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Tax Court Reverses Course on Easement Donations; Holds Proceeds Reg Violates APA

(Parker Tax Publishing April 2024)

The Tax Court held that a partnership was entitled to a conservation easement deduction because the easement deed it contributed to a charitable organization satisfied the applicable requirements set forth in Code Sec. 170(h)(2)(C) and Code Sec. 170(h)(5)(A). The court further held that Reg. Sec. 1.170A-14(g)(6)(ii) is procedurally invalid under the Administrative Procedure Act and that the easement deed at issue therefore did not need to comply with that regulation and, to the extent its decision in Oakbrook v. Comm'r, 154 T.C. 10 (2020) holds otherwise, that decision will no longer be followed. Valley Park Ranch, LLC v. Comm'r, 162 T.C. No. 6 (2024).


In 2016, Valley Park Ranch, LLC (Valley Park), a limited partnership, conveyed a conservation easement (the Easement) over approximately 45.76 acres of land (the Property) in Rogers County, Oklahoma, to Compatible Lands Foundation (CLF). The deed provided that if the conservation restriction is terminated, the donee will receive (1) an amount determined by a court, unless otherwise provided by state or federal law, or (2) in the event of the government's exercise of eminent domain, the respective share of the proceeds from a "qualified appraisal."

The deed also acknowledged that future circumstances could render the conservation purpose of the Easement obsolete or impossible to accomplish and made provisions for such circumstances. Relatedly, the deed also contemplated the prospect of extinguishment via condemnation and made provisions for that as well.

Valley Park filed a 2016 Form 1065, U.S. Return of Partnership Income, on which it claimed, under Code Sec. 170(h)(1), a $14.8 million deduction for a qualified conservation contribution. The IRS audited the return and disallowed the $14.8 million deduction because Valley Park did not establish that all the requirements of Code Sec. 170(h) and the corresponding regulations, specifically Reg. Sec. 1.170A-14(g)(6), which governs the "extinguishment" of an easement, had been met.

Under Code Sec. 170(h)(1), a "qualified conservation contribution" is defined under Code Sec. 170(h)(1) as a contribution (1) of a qualified real property interest, (2) to a qualified organization, and (3) exclusively for conservation purposes. Under Code Sec. 170(h)(2)(C), a "qualified real property interest" includes a restriction (granted in perpetuity) on the use which may be made of the real property. Code Sec. 170(h)(5)(A) provides that a contribution cannot be treated as "exclusively for conservation purposes," unless the conservation purpose of the contribution is "protected in perpetuity." While the statute does not define the term "protected in perpetuity" nor elaborate on the requirement, the IRS issued regulations attempting to deal with the subject.

Under those regulations, when a subsequent unexpected change in the conditions surrounding the property subject to a donated easement makes impossible or impractical the continued use of the property for conservation purposes, the perpetuity requirement can still be satisfied if two conditions are met. First, Reg. Sec. 1.170A-14(g)(6)(i) provides that the restriction must be extinguished by a judicial proceeding and second, Reg. Sec. 1.170A-14(g)(6)(ii) provides that all the donee's proceeds from a subsequent sale or exchange of the property must be used by the donee organization in a manner consistent with the conservation purposes of the original contribution. Upon extinguishment, Reg. Sec. 1.170A-14(g)(6)(ii) also provides that a donee organization must receive as proceeds 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. This regulation is referred to as the "proceeds regulation."

The Administrative Procedure Act (APA) prescribes a three-step procedure for notice-and-comment rulemaking. First, an agency must issue a general notice of proposed rulemaking, ordinarily by publication in the Federal Register. Second, if notice is required, the agency must give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments, and the agency must consider and respond to significant comments received during the period for public comment. Third, in issuing the final rule, the agency must include in its text a concise general statement of the rule's basis and purpose. Thus, basis and purpose statements must contain sufficient information to allow a court to exercise judicial review.

