Glade Creek Partners, LLC, Sequatchie Holdings, LLC, Tax Matters Partner v. Commissioner

T.C. Memo. 2020-148

UNITED STATES TAX COURT

GLADE CREEK PARTNERS, LLC, SEQUATCHIE HOLDINGS, LLC, TAX
MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 22272-17. Filed November 2, 2020.

Gregory P. Rhodes, David M. Wooldridge, Ronald A. Levitt, and Michelle

A. Levin, for petitioner.

W. Benjamin McClendon, Amber B. Martin, and William W. Kiessling, for

respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GOEKE, Judge: In 2012 Glade Creek Partners, LLC (Glade Creek),

donated a conservation easement on 1,313 acres of undeveloped real estate on the

Cumberland Plateau in Bledsoe County, Tennessee, and claimed a $17.5 million
 -2-

[*2] charitable contribution deduction (easement deduction) for its short tax period

November 30 to December 31, 2012 (December 31, 2012, short tax period).1 The

land was part of a failed residential development. Glade Creek acquired the land

in a transaction intended to rescue the developers from debt associated with the

failed development. The primary issue is whether Glade Creek is entitled to the

easement deduction under the technical requirements of section 170. We hold it is

not. We hold that the deed of easement does not protect the conservation purposes

in perpetuity as required by section 170(h)(5). We hold further that Glade Creek

is entitled to deduct a $35,077 cash charitable contribution that respondent

denied.2

Respondent asserts a 40% penalty under section 6662(e) and (h) for a gross

valuation misstatement on the basis of the reported value of the easement and,

alternatively, with respect to Glade Creek’s misstatement of the value of the

charitable contribution, a 20% penalty under section 6662(a) and (b)(1), (2), and

1
All section references are to the Internal Revenue Code in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. Some dollar amounts and the acreage of land parcels are rounded.
2
Petitioner contends that it has produced credible evidence regarding the
deductibility and the value of the easement contribution and the burden of proof
has shifted to respondent under sec. 7491(a)(1). We decide the issues here on the
basis of the record and the preponderance of the evidence and find the sec. 7491
issue moot.
 -3-

[*3] (3) for negligence or disregard of rules or regulations, a substantial

understatement of income tax, or a substantial valuation misstatement. We sustain

the 20% accuracy-related penalty for a substantial valuation misstatement in

excess of the easement’s fair market value, which we determine to be $8,876,771.

We do not impose a 20% penalty on the remainder of the adjustment.

FINDINGS OF FACT

Glade Creek is a Georgia limited liability company (LLC) and has elected

partnership status for Federal tax purposes. When the petition was timely filed, its

principal place of business was in Georgia.

I. History of the Property

In January 2006 International Land Co. (ILC) purchased 1,997.25 acres of

land in Bledsoe County (Bledsoe property) for over $9 million in a seller-financed

arrangement. ILC planned to subdivide and market lots on 1,993 acres of the

Bledsoe property in separate phases to out-of-State purchasers for the construction

of vacation homes.3 The first phase of ILC’s plan was tract I, a 677-acre parcel

with 415 lots, and subsequent phases were tracts II and III, noncontiguous parcels

connected by tract I, of 630.4 and 685.5 acres, respectively, with 391 more lots.

3
Approximately 4 acres of the 1,997-acre Bledsoe property were not part of
ILC’s development.
 -4-

[*4] The easement property is 1,312 acres of tracts II and III; 4 acres are not

subject to the easement.

When ILC purchased the Bledsoe property, it was undeveloped, with rolling

mountains and level, buildable areas, forests, streams, ponds, waterfalls, and four

miles of bluffs overlooking the Sequatchie Valley. The property required

significant infrastructure to support a residential development, including improved

hydraulic capacity for water service, electrical infrastructure, and roads. The

property was serviced with one low-current electrical power line typical in rural

areas and no interior roads. Also, the local water authority did not have a

sufficient water supply to support a residential community. The surrounding area

was primarily used for agriculture or recreation. Nearby commercial development

was limited; it included restaurants, grocery stores, a pharmacy, a small hospital,

service stations, and limited retailers. There was also a State prison nearby.

ILC was owned by a small group of out-of-State developers. Before

purchasing the land, ILC sought the advice of a local businessman, James Vincent,

on its development potential. Mr. Vincent was a local real estate investor and had

contacts with local government officials to facilitate the project from his time as a

commissioner of a nearby county where he served on the planning commission

and as a State representative. After ILC purchased the land Mr. Vincent became
 -5-

[*5] highly involved in the development project. He assisted with procuring

permits from State and local governments, utility contracts, and bank financing.

He invested a considerable amount of his own money in the infrastructure and

personally guaranteed ILC’s bank loans. At first Mr. Vincent did not have a

financial interest in the development, but ILC later agreed to compensate him for

his services and reimburse his expenses with a percentage of its profits.

ILC obtained permits and approvals with respect to all three tracts.

However, development was limited to 50 acres at any time of residential

construction by individual lot buyers to minimize the disruption to the land. The

approval process involved testing the soil for its suitability for construction,

including water absorption. ILC obtained a 25-year contract from a nearby water

authority for a water supply sufficient to support development of all three tracts. It

spent $1.2 million to construct a pump station to provide hydraulic pressure to

transport the water to the Bledsoe property and $2 million to install water main

pipes from the pump station throughout tract I. It paved roads throughout tract I.

It installed electrical infrastructure that could service a residential development on

all three tracts. Electricity would be connected to individual lots when home

construction began. The improved water lines, roads, and electrical lines extended

to the borders of tracts II and III for the later planned development of those tracts.
 -6-

[*6] Overall, ILC spent approximately $6 million on the infrastructure and

approval process.

In March 2007 ILC recorded the planned lots on tract I and easements along

creeks and waterfalls and placed restrictions on the cutting and clearing of timber.

It did not record the lots on tracts II and III. It planned to market tracts II and III

after tract I lots sold out. Mr. Vincent believed that recording the lots would

increase property tax. ILC began sales of tract I lots in March 2007, selling 75

lots in 2007 and 46 lots in 2008. Lots with bluff views sold for as much as

$150,000. Sometime in 2009 ILC stopped marketing the lots because it ran out of

money, causing sales to slow dramatically; it sold only nine lots in 2009. Facing

slow sales, a depressed real estate market, and substantial debt, the investors faced

enormous pressure and uncertainty. One investor walked away. The remaining

investors and Mr. Vincent devised a plan to transfer the unsold lots in tract I and

all of tracts II and III to Mr. Vincent and two members of ILC. Mr. Vincent was

not a member of ILC but had invested substantial amounts of time and money in

the project and had personally guaranteed ILC’s bank loans.

In April 2010 the three men organized Hawks Bluff Investment Group, Inc.

(Hawks Bluff), an S corporation, as equal owners, and acquired the remaining

unsold land by warranty deed in exchange for the assumption of ILC’s liabilities.
 -7-

[*7] Initially, the three men made equal monthly payments on the debt (Hawks

Bluff debt), which totaled $33,000 per month. A short time later one stopped

making payments and surrendered his interest in exchange for the two remaining

members, Mr. Vincent and Mr. Tague, assuming his share of the debt and

releasing him from liability. The prospects of the development continued to

worsen. Messrs. Vincent and Tague struggled to make debt payments. Without

any marketing Hawks Bluff sold only two lots during 2010 and 2011 and no lots

in 2012. In April 2011 Hawks Bluff entered into a mortgage modification

agreement that paid off $2.1 million of the remaining $5.2 million unpaid purchase

price to the original seller of the Bledsoe property through a land transfer to the

mortgagee and the issuance of two promissory notes and the mortgagee’s

agreement to reduce the outstanding debt by an additional $1.3 million “in

consideration of the downturn in the economy and the difficulty encountered * * *

in marketing the Hawks Bluff Subdivision”. After this modification, Hawks Bluff

owed $1.8 million to the original seller and had approximately $3.3 million in total

debt. Mr. Vincent worried about the possibility that Mr. Tague would stop paying

his share of the Hawks Bluff debt especially since Mr. Vincent had personally

guaranteed a considerable portion of the loans for the infrastructure. Mr. Vincent
 -8-

[*8] was not certain that he could fund the monthly debt payments for an extended

time if Mr. Tague stopped making payments.

In his efforts to find a financing solution, Mr. Vincent learned about

conservation easements from the president of the bank that held the infrastructure

loans. At the bank president’s suggestion, Mr. Vincent sought advice from

Matthew Campbell about donating a conservation easement on the Bledsoe

property to raise money to repay the debt. Mr. Vincent also considered harvesting

timber from the land and selling the land to a developer, most likely through fire

sales of 5- to 15-acre parcels. He believed that these two options would have

raised enough money to repay the Hawks Bluff debt. However, for Mr. Vincent,

neither option would satisfy his desire to protect the Cumberland Plateau and the

natural beauty of the Bledsoe property. He did not want to sell to a developer who

would use it for a mobile home community, recreational vehicle park, or other

environmentally insensitive development. He believed that these types of

developments would negatively affect the development on tract I, which Hawks

Bluff would continue to own and market the unsold lots. He also felt a duty to the

individuals who had purchased tract I lots to maintain the original vision of ILC’s

plan. He had no desire to develop the land himself.
 -9-

[*9] II. Easement Transaction

Mr. Vincent decided to pursue a conservation easement on tracts II and III.

