Bar News - May 18, 2012
Real Property Law: Conservation Easement Hot Topics: Appraisal and Perpetuity Requirements
By: Rebecca A. Wagner
In the last few years, the Internal Revenue Service (IRS) has been denying taxpayer deductions for conservation easements citing technical deficiencies, and often winning when challenged in court. Thus, when representing a landowner who plans to take a federal tax deduction for the donation of a conservation easement, it is key to follow the requirements in the Internal Revenue Code (IRC) and accompanying Regulations to the letter.
Two areas have been of particular interest to the IRS of late: appraisals and perpetuity requirements.
For charitable contributions of property in excess of $5,000, which is most, if not all conservation easements, IRS regulations provide very specific substantiation requirements. Indeed,26 CRF 1.170a-13(c) provides that "[n]o deduction under section 170 [of the Internal Revenue Code] shall be allowed with respect to a charitable contribution" unless the substantiation requirements of that sectionare met.
In short, section 1.170a-13(c) requires the donor to attach a qualified appraisal, prepared by a qualified appraiser, and an appraisal summary to the donor’s tax return when the donor first claims a deduction for a conservation easement valued at more than $5,000. This is in addition to the Form 8283 and accompanying summary that the donor must also file with the tax return.The qualified appraisal must be completed not earlier than 60 days before the donation, or by the due date of the tax return on which the donor is first claiming the deduction.
There is a laundry list of information that must be provided in the qualified appraisal - § 1.170a-13(c)(3)(ii) lists 11 items, including the conservation easement contribution (or expected contribution) date, the date the appraisal was performed, and "[a] statement that the appraisal was prepared for income tax purposes." § 1.170a-13(c)(3)(ii)(G).The provision for the appraisal summary also lists a number of required items, some of which need not be included on the qualified appraisal. See § 1.170a-13(c)(4). Leaving out any of the items listed in the above sections can result in the donor’s tax deduction being denied.
In Lord v. Commissioner, T.C. Memo 2010-196, the IRS denied the taxpayer’s conservation easement deduction because the donation was not properly substantiated. When the taxpayer brought the matter before the Tax Court, the court held that the appraisal was not a qualified appraisal because it "does not include the following significant information: The easement contribution date, the date the appraisal was performed, or the appraised fair market value of the easement contribution on the contribution date." Id. The court did not permit the taxpayer to rely on the doctrine of substantial compliance, stating that that doctrine "is not applicable if significant information is omitted." Id.
In Friedberg v. Commissioner, T.C. Memo. 2011-238, however, the Tax Court was faced with an appraisal that, among other issues, was dated on several different days. The petitioner stated the discrepancy was due to transcription error. The Tax Court accepted this argument and held that the appraisal substantially complied with the Regulations. Interestingly, the court stated that"the errors regarding the date of the appraisal report do not relate to the substance or essence of the contribution [but, rather,] are more procedural." Id. However, the court also went on to say that "there may be cases in which the failure to meet [the requirements regarding the date of the appraisal report] would be significant," possibly referring to the court’s holding in Lord. Id.
The takeaway from these two cases, and others not cited here, is that strict compliance with the requirements of § 1.170a-13(c) is mandatory. While the doctrine of substantial compliance may be available for a minor error in the information provided, it will not be if the information is not provided in the first place.
The IRS also pays particular attention to whether the conservation easement will be protected in perpetuity, as required by IRC 170(h)(5)(A) and 26 CFR 1.170a-14(g).
In Kaufman v. Commissioner, 134 T.C. 182 (2010), the IRS challenged the Kaufmans’ claimed conservation easement deduction because their mortgage subordination did not fully protect the land trust’s right to proceeds in the event of extinguishment, as required by 26 CFR 1.170a-14(g)(6). The problem, the IRS claimed, was that:
the bank retained a "prior claim" to all proceeds of condemnation and to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the property. Moreover, … the bank was entitled to those proceeds "in preference" to [the land trust] until the mortgage was satisfied and discharged. The right of [the land trust] to its proportionate share of future proceeds was thus not guaranteed.Id. Thus, the IRS argued, the conservation easement was not protected in perpetuity. The Tax Court agreed with the IRS and upheld the denial of the Kaufmans’ deduction. On reconsideration, the Tax Court upheld its prior holding, again denying the Kaufmans’ deduction. See136 T.C. 13 (2011).
Further, in Carpenter v. Commissioner, T.C. Memo. 2012-1, the IRS challenged the taxpayers’ conservation easement deductions because the conservation easements at issue provided that the easements could be extinguished "by mutual written agreement of both parties" if the purposes of the easements became impossible to accomplish. While the Tax Court "declined to rule that a conservation deed must require a judicial proceeding to extinguish an easement for the easement to be perpetual," the court did not like the seeming ease with which the easement could be extinguished and upheld the IRS’s denial based on a lack of compliance with perpetuity requirements. Id.
The outcome in Carpenter may have differed, though, had it been based on New Hampshire law, rather than on Colorado law. In Carpenter, the taxpayers argued that charitable trust principles apply to conservation easements. However, because no court in Colorado had determined that the donation of a conservation easement created a charitable trust, and indeed had held in other cases that creating a trust requires the clear intent to do so, the Tax Court did not accept this argument.
In New Hampshire, the Attorney General considers the donation of a conservation to constitute creation of a charitable trust, and so applies charitable trust principles to conservation easements. See Amending or Terminating Conservations Easements: Conforming to Charitable Trust Requirements, Guidelines for New Hampshire Easements Holders, section I(B). Thus, according to the Attorney General, "[t]he release, extinguishment, or other termination of a conservation easement, whether in whole or in part, requires court approval in a cy pres proceeding. "Guidelines, section IV.
It is not clear, however, what weight the Attorney General’s Guidelines would carry were a conservation easement containing language like that in the easements in Carpenter to be challenged by the IRS and go before the Tax Court, especially since the issue has not been decided by a New Hampshire court. Therefore, those drafting conservation easements in New Hampshire should still pay particular attention to whether the conservation easement will be protected in perpetuity.
|Rebecca A. Wagner
Rebecca A. Wagner is a solo practitioner in West Lebanon, NH. Her practice includes land conservation, real estate, tax, environmental law and estate planning. For more information, visit www.nhconservationlaw.com.