146 T.C. No. 13
UNITED STATES TAX COURT
DOUGLAS G. CARROLL, III AND DEIRDRE M. SMITH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5445-13. Filed April 27, 2016.
In 2005 Ps contributed a conservation easement on a parcel of
land to two qualified organizations. Ps’ conservation easement
provides that, in the event that the conservation purpose is
extinguished because of an unexpected change in circumstances
surrounding the donated property, the donee organizations are
entitled to a proportionate share of extinguishment proceeds at least
equal to (1) the amount allowable as a deduction for Federal income
tax purposes over (2) the fair market value of the property at the time
of the contribution. Ps claimed a charitable contribution deduction on
their 2005 Federal income tax return and carried forward the
remaining deduction to their taxable years 2006, 2007, and 2008.
I.R.C. sec. 170(h) allows a deduction for a “qualified
conservation contribution.” A qualified conservation contribution
requires that the contribution be exclusively for conservation
purposes. I.R.C. sec. 170(h)(1)(C). For a contribution to be made
exclusively for conservation purposes, the conservation purpose must
be protected in perpetuity. I.R.C. sec. 170(h)(5)(A).
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Sec. 1.170A-14(g)(6)(ii), Income Tax Regs., provides that the
conservation purpose of a contribution is not protected in perpetuity
unless the contribution “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. * * * Accordingly, when a change in conditions
give rise to the extinguishment of a perpetual conservation restriction
under paragraph (g)(6)(i) of this section, 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”.
Held: Ps’ easement provides that the value of the contribution
for purposes of determining the donees’ rights to extinguishment
proceeds is the amount of Ps’ allowable deductions rather than the
fair market value of the easement and therefore does not comply with
the requirements of sec. 1.170A-14(g)(6), Income Tax Regs. The
conservation purpose is not protected in perpetuity as required by
I.R.C. sec. 170(h)(5)(A).
Held, further, Ps are liable for accuracy-related penalties under
I.R.C. sec. 6662.
Scott A. Schwartzberg, David J. Polashuk, and William J. Marchica, for
petitioners.
Michael A. Raiken, Elizabeth C. Mourges, and Nancy M. Gilmore, for
respondent.
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RUWE, Judge: Respondent determined deficiencies in petitioners’ Federal
income tax and accuracy-related penalties as follows:
Accuracy-related penalty
Year Deficiency sec. 6662
2006 $57,768 $11,553.60
2007 103,771 20,754.20
2008 17,777 3,555.40
After concessions,1 the issues remaining for decision are: (1) whether petitioners
are entitled to carryforward charitable contribution deductions for the taxable
years 2006, 2007, and 2008 (years in issue) from their 2005 contribution of a
conservation easement to the Maryland Environmental Trust (MET) and the Land
Preservation Trust, Inc. (LPT), and (2) whether petitioners are liable for accuracy-
related penalties under section 6662(a) for the years in issue.2
1
The parties entered into a stipulation of settled issues for all of the other
issues regarding deficiencies for the years in issue.
2
In his pretrial memorandum respondent asserts that petitioners are liable for
substantial and/or gross valuation misstatement penalties for the years in issue.
Respondent indicates on page 2 of his pretrial memorandum that he anticipates
making a motion that the pleadings conform to the facts to increase the penalty
from 20% to 40%. Respondent never filed such motion.
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Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.3
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The stipulation of
facts, the supplemental stipulation of facts, the second supplemental stipulation of
facts, the stipulation of settled issues, and the attached exhibits are incorporated
herein by this reference.
Petitioners resided in Maryland when they filed their petition.
On June 1, 1985, petitioner Douglas G. Carroll III (Dr. Carroll) became the
sole owner of approximately 25.8533 acres of land on Greenspring Valley Road in
Lutherville, Maryland (subject property).4 The subject property consists of two
parcels, primarily of open pastureland and woodland, and is part of the Green
3
Pursuant to sec. 7491(a) the burden of proof on factual issues may shift to
the Commissioner where the taxpayer complies with certain requirements.
Petitioners argue that the burden of proof should shift to respondent. Respondent
argues that petitioners did not meet the requirements of sec. 7491(a) to shift the
burden of proof. Because our conclusions are based on a preponderance of the
evidence, the allocation of the burden of proof in this case is immaterial. See
Foster v. Commissioner, 138 T.C. 51, 53 n.4 (2012); McGowen v. Commissioner,
T.C. Memo. 2011-186, 2011 Tax Ct. Memo LEXIS 185, at *5 n.3.
4
The subject property has been owned by Dr. Carroll’s family since 1920.
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Spring Valley National Register Historic District. The first parcel (parcel 1) was
approximately 3.92 acres, and the second parcel (parcel 2) was approximately
21.83 acres. The diagram below illustrates the layout of the two parcels.
Parcel 2
21.83 acres
Parcel 1
3.92 acres
The subject property is zoned RC-2, Agricultural, which is a restrictive type of
zoning established to foster and protect agriculture in appropriate areas of
Baltimore County, Maryland, and permits a maximum of two development rights
on each parcel from 2 to 100 acres. On parcel 1 is a two-story residence which
serves as the primary residence for Dr. Carroll and his family (Carroll residence),
and on parcel 2 was an approximately 1,000-square-foot tenant house (tenant
house) where a farmhand resides. Four properties adjacent to the subject property
are encumbered by conservation easements held by either MET or the Maryland
Agricultural Land Preservation Foundation (MALPF).
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The Gift Deed
On November 14, 2005, Dr. Carroll sent (via facsimile) a handwritten letter
to Attorney David Haile5 requesting that Mr. Haile draft a deed transferring
ownership of the subject property from Dr. Carroll to (1) Dr. Carroll, (2) Dr.
Carroll’s wife (Ms. Smith), and (3) petitioners’ three minor children, as tenants in
common. In his letter to Mr. Haile, Dr. Carroll instructs, in pertinent part:
If it is possible not to define the % interests, that would be
preferable. But they could be defined as the “maximum % interest
allowed under the UGMA[]” or some equivalent language.
It is my intent to create conservation easements on this property
& then form a [sic] LLC or family partnership that further defines the
interests & restrictions.
On November 22, 2005, Dr. Carroll executed a deed (gift deed) transferring
his interest in the subject property to (1) himself, (2) Ms. Smith, and (3) himself as
custodian for each of petitioners’ three minor children under the Maryland
Uniform Transfer to Minors Act, as tenants in common.6 The gift deed does not
provide specific ownership percentages transferred to Dr. Carroll, Ms. Smith, or
5
Mr. Haile is a general practice attorney licensed to practice law in
Maryland who focuses on real property transfers. Mr. Haile does not answer tax
questions or give tax advice.
6
Dr. Carroll testified that when the gift deed was executed petitioners’ minor
children were ages 9, 13, and 15, respectively.
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petitioners’ three minor children. On November 29, 2005, the gift deed was
recorded in the land records for Baltimore County, Maryland.
Lot Line Adjustment
On September 20, 2005, Dr. Carroll sent a letter to the Baltimore County
Agricultural Land Preservation Advisory Board (BCALPAB) requesting a lot line
adjustment for the subject property. Dr. Carroll’s request was to change the lot
line dividing parcels 1 and 2 to create one 18-acre parcel and one 7.8-acre parcel.
On October 19, 2005, BCALPAB recommended that parcel 1 be at least 20 acres.
On December 7, 2005, Dr. Carroll sent (via facsimile) a letter dated October 20,
2005, to BCALPAB proposing a new lot line adjustment. The letter proposed to
create one 20.93-acre lot and one 4.8-acre lot. On December 13, 2005, BCALPAB
met and recommended approval of Dr. Carroll’s December 7, 2005, request for a
lot line adjustment. Following the lot line adjustment, both the Carroll residence
and the tenant house were located on parcel 1. The diagram below illustrates the
layout of the two parcels following the lot line adjustment.
