T.C. Memo. 2012-345
UNITED STATES TAX COURT
WALTER C. MINNICK AND A.K. LIENHART, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 29632-09. Filed December 17, 2012.
Tim Alan Tarter, for petitioners.
Anne Ward Durning and Michael R. Harrel, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: In 2006 Walter C. Minnick gave to charity a
conservation easement on his 74-acre parcel of land in the foothills near Boise,
Idaho. On their joint income-tax returns, Minnick and his wife, A.K. Lienhart,
claimed a charitable-contribution deduction of $389,517 for 2006 and carryover
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[*2] charitable-contribution deductions of $148,977 and $402,506, respectively, for
2007 and 2008. In a notice of deficiency for years 2007 and 2008, the IRS
disallowed the carryover deductions. The notice determined deficiencies in federal
income tax for 2007 and 2008 of $42,306.70 and $140,877, respectively, and 20%
accuracy-related penalties under section 6662(a), as increased to 40% under section
6662(h), of $16,922.10 and $56,350.80, respectively. The respondent is referred to
here as the IRS. The petitioners are referred to as Minnick and Lienhart. All
references to sections are to the Internal Revenue Code of 1986, as amended and in
effect at the relevant times.
FINDINGS OF FACT
Minnick and Lienhart resided in Idaho at the time they filed their petition.
On January 25, 2005, U.S. Bank recorded a mortgage on the 74-acre parcel
of land.
On September 5, 2006, the Board of Ada County Commissioners permitted
Minnick to subdivide the land into seven single-family residential lots.
On September 7, 2006, Minnick granted a conservation easement on the land
to the charitable organization Land Trust of Treasure Valley, Inc. (the “Land
Trust”). The terms of the easement prohibited Minnick and any subsequent owner
from building on or altering the portions of the land outside the areas designated
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[*3] as “building envelopes” for each lot. The portions of the land thus restricted by
the easement constituted 80% of the 74-acre parcel. The conservation easement
stated: “Grantor [i.e. Minnick] warrants that * * * [he] owns the Property in fee
simple and has conveyed it to no other person, and that there are no outstanding
mortgages, tax liens, encumbrances, or other interests in the Property that have not
been expressly subordinated to the Easement.” Contrary to this warranty provision,
U.S. Bank’s mortgage was not then subordinated to the conservation easement. The
conservation easement also provided that Minnick and the Land Trust could amend
the terms of the easement if circumstances arose under which an amendment would
be “appropriate”.
When Minnick and Lienhart filed their original 2006 income-tax return, they
did not claim a charitable-contribution deduction for the grant of the conservation
easement. Minnick had not yet received a written appraisal of the easement.
On or about December 26, 2007, Minnick and Lienhart filed an amended
income-tax return for 2006. On the amended return, they reported that the value of
the easement was $941,000. This value was taken from an appraisal by G. Joseph
Corlett, who had been hired by Minnick. The amended return reported that the
charitable-contribution deduction for the grant of the easement was limited to
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[*4] $389,517 for 2006. The amended return was prepared by Bruce Stratton, a
certified public accountant (C.P.A.). Both Stratton and Minnick intended that
Corlett’s appraisal be attached to the amended return for 2006, but for some reason
the amended return the IRS received did not have the appraisal attached to it.
Minnick never asked Stratton whether he was entitled to the $941,000 deduction,
and Stratton did not tell him that he was. Minnick had worked for a few months as
a lawyer near the beginning of his career, spending some time in tax law. He later
went into the building-supply business. Lienhart was uninvolved in determining
whether the conservation easement gave rise to a charitable-contribution deduction.
On their 2007 and 2008 returns Minnick and Lienhart claimed carryover
charitable-contribution deductions of $148,977 and $402,506, respectively, for the
2006 grant of the conservation easement.
The IRS issued the notice of deficiency on September 17, 2009. The reason
given by the notice of deficiency for disallowing the carryover deductions was lack
of documentation of the value of the contribution. The IRS no longer challenges the
deductions for lack of documentation.
