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Taxpayer Had Reasonable Cause for Incomplete Substantiation of Conservation Easement

(Parker Tax Publishing July 2023)

The Tax Court held that a partnership's deduction for the donation of a conservation easement on a tract of land failed to comply with the substantiation and reporting requirements of Code Sec. 170(f)(11) because the partnership did not include its basis in the land on its tax return, but that the failure was due to reasonable cause. The court found that because the IRS alleged noncompliance with Code Sec. 170(f)(11) for the first time in its pretrial memorandum, the burden shifted to the IRS to prove the absence of reasonable cause and the IRS failed to do so. Murfam Enterprises, LLC v. Comm'r, T.C. Memo. 2023-73.


Murfam Enterprises, LLC, is a partnership owned by the Murphy family, a multi-generation farming family from Bladen County, North Carolina. In 2010, Murfam donated a conservation easement on a tract of undeveloped land to the North American Land Trust. The conservation easement deed specifically prohibited any agricultural activities on the land. Murfam hired an appraiser to value the conservation easement. The appraiser determined that the value of the land before the donation of the easement was $10.5 million, computed the after value to be $4.8 million, and therefore valued the easement at $5.7 million.

Murfam engaged Dixon Hughes Goodman (Dixon) - one of the largest CPA firms in North Carolina - to prepare its tax return for its 2010 tax year. Dixon requested all the information it deemed necessary to prepare Murfam's return, and Murfam provided to Dixon all the information that the firm had requested. Dixon prepared Murfam's Form 1065 on the basis of the information received from Murfam. Murfam's return reported the donation of the easement and claimed a corresponding charitable contribution deduction of $5,744,600 (i.e., the appraised value of the easement). Murfam's return included a Form 8283, Noncash Charitable Contributions. Certain portions of the Form 8283 were either missing or incomplete: Page 1 was not included, and Part 1 of Section B did not report the date or the manner in which the donor acquired the property, the donor's cost or adjusted basis in the property, or whether the contribution was made as part of a bargain sale.

The IRS examined Murfam's 2010 return and issued to Dell Murphy, as Murfam's tax matters partner, a Final Partnership Administrative Adjustment (FPAA). The FPAA reduced Murfam's charitable contribution to $446,000. It did not assert liability for any penalty, nor did it determine to deny the charitable contribution on the basis of Murfam's failure to fully complete Form 8283.

Dell Murphy petitioned the Tax Court to challenge the adjustment in the FPAA. In its answer, the IRS asserted - for the first time - a gross valuation misstatement penalty under Code Sec. 6662(e) or (h) or, in the alternative, an accuracy-related penalty under Code Sec. 6662(a). Like the FPAA, the answer did not allege that the deduction should be denied due to Murfam's failure to substantiate the donation. Rather, the IRS first made that contention in its pretrial memorandum. The case went to trial, and both parties offered expert reports and testimony regarding the value of the conservation easement. Additionally, the Murphy family testified regarding their businesses and the preparation of Murfam's 2010 tax return.

Under Tax Court Rule 142(a), the IRS bears the burden of proof "in respect of any new matter, increases in deficiency, and affirmed defenses, pleaded in the answer." In Wayne Bolt & Nut Co. v. Comm'r, 93 T.C. 500 (1989), the Tax Court held that a new theory that is presented to sustain a deficiency is treated as a "new matter" when it either (1) alters the original deficiency or (2) requires the presentation of different evidence.

Under Code Sec. 6664(c)(1), no penalty will be imposed on an underpayment of tax if it is shown that there was a reasonable cause for the underpayment and that the taxpayer acted in good faith. In RERI Holdings I, LLC v. Comm'r, 149 T.C. 1 (2017), aff'd sub nom. Blau v. Comm'r, 2019 PTC 200 (D.C. Cir. 2019), the Tax Court held that where the IRS asserts a penalty for the first time as "new matter" in its answer and reasonable cause is at issue, the IRS's burden of proof on the imposition of that penalty includes showing the absence of reasonable cause.

Another "reasonable cause" provision was significant in this case. Under Code Sec. 170(f)(11) and Reg. Sec. 1.170A-13(c)(2)(i)(B), taxpayers must substantiate charitable deductions like the one in this case by attaching a fully completed appraisal summary that includes the basis of the property. If a donor fails to meet these requirements, then Code Sec. 170(f)(11)(A)(i) provides that no deduction will be allowed. However, under an exception provided in Code Sec. 170(f)(11)A)(ii)(II), the deduction will not be disallowed if the taxpayer's failure to meet such requirements is due to reasonable cause and not to willful neglect.