-8-
Parcel 2
4.8 acres
Parcel 1
20.93 acres
Deed of Conservation Easement
On December 15, 2005, petitioners and Dr. Carroll as custodian of
petitioners’ three minor children executed a deed of conservation easement
(conservation easement) for no consideration on parcel 1 of the subject property in
favor of MET7 and LPT8 as joint easement holders.9 Respondent concedes that
7
MET is a land trust created by the Maryland General Assembly pursuant to
subtitle 2 of title 3 of the Natural Resources Article of the Annotated Code of
Maryland (1983 repl. vol.) in 1967 to conserve, improve, and perpetuate
Maryland’s natural environment. One of MET’s most active programs is
statewide work pertaining to conservation easements. The focus of MET is on
agricultural properties and properties that are considered environmentally sensitive
(such as critical areas, wildlife habitats, farms, and wetlands) and are larger than
25 acres.
8
LPT is a sec. 501(c)(3) organization whose mission is, among other things,
to preserve and encourage conservation easements.
9
The benefits of multiple agencies holding a conservation easement include
sharing the responsibilities of monitoring and enforcing the terms of the
(continued...)
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both MET and LPT are qualified organizations as defined in section 170(h)(3).
The terms of the conservation easement provide that it was executed to “maintain
the significant conservation features * * * and the dominant scenic, cultural, rural,
agricultural, woodland and wetland characteristics of the Property, and to prevent
the use or development of the Property for any purpose or in any manner that
would conflict with these features and characteristics and the maintenance of the
Property in its open-space condition.” Article I of the conservation easement
provides:
This Conservation Easement shall be perpetual. It is an
easement in gross and as such is inheritable and assignable in
accordance with Article VI and runs with the land as an incorporeal
interest in the Property, enforceable with respect to the Property by
Grantees against Grantors and their personal representatives, heirs,
successors and assigns.
Article II of the conservation easement sets forth activities that are restricted
and/or prohibited on the encumbered property. Article II authorizes the Carroll
residence to remain on the subject property and limits the tenant house to 2,000
square feet. Any construction or work contemplated by petitioners must be
approved in advance by MET and LPT and “[s]uch approval shall be granted or
9
(...continued)
conservation easement and accessing resources available to the coholding agency.
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denied based on the Grantees’ opinion as to whether or not the proposed location
conforms with the conservation values listed in Exhibit B”.
Article III of the conservation easement authorizes MET and LPT to “enter
the Property at reasonable times for the purpose of inspecting the Property to
determine whether the Grantors are complying with the Terms of this
Conservation Easement”. In the event that petitioners are found to be in breach of
the terms of the conservation easement, Article III authorizes MET and LPT to
(1) institute a lawsuit to enforce the terms of the conservation easement or
(2) require that the subject property be restored promptly pursuant to the
conservation easement.
Exhibit B attached to the conservation easement provides:
The following public open space conservation values are
associated with the Property:
1. Master Plan: This Conservation Easement is consistent with
and supports the land use policy of the Baltimore County
Master Plan, adopted in 2000 by the Baltimore County
Planning Board. The Property lies within an Agricultural
Preservation Area. County goals for Agricultural Preservation
Areas include:
(a) Permanently preserve lands for agriculture and avoid
conflicts with incompatible uses.
(b) Actively pursue and promote easement and other
programs designed to preserve agriculture.
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(c) Protect, conserve and restore all essential natural
resources (including forests), with particular attention to
groundwater.
(d) Preserve and enhance the County’s significant scenic
resources as designated on the scenic resources map,
including scenic corridors, scenic views and gateways, as
an essential component contributing to the County’s
quality of life.
2. Area of Critical State Concern: The Property lies within the
Jones Falls watershed, which was designated an Area of
Critical State Concern for Baltimore County in 1977 by the
Baltimore County Planning Board. Significant Critical Areas
relating to the Jones Falls are trout waters, floodplain areas,
and prime agriculture, forestry, and wildlife lands. (Source:
Designation of Areas of Critical State Concern within
Baltimore County, Baltimore County Planning Board, 1977).
3. Agricultural Land and Woodland: The Property includes about
19 acres of productive agricultural land and woodland.
4. Historic Value: The Property is located in the Green Spring
Valley National Register Historic District.
5. Part of Larger Conservation Area: The Property is surrounded
by easements held by either the Maryland Environmental Trust
or the Maryland Agricultural Land Preservation Foundation.
6. Vegetative Buffer Strip: A vegetative buffer strip will be
maintained next to the tributary of Dipping Pond Run on the
Property. Buffer strip standards are consistent with guidelines
issued by the Maryland Department of Natural Resources for
the protection of surface water quality.
7. Maryland Environmental Trust Policy: The conservation
values of the Property defined above are pursuant to the
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conservation policies adopted by the Maryland Environmental
Trust on February 6, 2002.
Article VI of the conservation easement provides miscellaneous provisions,
including a provision concerning division of proceeds in the event that unexpected
changes in the conditions surrounding the subject property make it impossible or
impractical to continue using it for the intended conservation purposes. Article
VI.D, subparagraphs (1) and (2), of the conservation easement provides:
(1) The granting of this Conservation Easement gives rise to a
property right, immediately vested in Grantees, with a fair market
value equal to the ratio of the value of this Conservation Easement on
the effective date of this grant to the value of the Protected Property
without deduction for the value of the Conservation Easement on the
effective date of this grant. The value on the effective date of this
grant shall be the deduction for federal income tax purposes
allowable by reason of this grant, pursuant to Section 170(h) of the
Code. The parties shall include the ratio of those values with the
Baseline Determination and shall amend such values, if necessary, to
reflect any final determination thereof by the Internal Revenue
Service or a court of competent jurisdiction. For purposes of this
paragraph, the ratio of the value of the Conservation Easement to the
value of the Property unencumbered by the Conservation Easement
shall remain constant, and the percentage interests of Grantors and
Grantees in the fair market value of the Property thereby determinable
shall remain constant.
(2) If circumstances arise in the future that render the entire
purpose of this Conservation Easement impossible to accomplish, this
Conservation Easement may only be terminated or extinguished
whether with respect to all or part of the Property, by judicial
proceedings in a court of competent jurisdiction. In the event of any
sale of all or a portion of the Property (or any other property received
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in connection with an exchange or involuntary conversion of the
Property) after such termination or extinguishment, and after
satisfaction of prior claims and net of any costs or expenses
associated with such sale, Grantors and Grantees shall divide the
proceeds from such sale (minus any amount attributable to the value
of additional improvements made by Grantors after the effective date
of this Conservation Easement, which amount is reserved to Grantors)
in accordance with their respective percentage interests in the fair
market value of the Property, as such percentage interests are
determined under the provisions of the preceding paragraph, adjusted,
if necessary, to reflect a partial termination or extinguishment of this
Conservation Easement. All such proceeds received by Grantees
shall be used by Grantees in a manner consistent with Grantees’
conservation purposes.
On February 24, 2006, Terry Dunkin of Colliers Pinkard visited the subject
property to appraise the easement. By letter dated May 4, 2006, Mr. Dunkin
determined the value of the easement to be $1.2 million.
On March 8, 2006, MET mailed petitioners a letter acknowledging receipt
of the conservation easement. On a date not included in the record, the
conservation easement was accepted by MET’s board of directors and ratified by
the Maryland board of public works (which is composed of the Governor of
Maryland, the Comptroller of Maryland, and the Treasurer of Maryland) as being
consistent with MET’s policies and procedures. On a date not included in the
record, the conservation easement was accepted by LPT’s board of trustees as
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being consistent with its mission to preserve and encourage conservation
easements in Baltimore County, Maryland.
