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Eleventh Circuit Affirms Tax Court's Denial of Deduction for Conservation Easement

(Parker Tax Publishing July 2021)

The Eleventh Circuit affirmed a Tax Court decision holding that a conservation easement deed failed to protect the conservation purpose in perpetuity as required by Code Sec. 170(h)(5)(A) because the formula for the distribution of extinguishment proceeds impermissibly provided that the donee's portion of such proceeds would not include any post-donation increase in value attributable to improvements. The court also found that the deed was not saved by language purporting to override the formula if it was different from the one required under Reg. Sec. 1.170A-14(g)(6)(ii) because that provision was an unenforceable condition subsequent savings clause rather than simply an interpretive tool. TOT Property Holdings, LLC v. Comm'r, 2021 PTC 178 (11th Cir. 2021).


In 2013, TOT Holdings, LLC executed a deed that donated to Foothills Land Conservancy (Foothills) a conservation easement encumbering almost all of a 652-acre piece of rural, undeveloped land in Van Buren County, Tennessee.

The conservation easement deed contained an extinguishment provision in Section 9.1 stating that, if circumstances arose in the future that rendered the conservation purpose of the easement impossible to accomplish, the easement would be extinguished by judicial proceedings and Foothills would be entitled to proceeds from the sale of the property equal to its fair market value unencumbered by the easement, as determined by the formula provided in Section 9.2, or Reg. Sec. 1.170A-14, "if different." Under the formula set forth in Section 9.2, the condemnation proceeds to Foothills would be reduced by any increase in value after the date of the grant attributable to improvements. Section 9.2 also stated that it was "intended to adhere to and be consistent with" Reg. Sec. 1.170A-14(g)(6)(ii). Sections 9.1 and 9.2 together were referred to as the "Treasury Regulation Override."

TOT Holdings filed a partnership return for 2013 reporting a charitable contribution of a qualified conservation easement of $6.9 million. The IRS determined that the easement did not qualify for the claimed deduction and that accuracy-related penalties applied. In a final partnership administrative adjustment, the IRS disallowed the deduction because TOT had not established that the deduction met the requirements of Code Sec. 170 or that the value of the easement was $6.9 million as claimed. The IRS also asserted a 40 percent penalty for a gross valuation misstatement or, in the alternative, a 20 percent penalty for negligence under Code Sec. 6662.

TOT took its case to the Tax Court. The Tax Court upheld the IRS's determinations after finding that the deed failed to protect the easement purpose in perpetuity as required by Code Sec. 170(h)(5)(A). The Tax Court determined that the formula for the distribution of extinguishment proceeds was inconsistent with Reg. Sec. 1.170A-14(g)(6)(ii) because it impermissibly provided that Foothills' proportion of the proceeds would subtract out, and thus not include, any increase in value (after the date of the charitable gift) attributable to improvements. The Tax Court further found that the Treasury Regulation Override in the deed was an unenforceable condition subsequent savings clause. The Tax Court also upheld the imposition of the 40 percent gross valuation misstatement penalty after finding that that TOT's valuation was a misstatement of 200 percent or more of the correct value. The Tax Court found that the IRS had complied with the requirement under Code Sec. 6751(b)(1) that the initial determination of the penalty be approved in writing by the immediate supervisor of the individual making such determination. TOT appealed to the Eleventh Circuit.

Under Code Sec. 170(f)(3)(B)(iii), a deduction is allowed for a qualified conservation contribution. A qualified conservation contribution is defined in Code Sec. 170(h)(1) as a contribution (1) of a qualified real property interest, (2) to a qualified organization, (3) exclusively for conservation purposes. Under Code Sec. 170(h)(5), the conservation purpose of the easement must be protected in perpetuity. Reg. Sec. 1.170A-14(g)(6)(i) provides that, if a subsequent unexpected change in the conditions surrounding the property makes the it impossible or impractical to use the property for conservation purposes, the conservation purpose will be nonetheless treated as protected in perpetuity if the restrictions are extinguished in a judicial proceeding and all of the donee's proceeds, as determined under Reg. Sec. 1.170A-14(g)(6)(ii), from a subsequent sale are used by the donee organization consistently with the conservation purposes of the original contribution. Reg. Sec. 1.170A-14(g)(6)(ii) provides that the donation of the perpetual conservation restriction "gives rise to a property right, immediately vested in the donee organization, with a FMV that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time."