On December 14, 2009, Minnick and Leinhart timely filed a petition with this
Court.
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[*5] On September 12, 2011, Minnick and U.S. Bank executed an agreement
under which U.S. Bank subordinated its mortgage to the conservation easement.
The effect of this subordination agreement is that the conservation easement will
remain in force if U.S. Bank becomes the owner of the land by foreclosure.
The IRS’s September 19, 2011 pretrial memorandum asserted that no
carryover charitable-contribution deductions should be allowed for the grant of the
conservation easement. It asserted the following reasons: (1) the grant of the
conservation easement was a condition of receiving permission from the county to
subdivide the land; (2) the conservation easement was not protected in perpetuity
because (a) the terms of the easement allowed Minnick and the Land Trust to amend
the easement by agreement, (b) U.S. Bank’s mortgage on the land was not
subordinated at the time of the grant, and (c) the easement failed to provide for the
allocation of proceeds to the Land Trust in the event the easement was extinguished;
(3) Minnick and Lienhart’s deduction for the contribution of the easement is limited
to the basis allocated to the easement; and (4) the easement was overvalued.
This case was tried in Boise, Idaho, on October 4, 2011. At trial, the IRS
moved to amend its answer. The Court took the motion under advisement. On
January 5, 2012, the Court granted the motion, allowing the IRS to amend its
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[*6] answer to assert that the claimed deductions are not permitted because the
requirements of section 170 and the corresponding regulations have not been
satisfied and because Minnick and Lienhart have not established that the value of
the easement was $941,000.
OPINION
1. Because U.S. Bank’s mortgage was not subordinated to the conservation
easement when it was granted, no deduction is permitted for the grant of the
conservation easement.
A contribution of a conservation easement is deductible only if the
requirements of 26 C.F.R. sec. 1.170A-14 are met. See sec. 170(f)(3)(A), (B)(iii);
26 C.F.R. sec. 1.170A-14(a) (2012). 26 C.F.R. sec. 1.170A-14(a) (2012) requires
that the easement be contributed to “a qualified organization exclusively for
conservation purposes.” 26 C.F.R. sec. 1.170A-14(g)(2) (2012) provides that “no
deduction will be permitted under this section [i.e., 26 C.F.R. sec. 1.170A-14
(2012)] for an interest in property which is 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.”
Because U.S. Bank had a mortgage on Minnick’s land that was not subordinated to
the conservation easement when the easement was granted, the IRS contends
Minnick and Lienhart cannot deduct the value of the conservation easement
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[*7] granted to the Land Trust. This contention about the mortgage was not raised
by the IRS in the notice of deficiency; it was raised in the amended answer, and
therefore the IRS has the burden of proof regarding all factual issues underlying the
contention. See Tax Ct. R. Pract. & Proc. 142(a)(1).
Minnick and Lienhart argue that the September 2011 subordination agreement
with U.S. Bank satisfies the subordination requirement in the regulation. The
argument is unavailing. In Mitchell v. Commissioner, 138 T.C. 324, 332 (2012), we
held that a subordination agreement must be in place at the time that the
conservation easement is granted.
