T.C. Memo. 2020-115
UNITED STATES TAX COURT
COTTONWOOD PLACE, LLC, HUGH F. SMISSON, III,
TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14076-17. Filed August 4, 2020.
Charles E. Hodges II, Antoinette G. Ellison, and Aditya Shrivastava, for
petitioner.
Christopher D. Bradley, Jason P. Oppenheim, and John T. Arthur, for
respondent.
MEMORANDUM OPINION
KERRIGAN, Judge: This case is before the Court on respondent’s motion
for partial summary judgment. On March 27, 2017, respondent issued a notice of
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[*2] final partnership administrative adjustment (FPAA) for tax year 2009 to Hugh
F. Smisson III, as tax matters partner for Cottonwood Place, LLC (Cottonwood).
In the FPAA respondent disallowed a $4,592,000 deduction for a noncash
charitable contribution and asserted a gross valuation misstatement penalty
pursuant to section 6662(h), or in the alternative, a penalty pursuant to section
6662(a).
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the year at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
Respondent contends that the extinguishment clause in Cottonwood’s deed
of conservation easement violates the requirements of section 1.170A-14(g)(6)(ii),
Income Tax Regs. Petitioner, by contrast, contends that respondent’s
interpretation of the regulation is incorrect or, alternatively, if respondent’s
interpretation is found to be correct, that the regulation is invalid. Petitioner
further contends that Cottonwood substantially complied with the requirements of
the regulation.
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[*3] Background
There is no dispute as to the following facts drawn from the parties’ motion
papers and attached exhibits. When the petition was filed, Cottonwood’s principal
place of business was in Georgia.
On August 9, 2007, HRH Investments, LLC (HRH), purchased from
Augusta Woodlands, LLC, a 1,490-acre tract of land in Effingham County,
Georgia. The deed for the purchase was recorded in Effingham County. HRH
subdivided the property into smaller parcels and contributed 140.56 acres
(property) to Cottonwood in December 2008.
On December 31, 2009, Cottonwood granted a conservation easement of
135.56 acres of the property to the Georgia Land Trust, Inc., by deed recorded in
Effingham County. The deed includes provisions for the distribution of proceeds
in the event of extinguishment or condemnation. If the easement is terminated or
extinguished by judicial proceedings or condemnation, “[t]he amount of the
proceeds to which Grantee shall be entitled, after the satisfaction of any and all
prior claims, shall be determined, unless otherwise provided by Georgia law at the
time, in accordance with the Proceeds paragraph below.” If the easement is taken,
in whole or part, by the exercise of eminent domain, the Grantee shall be entitled
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[*4] to compensation in accordance with applicable law and the proceeds
paragraph included in the deed.
Paragraph 19 of the deed, referred to as the proceeds paragraph, provides
that the conservation easement grants a real property interest immediately vested
in the grantee. The proceeds paragraph states in pertinent part:
As required under Treas. Reg. § 1.170A-14(g)(6)(ii), the parties
stipulate to have a current fair market value determined by
multiplying the fair market value of the Property unencumbered by
this Conservation Easement (minus any increase in value after the
date of this Conservation Easement attributable to improvements) by
the ratio of the value of the Conservation Easement at the time of this
conveyance to the value of the Property at the time of this conveyance
without deduction for the value of the Conservation Easement. The
value of this Conservation Easement at the time of this conveyance,
and the value of the Property at the time of this conveyance without
deduction for the value of the Conservation Easement, shall be
determined according to that certain Property Appraisal Report, on
file at the office of the Grantee, prepared on behalf of Grantor to
establish the value of the gift of this Conservation Easement. The
values at the time of this Conservation Easement shall be those values
used to calculate the deduction for federal income tax purposes
pursuant to § 170(h) of the Code.
In the deed Cottonwood reserved specific rights for forestry and other
agricultural purposes. The reserved rights include the right to construct a limited
number of improvements, including driveways, utilities, an irrigation system, and
a pond. The deed provides the grantor with the right to construct and maintain one
pond that is under four acres.
