Opinion
14875-20
03-31-2022
JONATHAN M. GALLANT & SARAH D. GALLANT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Christian N. Weiler Judge
This case involves a charitable contribution deduction claimed by D&G for a conservation easement. The Internal Revenue Service (IRS or respondent) disallowed this deduction and determined an accuracy-related penalty. On August 5, 2021, respondent filed a motion for partial summary judgment, and on November 30, 2021, petitioners filed a response to respondent's motion. On February 17, 2022, this case was assigned to the undersigned for trial or other disposition. By order served on February 18, 2022, the Court ordered respondent to file a reply to petitioners' response, and respondent filed his reply on March 11, 2022.
Based on the reasoning below, we will deny respondent's motion for partial summary judgment in part, and grant it, in part.
Background
The following facts are derived from the pleadings, the parties' motion papers, and the exhibits and declarations attached thereto. They are stated solely for purposes of deciding respondent's motion for partial summary judgment and not as findings of fact in this case. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994).
Petitioner Jonathan Gallant is one of two partners in D&G, an LLC. D&G was a partnership for federal income tax purposes during the 2016 tax year. In December 2014, D&G purchased 9.92 acres in DeKalb County, Georgia, for approximately $6,000. By deed recorded on December 21, 2016, D&G granted a conservation easement over the 9.92 acres in favor of Southern Conservation Trust, Inc. (Southern Conservation).
Under the deed, D&G reserves the right to make improvements to the property, including the right to construct trails and footpaths on the property, install signs and other marks, construct low impact amenities, maintain and manage the property to prevent erosion, and install picnic tables, benches, and the like.
The deed also provides for the extinguishment or termination of the easement under its Section 9.1, stating that it "can only be terminated or extinguished, whether in whole or in part, by judicial proceedings . . . ." More specifically, under the terms for extinguishment, valuation of the conservation easement would be determined under its Section 9.2, as follows:
"9.2 Valuation. This Easement constitutes a real property interest immediately vested in Grantee, which for the purposes of Section 9.1, the parties stipulate to have a fair market value determined by multiplying (1) the fair market value of the Property encumbered by the Easement (minus any increase in the value after the date of this grant attributable to the improvements) by (2) x/y, which is the ratio of the value of the Easement at the time of this grant to the value of the property, without deduction for the value of the Easement, at the time of this grant. For the purposes of this paragraph, the ratio of the value of the Easement to the value of the Property unencumbered by the Easement shall remain constant."
On its 2016 federal partnership tax return, D&G claimed a $2,510,000 charitable deduction for its donation of the conservation easement to Southern Conservation. Since Mr. Gallant owned 50% of D&G, $1,225,000 flowed through to him. Of that amount, petitioners claimed $569,821 as an itemized deduction on their 2016 joint personal income tax return. The IRS examined D&G's federal partnership return and by notice of deficiency disallowed the conservation easement deduction in full, petitioners' itemized deduction, and asserted an accuracy-related penalty under I.R.C. § 6662 against petitioners. On December16, 2020, petitioners timely filed their petition with the Tax Court challenging the IRS' notice of deficiency.
Revenue Agent (RA) Erica Jenkins made the initial determination that the accuracy-related penalty under I.R.C. § 6662 applied against petitioners in her examination report dated June 23, 2020. RA Jenkins's initial determination was personally approved, in writing, on June 24, 2020, by her immediate supervisor, Adam Wooten, by his electronic signature of Letter 5153 (the cover letter for the examination report of RA Jenkins), which was the first time respondent informed petitioners that he intended to pursue the accuracy-related penalty under I.R.C. § 6662.
On October 11, 2021, D&G executed a correction to the deed of conservation easement and recorded said document on October 12, 2021, in DeKalb County, Georgia. The corrected deed has an effective date of December 16, 2016, and deleted the language found above in its Section 9.2 and replaces the language of its Section 9.3 with the following:
"Whenever all or a part of the property is taken in exercise of eminent domain by public, corporate, or other authority so as to abrogate the restrictions imposed by this Conservation Easement, Grantor and Grantee shall join in appropriate actions at the time of such taking to recover the full value of the taking and all incidental or other damages resulting from the taking, which proceeds shall be divided in accordance with the proportionate value of the Grantor and Grantee's interest as specified in Section 9.1."