Courts and the IRS have refused to enforce a clause that purports to save an instrument from being out of compliance with the tax laws if the clause is operative by way of a condition subsequent. A condition subsequent rests on a future event, the occurrence of which terminates or discharges a contractual duty. Under Belk v. Comm'r, 2014 PTC 614 (4th Cir. 2014), however, a clause may be upheld as a valid interpretive tool rather than a savings clause if it simply illustrates intent and does not depend on a subsequent adverse action by the IRS. TOT argued that the Treasury Regulation Override was an interpretive guide that required compliance with the regulation, rather than an unenforceable condition subsequent savings clause. TOT also challenged the Tax Court's findings regarding the valuation of the property and the IRS's compliance with the Code Sec. 6751(b)(1) penalty supervisory approval requirement.


The Eleventh Circuit affirmed the Tax Court's denial of the deduction and upheld the imposition of the gross valuation misstatement penalty. The court found that the language in Sections 9.1 and 9.2 - especially the "if different" language - constituted an unenforceable condition subsequent savings clause, and not merely interpretive guidance as TOT argued.

The Eleventh Circuit found that three features of the Treasury Regulation Override made that provision an unenforceable savings clause. First, the court found that the formula in the easement deed unambiguously provided that Foothills' proportionate share of the condemnation proceeds would be determined by subtracting the increase in value for post-donation improvements. Thus, the court said that there was no interpretive question for the savings clause to help clarify. Second, the operation of the Treasury Regulation Override meant that the preferred formula - expressly described in the easement deed - was simply nullified. The court reasoned that, under the easement deed, the application of the regulation was conditioned on whether it was different from the plain text of the express formula in Section 9.2. If it was different, then the Override operated to simply rewrite the easement deed to eliminate the Section 9.2 formula, leaving operative only the regulatory formula. The court found that if enforced, the Override would impermissibly countermand the plain text of the easement deed. Third, the court found that for the Override provision to be triggered and for the regulation to apply as the proper formula, a future event would have to occur, i.e., a determination that the proper interpretation of the regulation is different from the formula set forth in Section 9.2. Thus, the Eleventh Circuit found that Foothills' property right to proceeds equal to the regulatory proportionate value was not immediately vested as required under Reg. Sec. 1.170A-14(g)(6)(ii).

The Eleventh Circuit further found that there was ample evidence to support the Tax Court's valuation findings and thus upheld the imposition of the 40 percent gross valuation misstatement penalty. The court noted that 17 days before the conservation easement deed, TOT Holdings (which held only the property plus $100 cash) was sold in an arm's length transaction for $1,039,200 -- slightly less than the valuation of $1,128,000 independently arrived at by the IRS's valuation expert and adopted by the Tax Court. In the court's view, this sale provided overwhelming support for the Tax Court's finding of the property's fair market value as well as its highest and best use as an investment property held for recreation and timber revenue.

Finally, the Eleventh Circuit held that the IRS satisfied the written supervisory approval requirement of Code Sec. 6751(b)(1). The court noted that a transmittal letter signed by the revenue agent's immediate supervisor stated that it included "all proposed adjustments including facts, law and conclusion" that were to be discussed at a closing conference. The court concluded that the Tax Court was correct in inferring from the transmittal letter and its language that the supervisor who signed the letter approved the proposed penalties as well as the other adjustments in the revenue agent's report.

For a discussion of the rules for contributions of partial interests in property, see Parker Tax ¶84,155. For a discussion of the penalty supervisory approval requirement, see Parker Tax ¶262,195.

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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