Mr. Campbell understood that the goal was to raise enough money to repay the

Hawks Bluff debt and designed the easement transaction with that goal in mind.

He designed the easement transaction to occur through two newly organized

entities, one to hold the easement property, Glade Creek, and the second,

Sequatchie Holdings, LLC (Sequatchie), to promote the easement transaction to

investors. Sequatchie would use the proceeds from its private offering to purchase

a majority membership interest in Glade Creek and then vote to grant the

conservation easement. Mr. Campbell set the offering price for Sequatchie to raise

enough money to repay the Hawks Bluff debt and did not consider the property’s

fair market value. The debt was repaid before the easement’s grant.

Mr. Vincent believed that the land was worth substantially more than what

Sequatchie paid for its Glade Creek interest. However, the transaction

accomplished his primary goal, to repay the Hawks Bluff debt while preserving

the land and protecting the original vision of the development. In Mr. Vincent’s

opinion the easement transaction was the only option that satisfied all his

objectives. He was proud of the conservation easement but did not understand the
 - 10 -

[*10] specifics of the easement transaction. Hawks Bluff retained the unsold lots

in tract I and continued to sell them. In 2015 it sold 24 lots.

Glade Creek was organized on August 3, 2012. Hawks Bluff owned 98%,

and Messrs. Tague and Vincent each owned 1%. Hawks Bluff contributed the

easement property subject to a $1,776,000 mortgage. Glade Creek had a carryover

basis in the land of $3,861,316. Messrs. Vincent and Tague each contributed

$1,000 and a promissory note for $36,500. Sequatchie was organized on August

12, 2012. Evrgreen Capital Administration, LLC (Evrgreen), was Sequatchie’s

managing member and tax matters partner. Mr. Campbell is Evrgreen’s founder

and became Glade Creek’s manager as part of the easement transaction. After the

transaction, Sequatchie was Glade Creek’s tax matters partner. Evrgreen manages

about 30 entities similar to Sequatchie that sold membership interests to investors

by promoting charitable contribution deductions for conservation easements.

As Sequatchie’s and Glade Creek’s manager, Mr. Campbell engaged the

professionals necessary to complete the easement transaction, including a

brokerage firm, Dempsey Lord Smith, LLC (Dempsey Lord Smith), a securities

lawyer, Michael Horten, for assistance with the private offering, and Tim Pollock

of Morris, Manning, & Martin, LLP, for tax advice on the easement deduction.

Mr. Pollock reviewed the deed to ensure that it complied with section 170(h). He
 - 11 -

[*11] had the relevant information necessary to offer his professional opinion and

advised that the easement donation would qualify for a charitable contribution

deduction. Mr. Campbell also engaged two appraisers, Claud Clark III and James

Clower, to value tracts II and III for the private offering. Mr. Campbell prepared a

restricted report dated October 26, 2012, of the value of the easement without

visiting the easement property. He used a before and after valuation method

which valued the easement property unencumbered by the easement and used for a

hypothetical development similar to ILC’s project (before value) and valued the

property restricted by the easement (after value).

On November 29, 2012, Sequatchie entered into an agreement with the

members of Glade Creek to purchase one Glade Creek interest for each Sequatchie

interest issued in its private offering up to 3,363,000 interests. Glade Creek

members would sell their interests on the basis of their relative ownerships. That

same day, Sequatchie issued a private placement memorandum (PPM) offering

membership interests for $1 each.4 The PPM set a minimum and a maximum

number of interests for sale at 3,186,000 and 3,363,000, respectively, which would

4
Dempsey Lord Smith, Mr. Pollock, and Mr. Horten drafted the PPM.
 - 12 -

[*12] result in Sequatchie’s ownership of 90% to 95% of Glade Creek.5 The PPM

states that the purpose of the offering was to raise funds to purchase Glade Creek

and that Glade Creek owns 1,316 acres of undeveloped land. It identifies three

options for the land: holding it for future appreciation or future development or

granting a conservation easement on all or part of the land. It contains 10 pages

discussing Federal tax considerations and 5 pages discussing tax risks from an

easement deduction including audit risks and the speculative nature of valuations.

It does not analyze the potential benefits or risks from developing or holding the

property. It estimates that the conservation easement would generate a charitable

contribution deduction of $17.7 million on the basis of Mr. Clark’s appraisal.

Before the PPM, Dempsey Lord Smith issued an offering overview promoting the

$17.7 million deduction which lists the tax benefits for different investment

amounts; for example, a $250,000 investment would generate a $1.25 million

charitable contribution deduction.

Sequatchie sold 3,224,400 interests. On December 27, 2012, it purchased

3,224,000 interests in Glade Creek and paid out the subscription proceeds as

follows: $1,776,000 for repay of the Hawks Bluff debt, $504,954 for payment to

5
Members could put their interests back to Sequatchie for three cents per
unit beginning on January 1, 2017.
 - 13 -

[*13] Glade Creek’s members for their interests, $300,000 for Evrgreen’s

management fees, $77,400 for legal and escrow fees, $290,196 for broker fees,

$24,750 for miscellaneous expenses, and $225,000 for Glade Creek’s capital

reserves. Sequatchie retained $26,000 for working capital reserves.

III. Grant of Easement

On December 29, 2012, two days later, Glade Creek granted a conservation

easement to the Atlantic Coast Conservancy, Inc. (Conservancy), on 1,313 acres of

tracts II and III.6 The deed of easement states that the easement is intended to

preserve open space for wildlife habitats threatened by development and provide

significant public benefit, scenic views of the Cumberland Plateau, and

agricultural land. It states that the easement property “will be retained forever

predominantly in its natural condition” and the easement will “prevent any use

* * * that will materially impair or interfere with the Conservation Values”. The

deed grants enforcement rights to the Conservancy so that it can protect the

easement property and prevent uses inconsistent with the conservation values.

The deed contains nonexclusive lists of prohibited and permitted uses.

Glade Creek reserved the right to engage in all uses not expressly prohibited by

the deed that are consistent with the easement’s conservation purposes. Prohibited

6
Three acres, 1.5-acres on each tract, are not subject to the easement.
 - 14 -

[*14] uses include the change, disturbance, or impairment of the natural habitat,

construction of buildings, structures, and roads, removal, cutting, or destruction of

natural vegetation, and exploration or extraction of minerals, oil, gas, or other

materials. Permitted uses include agriculture and the construction of a single-

family dwelling, accessory buildings, access roads, fences, a subsistence garden,

hunting stands and platforms, and trails. Construction of the dwelling and

accessory buildings is expressly conditioned on 30 days’ written notice to the

Conservancy and before commencing construction. The Conservancy has 30 days

to grant or withhold its approval on the basis of its informed judgment about the

construction’s impact on the easement property, and if it does not timely respond,

approval is deemed given (default provision).7 The deed expressly states that

Glade Creek may engage in the other enumerated permitted uses without prior

written notice or approval.

The deed addresses the involuntary extinguishment of the conservation

easement and allocates any proceeds from an extinguishment as follows:

[T]his Easement shall have at the time of Extinguishment a fair
market value determined by multiplying the then fair market value of

7
The deed provides for a liberal construction of its terms, which is relevant
when interpreting an ambiguous provision: “Any general rule of construction to
the contrary notwithstanding, this Easement shall be reasonably construed in favor
of the grant to affect [sic] the Purpose of this Easement”.
 - 15 -

[*15] the Easement Area unencumbered by the Easement (minus any
increase in value after the date of this grant attributable to
improvements) by the ratio of the value of the Easement at the time of
this grant to the value of the Easement Area, without deduction for
the value of the Easement, at the time of this grant. The Conservation
Values at the time of this grant shall be those Conservation Values
used to calculate the deduction for federal income tax purposes
allowable by reason of this grant, * * * [and] the ratio * * * shall
remain constant.

Thus, the deed subtracts from the extinguishment proceeds any increase in the fair

market value of the easement property attributable to posteasement improvements

before determining the Conservancy’s share.

At the time of the easement’s grant the easement property had an assessed

value of approximately $2.2 million. County records show that the property was

sold for $2.2 million and $4.8 million in August 2004 and January 2005,

respectively.

IV. Partnership Return

Glade Creek filed Form 1065, U.S. Return of Partnership Income, for its

December 31, 2012, short tax period (2012 return). Glade Creek reported a basis

in the easement property of $3,861,316 and claimed an easement deduction of

$17,504,000 and a cash contribution deduction of $40,077. Mr. Clark prepared a

second fair market appraisal of the easement property dated February 10, 2013,

that Glade Creek attached to the 2012 return (February 2013 appraisal). He
 - 16 -

[*16] determined the same before value, $18,486,892, as in his October 2012

report, but his after value, $787,752, differs by $552 because he corrected an

omission of .92 acres from the October 2012 report. The per-acre after values are

the same in both valuation reports, $600 per acre. On the basis of these figures

Mr. Clark appraised the easement at $17,504,000.

