The memorandum opinion in Paul-Adams Quarry Trust, LLC, Francis L. Adams, Tax Matters Partner, v. Commissioner Of Internal Revenue, T.C. Memo. 2025-112, addresses the proper valuation of a qualified conservation contribution under Internal Revenue Code (I.R.C.) § 170(h), specifically focusing on whether the highest and best use of the property supported the substantial charitable deduction claimed, and whether accuracy-related penalties applied.

Facts of the Case

The petitioner is Francis L. Adams (P), the tax matters partner of Paul-Adams Quarry Trust, LLC (Paul-Adams or LLC). In 2007, P and his partner, Robert Elliot Paul, Sr. (Mr. Paul), purchased a 207.32-acre property in Elbert County, Georgia, for $429,875 (approximately $2,073 per acre). Both Adams and Paul were seasoned businessmen with extensive experience in the granite dimension stone industry.

Beginning in late 2010, they attempted to quarry granite dimension stone on the property. This operation experienced significant losses, totaling $358,794, and was abandoned in 2012, despite Mr. Adams actively searching for granite supply for his separate fabrication business at that time. The property was eventually contributed to the LLC.

In December 2017, Paul-Adams granted a conservation easement (a "qualified real property interest" under I.R.C. § 170(h)(1)(A)) over the property to Oconee River Land Trust (Oconee Trust or C), a "qualified organization". The LLC claimed a charitable contribution deduction of $10,234,108 (about $49,364 per acre) for the easement. This value was supported by an appraisal concluding that the property’s highest and best use was granite mining, valuing the property before the easement at $10,545,088 and after the easement at $310,980.

Taxpayer’s Request for Relief and Commissioner’s Position

The Commissioner of Internal Revenue (R) issued a Notice of Final Partnership Administrative Adjustment (FPAA) denying the deduction in full and determining a 40% accuracy-related penalty under I.R.C. § 6662(h), or alternatively, a 20% penalty under I.R.C. § 6662(a).

P challenged these adjustments, maintaining that R bore the burden of proof. P contended that the appraisal was a qualified appraisal and that the valuation was accurate based on the property’s highest and best use as an active granite mine. P also argued that no penalties should apply, or, if the gross valuation misstatement penalty was applicable, that I.R.C. § 6662(h) was unconstitutionally void for vagueness.

R maintained that the highest and best use was not an active granite mine. R argued that if any deduction was allowed, it should be limited to $612,000, based on R’s expert valuation.

Analysis of the Burden of Proof and Substantiation

Burden of Proof: The Court held that P bore the burden of proof, noting that I.R.C. § 7491(c) (which places the burden of production on the Commissioner regarding penalties for individuals) does not apply in this TEFRA partnership-level proceeding. The Court was ultimately able to decide the issues based on the preponderance of the evidence.

Substantiation (Qualified Appraisal): I.R.C. § 170(f)(11)(D) requires a "qualified appraisal" for charitable contributions valued over $500,000, a requirement applied at the partnership level pursuant to I.R.C. § 170(f)(11)(G). R challenged Mr. Fletcher’s status as a qualified appraiser under the "knowledge regulation," Treas. Reg. § 1.170A-13(c)(5)(ii), asserting that P had knowledge of facts that would cause a reasonable person to expect the appraiser to "falsely to overstate the value".

The Court noted the evidence raising "eyebrows," including Mr. Adams’ participation in prior syndicated easement transactions and the discovery of a discounted cash flow model spreadsheet authored by P’s facilitator (Mr. Walstad) in the appraiser’s work file. However, the Court determined that the record did not establish P had the requisite knowledge leading to the expectation of a falsely overstated value, which is required by the regulation (Treas. Reg. § 1.170A-13(c)(5)(ii)). The Court held that the appraisal attached to the return was a qualified appraisal prepared by a qualified appraiser.

Legal Framework for Valuation

The charitable contribution deduction is generally limited to the fair market value (FMV) of the property at the time of donation (Treas. Reg. § 1.170A-1(c)(1)). FMV is defined as the price a willing buyer and willing seller would agree upon, neither being compelled and both having reasonable knowledge of relevant facts (Treas. Reg. § 1.170A-1(c)(2)).

Since comparable easement sales were not available, the FMV of the easement was calculated using the "before-and-after" valuation method. This calculation requires determining the property’s value based on its highest and best use before and after the easement was granted (Treas. Reg. § 1.170A-14(h)(3)(ii)). The highest and best use must be physically possible, legally permissible, and financially feasible, focusing on the use "likely to be needed in the reasonably near future". Valuation elements dependent on events "not fairly shown to be reasonably probable" must be excluded as they constitute "mere speculation and conjecture" (Olson v. United States, 292 U.S. 246, 257 (1934)).

Determining Highest and Best Use

Petitioner’s Proposed Use: P argued for an active granite dimension stone quarry.

Court’s Analysis: The Court noted that the actual use of the property in December 2017 was vacant, with the pit inactive for five years. The default presumption is that current use is the highest and best use unless rebutted by proving a different use is reasonably probable in the near future.

