LLCs Denied Deductions for Conservation Easement Donations

Green Valley Investors, LLC, Bobby A. Branch, Tax Matters Partner, et. al.
Petitioner
v.
Commissioner of Internal Revenue,
Respondent

United States Tax Court

ORDER

In these four related cases, petitioner Bobby A. Branch is the tax matters partner for four entities: Green Valley Investors, LLC (Green Valley) in No. 17379-19; Vista Hill Investments, LLC (Vista Hill) in No. 17380-19; Big Hill Partners, LLC (Big Hill) in No. 17381-19; and Tick Creek Holdings, LLC (Tick Creek) in No. 17382-19. We sometimes refer to these entities individually as “LLC” and these four entities collectively as “the LLCs”. In December 2014, Green Valley, Big Hill, and Tick Creek each granted a conservation easement to Triangle Land Conservancy (TLC). In December 2015, Vista Hill did the same. Each LLC claimed a corresponding charitable contribution deduction. By notices of final partnership administrative adjustment (FPAA) issued on June 24, 2019, the Internal Revenue Service (IRS) disallowed the deductions and determined accuracy-related penalties under section 6662.¹ On September 20, 2019, Mr. Branch timely petitioned this Court challenging these determinations.

In each of these four related cases, the Commissioner of Internal Revenue (respondent) twice moved for partial summary judgment. In his first motion for partial summary judgment, respondent contended each LLC is not entitled to a deduction for the charitable contribution of an easement because the easement does not protect the conservation purpose in perpetuity, as required by section 170(h)(5)(A). In his second motion for partial summary judgment, respondent argued that each LLC grossly misstated the value of the respective donated easement and that the penalty for a gross valuation misstatement should apply. We grant respondent's first motion for partial summary judgment and deny respondent's second motion for partial summary judgment in each of these four related cases for the reasons set forth below.

Background

The background of these four related cases is drawn from the undisputed portions of the exhibits attached to the parties' motion papers.

A. The Syndicated Conservation Easement Transaction

In 2011, Bobby A. Branch and Elizabeth N. Branch bought a little over six-hundred acres of land in North Carolina (Parent Tract) in two transactions. Later that year, Mr. and Mrs. Branch transferred the Parent Tract to Bonlee Investment Properties, LLC (Bonlee). Mr. Branch served as the sole member and manager of Bonlee.

In August 2014, Bonlee engaged Strategic Capital Partners, LLC and Bridge Capital Associates, Inc. (collectively Strategic Capital) for investment banking services. In September 2014, Bonlee engaged Van Sant & Wingard, LLC to perform appraisals for proposed conservation easements on sections of the Parent Tract.

Around the same time in September of 2014, Mr. Branch formed Green Valley, Big Hill, and Tick Creek. In February of 2015, Mr. Branch formed Vista Hill. Mr. Branch and Bonlee were the initial members of each LLC. Mr. Branch contributed cash to each LLC in exchange for a one-percent membership interest in each LLC.

Bonlee contributed a portion of the Parent Tract to each LLC in exchange for a 99-percent membership interest in each LLC. Specifically, on November 24, 2014, Bonlee contributed 141.65 acres to Green Valley (Green Valley Property). Bonlee also contributed 96.71 acres to Big Hill (Big Hill Property) and 108.35 acres to Tick Creek (Tick Creek Property) on November 24, 2014. On June 16, 2015, Bonlee contributed 112.46 acres to Vista Hill (Vista Hill Property).

Strategic Capital acted as a placement agent with respect to four separate private placement offerings. Strategic Capital issued a Confidential Private Placement Memorandum with respect to each LLC. With Strategic Capital's assistance, Green Valley, Vista Hill, and Big Hill offered investors the opportunity to buy up to 95 Class A Units in each LLC for $50,000 per Unit, for a total offering price of $4.75 million. Tick Creek offered investors the opportunity to buy up to 190 Class A Units for $25,000 per Unit for a total offering price of $4.75 million.

