With the increased popularity and scrutiny of Conservation Easements, we thought it would be of interest to outline a recent tax court decision. In a case of first impression, the Tax Court has found that a conservation agreement violated the regulations by not guaranteeing the donee organizations a proportionate share of extinguishment proceeds based on the fair market value of the conservation easement at the time of the gift. The purpose of petitioners’ contribution was not protected in perpetuity, and it failed to qualify as a qualified conservation contribution, the court held.
Take Away A qualified conservation contribution means a contribution of a qualified real property interest, to a qualified organization, exclusively for conservation purposes. All three requirements must be satisfied for a donation to be a qualified conservation contribution.
The taxpayer owned real property in Maryland. In 2005, the taxpayer granted a conservation easement in the property to two qualified organizations, intending to preserve the property for conservation purposes. The taxpayer valued the easement at $1.2 million.
One provision in the conservation easement addressed termination/extinguishment of the easement. In the event the conservation purpose would be extinguished because of an unexpected change in circumstances, the donee organizations would receive a proportionate share of the extinguishment proceeds. Their share would be based on a fraction equal to the amount allowed as a deduction for federal income tax purposes over the fair market value of the property at the time of contribution.
The taxpayer reported the conservation easement donation on his 2005 return. The taxpayer claimed a $490,000 noncash charitable contribution deduction and carried forward $710,000 of the remaining $1.2 million easement contribution to subsequent tax years.
The law requires that the conservation purpose of the conservation easement be protected in perpetuity. The regulations addresses subsequent unexpected changes in the conditions surrounding the donated property that make it impossible or impractical to continue using the property for the intended conservation purpose.
The court found that the challenged language in the conservation agreement did not satisfy the regulations. Under the regs, the proportionate share of extinguishment proceeds must be determined by the fair market value of the easement on the date of the gift over the fair market value of the whole property on the date of the gift.
The court found that the regulations are designed to prevent taxpayers from reaping a windfall if encumbered property was subsequently destroyed or condemned. The conservation agreement violated the regulations by providing the taxpayer with a potential windfall in the event that a change of conditions extinguished the conservation easement.
The conservation agreement violated the regulations by not guaranteeing the donee organizations a proportionate share of extinguishment proceeds based on the fair market value of the conservation easement at the time of the gift. The purpose of petitioners’ contribution was not protected in perpetuity, and it failed to qualify as a qualified conservation contribution.
The court also upheld the substantial understatement penalty imposed by the IRS. A taxpayer must satisfy a three-prong test to be found to have reasonably relied on professional advice to negate the penalty: (1) the adviser was a competent professional who had sufficient expertise to justify the reliance; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment.
Here, the taxpayer failed to show that he had acted with reasonable cause and in good faith with respect to the protected-in-perpetuity requirement the regulations. The taxpayer, a physician, testified that he personally handled the conservation easement and did not consult with an attorney or other adviser. The taxpayer failed to clarify why he did not seek advice from a tax attorney or other adviser to ensure the conservation easement’s compliance with the regs.
If you need any assistance with the construction of your conservation easement or the related tax benefits, please do not hesitate to contact us.