On November 23, 2021, the Tax Court issued a Memorandum Opinion in the case of 901 South Broadway Limited Partnership v. Commissioner (T.C. Memo. 2021-132). The primary issue presented in 901 South Broadway Limited Partnership was whether a partnership’s gift to a qualified organization satisfied the requirement of IRC § 170(h)(5)(A) that the gift’s conservation purposes must be protected in perpetuity.
Held: DO NOT GET CREATIVE WITH CONSERVATION EASEMENTS!!!
Background to 901 South Broadway Limited Partnership v. Commissioner
The petitioner, 901 South Broadway Limited Partnership, contributed a facade easement on a building at 901 South Broadway Avenue, Los Angeles, California to the Los Angeles Conservancy. When the petitioner granted the easement to the Conservancy, the underlying property was subject to five deeds of trust securing loans made to the partnership.
The lenders to which the petitioner was indebted (and for which loans the building served as collateral) were the beneficiaries of deeds of trust encumbering the building, and the Tax Court found in a pre-trial order that the petitioner failed to show that the lenders had subordinated their rights in the property to the Conservancy’s right to enforce the gift’s conservation purposes, as required by Treas. Reg. § 1.170A-14(g)(2).
Summary of Opinion in 901 South Broadway Limited Partnership v. Commissioner
The Tax Court concluded that, because (1) the deeds of trust encumbering the building provide the lenders with a priority right to use the proceeds of insurance or condemnation, in specified circumstances, to satisfy the indebtedness secured by the deeds of trust, and (2) the lenders did not subordinate those priority rights to the right of the Conservancy to enforce in perpetuity the conservation purposes of the partnership’s gift of the easement, that gift was not deductible under IRC § 170.
Applicable Law on Conservation Easements
IRC § 170(a)(1) allows a deduction for “any charitable contribution payment of which is made within the taxable year.” In turn, IRC § 170(c) defines the term “charitable contribution” to mean “a contribution or gift to or for the use of” a specified organization.
As a general rule, a taxpayer is not allowed a deduction for a contribution of part of the taxpayer’s interest in property. That general rule does not apply, however, to “a qualified conservation contribution.”
IRC § 170(h)(1) defines “qualified conservation contribution” to mean “a contribution–(A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes.” The term “qualified real property interest” includes “a restriction (granted in perpetuity) on the use which may be made of…real property.” Under IRC § 170(h)(5)(A), the contribution of a qualified real property interest will not be treated as having been made exclusively for conservation purposes “unless the conservation purpose is protected in perpetuity.”
When property covered by a conservation easement is subject to one or more mortgages, satisfaction of IRC § 170(h)(5)(A) requires that the mortgagees’ rights in the property be subordinated to those of the donee. Treas. Reg. § 1.170A-14(g)(2) provides:
No deduction will be permitted under this section for an interest in property 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.
Treas. Reg. § 1.170A-14(g)(3) provides:
A deduction shall not be disallowed under IRC § 170(f)(3)(B)(iii) and this section 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.
Treas. Reg. § 1.170A-14(g)(6)(i) acknowledges the possibility that an “unexpected change in the conditions” can render “impossible or impractical” the continued fulfillment of the purposes of the gift of a conservation easement. The prospect of those circumstances’ arising does not require denial of a deduction for the gift as long as two conditions are met.
First, the easement must be “extinguished by judicial proceeding.”
Second, the donee must receive a share of the proceeds specified in Treas. Reg. § 1.170A-14(g)(6)(ii) and use those proceeds “in a manner consistent with the conservation purposes of the original contribution.”
Treas. Reg. § 1.170A-14(g)(6)(ii) provides:
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…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…
When a change in conditions gives rise to the extinguishment of a perpetual conservation restriction…the donee organization…must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction…
In Palmolive Bldg. Inv’rs, LLC v. Commissioner, 149 T.C. 380, 394-395 (2017), the Tax Court addressed a charitable contribution deduction claimed for a façade easement created by a deed that provided that each holder of a mortgage on the subject property “shall have a prior claim to insurance and condemnation proceeds and shall be entitled to same in preference to Grantee until the mortgage is paid off…” The IRS argued that the deed in issue did not satisfy the requirement of Treas. Reg. § 170(h)(5)(A).
In particular, the IRS argued that a lender’s priority right to insurance or condemnation proceeds rendered the subordinations of the mortgagees insufficient to satisfy Treas. Reg. § 1.170A-14(g)(2). The Tax Court agreed, because the easement donee is not assured in perpetuity of its right to insurance or condemnation proceeds. Instead, the donee was given a “contingent prospect of receiving proceeds” only if the eventual value of the property permits it or if the mortgagee agrees “to suffer loss, to forfeit the repayment of its loan, and to gratuitously let the donee move to the front of the line.”
The petitioner was directed to show cause why the Tax Court should not enter decision in the case in the IRS’s favor on the ground that the mortgages on the building were not subordinated as required by Treas. Reg. § 1.170A-14(g)(2). In its two responses to the show cause order, the petitioner did not show adequate cause to prevent the Tax Court from making the show cause order absolute.
The petitioner has not established that resolution of the legal issue of the adequacy of the mortgages’ subordination turns on a genuine question of material fact. Therefore, the Tax Court saw “no need for conducting a trial of the case.” Further, the petitioner failed to convince the Tax Court that, as a matter of law, the mortgages were adequately subordinated.
Therefore, the Tax Court concluded that
the deeds of trust provide the Lenders with a priority right to use the proceeds of insurance or condemnation, in specified circumstances, to satisfy the indebtedness secured by the deeds of trust, and
the Lenders did not subordinate those priority rights to the right of the Conservancy to enforce in perpetuity the conservation purposes of the partnership’s gift of the easement.
Thus, the gift cannot be treated as having been made exclusively for conservation purposes. Because the gift was not exclusively for conservation purposes, it was not a “qualified conservation contribution”, within the meaning of IRC § 170(h)(1).
The partnership, having contributed a partial interest in property not covered by an exception provided in IRC § 170(f)(3)(B), is not entitled to a deduction for the gift under IRC § 170. Consequently, the Tax Court entered the decision in the IRS’s favor.
- See IRC § 170(f)(3). ↑
- IRC § 170(f)(3)(B)(iii). ↑
- IRC § 170(h)(2)(C). ↑
- Id. at 393. ↑
- Id. at 404-05. ↑
- IRC § 170(h)(5)(A); Treas. Reg. § 1.170A-14(g)(2). ↑
- IRC § 170(f)(3)(A). ↑
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