds,” meaning that the value of any donor improvements “cannot be subtracted” from the proceeds before applying that percentage. (JA1213, 1216 (citing PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 208 (5th Cir. 2018).) Because Oakbrook's deed called for such subtraction, the court concluded that it violated the proceeds regulation in that regard as well. (JA1216-17.) Finally, the court determined that Oakbrook is not liable for an I.R.C. § 6662 penalty (a determination we do not appeal, see, supra, p. 6 n.3).

SUMMARY OF ARGUMENT

Oakbrook's conservation easement deed provides that, in the event the easement is judicially extinguished, the Conservancy is entitled to a share of the proceeds from any resulting sale in an amount equal to the date-of-grant value of the easement, less the judicially determined value of any post-grant donor improvements to the property. This provision violates both the statute governing the deductibility of conservation easements (I.R.C. § 170(h)) and one of the regulations implementing that statute (Treas. Reg. § 1.170A-14(g)(6)(ii)).

1. To qualify for a charitable contribution deduction, a conservation easement must be a “qualified real property interest.” I.R.C. § 170(h)(1)(A), (2). Oakbrook's deed fails to give the Conservancy the required “interest in real property” (§ 170(h)(2)) because it does not provide for fair-market-value compensation of the Conservancy if the easement is judicially extinguished. And because the Conservancy may receive less than the fair market value of the easement upon extinguishment (in which case it would receive less money to reinvest for conservation purposes), the deed fails to protect the conservation purpose of the easement in perpetuity as required by § 170(h)(5)(A).

2. Because the deed violates § 170(h) itself, this Court need not address the validity of the regulation implementing the protected-in-perpetuity requirement of § 170(h)(5)(A) (which the deed likewise violates). If the Court does reach that issue, it should uphold the Tax Court's conclusion that the regulation is procedurally and substantively valid.

a. The proceeds regulation — Treas. Reg. § 1.170A-14(g)(6)(ii) — provides that the donee's share of extinguishment proceeds must be determined based on the proportionate value of the donee's interest in  the property as of the date of grant, and that such percentage must be applied to the total amount of proceeds (i.e., the regulation does not contemplate any carve-out of amounts attributable to permissible post-grant improvements to the property added by the donor). Contrary to Oakbrook's contention, the Treasury Department satisfied the notice-and-comment rules of the Administrative Procedure Act in issuing this regulation. No commenters argued that the donee should receive a fixed amount (or some other measure) of extinguishment proceeds rather than the proportionate share mandated by the regulation. Oakbrook's argument thus boils down to a contention that Treasury should have responded to a comment about the proportionate-share rule that it did not receive. And the lone comment addressing the donor-improvements issue (in a single paragraph) did not suggest an alternative and therefore did not require a response by Treasury.

b. The proceeds regulation is substantively valid under the Chevron framework because it represents a reasonable interpretation of the statute. Oakbrook does not challenge that conclusion as applied to the proportionate-share rule, arguing instead that that aspect of the regulation does not satisfy the reasoned decision-making standard of State Farm. But Treasury necessarily satisfied that standard as the result of its compliance with the APA's notice-and-comment rules.

Oakbrook instead focuses on the donor-improvements aspect of the regulation, i.e., its implicit prohibition against subtracting the value of donor improvements from the pool of extinguishment proceeds to which the proportionate-value percentage is applied. But Oakbrook's deed does not even implicate that issue, as it subtracts the value of donor improvements directly from the fixed amount allocable to the donee under the deed. Regardless, this aspect of the proceeds regulation represents a reasonable construction of the statute because it furthers the statutory protected-in-perpetuity requirement. Donors (and their successors) have a strong incentive to overvalue improvements in the event of a judicial extinguishment, thereby decreasing the amount of extinguishment proceeds available to donee organizations to reinvest in furtherance of conservation purposes. Moreover, the prohibition against improvements-subtraction clauses reflects an eminently practical solution to the improvements issue by virtue of being an administrable bright line rule.

ARGUMENT
The Tax Court correctly upheld the IRS's disallowance of the charitable contribution deduction Oakbrook claimed on its 2008 partnership return

Standard of review

This Court reviews “the Tax Court's factual findings for 'clear error' and its application of law de novo.” Alioto v. Commissioner, 699 F.3d 948, 952 (6th Cir. 2012) (citation omitted).

A. Oakbrook's deed renders the easement nondeductible under I.R.C. § 170(h) without regard to the proceeds regulation

Oakbrook devotes very little of its opening brief to the language of the deed at issue in this case. It undoubtedly would prefer that this Court jump right into a broad analysis of the validity of the proceeds regulation. The Court should decline to do so. Rather, the Court can and should resolve this case by holding that Oakbrook's deed violates the statute itself.

Article VI, Section B(2) of Oakbrook's deed provides that, “upon a subsequent sale, disposition, or involuntary conversion of the Conservation Area” occasioned by a judicial extinguishment of the easement, the Conservancy “shall be entitled to a portion of the proceeds equal to the fair market value of the Conservation Easement as provided above.” (JA122.) And that section provides “above” that such fair market value shall equal 

the 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, (c) less amounts 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 as further described . . . below.