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[*5] Discussion
Summary judgment may be granted where the pleadings and other materials
show that there is no genuine dispute as to any material fact and that a decision
may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v.
Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). The
burden is on the moving party to demonstrate that there is no genuine dispute as to
any material fact and that the party is entitled to judgment as a matter of law. FPL
Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74-75 (2001). After reviewing
the pleadings and the motion with accompanying exhibits, we conclude that a
decision may be rendered as a matter of law.
I. Qualified Conservation Contribution
Section 170(a)(1) allows a deduction for any charitable contribution made
within the taxable year. If the taxpayer makes a charitable contribution of
property other than money, the amount of the contribution is generally equal to the
fair market value (FMV) of the property at the time the gift is made. See sec.
1.170A-1(c)(1), Income Tax Regs.
The Code generally restricts a taxpayer’s charitable contribution deduction
for the donation of “an interest in property which consists of less than the
taxpayer’s entire interest in such property”. Sec. 170(f)(3)(A). However, there is
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[*6] an exception to this rule for a “qualified conservation contribution.” Sec.
170(f)(3)(B)(iii). This exception applies to a “qualified conservation
contribution”, which is a contribution of a qualified real property interest to a
qualified organization exclusively for conservation purposes. Sec. 170(h)(1).
Section 170(h)(5)(A) provides that a contribution will not be treated as
being made exclusively for conservation purposes “unless the conservation
purpose is protected in perpetuity.” The accompanying regulation recognizes that
“a subsequent unexpected change in the conditions surrounding the [donated]
property * * * can make impossible or impractical the continued use of the
property for conservation purposes”. Sec. 1.170A-14(g)(6)(i), Income Tax Regs.
In these circumstances the conservation purpose can be treated as protected in
perpetuity if the restrictions are extinguished by judicial proceeding and the
easement deed ensures that the charitable donee, following the sale of the
property, will receive a proportionate share of the proceeds and use those proceeds
consistently with the conservation purposes underlying the original gift. Id. This
results in the satisfaction of the “perpetuity” requirement because the sale
proceeds replace the easement as an asset deployed by the donee “exclusively for
conservation purposes”. Sec. 170(h)(5)(A); see also Oakbrook Land Holdings,
LLC v. Commissioner, 154 T.C. ___, ___ (slip op. at 7) (May 12, 2020).
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[*7] Section 1.170A-14(g)(6)(ii), Income Tax Regs., specifies that the donee’s
share of proceeds is as follows:
[F]or 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. * * * For purposes of this paragraph * * *, that
proportionate value of the donee’s property rights shall remain
constant. 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,
unless state law provides that the donor is entitled to the full proceeds
***.
To meet the requirements of section 1.170A-14(g)(6)(ii), Income Tax Regs.
(proceeds regulation), the deed must guarantee that the donee will receive “a
proportionate share of extinguishment proceeds”. Carroll v. Commissioner, 146
T.C. 196, 219 (2016); see PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193,
207 (5th Cir. 2018) (“[T]he ‘proportionate value’ is a fraction equal to the value of
the conservation easement at the time of the gift, divided by the value of the
property as a whole at that time.”).
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[*8] Respondent contends that the deed violates the proceeds regulation because
it provides that the portion of proceeds required to be allocated to the donee in the
event of an extinguishment shall be reduced by the value of improvements to the
land made by Cottonwood after the grant of the easement. The proceeds
regulation specifically states that the donee “must be entitled to a portion of the
proceeds at least equal to that proportionate value”. Sec. 1.170A-14(g)(6)(ii),
Income Tax Regs. The word “must” clearly requires that the donee receive at least
the proportionate value. PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d at 208.
The regulation does not permit that “any amount, including that attributable
to improvements, may be subtracted out” of the proceeds. Id.; see also Coal Prop.
Holdings, LLC v. Commissioner, 153 T.C. 126, 138 (2019). Since the deed
reduces the donee’s share of the proceeds by reducing the FMV of the
unencumbered property at the time of sale by any increase in value attributable to
posteasement improvements before applying the proportionate distribution
percentages, the conservation purpose is not protected in perpetuity. See sec.