On October 17, 2006, respondent received petitioners’ 2005 Federal income
tax return reporting their donation of the conservation easement valued at $1.2
million. This was 100% of Mr. Dunkin’s value undiminished by any amount
attributable to the interests of petitioners’ children in the property. Petitioners
attached to their 2005 Federal income tax return a Form 8283, Noncash Charitable
Contributions, signed by Mr. Dunkin. Petitioners claimed a $495,356 noncash
charitable contribution deduction on Schedule A, Itemized Deductions, of their
2005 return and carried forward $704,644 of the remaining $1.2 million easement
contribution to subsequent tax years. On October 23, 2007, October 20, 2008, and
October 19, 2009, respondent received petitioners’ 2006, 2007, and 2008 tax
returns, respectively. On their respective Schedules A petitioners claimed
carryover noncash charitable contribution deductions of $196,008 for 2006,
$406,467 for 2007, and $55,539 for 2008.
Notice of Deficiency
On January 30, 2013, respondent issued to petitioners a notice of deficiency
for the years in issue. In the notice of deficiency respondent disallowed
petitioners’ claimed noncash charitable contribution deductions for the years in
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issue. Petitioners timely filed a petition with this Court disputing the
determinations in the notice of deficiency.
OPINION
I. Conservation Easements Generally
Any charitable contribution made during a taxable year is allowed as a
deduction only if the contribution is verified under regulations prescribed by the
Secretary. Sec. 170(a)(1). Section 170(f)(3) generally does not allow an
individual to deduct as a charitable contribution the gift of property consisting of
less than his or her entire interest in that property. An exception applies in the
case of a “qualified conservation contribution.” Sec. 170(f)(3)(B)(iii). Section
170(h)(1) defines a “qualified conservation contribution” as follows:
(1) In general.--For purposes of subsection (f)(3)(B)(iii), the
term “qualified conservation contribution” means a contribution--
(A) of a qualified real property interest,
(B) to a qualified organization,
(C) exclusively for conservation purposes.
All three requirements must be satisfied for a donation to be a qualified
conservation contribution. See Irby v. Commissioner, 139 T.C. 371, 379 (2012);
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Simmons v. Commissioner, T.C. Memo. 2009-208, 2009 Tax Ct. Memo LEXIS
213, at *9, aff’d, 646 F.3d 6 (D.C. Cir. 2011).
Respondent concedes that petitioners’ conservation easement was granted to
qualified organizations--i.e., MET and LPT--in satisfaction of section
170(h)(1)(B). However, respondent argues that petitioners’ conservation easement
does not constitute a qualified real property interest under section 170(h)(1)(A)
and was not contributed exclusively for conservation purposes under section
170(h)(1)(C). We begin our discussion by addressing whether petitioners’
donation of the conservation easement is a qualified real property interest.
A. Qualified Real Property Interest
The term “qualified real property interest” includes “a restriction (granted in
perpetuity) on the use which may be made of the real property.” Sec.
170(h)(2)(C). Section 1.170A-14(b)(2), Income Tax Regs., provides the following
with respect to section 170(h)(2)(C):
A perpetual conservation restriction is a qualified real property
interest. A “perpetual conservation restriction” is a restriction
granted in perpetuity on the use which may be made of real property--
including, an easement or other interest in real property that under
state law has attributes similar to an easement (e.g., a restrictive
covenant or equitable servitude). * * *
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Article I of petitioners’ conservation easement provides that the easement is
perpetual, inheritable, and assignable, runs with the land as an incorporeal interest,
and is “enforceable with respect to the Property by Grantees against Grantors and
their personal representatives, heirs, successors and assigns.” Article II of the
conservation easement imposes numerous restrictions on the use of the subject
property which are consistent with the conservation purposes of the easement,
including: limitations on development rights, prohibition on transferring
development rights from the encumbered property, and limitations on the number
and size of structures that may be built on the subject property. Article II.K of the
conservation easement requires that all rights reserved by petitioners and Dr.
Carroll as custodian of petitioners’ minor children “shall be exercised so as to
prevent or to minimize damage to water quality, air quality, land/soil stability and
productivity, wildlife, scenic and cultural values, and the natural topographic and
open-space character of the Property.” Moreover, representatives of MET and
LPT testified that both agencies will continue to conduct inspections of the subject
property to ensure compliance and will litigate violations of the terms of the
conservation easement. The express terms of the conservation easement satisfy
the requirements of section 1.170A-14(b)(2), Income Tax Regs., by providing
legally enforceable restrictions that will prevent uses of the retained interest in the
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subject property that are inconsistent with the conservation purposes of the
contribution. Accordingly, we hold that petitioners’ contribution of the
conservation easement is a qualified real property interest pursuant to section
170(h)(2)(C).
B. Conservation Purpose
In order for a contribution of property to constitute a “qualified conservation
contribution” it must be donated “exclusively for conservation purposes”. Sec.
170(h). A contribution is made “exclusively for conservation purposes” if it meets
the requirements of section 170(h)(4) and (5). Section 170(h)(4)(A) provides that
a contribution is for conservation purposes only if it serves one of four delineated
conservation purposes:
(A) In general.--For purposes of this subsection, the term
“conservation purpose” means--
(i) the preservation of land areas for outdoor recreation
by, or the education of, the general public,
(ii) the protection of a relatively natural habitat of fish,
wildlife, or plants, or similar ecosystem,
(iii) the preservation of open space (including farmland
and forest land) where such preservation is--
(I) for the scenic enjoyment of the general public,
or
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(II) pursuant to a clearly delineated Federal, State,
or local governmental conservation policy,
and will yield a significant public benefit, or
(iv) the preservation of an historically important land
area or a certified historic structure.
Under section 170(h)(4)(A), each of these four prongs is a conservation purpose in
and of itself, and a taxpayer’s satisfaction of one of these prongs is sufficient to
establish the existence of a conservation purpose. See S. Rept. No. 96-1007, at 10
(1980), 1980-2 C.B. 599, 604. Petitioners contend that their contribution satisfies
the third prong of section 170(h)(4)(A), i.e., that it preserves open space pursuant
to a clearly delineated Federal, State, or local government conservation policy and
yields a significant public benefit.
The general requirements necessary to establish that the contribution of a
conservation easement preserves open space pursuant to a clearly delineated
Federal, State, or local governmental policy are set forth in section 1.170A-
14(d)(4)(iii)(A), Income Tax Regs., which provides:
(A) In general.--The requirement that the preservation of open space
be pursuant to a clearly delineated Federal, state, or local
governmental policy is intended to protect the types of property
identified by representatives of the general public as worthy of
preservation or conservation. A general declaration of conservation
goals by a single official or legislative body is not sufficient.
However, a governmental conservation policy need not be a
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certification program that identifies particular lots or small parcels of
individually owned property. This requirement will be met by
donations that further a specific, identified conservation project, such
as the preservation of land within a state or local landmark district
that is locally recognized as being significant to that district; the
preservation of a wild or scenic river, the preservation of farmland
pursuant to a state program for flood prevention and control; or the
protection of the scenic, ecological, or historic character of land that
is contiguous to, or an integral part of, the surroundings of existing
recreation or conservation sites. For example, the donation of a
perpetual conservation restriction to a qualified organization pursuant
to a formal resolution or certification by a local governmental agency
established under state law specifically identifying the subject
property as worthy of protection for conservation purposes will meet
the requirement of this paragraph. A program need not be funded to
satisfy this requirement, but the program must involve a significant
commitment by the government with respect to the conservation
project. For example, a governmental program according preferential
tax assessment or preferential zoning for certain property deemed
worthy of protection for conservation purposes would constitute a
significant commitment by the government.
