Conservation Easements under Turner and Glass

Conservation Easements under Turner and Glass

Article posted in Conservation Easement on 11 July 2006| comments
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Summary

IRC section 170(h)(1) provides an income tax charitable deduction for qualified conservation contributions of real property. In this article, University of Baltimore School of Law professor Wendy C. Gerzog discusses two recent tax court decisions that contrast how and how NOT to successfully plan such gifts.

by Wendy C. Gerzog, J.D., LL.M.

Recently, the Tax Court decided Turner1, a published opinion that shows how not to get a charitable deduction. Indeed, the taxpayers in Turner exhibited extraordinary chutzpah -- in return for which they found themselves saddled with a 20 percent negligence penalty.2 It is likely that Turner is part of the increased IRS scrutiny of abusive conservation easements.3

Turner gave the Tax Court an opportunity to explain some of the law regarding conservation easements, particularly what constitutes an "open space" or a "historical" conservation purpose. Likewise, Glass4, another fairly recent Tax Court published opinion, gave the court a chance to examine the preservation of a natural habitat or ecosystem conservation purpose and to amplify what the statute means by "exclusively for conservation purposes."5 (Emphasis added.)

Although these are income tax cases, because gift and estate tax conservation easements must qualify under the same section for a deduction or exclusion,6 they are instructive for transfer tax purposes as well. Indeed, they are particularly significant because of the expansion of the conservation easement exclusion for estate tax purposes under section 2031(c) in 2001.7

Turner

James Turner, a real estate attorney in Alexandria, Va., was a 60 percent owner and general manager of a limited liability company that was formed to acquire and develop real estate. In 1997 and 1998, he or the LLC purchased land located in the Mount Vernon area, next to President Washington's Grist Mill.8 Because a little more than half of the property is located in a designated 100-year floodplain, about half of the land cannot be developed.9

The Grist Mill property was at all times zoned for a maximum of 30 single-family dwellings.10 There was no application for rezoning, which would have been expensive, time-consuming, and unlikely to be successful without a proffer compensating the county for the additional needs dictated by the rezoning.11

From the middle of 1998 until his agreement with Mount Vernon Development, LLC (MVD) on February 9, 1999, Turner actively tried to sell the Grist Mill property.12 At the end of 1998, he received his requested waiver from the Fairfax County on-site stormwater detention requirements by providing a floodplain easement. Turner's development plans, however, erroneously denoted the floodplain easement as a conservation easement.13

The sales agreement with MVD comprised the sale of 29 lots, subject to the possibility that Turner would give lot 30 to the Mount Vernon Ladies Association (MVLA).14 According to the court:

Despite these express plans for 30 lots, in a letter dated the next day, February 10, 1999, [County Supervisor] Hyland requested petitioner consider limiting development of the Grist Mill property to 30 single-family homes. The letter inferred that petitioner could have built 62 lots "by-right". The letter contained the statement that limiting the development to 30 residential units would preserve the historical nature of the Grist Mill and might provide tax benefits. The parties to this proceeding acknowledge that the reference to 62 building lots "by-right" was incorrect and would have required rezoning. Although Hyland signed this letter, petitioner and his advisers had prepared it and requested Hyland to sign it. Hyland relied on petitioner for the truth or accuracy of the statements in the letter. At the time Hyland signed the letter, he was unaware that petitioner had plans to develop and sell 30 lots. Petitioner intended to use the letter to substantiate a tax deduction he planned to take for a conservation easement.15 [Emphasis added.]

Likewise, the MVLA, in a letter incorporating Turner's suggested language, requested the Architectural Review Board (ARB) to support Turner's proposed 30 residence subdivision, including his donation of one lot to the MVLA for Grist Mill parking.16 The MVLA also mistakenly believed that Turner could build at least 60 homes and had requested him to limit his development to half that amount.17

On December 6, 1999, the date it closed with MVD, Turner's LLC executed a conservation deed, recorded the next day, in which, besides a description of the adjacent historical sites, it recited that the MVLA and the ARB desired the LLC to limit development to 30 single-family residential lots; moreover, the deed stated that the LLC voluntarily would restrict development to those 30 lots despite its ability to build 62 lots on that property.18

The taxpayers took an income tax conservation easement charitable deduction for 1999 in the amount of $342,781.19 Fairfax County, the donee of the conservation easement, did not sign or acknowledge either the deed or the taxpayers' Form 8283, "Donee Acknowledgement."20 The Tax Court in Turner considered three issues:

  • whether the taxpayers made a qualified conservation easement under section 170(h)(1);
  • if so, what was its value; and
  • if not, should the taxpayers be subject to an accuracy-related penalty under section 6662.21

Qualified Conservation Easements

While charitable deductions of less than the taxpayer's full interest in property are generally denied, one of the exceptions to the rule is the deduction for a "qualified conservation contribution."22 To be a "qualified conservation contribution," section 170(h)(1) requires a gift to be (A) of a qualified real property interest, (B) donated to a qualified organization, (C) exclusively for conservation purposes.

