In February of 2020, the United States Tax Court issued a Memo, Railroad Holdings, LLC T.C. Memo. 2020-22 (U.S.T.C. Feb. 5, 2020), and an Order, Rock Creek Holdings, LLC, Tax Court Order, 2/10/2020. Both the Memo and the Order pertain to the conservation easement in dispute in the cases. In the first case, the Court held that Railroad Holdings, LLC (Railroad Holdings) was not entitled to a charitable deduction for its contribution of a conservation easement because the conservation purpose of the easement was not “protected in perpetuity” within the meaning of IRC § 170(h)(5)(A). In the latter case, the Court held that Rock Creek Holdings, LLC (Rock Creek) was also not entitled to a charitable contribution deduction for its donation of a conservation easement. In Rock Creek’s case, the deed granting the easement failed to protect the conservation purpose of the donation because it did not provide the donee with the proportionate share of proceeds to which it was entitled upon extinguishment.
Background
Generally, per IRC § 170(f)(3)(A), a taxpayer may only claim a charitable deduction for the donation of “an interest in property which consists of less than the taxpayer’s entire interest of such property.” IRC § 170(h) identifies and defines an exception to IRC § 170(f)(3)(A), namely a “qualified conservation contribution.” Under IRC § 170(h)(5)(A), “[a] contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.”
At the time of these two cases, in order to qualify as a conservation contribution under IRC § 170(h), the conservation purpose must be protected in perpetuity. As such, any interest in the property retained by the donor must be subject to legally enforceable restrictions that will prevent uses of the retained interest inconsistent with the conservation purpose of the donation. See 26 CFR § 1.170A-14(g)(1). An easement may be extinguished, and if the extinguishment does occur, the donation will be deemed to have been in perpetuity if the proceeds of the extinguishment are paid to the donee organization and the donee uses them for conservation purposes. See Reg. 1.170A-14(g)(6)(ii). The donee must be entitled to a proportionate share of the proceeds at least equal to the proportionate value of the perpetual conservation restriction. If the donee is not granted a proportionate share of the proceeds, the perpetual use restriction of the conservation easement agreement is not satisfied, and the donor has failed to meet the requirement that the conservation purpose of the contribution be protected in perpetuity.
Railroad Holdings, LLC v. Commissioner of Internal Revenue, 2020-22 (U.S.T.C. Feb. 5, 2020)
In 2012, Railroad Holdings contributed a conservation easement deed to Southeast Regional Land Conservancy, Inc. (SERLC), a qualified charitable organization. If the easement were ever extinguished and proceeds were to be allocated between Railroad Holdings and SERLC, as detailed in the deed, then SERLC would be entitled to a portion of the proceeds. Specifically, SERLC was entitled to the portion at least equivalent to the fair market value of the conservation easement as of the date of the conservation easement. SERLC was not entitled to a proportionate share of the proceeds.
Railroad Holdings claimed a charitable contribution deduction of $16 million for the contribution on its 2012 tax return. The Internal Revenue Service (IRS) disallowed this deduction because the easement was not a qualified conservation contribution under IRC § 170(h).
The Tax Court agreed with the IRS and disallowed the deduction, since SERLC’s proportionate share of the extinguishment could not be said to have been perpetual. Put differently, the Court said that if SERLC was entitled to 10% of the value of, say, a $10 million property at the time of contribution per its deed, it would be entitled to $1 million. If, at the time of extinguishment, the property appreciated to $20 million, SERLC would not be entitled to 10% of $20 million (i.e., $2 million), but the “constant” $1 million. For that reason, Railroad Holdings’ contribution cannot be said to have been made “in perpetuity” within the meaning of IRC § 170(h)(5)(A).
Rock Creek Holdings, LLC, Tax Court Order, 2/10/2020
Rock Creek’s case was decided similarly by the Court, which even cited Railroad Holdings’ case in its analysis. The Court published on its website an Order holding that Rock Creek was not entitled to a charitable contribution deduction for its donation of a conservation easement, since the deed granting the easement did not provide the donee with the proportionate share of the proceeds to which it was entitled upon extinguishment. As a result, the deed failed to protect the conservation purpose of the donation.
In September of 2013, Rock Creek purchased 748 acres of land for $1.2 million. Three months later, Rock Creek contributed to SERLC a conservation easement covering 719 of those acres. The conservation easement gave rise to a real property right and interest immediately vested in SERLC. The fair market value of SERLC’s right and interest was equal to the difference between 1) the fair market value of the property, as if not burdened by the conservation easement, and 2) the fair market value of the property burdened by the conservation easement, as such values were determined at the date of the conservation easement. If the easement were extinguished, SERLC would be entitled to a portion of the proceeds “at least” equal to the fair market value of the conservation easement as of the date of the donation. SERLC was also required to use its share of the proceeds in a manner consistent with the conservation purposes set forth in the deed.
On its 2013 return, Rock Creek claimed a noncash charitable contribution of $7.875 million for its contribution of the easement to SERLC. The IRS disallowed the deduction, determining that SERLC did not have a right to participate in any future appreciation of the property, and therefore the donation of the easement was not a qualified conservation contribution. In other words, the easement did not protect the conservation purpose of the easement in perpetuity. The Court cited Coal Property Holdings, LLC v. Commissioner, 153 T.C. 126 (Oct. 28, 2019) and Railroad Holdings, LLC in its Order, which determined that the IRS properly disallowed the deduction. The Rock Creek deed established a minimum for the proceeds SERLC was entitled to, but that minimum was not required to rise with the value of the property. As such, the deed did not provide the donee with proportionate share of the potential appreciation to which they were entitled under Reg. 1.170A-14(g)(6)(ii).