In December of 2014, investors purchased Class A Units in Green Valley, Big Hill, and Tick Creek. In late 2015, investors bought Class A Units in Vista Hill. On December 30, 2014, Green Valley executed a deed of conservation easement in favor of TLC, according to which Green Valley encumbered 136.12 acres of the Green Valley Property with a conservation easement. On December 30, 2014, Big Hill also executed an easement deed in favor of TLC, according to which Big Hill encumbered all 96.71 acres of the Big Hill Property. Also on the same date, Tick Creek executed a deed of conservation easement in favor of TLC, according to which Tick Creek encumbered all 108.35 acres of the Tick Creek Property. On December 2, 2015, Vista Hill executed an easement deed in favor of TLC, encumbering all 112.46 acres of the Vista Hill Property (collectively, Easement Deeds).

B. The Easement Deeds

The Easement Deeds address the possibility that the conservation easement is terminated and the property is sold or taken for public use. The Easement Deeds include the following language in substantially² the same form:

At the time of conveyance of the Conservation Easement to Grantee, this perpetual Conservation Easement gives rise to a real property right, immediately vested in Grantee with a fair market value that is at least equal to the proportionate value that this Conservation Easement bears to the value of the Property as a whole on the date of this Conservation Easement. If the easement or part thereof is terminated and the Property is sold or taken for public use, then, as required by U.S. Treas. Reg. Section 1.170A-14(g)(6), Grantee shall be entitled to a percentage of the gross sale proceeds or condemnation award (minus any amount attributed to new improvements made after the date of the conveyance, which amount shall be reserved to Grantors), equal to the ratio of the appraised value of this easement to the unrestricted fair market value of the Property, as these values are determined on the date of this Conservation Easement and all such proceeds shall be used by Grantee in a manner consistent with the conservation purposes of this Conservation Easement.

(emphasis added). The Easement Deeds also contain a paragraph referred to by petitioner as an “interpretive clause”, stating that the Easement Deeds “shall be interpreted under the laws of North Carolina, resolving any ambiguities and questions of the validity of specific provisions as to give maximum effect to its conservation purposes.”

C. Tax Reporting and IRS Adjustments

Green Valley, Big Hill, and Tick Creek each timely filed Form 1065, U.S. Return of Partnership Income for 2014, and Vista Hill timely filed Form 1065 for 2015. On its Form 1065, Green Valley claimed a deduction of $22,559,000 for its charitable easement contribution to TLC. Similarly, Big Hill claimed a charitable deduction in the amount of $22,626,000, and Tick Creek claimed a charitable deduction in the amount of $22,605,000 for taxable year 2014. Vista Hill claimed a charitable deduction in the amount of $22,498,000 for taxable year 2015.

Green Valley's Form 1065 included an appraisal prepared by Van Sant & Wingard (Van Sant & Wingard Appraisal), which employed a discounted cash flow analysis of the revenue that a quarry on the property could produce if it sold the maximum volume of road construction aggregate that the market would support. Considering the potential for a quarry, the Van Sant & Wingard Appraisal concluded that the Green Valley Property had a value of $22,800,000 out of which the appraisal subtracted $241,000 as an alleged post-easement value to arrive at a value of $22,559,000. Vista Hill, Big Hill, and Tick Creek included similar appraisals employing a sales comparison approach in support of the respective deductions claimed.

The IRS issued four FPAAs to the LLCs, respectively, on June 24, 2019. The FPAAs determined that the LLCs had not established that the claimed charitable contribution deductions met the requirements of section 170, or, alternatively, that the value of the charitable contribution deductions exceeded $0. The IRS also determined that the underpayment resulted from a gross valuation misstatement under section 6662(h), or alternatively, that the underpayment was attributable to (1) a substantial valuation misstatement under section 6662(e); (2) negligence or disregard of rules or regulations under section 6662(c); or (3) a substantial understatement of tax under section 6662(d).

Discussion

D. Standard for Summary Judgment

A party may move for summary judgment regarding all or any part of the legal issues in controversy. See Rule 121(a); Wachter v. Commissioner, 142 T.C. 140, 145 (2014). We may grant summary judgment if the pleadings, stipulations and exhibits, and any other acceptable materials show that there is no genuine dispute as to any material fact and that a decision may be rendered as a matter of law. See Rule 121(a) and (b); see also CGG Americas, Inc. v. Commissioner, 147 T.C. 78, 82 (2016); Elec. Arts, Inc. & Subs. v. Commissioner, 118 T.C. 226, 238 (2002). We construe the facts and draw all inferences in the light most favorable to the nonmoving party to decide whether summary judgment is appropriate. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). The moving party has the burden of proving that there is no genuine issue of material fact. Naftel v. Commissioner, 85 T.C. 527, 529 (1985). However, the nonmoving party may not rest upon the mere allegations or denials in its pleadings but instead must “set forth specific facts showing that there is a genuine dispute for trial.” Rule 121(d); see also Sundstrand Corp. v. Commissioner, 98 T.C. at 520.