Although the government in Turner asserted that the taxpayers failed to prove requirements (A) and (C) of section 170(h)(1),23 the court analyzed the "exclusively for conservation purposes" third prong and, holding that the taxpayers failed to show they satisfied this criteria, found it unnecessary to address the first requirement.24

For the donated land interest to qualify as serving exclusively conservation purposes, it must satisfy the requirements of both subsections 170(h)(4) and 170(h)(5).25 In Turner, the taxpayers asserted that they satisfied two conservation purposes: the preservation of open space and the preservation of a historic land area.26 Ruling against the taxpayers, the Turner court clarified the scope of those two purposes.

To underscore the meaning of the open space conservation objective, the court cited specific qualifying examples noted in the legislative history that focus on "the preservation of the natural state of land":27

the preservation of . . . [land] as a public garden . . . (1) the preservation of farmland pursuant to a State program for flood prevention and control; (2) the preservation of a unique natural land formation for the enjoyment of the general public; (3) the preservation of woodland along a Federal highway pursuant to a government program to preserve the appearance of the area so as to maintain the scenic view from the highway; and (4) the preservation of a stretch of undeveloped oceanfront property located between a public highway and the ocean so as to maintain the scenic ocean view from the highway.28

The Tax Court agreed with the government that the Grist Mill property deeds lacked restrictions on open space (such as a maximum size or height of the homes, or a rezoning density limitation) and that the building constraints were due to its status as a designated floodplain.29

Likewise, the Turner court referred to the Senate report to explain what constitutes a "historically important land area."

The term "historically important land area" is intended to include independently significant land areas (for example, a Civil War battlefield) and historic sites and related land areas,the physical or environmental features of which contribute to the historic or cultural importance and continuing integrityof certified historic structures such as Mount Vernon, or historic districts, such as Waterford, Virginia, or Harper's Ferry, West Virginia.30* * * [Emphasis added by the court.]

Dismissing the argument that the Grist Mill property had independent significance,31 the Tax Court emphasized that while land neighboring a historic structure "makes that land historically important . . . proximity alone does not provide a basis to support a claim of protection of a historical structure."32

Thus, noting that the taxpayers' claims of relinquishing rights "to develop and/or to preserve the floodplain ring hollow as no homes could have been built on that land,"33 the Tax Court in Turner rejected their arguments that they preserved the historic Grist Mill by the open floodplain, "the 'quiet and peaceful atmosphere' of limited development, and the requests of Hyland and the MVLA to limit development."34

Finally, explaining that Congress intended to limit the deduction to conservation easements that create a substantial public benefit,35 the Turner court concluded that the taxpayers did not prove there was any public benefit enhanced by their so-called conservation easement, particularly when, in reality, they were merely developing their land in conformity with the property's zoning and county restrictions.

Glass36

Because the Tax Court in Turner found that the taxpayers' purported donation did not serve a conservation purpose under section 170(h)(4), the court did not need to analyze the exclusivity requirement under section 170(h)(5) as it had in Glass. Glass, however, provides a helpful examination of that additional prong as well as a contrast to Turner.

The government in Glass conceded that the taxpayers had satisfied the first two requirements of a qualified conservation contribution.37 That is, they had made a donation of a qualified real property interest to a qualified organization.38 Thus, the Glass court concentrated its analysis on the third criteria: "exclusively for conservation purposes."39

The taxpayers in Glass claimed a deduction for their contribution of two conservation easements under section 170(h)(4)(A)(ii) for "the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem."40 Moreover, the taxpayers asserted that they satisfied the "exclusively for conservation purposes" requirement under section 170(h)(5).

