We recently issued the first of four blogs regarding the Tax Court’s opinion in Bosque Canyon Ranch, TC Memo 2015-130. The first post, which can be found by clicking here, discusses the facts of the case and foreshadows three subsequent discussions on the various issues addressed by the court. This post analyzes the first of those three issues: the court’s holding that the easement failed to qualify as a “qualified real property interest” under Code Sec. 170(h)(2)(C) because the taxpayer reserved the right to “modify” the boundary lines of the donated interest.
In Bosque, the partnership issued limited partnership units entitling each purchaser to become a limited partner. The relevant documentation also provided the partnership would subsequently distribute to each limited partner a 5-acre parcel free and unencumbered by a contemplated conservation easement (the “Homesites”). The distribution of Homesites was conditioned on the partnership granting the conservation easement to the North American Land Trust (NALT).
The easement deed provided that NALT and the Homesite owner could, by mutual agreement, modify the boundaries of the Homesite, provided that any such modification could not, in the NALT’s reasonable judgment, directly or indirectly result in any material adverse effect on any of the conservation purposes. The easement deed also provided that the area of each Homesite could not be increased. Importantly, the Homesite parcels were “outparcels,” exempt from the easement and its restrictions. The Homesites were not, as is often the case, areas within, and subject to, the easement and its restrictions.
The Tax Court determined the ability of the parties to modify the boundaries of the Homesites caused the easement to fail to be a “qualified real property interest” under Code Sec. 170(h)(2)(C). The Court cited to its prior holding in Belk v. Commissioner, 140 T.C. 1, 10-11 (2013), supplemented T.C. Memo. 2013-154, aff’d, 774 F.3d 221 (4th Cir. 2014). Belk held that an easement is not a qualified real property interest if the boundaries of the property subject to the easement may be modified.
The Tax Court’s decision in Bosque is arguably consistent with Belk. Specifically, the Tax Court’s opinion in Belk seemed clear that any ability of the parties to modify the boundaries of a conservation easement violates I.R.C. §170(h)(2)(C). The court subsequently decided that the degree or size of the boundary change is irrelevant. See Balsam Mountain Inv. LLC v. Comm’r, T.C. Memo 2015-43. Because the “outparcels” in Bosque were areas fully exempt from the conservation easement deed, modifying the boundaries of the outparcels would change the property protected by the easement. Areas that were once encumbered by the easement could become an “outparcel,” fully unencumbered by the easement.
The “outparcels” in Bosque are distinguishable from the traditional reserved right to build a homesite frequently found in conservation easement deeds. Land trusts have long-recognized that it is beneficial to the preservation of the property to have an interested party living on and aiding the stewardship of the property. Therefore, many easement deeds provide the reserved right to build a homesite somewhere on the easement property. Unlike the Bosque outparcels, such reserved rights to build a homesite provide that the homesite will remain subject to the easement and its restrictions and will continue to be monitored by the land trust. The land owner will, however, be able to build a house in this area, subject to the easement’s various restrictions and requirements.
Thus, the first key take-away issue out of Bosque revolves around the distinction between “Reserved Right Homesites” and the “Outparcel Homesites.” Outparcel Homesites are completely exempt from the easement deed restrictions but Reserved Rights Homesites remain subject to the easement deed restrictions. If the area of an Outparcel Homesite can be modified to included property previously subject to the easement, then some of the easement property can be substituted for non-easement property, implicating the application of Belk, and causing a violation of Code Sec. 170(h)(2)(C).
Although the Bosque decision can be viewed as a logical extension of Belk, we are aware of IRS attempts to extend Belk even further to invalidate traditional Reserved Right Homesites. Moreover, he IRS is now trying to extend Belk to attack traditional “amendment” clauses that merely allow the parties to the easement to amend it by mutual consent. We hope this is a bridge too far. It is certainly a troubling development. Ironically, IRS has previously approved Reserved Right Homesites in Private Letter Rulings 200403044 (Jan. 16, 2014) and 9603018 (Jan. 19, 1996) (as noted by the Court in Belk) as well as in Treas. Reg. §170A – 14(f) (Ex.4). Moreover, a model easement deed suggested by the Land Trust Alliance (and contained on its website) contains the same amendment clause the IRS now argues is impermissible under Belk. The IRS is in frequent contact and discussions with the Land Trust Alliance, and it is surprising that IRS is now trying to invalidate easements containing such a widely used and long-standing provision. Also, consider that most states permit amendment of easement deeds by mutual consent, even if the deed is silent. Is this the next phase of the IRS attack?
Having been involved in the Belk case, we are confident that the Tax Court did not intend its decision to apply to such situations. Indeed, the Court was clear in its two opinions about the limits of Belk’s reach. However, at that time we cautioned that IRS would attempt to extend the decision to greater lengths.