In Belair Woods, LLC v. Comm'r, T.C. Memo. 2018-159, the Tax Court considered the relatedness of the Code Sec. 170(f)(11)(A)(ii)(II) reasonable cause defense to the reasonable cause defense in the penalty context, and concluded that the same standard - "ordinary care and business prudence" - should apply in both instances. However, before deciding this case, the Tax Court had not previously addressed explicitly the question of the burden of proof on the "reasonable cause" defense when the IRS raises the issue of noncompliance with Code Sec. 170(f)(11) as "new matter" in litigation and reasonable cause for the noncompliance is at issue.


The Tax Court held that the determination of which party bears the burden of proof on reasonable cause under the substantiation provisions of Code Sec. 170(f)(11) depends (as it does for penalty liability) on whether the IRS's contention of noncompliance with the substantiation provisions is "new matter." According to the Tax Court, if the IRS's contention about noncompliance with Code Sec. 170(f)(11) is new matter, then the IRS bears the burden on that contention and on the "reasonable cause" defense to it - i.e., the IRS must prove the absence of reasonable cause.

The court found that this shift in the burden of proof occurred in this case because the IRS did not assert that Murfam's charitable contribution deduction should be entirely disallowed due to its failure to comply with the Code Sec. 170(f)(11) substantiation requirements until it filed its pretrial memorandum. Murfam's compliance with the appraisal summary requirement was thus "new matter" and therefore, the IRS's burden included showing that the failure to fully complete the appraisal report was not due to reasonable cause or was due to willful neglect. The court explained that the FPAA issued to Murfam determined that a deduction under Code Sec. 170(h) was allowable, but for a significantly lower amount than what Murfam claimed on its return. Murfam bore the burden to prove the value of the charitable contribution deduction. However, the court said that the IRS's appraisal summary theory, if correct, would deny the charitable contribution deduction entirely, would accordingly increase the deficiency beyond the determination in the FPAA, and would require different evidence (to prove reasonable cause for the noncompliance). For this reason, the court found that the IRS's appraisal summary theory was new matter for which it bore the overall burden of proof, including showing a lack of reasonable cause for Murfam's noncompliance.

The court noted that a frequent ground for claiming reasonable cause (and Murfam's ground in this case) was reliance on professional advice. Under Code Sec. 6664(c) and Reg. Sec. 1.6664-4(c), reasonable cause is based on reliance on an advisor when (1) the advisor was a competent professional with sufficient expertise to justify reliance, (2) the taxpayer provided necessary and sufficient information to the advisor, and (3) the taxpayer actually relied in good faith on the advisor's judgment. In addition, Reg. Sec. 1.6664-4(c)(1) provides that in no event will a taxpayer be considered to have reasonably relied on an advisor in good faith unless the advice (1) is based on all facts and circumstances and the applicable law, (2) is not based on unreasonable factual or legal assumptions, and (3) is not based on an assertion of the invalidity of a regulation.

Applying these rules, the court found that Hughes was a well-known CPA firm with a good reputation, that Murfam relied on Hughes to prepare its returns, that Hughes requested and received all the information it thought necessary for preparing Murfam's returns, and that Hughes prepared Murfam's returns in accordance with that information. While the IRS contended in its pretrial memorandum that Murfam's Form 8283 lacked the basis information because Murfam declined to give it to Hughes, the court found that there was no evidence to support this claim. There was no evidence, the court found, to establish whether Hughes asked for the information, whether Murfam provided the information, or, if not, why Murfam did not provide the information.

Turning to the issue of the value of the easement, the court generally adopted Murfam's valuation, although the court's valuation was slightly lower than Murfam's at $5.6 million. The court also found that Murfam was not subject to any penalty under Code Sec. 6662. In the court's view, Murfam had reasonable cause because it hired a competent appraiser who valued the easement using a credible method and that the valuation was within 2 percent of the amount the court determined to be the correct value. The court also found that Murfam acted in good faith by hiring professional, reputable accountants to prepare its returns and provided all information necessary to prepare the returns that was requested of it.

For a discussion of the reporting requirements for charitable contributions, see Parker Tax ¶84,195.

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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