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Hewitt v. Commissioner (T.C. Memo. 2020-89)

On June 17, 2020, the Tax Court issued a Memorandum Opinion in the case of Hewitt v. Commissioner (T.C. Memo. 2020-89). The primary issue before the court in Hewitt was whether the petitioners are entitled to carryover of the charitable contribution deduction for the donation of a conservation easement, which, not unsurprisingly, depends on whether the conservation easement satisfies the perpetuity requirement in IRC § 170(h)(5) and accompanying Treasury Regulations.

Background

In 2012, the petitioner-husband (PH) granted a conservation easement over 257 acres of his family farm in Alabama. Prior to granting the easement, PH consulted with an accounting firm that PH believed was “well respected in the tax community” and possessed significant “experience with the donation of conservation easements.” PH also met with the CEO of a nature conservancy, which was a qualified organization under IRC § 170(h)(3).

The conservancy drafted the deed relying on published guidance from Land Trust Alliance, a national land trust organization. The accounting firm reviewed the deed and advised PH that it complied with the requirements of the Code and the accompanying regulations. Sadly, the deed suffered from the same infirmity as each of the conservation easements examined by the Tax Court in 2020.

The Damn Extinguishment Clause Strikes Again

The IRS took issue with the clause regarding the allocation of proceeds from an involuntary extinguishment. In particular, the clause provided that the easement will have “at the time of extinguishment” a fair market value “determined by multiplying the then fair market value of the property unencumbered by the Easement (minus any increase in value after the date of this grant attributable to improvements) by the ratio of the value of the easement at the time of this grant to the value of the property, without deduction for the value of the easement, at the time of this grant.” The clause also provided that the “ratio of the value of the Easement to the value of the Property unencumbered by the Easement shall remain constant.”

Basis. For Pete’s Sake, Include Basis.

The Petitioners attached Form 8283 (Noncash Charitable Contributions) to their 2012 return but did not report the basis in the easement property on the form. PH was advised by the accounting firm he could attach a statement to Form 8283 stating that basis information was not available and further advised PH that the deduction would not be disallowed on this basis. In reliance on the advice of the accounting firm, the petitioners attached a statement prepared by the accounting firm to Form 8283.

The statement noted that the taxpayer’s basis in the property is not included “because of the fact that the basis of the property remains to be determined with accuracy.” In addition, the statement (written by a supposedly “competent” accounting firm) contended that the easement’s basis is “not taken into consideration when computing the amount of the deduction.”

I don’t know what the northeast Alabama tax community is like, but if the accounting firm that prepared this statement is “well respected” within it, I have serious doubts about said “tax community.”

The “Qualified” Appraisal

Petitioners attached an appraisal of the easement prepared by an appraiser recommended by the very same boneheaded accounting firm that gave the petitioners such brilliant advice heretofore. PH, similarly, “understood” that the appraiser was “competent and experienced.” The appraiser, to his credit, used an accepted appraisal method (before and after valuation method less enhancement value).

For unknown reasons, perhaps he was otherwise occupied appraising a prize heifer, the appraiser did not testify at trial, and his appraisal was not received into evidence. For even more unknown reasons, perhaps pity (if the IRS is institutionally capable of such an emotion), the IRS stipulated that the appraisal was a qualified appraisal by a qualified appraiser.

If I had to guess, the IRS knew that they had PH by the short hairs on the perpetuity issue, and so they took the path of least resistance and just said, screw it, the valuation’s fine…

Notice of Deficiency and Trial “Experts”

The IRS issued a notice of deficiency for the petitioners’ 2013 and 2014 returns, disallowing the carryover deductions on the basis of a lack of substantiation. Interestingly, the IRS did not challenge the easement deduction (capped at $58,000 based on the petitioners’ gross income) when it was first claimed in 2012. The petitioners  presented only three “expert” witnesses at trial.

The first expert opined (and I swear that I am not making this up) that the highest and best use of the easement property was the development of a mobile home community. The second opined about the construction costs of the mobile home community. The third opined about the valuation of said mobile home community ($3.1m). The IRS presented one expert witness, who stated that the value of the easement property was $190,000. The IRS’s expert had no opinion about the mobile home community.

