Opinion
8018-21
06-17-2022
PARK LAKE III, LLC, JAMES T. HOLLOWAY, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Albert G. Lauber Judge
This is a syndicated conservation easement case. The Internal Revenue Service (IRS or respondent) disallowed the charitable contribution deduction claimed for the easement by Park Lake III, LLC (Park Lake III), and determined penalties. Currently before the Court is respondent's motion for partial summary judgment, filed April 7, 2022. Respondent contends that the deduction was properly disallowed because the easement's conservation purpose was not "protected in perpetuity." See § 170(h)(5)(A). We will deny the motion.
Unless otherwise indicated, all statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure.
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 and not as findings of fact in this case. See Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994).
Park Lake III is an Alabama limited liability company organized in November 2016. It is treated as a TEFRA partnership for Federal income tax purposes, and petitioner James T. Holloway is its tax matters partner. Park Lake III had its principal place of business in Alabama when the petition was timely filed. Absent stipulation to the contrary, appeal of this case would lie to the U.S. Court of Appeals for the Eleventh Circuit. See § 7482(b)(1)(E).
Before its repeal, TEFRA (the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, §§ 401-407, 96 Stat. 324, 648-71) governed the tax treatment and audit procedures for many partnerships, including Park Lake III.
After Park Lake III was organized in 2016, it acquired roughly 101 acres of land (Property) in Montgomery County, Alabama. In December 2017 Park Lake III granted to the National Farmer's Trust (Trust or grantee) a conservation easement over the Property. The deed of easement was recorded on December 27, 2017.
The easement deed states that it "gives rise to a real property right and interest." Article 6.1 provides that the fair market value (FMV) of the Trust's right and interest "shall be equal to the difference between (a) the [FMV] of the Conservation Area as if not burdened by th[e] Conservation Easement, and (b) the [FMV] of the Conservation Area burdened by th[e] Conservation Easement." The deed thus defines the Trust's property right as equal to the FMV of the easement, but it does not specify the point in time at which this calculation is to be made.
The deed does not address the possibility that the easement might be extinguished in a future judicial proceeding. Rather, article 6.5 expresses the parties' intention that "no change in conditions . . . will at any time or in any event result in the extinguishment of any of the covenants, restrictions or easements" contained in the deed. Article 6.7 acknowledges "that circumstances could arise which would justify the modification of certain of the restrictions" set forth in the deed. In that event, article 6.7 specifies that the Trust and Owner (viz., Park Lake III or its successor) "shall mutually have the right, in their sole discretion, to agree to amendments to [the deed] which are not inconsistent with the Conservation Purposes." This procedure is subject to the proviso that the Trust shall have no power to agree to any amendment "that would result in this Conservation Easement failing to qualify as a qualified contribution under Section 170(h) of the Internal Revenue Code."
Article 6.6 addresses the possibility that the easement restrictions might be abrogated "by exercise of eminent domain." In that event, the Trust and Owner "shall join in appropriate actions . . . to recover the full value of the taking and all incidental or direct damages." Upon such recovery, "[t]he Trust shall be entitled to the Trust's Proportionate Share of the recovered proceeds," but the term "Proportionate Share" is not defined.
Park Lake III timely filed Form 1065, U.S. Return of Partnership Income, for its 2017 tax year. On that return it claimed a charitable contribution deduction of $14,020,000 for the donation of the easement. In support of this supposed value Park Lake III relied on an appraisal prepared by Robert Wombwell.
The IRS selected Park Lake III's return for examination. On February 24, 2021, the IRS issued petitioner a notice of final partnership administrative adjustment disallowing the charitable contribution deduction in full. The IRS determined a 40% "gross valuation misstatement" penalty under section 6662(h) and (in the alternative) a 20% accuracy-related penalty under other Code provisions. Petitioner timely petitioned this Court for readjustment of the partnership items.
Discussion
A. 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 (here petitioner). Sundstrand Corp., 98 T.C. at 520.
B. "Protected in Perpetuity"
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." § 170(f)(3)(A). But there is an exception for a "qualified conservation contribution." § 170(f)(3)(B)(iii), (h)(1). For the donation of an easement to be a "qualified conservation contribution," the conservation purpose must be "protected in perpetuity." § 170(h)(1)(C), (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 193, 201 (5th Cir. 2018).
In 1986 the Department of the Treasury issued final 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 extinguishment of the easement. See Treas. Reg. § 1.170A-14(g)(6). The 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 grantee, 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." § 170(h)(5)(A).
This regulation sets forth a formula for determining the proportionate share the grantee must receive upon any extinguishment of the easement. Treasury Regulation § 1.170A-14(g)(6)(i) provides that the grantee must be entitled to proceeds "determined under paragraph (g)(6)(ii)." That paragraph, captioned "Proceeds," provides in part as follows:
[F]or a deduction to be allowed under this section, at the time of the gift the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right, immediately vested in the donee organization, with a fair market value that is at least 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 that time . . . . For purposes of this paragraph . . ., that proportionate value of the donee's property rights shall remain constant. Accordingly, when a change in conditions give rise to the extinguishment of a perpetual conservation restriction under paragraph (g)(6)(i) of this section, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction, unless state law provides that the donor is entitled to the full proceeds . . . .
