When the Tax Court issued its opinion in Pine Mountain Preserve, LLLP v. Commissioner of Internal Revenue, 151 T.C. 14 (December 27, 2018), the conservation community gave a collective sigh of relief because the court dismissed the IRS’s arguments challenging amendment clauses in conservation easements. But alas, the Tax Court giveth and the Tax Court taketh away. That sigh of relief came with some bitter medicine regarding floating homesites. More below.
Soothing Relief: Amendments
One of the new tools the IRS is using to challenge conservation easement deductions is the argument that an easement with an amendment clause cannot protect its conservation purposes in perpetuity (as required by the Treasury Regulations) since, the IRS argues, the parties potentially could amend the easement to permit an act that would be destructive to the conservation values. This argument is made even where, as in Pine Mountain, the amendment clause specifically says that no amendment is permitted where it would be inconsistent with the conservation purposes or could defeat the perpetual nature of the easement.
Luckily, the specious amendment argument was put to rest by the Tax Court in Pine Mountain. The Tax Court wisely noted that parties to a contract generally may amend the contract regardless of whether the contract explicitly permits the parties to do so. Accordingly, the inclusion of an amendment clause with appropriate limitations in a conservation easement is a “limiting provision” that is actually desirable.
Bitter Medicine: Floating Homesites
Not so luckily, in the same opinion, the Tax Court chose to support a different problematic tool that the IRS has been using: the argument that an easement’s conservation purposes will not be preserved in perpetuity where the donor has reserved the right to build a homesite on property protected by a conservation easement and the easement permits the donor to move the location of the homesite somewhere else within the easement area boundaries. This right has been reserved by owners in many conservation easements over the past few decades and is only now under fire.
The Pine Mountain property totals approximately 6,224.23 acres acquired piecemeal over a three-year period for $37,070,435. The owner, a development partnership (which sold limited partnership interests to investors), then preserved the property with a sequence of three conservation easements in favor of the North American Land Trust (NALT), after which the partnership claimed approximately $33,376,000 in charitable tax deductions. The easements permitted the owner to retain 16 one-acre sites within which to build homes and to move the locations of those building sites. However, the building sites were still subject to limitations in the easement regarding size and location.
As always, bad facts make bad law, and the court’s mood likely was influenced by a couple of bad facts here, including:
- The sale of partnership interests, which, while not necessarily evil in themselves, are under heightened scrutiny due to the syndicated easement disaster;
- Extremely high deduction amounts for the easement, which were close in value to the original purchase price of the entire fee interest in the property; and
- The owners’ retention of additional reserved rights to build a 5,000 sq. ft. barn outside of the one-acre building envelope, a ten-acre envelope for an additional barn, a riding stable, and an indoor riding ring; two scenic overlooks (including a guest bedroom); 14 piers and boat launches; 5 five-acre ponds, and unlimited hunting blinds and stands.
Regardless of the extra outbuilding rights, the court’s opinion regarding perpetuity focuses on the owner’s ability to relocate the one-acre homesites with NALT’s consent. Internal Revenue Code Section 170(h) provides a charitable tax deduction for contributions of a qualified real property interest to a qualified organization exclusively for conservation purposes and Section 170(h)(2)(C) defines qualified real property interest to include a “restriction (granted in perpetuity) on the use which may be made of the real property.”
The opinion unsatisfactorily fails to address how permanent restrictions as to size and location (requiring land trust consent) cannot qualify as “perpetual” restrictions on the use which may be made of the real property. The Tax Court focuses on the land outside of the building envelopes, but the land within the building envelopes is also “the real property” restricted by the easement. The Tax Court erroneously applies previous opinions in Belk v. Commissioner and Balsam Mountain v. Commissioner to this scenario and distinguishes the facts of Bosque Canyon Ranch (a little more from me on that case here), but none of those cases is applicable to the Pine Mountain facts. It is important to differentiate between the concepts of:
- Moving the exterior boundary of an easement (Belk/Balsam Mountain),
- Moving interior boundaries of an easement, where the homesites are literally carved out of the legal description and not subject to the easement, e., the “swiss cheese easement” (Bosque Canyon), and
- Moving homesites that are protected by and subject to the easement within the easement boundaries (Pine Mountain).
It makes sense that retaining the right to move the exterior boundaries of an easement simply does not protect the original easement area in perpetuity. Moving homesite envelopes that are subject to the easement to another area within the easement boundaries is not the same thing, and Judge Morrison agrees in his thorough dissenting opinion. Regardless of the location of the homesites, they are subject to size and location restrictions that are protective of conservation values and would not otherwise apply in the absence of the easement. Further, any relocation requires land trust consent, which should provide some comfort that the conservation purposes will continue to be served. But, while the Pine Mountain opinion ironically defers to land trust oversight in the context of amendments, it gives no weight to land trust oversight in the context of homesite relocation.
Two important points that the opinion does not address are:
- Most land trusts would much prefer to have adjacent building areas subject to restrictions so that there cannot be unfettered growth or even industrial use right next to the conserved land. Including the homesite within the easement area and encumbering it with restrictions is beneficial to the conservation values both within the homesite itself (due to restricted size and usually some prohibited uses) and in the remaining easement area. Permitting relocation of the homesite can also be beneficial where sensitive environmental features are discovered at the original homesite location.
- The appraisal of the conservation easement must exclude the value of any development permitted in the homesite and may even include a premium for the right to move the location of the site. The taxpayer who retained a floating homesite has already reduced the amount of the tax deduction to account for that retained right.
This is complicated stuff, but it is important to step back and look at the big picture. What is being conserved? Will the provision in question further such conservation in perpetuity? With floating easement boundaries, the answer is no. With floating homesites protected by an easement, the answer is yes. Hopefully, the circuit courts will be able to see the difference.