Last month, the Fourth Circuit handed down its decision in Belk v. Comm’r, which is the first Appellate court opinion to interpret the Section 170(b)(2) requirement of a “qualified real property interest” in the context of donating a conservation easement. The Fourth Circuit held that to be a “qualified real property interest,” an easement must cover a fixed parcel of land. Consequently, it held that a provision allowing a substitution of the underlying land violated a perpetuity component of “qualified real property interest.” The Fourth Circuit also refused to give effect to a savings clause in the easement deed that prohibited the Land Trust from agreeing to any amendment (including an amendment to substitute the underlying land) if the amendment would cause the easement to fail to qualify as a charitable donation under Section 170(h). This decision will have far-reaching implications for taxpayers considering donation of conservation easements, and also for tax planners who use savings clauses in various contexts to protect the anticipated tax treatment of agreements.
The easement in Belk was donated to the Smokey Mountain National Land Trust (now Southeast Regional Land Conservancy; the “Land Trust”) in 2004 on 410 acres. The easement deed allowed the Belks and the Land Trust to mutually agree to substitute a portion of the land covered by the conservation easement with an adjacent parcel of land of equal or greater in size, value and ecological features (the “Substitution Clause”). Because the parties could agree to substitute easement property, the Tax Court disallowed the charitable deduction because it found that the easement was not a perpetual restriction on the use of real property, and therefore was not a “qualified real property interest” under I.R.C. § 170(h)(2)(C). The interpretation of this provision had never been addressed by any court or in any IRS guidance.
On Appeal, the Belks claimed that Congress intended for easements themselves to be perpetual, and to perpetually protect the conservation purposes of the easement, but that Congress did not intend to require that the specific land underlying the easement be fixed in perpetuity. Such a requirement would deny land trusts flexibility to address most future changes and events. The Fourth Circuit disagreed. It found that Congress’ use of the term “the” in the phrase “a restriction (granted in perpetuity) on the real property” meant Congress required the easement to attach to a defined parcel of real property that could never be changed by an agreement of the land trust and landowner.
Notably, the Fourth Circuit limited the holdings of Simmons and Kaufman, two Court of Appeals decisions holding that an easement deed meets the perpetuity requirements of the Code, even if it gives the donee the right to abandon the easement altogether. The Fourth Circuit reasoned that Simmons and Kaufman concerned only perpetual protection of the conservation purpose (§ 170(h)(5)(A)) and did not address perpetuity of the use restrictions (§ 170(h)(2)(C). Under Simmons and Kaufman, a deduction did not fail merely because the land trust could choose not to enforce the easement. But under the Fourth Circuit’s decision in Belk, a deduction fails if the landowner and land trust can agree to relocate the easement to other property.
The second notable aspect of the Belk opinion is the discussion of savings clauses. A savings clause is a tool used by tax planners to protect the anticipated tax consequences of an agreement in the event a provision of the agreement would defeat that preferred tax treatment. The Fourth Circuit previously rejected certain savings clauses that were triggered by “conditions subsequent” that nullify a transaction if there is an adverse determination by a Court or the IRS. However, the savings clause in Belk prohibited the Land Trust prospectively from agreeing to any amendment that would cause the easement to fail to qualify for a charitable deduction under I.R.C. § 170. If the tax law developed such that a particular amendment would negate the deduction, the Land Trust was prohibited from agreeing to it.
The Fourth Circuit disagreed with the Belks’ claim that the clause was “interpretive,” serving to guide the Land Trust concerning types of amendments that were appropriate. Instead, the Fourth Circuit found that no interpretive assistance was needed where the deed included a provision such as the Substitution Provision that, in its view, was so evidently inconsistent with I.R.C. § 170(h)(2)(C). The Fourth Circuit disregarded the fact that an adverse decision was not necessary for the savings clause to be operative, saying this was a “distinction without a difference.” The Court found that the easement deed plainly permitted substitutions, and concluded that the only time the savings clause would be invoked to prohibit offending substitutions would be following an adverse determination by the IRS or a Court. The Court apparently did not consider to be sufficient the Land Trust’s exercise of its judgment not to amend. In this context, the Fourth Circuit opinion can be viewed as broadening the types of savings clauses that will be deemed void for tax purposes.