The donee of the conservation easement in Glass was the Lake Traverse Conservancy Trust (LTC), an organization that has been in existence for several decades and has the largest membership of any nonprofit in northern Michigan. LTC sought and continues to seek conservation easements for property along the Lake Michigan shoreline to ensure the protection of wildlife (especially bald eagles), plants (for example, Lake Huron tansy and pitcher's thistle), the bluff (from erosion), and scenic views.41

While the taxpayers in Glass were not restricted in their use of the unencumbered part of their property, the deeds, prepared by LTC, stated an intention to conserve "the scenic and natural resource values of the Property" in perpetuity and convey the conservation easement to protect the property from any use conflicting with those values. Further, in the deed, the taxpayers acknowledged that they were relinquishing their development rights in association with the easement property that the conservation easement constituted a servitude, running with the land. It lists prohibited activities and makes the taxpayers liable for LTC's enforcement costs associated with the easement. Finally, the deeds limited LTC's transferability of the restricted property to a qualified conservation organization that will enforce the easement.42

The court in Glass disagreed with the government, which had argued that the taxpayers did not satisfy the examples in the regulations for a significant natural habitat or ecosystem.43 The court explained the legislative history indicated that the contribution serves conservation purposes "if it will operate to protect or enhance the viability of an area or environment in which a fish, wildlife, or plant community normally lives or occurs."44 Moreover, the court cited the testimony of LTC's executive director that the land is a known roosting spot for bald eagles and that it "is a proper and normal environment for Lake Huron tansy, pitcher's thistle, and bald eagles, among other species."45 The court held that, under the commonly accepted definitions of "habitat" and "community,"46 the taxpayers proved that the encumbered shoreline serves the conservation purpose of protecting a natural habitat or ecosystem and, therefore, qualifies under section 170(h)(4)(A)(ii).

At the same time, reviewing the limited legislative history on section 170(h)(5)(A),47 the Glass court said this section compels the donee to enforce the conservation easement in perpetuity. Applying this explanation, the Tax Court held that the taxpayers satisfied that requirement as well: The contributee, LTC, is a legitimate, longstanding nature conservancy dealing at arm's length with petitioners, and LTC has agreed (and has the commitment and financial resources) to enforce the preservation-related restrictions included in deed 1 and deed 2 in perpetuity. . . . [T]hose restrictions are legally enforceable to limit in perpetuity any inconsistent use of the encumbered shoreline, and . . . any subsequent holder of the conservation easements must be an entity fully committed to carrying out the contributions' charitable purposes.48

While ruling in favor of the taxpayer on the allowance of the deduction, the court noted that the fact that the taxpayers merely gave a small part of their property to LTC while they retained the right to build on the remainder of the land was very relevant to a determination of its value.49 Moreover, as a matter of policy, the court referred to the recent Joint Committee on Taxation report characterizing section 170(h) as too broad to enable the government to dispute a taxpayer's claim of a conservation purpose, particularly because both the donor and donee are motivated to agree on that characterization.50 In its report, the JCT recommends that Congress amend the statute to require the "protection of natural habitats" purpose in section 170(h)(4)(ii) be tied to "a clearly defined governmental policy; i.e., it furthers a specific, identified conservation project."51 Also, after the contribution, the donor or his family cannot have the right to use any part of the land as a personal residence.52 If those recommendations had been in effect with respect to the Glasses' conservation easements, since they lived on the unencumbered part of the property, they would have been denied their deduction.

Conclusion

Both Turner and Glass provide useful commentary on the requirements a taxpayer must satisfy to qualify for a conservation easement charitable deduction or the estate tax conservation easement exclusion. Because of the increased popularity of conservation easements, as well as the heightened IRS examination of these transfers, both cases provide a welcome judicial gloss on this tax benefit.


Copyright 2006 Wendy C. Gerzog. All rights reserved.



  1. Turner v. Commissioner, 126 T.C. No. 16, Doc 2006-9514, 2006 TNT 95-10 (2006).back

  2. Section 6662. See Turner, at 31-38.back

  3. See Notice 2004-41, 2004-1 C.B. 31, ("This notice informs taxpayers that the Service will, in appropriate cases, reduce or disallow deductions claimed by taxpayers under section 170 of the Code for transfers in connection with conservation easements. This notice also informs participants in these transactions that they may be subject to other adverse tax consequences, including penalties, excise taxes, and loss of tax-exempt status, as appropriate." Id.). The docket number of the Turner case is 5165-04, indicating that the taxpayers filed their petition in the Tax Court in 2004.back

