On February 5, 2020, the Tax Court issued a Memorandum Opinion in the case of Railroad Holdings LLC v. Commissioner (T.C. Memo. 2020-22). The issue presented in Railroad Holdings LLC v. Commissioner was whether the extinguishment provisions contained in the grant of a conservation easement violated IRC § 170(h)(5)(A).
Background to Railroad Holdings LLC v. Commissioner
The petitioner executed a conservation easement deed in favor of a charitable organization. The deed provided that, if the easement were ever extinguished and proceeds were to be allocated between the petitioner and the charitable organization, then the organization would be entitled to a portion of the proceeds at least equal to the fair market value of the conservation easement as of the date of the grant of the conservation easement, rather than being entitled to a proportionate share of the proceeds. The petitioner claimed a charitable contribution deduction for the contribution, and the IRS disallowed the deduction.
Deduction for Qualified Conservation Contribution
IRC § 170(a)(1) allows a deduction for any charitable contribution made within the taxable year. If the taxpayer makes a charitable contribution of property, other than cash, the amount of the contribution is generally equal to the fair market value of the property at the time the gift is made. See Treas. Reg. § 1.170A-1(c)(1). The Code restricts a taxpayer’s charitable contribution deduction for 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). However, there is an exception to this rule for a qualified conservation contribution. IRC § 170(f)(3)(B)(iii).
A qualified conservation contribution is defined as a contribution of a qualified real property interest to a qualified organization to be used exclusively for conservation purposes. IRC § 170(h)(1). Under IRC § 170(h)(2)(C), a qualified real property interest includes an interest in real property that is a restriction granted in perpetuity on the use of the real property. Critically, a contribution is not treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. IRC § 170(h)(5)(A).
Proceeds from Extinguishment – The Proportionality Requirement
Any interest in the property retained by the donor must be subject to legally enforceable restrictions that will prevent uses of the retained interest inconsistent with the conservation purpose of the donation. Treas. Reg. § 1.170A-14(g)(1). An easement may be extinguished, however, by a change in circumstances and judicial intervention, and in such an instance the easement would not have lasted in perpetuity. However, the Treasury Regulations provide that if an extinguishment does occur, the donation will nonetheless be deemed to have been in perpetuity if the proceeds of the extinguishment are paid to the donee organization and the donee uses them for its conservation purposes. Treas. Reg. § 1.170A-14(g)(6)(ii).
In order for a deduction to be allowed, at the time of the gift, the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right, immediately vested in the donee organization, 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. Id. Such proportionate value of the donee’s property rights must remain constant. Id. As such, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction. Id.
In Coal Property Holdings, LLC v. Commissioner, 153 T.C. No. 7 (Oct. 28, 2019), the Tax Court addressed the deductibility of a conservation contribution where the easement deed contained a proportionality formula strikingly similar (read, practically identical) to the formula contained in the easement deed in Railroad Holdings, LLC and found the proportionality formula violative of the “protected in perpetuity” clause of the Code and Treasury Regulations. See also Carroll v. Commissioner, 146 T.C. 196, 212 (2016).
Although the deed in the present case (as in Coal Property Holdings, LLC) incorporates the phrase “proportionate value” from the Treasury Regulation, the deed does not create a proportion or fraction that represents the donee’s share of the property right, and, as such, a corresponding fraction of proceeds to which the donee is perpetually entitled. See PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 205-206 (5th Cir. 2018).Add to favorites