Minnick and Lienhart argue that Mitchell is distinguishable because the
warranty provision in the easement demonstrates that Minnick intended that the
mortgage be subordinated at the time he granted the conservation easement. They
also contend that U.S. Bank would have been willing to freely subordinate its
mortgage at the time the conservation easement was granted. We are not persuaded
by these attempts to distinguish Mitchell. Intention and willingness are not what
matters. The regulation required a subordination agreement. Without a
subordination agreement, U.S. Bank would have been able to seize the land in the
event of default on the mortgage, thus owning the land free of the conservation
easement. See id. at 332. For the sake of completeness, we add that we do not
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[*8] agree with Minnick and Leinhart that the warranty provision demonstrates that
Minnick intended that the mortgage be subordinated when he granted the
conservation easement. The warranty provision means only that Minnick falsely--
although we think unintentionally--represented to the Land Trust that the U.S. Bank
mortgage had been subordinated to the conservation easement at the time he granted
the easement. We also cannot agree with Minnick and Lienhart that U.S. Bank
would have been willing to agree to freely subordinate its mortgage in 2006. There
are two reasons we do not make such a finding. First, Minnick and Lienhart failed
to propose this as a finding of fact in their opening brief, as required by our rules of
procedure. Tax Ct. R. Pract. & Proc. 151(e)(3). Second, the idea that U.S. Bank
would have subordinated its mortgage in 2006 is contradicted by the record. A loan
manager at U.S. Bank testified that shortly before trial Minnick asked him to sign a
letter stating that U.S. Bank would have been willing to agree to subordinate its
mortgage to the conservation easement in 2006 had it known about the conservation
easement. The loan manager refused to sign such a statement and he did not make
the statement under oath when he testified. Furthermore, the bank required
Minnick to pay down a portion of the loan as consideration for the bank signing
the subordination agreement in 2011. Thus, the bank did not freely
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[*9] subordinate its mortgage in 2011. This suggests that it would not have freely
subordinated its mortgage in 2006.
Minnick and Lienhart argue that Mitchell is inapposite because it did not
consider the effect of the Uniform Conservation Easement Act (“Act”), Idaho Code
Ann. secs. 55-2101 to 55-2109 (2012). They contend that the Act imposes the
doctrine of cy pres on all conservation easements in Idaho and that the cy pres
doctrine has the effect of subordinating the U.S. Bank mortgage to the
conservation easement.1 The Act does not support this theory. The Act allows
1
The operation of the cy pres doctrine has been summarized as follows:
If property is given in trust to be applied to a particular charitable
purpose, and it is or becomes impossible or impracticable or illegal to
carry out the particular purpose, and if the settlor manifested a more
general intention to devote the property to charitable purposes, the trust
will not fail but the court will direct the application of the property to
some charitable purpose which falls within the general charitable
intention of the settlor.
Restatement, Trusts 2d, sec. 399 (1959). The operation of the cy pres doctrine can
be illustrated by the following example. A person bequeathed property in trust to
establish a hospital in a particular town. Before the hospital could be built, a similar
hospital was established in the same town. No useful purpose would be
accomplished by having two hospitals. Cy pres would require a court to direct the
trust funds to some other way of assisting the town’s sick--if the person who made
the bequest had a general intent to provide for the town’s sick. Id. cmt. k.
Thus, the cy pres doctrine allows the property owned by a trust to be directed
to a use different from that directed by the instrument that established the trust. The
(continued...)
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[*10] actions regarding conservation easements to be brought in court. Idaho Code
Ann. sec. 55-2103 (“An action affecting a conservation easement may be brought”.)
But once an action was brought, U.S. Bank’s mortgage would have been protected,
for Idaho Code Ann. sec. 55-2102(4)--part of the Act--provides: “An interest in real
property in existence at the time a conservation easement is created is not impaired
by it unless the owner of the interest is a party to the conservation easement or
consents to it.” U.S. Bank’s mortgage on Minnick’s land is an “interest in real
property” that was “in existence at the time” Minnick created the conservation
easement. See, e.g., Suchan v. Suchan, 741 P.2d 1289, 1298 (Idaho 1986) (a
mortgage interest can exist in real property capable of being transferred). U.S. Bank
was not a party to the conservation easement when it was created, and it did not
consent to the easement. Therefore, under Idaho Code Ann. sec. 55-2102(4), the
mortgage was not impaired by the 2006 conservation easement.
Minnick and Lienhart also contend that there was only a remote possibility
that Minnick would default on the U.S. Bank loan. But we held in Mitchell v.
1
(...continued)
doctrine does not expand the property interests owned by the trust. Thus, it is
difficult to see how the cy pres doctrine, if it somehow governed the easement on
Minnick’s land, would defeat U.S. Bank’s mortgage on the same land.
