Eighth Circuit Agrees With Two Other Circuits That Failure to Obtain Subordination Before Donation Dooms Conservation Easement Deduction

In the case of RP Golf LLC v. Commissioner, Case No. 16-3277, CA8 the taxpayer was hoping the Eighth Circuit Court of Appeals would override the Tax Court’s ruling and go against two of its sister Circuits to find that a conservation easement deduction was not barred merely because a mortgage on the property was not subordinated to the rights of the charity prior to the date of the transfer.

The matter in question involved an attempt to donate a qualified conservation easement, as defined at IRC §170(b)(1)(E), for which a charitable contribution deduction is allowed despite the transfer of only the limited conservation easement interest.  As the Court described the contribution and later actions to deal with the mortgage:

In December 2003, RP Golf granted a permanent conservation easement to PLT, a Missouri not-for-profit corporation. The easement’s purpose was to “further the policies of the State of Missouri designed to foster the preservation of open space and open areas, conservation of the state’s forest, soil, water, plant and wildlife habitats, and other natural and scenic resources.”

On April 14, 2004, Great Southern and Hillcrest signed subordinations of their mortgages to PLT’s right to enforce the easement. Both subordinations state an effective date of December 31, 2003. Also on April 14, RP Golf filed its 2003 partnership tax return claiming a $16.4 million tax deduction for the easement.

Under IRC §170(h)(5)(A) a conservation easement deduction will not be allowed unless the conservation purpose is “protected in perpetuity.”  Reg. §1.170A-14(g)(2) provides the following requirements for a property subject to a mortgage to have an easement transferred that is protected in perpetuity:

… no deduction will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity.

Both the Ninth Circuit (in the case Minnick v. Commissioner, 796 F.3d 1156, 9th Circuit 2015) and the Tenth Circuit (in the case of Mitchell v. Commissioner, 775 F.3d 1243, 10th Circuit 2015) held that a subordination that took place after the date of the contribution was not sufficient to meet the “in pertuity” requirement, requiring a complete denial of the deduction.  Both Courts noted that the plain language of the regulations requires the subordination take place at the same time or before the transfer.

The taxpayer in this case argues that such a holding is in error, since it argued:

RP Golf claims this is a technicality that posed no threat to the easement. It invokes the next provision, § 1.170-14(g)(3):

A deduction shall not be disallowed . . . merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible.

However, the Eighth Circuit panel accepted the view of the Tenth Circuit in Mitchell noting:

Mitchell rejected this argument: “[T]he remote future provision cannot reasonably be read as modifying the strict mortgage subordination requirement.” Mitchell, 775 F.3d at 1254. Instead, it held that the subordination requirement “is evidence that in promulgating the rules, the Commissioner specifically considered the risk of mortgage foreclosure to be neither remote nor negligible, and therefore chose to target the accompanying risk of extinguishment of the conservation easement by strictly requiring mortgage subordination.” Id. at 1253. See Comm’r v. Nat’l Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148 (1974) (“The propriety of a deduction does not turn upon general equitable considerations. . . . Rather, it depends upon upon legislative grace; and only as there is clear provision therefore can any particular deduction be allowed.” (internal quotation omitted)).

The regulations “do not permit a charitable contribution deduction unless any existing mortgage on the donated property has been subordinated, irrespective of the likelihood of foreclosure.” See Mitchell, 775 F.3d at 1255. In order to take the qualified conservation contribution deduction, Hillcrest and Great Southern must have subordinated their mortgages to PLT’s interest before RP Golf conveyed the easement in December 2003.

The panel also did not find the Tax Court had arrived a “clearly erroneous” conclusion in determining that the taxpayer had not presented sufficient testimony or evidence of an alleged oral agreement that the taxpayer alleged they had with the lenders.