Originally published on Forbes.com June 5th, 2013
When you make a charitable contribution of anything other than money or marketable securities, there will always be a valuation issue. At least, it will usually be clear what it is that you are giving away. A conservation easement is different. You are keeping the property as it is and giving up all the hypothetical possibilities. Ideally, to value a conservation easement, you should find comparable properties both with and without the easement and compute the difference. Since such comparables are rarely available the alternative is to come up with another use and value the property as hypothetically improved. Then you subtract the hypothetical cost to bring it to that use including perhaps some sort of hypothetical risk premium. Then you subtract the value of the property as it is currently used. The remainder is the value of the conservation easement.
Mr. Mountanos had three experts testify about the valuation. The IRS did not even bother to have their own expert. They just cross-examined the taxpayer experts. The IRS has a presumption working in its favor that the highest and best use is the current use. If the highest and best use is the current use, a conservation easement is worthless. Mr. Mountanos had experts who indicated that 287 or the ranch’s 882 acres could be converted into a vineyard. The balance could be subdivided into 22 residential parcels – hypothetically speaking.
Petitioner failed to show that vineyard use was a legally permissible, physically possible and economically feasible use of the ranch.
Other than that, Mrs. Lincoln, how did you enjoy the play? The ranch is totally surrounded by federal land. There is an access easement, but it is restricted to single-family use and there is no indication that the Bureau of Land Management would alter the easement. Then there was the matter of water rights. Apparently it takes water to grow grapes. Who knew? Then there was the small matter of whether there would be any demand for a vineyard if the logistical obstacles were overcome.
The problem with subdivision was that there had been a contract in place under something called the Williamson Act
The California Land Conservation Act of 1965–commonly referred to as the Williamson Act–enables local governments to enter into contracts with private landowners for the purpose of restricting specific parcels of land to agricultural or related open space use. In return, landowners receive property tax assessments which are much lower than normal because they are based upon farming and open space uses as opposed to full market value.
Apparently the taxpayer experts had not figured out a way around the restriction on subdivision that the contract called for.
There have been quite a few decisions of late where conservation easements or façade easements in urban areas have been declared worthless by the Tax Court because the hypothetical developments proposed are already restricted. I compare easements like that to me renouncing my superpowers.
There is an interesting computation, I thought would be worth making. The deduction computed on the 2005 return was $4,691,500. Only $1,343,704 could be used. That could have saved Mr. Mountanos as much as $470,000. If his income had a high capital gain component, it would have been quite a bit less, but let’s run with that for now. The deficiency for 2006, 2007 and 2008 was about $1,100,000. That would put the penalty at around $440,000. So, thanks to the statute of limitations, he may be roughly even on the whole deal, until you throw in the interest, attorney fees, and stress and aggravation.
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