Conservation Easement Ruling Favors IRS but It’s Not a Slam Dunk

BRIARCREEK PRESERVE, LLC, LDHL INVESTMENTS, LLC, TAX MATTERS PARTNER,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

United States Tax Court
Washington, DC 20217

ORDER

This case concerns whether Briarcreek Preserve, LLC, is entitled to a charitable contribution deduction for a donation of a conservation easement, and if not, whether Briarcreek is liable for an accuracy-related penalty. Currently before the Court are cross-motions for partial summary judgment under Rule 121 pertaining to Treasury Regulation §§ 1.170A-14(g)(6) and -13(c).¹

Treasury Regulation § 1.170A-14(g)(6) defines the amount of proceeds the easement donee must receive from a sale of the property following judicial extinguishment of the easement. Part II.A infra explains that we will grant respondent's motion and deny petitioner's motion insofar as we agree with respondent that the “improvements” clause in Briarcreek's easement does not conform to this regulation. However, the Golsen rule prevents this Court from denying a deduction on this ground because the Eleventh Circuit has deemed respondent's interpretation of the regulation invalid. We will hold petitioner's motion in abeyance pending further appellate developments on the issue of the regulation's validity.

Treasury Regulation § 1.170A-13(c) requires the taxpayer to disclose on its return the basis of the property subject to the easement. Following this Court's reasoning in Oakhill Woods, LLC v. Commissioner, T.C. Memo. 2020-24, Part II.B infra explains that we will deny petitioner's motion insofar as we sustain the regulation,² and we will grant respondent's motion and deny petitioner's motion insofar as we conclude that Briarcreek did not comply with the basis disclosure requirement. We also deny petitioner's motion to the extent it asserts a reasonable cause defense, and reserve the issue of whether Briarcreek's reliance on professional advice excuses its noncompliance.

Background

Neither party disputes the following facts, which the Court derives from the Petition, the motion papers, and the attached declarations and exhibits. Briarcreek is a Georgia limited liability company that has operated at all relevant times as a partnership for Federal income tax purposes, and had its principal place of business in Georgia when its petition was filed.

On or about June 28, 2006, Derek Hutcheson and W. Darrel Hutcheson purchased 227.46 acres of woodland real estate in Burke County, Georgia, and contributed their ownership interests to two single-member limited liability companies, LDHL Investments, LLC (petitioner), and WDHL Investments, LLC. On December 22, 2010, these companies transferred the property to Briarcreek, which donated a conservation easement over the property to the Georgia Land Trust, a section 170(h)(3) “qualified organization.” See discussion of § 170 infra. The easement deed, which was recorded on December 30, 2010, recites the conservation purposes and generally prohibits any residential, commercial, or industrial use of, or activity on, the property. It also reserves certain rights to Briarcreek as grantor, including the rights to conduct commercial agricultural and forestry activities. In addition, Briarcreek reserved the right to construct “a limited number of improvements and buildings,” which could include two “single-family residential dwellings,” “reasonable appurtenances typically associated with single-family residential dwellings,” and roads and utilities to service such structures.

In the event the property was sold following judicial extinguishment of the easement, paragraph 17 of the deed provides that “[t]he amount of the proceeds to which Grantee shall be entitled, after the satisfaction of any and all prior claims, shall be determined . . . in accordance with the Proceeds paragraph.” Paragraph 19, captioned “Proceeds,” specifies that the grantee's share of any future proceeds would be determined “by multiplying the fair market value of the Property unencumbered by this Conservation Easement (minus any increase in value after the date of the Conservation Easement attributable to improvements) by the ratio of the value of the Conservation Easement at the time of this conveyance to the value of the Property at the time of this conveyance without deduction for the value of the Conservation Easement” (emphasis added).

Briarcreek filed a Federal partnership tax return for its short tax period December 29 to December 31, 2010, on which it claimed a charitable contribution deduction of $2,434,000 for donating the easement. Although the Internal Revenue Service (IRS) required the donor to list the cost or adjusted basis of such property on Form 8283 (Rev. 12-2006), Noncash Charitable Contributions, Briarcreek explicitly declined to provide this information, explaining in an attachment (Form 8283 statement) that

A declaration of the taxpayer's basis in the property is not included in Section B, Part 1, 5(f) of the attached Form 8283 because of the fact that the basis of the property is not taken into consideration when computing the amount of the deduction. Furthermore, the taxpayer has a holding period in the property in excess of 12 months and the property otherwise qualifies as “capital gain property”.