(JA121-122 (emphasis added).)

These restrictions on the donee's share of extinguishment proceeds are inconsistent with the “qualified real property interest” contemplated in I.R.C. § 170(h)(2) in at least two respects. First, rather than allowing the Conservancy (or its successor) to be compensated for any appreciation in the value of its property right upon judicial extinguishment, the deed limits the extinguishment proceeds the Conservancy may receive to a fixed amount equal to the date-of-grant value of the easement. (JA121-22.) Second, even if use of the easement's date-of-grant value might otherwise adequately compensate the donee (i.e., where such value is equal to or greater than the easement's extinguishment-date value), the deed provides that the donee's share of extinguishment proceeds must (at least in some instances) be reduced by the value of any post-grant improvements added to the property by Oakbrook, which could have the effect of reducing the donee's share in that situation to an amount less than the easement's extinguishment-date value. (Id.)

1. The fixed-value aspect of the deed's proceeds provision violates § 170(h)

In order to be deductible, a conservation easement must be a “qualified real property interest.” I.R.C. § 170(h)(1)(A), (2). As Judge Toro correctly explained in his concurring opinion below, “[o]ne of the rights inherent in a real property interest” is the “right to be compensated at fair market value upon a subsequent transfer or taking.” (JA1089 (citing Tennessee law).) Under the terms of the deed at issue here, the Conservancy did not receive that right; it instead received a right to a fixed amount of proceeds that may or may not correspond to the value of its property interest as determined at the time of the subsequent transfer or taking.⁹ Thus, as Judge Toro (and three other Tax Court judges) concluded, the Conservancy “never received the type of 'interest[ ] in real property' contemplated by section 170(h)(2)(C).” (JA1091.)

The fixed-value aspect of the deed's proceeds provision also violates I.R.C. § 170(h)(5)(A). Under § 170(h)(5)(A), a conservation easement is not deductible unless its “purpose is protected in perpetuity.” See also Glass v. Commissioner, 471 F.3d 698, 713 (6th Cir. 2006) (construing the protected-in-perpetuity requirement to mean that the donee must “hold the qualified real property interest 'in perpetuity exclusively for one or more of the conservation purposes listed in section 170(h)(4)'”). As Judge Toro explained (JA1088), there is no dispute that the protected-in-perpetuity requirement may be satisfied by payment of a portion of extinguishment proceeds to the donee if the donee uses that amount to further the easement's conservation purposes. See Treas. Reg. §§ 1.170A-14(g)(6)(i) & (ii). The question is whether the amount of extinguishment proceeds payable to the donee under this deed satisfies the protected-in-perpetuity requirement. It does not. By fixing the donee's share of extinguishment proceeds at the easement's value on the day it was granted, the deed “fails to account for any market-based appreciation that may have occurred after the grant of the easement.” (JA1091.) Accepting that monetary compensation to the donee (to be used for conservation purposes) upon judicial extinguishment can satisfy the protected-in-perpetuity requirement, “no reasonable reading of the statute would bless the donee receiving an amount that is less than the fair market value of its 'interest[ ] in real property' as of the time of the conversion of its interest into cash.” (JA1092 (Toro, J, concurring).)¹⁰

Indeed, the value of real property has risen dramatically in this country over the past century. According to U.S. Census data, the median value of a Tennessee home (including the underlying land) in 1940 was $1,826.¹¹ Suppose an easement had been granted on real property in Tennessee in 1940 that fixed the donee's share of extinguishment proceeds at the 1940 value of the easement. If that easement was extinguished today, the donee would receive less than pennies on the dollar for its property interest.¹² Almost inevitably, a similar result will eventually occur in the context of this easement. If the easement is judicially extinguished 20, 50, or 100 years from now, the easement's value in 2008 when it was granted will almost certainly be less (and probably a lot less) than its extinguishment-date value. So a fixed-value extinguishment proceeds award would fail to protect the public's investment in the conservation easement (in the form of the “tax expenditure” resulting from its deductibility).

And, the fact that the fixed-value aspect of the deed's proceeds provision would adequately protect the donee's interest if property values remain steady or decline (contrary to historic trends) does not help Oakbrook. As Judge Toro's concurrence indicates, the fact that the deed precludes the donee from receiving the benefit of any post-grant appreciation in the value of its interest in the property is the significant point. (See JA1092.) Because this deed provides the donee a fixed amount of extinguishment proceeds that has no correlation to the extinguishment-date value of the donee's interest in the property, it violates the statute's protected-in-perpetuity requirement.

