Last week we posted the first in a series of blog articles regarding the Fifth Circuit's recent opinion in Bosque Canyon Ranch, LP v. Commissioner, No. 16-60068. The first blog post, which is found here, provides an overview of the facts of, and foreshadows three subsequent discussions on, various issues addressed in Bosque. This post analyzes the first of those three issues: How does the Fifth Circuit more narrowly limit the application of Belk v. Commissioner, 140 T.C. 1 (2013), aff'd, 774 F. 3rd 221 (4th Cir. 2014), which the IRS aggressively uses to argue that certain retained rights in a conservation easement violate the perpetuity requirements found in Section 170 (h)(2)(c).
Readers will recall that Bosque involves conservation easements granted by two limited partnerships that were intended to protect thousands of acres of Texas ranch land that provides habitat for gold-cheeked warblers and to protect watershed, scenic vistas and mature forest. The partnerships were owned by investors (in the partnerships) who were given the right to build ranch homes on select 5-acre sites (“homesite parcels”). The rest of the land was reserved for conservation, recreation and agricultural use. To be clear, the homesite parcels were not part of the conserved area, but were located contiguous to it.
The easements in Bosque could only be amended with the land trust's (in this case, the North American Land Trust, or NALT) consent and then only to modify the boundaries of the homesite parcels, but not to increase the size of the homesite parcels to more than five acres. One of the main issues in the case was whether the ability to amend the easements, with the land trust's approval, to modify the boundary of the homesite parcels, violated the perpetuity requirement of Section 170(h)(2)(C). In that regard, the IRS argued and the Tax Court agreed that such a right to amend to change the boundary of an easement disqualified the easement, citing Belk. The Fifth Circuit found Belk distinguishable and held that reliance on Belk was misplaced.
Before analyzing the facts, the Fifth Circuit explained that Congress has consistently and historically provided bipartisan support for the use of conservation easements (citing legislative history from 1980) to protect important lands. The Fifth Circuit recognized that the easements at issue did indeed protect certain land in perpetuity, subject only to a few reserve rights that both the land trust and the land owner agreed could be exercised without having an adverse effect on the protected conservation purposes. The Court also recognized that an amendment to make minor modifications of boundary lines of the homesite parcels, all within the four corners of the ranch property, could only be made with the approval of the NALT. In distinguishing Belk, the court noted that (1) NALT had to approve any such amendments (giving a nod to the importance of land trusts in conservation easement operations), and (2) the homesite parcels could not be increased in size and that the external boundaries of the easement area nor the total acreage of the easement could change.
The Fifth Circuit observed that in Belk the easement could be moved, lock, stock and barrel, to a tract or tracts different and remote from the original easement property, allowing the donor to change the nature of the eased property and possibly undermining the appraisal of the property. But in the present case, the Court noted that those problems did not exist, comparing Bosque more favorably to the facts in Commissioner v. Simmons, 646 F. 3d 6 (D.C. Cir. 2011) and Kaufman v. Shulman, 687 F. 3d 21 (1st Cir. 2012). The Fifth Circuit noted that its sister circuits (in those cases) ruled that the conservation easements were perpetual even though the trust (in such cases) could consent to the partial lifting of certain restrictions. Highlighting the common sense reasoning in Simmons and Kaufman, the Fifth Circuit recognized “that an easement may be modified to promote the underlying conservation interests and that the need for flexibility to address changing or unforeseen conditions on or under property subject to a conservation easement clearly benefits all parties, and ultimately the flora and fauna that are their true beneficiaries.”
The Fifth Circuit's final lasso regarding perpetuity is found in its final point: “Most IRC provisions that intentionally create narrow ‘loopholes' to cover narrowly specific situations are deemed to have been adopted in an exercise of legislative grace, and thus are subject to strict construction.” But the Fifth Circuit recognized that Section 170(h) was adopted at the insistence of conservation activists (not property-owning, potential donor taxpayers), by an overwhelming majority of Congress, with the hope that adding thousands of acres of primarily rural property for various conservation purposes would never be developed. Accordingly, the Fifth Circuit found that the usual strict rules of construction of tax loopholes “is not applicable to grants of conservation easements made pursuant to Section 170(h).” Indeed, it appears that the Fifth Circuit does not believe that a conservation easement is even a tax loophole, but instead is a tax incentive Congress overwhelmingly created to encourage conservation.
The Fifth Circuit's final comments regarding loopholes demonstrates that the Fifth Circuit does not agree with the hyper technical approach we have seen the IRS and some courts take in analyzing whether a conservation easement grant satisfies the requirements of Section 170(h). While this case applies that point of view to the perpetuity requirement of Section 170(h)(2)(c) and clearly distinguishes how Belk has been applied in the past, the theory would also apply to other issues that the IRS uses as a hammer to deny deductions with respect to grants of conservation easements where good conservation, which Congress clearly supports, is taking place.