Retained Development Rights in Conservation Easements

On Monday, Judge Halpern’s Tax Court Memo in Carter v. Commissioner upheld the taxpayers’ conservation easement deduction against one procedural and one substantive challenge.  But it reduced the claimed deduction from $14 million and change to $1 million, and then upheld a 40% valuation penalty.  The case concerned the extent to which a donor may retain rights to build homes, boat docks and roads on or through the conservation property and still be deemed to have made a gift to conservation in perpetuity. 

Procedurally, the taxpayers failed to comply with Treasury Regulation §1.170A-14(g)(5)(i)(D) requiring donor to provide documentation of the ex ante [“before”] valuation on or before the date of the gift, and evidence that the donee agreed with the before valuation, also on or before the gift.  Ex ante valuation is required so that the nonprofit to whom the conservation easement is conveyed can monitor future developments to ensure those developments do not defeat the conservation purpose.  The taxpayer and nonprofit completed the paperwork four or five months after the gift.  But the Court ruled that substantial compliance is sufficient and that the five month delay constituted substantial compliance.

Substantively, the Court held that the donor’s retention of rights to build homes, docks and roads through the property did not preclude the deduction.  The Court had to address two regulatory requirements.  Something tells me the subtle distinction between the two regulations makes room for planning.  The first, Treasury Regulation §1.170A-14(e)(2), denies a deduction when the retained right is destroys any “conservation interest” even if the retention is not inconsistent with the donor’s conservation purpose. The other, Treasury Regulation §1.170A-14(g)(1), denies deduction if the retained rights are “inconsistent” with the donor’s conservation purposes.  I am not sure the distinction would have made a difference and probably both regulations are applicable.  The Court relied only on the latter regulation, which might actually be harder for taxpayer.  Presumably, a right is more easily “inconsistent” than it is “destructive.”  On the other hand, the first requirement looks at the effect of retained rights on a broader range of “conservation interests,” destruction of any one of which precludes deduction. The second regulation looks only at the effect of retained rights on the donor’s conservation purpose.  Here is the thought provoking language from the opinion:

The question before us, as we see it, is whether the partnership’s exercise of its reserved rights in the Dover Hall property would be “inconsistent with the conservation purposes” of the partnership’s donation of the easement to NALT. Treas. Reg. §1.170A-14(g)(1). Respondent’s reliance on Treasury Regulation §1.170A-14(e)(2) strikes us as misplaced. Treasury Regulation §1.170A-14(e)(2) generally requires denial of a deduction when the contribution of a qualified real property interest would accomplish its specified conservation purposes but would also “permit destruction of other significant conservation interests.” Respondent’s position, as we understand it, is that the partnership’s reserved rights to limited development of the Dover Hall property would undermine the very conservation purposes for which the partnership claims to have conveyed the easement. Therefore, we view the governing authority as Treasury Regulation §1.170A-14(g)(1) rather than Treasury Regulation §1.170A-14(e)(2). And the relevant question under Treasury Regulation §1.170A-14(g)(1) is whether the partnership’s exercise of its reserved rights would be “inconsistent with the conservation purposes” of its donation.

darryll k. jones