E. Qualified Conservation Contributions

Section 170(a)(1) allows a deduction for any charitable contribution made within the taxable year. When a taxpayer makes a charitable contribution of property other than money, the amount of the contribution is equal to the fair market value of the donated property at the time of the gift. Sec. 1.170A-1(c)(1), Income Tax Regs. The Code generally disallows a charitable contribution deduction for the donation of “an interest in property which consists of less than the taxpayer's entire interest in such property.” Sec. 170(f)(3)(A).

However, a “qualified conservation contribution” constitutes an exception to this general rule. Sec. 170(f)(3)(B)(iii). A “qualified conservation contribution” is a contribution of a qualified real property interest, to a qualified organization, and exclusively for conservation purposes. Sec. 170(h)(1).

A contribution will not be treated as made exclusively for conservation purposes “unless the conservation purpose is protected in perpetuity.” Sec. 170(h)(5)(A). The regulation interpreting the “protected in perpetuity” requirement recognizes that “a subsequent unexpected change in the conditions surrounding the [donated] property * * * can make impossible or impractical the continued use of the property for conservation purposes”. Sec. 1.170A-14(g)(6)(i), Income Tax Regs. In these circumstances, “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 by the donee organization in a manner consistent with the conservation purposes of the original contribution.” Id.

Specifically, the donee must receive a proportionate share of proceeds in the case of extinguishment under the Regulations as follows:

[F]or 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. * * * 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 gives 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.

Section 1.170A-14(g)(6)(ii), Income Tax Regs. (the “Proceeds Regulation”).

The Proceeds Regulation does not provide that “any amount, including that attributable to improvements, may be subtracted out” of the proceeds. PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 208 (5th Cir. 2018); see also Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 138-40 (2019). Thus, language that subtracts the amount attributable to improvements from a condemnation award before calculating the percentage of the proceeds that would go to the donee violates the Proceeds Regulation. See, e.g., PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d at 207-08; Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. at 138-40; Sells v. Commissioner, T.C. Memo. 2021-12, at *14; Red Oak Estates, LLC v. Commissioner, T.C. Memo. 2020-116, at *15; Cottonwood Place, LLC v. Commissioner, T.C. Memo. 2020-115, at *15; Smith Lake, LLC v. Commissioner, T.C. Memo. 2020-107, at *8-*9; Engelwood Place, LLC v. Commissioner, T.C. Memo. 2020-105, at *9; Hewitt v. Commissioner, T.C. Memo. 2020-89, at *5; Oakbrook Land Holdings, LLC v. Commissioner, T.C. Memo. 2020-54, at *37-*38.

F. Analysis

1. The Easement Deeds Violate the Proceeds Regulation

Here, the Easement Deeds do not comply with the Proceeds Regulation. Specifically, the Easement Deeds would subtract the amount attributable to new improvements from the extinguishment proceeds before calculating the percentage of the proceeds that would go to the donee. This language violates the Proceeds Regulation, and thus the contributions here fall outside of the definition of qualified conservation contributions under section 170(h)(1). See, e.g., PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d at 207-08; Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. at 138-40; Sells v. Commissioner, T.C. Memo. at *14; Red Oak Estates, LLC v. Commissioner, at *15; Cottonwood Place, LLC v. Commissioner, at *15; Smith Lake, LLC v. Commissioner, at *8-*9; Engelwood Place, LLC v. Commissioner, at *9; Hewitt v. Commissioner, at *5; Oakbrook Land Holdings, LLC v. Commissioner, at *37-*38.