Petitioner and Derek Hutcheson, in a declaration accompanying petitioner's motion papers, allege that Briarcreek relied on third parties to prepare and file the return, including Form 8283. These included Forever Forests, an organization specializing in the conservation of underdeveloped land and experienced with conservation easements, and Habif, Arogeti, & Wynne, a large regional accounting firm.

Respondent issued Briarcreek a notice of final partnership administrative adjustment (FPAA) dated October 24, 2017, disallowing the deduction because Briarcreek had not shown that the requirements of section 170 were met. The FPAA alternatively determined that if any deduction were allowable, Briarcreek had not established that the fair market value of the easement exceeded $0. The FPAA determined a section 6662(h) 40% “gross valuation misstatement” penalty and, in the alternative, a section 6662(a) 20% accuracy-related penalty. Petitioner sought readjustment of the charitable contribution deduction in this Court, see § 6226(f),³ and the parties filed cross-motions for partial summary judgment.

Discussion

I. Summary Judgment Standard

The purpose of summary judgment is to expedite litigation and avoid costly and unnecessary trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). We may grant a motion for summary judgment, or partial summary judgment regarding an issue, when there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); Elec. Arts, Inc. 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 nonmoving party may not rest upon the mere allegations or denials in its pleadings but must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); Sundstrand, 98 T.C. at 520.

II. Analysis

Respondent contends that the IRS properly disallowed the charitable contribution deduction for two independently sufficient reasons. First, the conservation purpose underlying the easement is not “protected in perpetuity” as required by section 170(h)(5)(A) because the donee would receive inadequate proceeds from sale of the property under Treasury Regulation § 1.170A-14(g)(6) in the event of judicial extinguishment of the easement. Second, Briarcreek failed to disclose the property's basis on Form 8283 as required by Treasury Regulation § 1.170A-13(c). We consider each argument in turn.

A. “Protected in Perpetuity” Requirement

The Code generally disallows a deduction for charitable contributions of partial interests in property. § 170(f)(3)(A). However, a taxpayer may claim a deduction for “qualified conservation contributions,” which include the contribution to a qualified organization, exclusively for conservation purposes, of a restriction (granted in perpetuity) on the use which may be made of the donor's real property. See § 170(f)(3)(B)(iii), (h)(1)-(2). For the donation of an easement to be a qualified conservation contribution, the conservation purpose must be “protected in perpetuity.” See § 170(h)(5)(A).

Treasury Regulation § 1.170A-14(g)(6)(i) recognizes 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.” Despite that possibility, “the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding” and the easement deed ensures that the charitable donee, following sale of the property, will receive a proportionate share of the proceeds to use consistently with the conservation purposes underlying the gift. Treas. Reg. § 1.170A-14(g)(6)(i)-(ii). The sale proceeds effectively replace the easement as an asset deployed by the donee “exclusively for conservation purposes.” See § 170(h)(5)(A).

The regulation requires that in the event the property is sold following extinguishment of the easement, the donee must receive a ratio of the sale proceeds “at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time.” See Treas. Reg. § 1.170A-14(g)(6)(ii). This Court and the U.S. Court of Appeals for the Eleventh Circuit, the appellate venue for this case absent a stipulation by the parties, see § 7482(b)(1)(E), have agreed with the IRS that this language precludes a deduction for easements like Briarcreek's, which subtracts any increase in the value attributable to improvements between the grant and extinguishment of the easement before apportioning the sale proceeds. See TOT Prop. Holdings, LLC v. Commissioner, 1 F.4th 1354, 1363 (11th Cir. 2021), aff'g T.C. Dkt. No. 5600-17 (Nov. 22, 2019) (bench opinion); Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 139 (2019).

To illustrate, assume a taxpayer donates a conservation easement worth $30 on unimproved property with an unencumbered value of $100. The judicial extinguishment regulation mandates that the donee receive at least 30% of total sale proceeds ($30 ÷ $100 = 0.3). Assume further that the taxpayer later adds improvements worth $50, and sells the property for $150 following judicial extinguishment of the easement. Briarcreek's deed would allocate the donee $30, which is 30% of $100, the difference between the $150 of sale proceeds and the $50 value of the improvements. But $30 is only 20% of the $150 total sale proceeds. The regulation requires that the donee receive at least 30% of $150, or $45.