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[*11] Commissioner, 138 T.C. at 333, 337, that the likelihood of default is
irrelevant. Further, the factual allegation that there was only a remote possibility
that Minnick would default on the U.S. Bank loan was not set forth in Minnick and
Lienhart’s proposed findings of fact. We do not make a finding that the allegation is
correct. See Tax Ct. R. Pract. & Proc. 151(e)(3).
The value of the conservation easement is not deductible as a charitable
contribution because Minnick and Lienhart failed to meet the subordination
requirement set forth in the regulation. We therefore need not reach the IRS’s
alternative arguments for denying the deduction, i.e. that the easement did not serve
conservation purposes, that the conservation easement was not protected in
perpetuity because it could be amended by agreement of Minnick and the Land
Trust, that the Land Trust would not receive a proportionate share of the proceeds if
the easement was extinguished, and that any charitable deduction is limited to the
amount of basis of the land allocated to the easement.
2. Minnick and Lienhart are liable for penalties.
Section 6662 imposes an accuracy-related penalty if any part of an
underpayment of tax required to be shown on a return is due to, among other
things, negligence or disregard of rules or regulations (hereinafter referred to,
without distinction, as “negligence”), a substantial understatement of income tax,
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[*12] or a substantial valuation misstatement. Sec. 6662(a) and (b)(1), (2), and (3).
The penalty is 20% of the portion of the underpayment of tax to which the section
applies. Sec. 6662(a). In the case of a gross valuation misstatement, section
6662(h) increases the penalty to 40%.
Section 6664(c) provides a reasonable-cause exception to the accuracy-
related penalty. Generally, under section 6664(c)(1), no penalty is imposed under
section 6662 with respect to any portion of an underpayment if it is shown that there
was reasonable cause for such portion and that the taxpayer acted in good faith with
respect to such portion. In determining whether such a showing has been made,
“the most important factor is the extent of the taxpayer’s effort to assess the
taxpayer’s proper tax liability.” 26 C.F.R. sec. 1.6664-4(b)(1) (2012). Reliance on
a professional tax-return preparer or an appraiser can constitute reasonable cause
and good faith “if, under all the circumstances, such reliance was reasonable and the
taxpayer acted in good faith.” Id.
Under section 7491(c), the IRS bears the burden of production with regard to
penalties and must come forward with sufficient evidence indicating that it is proper
to impose penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
However, once the IRS has met the burden of production, the burden of proof
remains with the taxpayer, including the burden of proving that the penalties are
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[*13] inappropriate because of reasonable cause. Id. at 446-447. Minnick and
Lienhart argue that the IRS has the burden of proof with respect to the subordination
requirement to the extent it relates to penalties. The IRS does not take a position
on which party has the burden of proof. We base our findings regarding penalties
on the preponderance of the evidence. Therefore, we need not determine which
party has the burden of proof.
The IRS had initially determined that, on account of its disallowance of
Minnick and Lienhart’s carryover charitable-contribution deductions for the grant
of the conservation easement to the Land Trust, they underpaid the tax required to
be shown on their 2007 and 2008 returns and were (1) liable for the accuracy-
related penalty on one or more of three grounds (negligence, substantial
understatement of income tax, or substantial valuation misstatement), and (2)
liable for the section-6662(h) increase in the penalty from 20% to 40% for a gross
valuation misstatement. This determination was reflected in the notice of
deficiency. The IRS now concedes that “if petitioners’ claimed deduction fails to
satisfy the legal requirements of I.R.C. § 170 or the Regulations thereunder, or both,
respondent concedes that neither of these [substantial valuation misstatement or
gross valuation misstatement] penalties would apply.” As we hold here, the
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[*14] deductions fail to satisfy the subordination requirement; this means that the
IRS does not assert that the substantial valuation misstatement and gross valuation
misstatement components of the accuracy-related penalty apply.
Negligence, for section-6662 purposes, is the lack of due care or the failure to
do what a reasonably prudent person would do under like circumstances. Hofstetter
v. Commissioner, 98 T.C. 695, 704 (1992). Negligence includes failing “to make a
reasonable attempt to comply with the provisions of the internal revenue laws or to
exercise ordinary and reasonable care in the preparation of a tax return.” 26 C.F.R.
sec. 1.6662-3(b)(1) (2012); see also sec. 6662(c).