Respondent issued to petitioner a notice of final partnership administrative

adjustment (FPAA) asserting that Glade Creek was not entitled to deduct the

$17,504,000 easement donation or $35,077 of its cash donation and asserting a

40% section 6662(e) and (h) penalty with respect to the easement deduction and,

alternatively, a 20% penalty under section 6662(a) and (b)(1), (2), and (3) for

negligence or disregard of rules or regulations, a substantial understatement of

income tax, or a substantial valuation misstatement.

V. Expert Testimony

A. Petitioner’s Experts

Petitioner presented Mr. Norton as a land-use expert and Mr. Clark as a

valuation expert. Mr. Norton prepared a market study of economic trends, housing

demand, the target market, and regional attractions and amenities. He opined that

the highest and best use of the land before the easement’s grant was residential

development and after the easement’s grant, recreational use. He envisioned a
 - 17 -

[*17] resort-style community offering outdoor activities marketable to

multigenerational families as vacation homes. He opined that the easement

property had excellent development potential because of its bluff views, streams,

and flat buildable areas. He testified that the property was not too steep for

development and that the property’s easy access from three interstate highways,

the existing development approvals and infrastructure from ILC’s project, and its

proximity to three major Tennessee cities (Chattanooga, Knoxville, and

Nashville), commercial development, and a popular State park increased its

development potential.

As part of his testimony, Mr. Norton provided a concept plan for a

hypothetical development similar to ILC’s project with slight alterations for the

construction of two lakes, a community pool, and a pavilion area. He identified

five types of lots on the easement property: interior, nature view, bluff view,

premium bluff view, and lake front, and estimated a price range and average price
 - 18 -

[*18] for each lot type on the basis of the lot prices in seven nearby benchmark

residential communities (benchmarks):8

Lot type No. of lots Low High Average
Interior 187 $30,000 $70,000 $50,000
Nature view 88 45,000 80,000 62,500
Bluff view 41 70,000 130,000 100,000
Lake view 42 70,000 130,000 100,000
Premium bluff view 53 90,000 160,000 125,000

He calculated the combined price range and average prices for each lot type

for the seven benchmarks:

Lot type Low High Average
Standard $44,059 $100,945 $65,308
Premium 107,279 161,636 133,473

He did not adjust the lot prices for differing sizes of the lots.

Mr. Norton testified that a development on the easement property would

require aggressive marketing of the lots and upfront investments in community

amenities to attract buyers. He also recommended the construction of model

homes and for-sale homes to differentiate the hypothetical development from its

8
The benchmarks were Jasper Highlands, Cooley’s Rift, Brow Wood,
Fairfield Glade, Hawks Bluff Van Buren, Long Branch Lakes, and ILC’s tract I.
 - 19 -

[*19] competitors. He testified that lots would sell out within seven years and the

number of annual sales (absorption rate) over the seven-year absorption period

would follow a bell curve with sales increasing annually as the development is

built then decreasing in later years.

In his expert report Mr. Clark determined that the conservation easement

had a fair market value of $16,245,000, slightly less than the $17,504,000 value

that he determined in his February 2013 appraisal and that Glade Creek reported

on its 2012 return. Mr. Clark reviewed Mr. Norton’s market analysis and the sale

data of the benchmarks. For his before valuation he performed a discounted

cashflow analysis from the sale of lots in Mr. Norton’s hypothetical development

and determined a before value of $17,314,049. Mr. Clark agreed with Mr.

Norton’s vision of amenities, marketing, and model and for-sale homes. He priced

the lots using Mr. Norton’s average price for each lot type. His absorption rate

was also on a bell curve over seven years but had different annual sale numbers

with higher initial sales. Mr. Clark estimated gross revenues of $32,689,186,

adjusted for 3% to 4% annual appreciation of the unsold lots over the seven-year

absorption period.

Mr. Clark estimated the development costs by taking into account the cost

savings because of the existing approvals and infrastructure from ILC’s project.
 - 20 -

[*20] He estimated construction costs of $3.4 million to build two lakes, roads,

underground electricity, telephone, and waterlines, a pool, and other amenities and

$3.4 million in operating costs over the absorption period for sales commissions,

marketing, closing costs, property tax, and overhead. He also treated the

hypothetical developer’s profit as a line-item expense and calculated the

developer’s profit to be 15% of his estimated construction and operating expenses.

On the basis of his sales projections and estimated expenses, he calculated the

hypothetical development’s annual net revenues and applied a 11.25% discount

rate, resulting in a before value of $17,314,049.

Mr. Clark determined the easement property’s after value was $919,000

with an enhancement value of $150,000 for the acres not subject to the easement.

He opined that the easement had a fair market value of approximately

$16,245,000.

B. Respondent’s Expert

Respondent offered Ben Broome as an expert witness. Mr. Broome opined

that the highest and best use of the easement property before the easement’s grant

was rural residential, agricultural, and recreational. He opined that the easement

property had limited utility for residential development because of its steep

topography. He determined a before value of $1,200 per acre, $1,580,000.
 - 21 -

[*21] Mr. Broome used a comparable sales method to determine the before and

after values but testified that there were few sales of large acreage parcels near the

easement date. He identified seven properties as comparable to the easement

property (comparables) that yielded sale prices of $630 to $2,200 per acre. He

made qualitative adjustments to the sale prices to account for differences in the

topography, access, infrastructure, and location between each comparable and the

easement property. Five of the seven comparables were sold over four years

before the easement date. The closest sale was two years and nine months before

the easement date. However, Mr. Broome opined that no adjustment was

necessary for the time lapse. Three comparables were sold for their timber.

In his brief respondent mentions only three comparables as relevant:

Property Sale date Acres Price Per-acre price
Brock Rd. Feb. 24, 2010 875 $1,312,770 $1,500
Highway 70E May 6, 2009 5,833 4,104,000 704
Porch Rock Rd. Jan. 2, 2010 670 422,500 630

The Brock Rd. property had been logged before its sale, was accessible only

by an easement, and did not have any existing permits or approvals or a ready

supply of water to support development. The Highway 70E property was sold in

bankruptcy and was over four times the size of the easement property. The Porch
 - 22 -

[*22] Rock Rd. property was purchased by a logging company for its timber. Mr.

Broome’s highest priced comparable, Old CC Rd., is a 1,117-acre parcel

consisting of mountainous woodland and pastureland that sold for $2,200 per acre

in May 2008. Mr. Broome testified that Old CC Rd.’s pastureland makes it better

suited for residential development than the easement property.

To determine the after value Mr. Broome used a diminution in value method

that applies a percentage decrease to the before value. He applied a 40% decrease

in the value of the easement property after the easement’s grant. He relied on an

article published in 1998 that evaluated sales of agricultural easements in

California to determined the 40% decrease. At trial we struck the portion of his

report containing the after value analysis as not helpful.

OPINION

Section 170(a)(1) allows taxpayers to deduct charitable contributions made

within the taxable year. If the taxpayer makes a charitable contribution of

property other than money, the deduction is generally equal to the donated

property’s fair market value at the time of the donation. Sec. 1.170A-1(c)(1),

Income Tax Regs. Generally, a taxpayer is not entitled to deduct the donation of

“an interest in property which consists of less than the taxpayer’s entire interest”.

Sec. 170(f)(3)(A). An exception is made for a contribution of a partial interest in
 - 23 -

[*23] property that constitutes a “qualified conservation contribution.” Id.

subpara. (B)(iii). The exception applies where: (1) the taxpayer donates a

“qualified real property interest,” (2) the donee is “a qualified organization,” and

(3) the contribution is “exclusively for conservation purposes.” Id. subsec. (h)(1).

The donation must satisfy all three requirements. Irby v. Commissioner, 139 T.C.

371, 379 (2012). Respondent challenges Glade Creek’s easement deduction on

multiple grounds. We find that Glade Creek is not entitled to the easement

deduction because the contribution is not “exclusively for conservation purposes”.

We do not address respondent’s alternative arguments.9

I. Perpetuity Requirement

A contribution is “exclusively for conservation purposes” if its conservation

purpose is “protected in perpetuity.” Sec. 170(h)(5)(A) (perpetuity requirement).