Section 1.170A-14(d)(4)(iii)(B), Income Tax Regs., explains the effect of
governmental agency review in establishing whether a conservation easement is
pursuant to a clearly delineated governmental policy:
(B) Effect of acceptance by governmental agency.--Acceptance
of an easement by an agency of the Federal Government or by an
agency of a state or local government (or by a commission, authority,
or similar body duly constituted by the state or local government and
acting on behalf of the state or local government) tends to establish
the requisite clearly delineated governmental policy, although such
acceptance, without more, is not sufficient. The more rigorous the
review process by the governmental agency, the more the acceptance
of the easement tends to establish the requisite clearly delineated
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governmental policy. For example, in a state where the legislature
has established an Environmental Trust to accept gifts to the state
which meet certain conservation purposes and to submit the gifts to a
review that requires the approval of the state’s highest officials,
acceptance of a gift by the Trust tends to establish the requisite
clearly delineated governmental policy. However, if the Trust merely
accepts such gifts without a review process, the requisite clearly
delineated governmental policy is not established.
Petitioners have established that the contribution of their conservation
easement was accepted by a State government agency after a thorough review
process. At trial petitioners offered the testimony of Megan Benjamin, a
conservation easement planner with MET. Ms. Benjamin testified that MET does
not accept every conservation easement proposed to the agency and adheres to a
thorough review policy in determining which easements are suitable for
acceptance. According to Ms. Benjamin, a prospective property is first evaluated
by an MET conservation easement planner; if the property does not satisfy MET’s
policies, it is not accepted by the agency. However, if an easement is deemed
suitable by an MET conservation easement planner, it is submitted for approval to
the MET board of directors and then subsequently to the board of public works
which consists of the Governor of Maryland, the Comptroller of Maryland, and the
Treasurer of Maryland. Ms. Benjamin also testified that MET consults with local
governments to obtain opinions regarding whether prospective easements are
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consistent with local master plans and zoning. In addition, MET works with the
Department of Natural Resources and the Maryland Historical Trust to research
prospective conservation easements. Petitioners’ conservation easement was
subject to this multistep evaluation process before it was accepted by MET.10
Accordingly, we conclude that the thoroughness of MET’s easement-review
process, combined with the requisite approval from Maryland’s highest officials,
establishes that petitioners’ conservation easement preserves open space
(including farmland and forest land) pursuant to a clearly delineated Federal,
State, or local governmental conservation policy pursuant to section
170(h)(4)(A)(iii)(II).
C. Significant Public Benefit
In order for petitioners’ conservation easement to satisfy the conservation
purpose requirement of section 170(h)(4)(A)(iii) the easement must also “yield a
significant public benefit”. The regulations under section 170(h)(4)(A) provide
factors to be considered when evaluating whether the contribution of a
10
Ms. Benjamin further stated that, in MET’s opinion, petitioners’
conservation easement serves many conservation purposes, including: being
consistent with the county master plan and various other government policies and
plans, being productive agricultural land, having historic value, being within the
Green Spring Valley Historic District, being part of a larger conservation area,
providing a vegetative buffer strip, and being consistent with MET policy.
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conservation easement yields a significant public benefit. Section 1.170A-
14(d)(4)(iv)(A), Income Tax Regs., provides:
(iv) Significant public benefit.--(A) Factors.--All contributions
made for the preservation of open space must yield a significant
public benefit. Public benefit will be evaluated by considering all
pertinent facts and circumstances germane to the contribution.
Factors germane to the evaluation of public benefit from one
contribution may be irrelevant in determining public benefit from
another contribution. No single factor will necessarily be
determinative. Among the factors to be considered are:
(1) The uniqueness of the property to the area;
(2) The intensity of land development in the vicinity of
the property (both existing development and foreseeable trends of
development);
(3) The consistency of the proposed open space use with
public programs (whether Federal, state, or local) for conservation in
the region, including programs for outdoor recreation, irrigation or
water supply protection, water quality maintenance or enhancement,
flood prevention and control, erosion control, shoreline protection,
and protection of land areas included in, or related to, a government
approved master plan or land management area;
(4) The consistency of the proposed open space use with
existing private conservation programs in the area, as evidenced by
other land, protected by easement or fee ownership by organizations
referred to in § 1.170A-14(c)(1), in close proximity to the property;
(5) The likelihood that development of the property
would lead to or contribute to degradation of the scenic, natural, or
historic character of the area;
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(6) The opportunity for the general public to use the
property or to appreciate its scenic values;
(7) The importance of the property in preserving a local
or regional landscape or resource that attracts tourism or commerce to
the area;
(8) The likelihood that the donee will acquire equally
desirable and valuable substitute property or property rights;
(9) The cost to the donee of enforcing the terms of the
conservation restriction;
(10) The population density in the area of the property;
and
(11) The consistency of the proposed open space use
with a legislatively mandated program identifying particular parcels
of land for future protection.
Petitioners’ conservation easement yields a significant public benefit for the
following reasons. First, the record before us indicates that the subject property is
located in the Green Spring Valley, which is a highly desirable area of Baltimore
County, Maryland, and is under development pressure due to its close proximity to
Interstate 695, Interstate 83, and the urban centers of Towson, Pikesville, and
Lutherville. In the market area analysis attached to the May 4, 2006, appraisal
report, Mr. Dunkin states: “It is unusual that a property the size of the subject
property still exists in this area.” Second, the subject property is zoned RC-2,
Agricultural, which is a restrictive type of zoning established to foster and protect
- 25 -
agriculture in certain areas of Baltimore County, Maryland. Third, the Green
Spring Valley is specifically designated by the Baltimore County, Maryland,
Master Plan 2010 as an agricultural preservation area “created to protect the
county’s agricultural industry, as well as its natural resources, and areas of scenic
and historical significance.” Fourth, four properties adjacent to the subject
property are encumbered by easements held by either MET or MALPF.
Accordingly, on the basis of the record before us, we conclude that petitioners’
conservation easement yields a significant public benefit as required by section
170(h)(4)(A)(iii) and section 1.170A-14(d)(4)(iv)(A), Income Tax Regs.
II. Protected in Perpetuity
Section 170(h)(5)(A) provides that a “contribution shall not be treated as
exclusively for conservation purposes unless the conservation purpose is protected
in perpetuity.”11 If the conservation purpose is not protected in perpetuity, the
11
The perpetuity requirement of sec. 170(h)(5)(A) is separate and distinct
from the perpetuity requirement discussed in sec. 170(h)(2)(C). See Belk v.
Commissioner, 140 T.C. 1, 12 (2013) (“Section 170(h)(2)(C) requires that the
interest in real property donated by taxpayers be subject to a use restriction in
perpetuity, whereas section 170(h)(5) requires that the conservation purpose of the
conservation easement be protected in perpetuity.”), supplemented by T.C. Memo.
2013-154, aff’d, 774 F.3d 221 (4th Cir. 2014).
The Court of Appeals for the Fourth Circuit further noted this distinction by
stating: “Though both requirements speak in terms of ‘perpetuity,’ they are not
(continued...)
- 26 -
contribution is not a “qualified conservation contribution” and the taxpayers are
therefore not entitled to a deduction under section 170.
Section 1.170A-14(g), Income Tax Regs., elaborates on the protected-in-
perpetuity requirement of section 170(h)(5)(A) by setting forth substantive rules to
safeguard the conservation purpose of a contribution. Most pertinent to the instant
case, section 1.170A-14(g)(6), Income Tax Regs., addresses subsequent
unexpected changes in the conditions surrounding the donated property that make
it impossible or impractical to continue using the property for the intended
conservation purpose. Section 1.170A-14(g)(6), Income Tax Regs., provides as
follows:
(6) Extinguishment.--(i) In general.--If a subsequent
unexpected change in the conditions surrounding the property that is
the subject of a donation under this paragraph can make impossible or
impractical the continued use of the property for conservation
purposes, the conservation purpose can nonetheless be treated as
protected in perpetuity if the restrictions are extinguished by judicial
proceeding and all of the donee’s proceeds (determined under
paragraph (g)(6)(ii) of this section) from a subsequent sale or
exchange of the property are used by the donee organization in a
manner consistent with the conservation purposes of the original
contribution.
