Taxpayer Can't Value Conservation Easement Based on Hypothetical Mining Business

(Parker Tax Publishing April 2025)

The Tax Court held that a taxpayer that claimed a deduction for the donation of a conservation easement on rural land in Alabama incorrectly valued the donation based on an appraisal stating that the highest and best use of the land was limestone mining. The court noted that the land was zoned for agricultural and light residential use only and found that the taxpayer failed prove that rezoning to permit mining use was reasonably probable. Ranch Springs, LLC v. Comm'r, 164 T.C. No. 6 (2025).

Background

Ranch Springs, LLC (Ranch Springs) is an Alabama limited liability company. Ranch Springs was owned by brothers Tom and Bob Lewis and . The Lewis brothers are longtime Alabama residents with lifelong experience in the coal mining business. In December 2016 Ranch Springs purchased 110 acres of farmland in rural Alabama (i.e., the Ranch Springs Property) for $715,000, or $6,500 per acre. That approximated the going rate for similar property in the neighborhood during 2014-2020. The property's zoning classification permitted only agricultural and light residential use.

In August 2017, Tom's son-in-law, Jason Rudakas, engaged James Freeman and Ricky Novak on behalf of Ranch Springs to assist in implementing a syndicated conservation easement (SCE) transaction involving the Ranch Springs Property. Freeman and Novak were in the business of arrangement and helping to market SCE transactions, functions commonly regarded as being performed by "promoters." The promoters recommended an ownership structure that is common to many SCE transactions. Ranch Springs, which owned the Ranch Springs Property, would serve as the Property Company or "PropCo." It would eventually be owned by an Investment Company or "InvestCo," and units in the InvestCo would be marketed to investors. The PropCo would place a conservation easement on the property, and the investors would then receive, through the InvestCo, pro rata shares of the tax deduction that Ranch Springs claimed for the easement.

Also in August 2017, Rudakas engaged Claud Clark III to perform an appraisal for a proposed conservation easement on the Ranch Springs Property. Clark's appraisal asserted that the highest and best use (HBU) of the Ranch Springs Property was development as a limestone quarry. To value the easement, Clark hypothesized - and discounted to present value - the cashflow that supposedly could be derived from operating a limestone quarry on the property for 35 years. He opined, in other words, that the value of the raw land was equal to the assumed value of the hypothetical mining business.

On December 28, 2017, Ranch Springs granted a conservation easement over the Ranch Springs Property to Heritage Preservation Trust, a Code Sec. 501(c)(3) entity and a qualified organization under Code Sec. 170(h)(1)(B). The deed of easement prohibited commercial development of the property but reserved numerous rights to Ranch Springs, including the rights to use the property for agricultural, forestry, and recreational purposes and to build structures within a designated area.

On its income tax return for 2017, Ranch Springs claimed a charitable contribution tax deduction of $25,814,000 for the donation of the conservation easement. It asserted that the "before value" of the farmland (i.e., the value of the land before being encumbered by the easement) was $236,673 per acre. It thus took the position that the land had appreciated by 3,641 percent in 12 months. The IRS selected Ranch Springs's return for examination and, after an audit, disallowed in its entirety the deduction claimed for the conservation easement. The IRS determined that Ranch Springs had not established that it made a contribution or gift in 2017 and had otherwise failed to show that it had satisfied all the requirements of Code Sec. 170. Alternatively, the IRS determined that Ranch Springs failed to establish that the value of the easement exceeded zero. A gross valuation misstatement penalty was also determined. Ranch Springs petitioned the Tax Court for readjustment of partnership items.

Code Sec. 170(a)(1) allows a deduction for any charitable contribution made within the tax year. If the taxpayer makes a gift of property other than money, the amount of the contribution is generally equal to the fair market value (FMV) of the property at the time of the gift. Under Reg. Sec. 1.170A-1(a) and (c)(1), the FMV of property for charitable contribution purposes is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

Reg. Sec. 1.170A-14(h)(3) generally provides that the FMV of real property should reflect its highest and best use (HBU) on the valuation date. A property's HBU is the most profitable, legally permissible, use for which the property is adaptable and needed, or likely to be needed in the reasonably near future. In Whitehouse Hotel Ltd. V. Comm'r, 139 T.C. 304 (2012), the Tax Court defined HBU as the "the reasonably probably and legal use of vacant land or an improved property that is physically possible, appropriately supported, and financially feasible and that results in the highest value."

