Originally published on Forbes.com.
Last week was a big week for disallowing conservation easement deductions in the Tax Court with two big-dollar decisions coming out. We already covered Nathaniel and Stella Carter, which leaves Railroad Holdings LLC for today and hot off the presses today is Rock Creek Properties Holdings LLC. All in the Tax Court has disallowed over $30 million in deductions in less than a week.
Sort Of A Syndication
Railroad Holdings LLC is taxed as a partnership, meaning the tax effects of its transactions flow through to its owners. At the time of the granting of the easement a single partner, LCV Fund XI owned 98.99% of RHLLC.
According to this source, the fund has only one beneficial owner, so this is not exactly a syndication. I’m thinking of coming up with a new oxymoron – “bespoke syndication” which would fit this deal and also Coal Holdings.
The Contribution
Sage Mill Investment Property Two had purchased 454 acres of land in Aiken, County SC in 2008 for about $4,000,000. In a somewhat circuitous manner 452 acres of the parcel ended up in RHLLC with LCV Fund XI as the 98.99% partner. Those transfers took place on December 17, 2012. On December 26, 2012 RHLLC donated an easement to South East Regional Land Conservancy.
RHLLC claimed a $16,000,000 deduction for the easement. We don’t know what the investor paid for the deduction, which is what these deals come down to. It is reasonable to assume that the two acres left behind of the 474 had something special about them.
The Problem
The IRS denied the deduction entirely and asserted penalties. The ground that they used to deny the deduction was pretty technical. I am torn as to which of Reilly’s Laws of Tax Planning was violated here – the Fourth Law – Execution isn’t everything, but it’s a lot. – or the Eleventh Law – Pigs get fed. Hogs get slaughtered.
The technical problem is with the perpetuity requirement. These easements are supposed to be forever, but, you know, stuff happens. Like eminent domain or maybe it turns out that those passenger pigeons you were trying to preserve were already extinct. Who knew? That can cause the easement to be extinguished.
So now the property is back in the highest and best use game. The spirit of perpetuity is satisfied if you split up the proceeds proportionally with the charity that received the easement based on the fair market value of the easement when it was created.
Only the deal with SERLC did not call for that. Instead we have:
“SERLC, upon a subsequent sale, exchange or involuntary conversion of the Conservation Area, shall be entitled to a portion of the proceeds at least equal to the fair market value of the Conservation Easement as provided above.”
Bad Lawyering Or Going For Too Much?
If that was some sort of a slip-up, then its the Fourth Law, the one about execution. If it was done on purpose though, it is indicative of a real reach. Why risk a $16,000,000 deduction to get a better deal in the event something highly improbable happens?
The only thing I can think of is that maybe the extinguishment is not that improbable. Maybe that is the plan. But that would be uncharitable of me, so I will stick with poor execution.
Responding to inquires about possible appeal John P Barrie, attorney for the taxpayer, indicated that the question was premature. The decision was a summary judgement on the deduction. The penalty question remains open. And for that there may be a valuation question in which we will learn how property in Aiken County can multiply like the bread and fishes to increase four-fold or more in just over a week.
Deduction Denied
Judge Gustafson went with the IRS. There is a pretty lawyerly discussion of the taxpayer’s attempts to salvage compliance with the perpetuity requirement from the flawed language, but the Judge was not having any of it.
It is interesting to note that Judge Lauber’s decision in Coal Holdings also highlighted a problem with the perpetuity requirement and division of proceeds in the event of extinguishment. That deal had other problems, but one strike and you’re out and perpetuity was the strike Judge Lauber chose.
Professor McLaughlin Weighs In
University of Utah Law Professor Nancy McLaughlin wrote me about the RHLLC decision.
It is unclear whether the donor in this case was trying to be clever or failed to hire experienced tax counsel.
“Some important takeaways from this case:
1) Judge Gustafson states in his opinion that the donee land trust’s “personnel presumably composed the pertinent language in the deed.” The donor of a conservation easement should not rely on the donee, the donee’s template easement, or any other template or model easement (many of which are out-of-date) to satisfy the requirements for the §170(h) deduction. The risks of noncompliance (audit, litigation, denial of deductions, and interest and penalties) fall on the shoulders of the donor, not the donee. It is the responsibility of the donor and the donor’s legal counsel to ensure that all requirements are satisfied.
2) Any donor contemplating claiming a § 170(h) deduction should hire experienced tax counsel to assist with the donation. Not hiring counsel—or hiring counsel with no or insufficient experience with §170(h) or tax law generally—is foolhardy. And attorneys with no or insufficient tax expertise who represent easement donors risk malpractice claims.