11
(...continued)
one and the same. The provision at issue here, §170(h)(2)(C), governs the grant of
the easement itself, while the provision at issue in * * * Kaufman, § 170(h)(5)(A),
governs its subsequent enforcement.” Belk v. Commissioner, 774 F.3d at 228.
- 27 -
(ii) Proceeds.--In the case of a donation made after February
13, 1986, 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, 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. See § 1.170A-14(h)(3)(iii) relating to the
allocation of basis. For purposes of this paragraph (g)(6)(ii), that
proportionate value of the donee’s property rights shall remain
constant. Accordingly, when a change in conditions gives rise to the
extinguishment of a perpetual conservation restriction under
paragraph (g)(6)(i) of this section, 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,
unless state law provides that the donor is entitled to the full proceeds
from the conversion without regard to the terms of the prior perpetual
conservation restriction. [Emphasis added.]
These regulations have been described as “a single--and exceedingly
narrow--exception to the requirement that a conservation easement impose a
perpetual use restriction” on real property. Belk v. Commissioner, 774 F.3d 221,
225 (4th Cir. 2014), aff’g 140 T.C. 1 (2013). The requirements of section 1.170A-
14(g)(6)(i) and (ii), Income Tax Regs., are strictly construed; if a grantee is not
absolutely entitled to a proportionate share of extinguishment proceeds, then the
conservation purpose of the contribution is not protected in perpetuity. Kaufman
v. Commissioner (Kaufman I), 134 T.C. 182, 186-187 (2010), reconsideration
denied by Kaufman v. Commissioner (Kaufman II), 136 T.C. 294, 309 (2011),
- 28 -
aff’d in part, vacated in part and remanded in part sub nom. Kaufman v. Shulman
(Kaufman III), 687 F.3d 21 (1st Cir. 2012). In Kaufman III the Court of Appeals
for the First Circuit affirmed in part, vacated in part, and remanded in part our
Opinions in Kaufman I and Kaufman II. After remand by the Court of Appeals we
issued our opinion in Kaufman v. Commissioner, T.C. Memo. 2014-52, aff’d, 784
F.3d 56 (1st Cir. 2015). As subsequently explained, we rely only on those parts of
our Opinions in Kaufman I and Kaufman II that are consistent with the opinion of
the Court of Appeals in Kaufman III.
The taxpayers in Kaufman claimed a charitable contribution deduction for
their donation of a facade easement on their Boston rowhouse to a nonprofit
organization. Kaufman I, 134 T.C. at 184. Consistent with section 1.170A-
14(g)(6), Income Tax Regs., the facade easement granted the nonprofit
organization a proportionate share of future extinguishment proceeds, as follows:
In the event this Agreement is ever extinguished, whether through
condemnation, judicial decree or otherwise, Grantor agrees on behalf
of itself, its heirs, successors and assigns, that Grantee, or its
successors and assigns, will be entitled to receive upon the
subsequent sale, exchange or involuntary conversion of the Property,
a portion of the proceeds from such sale, exchange or conversion
equal to the same proportion that the value of the initial easement
donation bore to the entire value of the property at the time of the
donation * * * unless controlling state law provides that the Grantor
is entitled to the full proceeds in such situations, without regard to the
Agreement. Grantee agrees to use any proceeds so realized in a
- 29 -
manner consistent with the preservation purposes of the original
contribution.
Kaufman II, 136 T.C. at 299 (alteration in original). However, the taxpayers’
property was subject to a mortgage, and a “lender agreement” recorded with the
facade easement granted the mortgagee a “prior claim” to any condemnation or
insurance proceeds in preference to the nonprofit organization. Id. at 299-300.
We held that the taxpayers’ facade easement contribution failed as a matter of law
to comply with the perpetuity requirement of section 1.170A-14(g)(6), Income Tax
Regs., because the nonprofit organization was not absolutely guaranteed its
proportionate share of extinguishment proceeds. Kaufman I, 134 T.C. at 187. We
explained that the taxpayers “cannot avoid the strict requirement in section
1.170A-14(g)(6)(ii), Income Tax Regs., simply by showing that they would most
likely be able to satisfy both their mortgage and their obligation to * * * [the
nonprofit organization].” Id. at 186. In other words, although the taxpayers in
Kaufman granted the nonprofit organization a proportionate share of
extinguishment proceeds, and thus seemingly complied with section 1.170A-
14(g)(6), Income Tax Regs., the subsequently executed lender agreement undercut
this commitment by stipulating that the mortgagee and its assignees had a prior
claim to certain insurance and condemnation proceeds.
- 30 -
The taxpayers in Kaufman appealed to the Court of Appeals for the First
Circuit. Kaufman III, 687 F.3d at 21. Although absent a stipulation to the
contrary an appeal of the instant case lies with the Court of Appeals for the Fourth
Circuit, the Court of Appeals for the First Circuit’s opinion in Kaufman III is
instructive on several points. The Court of Appeals in Kaufman III upheld as
valid section 1.170A-14(g)(6), Income Tax Regs., and explained that the
regulation is “designed in case of extinguishment both (1) to prevent taxpayers
from reaping a windfall if the property is destroyed or condemned and they get the
proceeds from insurance or condemnation and (2) to assure that the donee
organization can use its proportionate share of the proceeds to advance the cause
of historic preservation elsewhere.” Id. at 26 (fn. ref. omitted). In vacating our
decision the Court of Appeals found that the Government’s interpretation of
section 1.170A-14(g)(6), Income Tax Regs., was unreasonable, explaining that
“given the ubiquity of super-priority for tax liens, the IRS’s reading of its
regulation would appear to doom practically all donations of easements, which is
surely contrary to the purpose of Congress.” Id. at 27. The Court of Appeals
further explained that section 1.170A-14(g)(6), Income Tax Regs., did not require
that the donee have an absolute right to the extinguishment proceeds. Rather, it
- 31 -
was sufficient that the donee have an absolute right against the donor for its
proportion. Id.12
Although the issue in the instant case involves the application of section
1.170A-14(g)(6), Income Tax Regs., the determinative facts are distinguishable
from those in Kaufman, which involved the claim priority of a donee organization
and a mortgagee with respect to extinguishment proceeds. In the instant case the
issue is whether the donee has an absolute right against the donor upon
extinguishment. The matter sub judice involves the method of determining the
numerator of the formula in section 1.170A-14(g)(6)(ii), Income Tax Regs., for
purposes of calculating the donees’ entitlement to extinguishment proceeds.
12
As the Court of Appeals for the First Circuit later explained:
The Tax Court held that, because the Kaufmans’ mortgage lender had
retained a “claim to all insurance proceeds * * * and all proceeds of
condemnation” superior to the claim of the Trust, the Trust was not
guaranteed to receive its due proportion of the proceeds in the event
of a condemnation of the Kaufmans’ residence. We held that this was
error because it was sufficient that the Trust retained a claim to its
due proportion of the proceeds as against the owner-donor; the
regulation did not require the Trust to have an absolute right to those
proceeds as against the rest of the world.
Kaufman v. Commissioner, 784 F.3d 56, 63 n.5 (1st Cir. 2015) (alteration in
original) (internal citations omitted) (quoting Kaufman v. Shulman, 687 F.3d 21,
27 (1st Cir. 2012), aff’g in part, vacating in part, and remanding in part Kaufman
v. Commissioner, 136 T.C. 294 (2011), and 134 T.C. 182 (2010)), aff’g T.C.
