A claimed charitable easement deduction that is almost 179 times the amount allowed by the Tax Court probably makes you think that we are talking about a syndicated conservation easement. If you have been following that issue you may think that the Charitable Conservation Easement Program Integrity Act of 2022 has put a stop to such shenanigans. You might think that the war against abusive conservation easements has been won and the IRS is just bayonetting the wounded. Well it is not the case. J L Minerals LLC, Beasley Timber Management, LLC Tax Matters Partner v Commissioners of Internal Revenue is not about a syndicated deal. Here is the story.
The Properties
It starts in December 2015 when two real estate professionals use an LLC to buy 645 acres in rural Georgia (about $2,481 per acre). They then drop 64.7 acres into J L Minerals (JLM). The property, which Judge Urda refers to as the easement property, had been subject to a ten year mineral lease to a mining company, which never bothered to mine anything from it. If they had it would have been kaolin that they mined. Kaolin is a soft white clay that has a myriad of uses.
Along comes Beasley Timber which buys an awful lot of land to harvest the trees for the wood to use in various enterprises. They buy a 98% interest in both LLCs in January 2016. The price for the interest in J which has the easement property is $167,837 (about $2,647 per acre). L holds the larger parcel which goes for $3,132,162. According to Judge Urda’s opinion Beasley has a lot of experience with easement donations. As Judge Urda remarks:
“During discussions, the seller highlighted that the purchase would open the door to many millions of dollars in possible tax deductions through the donation of conservation easements—a vehicle well known to both buyer and seller.”
At the trial one of Beasley’s commercial lenders explained that the placement of conservation easements was something that it regularly did as part of its business operations.
The Deduction
In December 2017 J L Minerals donated a conservation easement to Heritage Preservation Trust. The easement was valued at $16,745,000 ($258,810 per acre). The premise for the valuation of an easement on the property at more than a hundred times what the entirety of the property had changed hands for two years before was that test borings indicated that there was a great prospect of having a kaolin mine on the property. According to the taxpayer’s expert, this eliminated the possibility of finding comparable sales. What was required was to figure out the discounted cash flow from the operation of a kaolin mine.
The IRS
Judge Urda seems to be comparing the IRS to Captain Renault in Casablanca.
“The parties have rounded up some of the usual suspects in this Court”, The IRS raised whether JL Minerals had donative intent, whether the donation was made exclusively for conservation purposes and whether the appraisal was a qualified appraisal. Judge Urda ruled for the taxpayer on all three of those issues, although he indicated that they barely scraped by.
Three strikes did not make an out for the IRS. Judge Urda found that the deduction amount was an “outrageous overstatement”- $16,475,000 claimed vs $93,600 allowed – and accordingly subject to the 40% gross misstatement penalty.
The Valuation
You may want to read the opinion if you are interested in learning about kaolin mining and the industry that it supports. I’m going to spare you a lot of the details. Judge Urda reviews some fundamental principles about the use of highest and best use methodology.
“Although this “concept ‘is an element in the determination of fair market value, . . . it does not eliminate the requirement that a hypothetical willing buyer would purchase the subject property for the indicated value.’” Excelsior Aggregates, LLC”
And then there is:
“The principle can also be articulated in terms of willingness to pay. If a proposed use is too risky for ‘a hypothetical willing buyer consider in deciding how much to pay for the property,’ then the use should not be deemed the highest and best available.” Palmer Ranch Holdings Ltd.
As it works out Judge Urda found that kaolin mining was not the highest and best use of the property.
“To put it bluntly, multiple kaolin processors had taken a close look at the easement property and, in at least two cases (Huber and then its successor, KaMin) decided that it was not worth mining or even keeping it as part of a long-term reserve. The actions of kaolin experts with skin in the game torpedo JL Minerals’s contention that the kaolin on the easement property “would justify . . . extraction in the reasonably foreseeable future.””
Even if mining had been the highest and best use of the property, the valuation was still inflated. Using the discounted cash flow method the appraisers were, in effect, valuing a hypothetical business operation that would be operating on the land not the land itself.
