Bosque Canyon Decision and Impact on Belk. Last Friday (August 11, 2017) the Fifth Circuit issued an important decision in Bosque Canyon Ranch, LP v Commissioner, No. 16-60068. This decision is significant for the land trust community because the Fifth Circuit severely limited the breadth (at least in the Fifth Circuit) of Belk v. Commissioner, 140 T. C. 1 (2013), aff'd, 774 F. 3d 221 (4th Cir. 2014).
In Belk, a case of first impression, the Tax Court (and then the Fourth Circuit) held that the subject easement property (golf course property in North Carolina) was not protected in perpetuity because the boundaries of the preserved area could be moved and new property substituted for old. The Court in Belk held that the underlying real property was not protected in perpetuity; therefore the easement deduction was disallowed in full.
The Preserver contains many articles describing Belk and Bosque, which readers may find relevant to this article.
Since the Belk decision was issued, the IRS has aggressively used it to deny deductions for numerous conservation easements by improperly extending the holding in Belk to situations in which donors have retained certain reserved rights, such as the right to build houses, driveways, roads, or other improvements. The IRS regularly argues at both the administrative level and in court that such reserved rights result in a disallowance of a deduction under Belk when the locations of such improvements are not fixed (i.e., they are floating building rights) even if such rights could only be exercised if there is no negative impact on the conservation purposes or values of the protected property and only with the land trust's consent. In our office, we call that being “Belked” by IRS.
Because the Fifth Circuit's opinion in Bosque refused to extend Belk as the IRS requested, courts may begin to interpret Belk differently (at least in the Fifth Circuit).
Bosque Facts. Bosque involves conservation easements granted by two limited partnerships, which were intended to protect and preserve certain Texas ranch land that provides habitat for gold-cheeked warblers. The easements also 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”), with the rest of the land reserved for conservation, recreation and agricultural use. To be clear, the homesite parcels were not part of the conserved area, but were contiguous to it. The easements could only be amended with the land trust's 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. In addition to the homesite parcels conveyed to the various investors for their investment in the partnerships, the investors also received a membership interest in a to-be-formed Bosque Canyon Ranch Association, which would own all the other property other than the homesite parcels.
What Happened in the Tax Court. The IRS disallowed the charitable deduction on various grounds, claimed that the distribution of the homesite parcels constituted disguised sales (resulting in income or gain to the partnership; the sales price in the disguised sale being equal to the amount contributed by each investor for his interest in the partnership) and asserted accuracy-related penalties, including the gross valuation misstatement penalty. After a four week trial, the Tax Court (Judge Foley) agreed with the IRS and disallowed the deductions in full, holding that (1) the conservation easements were not granted in perpetuity because the ability to make amendments to the boundary lines of the homesite parcels violated the perpetual restriction requirement under Belk , (2) the donors failed to make appropriate baseline documentation available to the land trust at the time of the grant of the easements under Reg. Section 1.170A-14(g)(5)(i) (discussing documentation necessary to allow the land trust to properly monitor the protected properties), and (3) the gross valuation misstatement penalty was applicable because the disallowance of the deductions caused the value of the deductions to be zero. Additionally, the Tax Court held that the facts in Bosque constituted a disguised sale transaction and that the partnerships' receipt of the limited partners' entire contributions to the partnerships were receipts from such disguised sales.
Fifth Circuit Vacates and Remands. All of these issues were appealed to the Fifth Circuit, which had a completely different view of the world than the IRS and Judge Foley. Specifically, the Fifth Circuit (1) vacated the Tax Court's holding regarding the perpetuity of the easements and the baseline documentation (in other words finding that the taxpayers were correct on those issues), and remanded to the Tax Court for it to consider other grounds asserted by the Commissioner to support the disqualification of the easements as charitable deductions but not addressed by the Tax Court (outlined in footnote 30 of the decision), (2) vacated the Tax Court's determination that the entirety of the partners' contributions were disguised sales and remanded for the Tax Court to determine the correct amount of any taxable income resulting from the disguised sales, and (3) vacated the imposition of the gross valuation misstatement penalty and remanded to the Tax Court to determine the value of the contribution and whether the gross valuation misstatement penalty is applicable, and if so, the proper amount of such penalty.
Because of the importance of all of these issues reviewed by the Fifth Circuit and how they may impact current conservation easement cases and planning, we will outline and analyze in future blogs entries why “Bosque is not Belk” as it relates to the perpetuity requirement for conservation easement gifts, as well as the other issues vacated and remanded by the Fifth Circuit in Bosque Canyon.