Memo. 2014-52.
- 32 -
For purposes of deciding this case, we will follow the principles of the
Kaufman opinions upon which both this Court and the Court of Appeals agree
with respect to the application of section 1.170A-14(g)(6), Income Tax Regs. No
reported cases have specifically addressed the formula in section 1.170A-
14(g)(6)(ii), Income Tax Regs., and thus this is an issue of first impression in this
Court.
Article VI.D, subparagraphs (1) and (2), of petitioners’ conservation
easement provides:
D. (1) The granting of this Conservation Easement gives rise to a
property right, immediately vested in Grantees, with a fair market
value equal to the ratio of the value of this Conservation Easement on
the effective date of this grant to the value of the Protected Property
without deduction for the value of the Conservation Easement on the
effective date of this grant. The value on the effective date of this
grant shall be the deduction for federal income tax purposes
allowable by reason of this grant, pursuant to Section 170(h) of the
Code. The parties shall include the ratio of those values with the
Baseline Documentation and shall amend such values, if necessary, to
reflect any final determination thereof by the Internal Revenue
Service or a court of competent jurisdiction. For purposes of this
paragraph, the ratio of the value of the Conservation Easement to the
value of the Property unencumbered by the Conservation Easement
shall remain constant, and the percentage interests of Grantors and
Grantees in the fair market value of the Property thereby determinable
shall remain constant.
(2) If circumstances arise in the future that render the entire
purpose of this Conservation Easement impossible to accomplish, this
Conservation Easement may only be terminated or extinguished
- 33 -
whether with respect to all or part of the Property, by judicial
proceedings in a court of competent jurisdiction. In the event of any
sale of all or a portion of the Property (or any other property received
in connection with an exchange or involuntary conversion of the
Property) after such termination or extinguishment, and after
satisfaction of prior claims and net of any costs or expenses
associated with such sale, Grantors and Grantees shall divide the
proceeds from such sale (minus any amount attributable to the value
of additional improvements made by Grantors after the effective date
of this Conservation Easement, which amount is reserved to Grantors)
in accordance with their respective percentage interests in the fair
market value of the Property, as such percentage interests are
determined under the provisions of the preceding paragraph, adjusted,
if necessary, to reflect a partial termination or extinguishment of this
Conservation Easement. All such proceeds received by Grantees
shall be used by Grantees in a manner consistent with Grantees’
conservation purposes. [Emphasis added.]
Section 1.170A-14(g)(6)(ii), Income Tax Regs., requires the grantee’s
proportionate interest upon extinguishment of a conservation easement to be a
percentage determined by (1) the fair market value of the conservation easement
on the date of the gift (numerator), over (2) the fair market value of the property as
a whole on the date of the gift. However, Article VI.D, subparagraph (1), of
petitioners’ conservation easement provides that the value of the easement on the
effective date “shall be the deduction for federal income tax purposes allowable by
reason of this grant, pursuant to Section 170(b) of the Code”. (Emphasis added.)
Respondent argues that petitioners’ conservation easement violates section
1.170A-14(g)(6)(ii), Income Tax Regs., because the conservation purpose is not
- 34 -
protected in perpetuity and consequently is not a qualified conservation
contribution. We agree with respondent.
The issue is whether, in the event of an extinguishment of petitioners’
conservation easement, MET and LPT would be guaranteed a proportionate share
of extinguishment proceeds as required by section 1.170A-14(g)(6)(ii), Income
Tax Regs. According to the express terms of Article VI.D, subparagraph (1), of
the conservation easement, the grantors (i.e., petitioners) agree that in the event of
a change in circumstances giving rise to an extinguishment of the conservation
easement, the grantees (i.e., MET and LPT) would be entitled to a proportionate
share of the proceeds arising from the extinguishment. However, the value of
MET’s and LPT’s proportionate interest is specifically defined in Article VI.D,
subparagraph (1), to be determined by the ratio of “the deduction for federal
income tax purposes allowable by reason of this grant, pursuant to Section 170(h)
of the Code” over the value of the subject property as a whole on the date of the
gift. This provision does not comply with the requirement of section 1.170A-
14(g)(6)(ii), Income Tax Regs., that the proportionate share of extinguishment
- 35 -
proceeds be determined by the fair market value of the easement on the date of the
gift over the fair market value of the whole property on the date of the gift.
The Court of Appeals for the First Circuit in Kaufman III, 687 F.3d at 26,
explained that section 1.170A-14(g)(6), Income Tax Regs., was designed to
prevent taxpayers from reaping a windfall if encumbered property was
subsequently destroyed or condemned. Inconsistent with this purpose, Article
VI.D, subparagraph (1), of petitioners’ conservation easement violates section
1.170A-14(g)(6)(ii), Income Tax Regs., by providing petitioners (or petitioners’
heirs) with a potential windfall in the event that a change of conditions
extinguishes the conservation easement. For example, if the Internal Revenue
Service denies petitioners’ charitable contribution deduction for Federal income
tax purposes for reasons other than valuation and the easement is extinguished in a
subsequent judicial proceeding, the numerator used pursuant to Article VI.D,
subparagraph (1), of the conservation easement will be zero, and MET and LPT
will not receive a proportionate share of extinguishment proceeds.
Petitioners appear to argue on brief that the deduction referenced in the
conservation easement was simply a method of determining the value of the
easement. But there is no evidence of why this provision was in the conservation
easement. Deductions for conservation easements can be denied for many reasons
- 36 -
unrelated to valuation. At the time the conservation easement was granted,
petitioners’ deduction faced many hurdles that were unrelated to the value of the
easement.13 Indeed, in this case respondent has made many arguments for
13
In Graev v. Commissioner, 140 T.C. 377, 396-397 (2013), we stated:
There are multiple requirements in section 170 and the corresponding
regulations that, if not followed, may lead to disallowance--and
valuation is only one of them. For example, an easement contribution
may be disallowed where--
•The donee fails to be a “qualified organization” described in
section 170(h)(3).
•The property subject to the easement fails to be of a
“historically important land area” or a “certified historic structure.”
Sec. 170(h)(4)(iv); see Turner v. Commissioner, 126 T.C. 299, 316
(2006).
•The taxpayer fails to contribute a “qualified real property
interest”. Sec. 170(a)(2); see Belk v. Commissioner, 140 T.C. 1
(2013).
•The easement fails to preserve conservation purposes “in
perpetuity”. Sec. 170(h)(5); see Carpenter v. Commissioner, T.C.
Memo. 2012-1; Herman v. Commissioner, T.C. Memo. 2009-205.
•The parties fail to subordinate the rights of a mortgagee in the
property “to the right of the qualified organization to enforce the
conservation purposes of the gift in perpetuity.” 26 C.F.R. sec.
1.170A-14(g)(2); see Mitchell v. Commissioner, 138 T.C. 324, 331-
332 (2012).
(continued...)
- 37 -
disallowance that are not based on valuation.
In the event of extinguishment, if the deductions were disallowed,
petitioners or their heirs could argue that petitioners never received a tax
deduction and, therefore, MET and LPT would not be entitled to extinguishment
proceeds. This argument is supported by the literal terms of the easement, and
there is no evidence of a different intent. This would provide petitioners or their
13
(...continued)
•The taxpayer fails to “[a]ttach a fully complete appraisal
summary * * * to the tax return”. 26 C.F.R. sec. 1.170A-13(c)(2)(B).
But see Kaufman v. Shulman, 687 F.3d 21, 28-30 (1st Cir. 2012),
aff’g in part, vacating and remanding in part Kaufman v.
Commissioner, 136 T.C. 294 (2011), and 134 T.C. 182 (2010).
•The appraisal fails to be a “qualified appraisal”. 26 C.F.R.
sec. 1.170A-13(c)(3); see Friedberg v. Commissioner, T.C. Memo.