9
Respondent makes two alternative arguments: (1) the deed fails the sec.
170(h)(5) perpetuity requirement on the basis of the default provision and (2) the
deed does not place a use restriction on the property in perpetuity as required by
sec. 170(h)(2) because a merger provision in the deed could terminate the
easement. In Hoffman Props. II, L.P. v. Commissioner, T.C. Dkt. No. 14130-15
(Mar. 14, 2018), aff’d, 956 F.3d 832 (6th Cir. 2020), we held that the donee did
not have sufficient legal rights to prevent inconsistent uses on the basis of a
default provision. This case differs in two ways: (1) the consent and default
provisions apply only to a single-family dwelling and not “all uses” as in Hoffman
Props. and (2) the deed in Hoffman Props. expressly stated that deemed consent
meant the use was not a violation of the deed; there is no such provision in the
deed here.
 - 24 -

[*24] The regulations interpreting section 170(h)(5) recognize that “a subsequent

unexpected change in the conditions surrounding the 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 such an event the

easement would not be protected in perpetuity. However, the regulation provides

a way for the perpetuity requirement to be deemed satisfied: “[T]he conservation

purpose can nonetheless be treated as protected in perpetuity if the restrictions are

extinguished by judicial proceeding” and the donee uses its share of the “proceeds

* * * from a subsequent sale or exchange of the property * * * in a manner

consistent with the conservation purposes of the original contribution.” Id.

Section 1.170A-14(g)(6)(ii), Income Tax Regs. (proceeds regulation),

requires that the donee’s share of the extinguishment proceeds be determined as

follows:10

[A]t 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. * * * [T]hat proportionate value
of the donee’s property rights shall remain constant. Accordingly,

10
We upheld the procedural and substantive validity of the proceeds
regulation in Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. __, __
(slip op. at 25, 28-31) (May 12, 2020).
 - 25 -

[*25] when a change in conditions gives rise to the extinguishment of a
perpetual conservation restriction * * * 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
***

The plain text of the proceeds regulation requires the donee to receive a

proportionate share of the extinguishment proceeds and does not permit the value

of any posteasement improvements to be subtracted out before determining the

donee’s share. Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 139

(2019) (holding that an easement deed with a nearly identical proceeds

computation failed the perpetuity requirement); Oakbrook Land Holdings, LLC v.

Commissioner, T.C. Memo. 2020-54, at *40-*41; see PBBM-Rose Hill, Ltd. v.

Commissioner, 900 F.3d 193, 208 (5th Cir. 2018).

The deed improperly subtracts any value attributable to posteasement

improvements from the extinguishment proceeds before determining the

Conservancy’s share. It does not properly allocate extinguishment proceeds to the

Conservancy in accordance with the proceeds regulation. The proceeds regulation

is not satisfied, and the easement’s conservation purposes are not protected in

perpetuity. Glade Creek is not entitled to the easement deduction.
 - 26 -

[*26] II. Cash Donation Deduction

Respondent argues that Glade Creek is not entitled to deduct a cash

contribution of $35,077 to the Conservancy because the escrow agent did not pay

the money to the Conservancy until January 2013. Petitioner argues that we

should treat the donation as made when Glade Creek paid the money at closing.

Ordinarily, a charitable contribution is made when its delivery is effected. Sec.

1.170A-1(b), Income Tax Regs. When delivery is effected through an agent acting

on behalf of the donee or donor, the critical question is whether the donor has

relinquished dominion and control. Fakiris v. Commissioner, T.C. Memo. 2017-

126, at *13-*14. Respondent argues that when an escrow is used for delivery,

conditions to delivery exist that must be satisfied before the delivery is effective.

See Short v. Commissioner, T.C. Memo. 1997-255, 1997 WL 305863, at *3-*4

(holding that the donor must make an irrevocable transfer of control over the

donated property); Parrott v. Parrott, 48 Tenn. (1 Heisk.) 681 (1870).

If the transfer of the charitable contribution depends on the performance of

some act or the happening of a precedent event to become effective, the taxpayer

is not entitled to a charitable contribution deduction unless the possibility that the

condition will not occur is so remote as to be negligible. Sec. 1.170A-1(e),

Income Tax Regs. Thus, a condition that is so remote as to be negligible is
 - 27 -

[*27] immaterial and does not preclude a finding that a transfer of control to the

donor occurred for purposes of the deductibility of the charitable contribution. Id.

A condition is so remote as to be negligible where “every dictate of reason would

justify an intelligent person in disregarding [it] as so highly improbable and

remote as to be lacking in reason and substance.” Briggs v. Commissioner, 72

T.C. 646, 657 (1979), aff’d without published opinion, 665 F.2d 1051 (9th Cir.

1981); see 885 Inv. Co. v. Commissioner, 95 T.C. 156, 161 (1990) (defining “so

remote as to be negligible” as “a chance which persons generally would disregard

as so highly improbable that it might be ignored with reasonable safety in

undertaking a serious business transaction” (quoting United States v. Dean, 224

F.2d 26, 29 (1st Cir. 1955))).

Irrespective of the use of an escrow agent, any conditions that existed at

closing were so remote as to be negligible. We find that Glade Creek relinquished

control upon payment of the $35,077 to the settlement agent at closing.

Respondent argues that we should infer that the settlement agent was Glade

Creek’s agent and material conditions existed before it would pay the $35,077 to

the Conservancy because petitioner did not introduce a copy of the escrow

agreement into evidence. See Wichita Terminal Elevator Co. v. Commissioner,
 - 28 -

[*28] 6 T.C. 1158, 1165 (1946) (inferring that unproduced evidence is unfavorable

to the party with possession over it), aff’d, 162 F.2d 513 (10th Cir. 1947). Under

the circumstances of this case, we find such an inference unwarranted. Ministerial

escrow tasks are generally not considered substantial limitations or restrictions on

a taxpayer’s receipt of funds and are not conditions precedent of the type that

precludes the transfer of control. SWF Real Estate LLC v. Commissioner, T.C.

Memo. 2015-63, at *83. The chance that the settlement agent would not pay the

escrowed funds to the Conservancy was so remote as to be negligible. Once the

funds were deposited into escrow, they were not under Glade Creek’s control.

Glade Creek had directed their payment to the Conservancy and could no longer

use or redirect the funds. We find that Glade Creek is entitled to deduct the

$35,077 donation for 2012.

III. Accuracy-Related Penalties

Respondent asserted a 40% penalty under section 6662(e) and (h) for a

gross valuation misstatement and, alternatively, a 20% penalty under section

6662(a) and (b)(1), (2), and (3) for negligence or disregard of rules or regulations,

a substantial understatement of income tax, or a substantial valuation

misstatement. The parties stipulated that respondent has complied with section

6751(b) for all asserted penalties. Only one accuracy-related penalty may be
 - 29 -

[*29] imposed on any given portion of an adjustment. Sec. 1.6662-2(c), Income

Tax Regs.

Taxpayers who meet the technical requirements for a charitable contribution

of a conservation easement may deduct the easement’s fair market value. Sec.

1.170A-1(c)(1), Income Tax Regs. A taxpayer makes a gross valuation

misstatement when it claims a value for the donated property that is 200% or more

of the correct amount. Sec. 6662(h). On its 2012 return Glade Creek claimed an

easement deduction of $17,504,000. If we find that the easement’s fair market

value is $8,752,000 or less, there is a gross valuation misstatement as the claimed

deduction is more than 200% of the correct amount. Reasonable cause is not

available as a defense to the gross valuation misstatement penalty for the

deduction of donated property but is a defense to the alternative penalties

respondent asserts. Sec. 6664(c)(3).

A. Valuation of Conservation Easement

The fair market value of property is the price at which it would change

hands between a willing buyer and a willing seller, neither being under any

compulsion to buy or sell and both having reasonable knowledge of relevant facts.

Sec. 1.170A-1(c)(2), Income Tax Regs. When there is a substantial record of sales

of comparable properties, we determine the donated property’s fair market value
 - 30 -

[*30] on the basis of the sale prices of those comparables. Sec. 1.170A-

14(h)(3)(i), Income Tax Regs. Because sales of conservation easements are rare,

the regulations authorize the use of a before and after valuation method to value

easements. Id. Under the before and after method, the easement’s fair market

value is the difference between the fair market value of the property

unencumbered by the easement (before value) and its fair market value after the

easement’s grant (after value). Id.; see Hilborn v. Commissioner, 85 T.C. 677,

688-689 (1985). When the donor owns additional property unencumbered by the

easement, the deduction is decreased for any enhancement to the value of the

unencumbered property as a result of the easement (enhancement value). Sec.

1.170A-14(h)(3)(i), Income Tax Regs.

An appraiser may use the comparable sales method or another accepted

method to estimate the before and after values. Hilborn v. Commissioner, 85 T.C.

at 689. Comparables must be similar in nature to the donated property and sold in

arm’s-length transactions within a reasonable time of the donation. Wolfsen Land

& Cattle Co. v. Commissioner, 72 T.C. 1, 19 (1979). It is appropriate to adjust the

sale price of a comparable to account for differences in the sale date and the size

or other features of the property. Id.
 - 31 -

[*31] We rely on expert opinions to assist us with the determination of fair market

value. Fed. R. Evid. 702. We evaluate expert opinions in the light of the experts’

demonstrated qualifications, the factors they considered to reach their conclusions,

and all other evidence in the record. See Parker v. Commissioner, 86 T.C. 547,

561 (1986); Casey v. Commissioner, 38 T.C. 357, 381 (1962). We are not bound

by an expert opinion and may accept or reject expert testimony, in part or in its

entirety, in the exercise of our sound judgment. Helvering v. Nat’l Grocery Co.,

304 U.S. 282, 295 (1938); Estate of Newhouse v. Commissioner, 94 T.C. 193, 217

(1990); Laureys v. Commissioner, 92 T.C. 101, 127 (1989).