When the Term “Conservation Purposes” Means in Perpetuity

Whenever I read one of these conservation easement cases that hinges on satisfying “perpetuity,” I cannot help but think of the philosophical debate between Christopher Robin (the IRS) and Winnie the Pooh (the luckless taxpayer). “Forever and ever is a very long time, Pooh,” Christopher posits. Pooh, thinking about the language in the easement he’s just granted to Eeyore’s land trust, replies “Forever isn’t long at all.” Though Pooh’s heart, like the heart of many of the unfortunate petitioners in the long line of conservation easement cases to come out in 2020, is in the right place, he is dead ass wrong. Forever (pronounced For-Eh-Ver for anyone who grew up in the 1990s and watched The Sandlot a thousand times) is, by definition, a very long time indeed.

Generally, a taxpayer is not entitled to deduct the donation of “an interest in property which consists of less than the taxpayer’s entire interest in such property”. IRC § 170(f)(3)(A). A limited exception applies when the contribution is a “qualified conservation contribution” as defined in IRC § 170(f)(3)(B)(iii).

For the exception to apply, the interest donated must be of “qualified real property,” the donee must be a “qualified organization,” and the contribution must be made “exclusively for conservation purposes.” IRC § 170(h)(1). If the contribution fails to meet all three tests, it fails. Irby v. Commissioner, 139 T.C. 371, 379 (2012). Critically, a contribution is “exclusively for conservation purposes” only if its conservation purposes are protected for-eh-ver. See IRC § 170(h)(5)(A).

When For-Eh-Ver Unforeseeably Ends

Just as Hercules (the dog in The Sandlot, not the demigod son of Zeus and Alcmene) wasn’t actually locked up for-eh-ver, due to unforeseen future events, so too may a conservation easement be affected by a subsequent unexpected change in the conditions surrounding the property, which change would make the continued use of the property for conservation purposes “impossible or impractical.” Treas. Reg. § 1.170A-14(g)(6)(i).

The regulations are not nescient to this potentiality, so long as the easement is “extinguished by judicial proceeding” and the donee uses “all of the donee’s proceeds from a subsequent sale or exchange of the property” in a manner “consistent with the conservation purposes” of the original easement. Id. It is the “donee’s proceeds,” or share of the proceeds that the donee receives, that has tripped up all challengers so far in 2020.

The “proceeds regulation,” as the Tax Court denominates Treas. Reg. § 1.170A-14(g)(6)(ii), states in part that at the time of the gift the donor must agree that the easement donation gives rise to a property right, immediately vested in the donee, “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.”

Where the Deed in Hewitt Goes Wrong

The deed in the present case suffers from the same infirmity as the deed in Oakbrook Land Holdings, LLC v. Commissioner, T.C. Memo. 2020-54, did. The deed subtracts the value of post-easement improvements before determining the Conservancy’s share of the extinguishment proceeds and fails to allocate the extinguishment proceeds in accordance with the proceeds regulation. See Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 138-39 (2019); see also PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 208 (5th Cir. 2018). The proceeds regulation does not permit the value of post-easement improvements to be subtracted from the proceeds before determining the donee’s share. Coal Prop. Holdings, LLC, 153 T.C. at 138-39; Oakbrook Land Holdings, LLC, T.C. Memo. 2020-54, *40-*41.

Hands Bound as to Perpetuity, Not as to Penalties

The petitioners make valiant arguments, just as the taxpayer in Oakbrook Land Holdings, LLC had, but sadly they fell upon the ears of the Tax Court that had been plugged with wax by the IRS like Odysseus’ own ears when he passed the island of the Sirens. To be clear, the Tax Court is sympathetic, but their collective jurisprudential hands are bound.

As such, the Tax Court held that the easement does not protect the conservation purposes of the contribution “in perpetuity” as required by IRC § 170(h)(5) because the deed would not allocate to the donee a share of the proceeds in the event the property is sold following a judicial extinguishment of the easement, in violation of Treas. Reg. § 1.170A-14(g)(6)(ii).

Perhaps tipping their cap to the plight of the poor petitioners, the Tax Court eschews the IRS’s proposed gross valuation misstatement penalty of IRC § 6662(h)(2) by performing its own valuation of the easement, which value ($1.2m) was not grossly overstated by the petitioners. The Tax Court next rejects the IRC § 6662(a) and IRC § 6662(b)(1) accuracy related penalty on the basis of reasonable cause (not available to gross valuation misstatement penalties under IRC § 6664(c)(3)). See also Treas. Reg. § 1.6664-4(b)(1).

(T.C. Memo. 2020-89) Hewitt v. Commissioner

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