LLC Challenges Denial of Conservation Easement Deduction

CAPITAL SHIP, LLC,
LLH INVESTMENT FUND II, LLC,
TAX MATTERS PARTNER,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE
Respondent.

UNITED STATES TAX COURT

PETITION FOR READJUSTMENT OF PARTNERSHIP ITEMS UNDER CODE SECTION 6226¹

Pursuant to Tax Court Rule 241, LLH Investment Fund II, LLC hereby petitions for readjustment of the partnership items set forth by the Commissioner of Internal Revenue (“Respondent”) in a Notice of Final Partnership Administrative Adjustment (hereafter the “FPAA”), which is dated July 12, 2021, and as the basis for its case alleges as follows:

1. Petitioner. LLH Investment Fund II, LLC (hereafter “Petitioner”) is the Tax Matters Partner for Capital Ship, LLC.

2. Capital Ship, LLC. The FPAA and this petition relate to Capital Ship, LLC (hereafter “Capital Ship”), a limited liability company organized and existing under the laws of the State of Florida. Capital Ship is treated as a TEFRA partnership for federal income tax purposes. Capital Ship maintains its principal place of business in Florida.

3. The Form 1065 federal partnership tax return (the “Tax Return”) of Capital Ship for the tax year ending December 31, 2016 was timely filed electronically with the Internal Revenue Service (“IRS”).

4. Status of the Petitioner. Petitioner is the Tax Matters Partner of Capital Ship.

5. The FPAA. The FPAA (a copy of which is attached hereto and marked “Exhibit A”) was mailed to Petitioner on July 12, 2021. The IRS office located in Gainesville, GA issued the FPAA.

6. Taxable Year. The FPAA issued to Capital Ship was issued for the taxable year ending December 31, 2016 (the “2016 Year”).

7. Assignment of Errors. The errors committed by Respondent in the FPAA are as follows:

a. Non-Cash Contribution Issue. Respondent erred in determining that a non-cash charitable contribution deduction in the amount of $76,300,000 for the 2016 Tax Year was not allowed, in whole or in part, on the stated basis that: “You have not established that Capital Ship LLC made a noncash charitable contribution during the tax year ended December 31, 2016 . . . the charitable contribution claimed on Capital Ship LLC Return of Partnership Income (Form 1065) is reduced by $76,300,000 for the tax year ended December 31, 2016.”

b. Among other documents produced, Petitioner provided Respondent with a copy of the Deed of Conservation Easement (“Easement Deed”) dated December 19, 2016, which was also filed with the Clerk of the Court of Polk County, Florida on December 22, 2016. The Easement Deed conclusively established the non-cash charitable contribution.

c. Petitioner is unable to respond with more specificity to Respondent's contention regarding the Non-Cash Charitable Contribution Issue because Respondent has not explained its determination that Petitioner did not make a non-cash charitable contribution.

d. During the course of the audit, Petitioner provided all documentation establishing the gift of a non-cash charitable contribution. Respondent never indicated that the documentation was incomplete or that additional documentation was necessary to establish the donation of a non-cash charitable contribution.

e. Qualified Contribution Issue. Respondent erred in determining that a noncash charitable contribution deduction in the amount of $76,300,000 for the 2016 Tax Year was not allowed, in whole or in part, on the stated basis that: “To the extent you are able to establish that a noncash charitable contribution has been made, you failed to establish that it satisfied all the requirements of I.R.C. § 170 and the corresponding Treasury Regulations for deducting a noncash charitable contribution . . . the charitable contribution claimed on Capital Ship LLC's Return of Partnership Income (Form 1065) is reduced by $76,300,000 for the tax year ended December 31, 2016.”

f. Petitioner is unable to respond with more specificity to Respondent's contention regarding the Qualified Contribution Issue because Respondent has not identified which requirements under I.R.C. § 170 were not met or the manner in which they were not met.

g. Capital Ship and its members satisfied all of the requirements of I.R.C. § 170 and the applicable Treasury Regulations necessary to be entitled to a deduction in the amount of at least $76,300,000 for the 2016 Year attributable to Capital Ship's contribution of the qualified conservation easement (the “Easement”).

h. Respondent's failure to identify any deficiencies in the Easement, or otherwise identify how Capital Ship failed to comply with I.R.C. § 170, makes the FPAA and its corresponding allegations arbitrary and capricious, resulting in an invalid FPAA for the 2016 Year under the Administrative Procedure Act (“APA”) and other relevant law.

i. Other Deductions Issue. Respondent erred in determining “you claimed a deduction of $3,484,856.00 for 'Other Deductions'. You have failed to establish that $3,424,779.00 of this amount was deductible.”