1. Highest and Best Use

The fair market value of land is generally determined on the basis of its

highest and best use. Hilborn v. Commissioner, 85 T.C. at 689-690. The highest

and best use is “the highest and most profitable use for which property is adaptable

and needed or likely to be needed in the reasonably near future”. Olson v. United

States, 292 U.S. 246, 255 (1934); see Symington v. Commissioner, 87 T.C. 892,

897 (1986). Whether the owner has put the property to such use or intends to do

so is not determinative. Stanley Works & Subs. v. Commissioner, 87 T.C. 389,

400 (1986). Highest and best use is a question of fact and requires an objective
 - 32 -

[*32] assessment of the likelihood that the donated property would be put to such

use. Id. at 408; sec. 1.170A-14(h)(3)(ii), Income Tax Regs.

The parties’ experts disagree over the highest and best use of the easement

property unencumbered. Respondent argues that its highest and best use was rural

residential, agricultural, or recreational use. He argues that the residential

development petitioner advocated, similar to ILC’s project, was not economically

feasible on the easement date and that the property’s steep topography made it

unsuitable for residential development. He suggests that the soil could not support

development. His argument contradicts not only ILC’s project but also the

numerous State and county approvals and the credible testimony of Messrs.

Norton, Clark, and Vincent. Mr. Vincent testified about the work that went into

obtaining approvals for ILC’s plan including soil testing to determine its

suitability for development. He credibly testified that tracts II and III could have

been developed. While much of the land was steep, the hypothetical development

had a unit density per acre of .3, meaning that much of the land would not have

been used for home construction in the hypothetical plan. Mr. Broome did not

evaluate the extensive development work ILC performed on the property.

Respondent also argues that the failed developments by ILC and Long

Branch Lakes, one of the seven benchmarks, are proof that residential
 - 33 -

[*33] development was not financially feasible on the easement property.

Respondent argues that ILC’s project was a failure, citing the two sales in 2010

and 2011 and ignoring the lots sold during 2007 and 2008 despite the recession.

Mr. Broome also characterized the ILC development as a failure. He mistakenly

testified that ILC sold 19 lots from 2008 to 2012 when in fact it sold 55 lots. He

was unaware of ILC’s early success selling 121 lots in less than two years during

2007 and 2008, the later year affected by the recession. He did not account for the

negative impact of the economic recession or the distressed real estate market on

ILC’s project or the significant market rebound by the easement date. At trial he

acknowledged that poor market conditions affected the sale of tract I lots.

Further, Mr. Broome did not consider the internal turmoil among ILC’s

original members and later Hawks Bluff’s members that led some to abandon the

project. A factor contributing to the substantial decline in sales in 2009 through

2012 was the entities’ financial distress, which meant that there was no money

available for marketing. Mr. Broome did not speak to anyone involved in the ILC

project. He did not know that ILC had stopped marketing the tract I lots by 2010

and was unaware of the factors that contributed to the decline in sales of tract I

lots that were unrelated to the land’s development potential. He simply viewed
 - 34 -

[*34] ILC’s project as a failure and concluded it was not feasible to develop tracts

II and III.

The economy had significantly recovered by the easement date, and the

seven benchmarks Mr. Norton identified had some success. Mr. Vincent testified

that the land had relatively flat areas both above and below the escarpment

suitable for single-family homes. The easement property had plotted lots, a

concept plan designed by a licensed engineer, and significant infrastructure work

including upgraded utility and water capacity, completed soil testing, and

approvals for septic tanks and sewage and storm water plans. ILC’s decision not

to record the platted lots in tracts II and III until it was ready to develop those

tracts is irrelevant to their development potential. It did not record the lots to

avoid a potential property tax increase. Residential development was physically

and financially feasible on the easement date. In the light of the improved real

estate market and the significant infrastructure work and approvals previously

granted, a hypothetical buyer would have reasonably purchased the property for

the development of a vacation or residential community. See Frazee v.

Commissioner, 98 T.C. 554, 563 (1992). Accordingly, we hold that residential

development is the unencumbered property’s highest and best use.
 - 35 -

[*35] 2. Fair Market Value

Mr. Broome used a comparable sales method to determine the before and

after values of the unencumbered easement property. At trial we struck his after

value analysis as not helpful and reserved judgment on petitioner’s objection to

Mr. Broome’s before valuation. Petitioner argues that we should exclude Mr.

Broome’s report in its entirety or strike his before value analysis on three grounds:

his failure to research whether there were sales of comparable easements, his

incorrect use of market value instead of fair market value, and his failure to

adequately explain to the Court the qualitative adjustments he made to the sale

prices of the comparables to account for the differences in the physical features of

the easement property and the comparable properties. We find the first two

alleged errors immaterial. We find that the third ground affects the reliability of

Mr. Broome’s before valuation but is not a reason to exclude it.

Petitioner argues that a determination that there are no sales of comparable

easements is a mandatory step in the valuation process under the regulations

before an expert can employ the before and after valuation method. See Schmidt

v. Commissioner, T.C. Memo. 2014-159, at *33 (stating that the regulations apply

the before and after method “only where there is no substantial record of

comparable easement sales”); sec. 1.170A-14(h)(3)(i), Income Tax Regs.
 - 36 -

[*36] (requiring use of comparable sales to determine the fair market value of a

donated easement where a substantial record of sales exists). While Mr. Broome

did not perform this step, it has no impact on our ability to review his before

valuation as Mr. Clark testified there were no sales of comparable easements.

Mr. Broome’s use of market value instead of fair market value does not

require exclusion of his before valuation. See sec. 1.170A-1(a), (c)(1), Income

Tax Regs. (prescribing fair market value). We have stated: “In a case of unilateral

noncompliance, where one party’s proffered method complies with the regulation

but the other’s does not, it might be appropriate, or even mandatory, for a court to

adopt the opinion of the expert whose method complies with the regulation.” Pine

Mountain Pres., LLLP v. Commissioner, T.C. Memo. 2018-214, at *28, aff’d in

part, rev’d in part, vacated, and remanded, __ F.3d __, 2020 WL 6193897 (11th

Cir. Oct. 22, 2020). Mr. Broome was unaware that the regulations prescribed the

fair market value standard. He testified that the two standards are similar but not

identical; he did not explain the differences fully. We have observed that market

value adopts selective components of fair market value, but even though the two

standards are not identical, we have accepted the two terms as consistent. Crimi v.

Commissioner, T.C. Memo. 2013-51, at *61-*62 & n.27. We find the application
 - 37 -

[*37] of the market value immaterial to our determination of whether to rely on

Mr. Broome’s before value.

We agree with petitioner that Mr. Broome’s limited explanation of the

adjustments he made to the comparable sale prices makes his before valuation

unreliable. We have rejected comparable sale valuations that lacked detailed

analysis of the price adjustments necessary to account for the differences between

the subject property and the comparable. See Estate of Wineman v.

Commissioner, T.C. Memo. 2000-193, slip op. at 29-30.

Mr. Broome described in general terms the characteristics of each

comparable that made it inferior or superior to the easement property. He did not

provide the quantitative adjustments causing us to be unable to evaluate whether

he properly adjusted the comparable sale prices to account for the differences

between the comparables and the easement property. He testified that quantitative

price adjustments, or percentage adjustments, are hard to support. However, a

more significant issue is Mr. Broome’s choice of comparables. His comparables

would not support a vacation community similar in size to the hypothetical

development that we have determined to be its highest and best use. Because he

rejected a vacation community as the easement property’s highest and best use,

Mr. Broome’s valuation is of little relevance. He was not evaluating the
 - 38 -

[*38] comparables for their development potential and chose comparables that

were generally inferior for such a use because of their topography, physical

features, and access.

Not only were his comparables dissimilar from the easement property, the

sales occurred an average of four years before the easement date during a

distressed real estate market. The closest sale was nearly three years before the

easement date. He did not make a market timing adjustment to the comparable

sale prices to account for the significant change in market conditions between the

comparable sale dates and the easement date, an omission that makes his valuation

wholly unreliable. Five of the seven sales occurred during the downturn in the

real estate market and the other two sales occurred at the beginning of the

recovery.

Mr. Broome also failed to take into account the sales history of lots in ILC’s

project. He relied on inaccurate sale information on tract I lots: 121 lots in 2007

and 2008 despite the beginning of a distressed real estate market and economic

recession. This data supports the income potential of the development of tracts II

and III. Mr. Broome was unaware of the issues facing ILC and Hawks Bluff

unrelated to the development potential of the land including that ILC stopped

marketing the lots during 2009.
 - 39 -

[*39] Further, Mr. Broome did not consider the significant infrastructure work

and approvals previously granted for ILC’s project. Mr. Vincent and ILC invested

vast amounts of time and money on the development of all three tracts, spending

over $6 million. Most infrastructure work took place on tract I. However, ILC

had successfully completed numerous steps toward the development of all three

tracts. ILC constructed a pumping station and installed upgraded pipelines to

service all three tracts, upgraded electrical lines that could service residential

developments on all three tracts, paved access roads leading up to tracts II and III,

platted lots on the basis of a design by a licensed engineer, completed soil testing,

and obtained development approvals for all three tracts. Tracts II and III clearly

benefited from ILC’s work even though ILC had not yet extended utilities to those

tracts. Mr. Broome erred by disregarding the value added to the easement

property from ILC’s infrastructure and approvals.