Valley Park's tax matters partner, Reed Oppenheimer, petitioned the Tax Court for review of the IRS's adjustments. Oppenheimer argued that Reg. Sec. 1.170A-14(g)(6)(ii) is procedurally invalid under the APA because, as the administrative record demonstrated, comments raising significant concerns with Reg. Sec. 1.170A-14(g)(6)(ii) were filed during the rulemaking process and the IRS did not adequately respond to those comments. The failure to address those significant comments in the final regulation's basis and purpose statement, Oppenheimer said, was a violation of the APA's procedural requirements and thus the regulation was inapplicable to the conveyance at issue.

Both parties filed motions for partial summary judgment on the issues of whether the deed conveying the Easement was in accord with Reg. Sec. 1.170A-14(g)(6)(ii), whether that regulation is valid under the APA, and if not, whether the deed at issue satisfied the provisions in Code Sec. 170(h)(2)(C) and Code Sec. 170(h)(5)(A).


The Tax Court, in a holding at odds with a decision it issued four years earlier, held that Reg. Sec. 1.170A-14(g)(6)(ii) is invalid under the APA and that the easement deed at issue satisfied both Code Sec. 170(h)(2)(C) and Code Sec. 170(h)(5)(A) and Valley Park was thus entitled a charitable contribution deduction for its easement donation. In reaching its decision, the court took a second look at its holding in Oakbrook Land Holdings, LLC v. Comm'r, 154 T.C. 180 (2020), aff'd, 2022 PTC 70 (6th Cir. 2023), cert. denied (S. Ct. 2023), in which it held that, in a similar situation, a conservation easement did not satisfy the protected-in-perpetuity requirement in Code Sec. 170(h)(5)(A) and Reg. Sec. 1.170A-14(g)(6).

After the Tax Court's 2020 decision in Oakbrook, a unanimous panel of the Eleventh Circuit reversed the Tax Court's reliance on Oakbrook in Hewitt v. Comm'r, 2021 PTC 410 (11th Cir. 2021), rev'g and remanding T.C. Memo. 2020-89. The Eleventh Circuit held that the IRS's interpretation of Reg. Sec. 1.170A-14(g)(6)(ii), disallowing the subtraction of the value of post-donation improvements in allocating proceeds in the case of an extinguishment of a conservation easement, was arbitrary and capricious and therefore invalid under the APA's procedural requirements. In contrast, a couple months later, a divided panel of the Sixth Circuit affirmed the Tax Court's holdings in Oakbrook and rejected the reasoning of the Eleventh Circuit in Hewitt.

While noting that the Sixth Circuit affirmed its Oakbrook decision after the Eleventh Circuit's reversal in Hewitt, a majority of the Tax Court found that, after careful consideration of the Eleventh Circuit's reasoning in Hewitt, it was appropriate for it to change its position on the validity of Reg. Sec. 1.170A-14(g)(6)(ii). Dissenters on the Tax Court argued that changing the court's conclusion on the validity of Reg. Sec. 1.170A-14(g)(6)(ii) meant they were failing to follow stare decisis principles and would result in instability in the law. According to the majority, the Oakbrook decision had to be revisited precisely because the law is already unstable. The majority noted that where, as in the instant case, the court is faced with issues on which a Court of Appeals "has reversed our prior decision," it is obligated to thoroughly reconsider its position. Moreover, the majority noted, Oakbrook was decided just four years ago and thus was not entrenched precedent.

The Tax Court agreed with Oppenheimer's contention that the IRS violated the APA by failing to adequately respond to significant comments in the final regulation's basis and purpose statement. The court reviewed the most detailed comment, which was submitted by the New York Landmarks Conservancy (NYLC). The NYLC urged the IRS to delete the proposed proceeds regulation because it contained pervasive "problems of policy and practical application." NYLC stated that while Congress enacted the statute to encourage the protection of the environment through the donation of conservation restrictions, the proposed regulation would thwart the purpose of the statute by deterring prospective donors. Based on its concerns and because the possibility of extinguishment is a relatively remote possibility, NYLC stated it was unnecessary "to provide for allocation of proceeds after extinguishment." The Tax Court found NYLC's comments, as well as similar comments from others, persuasive. The court thus concluded that Reg. Sec. 1.170A-14(g)(6)(ii) is invalid and stated that, to the extent its decision in Oakbrook holds otherwise, that decision will no longer be followed.

For a discussion of the rules relating to charitable deductions relating to easement donations, see Parker Tax ¶84,155.

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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