Tony Townley is one of the cofounders of Zaxby’s a chain of fast casual restaurants.  There are more than 900 locations in 17 states. Goldman Sachs acquired a major stake to help accelerate growth in 2020.  Zaxby’s has concentrated on selling chicken fingers and wings with special sauces in the Southeast.

This story is about what Mr. Townley and his wife Elizabeth have done with some of the wealth generated by the phenomenal growth of the restaurant chain which Townley founded with his lifelong friend Zach McLeroy in 1990.  They have dedicated themselves to preservation through their partnership Log Creek LLLP.  And now they are in the United States District Court Middle District of Georgia fighting for the tax benefits that they think are supposed to support their efforts. At least that is one way of looking at it.

Some Numbers

I am drawing this narrative from documents filed in the ongoing case – Tony D. Townley and Elizabeth A. Townley v United States of America. The two key documents are the complaint filed October 28, 2022 and a motion by the United States for summary judgment as to valuation filed on November 14, 2023.

The Townley’s, who through Log Creek LLLP own approximately 40,000 acres in Georgia, donated conservation easements on three parcels totaling 794 acres, one parcel in 2018 and two in 2019, to the Oconee River Land Trust Inc. Their cost basis in the parcels was $1,277,420.  The assessed value of the properties was $1,678,435.  The Townley’s claim that the properties were worth $169,210,000 and that the easements reduce their value to $2,530,0000.  Netting from that the enhancement of value to adjacent parcels of $230,500 makes for a deduction of $166,499,500.  Only they claimed $166,499,000.  That $500 is driving me a little crazy, but you’re probably not concerned, so I will let it go.

Reilly’s Sixth Law of Tax Planning – Don’t do the math in your head. You can’t get the tax benefit of that deduction by simply multiplying by a marginal rate.  The charitable contribution deduction is limited to 50% of adjusted gross income and the qualified business income deduction (Section 199A) which is quite significant on the Townley returns is limited to taxable income over net capital gain.

The Townley adjusted gross income for 2018 was $44,318,207.  It is a complicated return with a lot of moving parts, but the main thing driving it is an S Corporation flow through of $34,882,957 from Plucked Chicken Inc, which was the parent company of the Zaxby’s empire.  2019 was similar with adjusted gross income of 40,868,075 which included a Plucked Chicken Inc flow-through of $35,856,370.  That was not enough adjusted gross income to use the full charitable contribution.

That came in 2020 when the Townleys had adjusted gross income of $985,025,987.  They got to use the $124,186,787 carryover from 2019.  It’s not all fun and games though, they had to give up all of their $7,587,470 QBI deduction.  What drove the nearly billion dollar AGI was net gain of $932,707,897 from eight entities (most of the dollars are from Plucked Chicken).  That’s connected to Tony Townley bowing out of Zaxby’s in favor of Zach McElroy’s new partner, Goldman Sachs.

Why District Court?

The Townleys claimed a charitable contribution for the first parcel on their original 2018 return in the amount of $46,671,800.  The appraisal was done by Clayton M. Weibel and Tanna Santagelo. Clayton Weibel was later indicted for other appraisals that he did of conservation easements, but unlike his codefendants jurors found him not guilty.  It should come as no surprise that the return was audited.

The auditor found that baseline documentation was not sufficient, the conservation easement failed to satisfy a valid conservation purpose and the appraisal was not qualified.  Failing all that IRS hired Peter Dittmar of RER Solutions to appraise the easement.  His value was a radically lower than Weibel’s – $310,000, less than 1% of the claimed deduction.  Other than that Mrs. Lincoln, how did you enjoy the play?  The Townleys could have joined the multitude that is fighting these issues in Tax Court, but they chose another way.

They got a new team and amended returns to remove the easement deductions and paid the balance due.  Then they reamended their returns to claim the deductions backed with new appraisals done by Kenny Associates.  When  IRS did not issue the requested refund, the filed the complaint in District Court.  One of advantage of this approach is that the interest clock is ticking in their favor rather than against them.  Also they don’t have to worry about a 40% overvaluation penalty.  The government is still going for a 20% excessive refund claim penalty. I don’t know if that is harder for them to win on than the negligence penalty that IRS routinely asserts on balance due returns.

The big difference and it is the lawyers who work out the odds here is that a district court judge is in charge not a tax court judge and some things may be decided by a jury. An attorney going with this strategy on a different sort of case told me that there is a sort of home court advantage to fighting it out in district court.  Judge Clay D. Land, who has this case, is a University of Georgia graduate, both undergraduate and law school and practiced in Columbus GA until he was appointed by George W Bush in 2001.  And then there are the jurors who might be influenced by how much they like those chicken fingers.

The claimed refunds are $6,757,047 for 2018, $6,071,342 for 2019 and $30,469,924 for 2020.  The Townley team is headed by David Aughtry of Chamberlain Hrdlicka. Somebody knowledgeable about these cases told me that he is first rate.  I note that he is a Citadel graduate, which really impresses me.

Schrödinger’s Granite Mine

The vast differences in appraisals of the easements and the Government’s position that the Kenny appraisals are wrong as a matter of law has to do with granite mining.  Tony Townley is very opposed to strip mining and when a quarry in the neighborhood caused problems with the water on his land he began looking into it.  Starting with his forester who went looking for substantial outcroppings, the team identified parcels that seemed likely prospects for mining.  Then the geologists were called in and test borings were done along with lab analysis of the results.

Kenny Associates identified the parcels as having granite mining as their highest and best use.  They valued them based on the discounted cash flow that would be derived based on twenty years or so of mining.  Most notably, they did not find any comparable sales, which is generally the preferred appraisal method.  Why were there no comparables? This is from the Kenny report.

