Last week, the Tax Court in Carroll v. Commissioner denied a taxpayer's deduction for a conservation easement donated in 2005. Sirote's own Ronald Levitt was quoted in a BNA Daily Tax Report article on the case, which is found here. The Court disallowed the deduction due to poor wording of the easement deed concerning the distribution of proceeds if the easement is extinguished, e.g., by condemnation. The Court ruled that the extinguishment language must track the language of the regulation exactly; otherwise the easement fails to meet the requirements of section 170. It is an unfortunate result for the taxpayer because the error probably was inadvertent and could have easily been avoided by a minor edit of the easement deed. This is yet another example of the all-out attack the IRS is making and will continue to make on conservation easement deductions.
The donated easement protects approximately 20 acres of land near Baltimore, Maryland. The taxpayer donated the easement in December 2005, and claimed a deduction of $1.2 million.
The Court concluded that the easement's conservation purpose was not protected in perpetuity because the language regarding extinguishment proceeds was inconsistent with the regulations. Treasury Regulation § 1.170A-14(g)(6) discusses unexpected changes in the conditions surrounding donated property. If the easement is extinguished, and the property is sold, the amount of proceeds that go to the donee must be equal to “the proportionate value that the perpetual conservation restriction at the time of the gift bears to the value of the property as a whole at the time.” The easement deed in this case stated that the numerator in this fraction would be the “deduction for federal income tax purposes allowable by reason of this grant,” rather than the fair market value of the conservation restriction on the date of the gift. The Court viewed this as allowing a “potential windfall” for the landowner if the easement was extinguished and the deduction was disallowed for reasons other than value. The Court also held that the requirements in Treasury Regulation § 1.170A-14(g) must be strictly complied with, despite the fact than any potential extinguishment was highly unlikely.
Even though the Court ultimately disallowed the deduction, there are several positive findings in the decision. First, the Court found that the easement was a qualified real property interest based on the land trust's testimony that it would enforce the restrictions in the easement. In addition, the Court found that the donation satisfied the conservation purpose requirement because the easement was accepted by a State agency after a thorough review process and the land was in a highly populated area that benefited from the easement.
The Carroll decision reflects the highly technical approach that the IRS and sometimes the Tax Court are taking in evaluating easements. In light of this approach, it is more important than ever that sophisticated counsel review all aspects of an easement donation to ensure compliance with the various technical requirements under section 170 and the regulations.