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Farm Owners Not Exempt from Deduction Limit for Conservation Easement Contribution

(Parker Tax Publishing September 2017)

The Tax Court held that the owners of a farm were not "qualified farmers" under Code Sec. 170(b) because neither the sale of farm property nor the sale of development rights in the property were activities included in the trade or business of farming as defined by Code Sec. 2032A. The individual owners were therefore limited under Code Sec. 170(b) to a charitable contribution deduction of 50 percent of their respective contribution bases in the conveyed conservation easement. Rutkoske v. Comm'r, 149 T.C. No. 6 (2017).

Mark and Felix Rutkoske are brothers and equal partners of Browning Creek, LLC, which is a partnership for tax purposes. Browning Creek was in the business of leasing land. In 2009, Browning Creek leased 355 acres of farmland in Maryland to Rutkoske Farms, a general partnership through which the Rutkoske brothers farmed the property. The same year, Browning Creek conveyed a conservation easement to a Code Sec. 501(c)(3) public charity in exchange for approximately $1.5 million. According to an appraisal ordered by Browning Creek, the fair market value of the property was around $4.9 million before the granting of the easement and $2.1 million after the conveyance. Later in 2009, Browning Creek sold its interest in the property to an unrelated party for approximately $2 million.

Browning Creek said its basis in the property interest sold was $1.7 million, with $240,000 allocated to the easement and $1.5 million allocated to the remaining interest in the property. Browning Creek reported a capital gain of approximately $1.7 million from the sale, consisting of $1.2 million from the sale of the easement and $490,000 from the sale of its remaining property interest. Browning Creek also reported a charitable contribution of approximately $1.335 million for the easement. The amount of the contribution equaled the difference between the value of the property before and after the granting of the easement minus the amount received from the sale of the easement.

As equal partners, each Rutkoske brother reported on his 2009 tax return a charitable contribution deduction of approximately $667,000 and a long term capital gain of approximately $877,000 from the sale of Browning Creek's interest in the property. Mark Rutkoske reported approximately $17,000 of wage income, interest income of $450, and a passthrough loss of approximately $177,000. Felix Rutkoske reported wage income of around $28,000, interest income of $580, and passthrough losses of approximately $177,000.

The deduction for a qualified conservation contribution is generally limited to 50 percent of the donor's contribution base, which equals the taxpayer's adjusted gross income less the value of any other charitable contributions for the year. If the taxpayer is a "qualified farmer," as defined under Code Sec. 170(b)(1)(E), for the year of the contribution then the value of the donation is deductible up to 100 percent of the contribution base, less the amount of all other charitable contributions made during the year. A qualified farmer is an individual whose gross income from the trade or business of farming (as defined in Code Sec. 2032A(e)(5)) is greater than 50 percent of his or her gross income for the year. Under Code Sec. 2032A(e)(5), the trade or business of farming includes cultivating soil, raising or harvesting agricultural or horticultural commodities, the handling of such commodities, and tree farming.

The Rutkoskes argued that they were qualified farmers for 2009 and that the 50 percent limitation in Code Sec. 170(b)(1)(E) therefore did not apply. In determining that their farming income exceeded 50 percent of their gross income for the year, the Rutkoskes included the proceeds from the sale of the easement as well as from the sale of the property. They argued that proceeds from the sale of real estate used in a farming business generates income from the trade or business of farming because farm real estate is integral to the farming activities described in Code Sec. 2032A(e)(5). The IRS disagreed and said that Code Sec. 2032A(e)(5) sets forth a list of specific activities that generate farming income, and that neither the sale of land nor of the sale of the right to develop land are listed in the statute. Proceeds from the sales therefore did not constitute income from the trade or business of farming for purposes of Code Sec. 170(b)(1)(E), according to the IRS.

The Tax Court agreed with the IRS, finding that the Rutkoskes were not qualified farmers in 2009. The court observed that Code Sec. 170(b)(1)(E)(v) and Code Sec. 2032A(e)(5) are unambiguous and that unequivocal evidence of legislative purpose would be necessary to override their plain meaning. The court recognized that acquiring and disposing of land is necessary to farming, because the Code Sec. 2032A(e)(5) farming activities could not be carried on without it. But the court noted that Code Sec. 170(b)(1)(E) is narrowly tailored and intended to provide a tax benefit for a specific action: the contribution of conservation easements by qualified farmers. The court therefore declined to broaden the scope of the activities contained in Code Sec. 2032(A)(e)(5). The court acknowledged that the Rutkoske brothers were farmers; they continued in the agricultural business after the property was sold and used most of the sale proceeds in their continuing farming operations. However, the court concluded that being a farmer does not make one a qualified farmer for purposes of the statute which, according to the court, speaks to income, not spending.

The court also noted that even if it agreed with the Rutkoskes' interpretation of Code Sec. 170(b)(1)(E), they would still not prevail because, under the partnership rules, the character of their income from the sale of the property had to be determined as if realized directly by the partnership. The court reasoned that Browning Creek was not in the business of farming but rather was in the business of leasing real estate, so that when the income flowed through to the Rutkoskes, it was not income from the trade or business of farming.

For a discussion of the deduction for conservation easements, see Parker Tax ¶84,155.25.

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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