Actions of the Partners: The previous abandonment of quarrying efforts by Mr. Adams and Mr. Paul (experienced quarrymen) after incurring $358,794 in losses strongly suggested that the operation was not profitable. This historical evidence contradicts the feasibility of an active quarry use.
Expert Economic Analysis: The Court found the discounted cash flow analyses provided by P’s experts (Mr. Fletcher and Mr. Proctor) "unrealistic, unreliable, and unhelpful".
- Unrealistic Volume/Market Share: Experts projected production volumes that would capture between 10% and 22% of Georgia’s total dimension stone market in the early years of operation. This defies credibility, especially given market conditions that were "relatively flat" leading up to 2017.
- Contradiction by Comparable Property: The projections were dramatically inconsistent with the actual production achieved by the superior Sterling Gray Quarry, which Mr. Adams leased and purchased (Sale 2).
- Geologic Uncertainty: P’s geologic experts (Dr. Schroeder and Mr. Black) did not establish sufficient confidence in the quality or quantity of the dimension stone to meet the standards defined by the SME Guide for 2017, confirming the need for extensive additional drilling and testing. None established that mining was economically viable.

Court’s Conclusion on Highest and Best Use (Before): The Court concluded that the proposed active quarry use was "too speculative and risky" to be the highest and best use. The highest and best use was determined to be for potential mining following more extensive drilling/testing, the creation of a mine plan, and completion of a market feasibility study.

Highest and Best Use (After): The Court agreed that the highest and best use after the easement was granted was for passive use and recreation.

Application of Valuation Principles

Valuation Before the Easement: The Court relied on the comparable sales approach provided by R’s expert, Mr. Sheppard, as this method is generally the most reliable for vacant, unimproved property, even when mineral extraction potential exists.

Mr. Sheppard’s analysis utilized four comparable sales of industrial-zoned properties in the Elberton granite area between 2018 and 2019, including the sale of the Sterling Gray Quarry (Sale 2). The Court upheld the use of post-easement sales because R established that no material intervening events had drastically changed market value since 2017.

Sale 2 (Sterling Gray Quarry): This comparable was found particularly instructive, as Mr. Adams exercised the purchase option for the 205.473-acre property for $1,292,367 ($6,290 per acre). The Court found this reflected an arm’s-length transaction, despite P’s challenge that it resulted from an option price. The historical success and exposed high-quality granite at Sterling Gray made it a superior property to Paul-Adams.
FMV Before: Based on the comparable sales, Mr. Sheppard selected a per-acre value of $4,750, resulting in a rounded "before" value of $985,000. This conclusion was reinforced by the property’s own prior sales history.

Rejection of Income Approach: Both Mr. Fletcher’s (owner-operator) and Mr. Proctor’s (owner-operator and royalty) discounted cashflow analyses were rejected because they were based on the faulty premise of an active quarry as the highest and best use. Furthermore, they were inherently speculative due to the lack of historical operational track record and reliance on exaggerated and unrealistic assumptions regarding demand, pricing, and efficiency. For instance, Mr. Proctor’s royalty method assumed an upstart mine could secure a minimum royalty ($5,349,000 NPV) far exceeding the terms Mr. Adams negotiated for the superior Sterling Gray Quarry lease ($36,000 minimum annual payment, resulting in a much lower NPV if properly modeled).

Valuation After the Easement: The Court adopted Mr. Sheppard’s comparable sales analysis for the property after the easement, which determined a value of $1,800 per acre, leading to an "after" value of $373,000.

Conclusion on Value and Penalties

Valuation Conclusion: The Court concluded that the value of the conservation easement was the difference between the determined before value and the determined after value, agreeing with the Commissioner’s expert: $985,000 (Before) − $373,000 (After) = $612,000.

Penalties: The claimed value of $10,234,108 exceeded 200% of the correct value ($1,224,000). Therefore, the valuation constituted a gross valuation misstatement under I.R.C. § 6662(h)(2)(A)(i).

The 40% gross valuation misstatement penalty applies. The reasonable cause defense available under I.R.C. § 6664(c)(1) is statutorily unavailable for a gross valuation misstatement regarding charitable contribution property (I.R.C. § 6664(c)(3)).

Finally, the Court rejected P’s constitutional challenge, holding that the penalty statute (I.R.C. § 6662(h)) is not void for vagueness, as a person of ordinary intelligence has fair notice of the prohibition (value claimed must not be 200% or more of the correct amount).

In summary, the Court determined that the taxpayer’s claimed deduction, which hinged on an unrealistic assumption of highest and best use as an active granite mine, had "no basis in reality". This discrepancy resulted in a gross valuation misstatement, leading to the application of the 40% penalty.

Analogy: Determining the value of raw land with potential minerals is like appraising an unfinished novel—while the author (taxpayer) believes the book holds immense value based on its projected sales as a global bestseller (active quarry use), a careful editor (the Court) must value the work based on its current market reality, acknowledging that an unproven manuscript (potential mining requiring further study) sells for much less than a commercially proven success. The difference between the dream valuation and the market reality triggered the penalty.

Prepared with assistance from NotebookLM.