“The appraisers endeavored to find sales of land where both the buyer and seller had reasonable knowledge of the relevant facts. Specifically, land sales where the seller had a qualified drilling company under the guidance of a Professional Geologist drill the property, a Qualified Laboratory test the material found from the drill results, a Professional Geologist along with a Professional Engineer evaluate the reserves on-site based on the physical characteristics of the property, a mining consultant working in tandem with the Professional Geologist and Professional Engineer evaluate the supply and demand as well as the target market. Further, the mining consultant would have established the permitting schedule, the market pricing, production schedule, the capital expenditures, the operating costs, and the life of mine. All of the above is only possible on a property is unique and has the quality and quantity of material on-site that is financially feasible to extract. However, the appraisers were unable to find any land sales that had all the above-described due diligence similar to the subject property.”

What’s this got to do with Schrödinger? Physicist Erwin Schrödinger devised a thought experiment in 1935.  It involves a Geiger counter, a radioactive source, a flask of poison and a cat inside a sealed box.  If the Geiger counter detects radioactivity the flask is shattered and the poison kills the cat.  The idea is that when you open the box the cat will be alive or dead, but before you do the cat is both alive and dead. All this Georgia land has been changing hands for thousands of dollars an acre, but some of it should have been trading for hundreds of thousands, but nobody opened the box.

It came out in the depositions that in valuing each of the hypothetical mines, they gave no consideration to the others.  And the demand for granite is limited to local needs because it is so expensive to ship.  The other problem is that the IRS appraiser found comparable sales of land that changed hands specifically for the purpose of quarrying. None had values that supported Kenny’s DCF values.  Kenny has done a lot of appraisals for granite mines in the region, but according to the depositions they don’t know of anybody relying on their appraisal to actually buy a property to start mining.

There is a kind of joke about conservation easements that I think I picked up from law professor Nancy McIntyre, although she did not originate it.  Subdivisions for housing has long been one of the go to highest and best uses for valuing easements on farmland.  The joke is that if all the hypothetical subdivisions that have supported easement deductions had been executed we would have all the housing that we need for the next several hundred years and a really severe food shortage.  The current deals threaten to turn the state of Georgia into a vast granite mine.  Can’t think of anybody who would like that who isn’t named Sherman..

Judge David Gustafson in the Tax Court recently ruled on a case where promoters were getting easements on a multiplicity of assisted living facilities in the same general area. I wrote:

“:Judge Gustafson puts himself in the shoes of a developer of an assisted living facility and looks at the available places in Harlan County where such a facility could be built and finds many that had been granted conditional approval. He did not have to look far. There are ten examples. They all have docketed Tax Court cases.”

On The Penalty

My favorite deposition was the one of Russell Wills CPA.  He is at OTF Management LLC which oversees all the various Townley property not directly related to the restaurant empire.  As Townley was being deposed he indicated that he relied on Russ to know which property was in which entity and the like.  Willis is a young CPA and he seems to perfectly fit the consigliere type of role that CPAs can play to an entrepreneur like Townley.

On the subject of the appreciation of the property being beyond belief, he countered with the example of Zigby’s where $17,000 turned into $2 billion.  Russ had to school the DOJ tax attorney questioning him on how you allocated the price of timber land between the land and the trees.  That is the sort of thing that you generally don’t learn about in school.  I think his testimony gives a good sense of the sincerity that he and the Townleys had in following the advisors. He said that he had:

“…the confidence that Tony has the wherewithal to do this.  I mean, he’s nobody’s fool to have created what he created .  And again, it ties right back into how we value timber.  Rock is a natural resource, timber is a a natural resource, and you look at the value of that resource over time.  We gave up the right to ever extract this rock.  That rock is in the ground forever more, regardless of how this case comes out.  But to be clear, we have zero dollars of this money today.”

That is actually not that great an argument for the deduction being good, but it is a good argument that the penalty should not apply.

Reflection

This was not a syndicated conservation easement.  The Townleys had owned the property involved for quite a while and they are doing this on their own account. The Land Trust Alliance has fought long and hard against the syndicated deals, which for the most part needed to be abusive in order to work.  They celebrated when the Charitable Conservation Easement Program Integrity Act was passed.  That act would not in any way affect this sort of transaction.  When I was writing critically about the syndicated deals, I would often get chided by someone who thought of me as abysmally ignorant.  One time he wrote me

“How can 90% of all millionaires make their money from exploiting Real Estate but when the tax code is used by more than the upper .005% it is a fraud? How can the likes of Ted Turner and John Malone use the code but when a group of 30 people does its a fraud?

How can one landowner who could never even get close to using a small 8 million dollar deduction be left to only selling their land to a developer or just giving away something with no incentive unless they have an income?”

For the most part syndicated conservation easement transactions don’t work without abusive appraisals since they are sold to people who in December realize they will have a big balance due.  Once you get rid of those actors though you are still left with the valuation problem and people with a lot of capital and some patience will be able to exploit the system.  If we must use the tax code to support preservation, we might want to look to the model of the Low Income Housing Tax Credit where the amount of the subsidy is capped and distributed to projects by state agencies.

—————————————————————————————————————————————————————————

For great value continuing professional education.  I recommend the Boston Tax Institute

You can register on-line or reach them by phone (561) 268-2269 or email vc@bostontaxinstitute.com.  Mention Your Tax Matters Partner if you contact them.

Originally published on Forbes.com.

For articles oriented toward tax professionals check out Think Outside The Tax Box.