2. The improvements language in the deed's proceeds provision likewise violates § 170(h)

The deed's proceeds provision compounds the fixed-value problem by reducing that amount — as expressed in Article VI, Section B(2), the difference between clause (a) and clause (b) — by the value of any donor improvements (clause (c)). Thus, even in the seemingly unlikely situation where the fixed-value aspect of the deed's proceeds provision might otherwise result in the donee receiving at least the extinguishment-date value of the easement, subtracting the value of donee improvements from the donee's portion of the proceeds could reduce that amount below the extinguishment-date value of the easement.¹³

And in the more likely scenario where the fixed-value aspect of the deed's proceeds provision would, by itself, result in an inadequate share of extinguishment proceeds for the donee, the improvements-subtraction language would exacerbate the problem. Suppose that, in say 50 years, the easement at issue is judicially extinguished pursuant to eminent domain. Under the terms of the deed, the Conservancy would be compensated for what the easement was worth in 2008 minus the value of any post-grant improvements (whose value is specified in the condemnation award). It seems likely that the barns, field houses, observation pavilions, and other permitted post-grant improvements (including an operating historic-replica water wheel) (JA113-15) would have significant value that would increase over time. The value of the post-grant improvements may well exceed the 2008 value of the easement, in which case the Conservancy would be entitled to $0 in extinguishment proceeds. Thus, if the fixed-amount language in the deed's proceeds provision stood by itself, the public would not recoup the value of its tax-expenditure investment in the easement upon judicial extinguishment, but at least it would get its money back (i.e., the amount of the tax deduction would be recovered and used for conservation purposes). With the addition of the improvements-subtraction language, the public may not even get that.

* * * * *

Because the proceeds provision of Oakbrook's deed violates the statute itself, there is no need for this Court to address the validity of the proceeds regulation. In any event, as demonstrated below, the proceeds regulation is both procedurally and substantively valid.

B. The proceeds regulation is procedurally valid

The Administrative Procedure Act (5 U.S.C. § 551 et seq.) sets forth the requirements for notice-and-comment rule making, prescribing “a three-step procedure.” Perez v. Mortg. Bankers Ass'n, 575 U.S. 92, 96 (2015). First, the agency issues a notice of proposed rulemaking; second, it gives interested persons an opportunity to submit comments; and third, it includes a concise general statement of basis and purpose when it issues the final rule. Id.; see 5 U.S.C. § 553(a)-(c).

The agency also must “consider and respond to significant comments received during the period for public comment.” Perez, 575 U.S. at 96 (citations omitted). But “[c]omments must be significant enough to step over a threshold requirement of materiality before any lack of agency response or consideration becomes of concern.” Vermont Yankee Nuclear Power Corp. v. Nat. Res. Def. Council, Inc., 435 U.S. 519, 553 (1978) (citation omitted); see also Home Box Off., Inc. v. F.C.C., 567 F.2d 9, 36 n.58 (D.C. Cir. 1977) (explaining that comments are significant if they “raise points relevant to the agency's decision and which, if adopted, would require a change in an agency's proposed rule, but comments that are “purely speculative and do not disclose the factual or policy basis on which they rest require no response”). This Court has likewise explained that the APA does not require the agency to “respond to every comment”; rather, the agency need only explain its resolution of “any significant problems raised by the comments.” Navistar Int'l Transp. Corp. v. Environmental Protection Agency, 941 F.2d 1339, 1359 (6th Cir. 1991) (citation omitted).

Oakbrook argues (Br. 38-41) that the proceeds regulation is procedurally invalid because the preamble to the final conservation easement regulations did not include a specific discussion of the proceeds regulation and did not respond to the 13 commenters (out of 90) who addressed that regulation. This argument fails.

1. Comments on aspects of the proceeds regulation that have no bearing on the proportionate-value rule or the issue of improvements are immaterial to the APA analysis here

As an initial matter, Oakbrook's argument incorrectly frames the issue. Oakbrook asks this Court to consider whether the Treasury Department adequately explained, and considered comments addressing, the proceeds regulation as a whole. But Oakbrook does not (and could not) mount some sort of facial challenge to the proceeds regulation. Whether, for instance, the proceeds regulation might discourage easement donation (Br. 31) or could be enforced against a grantor's heir or assigns (Br. 32) has no bearing on the denial of Oakbrook's conservation easement deduction. Thus, even if it were true that the Treasury Department should have addressed comments regarding those issues, it would not follow that its failure to do so somehow invalidates a completely different aspect of the regulation. Indeed, if that were how APA § 553 operated, one could object to any of the host of rules included in the conservation easement regulations — regardless of Treasury's response to comments regarding that particular rule — on the theory that there must have been at least one significant comment, relating to some aspect of the regulations, in the 700 pages of submitted comments that Treasury did not adequately address. That cannot be the law.

So there is no need for this Court to decide whether any of the 13 comments that addressed the proceeds regulation raised any point that cast doubt upon any aspect of the proceeds regulation's reasonableness and therefore required a response. The aspect of the proceeds regulation at issue here is the proportionate-value rule, i.e., the requirement that the donee must be entitled to a portion of any extinguishment proceeds that corresponds to the proportionate value of its interest (expressed as a percentage) in the property, determined as of the date of grant. Under this straightforward rule, if the easement was worth 50% of the value of the property as a whole on the grant date, then the donee is entitled to 50% of any extinguishment proceeds. Thus, the relevant question here is whether Treasury failed to respond to significant comments addressing the proportionate-value rule.

The comments that addressed the proportionate-value requirement of the proceeds regulation were favorable. As the Tax Court explained, “commenters urged that 'the proportionate value, not the absolute value, * * * is the important figure,' and that 'the proportionate value assigned to an easement at the time of gift is the minimum that a grantee organization should receive in the event of an extinguishment and sale.'” (JA1063.) In other words, the commenters sought clarification that date-of-grant proportionate value, rather than any other measure (such as a fixed amount), was the required measure of the donee's share of extinguishment proceeds. (See also JA699, 717.)