In other words, the grantee's proportionate share is to be determined by a fraction, the numerator of which is "the fair market value of the conservation easement on the date of the gift," and the denominator of which is "the fair market value of the property as a whole on the date of the gift." Carroll v. Commissioner, 146 T.C. 196, 216 (2016); see also PBBM-Rose Hill, 900 F.3d at 207.
Respondent contends that the deed at issue violates the "judicial extinguishment" regulation. But this deed, unlike most easement deeds the Court has examined, does not explicitly address the subject of judicial extinguishment. Rather, it expresses the parties' intention that "no change in conditions . . . will at any time or in any event result in the extinguishment" of the easement. Should circumstances arise that would justify modifying certain restrictions, the deed envisions that Park Lake III and the Trust would agree to appropriate amendments, with the proviso that the Trust would have no power to agree to any amendment that would violate section 170(h). Given this text, petitioner has a reasonable argument that the deed violates neither the "judicial extinguishment" regulation nor the statutory requirement that the conservation purpose be "protected in perpetuity." See Morgan Run Partners, LLC v. Commissioner, T.C. Memo. 2022-61 (denying summary judgment in a case involving a similar deed).
In any event, petitioner contends that Treasury Regulation § 1.170A-14(g)(6)(ii) is substantively invalid under Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984), and constitutes "arbitrary and capricious" rulemaking in violation of the Administrative Procedure Act (APA). We rejected these arguments in a Court-reviewed Opinion that was recently affirmed by the U.S. Court of Appeals for the Sixth Circuit. Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180, 189-200 (2020), aff'd, 28 F.4th 700 (6th Cir. 2022). However, on December 29, 2021, the Eleventh Circuit held that "the Commissioner's interpretation of § 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. 2021), rev'g and remanding T.C. Memo. 2020-89 (applying Oakbrook).
We are obligated to follow the law as established by the Eleventh Circuit on this issue. See Golsen v. Commissioner, 54 T.C. 742, 756-57 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971). At the moment, it is not entirely clear whether the Eleventh Circuit invalidated the "judicial extinguishment" regulation in its entirety, or whether the court invalidated that regulation only insofar as it is interpreted to disallow deductions based on carve-outs for donor improvements. Compare Hewitt, 21 F.4th at 1353 ("[T]he Commissioner's interpretation of [the regulation] to disallow the subtraction of the value of post-donation improvements . . . is arbitrary and capricious . . . ."), with id. at 1339 n.1 ("[W]e conclude that § 1.170A-14(g)(6)(ii) is procedurally invalid under the APA . . . ."). The Eleventh Circuit may have the opportunity to define further the scope of its opinion in Hewitt, and we hesitate to address the question presented before the authoring court has had the chance to do so.
Acknowledging this uncertainty, respondent argues that, even without resort to the regulation, Park Lake III's deed fails to meet the statutory requirements. Section 170(h)(2)(C) requires that the donee of a conservation easement receive an "interest in real property" that is "granted in perpetuity." Respondent asserts that "the deed guarantees a fixed amount to the [Trust] upon extinguishment," and that the Trust therefore "never received [an] interest in property." See Oakbrook, 154 T.C. at 202-07 (Toro, J., concurring) ("One of the rights inherent in a real property interest . . . is the property holder's right to be compensated at fair market value upon a subsequent transfer or taking.").
But it is not obvious that the deed limits the Trust's share of future proceeds to a fixed historical value. Article 6.6 says that in the event of eminent domain the Trust shall be entitled, not to a fixed historical value, but to "the Trust's Proportionate share of the recovered proceeds." Oddly, the term "Proportionate Share," though seemingly intended as a term of art, is not defined in the deed. This creates an ambiguity that would need to be resolved under principles of Alabama law, which might include parol evidence. See Moore v. Pa. Castle Energy Corp., 89 F.3d 791, 795-96 (11th Cir. 1996).
For all these reasons, we will deny respondent's motion for partial summary judgment at this time, without prejudice to his resubmission of the arguments set forth therein should subsequent developments warrant that action. This is the course we have followed in other cases presenting this scenario. See, e.g., Maxwellton Propco, LLC v. Commissioner, T.C. Dkt. No. 11598-20 (Order served May 9, 2022); Sand Valley Holdings, LLC v. Commissioner, T.C. Dkt. No. 12141-20 (Order served Feb. 18, 2022); Rocky Comfort Creek Holdings, LLC v. Commissioner, T.C. Dkt. No. 12106-20 (Order served Feb. 17, 2022).
Accordingly, it is
ORDERED that respondent's Motion for Partial Summary Judgment, filed April 7, 2022, is denied. It is further
ORDERED that the parties shall file, on or before July 15, 2022, a joint status report expressing their views as to the conduct of further proceedings in this case and the consolidated case at docket No. 12115-20.