The Tax Court rejected a procedural challenge to the same regulation. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180, 189-95 (2020), aff'd, ___ F.4th ___, 2022 WL 766050 (6th Cir. March 14, 2022). The taxpayer conceded the regulation's validity in TOT Prop. Holdings, 1 F.4th at 1362 n.13, but the Eleventh Circuit later overturned the foregoing application of the rule because the IRS failed to respond to significant public comments on the proposed regulation, as required by the Administrative Procedure Act (APA) at 5 U.S.C. section 553(c). Hewitt v. Commissioner, 21 F.4th 1336, 1342-50 (11th Cir. 2021), rev'g T.C. Memo. 2020-89; see also Golsen v. Commissioner, 54 T.C. 742, 757 (1970) (holding that the Tax Court will follow a Court of Appeals decision which is squarely on point where appeal from our decision lies to that Court of Appeals alone), aff'd, 445 F.2d 985 (10th Cir. 1971). As in Hewitt, the IRS contends that Briarcreek's deed failed to comply with the judicial extinguishment regulation because of its “improvements” clause, and petitioner argues that the regulation is invalid. Although the Golsen rule prevents this Court from denying petitioner's deduction on this ground, we will hold petitioner's motion in abeyance pending further appellate developments on the validity of Treasury Regulation § 1.170A-14(g)(6). Cf. Montgomery-Ala. River, LLC v. Commissioner, T.C. Dkt. No. 9254-19 (Feb. 25, 2022) (order taking a similar approach).

B. Basis Disclosure Requirement

Section 170 and the regulations thereunder provide rules for taxpayers seeking to deduct a charitable contribution. A taxpayer generally may deduct the fair market value of any non-cash charitable contribution, with fair market value determined at the time of contribution. Treas. Reg. § 1.170A-1(c)(1).

Taxpayers must satisfy disclosure requirements to deduct a charitable contribution. The Deficit Reduction Act of 1984 (DEFRA) directed the Secretary of the Treasury or his delegate to prescribe regulations that “require any individual, closely held corporation, or personal service corporation claiming a deduction under section 170” to include the cost basis of the contributed property on “the return on which such deduction is first claimed.” Pub. L. No. 98-369, § 155(a)(1), 98 Stat. at 691. The Treasury responded by adopting Treasury Regulation § 1.170A-13(c), which requires the classes of taxpayers listed in DEFRA section 155(a)(1), as well as partnerships, to include the “cost or other basis of the property” on an appraisal summary attached to the return. See T.D. 8003, 1985-1 C.B. 64 (explaining that the Treasury adopted the initial version of the regulation to implement DEFRA section 155(a)). The IRS has prescribed Form 8283 to be used as the appraisal summary, see Jorgenson v. Commissioner, T.C. Memo. 2000-38, slip op. at 21, and Form 8283 directs the taxpayer to disclose the “Donor's cost or adjusted basis” of property like the tract at issue in this case on line 5(f) of Section B, Part I. Failure to comply with the basis reporting requirement generally precludes a deduction. See § 170(a)(1) (providing that a taxpayer may deduct a charitable contribution “only if verified under regulations prescribed by the Secretary” (emphasis added)).

The regulation permits an exception to the reporting requirement where the taxpayer has “reasonable cause for being unable to provide” the basis of the contributed property. In such case, the taxpayer must attach an appropriate explanation to the appraisal summary, and the taxpayer's deduction “will not be disallowed simply because of the inability (for reasonable cause) to provide” this information. Treas. Reg. § 170A-13(c)(4)(iv)(C)(1); see also Form 8283 Instructions at 5 (hereinafter “Instructions”) (directing taxpayer who has reasonable cause for not providing the basis of contributed property to attach an explanation so the deduction will not automatically be disallowed).

1. Validity of the Regulation

Petitioner makes two related arguments against the validity of Treasury Regulation § 1.170A-13(c). First, petitioner argues that the regulation lacks the force of law as an interpretive regulation promulgated under section 7805. Courts enforce regulations enacted via the APA notice-and-comment procedure, including those promulgated under section 7805, unless they are “arbitrary, capricious, or manifestly contrary to the statutory text.” Romano-Murphy v. Commissioner, 816 F.3d 707, 717 (11th Cir. 2016) (citing Mayo Found. for Med. Educ. & Research v. United States, 562 U.S. 44, 53 (2011)), vacating and remanding T.C. Memo. 2012-330. Petitioner does not deny that the Treasury followed the notice-and-comment procedure of 5 U.S.C. § 553 (1982) in issuing the final version of Treasury Regulation § 1.170A-13(c). See T.D. 8199, 1988-1 C.B. 99 (summarizing and responding to comments on the proposed regulation published in the Federal Register).