j. Respondent erred in determining that the Other Deductions in the amount of $3,424,779.00 for the 2016 Tax Year were not allowed, in whole or in part, on the stated basis that: “you have failed to show 1) these were ordinary and necessary expenses paid or incurred in carrying on a trade or business, 2) these were deductible expenses under I.R.C. § 212, and 3) these were not nondeductible syndicated expenses. Accordingly, the 'Other Deductions' claimed on Schedule K, Line 20b of your U.S. Return of Partnership Income (Form 1065) for the tax year ended December 31, 2016 is reduced by $3,424,779.00.”

k. Capital Ship and its members satisfied all requirements of the Code necessary to be entitled to a deduction in the amount of at least $3,484,856.00 for the 2016 Year attributable to “Other Deductions.”

l. Petitioner is unable to respond with more specificity to Respondent's contention regarding the Other Deductions Issue because Respondent has not identified which requirements under I.R.C. § 212 were not met or the manner in which they were not met. Respondent has provided no factual basis for why he determined the claimed deductions were not ordinary and necessary expenses paid or incurred in carrying on a trade or business or why he determined the claimed deductions to be “nondeductible syndication expenses.” Petitioner substantiated its deductions throughout the course of the IRS's examinations of the Tax Return.

m. Respondent's failure to support his determination makes the FPAA and its corresponding allegations arbitrary and capricious resulting in an invalid FPAA for the 2016 Year under the APA and other relevant law.

n. Valuation Issue. Respondent erred in determining that Capital Ship failed to demonstrate the value of the Easement. This assigned error is referred to herein as the “Valuation Issue.”

o. Respondent's determination with respect to the Valuation Issue is arbitrary, capricious, and lacks a reasoned basis, resulting in an invalid FPAA for the 2016 Year under the APA and other relevant law.

p. Respondent provides no support for his determination that Capital Ship failed to establish the value of the non-cash charitable contribution and has offered no supportable reasons why the qualified appraisal submitted with the Tax Return does not establish the fair market value of the Easement.

q. Capital Ship has established, through a qualified appraisal and other evidence, the value of the Easement to be at least $76,300,000.

r. Gross Valuation Misstatement Penalty Issue. Respondent erred in determining that “the underpayments of tax resulting from the adjustment of partnership items of $76,300,000.00 are attributable to a gross valuation misstatement. It is therefore determined that a 40% penalty shall be imposed on the underpayments of tax resulting from the gross valuation misstatement as provided by I.R.C. § 6662(h).”

s. The Easement was neither overvalued by Capital Ship nor was there an underpayment of tax.

t. Capital Ship has established, through a qualified appraisal, and other evidence, the value of the Easement to be at least $76,300,000.

u. Because Respondent has not made a determination as to the value of the Easement, Respondent has no basis upon which he can determine it is overvalued.

v. Additionally, under I.R.C. § 6751, no penalty may be assessed by the IRS unless the initial determination of such penalty is personally approved, in writing, by the immediate supervisor of the person making such a determination.

w. On information and belief, the revenue agent failed to obtain personal approval, in writing, from her immediate supervisor prior to conveying the penalty determination to Capital Ship.

x. Consequently, Respondent erred in asserting a gross valuation misstatement penalty under I.R.C. § 6662(h) in connection with the Easement donation.

y. Reportable Transaction Penalty Issue. Respondent erred in determining “that the adjustment [sic] to charitable contribution partnership items are attributable to a listed transaction under I.R.C. § 6707A(c), specifically a transaction described in Notice 2017-10. These adjustments result in a reportable transaction understatement as defined in I.R.C. § 6662A(b). If the I.R.C. § 6662(h) penalty is found not to apply to any portion of the understatement, then a 20% penalty under I.R.C. § 6662A applies to that amount.”

z. Respondent's determination is erroneous because the charitable contribution of the Easement does not warrant a reportable transaction penalty. All details of the donation were properly disclosed to the IRS. Moreover, Capital Ship relied on competent advisors, and substantial authority exists for the position taken on its Tax Return. Capital Ship reasonably believed that its treatment of the donation was proper.

aa. Respondent failed to comply with the notice-and-comment provisions of the APA in promulgating Notice 2017-10. As such, Notice 2017-10 was issued unlawfully.

bb. Because Notice 2017-10 is an unlawful agency action, Capital Ship may not be penalized for any understatement of tax attributable to participation in a transaction listed in Notice 2017-10.

cc. Respondent's assertion of a reportable transaction penalty under I.R.C. § 6662A is arbitrary and capricious, based on unlawful agency action, and results in an invalid FPAA for the 2016 Year under the APA and other relevant law.

dd. In the alternative, Capital Ship cannot be penalized under I.R.C. § 6662A because Capital Ship correctly reported the charitable contribution deduction in connection with the Easement donation on the Tax Return, therefore, no underpayments exist.

ee. Capital Ship and its members had substantial authority for the position taken on the Tax Return, had reasonable cause, and acted in good faith.