2011-238.
•The appraiser fails to be a “qualified appraiser”. 26 C.F.R.
sec. 1.170A-13(c)(5); see Rothman v. Commissioner, T.C. Memo.
2012-218 (reserving the question on whether an appraiser was
“qualified”).
•The parties fail to record the easement or otherwise fail to
effect “legally enforceable restrictions”. 26 C.F.R. sec. 1.170A-
14(g)(1); see Satullo v. Commissioner, T.C. Memo 1993-614, aff’d
without published opinion, 67 F.3d 314 (11th Cir. 1995).
•The taxpayer fails to “[m]aintain records” necessary to
substantiate the charitable contribution. 26 C.F.R. sec. 1.170A-
13(c)(2)(C), Income Tax Regs.
- 38 -
heirs with a windfall and deprive the donees of their ability to use a share of the
extinguishment proceeds for conservation purposes. See Kaufman III, 687 F.3d at
26. We conclude that Article VI.D, subparagraphs (1) and (2), of petitioners’
conservation easement violates the requirements of section 1.170A-14(g)(6)(ii),
Income Tax Regs., by not guaranteeing MET and LPT a proportionate share of
extinguishment proceeds based on the fair market value of the conservation
easement at the time of the gift. Because the purpose of petitioners’ contribution
is not protected in perpetuity, it does not qualify as a qualified conservation
contribution, and therefore petitioners are not entitled to a carryforward charitable
contribution deduction for the years in issue.
Petitioners argue that respondent ignores the last sentence of section
1.170A-14A(g)(6)(ii), Income Tax Regs., which provides an exception to the
proportionality requirement if “state law provides that the donor is entitled to the
full proceeds from the conversion without regard to the terms of the prior
perpetual conservation restriction.” According to petitioners, Maryland law
requires that extinguishment proceeds be distributed to easement donors without
regard to the conservation easement. Specifically, petitioners cite Md. Code Ann.,
Real Prop. sec. 12-104(g) (LexisNexis 2016), which provides:
- 39 -
(g) Land over which easement donated to Maryland Historical Trust
or Maryland Environmental Trust.--If any easement in gross or other
right to restrict use of land or any interest in land has been donated to
the Maryland Historical Trust or the Maryland Environmental Trust,
damages shall be awarded in any condemnation proceedings under
this title to the fee owner and leasehold owner, as their interests may
appear, and shall be the fair market value of the land or interest in it,
computed as though the easement or other right did not exist.
[Emphasis added.]
Petitioners are correct that Maryland law mandates that, with respect to an
easement donated to MET, the extinguishment proceeds in any condemnation
proceeding be “computed as though the easement or other right did not exist.” Id.
However, there are two problems with petitioners’ position. First, by its own
terms, Md. Code Ann., Real Prop. sec. 12-104(g) applies only to “the Maryland
Historical Trust or [the] Maryland Environmental Trust.” Petitioners’
conservation easement provides both MET and LPT with coextensive rights in the
subject property. While MET is specifically covered by Md. Code Ann., Real
Prop. sec. 12-104(g), LPT is not mentioned. Thus, in the event that the
conservation easement is judicially extinguished in a condemnation proceeding,
MET’s extinguishment proceeds would be controlled by State statute. However,
LPT would still be entitled to proceed under the conservation easement whose
terms fail the proportionality requirement of section 1.170A-14(g)(6)(ii), Income
Tax Regs. The second problem with petitioners’ argument is that Md. Code Ann.,
- 40 -
Real Prop. sec. 12-104 applies narrowly to condemnation proceedings, and section
1.170A-14(g)(6), Income Tax Regs., applies broadly to any “subsequent
unexpected change in the conditions surrounding the property that is the subject of
a donation * * * mak[ing] impossible or impractical the continued use of the
property for conservation purposes”. Although Maryland law would apply to
MET in a condemnation proceeding, it would not apply to either MET or LPT in a
extinguishment proceeding that was not based on condemnation (e.g., the
destruction of the subject property or where the characteristics of the
neighborhood render the conservation purpose impractical). For these reasons,
Md. Code Ann., Real Prop. sec. 12-104 does not satisfy the State law exception in
section 1.170A-14(g)(6), Income Tax Regs.
Petitioners also contend that respondent’s rationale is “circular in nature”,
arguing that the disallowance of their charitable contribution deduction under
section 1.170A-14(g)(6), Income Tax Regs., hinges on the possibility that
respondent may disallow petitioners’ deduction on another ground. This argument
is unpersuasive. The regulatory requirements set forth in section 1.170A-14(g),
Income Tax Regs., are designed to protect the conservation purpose of a
conservation contribution and must be satisfied at the outset for a contribution to
be deductible. Although section 1.170A-14(g)(6)(ii), Income Tax Regs., imposes
- 41 -
a technical requirement, it is a requirement intended to preserve the conservation
purpose, and petitioners could have avoided this adverse outcome by strictly
following the proportionality formula set forth in the regulation. This Court is
obligated to apply statutes as written and follow accompanying regulations when
consistent therewith. See Michaels v. Commissioner, 87 T.C. 1412, 1417 (1986).
Petitioners also argue that respondent “ignores the safe harbor from unlikely
events” in section 1.170A-14(g)(3), Income Tax Regs.14 Petitioners emphasize
that “[r]espondent has not cited to a single instance where a conservation easement
actually has been extinguished, nor has [r]espondent offered any potential reasons
why the Easement donated by [p]etitioners ever would be extinguished.” In
Kaufman III, 687 F.3d at 27, the Court of Appeals for the First Circuit specifically
agreed with our rationale in Kaufman II, 136 T.C. at 313, that “[o]ne does not
satisfy the extinguishment provision [in section 1.170A-14(g)(6), Income Tax
Regs.] * * * merely by establishing that the possibility of a change in conditions
14
Sec. 1.170A-14(g)(3), Income Tax Regs., provides, in pertinent part:
(3) Remote future event.--A deduction shall not be disallowed
under section 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. * * *
- 42 -
triggering judicial extinguishment is unexpected.” (Alteration in original.) To
accept petitioners’ argument would effectively nullify the proportionality
requirement of section 1.170A-14(g)(6), Income Tax Regs., because, by its own
terms, the regulation applies to “unexpected” changes in conditions, which likely
encompass events that are “so remote as to be negligible”. See sec. 1.170A-
14(g)(3), Income Tax Regs. Thus, petitioners cannot circumvent the strict
requirement of section 1.170A-14(g)(6), Income Tax Regs., by showing that the
probability of extinguishment is so remote as to be negligible under section
1.170A-14(g)(3), Income Tax Regs.
III. Alternative Issues
Respondent raised various other issues, including the valuation of
petitioners’ conservation easement, petitioners’ ownership percentages of the
subject property at the time the conservation easement was granted to MET and
LPT,15 and whether petitioners’ appraisal attached to their return was a qualified
15
Respondent argues that, before executing the easement, Dr. Carroll had
conveyed the subject property to himself, his wife, and his three minor children as
tenants in common, and therefore “petitioners only had a 40% interest in the
Property at the time they executed the Easement, thereby limiting any deduction to
40% of the deemed value of the donation.” Thus, respondent in effect argues that,
even if we accept petitioners’ valuation of the easement, petitioners’ conservation
easement deduction should be limited to $480,000 (40% of the $1.2 million that
petitioners claimed).
- 43 -
appraisal as required by section 1.170A-13(c)(3)(ii)(I), Income Tax Regs. Our
decision, supra, that petitioners’ conservation easement fails to satisfy the
proportionality requirements of section 1.170A-14(g)(6)(ii), Income Tax Regs.,
resolves this case, and therefore we will not address the parties’ other arguments.