Treasury responded by clarifying that date-of-grant proportionate value is the required measure of the donee's share of extinguishment proceeds. The proposed version of the regulation had stated that the donated right must be deemed to have a fair market value — which would in turn determine its share of extinguishment proceeds — that is “a minimum ascertainable proportion of the fair market value to the entire property.” 48 Fed. Reg. 22940, 22946 (May 23, 1983). This provision was modified in the final regulation to clarify that the donated right must be deemed to have a fair market value “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.” 51 Fed. Reg. 1496, 1505 (January 14, 1986). The Tax Court thus concluded that “Treasury clearly considered comments it received” concerning “the requirement that the donee receive a proportional share of the [extinguishment] proceeds” because it “substantially revised the text” of the proceeds regulation “in response to those comments.” (JA1069.) Notably, Judge Toro's concurrence does not disagree with this aspect of the court's decision. (See JA1107-28 (expressing disagreement only with the determination that the rule's failure to account for donor improvements satisfied the APA's procedural requirements).)

None of the comments suggested that Treasury should allow donors to provide donees with a fixed amount of extinguishment proceeds rather than a proportionate amount. In essence, then, Oakbrook faults Treasury for failing to respond to a comment that was never made. See SIH Partners LLLP v. Commissioner, 923 F.3d 296, 304 (3d Cir. 2019) (declining to rule the a Treasury regulation violated the APA because, inter alia, Treasury “did not receive any comment” about the challenged aspect of the regulation), cert. denied, 140 S. Ct. 854. (2020). Oakbrook's procedural challenge to the proportionate-share requirement is therefore meritless.

2. The one comment that touched on the issue of improvements in the context of the proceeds regulation did not require a response

Oakbrook focuses (Br. 38) on the one commenter that discussed the question of how to deal with extinguishment proceeds attributable to improvements on the property. According to Oakbrook (Br. 41), Treasury's failure to address this comment is “[p]articularly relevant.” Before we address this argument, however, we note that the current judicial debate regarding the validity of the proceeds regulation as applied to donor improvements revolves around deed provisions that — contrary to the regulation — subtract the value of donor improvements from the total amount of extinguishment proceeds before allocating those proceeds between the donor and the donee based on proportionate value. See Hewitt v. Commissioner, T.C. Memo 2020-89 at [*8] (2020), appeal pending, No. 20-13700-HH (11th Cir.). But that issue is not implicated here, since Oakbrook's deed does something much different: it subtracts the value of donor improvements from the fixed amount of extinguishment proceeds to which the donee would otherwise be entitled under the deed. So, it is important to make this point clear: even if the regulatory rule disallowing the kind of improvements-subtraction clause at issue in Hewitt and similar cases were invalid, that would not impact this case. This provides another reason — i.e., in addition to the validity of the regulation's proportionate-share requirement, and the fact that the deed's proceeds provision violates the statute in any event — why this Court need not address the procedural validity of the proceeds regulation as applied to donor improvements.

Out of an abundance of caution, however, and because the Tax Court addressed the point, we briefly discuss the procedural validity of the proceeds regulation as applied to donor improvements. As the Fifth Circuit explained, the proceeds regulation “does not indicate that any amount . . . may be subtracted out” of extinguishment proceeds in determining the donee's share of such proceeds. PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 208 (5th Cir. 2018). Thus, under the proceeds regulation, the donee's proportionate share of extinguishment proceeds must be a proportionate share of all the extinguishment proceeds, including those attributable to donor improvements.

The comment that criticized this aspect of the proceeds regulation came from the New York Landmarks Conservancy (NYLC). NYLC recognized that, under the proposed regulation, the donee's proportionate share of extinguishment proceeds would include proceeds attributable to donor improvements. While it opined that this rule “would obviously be undesirable to the prospective donor,” it further posited that conservation easements do not have any real “monetary value” to conservation organizations, and that any extinguishment proceeds a donee received would therefore constitute a “windfall[ ]” to the donee. (JA671.) In NYLC's view, the possible deterrent effect of this aspect of the proceeds regulation on prospective donors outweighed the potential benefit of such “windfalls” to prospective donees. (Id.)

NYLC's criticism of the proceeds regulation as applied to donor improvements did not raise any “significant problem” and therefore did not “step over” the materiality threshold that would require a response. Vermont Yankee Nuclear Power, 435 U.S. at 553; Navistar, 941 F.2d at 1359. That is because, as explained in the next paragraph, the comment failed to cast doubt on the reasonableness of the rule. See, e.g., Hussion v. Madigan, 950 F.2d 1546, 1554 (11th Cir. 1992) (citation omitted).

