Another week, another conservation easement case. This week’s case isSchmidt v CIR, T.C. Memo 2014-159, which will be hailed as a “win” for taxpayers due to the court’s explicit approval of the discounted cash flow approach (“DCF Approach”) to valuing the highest and best use of property subject to a conservation easement. Schmidt, which was decided last week by Judge Marvel, relates to a conservation easement granted by Leroy Schmidt on property located in northern Colorado in close proximity to forests and mountains. Mr. Schmidt had purchased the property in May, 2000, as raw land with no development entitlements, but had considered possible development opportunities in the years prior to the granting of the easement.
Why This Case is Important:
Schmidt seems to be a significant taxpayer victory and will likely prove important for a few reasons. First,Schmidt is another in a line of cases, which includes the recent Palmer Ranch Holdings, Inc. v. Commissioner, T.C. Memo 2014-79 and Kiva Dunes T.C. Memo 2009-145 where the Tax Court recognizes and adopts the DCF Approach to value a conservation easement. Here, not only did the Tax Court approve of the DCF Approach, but the Court decided to apply the approach as it saw fit, rejecting the analyses of both the taxpayer and the IRS. In calculating its own value under the DCF Approach, the Court adopted and rejected elements of each party’s DCF model.
The Schmidt opinion is also important to taxpayers because it outlines a framework for how the Tax Court (or, at least, Judge Marvel) would like to see the DCF Approach applied. The Schmidt opinion contains an extensive analysis of the various factors that go into the DCF Approach, including number of lots, retail lot selling prices, retail lot price appreciation rate, timing to obtain entitlements, lot absorption, development costs, marketing/administrative costs and discount rate. This analysis will serve as a blueprint for appraisers, taxpayers and their representatives when valuing future easements. Applying the DCF Approach using the evidence and stipulations submitted by the parties, the Tax Court arrived at an easement value of $1,152,445, which was about $400,000 less than the taxpayer’s value and $600,000 greater than the Service’s value. However, given Judge Marvel’s extensive analysis, this result should be viewed as anything but a mere “compromise.”
Finally, Schmidt provides another tool in the arsenal of demonstrating the feasibility of highest and best use. Here, the taxpayer, and his advisors and consultants successfully demonstrated that development was reasonably probable. Specifically, the taxpayer hired an expert to prepare a development plan and the expert provided the taxpayer with a letter confirming that proper zoning would likely be obtained if the taxpayer decided to proceed with development. The Tax Court found that new applications for such subdivision plans would have to be resubmitted to the county, but that the need to resubmit did not impair the feasibility of the proposed development plan. This is in direct contrast to Mountanos v. Commissioner, T.C. Memo 2013-138, where the Tax Court was not able to find that the taxpayer had proven that the proposed highest and best use of the property as a vineyard was reasonably probable.
While the Service apparently raised issues with the taxpayer’s compliance with the technical requirements of section 170(h), those issues were not discussed in the Court’s opinion and were presumably conceded by the IRS. In addition, the Court’s opinion did not discuss conservation purposes of the easement, which must have likewise been conceded by the IRS.
Taxpayers considering the grant of a conservation easement, or who have donated a conservation easement that is under audit by the IRS, should familiarize themselves with the valuation methodology applied in Schmidtand use that methodology to determine and defend the value of their easements.