Long-Term Lessee Not Able to Claim Deduction for Donation of Qualified Conservation Easement

In the case of Harbor Lofts Associates et al. v. Commissioner, 151 TC No. 3 the Tax Court ruled that a long term lease holder did not hold a qualified real property interest which could qualify for a deduction for the donation of a conservation easement.

The taxpayer in this case had entered into a 61-year lease for buildings owned by a nonprofit development corporation (Economic Development Corporation).  The opinion describes the lease as follows:

Under the terms of the lease Harbor Lofts took on many of the rights and obligations often associated with property ownership. It is required to pay all insurance and utility costs and can use the buildings “for multi-family residential uses and such uses as may be incidental there to, and for no other purpose or purposes whatsoever without the prior written consent of” the Economic Development Corp. Harbor Lofts has a right of first refusal to purchase the buildings and is entitled to a portion of the proceeds if the land is taken under eminent domain.

The lease requires Harbor Lofts to keep and maintain the buildings at its own expense and allows it “to construct on any part or all of the Leased Premises such improvements, alterations and additions * * * as the Lessee may from time to time desire, provided that such do not materially impair the structural integrity of the buildings.” Its right to alter the buildings is not unfettered. Alterations over $100,000 must be approved by the Economic Development Corp. although approval may not unreasonably be withheld.2

Soon after the lease was executed, the buildings went through a historic restoration and were converted into multifamily residential apartment buildings. Harbor Lofts leases the apartments under a combination of Federal housing assistance programs and Massachusetts interest subsidy programs. Since the work was completed in the early 1980s, both buildings have been listed on the National Register of Historic Places.

In 2009, the taxpayer and EDC under the following actions that lead to the claim of a deduction for donation of a conservation easement on Harbor Lofts’ return:

On December 21, 2009, Harbor Lofts and the Economic Development Corp. entered into a preservation restriction agreement with Essex National Heritage Commission, Inc. (Heritage Commission), a Massachusetts nonprofit corporation.3 The Heritage Commission is a qualified organization under section 170(h)(3) and is chartered to “preserve and promote for the benefit of the public the historic, cultural, and natural resources of the North Shore in Essex County, Massachusetts * * * which purposes include the preservation of historically important properties”. Harbor Lofts (the buildings' lessee) joined together with the Economic Development Corp. (the buildings' fee simple owner) to grant a facade easement to the Heritage Commission to preserve the buildings' exterior. Pursuant to the facade easement Harbor Lofts and the Economic Development Corp. are responsible for all repairs and must maintain the buildings' facade “in the condition and appearance existing on the Effective Date of this grant as documented in photographs and written descriptions”.

On December 29, 2009, the same day the facade easement was recorded, Harbor Lofts and the Economic Development Corp. amended the lease by extending its term until December 31, 2056. Along with extending the term of the lease Harbor Lofts and the Economic Development Corp. revised the rent payment schedule; in conjunction with these amendments, Harbor Lofts paid $4,500,000 to the Economic Development Corp.

Generally, a taxpayer is not allowed to claim a deduction for a contribution of a partial interest in an asset.  However, an exception is found at IRC §170(h) for a qualified conservation contribution.  So long as certain conditions are met, a deduction may be claimed for “a restriction (granted in perpetuity) on the use which may be made of the real property[1]” that meets the conservation purposes found in this section.

The IRS did not question that the donation in question that the donation was to a qualified organization[2] and was exclusively for conservation purposes.[3]  Rather, the IRS argued that the contribution failed to meet the requirement to be a qualified real property interest[4] as the lessee held only a time limited contract right that, by definition, did not allow them to grant a restriction in perpetuity.

All parties agreed that EDC is the fee owner of the property under the relevant state law (Massachusetts) and that Harbor Lofts did not hold a fee interest. There also was no dispute that Harbor Loft had given up something of value, “the rights to make improvements, alterations, and additions to the buildings.”

But the Tax Court finds that what Harbor Lofts gave up could not meet the requirements for a conservation easement deduction.  The opinion provides:

Harbor Lofts argues that section 170(h) does not explicitly require fee ownership of real property. But Harbor Lofts, having a leasehold interest for a term of years, is incapable of granting a perpetual restriction on the use of the buildings. Harbor Lofts does not hold a fee interest and cannot grant, through the use of an easement or other State law instrument, a perpetual restriction on the buildings. Harbor Lofts does not hold perpetual property rights in the buildings, so it is not possible for it to contribute a perpetual restriction on the use of the buildings. Harbor Lofts is correct that the Code does not specifically require a donor to hold a fee interest, but only the owner of real property or holder of a fee interest is able to grant a perpetual conservation restriction.

…Harbor Lofts gave up contractual rights under the lease agreement, which are personal property rights. And a charitable contribution of a personal property right is not a qualified real property interest under section 170(h)(2)(C).

Additionally, the Court did not accept Harbor Lofts view that, because the EDC also entered into the façade restriction as well, that they had made a contribution similar to that made by tenants in common.

Harbor Lofts argues that by granting the facade easement jointly with the Economic Development Corp. that it has made a contribution under section 170(h) similar to one made by tenants in common. But Harbor Lofts at no point held a fee interest in the properties; it was not a tenant in common with the Economic Development Corp. The limited duration of a lease is far different from fee ownership as tenants in common.

The Court also found that the long-term lease did not make Harbor Lofts the equitable owner of the real property eligible to claim the deduction:

Although Harbor Lofts took on many of the rights and obligations often associated with property ownership, its possession of these rights and obligations is of a finite duration ending on the lease's expiration. Section 170(h)(2)(C) specifically sets forth a perpetuity requirement for a facade easement. Even if we were to find that Harbor Lofts holds equitable ownership in the buildings, it is equitable ownership for only a finite period and cannot satisfy the perpetuity requirements of section 170(h)(2)(C). See, e.g., Wachter v. Commissioner, 142 T.C. 140, 149 n.3 (2014).

And, as the Court notes, the time limit on Harbor Loft’s rights is fatal in a situation where the rights must be perpetual:

Section 170(h)(5) defines a contribution made “exclusively for conservation purposes” and states that a “contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.” As a time-limited lessee Harbor Lofts is incapable of making a contribution protected in perpetuity. Harbor Lofts as lessee does not have the power to impose perpetual restrictions on property in which it does not have an absolute right. It cannot give what it does not have. At most Harbor Lofts can create a restriction that runs through the term of the lease, which is not perpetual. The Economic Development Corp. on the other hand, as fee owner of the buildings, is capable of creating an easement or other State law restriction that runs with the buildings and can therefore protect the conservation purpose in perpetuity.


[1] IRC §170(h)(2)(C)

[2] IRC §170(h)(1)(B)

[3] IRC §170(h)(1)(C)

[4] IRC §170(h)(1)(A)