Second, petitioner invokes step one of the Chevron test, which requires a court reviewing an agency's construction of a statute it administers to “give effect to the unambiguously expressed intent of Congress.” Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837, 842-43 (1984). Petitioner argues that Treasury Regulation § 1.170A-13(c) is “manifestly contrary to the statutory text,” to quote Romano-Murphy supra, because the regulation requires the taxpayer to report basis on an attachment to the return, rather than on the return itself as instructed by DEFRA section 155(a)(1).

Oakhill Woods, T.C. Memo. 2020-24, at *22-*26, rejected this argument on three grounds. First, a taxpayer's “return” includes all IRS forms and schedules required to be filed as part of the return. See Treas. Reg. § 1.6011-1. Second, even if “appraisal summary” and “return” are mutually exclusive terms, DEFRA section 155 does not prohibit the Secretary from requiring the taxpayer to report basis on both the appraisal summary and the return. Third, DEFRA section 155(a)(3) provides that “the appraisal summary shall be in such form and include such information as the Secretary prescribes by regulations” (emphasis added).

The regulation also survived Chevron step 2, which provides that if Congress has not spoken to the precise question at issue, the reviewing court should determine whether the regulation “is based on a permissible construction of the statute.” Chevron, 467 U.S. at 843. DEFRA does not specify where the taxpayer must report basis, and the IRS reasonably solicits this information on the appraisal summary where it is accessible to examining agents. Oakhill Woods, T.C. Memo, 2020-24, at *26-*27.

We see no reason to depart from our rejection of petitioner's Chevron argument in Oakhill Woods.

2. Briarcreek's Failure to Comply with the Regulation

Oakhill Woods explains that a return like Briarcreek's does not comply with Treasury Regulation § 1.170A-13(c). In both cases, the taxpayer did not report its basis as the regulation and Form 8283 require, and stated on Form 8283 that it need not provide the information rather than showing that it could not provide the information. Cf. id. at *13. Like the taxpayer in Oakhill Woods, petitioner now contends that Briarcreek omitted basis because the Instructions failed to explain what basis Briarcreek should report: (a) the 2006 purchase price paid by the Hutchesons, (b) Briarcreek's basis in the transferred property, (c) the basis of the property as encumbered by the easement, or (d) some other basis calculation. Cf. id.

Briarcreek's Form 8283 statement did not offer this explanation, and neither the Form 8283 statement nor petitioner's motion papers explain what Briarcreek's basis would be under the alternative approaches petitioner suggests, or why these approaches would yield different basis figures. Cf. id. at *13-*14. Even if the IRS could have discerned the basis from other information reported on the return, as petitioner argues, Briarcreek's failure to complete Form 8283 thwarted the IRS' ability to efficiently identify overvalued property. See RERI Holdings I, LLC v. Commissioner, 149 T.C. 1, 14-17 (2017); Oakhill Woods, T.C. Memo. 2020-24, at *15-*22.

3. Reasonable Cause for Noncompliance

Congress codified Treasury Regulation § 1.170A-13(c) in 2004 by enacting section 170(f)(11)(C), which denies a charitable contribution deduction for taxpayers like Briarcreek that fail to attach to the return for the taxable year of the contribution “such information regarding such property . . . as the Secretary may require.” American Jobs Creation Act of 2004 (AJCA), Pub. L. No. 108-357, § 883(a), 118 Stat. at 1632; see also RERI Holdings I, LLC v. Commissioner, 143 T.C. 41, 72 n.21 (2014). Section 170(f)(11)(A)(ii)(II) created a broader reasonable cause defense than the regulation itself, excusing failure to comply with subparagraph (C) “if it is shown that the failure . . . is due to reasonable cause and not to willful neglect.” AJCA § 883(a), 118 Stat. at 1631. Reasonable cause requires that the taxpayer have exercised ordinary business care and prudence as to the challenged item. See United States v. Boyle, 469 U.S. 241, 246 (1985) (discussing a comparable reasonable cause defense). “The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.” Treas. Reg. § 1.6664-4(b)(1) (discussing a comparable reasonable cause defense). Petitioner argues that the section 170(f)(11)(A)(ii)(II) reasonable cause defense applies for two reasons.