As the Tax Court correctly recognized, the purpose of the proceeds regulation (and § 1.170A-14(g)(6) as a whole) “is plain on its face — to provide a mechanism to ensure that the conservation purpose can be deemed 'protected in perpetuity' notwithstanding the possibility that the easement might later be extinguished.” (JA1071-72.) To cast doubt upon the reasonableness of the proportionate-value rule as applied to donor improvements, the comment would have needed to explain why that aspect of the rule was not a reasonable means of furthering the purpose of the regulation. But NYLC offered no such explanation, other than its unsupported view that conservation easements lack any real “monetary value” to conservation organizations and that the benefit to such organizations of sharing in extinguishment proceeds attributable to donor improvements would therefore be outweighed by a corresponding deterrent effect on prospective donors. (JA671-72.) Perhaps most importantly, NYLC offered no alternative means — let alone any easily administrable means — of accounting for donor improvements in a manner that ensures the conservation purposes of the easement will be protected in perpetuity as required by the statute. Thus, Treasury had no alternative proposal to respond to.

3. Treasury's actions support its representation in the preamble to the final regulations that it considered all comments

Contrary to Oakbrook's contentions (Br. 41-42), Treasury's statement in the preamble to the final regulations that it considered all submitted comments is not meaningless. Indeed, Treasury's revision of the proposed version of the proceeds regulation (described above, pp. 43-44) supports its representation that it considered all submitted comments before determining which ones were significant enough to warrant a specific response.

The revisions to the proposed version of the proceeds regulation were clarifications rather than substantive changes. But they specifically responded to comments expressing some uncertainty about the regulation's meaning and requesting clarification. (See, e.g., JA699 (requesting that the final regulations clarify that “the proportionate value assigned to an easement at the time of gift is the minimum that a grantee organization should receive in the event of an extinguishment and sale of the easement, thus allowing the grantee to capture any increase in the proportionate value of the easement”); JA717 (similar).) Treasury's responsive clarifications are indicative of a comprehensive review of the submitted comments.

Relatedly, while Treasury did not specifically discuss the proceeds regulation in the preamble to the final regulations, it did discuss the statutory protected-in-perpetuity requirement in a way that illuminates its rationale for that rule. Thus, even if Treasury had been required to explain its thinking with regard to the proceeds regulation, it effectively did so. See Motor Vehicle Mfrs. Ass'n of U.S., Inc. v. State Farm Mut. Auto. Ins. Co., 463 U.S. 29, 43 (1983) (explaining that, under the reasoned decisionmaking standard embodied in the APA, courts should “uphold a decision of less than ideal clarity if the agency's path may reasonably be discerned”).

Specifically, in discussing the mortgage-subordination rule, Treas. Reg. § 1.170A-14(g)(2), Treasury explained (in response to comments) that, because “the conservation purposes of the donation must be protected in perpetuity,” a “mortgagee must subordinate its rights under the mortgage to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.” 51 Fed. Reg. at 1498. In other words, Treasury made clear that it views the protected-in-perpetuity requirement as requiring express protection of the full value of the donee's interest in order to adequately protect the easement's conservation purposes. That statement is entirely consistent with the approach taken in the proceeds regulation.

C. The proceeds regulation is substantively valid

Oakbrook argues (Br. 46-56) that the proceeds regulation represents an unreasonable interpretation of the statute under the framework set forth in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). Under that framework, this Court's first task is to determine whether Congress has “directly spoken to the precise question at issue.” Id. at 842. If so, that ends the matter. “But if the statute is instead 'silent or ambiguous with respect to the specific issue,' we then ask, at step two of the analysis, 'whether the agency's answer is based on a permissible construction of the statute.'” Tennessee Hosp. Ass'n v. Azar, 908 F.3d 1029, 1037-38 (6th Cir. 2018) (quoting Chevron). If so, then “Chevron requires a federal court to accept the agency's construction of the statute, even if the agency's reading differs from what the court believes is the best statutory interpretation.” Nat'l Cable & Telecomms. Ass'n v. Brand X Internet Servs., 545 U.S. 967, 980 (2005).

1. Oakbrook's reasoned decision-making argument is inapt in the context of Chevron analysis and is meritless in any event

Oakbrook first argues (Br. 47-50) that the proceeds regulation is substantively invalid because it is not the product of “reasoned decision-making.” Oakbrook's invocation of the reasoned decision-making standard, however — and its reliance on State Farm as a leading authority on that subject (Br. 47-51) — is inapt in the context of Chevron analysis. State Farm review focuses on the agency's contemporaneously expressed rationale for its action, which is part and parcel of the APA's notice-and-comment requirements that apply to agency rulemaking. Chevron analysis, on the other hand, examines whether an agency rule represents a permissible interpretation of the statute the agency is charged with administering.¹⁴ Thus, Oakbrook's reasoned decision-making argument simply rehashes its argument that the proceeds regulation is procedurally invalid.

In any event, Oakbrook's reasoned decision-making argument is meritless. Oakbrook begins (Br. 47-48) by quoting Simms v. Nat'l Highway Traffic Safety Admin., 45 F.3d 999, 1004 (6th Cir. 1995) — which, not coincidentally, it cites repeatedly in the context of its procedural argument — for the principle that “[a]gency 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.'” But, like most tax regulations, the proceeds regulation is not based on empirical studies or fact finding. Rather, it represents Treasury's considered judgment regarding the proper balance to strike between furtherance of the statutory protected-in-perpetuity requirement on one hand, and administrative convenience on the other. Thus, there were no comments contending that the proposed rule rested on erroneous data or fact finding, or pointing to other data that the commenters believed Treasury should consider. Cf. Altera Corp. & Subs. v. Commissioner, 926 F.3d 1061, 1082 (9th Cir. 2019) (holding that Treasury properly disregarded evidence cited by commenters that allegedly contradicted proposed rule at issue where such evidence was “irrelevant to [Treasury's] decisionmaking process”).

