On February 3, 2020, the Tax Court issued a Memorandum Opinion in the case of Carter v. Commissioner (T.C. Memo. 2020-20). The issues presented in Carter v. Commissioner were whether the restrictions contained in a conservation easement violated IRC § 170(h) and whether the IRS had satisfied the prior written supervisory approval requirement of IRC § 6751(b)(1).

Background to Carter v. Commissioner

The petitioners, through their partnership, conveyed an easement to NALT, a “qualified organization” within the meaning of IRC § 170(h)(3), which easement restricts the use of the covered property and generally prohibits the construction or occupancy of any dwellings. Petitioner’s partnership retained the right, however, to build single-family dwellings in specified “building areas,” the locations of which were to be determined, subject to NALT’s approval.

The partnership reported a charitable contribution deduction equal to the easement’s purported value, and the petitioners claimed deductions on their individual returns equal to their shares of the partnership’s deduction. Finding that the easement did not satisfy IRC § 170(h), the IRS asserted substantial (gross) valuation misstatement penalties pursuant to IRC § 6662(e) and IRC § 6662(h).

The Tax Court’s Holding

Because the restrictions applicable within the building areas permit uses that are antithetical to the easement’s conservation purposes, those restrictions are disregarded in determining whether the easement is included in the definition of “qualified real property interest” by reason of IRC § 170(h)(2)(C); consequently, the easement is not described in that section, and the petitioners are not entitled to charitable contribution deductions for the partnership’s conveyance to NALT of a partial interest in the underlying property. IRC § 170(f)(3); see also Pine Mountain Pres., LLLP v. Commissioner, 151 T.C. 247 (2018).

“Conservation Purposes” for Conservation Easement

IRC § 170(a)(1) allows a deduction for “any charitable contribution payment of which is made within the taxable year.” 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 a property. See IRC § 170(f)(3). That general rule does not apply, however, to “a qualified conservation contribution.” IRC § 170(f)(3)(B)(iii). IRC § 170(h)(1), in turn, defines “qualified conservation contribution” to mean (a) a contribution 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.” IRC § 170(h)(2)(C).

As pertinent here, IRC § 170(h)(4)(A) defines the term “conservation purpose” to mean (a) the preservation of land for recreational or educational uses by the general public, (b) “the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem,” (c) “the preservation of open space” that “will yield a significant public benefit,” or (d) “the preservation of an historically important land area or a certified historic structure.”

“Perpetual Restriction Requirement” for Conservation Easement

IRC § 170(h)(5)(A) provides that a contribution will not be treated as exclusively for conservation purposes, unless the conservation purpose is protected in perpetuity. Thus, as the Tax Court emphasized in Belk v. Commissioner, 140 T.C. 1, 12 (2013), aff’d, 774 F.3d 221 (4th Cir. 2014), IRC § 170(h) imposes two different perpetuity requirements. First, the use of the property in question must be restricted in perpetuity. Second, the conservation purposes must be protected in perpetuity.

A donor’s retention of limited development rights in specified portions of property covered by a conservation easement granted to a qualified organization is permitted under IRC § 170, but such retention is specifically circumscribed by the Code and Treasury Regulations. See, e.g., Butler v. Commissioner, T.C. Memo. 2012-72; see also Treas. Reg. § 1.170A-14(f), Ex. 4. The requirement that the donee approve the donor’s exercise of such development rights, for example, may provide assurance that any structures erected will not materially prejudice the achievement of the easement’s conservation purposes. Id.

Fixing the Boundaries of Development at the Time of the Grant

As Belk and its progeny establish, if the boundaries of the areas in which the easement allows development are not fixed at the outset, the donor’s retention of development rights can, and will, violate perpetual restriction requirement of IRC § 170(h)(2), even if the retention of rights does not violate the perpetual protection requirement of IRC § 170(h)(5). When the boundaries of the building areas are indeterminate at the time of the grant of the easement, the parcel of property that is subject to a perpetual use restriction is not considered to be “defined.” The Tax Court reasoned that, because the conservation easement permitted the donors to change what property was subject to the conservation easement, the use restriction was not granted in perpetuity. Belk, 140 T.C. at 10.

In response to the donor’s argument in Belk that the donee’s approval of any substitutions of property ensured that conservation purposes would be protected in perpetuity, the Tax Court held that the IRC § 170(h)(5) requirement (that the conservation purpose be protected in perpetuity) is separate and distinct from the IRC § 170(h)(2)(C) requirement (that there be real property subject to a use restriction in perpetuity).

Thus, satisfying IRC § 170(h)(5) does not necessarily affect whether there is a qualified real property interest under IRC § 170(h)(2)(C). The Tax Court notes that there is nothing to suggest that IRC § 170(h)(2)(C) should be read to mean that the restriction granted on the use which may be made of the real property does not need to be in perpetuity if the conservation purpose is protected.

Holding

So, this was a slam dunk for the IRS, right? No. The knuckleheads failed to obtain prior supervisory approval under IRC § 6751(b)(1) with respect to the gross valuation misstatement penalties under IRC § 6662(e) and IRC § 6662(h). Thus, the Tax Court’s hands were tied. Under IRC § 6751(b)(1), the Tax Court could not sustain the penalties, no matter how patently obvious and flagrant the violation was in reality. And it was pretty damn flagrant.

(T.C. Memo. 2020-21) Carter v. Commissioner

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