Wachter v. Commissioner—North Dakota Conservation Easements are Not Deductible
The Tax Court in Wachter reiterated the fundamental principle that, while state law determines the nature of property rights, it is federal law that determines the federal tax treatment of those rights. Wachter confirms that a state can render all conservation easement donations in the state ineligible for the various federal tax incentives offered to conservation easement donors by enacting laws that prevent conservation easements from complying with federal requirements.
In Wachter, the IRS argued that North Dakota’s law limiting the term of all real property easements to 99 years prevents conservation easements in the state from satisfying both:
(i) IRC § 170(h)(2)(C)’s requirement that a tax-deductible easement be “a restriction (granted in perpetuity) on the use which may be made of the real property” and
(ii) IRC § 170(h)(5)(A)’s requirement that the conservation purpose of a tax-deductible easement be protected in perpetuity.
The Tax Court noted that these are two separate and distinct perpetuity requirements, and the failure to satisfy either of them will prevent an easement from being deductible under IRC § 170(h). The court held that North Dakota law precludes conservation easements in the state from qualifying as granted “in perpetuity” under both of these subsections.
The taxpayers in Wachter argued that North Dakota’s 99-year limitation should be considered the equivalent of a remote future event that does not prevent an easement from being considered perpetual. They cited Treasury Regulation § 1.170A–14(g)(3), which provides, in part, that
A deduction shall not be disallowed … merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible.
This regulation merely restates a rule that applies to all charitable gifts (see Treasury Regulation § 1.170A-1(e)). The rule is intended to ensure that taxpayers are permitted to claim deductions for charitable gifts only if the donee (whether a government entity or charity) will actually receive and retain the gift for the benefit of the public. Thus, no deduction is allowed unless, on the date of the gift, the possibility that the donee’s interest would be “defeated” (i.e., that the property would be returned to the taxpayer and thereby removed from the charitable sector) is so remote as to be negligible.
The Tax Court in Wachter noted that the courts have construed the so-remote-as-to-be-negligible standard to mean:
‘a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety in undertaking a serious business transaction’ or ‘a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance.’
The Tax Court explained that the term “remote” refers to the likelihood of the event that could defeat the donee’s interest in the gift. It then explained that the likelihood of the event in Wachter that could defeat the donee’s interest in the charitable gifts of the conservation easements – expiration of the easements after 99 years – was not “remote.” On the date of the donation of the easements, the court explained, it was not only possible, it was inevitable that the donee would be divested of its interests in the easements by operation of North Dakota law. Accordingly, the easements were not restrictions granted “in perpetuity” and, thus, were not deductible under IRC § 170(h).
The courts have held that the so-remote-as-to-be-negligible standard cannot be invoked to cure a taxpayer’s failure to comply with specific requirements in the Treasury Regulations interpreting IRC § 170(h), including the mortgage subordination requirement (§ 1.170A-14(g)(2)), the judicial proceeding to extinguish requirement (§ 1.170A-14(g)(6)(i)), and the division of proceeds upon extinguishment requirement (§ 1.170A-14(g)(6)(ii)). See, e.g., Mitchell v. Commissioner, T.C. Memo 2013-204. This makes sense. The specific requirements in IRC § 170(h) and the regulations establish bright-line rules that promote efficient and equitable administration of the federal tax incentive program. If individual taxpayers could fail to comply with those requirements and claim that their donations are nonetheless deductible because the possibility of defeat of the gift is so remote as to be negligible, the IRS and the courts would be required to engage in an almost endless series of probability assessments with regard to each individual conservation easement donation. By including specific requirements in IRC § 170(h) and the regulations, Congress and the Treasury Department presumably intended to avoid just such inquiries.
Accordingly, it appears that taxpayers can invoke the so-remote-as-to-be-negligible standard with regard to an event that could defeat a gift of a conservation easement only if the event is not the subject of a specific requirement in IRC § 170(h) and the Treasury Regulations. One such event, provided as an example in Treasury Regulation § 1.170A-14(g)(3), is forfeiture of a conservation easement as a result of the donee’s failure to rerecord the easement under the applicable state’s marketable title act. The Treasury presumably assumed that the prospect of such forfeitures was so remote as to be negligible given that donees have a fiduciary obligation to protect the charitable assets they hold on behalf of the public and not transfer such assets to private parties. Another such event might be a tax lien foreclosure that could terminate a conservation easement. If the probability of such a foreclosure is so remote as to be negligible at the time of a conservation easement’s donation, it should not render the easement nonperpetual.
Nancy A. McLaughlin, Robert W. Swenson Professor of Law, University of Utah S.J. Quinney College of Law