The foregoing section is modeled after language found in IRS Chief Counsel Advice 202130014.
Discussion
A. The Parties' Arguments
Respondent's motion seeks summary adjudication on the grounds that D&G's conservation easement contribution was not a qualified contribution under I.R.C. § 170(h) because it does not satisfy the perpetuity requirement of I.R.C. § 170(h)(5)(A). In his motion for partial summary judgment, respondent cites to Treas. Reg. § 1.170A-14(g)(6)(ii) (the "proceeds regulation") and contends that the conservation deed in question violates this regulation by improperly carving out donor retained improvements. Respondent also cites to our holdings in Coal Property Holdings v. Commissioner, 153 T.C. 126 (2019); Carroll Palmolive Bldg. Invs. v. Commissioner, 149 T.C. 380 (2017); and the Fifth Circuit Court of Appeals's decision in PBBM-Rose Hill v. Commissioner, 900 F.3d 193 (5th Cir. 2018) as further support of his argument.
Respondent also argues that the requirements of I.R.C. § 6751(b)(1) have been met in this case, since RA Jenkins's initial determination was personally approved, in writing, on June 24, 2020, by her immediate supervisor, Mr. Wooten.
In response, petitioners contend that the original deed does not violate the proceeds regulation and respondent's motion is moot since the original deed has been corrected. Petitioners also contend that we are to liberally interpret the original deed consistent with the parties' intent. In the alternative, petitioners argue that the improvements allowed under the original deed would not increase the value of the property and the proceeds regulation is not a valid exercise of respondent's rule-making authority. Petitioners response does not address respondent's argument with respect to his burden of production under the requirements of I.R.C. § 6751(b)(1).
B. Summary Judgment Standard
The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. v. Commissioner, 116 T.C. 73, 74 (2001). We may grant partial summary judgment regarding an issue as to which there is no genuine dispute of material fact and a decision may be rendered as a matter of law. See Rule 121(b); Sundstrand Corp., 98 T.C. at 520. In deciding whether to grant partial summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Id. "If, in this generous light, a material issue is found to exist, summary judgment is improper." Nationwide Life Ins. Co. v. Bankers Leasing Ass'n, Inc., 182 F.3d 157, 160 (2d Cir. 1999).
C. Judicial Extinguishment
The Code generally restricts a taxpayer's charitable contribution deduction for the donation of "an interest in property which consists of less than the taxpayer's entire interest in such property." I.R.C. § 170(f)(3)(A). There is, however, an exception for a "qualified conservation contribution." I.R.C. § 170(f)(3)(B)(iii), (h)(1). For an easement of the sort involved here, a charitable contribution deduction is allowable only if the underlying conservation purpose is "protected in perpetuity." I.R.C. § 170(h)(5)(A); see TOT Prop. Holdings, LLC v. Commissioner, 1 F.4th 1354, 1362 (11th Cir. 2021); PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d at 201.
The Treasury Regulations set forth detailed rules for determining whether this "protected in perpetuity" requirement is met. Of importance here are the rules governing the mandatory division of proceeds in the event the property is sold following a judicial extinguishment of the easement. See Treas. Reg. § 1.170A-14(g)(6). The Treasury Regulations recognize that "a subsequent unexpected change in the conditions surrounding the [donated] property . . . can make impossible or impractical the continued use of the property for conservation purposes." Id. subdiv. (i). Despite that possibility, "the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding" and the easement deed ensures that the charitable donee, following sale of the property, will receive a proportionate share of the proceeds and use those proceeds consistently with the conservation purposes underlying the original gift. Ibid. In effect, the "perpetuity" requirement is deemed satisfied because the sale proceeds replace the easement as an asset deployed by the donee exclusively for conservation purposes.
