Originally published on Forbes.com.
Lew Taishoff’s nomination for best Tax Court decision of 2020 is Oakbrook Land Holdings 154 TC 10. We need to take Mr. Taishoff’s opinion very seriously. He covers the Tax Court with incredible intensity. He may have a break this holiday season as the Tax Court is not issuing anything while it converts its case management system.
There is a companion decision TC Memo 2020-54 issued the same day. The decisions are about a conservation easement charitable deduction in the amount of $9,545.000 in 2008. I will be referring to the two decisions as the regular decision and the memo.
The regular decision is something that I would normally not cover in depth because it is too lawyerly for me – a majority opinion, a concurrence and a dissent that dive deep into how the Administrative Procedures Act applies to an IRS regulation, but its nominated, so it requires a look.
The Memo Decision
The Tax Court has been rather preoccupied with conservation easements this year. Oakbrook is representative of one IRS approach – denying deductions based on technical errors. In this case it was the perpetuity requirement. In the memo decision Judge Holmes goes for air war metaphors distinguishing between “surgical strikes” on valuation and “three sorties” that the Commissioner “hopes will cause more widespread casualties”. The particular sortie in Oakbrook was:
…an attack on a clause commonly found in easements, particularly in the southeastern part of the country, that divides between donor and donee future hypothetical proceeds from a future hypothetical extinguishment of the easement in a way that he claims violates one of his regulations.
The easement is supposed to be perpetual, but that is a really long time. What happens if the property is taken by eminent domain? There is a regulation on that 1.170A-14(g)(6)(ii). The regulation requires that a proportion be established at the time of donation between the value of the easement and the overall value of the property.
…. the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction …
After spending fourteen pages laying out the facts Judge Holmes spends 27 pages comparing the conservation deed to the regulation along with some very interesting history – “We begin with a bit of a refresher on the common law of servitudes.”- The conservation deed was problematic for two reasons. It took the value of any subsequent improvements off the top of any extinguishment proceeds and it gave the donee the fixed amount determined at the time of donation. The second problem was fatal.
The regulation prohibits any scenario in which Oakbrook gets to recover compensation other than a proportionate share of the proceeds, with the proportion defined by the easement’s FMV over the FMV of the unencumbered and unimproved property.
The Regular Decision
That was the memo. The regular decision is by Judge Lauber, “Scholar Al”, as Mr. Taishoff has dubbed him. Judge Lauber starts out with a summary that suggests that the IRS could have launched a surgical strike at Oakbrook:
On its Federal income tax return for 2008, Oakbrook claimed for this donation a charitable contribution deduction of $9,545,000. Oakbrook thus took the position that the land covered by the easement had appreciated in value by about 700% in a single year during the worst real estate crisis to hit the United States since the Great Depression.
But that is not what his opinion will be about:
In this Opinion we address and reject petitioner’s challenge to the regulation.
More Judges
As a regular opinion, this is a big deal. Mr. Taishoff explained the process to me:
Mr. Reilly, As distinct from a Memorandum or a Summary Opinion, both of which are written by a single judge or STJ, a full-dress T.C. is reviewed and written at the direction of the entire Tax Court active (non-senior) bench, or as many as are available, but not less than a majority of all active judges. There is usually unanimity, both as to reasoning and result.
When fully staffed there are 19 active Tax Court judges serving fifteen-year terms that can be renewed. The “seniors” who are beyond their terms can still hear cases. Unless I miscounted fifteen judges were involved in the Oakbrook case as it related to the issue of the validity of the regulation.
Eleven judges agreed with the opinion written by Judge Lauber. Judge Gustafson mostly agreed with the opinion. Judge Toro concurred with the result, but did not believe it was necessary to get into the regulation, because he would rule against the taxpayer based on the Code, irrespective of the regulation. On the other hand, he believes that the regulation is at lease in part invalid.
Judge Holmes dissented holding that the regulation was invalid. Remember it was Judge Holmes that ruled against the taxpayer in the memo decision. It reminds me of the possibly apocryphal story of a pitcher in the Mexican League who was pitching in a game that was adjourned. He was traded later in the season and he pitched for the opposing team when the game was continued. He was officially both the winning and losing pitcher of that game.
The Importance Of Comments
As noted in the memo decision, there were two aspects of the regulation that Oakbrook took issue with. One was the proportionality requirement and the other the notion that the donee would implicitly share in the value of any improvements. On the proportionality Judge Lauber noted:
Needless to say, the easement might be extinguished many years after it was granted, and considerable inflation in property values might occur in the interim. If the donee’s share were limited to the easement’s historical FMV, its property right could be eviscerated in real dollar terms
On the improvements we have:
Treasury’s goal in prescribing this regulation was to ensure satisfaction of the statute’s “protected in perpetuity” requirement. In effect this requirement is deemed satisfied because the sale proceeds replace the easement as an asset deployed by the donee “exclusively for conservation purposes.” In certain factual scenarios, reducing the donee’s proceeds on account of donor improvements could frustrate this goal, especially if local land values should decline.
Judge Lauber noted that the New York Landmarks Conservancy, one of the ninety organizations that commented on the regulations, noted the improvements problem and indicated that it raised many questions. Judge Lauber was willing to let the lack of response to that comment slide.