Mr. Broome’s comparable sales are nothing more than a list of sales of large

tracts of land in the general area of the easement property. The comparables were

inferior to the easement property in terms of the development potential. Some of

his comparables were unbuildable, inaccessible tracts of timber land purchased by

timber companies. Mr. Broome’s highest priced comparable is Old CC Rd. which

sold for $2,200 per acre, a price which would result in a before value of $2.9
 - 40 -

[*40] million. We question its superiority to the easement property as Mr. Broome

opined for a residential resort development marketed as a mountain getaway.

Furthermore, the sale occurred over four years before the easement’s grant and

during the beginning of the recession, which Mr. Broome did not take into

account.

Mr. Broome’s before value, $1.5 million, severely undervalues the easement

property when compared to the $9 million ILC paid for all three tracts in 2006. He

even valued it at less than its assessed value, $2.2 million, and previous sales

prices for the tracts, $2.2 million in August 2004 and $4.8 million in January

2005. He ignored the value added from ILC’s infrastructure work and relied on

incorrect sales information from ILC’s project. We further fault his valuation

because he did not apply a timing adjustment. Even if the recovery of the real

estate market in Tennessee lagged the national recovery as respondent alleges,

making no adjustment is clearly wrong. We place no weight on Mr. Broome’s

before valuation. See Chiu v. Commissioner, 84 T.C. 722, 734 (1985) (stating that

we are not required to adopt the opinion of an expert that is contrary to our own

judgment).
 - 41 -

[*41] a. Before Value

Mr. Clark used a discounted cashflow analysis to value the easement

property. The discounted cashflow method values property on the basis of future

income projections. There is a degree of inherent unreliability in using it to value

undeveloped real property that does not have an income-producing history. See

Whitehouse Hotel Ltd. P’ship v. Commissioner, 139 T.C. 304, 324-325 (2012),

aff’d in part, vacated in part, and remanded, 755 F.3d 236 (5th Cir. 2014);

Ambassador Apartments, Inc. v. Commissioner, 50 T.C. 236, 243-244 (1968),

aff’d, 406 F.2d 288 (2d Cir. 1969). We are presented with limited options to

determine the before value as there are no comparable sales of the easement

property and the sales identified were not close to the easement date. Respondent

did not present any evidence of the easement property’s value to a developer but

raises valid concerns with Mr. Clark’s assumptions.

Mr. Norton prepared a market study of the demand for a resort-style

development on the easement property and determined price ranges for lots in a

hypothetical development on the easement property similar to ILC’s project,

which Mr. Clark used to compute the hypothetical development’s gross revenues

in his discounted cashflow analysis. Differing from ILC’s project, Mr. Norton

recommended the construction of model and for-sale homes and upfront capital
 - 42 -

[*42] investments in amenities and aggressive marketing. He determined the price

ranges for the lots in the hypothetical development on the basis of seven

benchmarks and provided the price range, average lot price, range of lot sizes, and

average lot size for each lot type in each benchmark. However, he used absolute

prices for the lots in the benchmarks, did not adjust the prices for lot sizes, and did

not provide per-acre prices.

Petitioner places significant weight on Jasper Highlands in its valuation

argument. Mr. Norton referred to Jasper Highlands as an excellent example of the

development potential of the easement property. Jasper Highlands was a 5,500-

acre development with 700 lots, 21.3 miles of bluff views, and 3,000 acres of

conserved land. It implemented a development strategy similar to Mr. Norton’s

recommendation of upfront investment in amenities “to show confidence to the

prospective buyer in a period where real estate purchasing prospects are more

educated and wearier about real estate investment after the real estate crisis”. Mr.

Broome acknowledged Jasper Highlands was a success. It sold over 230 lots from

2012 to 2015. Its sales increased substantially in 2016 and 2017 selling 270 and

200 lots, respectively, after completion of a road that provided better access to the

lots. Interior lot prices averaged $77,000, and view lots averaged $151,884.
 - 43 -

[*43] Jasper Highlands had significant advantages over the easement property,

including its proximity to Chattanooga, 30 miles, easier access from interstate

highways, significantly more land with bluff views, 21.3 miles versus 4 miles, and

greater commercial development, resulting in greater appeal to potential vacation

home buyers. Also, Mr. Norton was not aware of a State prison located 10 miles

from the easement property and at trial dismissed it as irrelevant.

Other benchmarks are also closer to major cities, have better accessibility

from interstate highways, and superior or distinctive features that give them an

advantage over the easement property. Fairfield Glade is a self-contained, 12,500-

acre community built in the 1970s and 1980s with its own commercial

development. In 2004 it added 212 acres with 196 new lots. The maturity of the

community enhanced the new lots’ marketability, and they sold for considerably

more than the lots in other benchmarks, averaging $86,000 for interior lots and

$135,000 for view lots, adjusted for size approximately $180,000 to $200,000 per

acre. Brow Wood is a retirement and assisted living community on 22 acres with

54 lots. The average prices for interior and view lots were $96,333 and $178,900,

respectively, and the averages per acre were $442,000 and $513,000, respectively.

Each of these three benchmarks had substantial advantages over and distinct

features from the hypothetical development on the easement property. By relying
 - 44 -

[*44] on them in his price recommendation Mr. Norton overestimated the prices of

the hypothetical development’s lots. In comparison Hawks Bluff Van Buren sold

all of its 200 lots before the recession and averaged $38,526 and $89,712 for

interior and view lots, respectively.11

Respondent argues that we should place the most weight on ILC and Long

Branch Lakes, the two benchmarks on the Cumberland Plateau in Bledsoe County.

He argues that both developments failed, indicating Bledsoe County could not

support the type of development Mr. Norton and Mr. Clark envision. He cites

numerous facts relating to Bledsoe County to argue it could not support the

hypothetical development, including that 23% of the population lives below the

poverty line, 35% had subprime credit, and the county had a 10.5% unemployment

rate. These statistics may have some effect on the valuation, but we recognize that

petitioner’s experts envision a vacation home community marketed to out-of-State

purchasers. Both ILC and Long Branch Lakes were marketed to out-of-State

purchasers.

Long Branch Lakes is a 4,500-acre, 400-lot development approximately 10

miles north of the easement property. It included lakefront lots and an equestrian

11
Hawks Bluff Van Buren is in Van Buren County, Tennessee, and is
unrelated to ILC’s project or the Bledsoe property.
 - 45 -

[*45] village marketed to horse owners with lots several acres in size. It made

upfront investments in amenities including a general store, swimming pools, two

large lakes, tennis courts, and sports fields. It enjoyed some initial success. It

started selling lots in 2007, selling 35. Sales increased during the recession, 42

and 53 lots in 2008 and 2009, respectively, before decreasing in 2010 to 35 lots.

In 2011 Long Branch Lakes experienced a significant drop in sales, selling only

five lots, which petitioner attributes to decreased marketing and the developer’s

decision to focus on other projects. Long Branch Lakes sold 51 lots from 2012 to

2016, an average of 10 per year, and approximately 200 remaining lots were sold

in bulk in 2017 as part of the developer’s bankruptcy.

Likewise, ILC had some initial success despite the looming recession. It

sold 121 lots during 2007 and 2008. Many factors contributed to ILC’s low sales

thereafter including the lack of funds to market the lots, the substantial debt

incurred for infrastructure costs, and the internal turmoil with members

abandoning their interests and walking away from their debt obligations. While

we do not agree that ILC and Long Branch Lakes show the hypothetical

development was not feasible, they do indicate a degree of uncertainty and risk to

a hypothetical development that Mr. Clark did not properly account for in his
 - 46 -

[*46] discounted cashflow analysis. Moreover, the sale prices for these lots

indicate that Mr. Clark overestimated the lot prices in a hypothetical development:

Lot type Low High Average
ILC
Interior $31,410 $98,813 $46,186
View 79,000 120,900 100,254
Long Branch
Interior 50,000 100,000 74,300
View 142,000 200,000 171,250

Mr. Clark priced interior lots in two categories, interior and nature view, at

$50,000 and $62,500, respectively, prices that are above the average for ILC’s

sales. While these prices are below the prices for Long Branch Lakes, its interior

lots were significantly larger averaging over three acres, and the average per-acre

price was approximately $24,000.

We find that Mr. Clark’s sale prices are not reasonably supported by the

market data. He priced 187 interior lots at $50,000 and an additional 88 interior

lots with nature views at $62,500, generating gross revenues of $14.85 million.