ff. Additionally, under I.R.C. § 6751, no penalty may be assessed by the IRS unless the initial determination of such penalty is personally approved, in writing, by the immediate supervisor of the person making such a determination.

gg. On information and belief, the revenue agent failed to obtain personal approval, in writing, from her immediate supervisor prior to conveying the reportable transaction penalty determination to Capital Ship.

hh. Consequently, Respondent erred in asserting a reportable transaction penalty under I.R.C. § 6662A in connection with the Easement donation.

ii. Additional Penalty Issue. Respondent erred in determining that any underpayments of tax from the adjustments of partnership items are attributable to “(1) negligence or disregard of rules or regulations, (2) substantial understatements of income tax, and (3) substantial valuation misstatements, as provided by I.R.C. § 6662(c), (d), and (e), respectively. Therefore . . . there shall be imposed a 20% penalty on the underpayments of tax as a result of I.R.C. § 6662(c), (d), and (e).”

jj. There was neither an underpayment of tax nor a valuation misstatement by Capital Ship. Moreover, any alleged underpayment would be the result of “reasonable cause.” Capital Ship obtained a qualified appraisal and made a good-faith investigation of the value of the Easement. Capital Ship and its members relied on competent advisors.

kk. Additionally, under I.R.C. § 6751, no penalty may be assessed by the IRS unless the initial determination of such penalty is personally approved, in writing, by the immediate supervisor of the person making such a determination.

ll. On information and belief, the revenue agent failed to obtain the personal approval, in writing, from her immediate supervisor prior to conveying the additional penalty determinations to Capital Ship.

mm. Consequently, Respondent erred in asserting any penalty under I.R.C. § 6662 in connection with the Easement donation.

nn. “Other Deductions” Penalty Issue. Respondent erred in determining that any underpayments of tax from the adjustments of “Other Deductions” are attributable to “(1) negligence or disregard of rules or regulations and (2) substantial understatements of income tax. Therefore, there shall be imposed a 20% penalty on the underpayments of tax resulting from the 'Other Deductions' adjustment as a result of I.R.C. § 6662(c) and (d).”

oo. There was neither an underpayment of tax, nor negligence or disregard of rules or regulations with respect to the Other Deductions claimed by Capital Ship. Moreover, any alleged underpayment would be the result of “reasonable cause.” Capital Ship and its members relied on competent advisors to properly report all expenses incurred for tax purposes.

pp. Additionally, under I.R.C. § 6751, no penalty may be assessed by the IRS unless the initial determination of such penalty is personally approved, in writing, by the immediate supervisor of the person making such a determination.

qq. On information and belief, the revenue agent failed to obtain the personal approval, in writing, from her immediate supervisor prior to conveying the “Other Deductions” penalty determinations to Capital Ship.

rr. Consequently, Respondent erred in asserting any penalty under I.R.C. § 6662 in connection with the Easement donation.

8. Facts. The facts upon which Petitioner relies for the foregoing assignments of error and its case are as follows:

a. Capital Ship, LLC. Capital Ship is a limited liability company formed under the laws of the State of Florida. Capital Ship is treated as a partnership for federal income tax purposes.

b. Tax Return. Capital Ship timely filed its Form 1065 federal partnership Tax Return for the 2016 Year. The partnership Tax Return contained all required attachments and information, including a properly completed Form 8283.

c. Property. During the 2016 Year, Capital Ship owned 437.04 acres of real property in Polk County, Florida (the “Capital Ship Property”).

d. Easement Donation. Capital Ship made a legally effective donation of the Easement over 437.04 acres of the Capital Ship Property (the “Easement Property”) by executing a Deed of Conservation Easement (the “Easement Deed”) on or about December 19, 2016 and recording the Easement Deed on or about December 22, 2016.

e. The Easement Deed is recorded in Polk County, Florida book of records in Book 10019 Pages 875-908.

f. The Easement encumbers economically and ecologically valuable real property.

g. The Easement is a restriction on the use of the Easement Property in perpetuity and protects the Easement Property in perpetuity. Capital Ship, its heirs or assigns, remain indefinitely subject to the restrictions in the Easement.

h. Donee. The Easement was donated to the Atlantic Coast Conservancy, Inc. (“ACC”). ACC has at all relevant times been recognized by the IRS as a publicly supported, I.R.C. § 501(c)(3) charitable organization, as described in I.R.C. §§ 170(b)(1)(A)(vi) and 509(a)(1), and received a determination letter to that effect from the Commissioner.

i. ACC was at all relevant times a “qualified organization” authorized to receive conservation easement donations pursuant to I.R.C. § 170(h)(1)(B).

j. ACC has the experience and means to monitor and enforce the Easement. ACC has expressed the intent to monitor and enforce its rights under the Easement Deed.