And how would the problem mentioned in the previous paragraph be solved, to prevent the donee’s share from being severely reduced or even eliminated? It is conceivable that Treasury could have drafted a regulation that addressed the possibility of donor improvements, dealing with these ancillary questions in some rational way. But that was a policy decision for Treasury, not this Court, to make.
A lot of the argument between the majority opinion and the dissent is about how well IRS handled the comments that it received between issuing the proposed regulation in 1983 and finalizing it in 1986. This has to do with compliance with the Administrative Procedures Act. As Judge Lauber, writing for the majority, put it:
Petitioner insists that Treasury failed to comply with the APA because the preamble to the final regulations did not discuss the “basis and purpose” of the judicial extinguishment provision specifically. But this provision represented one subparagraph of a regulation project consisting of 10 paragraphs, 23 subparagraphs, 30 subdivisions, and 21 examples. No court has ever construed the APA to mandate that an agency explain the basis and purpose of each individual component of a regulation separately
Judge Holmes in dissent covers the New York Land Conservancy’s comments in great detail. His overall conclusion on IRS observance of APA requirements is negative.
This makes the defining characteristic of section 1.170A-14(g)(6)(ii), Income Tax Regs., its utter lack of any contemporaneous explanation of its key choices–to require that donees get a fraction, rather than an absolute amount, of extinguishment proceeds and to require that they get a share of any proceeds from a donor’s improvements to the property.
What Is Next ?
I have to say that one element of the majority opinion is very persuasive. That is that the regulation has been in effect for over 30 years and that Congress has amended the deduction several times without expressing any concern about it. On the other hand, as noted in the dissent, it appears that the language used in Oakbrook is pretty common in easements and many basically legitimate easement deductions could be disallowed because of a technical error. So I will give the dissenting Judge Holmes the last word.
I will end with where I began in today’s Memorandum Opinion on the less controversial parts of this case: Conservation-easement cases might have been more reasonably resolved case-by-case in contests of valuation. The syndicated conservation-easement deals with wildly inflated deductions on land bought at much lower prices would seem perfectly fine fodder for feeding into a valuation grinder. Valuation law is reasonably well known, and valuation cases are exceptionally capable of settlement.
Congress, however, enacted these sections of the Code and presumably wanted reasonably valued conservation easements to be allowed. Yet we’ve come to a point where we are disallowing a great many conservation-easement deductions altogether, not for exaggeration of their value or lack of conservation purpose, but because of very contestable readings of what it means for an easement to be perpetual.
The taxpayer filed an appeal to the Sixth Circuit in November. We will probably be hearing more about this case.
Other Coverage
Mr. Taishoff of course covered both of the decisions. In Whitefish And Silt, he examines an obscure exchange between Judges Lauber and Holmes. He covers the memo decision in Keeping Things In Proportion.
But, of course, Oakbrook isn’t done if 6 Cir reverses 154 T. C. 10. Judge Holmes wrote their decision for them. See my blogpost “They Always Must Be With Us,” of even date herewith, as my high-priced colleagues would say.
He covered the regular decision in They Always Must Be With Us. He correctly predicted that there would be an appeal and he further predicts that Judge Holmes’s reasoning will prevail at Sixth Circuit.
Monte Jackel has Conservation Easement Donation and the Validity of Tax Regulations on Procedurally Taxing.
Where does this take us? This case shows that the Treasury and IRS need to pay more attention as to (1) what is a legislative rule as compared to an interpretative rule, and (2) has it considered all “significant” public comments and fully addressed them in the final rule.
And for commenters to regulations, this case seems to indicate that a comment letter should state that the issue is material, fully discuss the issue, and propose a practical alternative if one is available.
Leslie Book followed up that post with Oakbrook Land Holdings v Comm’r: A Follow-Up Post Exploring the Impact of Administrative Law on Validity of Tax Regulations.
Partnership For Conservation (P4C) celebrated Judge Holmes’s dissent with Tax Court Judge Excoriates IRS War On Conservation Easements. I have to admire P4C as they snatch a PR victory of sorts from the jaws of defeat.
Charles Reichert had a good summary in the Journal of Accountancy.
Misti M. Schmidt in a roundup of cases for Conservation Partners LLP rates the decision as “Terrible for legitimate easement donors”.
Many non-abusive easements recorded before 2017 are vulnerable to attack using this argument because many land trust forms excluded after-built improvements from the formula. The first case in which the extinguishment proceeds argument arose, Carroll, did not involve an abusive syndication.
Nancy Ortmeyer Kuhn covered the case as part of a larger survey on Bloomberg Tax – INSIGHT: Charitable Conservation Easements—IRS and Tax Court Act To Shut Them Down.
By disallowing conservation easements in total, along with imposing significant penalties, the IRS and the Tax Court are not carrying out the legislative intent behind Congress’ enactment of the legislation that supports conservation easements. While in the earlier years the valuation of the easement was frequently the issue, the IRS now almost always disallows 100% of the charitable deduction attributable to the conservation easement, which the Tax Court almost always upholds. (See case summaries in Appendix) Frequently, the reason for the disallowance is not the lack of a charitable conservation purpose or effect, but a very technical (and fixable) problem with document drafting.
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