The IRS contends that Minnick and Lienhart were negligent because they
should have known that a deduction would not be allowed for an easement to which
U.S. Bank’s mortgage was not subordinated. Minnick and Lienhart respond that
Minnick followed a model conservation-easement form given to him by the Land
Trust, that Minnick discussed with his C.P.A. the legal requirements for a
conservation easement, and that he hired an expert appraiser to appraise the
conservation easement. Minnick also contends that he should not be held to the
standard of an experienced tax attorney because he worked only for a few months as
an attorney and that he spent only a fraction of his time practicing tax law.
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[*15] It is true that Minnick’s experience as a lawyer did not include substantial tax
work. He worked as a lawyer for only nine months, during which only a portion of
his work involved tax law. After that he operated a business selling building
supplies.2 It is against this background that his efforts should be evaluated. His
wife Lienhart was uninvolved in determining whether the conservation easement
gave rise to a charitable-contribution deduction.
In determining whether the grant of the conservation easement gave rise to a
charitable-contribution deduction, Minnick did not exercise reasonable care. He did
not seek to subordinate U.S. Bank’s mortgage to the conservation easement until
2011. His failure to comply with the subordination requirement found in the
regulation appears to stem from his failure to solicit advice from his C.P.A. about
the deductibility of the conservation easement, and the failure of the C.P.A. to give
such advice. The C.P.A. explained to Minnick that the value of a conservation
easement is deductible under the Code. However, he did not tell Minnick that the
particular conservation easement Minnick granted to the Land Trust was
2
Minnick was also a politician--he served a term in the U.S. House of
Representatives from January 2009 to January 2011--but the details of his political
career are not in the record.
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[*16] deductible.3 In the absence of such advice, Minnick could not have
reasonably relied on the C.P.A. when he claimed a deduction for the conservation-
easement contribution. Minnick should have been alerted by the warranty provision
in the conservation easement that there might be a problem with the lack of
subordination. The easement contained a warranty from Minnick that there was no
unsubordinated mortgage on the land. It is true that the form Minnick used to grant
the easement was a “model”, but that does not matter. This model easement form
was not suited to Minnick’s particular parcel of land.
Although Minnick hired an appraiser to determine the value of the property,
this does not contstitute reasonable cause to avoid imposition of the accuracy-
related penalty. The appraiser’s job was to determine the value of the conservation
easement, not to determine whether other requirements for deducting the
3
Note the C.P.A.’s careful response to the following question from Minnick
and Lienhart’s counsel:
Q Did you advise Mr. Minnick as to whether the conservation
easement was deductible or not?
A I advised him that a conservation easement, the donation of a
conservation easement is deductible as a charitable contribution,
and is specifically provided for in the code.
We infer that the C.P.A. declined to tell Minnick the grant of the particular
easement was deductible and that Minnick should have recognized this.
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[*17] contribution of the easement--for example, the subordination requirement--had
been met.
We determine that the underpayments of tax for 2007 and 2008 resulting from
the disallowance of the charitable deduction carryovers were due to negligence. We
need not determine whether the underpayments were also due to substantial
understatements of income tax.
In contending that they have a good-faith-and-reasonable-cause defense,
Minnick and Lienhart reiterate the steps that Minnick took to determine that he was
entitled to a deduction, i.e., using the model form for granting an easement, hiring an
appraiser, and consulting a C.P.A. They also contend that Minnick’s failure to
secure a subordination agreement was inadvertent. This was one of the reasons the
taxpayer in Mitchell was held to have a good-faith-and-reasonable-cause defense.
