In BC Ranch II, LP v. Commissioner, the Fifth Circuit recently reversed the Tax Court in holding that a taxpayer qualified for a charitable contribution deduction for the donation of a conservation easement. The main issue involved whether the easement in question violated the in perpetuity requirement of §170(h)(2)(C). In BC Ranch, two limited partnerships donated one conservation easement each to a qualified donee and, subsequently, sold limited partnership interests. Each limited partnership interest entitled the limited partner to one five-acre homesite parcel. Pursuant to the deed of easement, the property covered by the easements could be amended, but only to the limited extent needed to modify the boundaries of the five-acre homesite parcels. Further, any modification could only be done within the ranch property subject to the easement. The modification provision also prohibited any amendment that would increase any homesite parcel above five acres. For any such a modification to occur, the donor, the donee, and the owner of the homesite parcel in question would have to agree and the modification would be permitted only if the boundary line modification did not, in the donee's reasonable judgment, directly or indirectly result in any material adverse effect on any of the conservation purposes.
In reversing the Tax Court, the Fifth Circuit held that the substitution provision in BC Ranch did not violate the in perpetuity requirement of §170(h)(2)(C). At first glance (and in the opinion of the dissenting judge), the Fifth Circuit opinion seemed to create a split in the circuits as a result of the Fourth Circuit opinion in Belk v. Commissioner. The facts of Belk were very similar to the facts of BC Ranch. In Belk, the taxpayer had developed a 410-acre parcel of property into a residential community containing a golf course. The taxpayer granted a conservation easement over the property constituting the golf course. Much like the easement in BC Ranch, the terms of the easement in Belk permitted the taxpayer to substitute an area of land contiguous to the property covered by the easement for an equal or lesser area currently covered by the easement. The right to substitute property subject to the easement was limited by numerous rights given to the donee charity, essentially giving the charity the right to veto any substitution. The Tax Court held that the substitution provision violated the in perpetuity requirement of §170(h)(2)(C). The Fourth Circuit affirmed the Tax Court and the Tax Court relied on Belk in its BC Ranch opinion.
Although the two cases seemed indistinguishable, the Fifth Circuit attempted to distinguish the facts of BC Ranch by stating, “[u]nlike here, the easement in Belk could be moved, lock, stock, and barrel, to a tract or tracts of land entirely different and remote from the property originally covered by that easement.”
Upon reading that statement, I was left somewhat dumbfounded. I actually went back and read the Belk opinion as I was certain that this statement was flat-out wrong.
In support of this “conclusion,” the Fifth Circuit attached a copy of the conservation easement plan, i.e., a map of the property owned by the donor/taxpayer showing the homesites as well as property covered by the original easement. The purpose of attaching the plan was to show that the ability to adjust the homesite parcels could only be done within the boundaries of the land owned by the taxpayer. According to the Fifth Circuit, “realistically and practically, the perpetuity requirement of the Conservation Easement is not invalidated by the provision for homesite parcel adjustment.”
The problem with the Fifth Circuit’s analysis is that it seems to have completely misread the adjustment provision in Belk. The adjustment provision in Belk required that any substituted land had to be contiguous to the original easement property. The fact that the property had to be contiguous means, by definition, that the substituted property could NOT “be moved, lock, stock, and barrel, to a tract or tracts of land entirely different and remote from the property originally covered by that easement.” By requiring the property to be contiguous means that the substituted property had to be property within a certain boundary of property owned by the donor taxpayer. I am sure that the Fourth Circuit could have attached a map/plan showing the total amount of property owned by the taxpayer, detailing the easement and the rest of the contiguous property owned by the taxpayer/donor.
Given that the Fifth Circuit’s opinion in BC Ranch almost certainly creates a split in the circuits, perhaps the first step that should be taken is for the IRS to file a Motion for Reconsideration asking the Fifth Circuit to explain its distinguishing statement that “the easement in Belk could be moved, lock, stock, and barrel, to a tract or tracts of land entirely different and remote from the property originally covered by that easement,” in light of the fact that the substituted property in Belk had to be contiguous to the original property covered by the easement.
Having said that, I am not convinced that the Tax Court and the Fourth Circuit got it right in the first place. Should the “in perpetuity” requirement of §170(h)(2)(C) be read as narrowly as the “in perpetuity” requirement of §170(h)(5)(A)? It seems that Congressional intent is to encourage these conservation easement contributions and the IRS is relying on technicalities to disallow these deductions. See Anson H. Asbury, Anyone for Tennis? Technical Foot Faults and the Conservation Easement Tax Deduction, 32 Tax Mgmt. Real Est. J. 195 (July 2016). To put it another way, Ronald Levitt of Sirote & Permutt PC told Bloomberg BNA in an April 2016 interview that the IRS’s rejection of deductions for conservation easements “leads you to the conclusion that there is no nit too small for the IRS to pick. They are looking for any reason to disallow these deductions, despite what Congress has said.”
I’ll leave that discussion for another day.
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