IV. Section 6662(a) Accuracy-Related Penalties
In the notice of deficiency respondent determined that petitioners are liable
for section 6662(a) accuracy-related penalties for 2006, 2007, and 2008 of
$11,553.60, $20,754.20, and $3,555.40, respectively. Section 6662(a) and (b)(2)
imposes a 20% accuracy-related penalty on any portion of an underpayment
attributable to a substantial understatement of income tax. Section 7491(c)
provides that the Commissioner bears the burden of production with regard to
penalties and must come forward with sufficient evidence indicating that it is
appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438,
446 (2001). However, once the Commissioner meets his burden of production, the
burden of proof remains with the taxpayer, including the burden of proving that
the penalty is inappropriate because of reasonable cause under section 6664. See
Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.
There is a substantial understatement of income tax for any taxable year if
the amount of the understatement of income tax for the taxable year exceeds the
- 44 -
greater of 10% of the tax required to be shown on the return for the taxable year or
$5,000. Sec. 6662(d)(1)(A). On their 2005 tax return petitioners claimed a $1.2
million charitable contribution deduction for their donation of a conservation
easement on the subject property. A portion of that deduction was carried over to
each of petitioners’ 2006, 2007, and 2008 returns. We have concluded that
petitioners are not entitled to a carryforward charitable contribution deduction for
any of the years in issue, and therefore, their understatement of income tax for
each of the years in issue exceeds the greater of 10% of the tax required to be
shown on their return or $5,000. Thus, respondent has met his burden of
production with respect to the section 6662(a) substantial understatement penalty.
Section 6664(c)(1) provides that the penalty under section 6662(a) shall not
apply to any portion of an underpayment if it is shown that there was reasonable
cause for the taxpayer’s position and that the taxpayer acted in good faith. See
Higbee v. Commissioner, 116 T.C. at 448. The determination of whether a
taxpayer acted with reasonable cause and in good faith is made on a case-by-case
basis, taking into account all of the pertinent facts and circumstances. Sec.
1.6664-4(b)(1), Income Tax Regs. Generally, the most important factor is the
extent of the taxpayer’s effort to assess his or her tax liability. Id. Reliance on
professional advice may constitute reasonable cause and good faith, but “it must
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be established that the reliance was reasonable.” Freytag v. Commissioner, 89
T.C. 849, 888 (1987), aff’d on other grounds, 904 F.2d 1011 (5th Cir. 1990), aff’d,
501 U.S. 868 (1991). We have previously held that a taxpayer must satisfy a
three-prong test to be found to have reasonably relied on professional advice to
negate a section 6662(a) accuracy-related penalty: (1) the adviser was a
competent professional who had sufficient expertise to justify the reliance; (2) the
taxpayer provided necessary and accurate information to the adviser; and (3) the
taxpayer actually relied in good faith on the adviser’s judgment. Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d
Cir. 2002).
Petitioners argue that they had reasonable cause because their conservation
easement deduction “was based on a qualified appraisal by a qualified appraiser,
and the taxpayer made a good-faith investigation of the value of the contributed
property.” We agree with petitioners that their conservation easement deduction
was based on an appraisal by a qualified appraiser. However, we have held that it
is the language found in Article VI.D, subparagraph (1), of the conservation
easement, not the valuation of the subject property, which caused the disallowance
of petitioners’ carryforward contribution deductions. Petitioners do not qualify for
the section 6664(c)(1) reasonable cause exception because they have not shown
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that they acted with reasonable cause and in good faith with respect to the
protected-in-perpetuity requirement of section 1.170A-14(g)(6), Income Tax Regs.
Dr. Carroll testified that he personally handled the conservation easement and did
not consult with an attorney or other adviser.
The testimony and other evidence presented at trial demonstrate that Dr.
Carroll is a highly educated medical school graduate and had previous experience
with conservation easements. Although Dr. Carroll did hire Mr. Haile in 2005 to
draft a gift deed for the subject property, Mr. Haile is not a tax attorney and does
not answer tax-related questions or give tax advice. Petitioners offered no
evidence which would explain why the terms of the conservation easement varied
from the requirements of section 1.170A-14(g)(6), Income Tax Regs., nor do they
clarify why Dr. Carroll failed to seek competent advice from a tax attorney or
other adviser to ensure the conservation easement’s compliance with pertinent
regulations. In the light of Dr. Carroll’s high level of sophistication and
experience with conservation easements, we conclude that petitioners have not
demonstrated that they acted with reasonable cause and in good faith in not
seeking competent tax advice regarding the conservation easement.16
16
Petitioners concede that they failed to report: (1) $2,545 of taxable State
refunds, credits, or offsets for 2006; (2) $8,496 of ordinary dividends, $6,000 of
(continued...)
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Accordingly, we hold that petitioners are liable for accuracy-related penalties
under section 6662(a).
Substantial and/or Gross Valuation Misstatement Penalties
Respondent did not determine an accuracy-related penalty under section
6662(e) or (h) in the notice of deficiency17 or in his answer. In his pretrial
memorandum respondent asserts that petitioners are liable for substantial and/or
gross valuation misstatement penalties. Respondent also indicates in his pretrial
memorandum that he anticipates making a motion that the pleadings conform to
16
(...continued)
rental income, $7,397 of qualified dividends, and $107,227 of long-term capital
gains for 2007; and (3) $14,826 of rental income, $958 of qualified dividends, and
$4,944 of interest income for 2008. Respondent concedes that petitioners are
entitled to additional capital losses of $30,772 for 2008.
17
On Form 4089, Notice of Deficiency--Waiver, attached to the notice of
deficiency, respondent states:
Since all or part of the underpayment of tax for the taxable years
ended December 31, 2006, December 31, 2007, and December 31,
2008 is attributable to one or more of (1) negligence or disregard of
rules or regulations, (2) any substantial understatement of income tax,
or (3) any substantial valuation overstatement, an addition to the tax
is charged as provided by Section 6662(a) of the Internal Revenue
Code. The penalty is twenty (20) percent of the portion of the
underpayment of tax attributable to each component of this penalty.
In addition, interest is computed on this penalty from the due date(s)
of the returns, including any extensions.
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the facts to increase the accuracy-related penalty from 20% to 40%; however,
respondent never filed such motion.
Rule 41(a) provides that, when more than 30 days have passed after an
answer has been served, “a party may amend a pleading only by leave of Court or
by written consent of the adverse party, and leave shall be given freely when
justice so requires.” Whether a party may amend his pleading lies within the
sound discretion of the Court. Estate of Quick v. Commissioner, 110 T.C. 172,
178 (1998). In determining whether to allow a proposed amendment, the Court
must consider, among other things, whether an excuse for the delay exists and
whether the opposing party would suffer unfair surprise, substantial
inconvenience, or other prejudice. See Foman v. Davis, 371 U.S. 178, 182 (1962).
The Court looks with disfavor on untimely requests for amendment that, if
granted, would prejudice the other party. See, e.g., Farr v. Commissioner, 11 T.C.
552, 566-567 (1948), aff’d sub nom. Sloane v. Commissioner, 188 F.2d 254 (6th
Cir. 1951).
Respondent has not explained his delay in asserting the section 6662(e) and
(h) penalties. In his pretrial memorandum respondent indicates that he anticipates
filing a motion to amend the pleadings to assert the substantial and/or gross
valuation misstatement penalties. Without further explanation respondent argues
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in his pretrial memorandum that petitioners are liable for substantial and/or gross
valuation misstatement penalties. However, at no time did respondent file a
motion with this Court requesting leave to amend his answer as required by our
Rules. Accordingly, we will not consider respondent’s assertion of substantial
and/or gross valuation misstatement penalties under section 6662(e) or (h).
In reaching our decision, we have considered all arguments made by the
parties, and to the extent not mentioned or addressed, they are irrelevant or
without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.