We begin with the simple observation that the evidence before us, including the testimony of market participants, firmly establishes that no one involved in the kaolin industry would have paid nearly $17 million for the easement property even if a person were to credit the GMT report and the discounted cashflow analyses that followed it. To put it another way, no rational businessperson would pay the net present value of a business simply to buy the property, as is implicit in Beasley Timber’s position equating the two values.
GMT’s own track record indicates that properties with similar deposits of kaolin are plentiful in Wilkinson County, and yet Messrs. Beasley and Loudermilk and various appraisers all noted that the per-acre values of land in Wilkinson County were somewhere between $600 and $2,400. No rational businessperson would pay $17 million for a piece of property with possibilities similar to one that could be purchased for under $200,000.
David Aughtry
The lead attorney for J L Minerals was David Aughtry of Chamberlain Hrdlicka by all accounts a first rate attorney. He is also representing Tony Townley, founder of Zaxby’s, in a similar case, which I have been covering. There an easement deduction of $166,499,500 was squeezed from property with basis of $1,277,420 and assessed value of $1,678,453 thanks to forgoing hypothetical aggregate mines. In that case the Townleys opted to pay the tax and sue for a $43 million refund in district court.
The judge in that case ruled in favor of Townley on the issues surrounding charitable intent and the like. The valuation question was to go before a jury. IRS was claiming an $8 million penalty for the refund claim being frivolous. Shortly before the scheduled trial there was a settlement for an undisclosed amount. We know that it is a refund of over $2,000,000 because the details have been sent up to the Joint Committee on Taxation. My guess is that it is considerably higher than that, although we are unlikely to ever know. That happened on July 24, 2024. As of this writing the case remains open. I am waiting with bated breath to see if the joint committee torpedoes the settlement. It seems unlikely as best I can tell.
What’s Syndication Got To Do With It?
Paul Neiffer in an article behind the Farm CPA Report paywall, which I am too thrifty to breach headlines with Another Syndicated Conservation Easement Bites the Dust. It is pretty clear to me from the opinion that there was no syndication going on here unless you think of it as a sort of bespoke syndication. Beasley did pick up a tack on the holding period by buying a 98% interest in a LLC rather than a fee simple purchase, but that is the only element that smacks at all of syndication. They were buying the property for use in their business and the easement deduction was sort of icing on the cake, although maybe there was more icing than cake in this deal. They had taken many conservation easement deductions in the past,
It happens that except in pretty exceptional circumstances syndicated conservation easements don’t work without inflated valuations. That does not mean that there were not inflated valuations elsewhere. The Land Trust Alliance fought to eliminate abuse by the passage of the Charitable Conservation Easement Program Integrity Act and celebrated its passage as something that ended abuse. We see from this case that not all abusive valuations involve syndication. We might view the syndicators as people who were spreading an advantage that was available to the very wealthy to the HENRYs (high income not rich yet). Once the flurry of cases backed up in Tax Court works through, the pressure may be off and inflated valuations on conservation deductions can once again become a privilege of wealth.
Other Coverage
As noted Paul Neiffer has something on Farm CPA Report – Another Syndicated Conservation Easement Bites the Dust.
Lew Taishoff has Blunging Farblundgeit, a title which he acknowledges can seem like incomprehensible gibberish. He invites you to read:
“Judge Patrick J. (“Scholar Pat”) Urda’s disquisition on kaolin mining in J L Minerals, LLC, Beasley Timber Management, LLC, Tax Matters Partner, T. C. Memo. 2024-93, filed 10/8/24. You will learn much about the mining, processing, buying, leasing, selling, and blunging of that useful clay, the greatest source of which is found in that very same GA Dixieland Boondockery which in turn is the launchpad of “a cover to fleece the public fisc” (T. C. Memo. 2024-93, at p. 69), the Section 170(h) conservation easement.”
Tristan Navera has something behind the Bloomberg Tax paywall – Tax Court Castigates ‘Laughable’ Conservation Easement Claim.
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.
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