k. ACC has made annual inspections of the Easement Property to ensure compliance with the terms of the Easement Deed.

l. Petitioner received a letter acknowledging the donation of the Easement in compliance with I.R.C. § 170(f)(8).

m. The Easement Deed conveys to ACC the right to enforce the terms of the Easement Deed and to protect the conservation purposes in perpetuity.

n. Baseline Documentation. In connection with the donation of the Easement, qualified individuals prepared a baseline report and accompanying documentation (the “Baseline Report”) for the Easement.

o. The Baseline Report contains an evaluation of certain conservation values and purposes protected by the Easement. The Baseline Report documents the condition of the Easement Property at the time of the Easement donation and describes several of the conservation values present within the Easement Property.

p. Highest and Best Use. The highest and best economical use of the Easement Property immediately preceding the Easement donation was for mining.

q. Once the Easement was placed upon the Easement Property, the highest and best use of the property changed dramatically. The Easement Property could no longer be economically developed because Capital Ship relinquished its right to develop the Easement Property in perpetuity.

r. Conservation Purpose. The Easement meets at least one of the four conservation purposes required under I.R.C. § 170(h)(4)(A) and Treasury Regulation § 1.170A-14(d), as documented by the Baseline Report, the Easement Deed, and the attributes of the Easement Property.

s. Respondent has made no independent determination that the Easement failed to preserve any single, much less all four, of the conservation purposes described in I.R.C. § 170(h)(4).

t. Appraisers. The appraisal of the value of the Easement (the “Appraisal”) was performed by Clayton M. Weibel, MAI (the “Qualified Appraiser”). The Qualified Appraiser was, at the time of the Appraisal, a “qualified appraiser” as defined in Treasury Regulation § 1.170A-13(c)(5).

u. Appraisal. The Appraisal prepared by the Qualified Appraiser and used as a basis for the charitable deduction taken for the donation of the Easement was a “qualified appraisal” under Treasury Regulation § 1.170A-13(c)(3).

v. Respondent has made no determination that the Qualified Appraiser was not a qualified appraiser or that the Appraisal was not a qualified appraisal, as defined in Treasury Regulation §§ 1.170A-13(c)(3) or (c)(5).

w. The Appraisal correctly determined the value of the Easement donated by Capital Ship. Capital Ship and its members reasonably relied upon the Appraisal in establishing the amount of the charitable contribution deduction. Capital Ship's reliance was reasonable and in good faith, and Capital Ship made an independent investigation of the value of the Easement.

x. Capital Ship satisfied all other requirements necessary to be entitled to a charitable deduction for the donation of the Easement, as reported on its Tax Return for the 2016 Year.

9. Pursuant to I.R.C. § 7491, the burden should be shifted to Respondent as to both the deductibility and the value of the Easement because Capital Ship has produced credible evidence establishing that it is entitled to a charitable contribution deduction for the Easement in the amount claimed on its Tax Return for the 2016 Year, and has otherwise maintained all records, cooperated with Respondent at all levels of the audit process, and complied with all requirements of the Internal Revenue Code and the Treasury Regulations.

10. Pursuant to I.R.C. § 7491(c), Respondent bears the burden of production with respect to any penalties asserted in the FPAA.

WHEREFORE, Petitioner prays that the Court dismiss the FPAA as invalid or otherwise readjust the partnership items consisting of the charitable contribution deduction for the Easement and the “Other Deductions” claimed and determine the amount of the deduction for the Easement and “Other Deductions” to have been properly deducted in the amount claimed. Petitioner further prays that the court declare that Notice 2017-10 is an unlawful agency action because Respondent failed to comply with the APA in promulgating the Notice. Petitioner further prays that the Court shift the burden of proof to Respondent and determine that the Commissioner erred in: (1) disallowing the noncash charitable contribution deduction of Capital Ship for the 2016 Year, (2) disallowing the “Other Deductions” claimed by Capital Ship for the 2016 Year, and (3) determining the application of penalties against Capital Ship for the 2016 Year.

Dated: October 1, 2021.

GREGORY P. RHODES
Tax Court Bar No. RG0309

SIDNEY W. JACKSON, IV
Tax Court Bar No. JS0169

RONALD A. LEVITT
Tax Court Bar No. LR0545

Dentons Sirote PC
2311 Highland Ave. So. Ste 500
P.O. Box 55757
Birmingham, AL 35205
(205) 930-5445

MICHELLE ABROMS LEVIN
Tax Court Bar No. AM0309

LOGAN C. ABERNATHY
Tax Court Bar No. AL0232

SARAH E. GREEN
Tax Court Bar No. GS21129

Dentons Sirote PC
305 Church Street SW, Ste 800
Huntsville, AL 35801
(256) 518-3605

Counsel for Petitioner