Details make a difference when attempting to qualify for a tax benefit, and a taxpayer who thought his conservation easement language complied with that found in the regulations discovered that the Tax Court noted a difference. In the case of Carroll v. Commissioner, 146 TC No. 13 the issue involved what happens if the easement is extinguished due to circumstances outside the taxpayer’s control.
Reg. 1.170A-14(g)(6) provides:
(i) In general.
If a subsequent unexpected change in the conditions surrounding the property that is the subject of a donation under this paragraph can make impossible or impractical the continued use of the property for conservation purposes, 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.
In case of a donation made after February 13, 1986, for a deduction to be allowed under this section, at the time of the gift the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right, immediately vested in the donee organization, with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time. See section 1.170A-14(h)(3)(iii) relating to the allocation of basis. For purposes of this paragraph (g)(6)(ii), that proportionate value of the donee's property rights shall remain constant. Accordingly, when a change in conditions give rise to the extinguishment of a perpetual conservation restriction under paragraph (g)(6)(i) of this section, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction, unless state law provides that the donor is entitled to the full proceeds from the conversion without regard to the terms of the prior perpetual conservation restriction.
The taxpayer in question had given an easement that in all other aspects qualified as a deductible charitable conservation easement. But the language that dealt with what happened upon an unexpected extinguishment provided “[t]he value on the effective date of this grant shall be the deduction for federal income tax purposes allowable by reason of this grant, pursuant to Section 170(h) of the Code…” and then went on to use that number compared to the fair value of the entire property at that date to determine what the charity’s interest would be.
A quick reading of the clause might suggest there isn’t a problem here—after all the deductible amount is the fair value of the conservation easement and if that value turned out to be different than originally claimed after an IRS exam finished then it seems there isn’t a problem—the value on exam is determined to be the fair value.
Except, as the Court noted, there are other reasons an easement could end being deemed nondeductible other than merely having no value—and if no deduction was allowed then the charity would receive nothing on a later extinguishment of the easement.
As the Court noted:
Petitioners appear to argue on brief that the deduction referenced in the conservation easement was simply a method of determining the value of the easement. But there is no evidence of why this provision was in the conservation easement. Deductions for conservation easements can be denied for many reasons unrelated to valuation. At the time the conservation easement was granted, petitioners’ deduction faced many hurdles that were unrelated to the value of the easement. Indeed, in this case respondent has made many arguments for disallowance that are not based on valuation.
In the event of extinguishment, if the deductions were disallowed, petitioners or their heirs could argue that petitioners never received a tax deduction and, therefore, MET and LPT would not be entitled to extinguishment proceeds. This argument is supported by the literal terms of the easement, and there is no evidence of a different intent. This would provide petitioners or their heirs with a windfall and deprive the donees of their ability to use a share of the extinguishment proceeds for conservation purposes. See Kaufman III, 687 F.3d at 26. We conclude that Article VI.D, subparagraphs (1) and (2), of petitioners’ conservation easement violates the requirements of section 1.170A-14(g)(6)(ii), Income Tax Regs., by not guaranteeing MET and LPT a proportionate share of extinguishment proceeds based on the fair market value of the conservation easement at the time of the gift. Because the purpose of petitioners’ contribution is not protected in perpetuity, it does not qualify as a qualified conservation contribution, and therefore petitioners are not entitled to a carryforward charitable contribution deduction for the years in issue.
Perhaps the taxpayer really did want protection from more than a change in the value assigned or perhaps it was simply a poor choice of “equivalent” words in drafting the easement, but the reality is that the Tax Court has yet again made it clear that taxpayers looking to avail themselves of the special rule allowing deductions for a partial interest in property for conservation easements will be held to a strict standard.