He used Mr. Norton’s average price for each lot type, but Mr. Norton’s price range

for interior lots started at $30,000. Also, Mr. Clark supports his $50,000 price for

interior lots with sales data from Jasper Highlands, which could support higher
 - 47 -

[*47] prices than the easement property because of its proximity to Chattanooga

and its greater commercial development among other superior features. Also, Mr.

Clark’s $100,000 price for lakefront and bluff view lots was likely too high. ILC’s

average price for bluff and premium bluff view lots was $100,254. ILC had no

lake view lots. We find the following prices more reasonable on the basis of the

benchmarks, expert testimony, and market data: interior, $40,000; nature view,

$50,000; lakefront and bluff view, $80,000; and premium bluff view, $125,000.

On the basis of these sale prices, without any adjustment to the absorption rate, we

determine gross revenues from a hypothetical development of approximately $25.1

million and $27.6 million when adjusted for annual appreciation of the unsold

lots.12 See infra note 15.

Respondent challenges Mr. Clark’s due diligence into the land’s capacity to

support a residential development and his estimate of construction and operating

costs. He argues that Mr. Clark’s report lacked detailed development costs and

Mr. Clark did not conduct a soil analysis to determine the feasibility of the

development. Mr. Clark consulted with local developers and construction

companies. He specified construction costs per linear foot for utilities and roads

12
We find that Mr. Clark’s estimated annual lot sales over the seven-year
absorption rate are supported by the market data including ILC’s sales history.
ILC sold 75 lots its first year.
 - 48 -

[*48] including the cost to grade, base, and chip and seal the roads. He estimated

overhead expenses on the basis of 1.5% of gross sales, which we find sufficient

for maintenance and holding costs. We find Mr. Clark’s cost estimates reliable

and supported by his due diligence. However, he failed to adjust costs for

inflation, which we find in error. Our estimate includes some cost inflation. In

total he estimated $6.8 million in construction and operating costs. We estimate

that costs would be lower in each year of the absorption period for two reasons:

(1) we eliminated the line-item expense for profit and accounted for profit by

increasing the discount rate, discussed below and (2) we calculated some costs

(overhead, sales commission, and closing costs) on the basis of a percentage of

gross revenues so costs decreased to reflect our reduction in projected gross

revenues. In total we estimated costs of $5.8 million and net revenues of $21.8

million. See infra note 15.

One aspect of Mr. Clark’s cost analysis that we find in error is his failure to

account for the construction costs for model and for-sale homes. The homes are a

feature of Mr. Norton’s hypothetical plan. Mr. Clark agreed with this plan feature.

Both experts testified about the need for upfront capital investments in amenities,

model homes, for-sale homes, and aggressive marketing. Petitioner argues the

homebuilding costs are irrelevant for purposes of valuing the land. While that
 - 49 -

[*49] may be true, in our opinion such costs are a factor that a hypothetical

developer would consider. The need to construct homes adds risk and requires

additional capital investment or financing. It is inappropriate to ignore these costs.

We account for the risk added by these costs through the discount rate, further

indicating that Mr. Clark did not adequately account for profit or risk with a line-

item expense of 15% of expenses.

Mr. Clark testified that a 15% profit margin was indicative of the risk

inherent to the developer over the absorption period. He characterized the 11.25%

discount and the 15% profit margin as a combined discount of 26.25%. However,

he did not apply the profit margin in the same manner as the 11.25% discount rate.

It is not a combined discount in his computation. Instead, he calculated “profit on

expenses” equal to 15% of the construction and operating costs each year,

resulting in a profit to the hypothetical developer of $891,025 for the entire

project. He deducted the developer’s profit as a line-item expense from gross

revenues and then applied an 11.25% discount rate to net revenues.13 The 11.25%

13
Mr. Clark applied a present value factor (PVF) to calculate the present
value of each dollar received or expended over the absorption period and used a
midyear convention, PVF = 1 / (1 + r)n-1/2 where r is the discount rate and n is the
year of the absorption period. See Schmidt v. Commissioner, T.C. Memo. 2014-
159, at *52-*53 (finding a midyear convention a more reasonable assumption as
sales and expenses would occur throughout the year).
 - 50 -

[*50] discount resulted in an $8.5 million reduction in net revenues. We disagree

with this method to account for the developer’s profit and eliminated the profit on

expenses from our cost estimate. A line-item expense for profit does not

adequately compensate a hypothetical developer for the risk inherent in the

project. Mr. Clark testified that the profit on expenses is one source of the

developer’s profit, but we are not convinced that an 11.25% discount rate plus a

line-item expense of less than $1 million is sufficient to induce a developer to

assume the risks involved with a residential development.

Mr. Clark determined the 11.25% discount rate on an assumption that a

hypothetical developer would finance the project with a debt-to-equity ratio of

60/40. He testified that the developer could borrow at 6% (60% debt at 6%

interest equals a rate of .036) and would receive an 18% return on his equity

investment (40% equity at an 18% return equals a rate of .072), resulting in a

combined rate of 10.8%, which he rounded to 11%. He then considered alternate

investment opportunities available to a hypothetical developer, including the

reserve bank discount rate, prime rate, Federal funds rate, 3-month certificate of

deposit rate, 6-month Treasury bill rate, 10-year U.S. bond rate, and speculative-

grade bond rate. On the basis of these rates he estimated a 2% current rate, a 5%

return on speculative investments, and a 5% nonliquidity rate, resulting in a sum
 - 51 -

[*51] of 12%. On the basis of these two rates (11% and 12%), he determined a

discount rate of 11.25%. We find the 18% return on equity insufficient to account

for the risk to a hypothetical developer. The 11.25% rate is too low even with the

additional line-item expense for profit. Mr. Clark did not adequately account for a

developer’s risk and underestimated the return on equity that would be necessary

to compensate for a developer’s risk in the light of the distance from major urban

areas, limited commercial development nearby, and competition from benchmarks.

Mr. Clark referred to the 11.25% discount rate and the 15% line-item

expense for profit as a combined discount. We disagree with his label. He

compared this purported 26.25% combined discount rate with data from a regional

survey of actual discount rates for real estate development in the Southeastern

United States and pro forma rates. Actual discount rates ranged from 17% to 40%

for planned developments with 100 to 500 units with slightly higher pro forma

rates.14 The average actual rate for such a development was 27.34%, and the

average pro forma rate was 26.25%. According to Mr. Clark’s report, for planned

developments such as the hypothetical development, profit risk is included in the

discount rate but for condominiums and cooperatives it is a line-item expense.

14
RealtyRates.com conducted the survey for the fourth quarter of 2012. The
survey included responses from appraisers, lenders, and local, regional, and
national developers.
 - 52 -

[*52] Mr. Clark deviated from industry practice by including profit as a line-item

expense and did not explain to our satisfaction why he did so. Applying a

discount rate of 26.25% to our computation of net revenues, the discounted

cashflow analysis would support a before value of approximately $9.3 million.15

ILC purchased the three tracts in 2006 for over $9 million after an extensive

investigation of the land’s development potential. It paid approximately $7

million for tracts II and III. The sale occurred between a willing buyer and a

willing seller in an arm’s-length transaction. The purchase price represents the

land’s fair market value in 2006. In April 2011 the seller agreed to reduce the

15
We compute the discounted value using a PVF computed as 1 / (1 +
n-1/2
0.2625) .
Gross Discounted
Year revenue Costs Net revenue PVF value
1 $1,300,000 $1,046,106 $253,894 .88999 $225,963
2 3,473,675 879,567 2,594,108 .70494 1,828,690
3 4,751,450 972,661 3,778,789 .55837 2,109,962
4 5,479,975 918,727 4,561,248 .44227 2,017,303
5 5,630,800 928,415 4,702,385 .35032 1,647,340
6 4,840,100 865,136 3,974,964 .27748 1,102,973
7 2,097,375 177,548 1,919,827 .21978 421,940
Total 27,573,375 5,788,160 21,785,215 --- 9,354,171
 - 53 -

[*53] unpaid purchase price by $1.3 million acknowledging the effects of the

downturn in the economy. While we consider this fact, we balance it against the

fact that Hawks Bluff was unable to pay its debt and was facing default. It is

likely that the seller considered these facts when it made its decision to reduce the

debt.

We also consider ILC’s $6 million investment in infrastructure and its work

to obtain approvals which benefited all three tracts, including ensuring a water

supply, upgrading water and electrical capacity, soil testing, Government

approvals, and access roads leading to the easement property. Mr. Vincent

credibly testified that ILC performed soil testing on tracts II and III. ILC’s

infrastructure and approval work clearly increased the fair market value of the

easement property. Mr. Clark estimated that development on tracts II and III

would require an additional $2.6 million for infrastructure costs. We find it

reasonable that the unencumbered easement property would have increased by

$2 and $2.5 million on the basis of appreciation and ILC’s infrastructure work.

On the basis of the record we find that the easement property had a before value of

$9,353,171. See supra note 15.