Next, Oakbrook contends (Br. 49, 50) that the proceeds regulation “cannot be the product of reasoned decision-making” because Treasury did not specifically explain why it required the “proportionate value” percentage to be determined on the basis of grant-date values, or why it specified that the percentage so determined must remain constant. Although Oakbrook contends (Br. 50) that “several commenters expressed concerns with the proposed regulation's requirements,” this vague assertion elides the fact that no commenter advocated the fixed-value approach for allocating extinguishment proceeds that Oakbrook's deed adopts.

Oakbrook then notes that Treasury had before it a Maryland statute that allocates proceeds from the condemnation of land that is subject to an “agricultural preservation easement” held by the Maryland Agricultural Land Preservation Foundation Fund, a creature of state law, and that the amount so allocable to the Fund “is the amount paid by the Fund for the easement and not a percentage.” (Br. 50 (citing JA742).) But the cited provision is reproduced on the 16th page of a 35-page attachment to the comment submitted to the IRS by the Maryland state agency. (See JA727-61.) And the 2-page comment neither addressed the proceeds regulation nor discussed the statutory provision cited by Oakbrook.¹⁵ Thus, Treasury may have had this “information” (Br. 50) before it, but it certainly was not brought to Treasury's attention. In any event, Oakbrook fails to explain how Maryland's decision about how to administer its easement acquisition program has any bearing on the reasonableness of the proportionate-value aspect of the proceeds regulation.

Oakbrook also appears to fault Treasury (Br. 50-51) for failing to consult the Restatement (Third) of Property: Servitudes (2000), even though that work was published 14 years after Treasury issued the conservation easement regulations in final form in 1986. More to the point, Oakbrook does not contend that any similar (then-existing) authority was brought to Treasury's attention, nor does it explain how its deed is consistent with the Restatement's view of how extinguishment proceeds should be allocated. Similarly, Oakbrook faults Treasury for having failed to give any reason why the proportionate-value rule better serves the statutory protected-in-perpetuity requirement than “the provision in Oakbrook's Deed.” (Br. 51.) Aside from the fact that Oakbrook's deed post-dates the final regulations by 22 years, Oakbrook does not point to any comment urging Treasury to adopt the fixed-value approach of that deed.

In sum, because Treasury was not required to discuss nonexistent comments questioning the proportionate-value rule (and also was not required to discuss an “unflagged” and irrelevant state statutory provision buried in the administrative record), Oakbrook's reasoned-decision-making argument — in addition to being inapt in the context of Chevron analysis — fails on the merits. In that regard, we are not aware of any decision holding that an agency violated the reasoned decision-making standard by failing to explain why it chose not to adopt an approach (here, the fixed-value approach contained in Oakbrook's deed) that no commenter advocated.¹⁶

2. The proceeds regulation reflects a reasonable interpretation of the statutory protected-in-perpetuity requirement, and that interpretation is therefore entitled to deference under Chevron

Oakbrook does not argue here that the proceeds regulation's proportionate-share requirement reflects an unreasonable interpretation of § 170(h). Rather, Oakbrook's actual Chevron argument (Br. 54-56), as opposed to its reasoned decision-making argument, is limited to the argument that the proceeds regulation unreasonably interprets § 170(h) by providing that the donee must be entitled to a proportionate share of the total amount of extinguishment proceeds, including any proceeds attributable to donor improvements. As we have noted, pp. 37-39, 45-46, supra, Oakbrook's deed does not merely preclude the donee from sharing in extinguishment proceeds that are attributable to donor improvements; it reduces the fixed amount of extinguishment proceeds to which the donee would otherwise be entitled under the deed by the amount of improvement-related proceeds. Accordingly, even if the proceeds regulation were substantively invalid for the reason urged by Oakbrook, that result would not render Oakbrook's conservation easement deductible. We nonetheless address this argument for the sake of completeness.

The parties appear to agree that Congress has not “directly spoken to the precise question at issue,” viz., how extinguishment proceeds attributable to donor improvements should be allocated between the donor and donee. Chevron, 467 U.S. at 842. The analysis therefore proceeds to Chevron step two. Here, the issue is whether a regulation that “does not indicate that any amount . . . may be subtracted out” of extinguishment proceeds in determining the donee's share of such proceeds, PBBM-Rose Hill, 900 F.3d at 208, reflects a permissible interpretation of the statute. See Mayo Found. for Med. Educ. and Research v. United States, 562 U.S. 44, 54, 58 (2011) (using “permissible” and “reasonable” interchangeably in this context). The proceeds regulation easily satisfies that test.