Mitchell v. Commissioner, 138 T.C. at 339-340. But, unlike the taxpayer in
Mitchell, Minnick was put on notice by the warranty provision in the conservation
easement that the unsubordinated mortgage posed a problem for the deductibility
of the conservation-easement contribution. Furthermore, Minnick failed to get
an opinion from his C.P.A. that he was entitled to a deduction. There is no
indication that there was such a failure in Mitchell. Id. We have already
explained why we think Minnick and Lienhart did not exercise reasonable care to
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[*18] evaluate the deductibility of the easement. The same reasons support our
view that Minnick and Lienhart did not have reasonable cause for claiming a
charitable-contribution deduction.
We hold that Minnick and Lienhart are liable for the accuracy-related
penalties. The penalty amounts for which they are liable are equal to 20% of the
underpayments attributable to the carryover charitable-contribution deductions, or
half the penalty amounts that were calculated in the notice of deficiency using a
40% rate. Therefore, the amounts for which Minnick and Lienhart are liable are
$8,461.05 for 2007 and $28,175.40 for 2008.
3. Evidentiary matters
The parties executed a stipulation of facts stating that all exhibits attached
to the stipulation “may be accepted as authentic” and “are incorporated in this
stipulation and made a part hereof; provided, however, that either party has the
right to object to the admission of any such * * * exhibits in evidence on the
grounds of materiality and relevancy”. The parties agree that the stipulation did
not waive hearsay objections to the attached exhibits. Among the documents
attached to the stipulation were Exhibits 9-J, 10-J, 11-J, 14-J through 34-J, and 41-
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[*19] R, 42-R, 43-R, and 45-R.4 At the beginning of the trial Minnick and Lienhart
objected to these documents on the ground that they were relevant to IRS theories
that had not been asserted in the notice of deficiency. The Court took the objections
under advisement. The Court later allowed the IRS to amend its answer to assert
these theories. As we describe, Minnick and Lienhart also objected to Exhibits 41-
R, 42-R, 43-R, and 45-R on grounds other than relevancy. Exhibits 41-R, 42-R, 43-
R, and 45-R are appraisals of the land by Sam Langston for U.S. Bank, dated
February 7, 2006, June 3, 2008, April 8, 2009, and August 1, 2011, respectively.
Minnick and Lienhart objected to these exhibits on hearsay grounds. They also
objected that the exhibits are in substance expert reports and that they were not
exchanged under Tax Court Rule of Practice and Procedure 143. They also
objected that the documents were not exchanged 14 days before trial as required
by the Court’s pretrial order. The Court took these objections to Exhibits 41-R, 42-
R, 43-R, and 45-R under advisement. Minnick and Lienhart clarified that they
did not object to these four exhibits to the extent they support findings of fact
other than the value of the conservation easement, such as U.S. Bank’s state of
mind. During trial, the IRS introduced Exhibit 49-R, an indemnification
4
Minnick and Lienhart objected to Exhibit “44-R” during trial. There is not a
44-R. There is a 43-R and a 44-J. They really meant to object to Exhibit 43-R.
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[*20] agreement between Minnick and U.S. Bank. Minnick and Lienhart objected
on the ground that it is relevant to IRS theories other than those raised in the notice
of deficiency. The Court also took this objection under advisement.
Minnick and Lienhart’s relevancy objections lost their force when the Court
permitted the IRS to amend its answer to assert its new theories. However, we
agree with Minnick and Lienhart that Langston’s opinion on the value of the
conservation easement, which is reflected in Exhibits 41-R, 42-R, 43-R, and 45-R,
should not serve as the basis for our decision. For it to do so would contravene Tax
Court Rule of Practice and Procedure 143, which requires that expert opinions be
brought before the Court in the form of an expert report and that the expert report be
exchanged with the other party before trial. We therefore admit Exhibits 41-R, 42-
R, 43-R, and 45-R, but we do not rely on these appraisals to the extent they opine
on the value of the conservation easement. We admit Exhibits 9-J, 10-J, 11-J, 14-J
through 34-J, and Exhibit 49-R without any conditions.
4. Conclusion
In reaching our holdings, we have considered all arguments made, and, to the
extent not mentioned above, we conclude they are moot, irrelevant, or without
merit.
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[*21] To reflect the foregoing,
Decision will be entered
for respondent.