3) Judge Gustafson makes clear that the parties’ purported “intention” to satisfy §170(h) requirements is irrelevant. This holding is appropriate. It would be impossible to fairly administer our tax system if compliance were based on taxpayers’ subjective intent, in part because some people would have no qualms about lying.
4) A donor cannot cure noncompliance with § 170(h) requirements by relying on a “savings” clause. With regard to the latter, Judge Gustafson explains:
“A donor cannot reserve in an easement deed a right that section 170(h) does not permit (such as a right to more than his share of extinguishment proceeds) but then save his charitable contribution by mentioning the rule he has violated and calling for that rule to kick in and save the day if his violation subsequently comes to light.”
This holding also is appropriate. If a savings clause worked to cure noncompliance, noncompliance would become the norm, and only the small percentage of easements picked up in the audit process would be “fixed,” while the vast majority of noncompliant donations would slip through the system. Many taxpayers would end up receiving lucrative deductions for the donation of conservation easements that would not contain the basic safeguards needed to ensure the perpetual protection of subject properties’ conservation values or the public’s investment in conservation in the event of a judicial extinguishment.
About Extinguishment
This is in no way a reflection on any particular land trust, but people being people I can’t help but think, there are some land trusts that are not in the best of hands. If the land trusts play ball with owners to not resist extinguishment, generally the state Attorney General should step in.
But the AG is just one official and what if the matter is not a priority for the AG’s office?
Well Professor McLaughlin indicates that there might be a role for activists then
As in the charitable context generally, in egregious cases where the AG either declines to enforce an easement or is complicit in the holder’s breach of its fiduciary duties to the public, the courts will be more willing to grant members of the public standing.
If you want to keep an eye on the easements in your area or places you travel there is a National Conservation Easement Database. Unfortunately it is not complete. I spoke with James Strittholt, President and Executive Director of the Conservation Biology Institute. He indicated that the database is only updated through 2015 and it is dependent on land trust reporting. There are other databases that cover smaller areas, but on a national level, the NCED is as good as it gets.
Development
Just Gustafson is not wasting any time. Lew Taishoff reports a ruling on a motion for summary judgement in another case Rock Property Holdings LLC. Same issue, some of the same players, same judge, same state – different county. Stunning multiple well over six as Mr. Taishoff observes.
But the point here is that Aiken, who had inherited various parcels of Georgia scrub land ”… had effectively received about $1.2 million for the entire property in September 2013; and Rock Creek Holdings claimed that the easement on the property was worth about $7.9 million three months later in December 2013.”
Other Coverage
Lew Taishoff has The Old Texas Maxim. It turns out that the maxim is a variation of Reilly’s Eleventh Law of Tax Planning.
Taishoff says invoking savings clauses and fancy-pants arithmetical lawyerbabble to try grabbing a few utterly hypothetical, speculative bucks is nonsense. The maxim: “Pigs git fat, hogs git et.”
Lewis Saret has a summary on Wealth Strategies Journal.
Ed Zollars has Language in Extinguishment Clause in Deed Dooms Conservation Easement Deduction
Roger McEowen gets into the case and points our other ways you can go wrong on perpetuity in Agricultural Law and Taxation Blog.
Jack Townsend has a technical analysis on Federal Tax Procedure.
Joe Kristan has Tax News and Views Derailed Deduction Roundup on the EideBailley Tax News & Views Blog.
“Appreciated property donations remain a powerful tax planning tool for charity-minded taxpayers. But if you don’t do everything right, like this easement donor, you might find yourself with nothing but the warm feeling of your donation to show for it.”
Having Joe Kristan back in the tax blogosphere is a great development which I hope to write on more later. I mourned when Joe hung up his keyboard in 2017 It was pretty clearly the result of him having an upstream merger.
I had a similar experience when CCR merged into a not-quite-Big 4 (more nimble you know). I didn’t give it up but it was pretty clear that the better career move would have been to. I solved the dilemma by getting fired for other reasons. Apparently EideBailley thinks that Joe’s writing will be good for their brand. I think it is a smart move on their part.
Some History
It has nothing to do with the case, but the history of Aiken County is fascinating. It was formed during Reconstruction and formerly enslaved African Americans had a strong role in its governance. It was the site of the Hamburg Massacre in 1876, which was a big step in the ultimate disenfranchisement of African Americans. Quite a few people I know are pretty jittery about the upcoming 2020 election. It will be no comfort to them, but I think that whatever happens in the 2020 election won’t be nearly as bad as 1876.
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