Petitioner argues that the Easement Deeds comply with the Proceeds Regulation and alternatively any failure to comply can be corrected by reformation under North Carolina law. Petitioner contends that the language “as required by U.S. Treas. Reg. Section 1.170A-14(g)(6)” in the Easement Deeds' paragraph on extinguishment proceeds, and the so-called interpretive clause providing that “any ambiguities and questions of validity of specific provisions” are to be resolved to maximize conservation purposes, effectively overrides the straightforward specific language violating the Proceeds Regulation. These arguments being made by petitioner are nearly identical to the prior arguments raised by other litigants with respect to the Proceeds Regulation.

The Fourth Circuit and this Court have declined to allow such general references to the statute or the regulations to override specific contractual provisions that run afoul of the rules on qualifying conservation contributions. See Belk v. Commissioner, 774 F.3d 221 (4th Cir. 2014) (reasoning that the taxpayers' intent to retain a disqualifying power was clear from the face of the easement such that a condition subsequent savings clause referring to the statute and applicable regulations could not “save” their deduction), aff'g 140 T.C. 1 (2013); Coal Property Holdings, LLC v. Commissioner, 153 T.C. at 140-145 (rejecting provision that directed parties to calculate proceeds based on Section 1.170A-14, Income Tax Regs. if different from specific formula set forth in another paragraph because such provision embodied a condition subsequent saving clause purporting to counteract the plain text of the deed upon a future adverse occurrence); Plateau Holdings, LLC v. Commissioner, T.C. Memo. 2020-93 (2020) (same); Railroad Holdings, LLC v. Commissioner, T.C. Memo. 2020-22 (noting that if language at issue were “actually a saving clause that purported to cure the proceeds formula, then it would be unenforceable and could not salvage what would otherwise be a failure of the formula to provide [donee] with the proportional value of extinguishment proceeds to which it is entitled”).

We have similarly considered and rejected arguments that a saving clause can retroactively reform a deed to comply with regulations. See Palmolive Bldg. Inv'rs, LLC v. Commissioner, 149 T.C. 380 (2017) (determining that a saving clause could not retroactively modify a deed to comply with section 170 and its regulations).

Petitioner also contends, in the alternative, that the Proceeds Regulation exceeds the scope of the statute, and violates the Constitution and the Administrative Procedures Act. We considered the argument that the Proceeds Regulation violates the Administrative Procedures Act (APA) in Oakbrook LandHoldings, LLC v. Commissioner, 154 T.C. 180 (2020). We concluded that the Department of the Treasury satisfied all applicable APA requirements when it promulgated the Proceeds Regulation, and that it was substantively valid in light of the statutory language. Id. at 189-200.³

2. Valuation of Conservation Easements

In his second motion for partial summary judgment, respondent contended that the Green Valley Property was not worth more than $4,162,923, the net amount investors paid to buy interests in Green Valley shortly before the grant of the easement. Respondent made the same argument regarding the other properties:

Parcel	Respondent: Not Worth More Than This Amount
Vista Hill Property	$3,880,699
Big Hill Property	$3,987,338
Tick Creek Property	$3,908,951

According to respondent, the arm's length sale price immediately prior to the grant of the easement is the most reliable evidence of a property's fair market value. Petitioner argued summary judgment on this issue is inappropriate considering the valuations offered in the Van Sant & Wingard Appraisals. We agree with petitioner.

Though respondent argues that the price paid by the investing partners is highly indicative of value, we must construe the facts and draw all inferences in the light most favorable to petitioner on this motion. See Sundstrand Corp. v. Commissioner, 98 T.C. at 520, aff'd, 17 F.3d 965 (7th Cir. 1994). Also, petitioner has convincingly argued that under this legal standard, the value of the conservation easements presents a genuine issue of material fact precluding summary judgment, since petitioner has offered appraisals with values substantially different from respondent's values. See Community Bank v. Commissioner, 79 T.C. 789, 793 (1982); Pabst Brewing Co. v. Commissioner, T.C. Memo. 1995-239, at *22-*25.⁴

Based on the foregoing reasoning, it is

ORDERED that respondent's first motion for partial summary judgment is granted and his second motion for partial summary judgment is denied, in each of these four related cases. It is further

ORDERED that on or before June 30, 2021, the parties shall file a joint status report (or if a joint report is not expedient, then separate reports) setting forth the issues remaining for trial and recommending a schedule for further proceedings in these cases.

(Signed) Christian N. Weiler
Judge