Charitable Easement Valuation: White Lies, Pigs and Hogs

I tell my students all the time that every clever tax strategy depends in part on at least one little white lie.  Something that is plausible but very unlikely.  A highly unlikely “fact,” but not a straight-out, bald-faced lie.  A short-lived Crummey power is a little white lie. It facilitates the mostly false assertion that a gift is a present interest, thereby allowing use of the annual gift exclusion.  We know damn well that the holder is not going to exercise the power, “but hey, it could happen!”  The trick to staying out of jail or avoiding massive penalties — to getting slaughtered — is to limit tax strategizing to little white lies.  When you start telling whoppers you are looking at penalties or maybe even jail time.  

The Tax Court issued a memo opinion Tuesday exemplifying the principle. Taxpayer bought some back-wood Georgia acreage for $1.6 million.  Very soon thereafter it granted a conservation easement and claimed a charitable deduction of $16,745,000 based on presumed highest and best use related to mineral interests.  It was Christmas after that because the taxpayer (an LLC taxed as a partnership) began allocating charitable contributions.  Like Santa Claus.  The Service rightfully challenged the whole thing as being more than a little white lie. 

I’ve almost completely stopped blogging about conservation easements.  There is no legal issue involved, the whole area is mostly about lying.  But this opinion provides a nice mini-dissertation on valuing in-kind charitable contributions in general, and conservation easements in particular.  In addition to “highest and best use,” the opinion talks about alternative use valuation and discounted cash flow analysis.  The impact of “market participant behavior” too.  Discounted cash flow analysis is determines the present value of future expected income.  It’s typically explained using calculations only Einstein could understand, but it too requires some white lying.  Here, Taxpayer argued that instead of granting the conservation easement it could have drilled for minerals on the property extracting income sufficient to support a $16,745,000 conservation easement valuation.  That’s more than a little white lie even to someone who knows nothing about it.  If the property, or any portion of it was worth that much, why has it been sitting for years until Congress enacted 170(h)?  

Anyway, the discounted cash flow analysis is of little use, the court explained, if the property is not presently producing income and never has produced income.  The taxpayers persisted anyway with straight faces.  Eventually, the Court said the conservation easement was worth only about $94,000.  Here is the court’s sober response and warning:

We could go on (and make similar observations about [the other valuation experts] Messrs. Hayter’s, Spears’s, and Kenny’s analyses). That is the point: Use of the discounted cashflow method with so few reliable inputs and so many variables and unknowns is simply an exercise in imagination. As such it is altogether unreliable, and we would ignore the laughable results it generated even if we thought mining were the easement property’s highest and best use.

We caution taxpayers in the future who choose to use this method without strong support that we will view the income approach and the discounted cashflow method with skepticism, particularly in the conservation easement context.

So once again, pigs turned into hogs and hogs got slaughtered. Ribs and bacon all around.

darryll k. jones