  4. Glass v. Commissioner, 124 T.C. 258, Doc 2005-11571, 2005 TNT 101-11 (2005).back

  5. Section 170(h)(5).back

  6. The income tax deduction is provided for by section 170(h) and is further explained in reg. section 1.170A-14. Section 2031(c)(8)(B) provides an estate tax exclusion for qualified conservation easements; that section identifies those easements with reference to the definition of "a qualified conservation contribution (as defined in section 170(h)(1) of a qualified real property interest (as defined in section 170(h)(2)(C)), except that clause (iv) of section 170(h)(4)(A) shall not apply, and the restriction on the use of such interest described in section 170(h)(2)(C) shall include a prohibition on more than a de minimis use for a commercial recreational activity." Gift and estate tax deductions are allowable under sections 2522(d) and 2055(f), respectively. Section 2522(d) provides: "A deduction shall be allowed under subsection (a) in respect of any transfer of a qualified real property interest (as defined in section 170(h)(2)(C)) which meets the requirements of section 170(h) (without regard to paragraph (4)(A) thereof)." Section 2055(f) provides for an identical description of the deduction for estate tax purposes.back

  7. The section 2031(c) conservation easement exclusion was enacted as part of the Taxpayer Relief Act of 1997, P.L. 105-34, section 508(a). If the executor so elects, the estate may exclude the lesser of a maximum of 40 percent of the value of the land subject to the qualified conservation easement, reduced by any amount of estate tax charitable deduction claimed under section 2055(f) for the same land, or $500,000 from the value of decedent's gross estate. That provision was amended by the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16, section 551(a), amending sections 2031(c)(2) and (c)(8), removing most of the geographical limitations of the statute. Before the 2001 act, the exclusion was restricted to land located close to a metropolitan area, national park, wilderness area, or urban national forest; with the 2001 amendment, the exclusion is available to conservation easements attached to any land within the United States or a U.S. possession.back

  8. Turner, at 3-4.back

  9. Turner, at 5.back

  10. Turner, at 10.back

  11. Turner, at 8-11.back

  12. Turner, at 13-15.back

  13. Turner, at 14.back

  14. Turner, at 15. The MVLA had expressed concern about additional parking needs for the Grist Mill as well as any negative impact caused by development of the land adjacent to the Grist Mill. Id. at 11-12.back

  15. Turner, at 15-16.back

  16. Turner, at 16.back

  17. Turner, at 13.back

  18. Turner, at 17.back

  19. Turner, at 18. The actual deduction was $1,248,000, but was limited by the taxpayer's adjusted gross income. Id. at n.6.back

  20. Turner, at 17-18.back

  21. Turner, at 3.back

  22. Section 170(f)(3)(B)(iii). See Turner, at 20.back

  23. Turner, at 22.back

  24. Turner, at 23, n.9.back

  25. Section 170(h)(4) provides:
     

    (A) In general. -- For purposes of this subsection, the term "conservation purpose" means --

    (i) the preservation of land areas for outdoor recreation by, or the education of, the general public, (ii) the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem, (iii) the preservation of open space (including farmland and forest land) where such preservation is --

    (I) for the scenic enjoyment of the general public, or (II) pursuant to a clearly delineated Federal, State, or local governmental conservation policy, and will yield a significant public benefit, or
     
    (iv) the preservation of an historically important land area or a certified historic structure.
     
    (B) Certified historic structure. -- For purposes of subparagraph (A)(iv), the term "certified historic structure" means any building, structure, or land area which --

    (i) is listed in the National Register, or (ii) is located in a registered historic district (as defined in section 47 (c)(3)(B)) and is certified by the Secretary of the Interior to the Secretary as being of historic significance to the district. A building, structure, or land area satisfies the preceding sentence if it satisfies such sentence either at the time of the transfer or on the due date (including extensions) for filing the transferor's return under this chapter for the taxable year in which the transfer is made.
     
    Section 170(h)(5) provides:

    Exclusively for conservation purposes. -- For purposes of this subsection -- (A) Conservation purpose must be protected. -- A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. (B) No surface mining permitted. --

    (i) In general. -- Except as provided in clause (ii), in the case of a contribution of any interest where there is a retention of a qualified mineral interest, subparagraph (A) shall not be treated as met if at any time there may be extraction or removal of minerals by any surface mining method. (ii) Special rule. -- With respect to any contribution of property in which the ownership of the surface estate and mineral interests has been and remains separated, subparagraph (A) shall be treated as met if the probability of surface mining occurring on such property is so remote as to be negligible.

