Last week, the Tenth Circuit upheld the Tax Court’s decisions Mitchell v. Commissioner, 138 T.C. No. 16 (2012), mot. for reconsideration denied, T.C. Memo 2013-204, to completely deny the taxpayer’s deduction for the donation of a conservation easement where the donor failed to subordinate the mortgage on the property to the conservation easement. A copy of the Tenth Circuit’s decision can be found here. This decision is part of a growing trend in which taxpayers who give up significant value on their property are unable to receive any of the associated tax benefits due to technical missteps. Just last month, the Fourth Circuit in Belk denied a charitable contribution deduction for the donation of a conservation easement where the taxpayer and land trust reserved the right to substitute the property underlying the easement. In light of these recent decisions, taxpayers and their advisers must be extremely careful to insure that charitable contributions comply with all the requirements of the Internal Revenue Code and the Treasury Regulations to avoid the harsh consequences of having the deduction denied in full. Our firm’s Ronald Levitt was quoted by BNA’s Daily Tax Report concerning this decision, which can be found here.
The taxpayer in Mitchell donated a conservation easement over 180 acres of unimproved land to a local land trust. Tenth Circuit was to decide whether donated conservation easement was protected “in perpetuity” as required by the Internal Revenue Code. Because “perpetuity” is not defined in the Code, IRS issued regulations outlining the requirements for perpetual protection. One of these requirements is that a mortgage on any property subject to the conservation easement must be subordinated to the easement (to prevent the mortgage lender from foreclosing on the property and extinguishing the easement). See 26 C.F.R. § 1.170A-14(g). The Treasury Regulations further provide that a deduction will not be disallowed based on some potential future event that could defeat the donee’s interest if the possibility of such future event “is so remote as to be negligible.” Id.
The taxpayer in Mitchell did not subordinate the mortgage at the time of the easement; and instead subordinated the mortgage two years later. The Tax Court denied the deduction in full, determining that the Regulations require subordination “at the time of the donation” for the donation to meet the requirements of a “qualified conservation contribution.”
On appeal, the taxpayer argued she was entitled to the deduction despite failing to strictly comply with the subordination requirement because (1) the regulations do not require subordination at the time of the contribution, and (2) the possibility that the bank would foreclose on the mortgage was so remote as to be negligible.
The Tenth Circuit disagreed, strictly interpreting the regulation to require subordination prior to claiming the deduction and also agreed with the Commissioner’s interpretation that the regulation requires that the mortgage be subordinated “at the time of the donation.” The Tenth Circuit also held that the “so remote as to be negligible” standard did not apply to mortgage foreclosures, which are not such “remote” future events. In addition, the “so remote as to be negligible” standard could not include mortgage foreclosures because the Regulations explicitly contemplated the possibility of foreclosure and included a requirement that mortgages be subordinated. In so holding, the Tenth Circuit limited the D.C. Circuit’s application of this standard in Simmons, 646 F.3d 6 (D.C. Cir. 2011), explaining that, unlike a mortgage foreclosure, the possibility that a donee would abandon its rights under an easement is a remote future event where the donee had never abandoned its rights previously.
The Tenth Circuit’s decision in Mitchell, like the Fourth Circuit’s holding in Belk, reflects a harsh view by the courts when it comes to strict compliance with the Treasury Regulations. In both cases, the taxpayers donated a very valuable restriction on their property to a charitable organization. And the donated restrictions in both cases were, as a practical matter, protected in perpetuity. However, the deductions were denied in full because the taxpayers failed to technically comply with the Treasury Regulations and the Code.
It is more important now than ever that taxpayer consult with their tax advisors prior to donating a conservation easement to insure the entire process complies with the Code and the Treasury Regulations.