Conservation easements can result in significant charitable deductions for real estate owners and investors. But can an owner or investor retain rights to the property and still get the charitable deduction? The courts continue to define when this is possible. The Pine Mountain Preserve LLLP v. Commissioner, 151 T.C. 14, case is the latest case to address this.
Facts & Procedural History
The facts are lengthy, but summarized as follows: The party in the court case is a partnership that was formed to hold real estate in Alabama.
The owners of the partnership transferred conservation easements for several parcels to the North American Land Trust (“NALT”). NALT is a nonprofit. The transfers resulted in charitable deductions for the owners of the partnership.
On audit, the IRS denied the charitable deductions given that the partnership retained the right to substitute property in the future. Thus, the IRS determined that the specific property subject to the conservation easements was not restricted in perpetuity and therefore it did not qualify for a charitable deduction.
About Conservation Easements
A conservation easement is a legal restriction placed on real property. It typically prevents the owner from developing or modifying the real property in the future.
This legal restriction reduces the value of the real property. Since some or all of the property rights are donated to a charitable entity or non-profit, the restriction can generate a sizeable charitable deduction for the owner.
Because the ownership structure is that of a partnership, the charitable deductions flow through to those who own the partnership. This is usually the original owner of the underlying property plus third-party investors who essentially purchase a charitable deduction.
The partnership and taxpayer have a number of reporting rules they have to comply with for these deductions to work. This includes filing an appropriate appraisal with the tax return. Failure to comply with these rules can result in no charitable deduction (unless reasonable cause is established for noncompliance).
Substituting Conservation Easement Property
This brings us back to the Pine Mountain Preserve case. The court had to address the question as to whether the owner’s ability to substitute property runs afoul of the conservation easement rules.
As noted in the U.S. Tax Court’s opinion in this case, the U.S. Tax Court has previously sided with the IRS and held that the ability to substitute property is determinative.
The U.S. Tax Court’s opinion describes the prior case law, which includes two types of cases with similar facts. In one fact pattern, the partnership could substitute property adjacent to the conservation easement property. In the other fact pattern, the partnership could substitute property that was within the original bounds of the conservation easement, but that was originally omitted from it. Thus, in the second fact pattern the outer bounds of the total acreage would not change–just sections within the outer bounds.
The Fifth Circuit Court of Appeals had sided with the taxpayer in a case involving the second type of fact pattern. The U.S. Tax Court in the present Pine Mountain Preserve case noted that this case was not appealable to the Fifth Circuit and that it believes that the charitable deductions are not allowable.
The partnership will no doubt appeal the decision to the Eleventh Circuit Court of Appeals.
Tax Deduction & Retaining Rights
The underlying dispute involves the definition of what exactly qualifies for a tax deduction.
Real estate owners want the tax deduction and to retain all interests in the property that they want. In this case, it was development rights. In other cases, it is limited use, such as hunting, etc. use.
Contrary to the owners, the IRS’s position is that the retention of just about any right invalidates the conservation easement for tax purposes.
These disputes matter. Conservation easements are big business. The charitable deductions they generate are significant. Since they are reported on the partners individual tax returns, they can also result in adjustments for quite a few taxpayers. Adjustments like the ones in this case can be problematic for both the IRS and the owners.