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Land Parcels' Modifiable Boundaries Defeats Deduction for Conservation Easement.

(Parker Tax Publishing August 12, 2015)

Because modifications were permitted to the boundaries between land parcels distributed to two partnerships' limited partners and property subject to easements, no charitable deductions for the easements was allowed and the Tax Court upheld a 40-percent gross valuation misstatement penalty. The court also found that the sale of the partnerships' interests in conjunction with the distribution of the parcels were really disguised sales of property under Code Sec. 707. Bosque Canyon Ranch, L.P. v. Comm'r, T.C. Memo. 2015-130.

Background

Bosque Canyon Ranch, L.P. (BCR I), a partnership, owned a tract of land in Bosque County, Texas, on which it spent $2.2 million on improvements. It then marketed limited partnership interest units in BCR I at $350,000 per unit. Each purchaser of a unit received a distribution of an undeveloped five-acre parcel of property and rights to build a house on the property. The distribution of the property was conditioned on BCR I granting the North American Land Trust (NALT), a Code Sec. 501(c)(3) organization, a conservation easement relating to 1,750 acres of the property. On December 29, 2005, BCR I granted an easement to NALT. Between October and December 2005 BCR I received signed subscription agreements and payments totaling $8.4 million from 24 purchasers of the limited partnership units.

In 2006, another related partnership, BCR II, engaged in transactions similar to those engaged in by BCR I. It received approximately $10 million in payments from the sale of land to 23 purchasers. In 2007, BCR II granted a conservation easement to NALT similar to the one granted by BCR I.

The 2005 and 2007 deeds granting the easements provided that portions of the area subject to the easements included the habitat of an endangered species of bird endemic to Texas. Property subject to the easement could not be used for residential, commercial, institutional, industrial, or agricultural purposes. In addition, the partnerships retained various rights relating to the property, including rights to raise livestock; hunt; fish; trap; cut down trees; and construct buildings and recreational facilities. The parcel owners and NALT could, by mutual agreement, modify the boundaries of the parcels, provided that any such modification could not, in NALT's reasonable judgment, directly or indirectly result in any material adverse effect on any of the conservation purposes.

On their tax returns for 2005 and 2007, BCR I and BCR II took charitable contribution deductions of $8.4 million and approximately $10 million, respectively, relating to the easement donations. The IRS challenged the deductions and assessed a 40 percent gross valuation misstatement penalty. According to the IRS, no deduction for the easements were allowed because the deeds conveying the easements violated the perpetuity requirement of Code Sec. 170(h)(2)(C). The IRS also found that the sale of the partnerships' interests were really disguised sales of property under Code Sec. 707(a)(2)(B) and Reg. Sec. 1.707-3(b)(1) and (c)(1).

Analysis

The partnerships argued that the deeds did not violate the perpetuity requirement because any modifications to the boundaries of the land parcels were subject to the reasonable judgment of the NALT, the exterior boundaries of the property subject to the easements could not be modified, and the overall amount of property subject to the easements could not be decreased.

The Tax Court held that, as a result of the boundary modifications, property protected by the 2005 and 2007 easements, at the time they were granted, could subsequently lose this protection. Thus, the restrictions on the use of the property were not granted in perpetuity. Accordingly, the easements did not constitute qualified real property interests and the partnerships were not entitled to charitable deductions relating to the easements.

The Tax Court also concluded that the property transfers to the limited partners who purchased units in BCR I and BCR II were disguised sales for the following reasons: (1) the timing and amount of the distributions to the limited partners were determinable with reasonable certainty at the time the partnerships accepted the limited partners' payments; (2) the limited partners had legally enforceable rights to receive their land parcels and the appurtenant rights; (3) the transactions effectuated exchanges of the benefits and burdens of ownership relating to the land parcels; (4) the distributions to the partners were disproportionately large in relation to the limited partners' interests in partnership profits; and (5) the limited partners received their land parcels in fee simple without an obligation to return them to the partnerships.

Finally, the court sustained the imposition of the 40 percent penalty on the portion of tax underpayment attributable to the gross valuation misstatements resulting from the charitable deductions taken for the easement contributions.

For a discussion of the rules for easement contribution deductions and disguised sales of partnership property, see Parker Tax ¶84,155 and ¶25,520, respectively. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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