170(h)(5)(A); sec. 1.170A-14(g)(6)(ii), Income Tax Regs.; see also PBBM-Rose
Hill, Ltd. v. Commissioner, 900 F.3d at 208; Coal Prop. Holdings, LLC v.
Commissioner, 153 T.C. at 145.
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[*9] II. Validity of Proceeds Regulation
Petitioner contends that the proceeds regulation is invalid under the criteria
established by Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837
(1984). He raises substantive challenges to the regulation. In Oakbrook Land
Holdings, LLC v. Commissioner, 154 T.C. at ___ (slip op. at 26-33), we upheld
the substantive validity of the proceeds regulation.
Petitioner contends that respondent’s interpretation of the proceeds
regulation is not entitled to deference under Auer v. Robbins, 519 U.S. 452, 461
(1997). We concluded in Oakbrook Land Holdings, LLC v. Commissioner, T.C.
Memo. 2020-54, at *25 (quoting Kisor v. Wilkie, 588 U.S. ___, ___, 139 S. Ct.
2400, 2415 (2019)), that “we see no need to rely on the Auer deference because
the ‘traditional tools of construction’ lead us to hold that the Commissioner’s
construction of the regulation is correct even if we look at the question de novo.”
Petitioner further contends that the proceeds regulation violates the first part
of the two-part inquiry established by Chevron. The first part is to inquire
“whether Congress has directly spoken to the precise question at issue.” Chevron,
467 U.S. at 842. In Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C.
at ___ (slip op. at 26), we concluded that Congress did not specifically address the
allocation of extinguishment proceeds. Petitioner argues that our analysis under
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[*10] the first part of Chevron requires reconsideration because the interpretation
of the proceeds regulation as we have upheld contradicts the basic income tax
principles created by Congress. We disagree.
Petitioner also argues that the proceeds regulation violates the second part
of the two-part inquiry in Chevron, which is whether the regulation “is based on a
permissible construction of the statute.” Chevron, 467 U.S. at 843. He contends
that the proceeds regulation exceeds the IRS’ statutory authority because there are
existing Federal tax laws which already address involuntary conversions.
Specifically, petitioner refers to sections 1001, 1011, 1012, 1031, and 1033.
Sections 1001, 1011, and 1012 address the general principles of computing gain or
loss and determining basis in general. Section 1031 provides rules for the tax
treatment of exchanges of real property held for productive use or investment.
Section 1033(a) addresses taxation of involuntary conversions which occur when a
property “(as a result of its destruction in whole or in part, theft, seizure, or
requisition or condemnation or threat or imminence thereof) is compulsorily or
involuntarily converted”. These Code sections address principles of tax law that
differ from section 170, which addresses the requirements for a charitable
contribution deduction.
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[*11] Deductions are a matter of legislative grace, and therefore, the taxpayer
needs to meet the requirements of the statute to be entitled to the deduction.
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). The Code sections that
petitioner cites do not address the requirements for claiming a charitable
contribution deduction for a conservation easement. The proceeds regulation
addresses the requirement that a conservation purpose be protected in perpetuity.
See sec. 170(h)(5); sec. 1.170A-14(g)(6)(ii), Income Tax Regs. We agree with our
conclusion in Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___
(slip op. at 26-32) that Congress has not spoken directly to the extinguishment of
conservation easements and that the proceeds regulation is a permissible
construction of the statute.
III. Petitioner’s Additional Arguments
A. Georgia Law
The proceeds regulation entitles the donee to a proportionate share of
postextinguishment proceeds “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.” Sec. 1.170A-14(g)(6)(ii), Income Tax Regs.
Petitioner argues that Georgia law allocates the full amount of any extinguishment
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[*12] proceeds to the donor, citing Anderson v. Lynch, 3 S.E.2d 85 (Ga. 1939),
rendering the proceeds regulation inapplicable in this case.
