A Conservation Easement Haircut

The Peaky Blinders version of the high and tight.

The Service is continuing its crusade against inflated conservation easement deductions.  Last week it carved another notch in its belt. as it successfully argued that a conservation syndicate should sit for a haircut limiting its arguably inflated deduction amount to basis.  This because the taxpayers made a fatal planning mistake.  But their efforts to exploit conservation easement deductions were rational, I think.  Its the law that’s irrational.  Consider this short summary of  and further comment on Mill Road 36 Henry, LLC v. Commissioner:

Two real estate partners acquired 120 acres of undeveloped land directly in the path of Atlanta’s westward sprawl.  Together, they paid $1.5 million for the whole 120 acres.  They put the back 40 acres into a new partnership through which the anticipated conservation deduction would be doled out via partnership allocations.  The new partnership thereafter donated an easement on the back 40 to the Southern Conservation Trust, a legit 501(c)(3) out of Fayetteville, Georgia.  The partnership claimed a $9 million charitable contribution deduction.  The Service denied it.  Taxpayers went to Tax Court.

There, the IRS complained that a plain vanilla promise to never ever mess with nature was not a valid conservation purpose and that the deed did not have the right language.  But Judge Gus brushed those complaints aside right along with the complaint that the new partnership didn’t do the appraisal right. 

Still, new partnership claimed a $9,000,000 deduction for an easement on property for which it paid less than $500,000.  That’s not so shocking considering IRC 170 allows a FMV deduction in many cases and that the easement must last much longer than a life in being plus 40 years.  The easement must last forever if the grantor wants a deduction.  I imagine any grantor could earn $9 million dollars exploiting land if given forever to do it.  By giving up that right, the grantor donates something worth the lost opportunity.  That really is the problem with conservation easements.  No valuation, no matter how outrageous, is entirely without logic because the grantor is giving something away forever.  I suppose valuation requires more than just logic but whatever the quantifiable limitation on valuation, it can’t be anything other than arbitrary.

The fairest thing would be to limit the charitable contribution deduction to basis rather than FMV.  In all cases, not just in cases involving ordinary income assets.  Its bad tax policy otherwise and it encourages abuse.  In this case Judge Gus reached the more legitimate result only because the partners were impatiently unaware of the many anti-abuse provisions in Subchapter K.  Under Subchapter K, “hot assets” – inventory and other ordinary income properties – retain their ordinary income flavor even after they are contributed to a partnership.  And 170(e)(1)(A), the charitable contribution deduction “haircut,” limits the deduction for donations of inventory to the donor’s cost.  So the partners contributed hot assets to the new partnerships when it contributed the back 40.  The partnership’s donation within five years consisted of the same hot asset as a matter of law.  So the partners had to sit for a haircut they hadn’t anticipated. 

You would think the strategy for generating a $9,000,000 deduction would have been tax opinionated about before execution.  The partners could have waited five years before making the donation because the ordinary income taint would have dissipated by then.  They might have won, even if they claimed a gazillion percent mark-up on their charitable contribution deduction.  But it wasn’t their purpose to preserve no stinking property. 

darryll k. jones