Last week the Tax Court issued its opinion Bosque Canyon Ranch, TC Memo 2015-130, in which the court concluded that a limited partnership wasn’t entitled to claim a charitable contribution deduction for a conservation easement. The decision to disallow the charitable deduction was based on two grounds. First, the court determined 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. Second, and in the alternative, the court determined that the taxpayer failed to satisfy Treas. Reg. § 1.170A-14(g)(5)(i), which provides that, for purposes of the qualified conservation contribution rules, if the exercise of rights reserved by the donor may impair conservation interests associated with the property, the donor must make available to the donee, before making the donation, sufficient documentation (known as “baseline documentation”) to establish the property’s condition at the time of the gift.
Distinct from the first two issues, which formed the basis of the court’s denial of the taxpayer’s charitable deduction, the Tax Court made two additional, noteworthy determinations. First, the court determined that the transaction structure used by the taxpayer to create the partnership and distribute lots to its members resulted in a disguised sale of the lots ultimately distributed out to the partners. Second, the court determined that the taxpayer was liable for the 40% gross valuation misstatement, irrespective of the actual value of the charitable contribution (the conservation easement) made by the taxpayer. The penalty issue, although glossed over quickly, has potentially far-reaching consequences in charitable contribution cases outside the conservation easement area, and in our opinion might be the most significant aspect of the decision.
Because of the significance of each of the court’s determinations, we will cover this case in a series of four different posts, each devoted to a separate issue raised by the case. Each post will analyze the impact and scope of the court’s decision with respect to a particular issue. This post outlines the facts of the case, which are provided below.
Between 2003 and 2005, Bosque Canyon Ranch, L.P. (BCR I), a limited partnership, made $2.2 million worth of improvements to Canyon Ranch (BC Ranch), a 3,744-acre tract it owned. In 2004, BCR I began marketing limited partnership units at $350,000 per unit. Each purchaser would become a limited partner of BCR I, and the partnership would subsequently distribute to that limited partner a fee simple interest in an undeveloped 5-acre parcel of property (Homesites). The distribution of Homesites was conditioned on BCR I granting the North American Land Trust (NALT), a tax-exempt organization, a conservation easement relating to 1,750 acres of BC Ranch.
In late 2005, BCR I granted an easement (the “Easement”) to the NALT. The easement deed meant to protect the habitat of the golden-cheeked warbler, an endangered species of bird. Although the easement deed eliminated many development rights relating to the property, BCR I reserved several rights, including rights to raise livestock; engage in hunting and fishing activities; and construct buildings, recreational facilities, fences, ponds, roads, trails, and wells.
The easement deed provided NALT and the owner of a Homesite could, by mutual agreement, modify the boundaries of the Homesites, 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, and the area of each Homesites could not be increased. Importantly, the Homesite parcels were completely exempt from the easement deed, and were what are often referred to as outparcels. The Homesites were not, as is often the case, areas within the easement deed allowing for the limited right to construct a home, but in all other respects subject to the easement deed.
At BCR I’s direction, the NALT prepared baseline documentation relating to the Easement. The baseline documentation, dated Dec. 29, 2005, included: maps, a recorded copy of the easement deed, photographs taken in 2004, existing conditions reports (i.e., including a Site Survey Report dated March 2007 that was prepared by a conservation biologist), and a signed owner acknowledgement (which certified that BCR I received and fully reviewed the attached baseline documentation in its entirety and that it was an accurate representation of the physical condition of the conservation area). In 2007, two years after the Easement was granted, the conservation biologist completed the report using notes that the NALT’s conservation biologist took during an April 2004 visit to the property.
On its 2005 Form 1065, U.S. Return of Partnership Income, BCR I claimed an $8.4 million charitable contribution deduction relating to the donation of the Easement. On audit, IRS challenged this deduction.