Respondent argues for the first time on brief that we should determine the

before value by reference to the $3,224,000 subscription price for 91% of
 - 54 -

[*54] Sequatchie, resulting in a before value of no more than $3,539,561. We

reject this argument as Mr. Vincent credibly testified that his objective in the

subscription was to receive enough money to repay the Hawks Bluff debt. The

subscription price was set for this purpose. It was not intended to reflect the

easement property’s fair market value, and it has no bearing on the easement

property’s fair market value. Mr. Vincent credibly testified that he wanted to

protect the original vision of ILC’s plan and to preserve the natural beauty of the

easement property. He had a financial interest in protecting the easement property

from timber harvesting or low-scale development because he retained ownership

of the unsold lots in tract I through Hawks Bluff and hoped to sell them.

Understandably, he had no desire to develop the tracts himself. We do not

question Mr. Vincent’s desire to preserve the property through a conservation

easement.

b. After Value

At trial, we excluded the portion of Mr. Broome’s report containing the after

value analysis. On brief respondent argues that the after value is $476,400, the

easement property’s assessed value for 2013, or $213,629, the value Glade Creek

reported on its 2012 return. We accept respondent’s argument as a concession and
 - 55 -

[*55] find an after value of $476,400. The easement’s fair market value is

$8,876,771. Accordingly, we do not sustain a penalty for gross valuation

misstatement.

B. Substantial Valuation Misstatement

A taxpayer makes a substantial valuation misstatement if the claimed value

is more than 150% but less than 200% of the correct amount, $8,752,001 to

$11,669,333 in this case. See sec. 6662(b)(3). Glade Creek made a substantial

valuation misstatement, and the 20% penalty will be imposed unless petitioner

establishes that Glade Creek acted with reasonable cause and in good faith in its

valuation of the easement. See sec. 6664(c)(3). We determine reasonable cause

and good faith on a case-by-case basis taking into account all pertinent facts and

circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the most

important factor is the taxpayer’s efforts in assessing its proper tax liability. Id.

Petitioner has the burden of proving reasonable cause. See Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001).

In the context of a valuation penalty, taxpayers can establish reasonable

cause on the basis of their reasonable reliance on a qualified appraisal by a

qualified appraiser and their own good faith with respect to the valuation. Sec.

1.6664-4(h), Income Tax Regs.; see Dunlap v. Commissioner, T.C. Memo.
 - 56 -

[*56] 2012-126; 1982 East, LLC v. Commissioner, T.C. Memo. 2011-84; Evans v.

Commissioner, T.C. Memo. 2010-207. A taxpayer may also rely on professional

advice as a defense if: (1) the taxpayer reasonably believed that the professional is

competent and has sufficient expertise, (2) the adviser has all necessary and

accurate information, and (3) the taxpayer actually relied on the advice in good

faith. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000),

aff’d, 299 F.3d 221 (3rd Cir. 2002). In general, reliance on a promoter is not

reasonable or in good faith and is not a defense to an accuracy-related penalty.

Mortensen v. Commissioner, 440 F.3d 375, 387 (6th Cir. 2006), aff’g T.C. Memo.

2004-279; Paschall v. Commissioner, 137 T.C. 8, 22 (2011); Neonatology Assocs.,

P.A. v. Commissioner, 115 T.C. at 98.

With respect to adjustments to amounts reported by an LLC, reasonable

cause is determined by examining the actions of the managing member. Stobie

Creek Invs. LLC v. United States, 608 F.3d 1366, 1380-1381 (Fed. Cir. 2010). As

Glade Creek’s manager, Mr. Campbell’s actions are those relevant for purposes of

the reasonable cause defense. Petitioner argues that Mr. Campbell relied on the

advice of two appraisers, Mr. Clark and Mr. Clover, to value the easement. We

find that the appraisers determined the before value to achieve the tax savings

goals of the easement transaction and did not attempt to accurately ascertain the
 - 57 -

[*57] easement’s fair market value.16 Glade Creek did not make a good faith

investigation of the easement’s fair market value and the reasonable cause defense

is not available.

Mr. Campbell knew that the easement was substantially overvalued. In fact,

overvaluing the easement was a part of the easement transaction he devised.

Neither Mr. Campbell nor the appraisers he selected actually sought to determine

the easement’s fair market value. Rather, Mr. Campbell wanted an appraisal that

accomplished his tax objectives for the easement transaction. The appraised value

was determined on the basis of the need to attract investors by providing a

sufficient tax benefit to raise enough money to repay the Hawks Bluff debt and to

pay the fees of the professionals involved. It was not a good faith valuation of the

easement property. Further, Mr. Campbell’s decision to engage two appraisers

does not establish a good faith investigation. Mr. Campbell did not make a good

faith investigation into the easement’s fair market value or rely on the appraisers

in good faith to ascertain the easement’s fair market value.

16
The parties also disagree over whether Mr. Clark’s appraisal was a
qualified appraisal and whether he was a qualified appraiser. See sec.
6664(c)(4)(B) and (C). As we find the appraisal was not in good faith and Glade
Creek is not entitled to a reasonable cause defense, we do not address these
alternative issues.
 - 58 -

[*58] Respondent argues that Mr. Campbell is a promoter. Through Evrgreen, he

manages 30 passthrough entities involved in easement transactions similar to the

one here where he markets investments in the entities as tax saving strategies.

Sequatchie’s promotion materials emphasized the tax benefits of an investment,

provided examples of the tax breaks from different investment amounts, and

warned investors of the potential tax risks from investing. Mr. Vincent

approached Mr. Campbell for a tax strategy. Sequatchie’s sole business purpose

was to acquire majority control over Glade Creek and then vote its interest to

cause Glade Creek to donate the easement for its tax benefits. Its investors voted

to grant the easement shortly after acquiring their interests.

Petitioner argues that Mr. Campbell reasonably and in good faith relied on

Mr. Pollock to provide tax advice and the Conservancy to draft the deed to meet

the legal requirements of a charitable contribution deduction for a conservation

easement. Irrespective of whether we agree with this argument, Mr. Campbell’s

tax scheme primarily relies on the overvaluation of the easement, and he knew the

easement was overvalued. Accordingly, we sustain the 20% penalty for a

substantial valuation misstatement for the portion of the underpayment attributable
 - 59 -

[*59] to the portion of the claimed value in excess of the easement’s fair market

value.17

C. Negligence or Disregard or Substantial Understatement Penalty

Respondent asserts the 20% penalty with respect to Glade Creek’s

underpayment attributable to a misstatement of value. He does not assert the 20%

underpayment penalty for negligence or disregard of rules and regulations or a

substantial understatement of income tax. He states that the issue with respect to

the 20% penalty is whether it “applies to Glade’s misstatement of value * * * for

negligence, a substantial understatement of income tax, or a substantial valuation

misstatement” and that “[s]hould the Court decide that the gross * * * or the

substantial valuation misstatement penalty * * * does not apply to any

underpayment of tax attributable to the adjustments * * *, then the accuracy-

related penalty under section 6662(a) applies to any underpayment of tax” for

negligence or disregard of rules or regulations or a substantial understatement of

17
As an alternative argument, respondent had argued that if we were to allow
the easement deduction, it is limited to Glade Creek’s basis in the easement
property on the basis that the easement property had been inventory in the hands
of Hawks Bluff. Respondent does not assert this argument as a basis to impose a
20% penalty.
 - 60 -

[*60] income tax.18 On brief, respondent’s discussion of the 20% penalty is

unclear at times as to the basis for that. He argues that Glade Creek did not act

with reasonable cause or in good faith because it improperly relied on the

Conservancy to draft the deed and on Mr. Clark’s appraisal, it did not obtain legal

advice regarding whether the conservation easement met the requirements of

section 170, and Mr. Campbell is a promoter. However, he does not state that he

seeks to apply the 20% penalty to the portion of the underpayment attributable to

the adjustment below the easement’s fair market value. On the basis of our

understanding of the issues as respondent presented at trial and on brief, we find

that he has conceded the 20% penalty on the portion of the underpayment

attributable to the amount of the deduction below the easement’s fair market.19

We do not impose a 20% penalty for negligence or disregard of rules or

regulations or provisionally impose a 20% penalty for a substantial understatement

18
Respondent asserts that we should provisionally apply the 20% penalty for
a substantial understatement of income tax subject to the subsequent determination
of each member’s resulting income tax deficiency and any defenses the member
may raise. See United States v. Woods, 571 U.S. 31, 39 (2013).
19
In the FPAA respondent asserted that Glade Creek had not established that
the easement had any value.
 - 61 -

[*61] of income tax on the portion of the easement deduction below the

easement’s fair market value.20

In reaching our holdings herein, we have considered all arguments made,

and, to the extent not mentioned above, we conclude they are moot, irrelevant, or

without merit.

To reflect the foregoing,

Decision will be entered under

Rule 155.

20
On the basis of respondent’s concession we do not address whether the
involvement of a promoter in the transaction requires us to sustain the penalty on
the portion of the deduction below the easement’s fair market value. Moreover,
we have determined that Glade Creek is not entitled to the reasonable cause
defense for the portion of the deduction in excess of the easement’s fair market
value irrespective of whether Mr. Campbell is a promoter.