Tax Court “Believes” Value of Conservation Easement is Zero - Decision No Walk in the Park for Donors

In Wendell Falls Development, LLC v. Commissioner, the Tax Court ruled that Wendell Falls was not entitled to a charitable deduction on its donation of a conservation easement over a 125-acre parcel to the Smokey Mountain National Land Trust that restricted use such that a public park would be the only use allowable. The Court reasoned that as Wendell Falls would derive a substantial benefit from the park due to its location in the middle of 1,280 acres of Wendell Falls’s master-planned community, no deduction was allowed. Additionally, the Court reasoned that even without the substantial benefit, the easement did not diminish the value of the land because its highest and best use is as parkland even without the easement. Based on the absence of evidence in the record supporting the court’s conclusory reasoning, an appeal by Wendell Falls would not be unexpected. The impact of the decision on deductions allowed for contributions of conservation easements remains to be seen. However, the Tax Court’s decision, which appears to rely on speculation and unsupported valuation, is unlikely to be upheld.

Wendell Falls purchased 27 contiguous parcels comprising 1,280 acres of unimproved land in Wake County, North Carolina between 2004 and 2007. Wendell Falls planned to subdivide the land into a master-planned community consisting of residential and commercial buildings. The community would also include an elementary school and a park. Wendell Falls considered placing the park upon 125 acres adjacent to a man-made lake and two creeks and considered charitable organizations for holding the conservation easement. In October 2006, the town of Wendell approved Wendell Falls’s application for a planned unit development (PUD) on the 1,280 acres. The approved PUD did not affect the 125 acre area and Wendell Falls did not receive preferential zoning in exchange for setting aside that area for a public park.  

In 2007, Wendell Falls sold the 125 acre area to Wake County for $3,020,000 with a precondition that the transferred land would be subject to a conservation easement restricting its use as a park. The county relied on an appraisal valuing the 125 acres at $3,020,000 for the 2007 sale. Wendell Falls concurrently granted Smokey Mountain National Land Trust a conservation easement on the transferred land, effectively restricting its use to a park and related structures (such as an environmental education center, overnight lodge, recreational day-use facilities, and sports fields).  

In 2008, Wendell Falls reported a $1,798,000 charitable contribution under IRC §170(c) on its timely-filed 2007 partnership tax return. The reported deduction was Wendell Falls’ appraised value of the easement at $4,818,000 less the $3,020,000 it received from the county on the sale. In 2009, it filed an amended return increasing the deduction to $4,818,000. In 2013, the IRS audited the amended return and reduced the deduction to $0. On appeal to the Tax Court, Wendell Falls supported its argument with an expert report valuing the easement at $5,919,000. The IRS’s expert report valued the easement at $1,600,000.  

The IRS argued that Wendell Fall’s sale precondition of a conservation easement ensured the 125-acres transferred could only be used as a park and the prospect of a public park significantly increased the value of the adjoining 1,280 acres. The Court held that the grant of the easement was in exchange for a substantial benefit not merely incidental to the charitable purpose.  

However, the Court did not consider that while the conservation easement was a precondition to the sale, Wendell Falls had no guarantee that the conservation easement would be preserved once the sale was completed. Accordingly, the presumed substantial benefit is not guaranteed and from a valuation standpoint, is unlikely to entirely eliminate the charitable deduction for the conservation easement.  

The Court also reasoned, alternatively, that the deduction would be $0 because the value of the easement is $0. The Court, while noting that the record did not include any comparable sales to ascertain the value differential, encumbered or not, nevertheless decided that the easement did not diminish the value of the land, as Wendell Falls intended for the contributed land to be a park and the easement was granted in order to ensure that result. Essentially, the Court held that use of the land as a park was its highest and best use and the easement served that very purpose negating any loss in value from the encumbrance. 

Notably, the Court seems to have relied heavily on Wendell Falls’ proposed plan and disregarded the diminished value at which Wendell Falls sold the land. Specifically, the Court stated that it “believes, as Wendell Falls did, that using the 125 acres as a park would make the master-planned community more desirable and therefore increase the value of the residential and commercial lots that Wendell Falls eventually intended to sell.”

None of the expert reports, from Wendell Falls or the Internal Revenue Service (IRS), considered the “enhancement in value” argument. Further, even the IRS’s expert report valued the easement at $1,600,000. While the fact that a park may certainly enhance the value of Wendell Falls’s proposed development, nothing in the record indicates that the enhancement should be valued at 100 percent, entirely eliminating the amount of the deduction.