Significantly, Oakbrook does not contend that the proceeds regulation reflects an impermissible interpretation of the statutory protected-in-perpetuity requirement (§ 170(h)(5)(A)) that it implements. Rather, it contends that the proceeds regulation is inconsistent with the statutory concept of the “qualified real property interest” that is the subject of the donation, see I.R.C. § 170(h)(2), since, in its view, the regulation overcompensates the donee for that interest in the situation where the extinguishment proceeds include amounts attributable to donor improvements. (See Br. 54 (quoting Judge Toro's concurrence).)

But the “qualified real property interest” is a restriction “on the use which may be made of the real property.” I.R.C. § 170(h)(2)(C). And “real property” includes land and improvements. See Black's Law Dictionary (11th ed. 2019) (defining “real property” as “[l]and and anything growing on, attached to, or erected on it, excluding anything that may be severed without injury to the land”). Since the requisite restriction, by definition, pertains to both land and improvements, Oakbrook's claim that the donee of a deductible conservation easement has no “interest” in donor improvements that must be accounted for in allocating extinguishment proceeds is unsupportable. See Belair Woods, LLC v. Commissioner, 120 T.C.M. (CCH) 73, at [*15] (T.C. 2020) (concluding that restrictions imposed by a deductible conservation easement “apply, not only to the land, but also to any improvements made by the grantor pursuant to its reserved rights”).

Further, even if compensating the donee for a fixed percentage of the value of improvements on the property in the event of extinguishment would sometimes overcompensate the donee, it is equally true that giving the donee no percentage of the proceeds attributable to improvements would overcompensate the donor. For instance, an easement might impose a height restriction so that a house on the property (or which may be built on the property) can only be one story tall and also might disallow any garage, shed, or other out-building on the residential lot. Valuation of the easement would include the value of this restriction — i.e., the difference between the encumbered and unencumbered values of the house, such that the donee of the easement would be entitled to some portion of the extinguishment proceeds attributable to the house.

The obvious rejoinder is that the determination of “some portion” requires a case-by-case approach, rather than the application of a fixed percentage as required by the proceeds regulation. But “[r]egulation, like legislation, often requires drawing lines.” Mayo Foundation, 562 U.S. at 59 (upholding Treasury Regulation at Chevron step two over taxpayer's objection that the regulation “draw[s] an arbitrary distinction”). And, in implementing the statutory protected-in-perpetuity requirement, it was entirely reasonable for Treasury to prefer an easily administrable, bright-line rule that might err on the side of ensuring full compensation of the donee — and thus full protection of the conservation purposes — over a potentially cumbersome, case-by-case approach that would perhaps better serve the interests of donors. Again, the regulations protect the public's investment in conservation easements (in the form of the “tax expenditure” resulting from the deductibility of such easements) by requiring the donee to use its proportionate share of extinguishment proceeds “in a manner consistent with the conservation purposes of the original contribution.” Treas. Reg. § 1.170A-14(g)(6)(i). That protection would be of little value if the regulations failed to protect a donee's ability to receive extinguishment proceeds corresponding to the full value of its interest in the real property.

Thus, the proceeds regulation reflects an eminently reasonable (and practical) interpretation of the protected-in-perpetuity requirement of § 170(h)(5)(A). Donors of conservation easements who include improvements-subtraction clauses in their easement deeds can — or their successors can — manipulate such clauses to the detriment of the donee (and therefore to the detriment of the conservation purposes). In particular, such donors/successors have a powerful incentive to overvalue the improvements on the property in the event of a judicial extinguishment. By doing so, the donor would unfairly increase the share of extinguishment proceeds that flow only to the donor and decrease the amount that must be split based on the originally-determined proportionate values of the donor's and donee's interests. Moreover, as a leading scholar in this area of the law has pointed out, donee organizations may often have limited resources to engage in a valuation battle with the donor/successor, and may also have conflicting incentives in that regard. See Nancy A. McLaughlin, Conservation Easements and the Proceeds Regulation, 56 Real Prop. Tr. & Est. L.J. 1, 25 (2021) (forthcoming; copy attached).

Finally, the reasonableness of Treasury's interpretation of the statutory protected-in-perpetuity requirement, as reflected in the proceeds regulation, is confirmed by the passage of time. As the Tax Court aptly observed, Congress has amended I.R.C. § 170 many times since the 1986 promulgation of the proceeds regulation, including after some cases addressing that regulation were decided, without suggesting any disagreement with the rule. (JA1080-81.) See SIH Partners, 923 F.3d at 302-05 (declining to invalidate a more-than-50-year-old regulation on the basis of hindsight and finding significant the fact that, long after the regulation was issued, the IRS considered changing the regulation but “chose to maintain the status quo”).

3. Oakbrook's remaining arguments (and those of its amici) are meritless

Oakbrook argues (Br. 19-22) that it was prejudiced by the IRS's alleged non-enforcement of the proceeds regulation prior to 2016. Taxpayers, however, do not have a reliance interest in the IRS's non-enforcement of the law. Union Equity Co-op. Exch. v. Commissioner, 481 F.2d 812, 817 (10th Cir. 1973) (“[I]t is well established that the Commissioner is not estopped from challenging erroneously reported items where Internal Revenue agents have failed in prior years to challenge similarly erroneously reported items.”). Thus, as long as the IRS's interpretation of the proceeds regulation is correct (something Oakbrook decided not challenge in this appeal), the possibility that the IRS may have missed the same problem in other conservation easement deeds it has reviewed does not affect the reasonableness of the regulation or its application to Oakbrook. And, though Oakbrook contends that the proceeds regulation's proportionate-value requirement is ambiguous (Br. 20-21), it bears repeating that Oakbrook has elected not to challenge the IRS's (and Tax Court's) interpretation of the regulation in this appeal. See p.34 n.9, supra.