Anderson involved contiguous parcels of land each subject to a mutually
restrictive covenant limiting the parcels to residential use. One of the parcels was
being taken by Fulton County for use as a public road, a nonresidential use. The
court held that the owners of the neighboring lots had no compensable interest
because they held no property interest in the lot being taken by Fulton County. Id.
at 89. The court concluded that the mutually restrictive covenant does not create a
property right entitling the neighboring property owners to compensation in a
condemnation proceeding of the servient estate but that, “[t]he most that can be
said is that the restrictive covenants * * * are enforceable as between parties
thereto and their successors with notice.” Id.
Petitioner contends that a conservation easement is a “negative” easement
and as such, should be treated as a restrictive covenant in accordance with Davista
Holdings, LLC v. Capital Plaza, Inc., 741 S.E.2d 266, 269 (Ga. Ct. App. 2013).
He argues that conservation easements do not create a property interest under
Anderson and that donees of conservation easements are therefore not entitled to
compensation from a sale following a condemnation proceeding.
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[*13] We do not find petitioner’s argument compelling. Petitioner does not cite
any Georgia authority that extends the principles of Anderson to conservation
easements held by charitable organizations. On the contrary Georgia has enacted
the Uniform Conservation Easement Act with minor modifications, see Ga. Code
Ann. secs. 44-10-1 to 44-10-8 (2003), which appears to support public policy in
favor of conservation easements.
The court in Anderson held that the plaintiffs owned no property interest in
the land sought to be condemned. Here, the deed explicitly provides that “this
Conservation Easement constitutes a real property interest, immediately vested in
Grantee.” See sec. 1.170A-14(g)(6)(ii), Income Tax Regs. (requiring donor to
agree that the easement “gives rise to a property right, immediately vested in the
donee organization”). We rejected a similar argument in Belair Woods, LLC v.
Commissioner, T.C. Memo. 2020-112, at *18-*21.
B. Substantial Compliance
Petitioner argues that an alternative reason to deny respondent’s motion for
partial summary judgment is that Cottonwood “substantially complied” with the
requirements of the proceeds regulation. This argument also fails.
This Court has previously held that “a donor must show strict, and not
substantial, compliance with the perpetuity requirements of the regulation. * * *
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[*14] Substantial compliance does not work here.” Oakbrook Land Holdings,
LLC v. Commissioner, at *37-*38 (citing Kaufman v. Commissioner, 134 T.C.
182, 186 (2010) (finding 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” their obligation to the land trust), vacated in
part by 687 F.3d 21 (1st Cir. 2012)).
C. Improvements
Finally, petitioner argues that partial summary judgment is not appropriate
because a question of fact remains as to whether the improvements authorized by
the deed would increase the value of the property. He argues that none of the
reserved improvements could increase the value of the property and that the deed
satisfies the requirements of the proceeds regulation because there would be no
improvements value to subtract from any extinguishment proceeds. We do not
agree.
The U.S. Court of Appeals for the Fifth Circuit explicitly held that the
proceeds regulation’s meaning is unambiguous as to improvements: Their value
cannot be subtracted. See PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d
at 208. Here, the deed explicitly allows for improvements to be made to the
property and allows any value derived from those improvements to be subtracted
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[*15] from the proceeds of a judicial extinguishment before the donee receives its
share of those proceeds. Whether those improvements will add value to the
property at some point “in perpetuity” is an unknowable speculation and not a
question of fact for this Court to address. We rejected a similar argument in Belair
Woods, LLC v. Commissioner, at *18 n.7.
IV. Conclusion
The deed granting the conservation easement reduces the donee’s share of
the proceeds in the event of extinguishment by the value of improvements made
by the donor. Accordingly, it does not satisfy the perpetuity requirement of
section 170(h)(5)(A). Furthermore, we reject petitioner’s challenge to the validity
of the proceeds regulation and conclude that the construction of section 170(h)(5)
as set forth in section 1.170A-14(g)(6), Income Tax Regs., is valid under Chevron.
See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___ (slip op.
at 26-33).
We will grant respondent’s motion for partial summary judgment. We have
considered all of the arguments made by the parties, and to the extent not
mentioned above, we conclude that they are moot, irrelevant, or without merit.
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[*16] To reflect the foregoing,
An appropriate order will be issued.