In Coal Property Holdings, 153 T.C. at 137-40, we held that a deed of easement failed to satisfy these regulatory requirements where the donee's share of post-extinguishment sale proceeds was improperly reduced by carve-outs for donor improvements. Accord, TOT Prop. Holdings, LLC v. Commissioner, 1 F.4th at 1363; PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d at 208. Respondent contends that the deed in this case has these defects, while petitioners resist these contentions and argue that the language found in the original deed is distinguishable.
D. Carve-Out for Donor Improvements
The deed provides that, if the property is sold following judicial extinguishment of the easement, D&G's share of the proceeds will be determined by "hav[ing] a fair market value determined by multiplying (1) the fair market value of the Property encumbered by the Easement (minus any increase in the value after the date of this grant attributable to the improvements) by (2) x/y, which is the ratio of the value of the Easement at the time of this grant to the value of the property . . . ."
This fraction is consistent with the formula set forth in the proceeds regulation. See Treas. Reg. § 1.170A-14(g)(6)(ii). However, before applying the regulatory apportionment fraction, the original deed at issue here-like the deed in Coal Property Holdings-reduces the sale proceeds by "any increase in value after the date of th[e] . . . [grant] attributable to improvements." See Coal Prop. Holdings, 153 T.C. at 138. As we explained, any such increase in value would be attributable to (1) appreciation in the value of the improvements existing when the easement was granted, plus (2) the fair market value of any new improvements that the donor later made to the property. Ibid. We held in Coal Property Holdings that reducing the grantee's share in this way violated the "granted in perpetuity" requirement because it prevented the grantee from receiving its full proportionate share of any future sale proceeds. Id. at 137-40.
Respondent's motion seeks to bring our decision in Coal Property Holdings to an illogical conclusion; namely, that no right of use or ownership in future improvements may be retained by the donor. However, we have never held that retaining rights to improvements in the donated property, ipso facto, violates the "granted in perpetuity" requirement.
In Coal Property Holdings, the improvements existing when the easement was granted "included 20 natural gas wells, two cell phone towers, various roads, and various electricity installations." Id. at 138. The donor reserved the right to make future improvements, including utility installations, roads, and driveways "for vehicular access to areas of the Property on which the existing and additional structures and related ancillary improvements are and may be constructed." Ibid. These existing and contemplated future improvements had obvious value. Cf. Englewood Place, LLC v. Commissioner, T.C. Memo. 2020-105, 120 T.C.M. (CCH) 28, 30 n.4 ("[T]he deed reserved to . . . [the donor] the right to make post-contribution improvements to the conserved area, including the rights (for example) to construct barns, sheds, roads, a residential driveway, and utilities (including water, septic, and power lines)."); Maple Landing, LLC v. Commissioner, T.C. Memo. 2020-104, 120 T.C.M. (CCH) 23, 26 n.4 (same).
Here, the original deed indicates how the "Property in its present state has not been developed . . ." and respondent's motion contends that D&G retained the right to construct trails and footpaths on the property, install signs and other marks, construct low impact amenities, maintain and manage the property to prevent erosion, and install picnic tables and benches. Accordingly, for purposes of ruling on respondent's motion for partial summary judgment, we assume that no improvements exist on the property in question.
Section 4 of the original deed expressly reserves to the "Grantor"-i.e., to D&G-the right to make limited improvements or alterations to the property, including recreational uses, trails, picnic tables and benches, removal of invasive species, placement of advertising, and signage providing notice, historical, and environmental information to visitors.
In short, the property has no existing improvements, and the permitted future improvements appear to consist of modest use intended for conservation, recreational, and educational purposes. At trial, petitioners may be able to establish that these improvements (if built) would be unlikely to increase the property's fair market value in a material way (if at all). If any increase in value attributable to improvements would be de minimis, petitioners could contend that the deed's "donor improvements" clause would not cause Southern Conservation to receive less than its proportionate share of the proceeds in the event the property was sold following judicial extinguishment of the easement.