The IRS also has never articulated any conflicting understanding of the proceeds regulation. And the fact that the IRS did not raise the improvements issue in earlier cases when it apparently could have done so (Br. 17) is neither surprising nor relevant. The IRS has often provided several alternative bases for denying conservation easement deductions; by the same token, it does not have to litigate every possible basis for doing so.

Oakbrook also points out that, in 2005, the Conservation Easement Handbook — a publication of the Land Trust Alliance — included a model easement that excluded “'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.” (Br. 19-20 (quoting the Handbook).) Oakbrook asserts (Br. 20 n.10) that more than 30 land trusts have represented that they have drafted conservation easement deeds that include this type of provision. Again, Oakbrook's deed goes well beyond the exclusion contemplated by this type of improvements-subtraction clause. See pp. 37-39, 45-46, supra. And, in any event, this Court has rejected the same sort of reliance-on-model-deeds argument. Hoffman Properties, 956 F.3d at 837.

Oakbrook's amici argue, based on a private letter ruling, that the IRS has switched its position on the issue of extinguishment proceeds attributable to donor improvements. (See Southeast Regional Land Conservancy Brief (SLRC Br.) 24-28; National Taxpayer Union Foundation Brief (NTUF Br.) 18.) That argument is meritless. In the private letter ruling the amici cite, the author appears to have believed that a conservation easement with an improvements-subtraction clause did not violate the proceeds regulation. See Priv. Ltr. Rul. 200836014 (June 3, 2008). But the letter does not include any reasoned determination in that regard.¹⁷ Id. And, in any event, private letter rulings have no precedential value. See I.R.C. § 6110(k)(3); see also, e.g., Glass, 471 F.3d at 709.

The National Taxpayer Union Foundation argues that the proceeds regulation is invalid because its “language is incoherent.” (NTUF Br. 16-20.) To the extent the Foundation contends that the IRS's interpretation of the regulation is incorrect, that issue is not before this Court because Oakbrook does not dispute the IRS's (and Tax Court's) interpretation of the regulation. See p.34 n.9, supra. To the extent the Foundation complains that the IRS's interpretation of the regulation was late in coming, that complaint is not legally significant. The IRS is not somehow estopped from enforcing the law because some conservation groups incorrectly understood the law, even if that incorrect understanding persisted for a long time. Notably, no court has disagreed with the IRS's interpretation of the proceeds regulation. And, taxpayers also had the option of seeking a private letter ruling on the extinguishment proceeds issue — which would be binding on the IRS as to those taxpayers — if they were unsure of how to comply with the proceeds regulation. Porter v. Ogden, Newell & Welch, 241 F.3d 1334, 1337 (11th Cir. 2001) (“A taxpayer ordinarily may rely upon a private letter ruling received from the IRS.”).

Finally, the Southeast Regional Land Conservancy raises state-law issues (SRLC Br. 15-21) that are beyond the scope of this appeal. Specifically, this appeal does not raise the issue of whether the proceeds regulation precludes deductibility of a conservation easement when state law does not allow the parties to follow the proportionate value rule set out in that regulation. Nor does it raise the question whether such a result would reflect a permissible interpretation of the statutory protected-in-perpetuity requirement. But cf. Wachter v. Commissioner, 142 T.C. 140, 149 (2014) (holding that the statutory perpetuity requirements could not be met in a state that limited conservation easements to a duration of 99 years).

In any event, even if the proceeds regulation does preclude a deduction when state law prevents the parties from agreeing to share extinguishment proceeds on the proportionate basis required by the regulation, that would not mean — as the Conservancy suggests — that the regulation creates a property right in contravention of state property law. It would simply mean that the regulation attaches federal tax consequences — i.e., the preclusion of a conservation easement deduction — based on a state property law rule.

The Conservancy also argues (SRLC Br. 23-24) that the IRS's interpretation of the proceeds regulation contradicts the remote-future-event regulation. But Treasury's decision to expressly address judicial extinguishment obviously means it did not consider that possibility “so remote as to be negligible.” See Treas. Reg. § 1.170A-14(g)(3). And this Court has explained that it is “hard to see how” a possibility specifically addressed in a deed could be covered by the remote-future-event regulation. Hoffman Properties, 956 F.3d at 838.

CONCLUSION

This Court should affirm the decision of the Tax Court.

Respectfully submitted,

DAVID A. HUBBERT
Acting Assistant Attorney General

Nathaniel S. Pollock

FRANCESCA UGOLINI (202) 514-3361
ARTHUR T. CATTERALL (202) 514-2937
NATHANIEL S. POLLOCK (202) 514-8139
Attorneys
Tax Division
Department of Justice
Post Office Box 502
Washington, D.C. 20044

APRIL 23, 2021