First, petitioner suggests that the Form 8283 statement demonstrates a reasoned justification for failing to disclose basis because the statement “invokes the then applicable instructions to Form 8283, which directed that basis should not be reported for property with a holding period of more than 12 months in one place and had no meaningful instruction in the other, and the law upon which that instruction most apparently was based.” We are not persuaded.

The instruction against providing basis applies to donated property of $5,000 or less and certain publicly traded securities, which are listed in Section A of the form — not property like Briarcreek's land, which is listed in Section B. Instructions at 1-2, 4-5. Petitioner's reference to the lack of “meaningful instruction” apparently denotes the alleged ambiguity of what Form 8283 means by “basis.” As noted in Part II.B.2 supra, Briarcreek alleged no such ambiguity in the Form 8283 statement and did not disclose what its basis would be under the alternative approaches petitioner suggests.

As for petitioner's point about the law underpinning the basis disclosure instruction, the sentence in the Form 8283 statement explaining that the property is a capital asset held for more than one year evidently refers to section 170(e)(1)(A). Section 170(e)(1)(A) requires that the amount of any deduction be reduced by “the amount of gain which would not have been long-term capital gain” if the property had instead been sold.⁴ Cf. Oakhill Woods, T.C. Memo. 2020-24, at *8 n.3 (drawing the same conclusion about a similar statement on Form 8283). Detecting built-in gain of gifted capital assets held for less than a year is one function of Form 8283, and this Court may deny a charitable contribution deduction based on section 170(e)(1)(A) to a taxpayer who fails to correctly report his basis in contributed property. See Alli v. Commissioner, T.C. Memo. 2014-15, at *43-*44.

On the other hand, an organization like Forever Forests that specialized in conservation easements should have been aware that Form 8283 also implements Treasury Regulation § 1.170A-13(c), and that the Treasury adopted the regulation in response to DEFRA, which Congress enacted amid concern about the IRS' ability to detect overvaluations of contributed property. See RERI Holdings, 149 T.C. at 14-15 (discussing the legislative history of DEFRA). Moreover, petitioner has identified no downside to providing the property's basis, even if accompanied by the caveat that Briarcreek considered the form's use of the term “basis” ambiguous.⁵ A competent tax adviser exercising ordinary business care and prudence would not have risked automatic disallowance of the deduction by consciously refusing to fill in a blank on a form based on the adviser's unverified theory about why the IRS needed the information. See Instructions at 5 (cautioning the taxpayer about automatic disallowance of the deduction for failure to include basis).

Second, petitioner claims that Briarcreek relied on third parties to prepare and file Form 8283. The good faith reliance on the advice of an independent, competent professional may satisfy the reasonable cause requirement. See Boyle, 469 U.S. at 250; Treas. Reg. § 1.6664-4(b)(1). To demonstrate such reliance, the taxpayer must prove by a preponderance of the evidence that (1) the adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser's judgment. See Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002); see also Gustashaw v. Commissioner, 696 F.3d 1124, 1138-39 (11th Cir. 2012) (explaining how to determine whether a taxpayer's reliance on professional advice satisfies the reasonable cause standard), aff'g T.C. Memo. 2011-195. Whether a taxpayer relies on advice and whether such reliance is reasonable hinge on the facts and circumstances of the case and the law that applies to those facts and circumstances. Neonatology, 115 T.C. at 98; Treas. Reg. § 1.6664-4(c)(1). The relevant facts and circumstances of this case remain subject to genuine dispute, so we will deny petitioner's motion as to reasonable cause.

It is therefore,

ORDERED that Respondent's Motion for Partial Summary Judgment, filed August 10, 2018, is granted insofar as the Court agrees that Briarcreek failed to comply with Treasury Regulation §§ 1.170A-14(g)(6) and -13(c). It is further

ORDERED that Petitioner's Motion for Partial Summary Judgment, filed October 26, 2018, is denied insofar as the Court agrees with respondent that Briarcreek failed to comply with the foregoing regulations. The motion is held in abeyance as to the validity of -14(g)(6), and denied as to whether reasonable cause excuses Briarcreek's noncompliance with -13(c).

(Signed) Travis A. Greaves
Judge