    However, because the taxpayers failed to satisfy the conservation purpose requirement under section 170(h)(4), the court considered it unnecessary to analyze whether the taxpayers' purported easement had qualified under section 170(h)(5). See Turner, at 23, n.10.
    back
  26. Section 170(h)(4)(iii) and (iv). Turner, at 22-23.back

  27. Turner, at 24.back

  28. Id., citing S. Rep. 96-1007, at 12 (1980), 1980-2 C.B. 599, 605.back

  29. Turner, at 24-25.back

  30. Turner, at 26, citing S. Rep. 96-1007, supra note 27 at 12, 1980-2 C.B. at 605.back

  31. Turner, at 28-29 ("We also note that petitioners are not in a position to claim that the Grist Mill property is independently significant, like a Civil War battlefield, as there is no evidence that anything on the property was historically unique. The Grist Mill property is thus a historically important land area only because of its proximity to the Grist Mill and the Woodlawn Plantation." Id.).back

  32. Turner, at 28.back

  33. Turner, at 27, n.11.back

  34. Turner, at 26-27. As earlier noted, both Hyland and the MVLA were under the misconception that Turner would have built twice the housing he actually could. See notes 15 and 17, supra.back

  35. Turner, at 28, citing S. Rep. 96-1007, supra note 27 at 9-10, 1980-2 C.B. at 603 ("[T]he committee believes that provisions allowing deductions for conservation easements should be directed at the preservation of unique or otherwise significant land areas or structures * * * the committee bill would restrict the qualifying contributions where there is no assurance that the public benefit, if any, furthered by the contribution would be substantial enough to justify the allowance of a deduction. * * *" Id.).back

  36. See note 4, supra.back

  37. Because the government untimely raised the argument that the taxpayers hadn't proved they satisfied the "contemporaneous written acknowledgment" requirement of section 170(f)(8), the court refused to address this additional issue. Glass, at 259.back

  38. Sections 170(h)(1)(A) and (B).back

  39. Section 170(h)(1)(C).back

  40. The taxpayers also claimed that they satisfied the open space purpose under section 170(h)(4)(A)(iii) but, finding that the taxpayers proved that they satisfied the natural habitat protection purpose, the court found it unnecessary to explore that contention.back

  41. Glass, at 266-267, 273-274. Moreover:
     

    When a landowner contributes an easement to LTC, LTC typically also asks for and receives a cash contribution from that landowner. The cash contribution is meant to help LTC monitor and, if necessary, enforce the terms of the easement. LTC also helps the landowner find an appraiser to value the contributed property by furnishing the landowner with a list of appraisers, all of whom attended a seminar on the subject sponsored by LTC. LTC also usually gives the landowner some brochures explaining the mechanics of a conservation easement and a guide detailing the tax ramifications of a conservation easement and the contribution thereof. *** LTC usually verifies its receipt of a contributed easement by signing Form 8283, Noncash Charitable Contributions.Id. at 274-275.

    back
  42. Glass, at 267-271.back

  43. Glass, at 281. See reg. section 1.170A-14(d)(3)(ii).back

  44. S. Rep. 96-1007, at 10, 1980-2 C.B. at 604.back

  45. Glass, at 281.back

  46. Glass, at 282.back

  47. Glass, at 279, n.16 ("Congress did not in the TRA 1976 define (or indicate the meaning of) either the word 'exclusively' or the term 'exclusively for conservation purposes.' Nor does the legislative history of the TRA 1976 shed any light on the meaning of that word or that term." Id.). Likewise, the statute is not particularly helpful in explaining the "exclusively for conservation purposes" requirement. "The statute contains no further specific guidance as to when a contribution of a qualified real property interest that is protected in perpetuity will be exclusively for conservation purposes." Glass, at 277. However, the court did find some assistance in subsequent tax legislation. According to the conference report for the Tax Reduction and Simplification Act of 1977:
     

    it is intended that a contribution of a conservation easement * * * qualify for a deduction only if the holding of the easement * * * is related to the purpose or function constituting the donee's purpose for exemption * * * and the donee is able to enforce its rights as holder of the easement * * * and protect the conservation purposes which the contribution is intended to advance. The requirement that the contribution be exclusively for conservation purposes is also intended to limit deductible contributions to those transfers which require that the donee hold the easement * * * exclusively for conservation purposes (i.e., that they not be transferable by the donee in exchange for money, other property, or services). Cited in Glass, at 279.H. Conf. Rep. 95-263, at 30-31 (1977), 1977-1, C.B. 519, 523.

    back
  48. Glass, at 283.back

  49. Glass, at 284, n.20.back

  50. Glass, at 284, n.19, citing Staff of the Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditure [JCT report] 286 (JCS-02-05) (Jan. 27, 2005), Doc 2005-1714 or 2005 TNT 18-18.back

  51. Id., citing JCT report, at 282.back

  52. Id., citing JCT report, at 283.back

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