Carpenter v. Commissioner Revisited – Federally-Deductible Conservation Easements Must be Extinguishable Only in a Judicial Proceeding
In Carpenter v. Commissioner, T.C. Memo 2013-172 (Carpenter II), the Tax Court denied the taxpayer’s motion for reconsideration and supplemented its opinion in Carpenter v. Commissioner, T.C. Memo. 2012-1 (Carpenter I). The court clarified that Treasury Regulation § 1.170A-14(g)(6)(i)—the “extinguishment” regulation—sets forth the conditions under which federally–deductible conservation easements can be permissibly extinguished, namely, in a judicial proceeding upon a finding that continued use of the property for conservation purposes has become impossible or impractical. The court specifically rejected the argument that the extinguishment regulation is merely a safe harbor, explaining: “To make our position clear, extinguishment by judicial proceedings is mandatory. Therefore, we reject petitioners’ argument that [the extinguishment regulation] contemplates any alternative to judicial extinguishment.“
The Tax Court also rejected the taxpayers’ argument that the First Circuit’s opinion in Kaufman v. Commissioner, 687 F.3d 21 (1st Cir. 2012) (Kaufman III), was an intervening change in law that required the Tax Court to reconsider its holding in Carpenter I that conservation easements extinguishable by mutual agreement of the parties do not satisfy the extinguishment regulation. The Tax Court explained that Carpenter is appealable to the Tenth Circuit rather than the First Circuit and Kaufman III addressed legal issues different from the one present in Carpenter in any event. In particular, Kaufman III addressed the proper interpretation of Treasury Regulation § 1.170A-14(g)(1) (the “general enforceability in perpetuity” regulation) and Treasury Regulation § 1.170A-14(g)(6)(ii) (the “proceeds” regulation), neither of which were at issue in Carpenter.
The Tax Court’s holdings in Carpenter I and II are consistent with IRS General Information Letter dated September 18, 2012, in which the agency advised that, while state law may provide a means for extinguishing a conservation easement for state law purposes, the requirements of IRC § 170(h) and the extinguishment and proceeds regulations must nevertheless be satisfied for a contribution to be deductible for federal income tax purposes.
The Tax Court’s holdings in Carpenter I and II are also consistent with public policy. To ensure consistent protection of the federal investment in conservation easements and the conservation values they are intended to “protect in perpetuity” for the benefit of the public, the high threshold for extinguishment set forth in Treasury Regulation § 1.170A-14(g)(6)(i) must apply uniformly to all federally-deductible easements, regardless of the parties to the easements or the states in which the easements are created. Uniform application of the extinguishment requirements also ensures that taxpayers will be treated equitably—that easement donors benefiting from sizable deductions will not be able to more easily escape the perpetual restrictions placed on their property in some states than in others. Requiring that the decision to extinguish a federally-deductible perpetual conservation easement be made by a court as opposed to the parties to the easement ensures that the decision will not be made solely by the parties who stand to benefit, financially or otherwise, from the extinguishment. And requiring that the extinguishment decision be made by a court as opposed to a state or local official, agency, committee, or administrative board helps to ensure that the decision to terminate federally-deductible easements will not be influenced by the short-term and often short-sighted political, economic, and development pressures to which state and local actors can be subject. Finally, the already substantial complexities associated with valuing federally-deductible conservation easements would be greatly exacerbated if the easements were subject to extinguishment pursuant to different processes and procedures, which, even if tied to state and local laws or ordinances, would vary over time as local politics and priorities change.
The easiest and most prudent way to comply with the extinguishment requirement appears to be to include a provision in the conservation easement stating that the easement can be extinguished in whole or in part only (a) in a judicial proceeding, (b) upon a finding by the court that a subsequent unexpected change in the conditions surrounding the property has made impossible or impractical the continued use of the property for conservation purposes, and (c) with a payment of proceeds to the holder as provided in Treasury Regulation § 1.170A-14(g)(6)(ii) to be used by the holder in a manner consistent with the conservation purposes of the original contribution (i.e., the easement should carefully track the provisions of both Treasury Regulation § 1.170A-14(g)(6)(i) and -14(g)(6)(ii)). The easement should also comply with the related “restriction on transfer” regulation, Treasury Regulation § 1.170A-14(c)(2), which mandates that the instrument of conveyance limit the holder’s ability to transfer the easement, whether or not for consideration, except in carefully prescribed circumstances. As an added precaution and to avoid any possible confusion, the easement might further provide that its provisions apply notwithstanding and in addition to any conditions that may or may not be imposed on the transfer or release or other extinguishment of a conservation easement under state law.
Nancy A. McLaughlin,
Robert W. Swenson Professof of Law
University of Utah SJ Quinney College of Law