Since market prices typically do not exist for conservation easements, courts usually value easements indirectly using a "before and after" approach in order to determine the reduction in property value attributable to the easement. Under that approach, the value of the easement is deemed equal to the FMV of the real estate before the easement was granted (before value) minus the FMV of the real estate as encumbered by the easement (after value).

Ranch Springs argued that the HBU of the Ranch Springs Property was as a limestone quarry. Although the property was zoned for agricultural use, Ranch Springs contended that rezoning to permit mining was reasonably probable based on an April 2018 letter from an Atlanta law firm, Bloom Parham, which stated that rezoning might be approved if there was no strong neighbor opposition to the mining request. Ranch Springs also relied on a September 2016 letter signed by Theo Perkins, the mayor of Harpersville at the time, stating that rezoning to allow mining would be approved if requested. The letter was drafted by Bob Lewis and typed up by Rudakas, who attempted to mimic the letterhead on the town's official stationery. The letter was presented to Mayor Perkins during a meeting, and he signed it at Lewis's request.

Tax Court's Analysis

The Tax Court held that the value of the easement donated by Ranch Springs was $335,500, based on a "before value" of $720,500, or $6,550 per acre. Because the claimed value of the easement exceeded the correct value by 7,694 percent, the court found that Ranch Springs was liable for a 40 percent penalty for a gross valuation misstatement under Code Sec. 6662(h).

In the court's view, Ranch Springs failed to prove that rezoning the Ranch Springs Property to permit operation of a limestone quarry was reasonably probable. The court observed that the Lewis brothers never submitted a rezoning application or take any other step toward securing the zoning change, special exception, and permits that would be required to conduct mining on the land. The court explained that the Lewis brothers did not take these seemingly obvious steps because (1) they feared that a rezoning application would trigger strong neighborhood opposition and (2) they believed these steps would be a waste of money because they had no intention of ever operating a limestone mine on Ranch Springs Property. The court was not persuaded by the evidence proffered by Ranch Springs. The court noted that the Bloom letter did not offer a definitive opinion that rezoning was reasonably probable. And the Mayor Perkins letter, in the court's view, held no probative value given that Perkins would have been in office if and when a rezoning application were submitted, and Perkins did not have a vote on the Zoning Commission.

Even if Ranch Springs could have secured rezoning approval, the court found that the use of the property as a limestone quarry was not financially feasible. The court observed that in 2017 there were seven well-established limestone quarries in Shelby County and nine more in adjoining counties. The Shelby County quarries produced more than 10 million tons of limestone during 2017, and the nearby quarries produced another 5 million tons. The court was unpersuaded by Ranch Springs' unsupported assumption that the local market could absorb an additional 500,000 to 700,000 tons of aggregates annually.

The court determined that the comparable sales approach provided the most reliable method for determining the "before value" of the Ranch Springs Property. Using that approach, the court found that the "before value" was $6,550 per acre - almost exactly the price that Ranch Springs paid to acquire the 100-acre tract in December 2016. The value of the easement using this approach came to $335,500. The value Ranch Springs claimed for the easement on its 2017 return was $25,814,000. Having determined that the value of the easement on the valuation date was only $335,500, the court found that the claimed value exceeded the correct value by $25,478,500 or 7,694 percent, and the valuation was thus gross under Code Sec. 6662(h). Generally, an accuracy-related penalty is not imposed if the taxpayer demonstrates reasonable cause and shows that he or she acted in good faith with respect to the underpayment. However, under Code Sec. 6664(c)(3) this defense is not available for gross overstatements.

For a discussion of the rules for contributions of partial interests in property, see Parker Tax ¶84,155. For a discussion of accuracy-related penalties, see Parker Tax ¶262,120.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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