Valuation of improvements can be difficult to quantify accurately and is an intensely factual matter. We have previously denied summary judgment in easement cases where the carved-out donor improvements had questionable (if any) real value. See, e.g., Little Horse Creek Prop., LLC v. Commissioner, T.C. Dkt. No. 7421-19 (Mar. 2, 2021) (order); Oconee Landing Prop., LLC v. Commissioner, T.C. Dkt. No. 11814-19 (Aug. 18, 2021) (order). Viewing the factual materials and the inferences drawn therefrom in the light most favorable to petitioners, we conclude that genuine disputes of material fact exist. Consequently, we deny respondent's motion for partial summary judgment as to this issue.
E. Proceeds Regulation Validity
In the alternative, petitioners contend that the proceeds regulation goes beyond its statutory limitations, suffers from fatal procedural defects in violation of the Administrative Procedure Act (APA), and lacks rational basis because it contradicts respondent's longstanding interpretation. We rejected this APA challenge in a recent Court-reviewed Opinion. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180, 189-200 (2020). However, on December 29, 2021, the Eleventh Circuit held that "the Commissioner's interpretation of [Treas. Reg.] § 1.170A-14(g)(6)(ii), to disallow the subtraction of the value of post-donation improvements . . . is arbitrary and capricious and therefore invalid under the APA's procedural requirements." Hewitt v. Commissioner, 21 F.4th 1336, 1353 (11th Cir. Dec. 29, 2021), rev'g and remanding T.C. Memo. 2020-89 (applying Oakbrook). Appeal of this case probably lies in the Eleventh Circuit. Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971).
Since the Court will deny respondent's motion for partial summary judgment in part based on genuine disputes of material facts, we find there is no need to address petitioners' legal argument at this time as to the deed's compliance with the proceeds regulation.
F. Correction to the Deed
In the alternative, petitioners also contend that the recorded correction to the deed brings the original deed into compliance with the proceeds regulation as interpreted in Oakbrook, supra, and that the correction relates back to the execution of the original deed. According to petitioners, because the deed at issue has been corrected and now complies with the proceeds regulation, respondent's motion for partial summary judgment is now moot. Petitioners cite several cases to support the proposition that under Georgia law, including this Court's order in Buckelew Farm, LLC v. Commissioner, Docket No. 14273-17 (Order served on Nov. 22, 2021).
Petitioners have offered a copy of the recorded correction to the deed of conservation easement dated October 11, 2021, along with their response to respondent's motion for partial summary judgment, and respondent did not lodge an objection to the document in his reply.
Since we will deny respondent's motion for partial summary judgment in part, based on genuine disputes of material facts, we find there is no need to address petitioners' argument at this time as to the deed's compliance (as retroactively amended) with the proceeds regulation.
G. I.R.C. § 6751(b) Compliance
RA Jenkins's immediate supervisor approved the determination to assert the penalty prior to the date the 30-day letter was sent to petitioners, and petitioners make no claim that the "initial determination" was before that date. Therefore, we find that written supervisory approval of the I.R.C. § 6662 accuracy-related penalty was given before the first formal communication of the penalty to petitioners and respondent has complied with the procedural requirements of I.R.C. § 6751(b).Accordingly, respondent has satisfied his burden of production with regard to the supervisory approval requirement of I.R.C. § 6751(b).
The 30-day letter was an exhibit submitted by respondent as part of his motion for partial summary judgment, and petitioners did not lodge an objection to the document in their response.
Considering the foregoing, it is
ORDERED that respondent's motion for partial summary judgment, filed August 5, 2021, is denied in part as to whether the deed satisfies the requirements of I.R.C. § 170(h)(5)(A) and the proceeds regulation, and is granted in part as to whether the requirements of I.R.C. § 6751(b) have been satisfied. It is further
ORDERED that on or before April 15, 2022, the parties shall file a status report (jointly if possible, otherwise separately) expressing their views as to the conduct of further proceedings in this case.