Beneficial Giving Bites Taxpayer in Wendell Falls Development, LLC

Donors of conservation easements have just been put on notice by the Tax Court. Frequently, donors of conservation easements (or related parties) own nearby property. The Tax Court recently denied a deduction for a conservation easement where, without any expert opinion, it determined there was an expectation that contiguous property would increase in value. It is unclear just how far-reaching this opinion will be applied, but the IRS may be expected to look closely at this issue in existing and future examinations.

Generally, a payment of money cannot constitute a charitable contribution if the contributor expects to receive a substantial benefit in return. ¹ In Rev. Rul. 67-246, the IRS set up a two-part test for determining when part of a “dual payment” is deductible. First, the payment is deductible only if and to the extent it exceeds the market value of the benefit received. Second, the excess payment must be “made with the intention of making a gift.”²

In Wendell Falls Development, LLC v. Comm’r, T.C. Memo 2018-45, the Tax Court completely denied a claimed conservation easement by determining, without any corresponding expert testimony, that contiguous property owned by the taxpayer will benefit from the easement. The conservation easement was placed on a 125-acre parcel owned by the developer as part of a planned 1,280 acre development outside of Raleigh, North Carolina, with the intention to use the 125-acre parcel as a park.

The taxpayer’s expert valued the conservation easement at $5,919,000 (more than claimed on the taxpayer’s return). The IRS expert valued the easement at $1,600,000. As a result, the IRS asserted a deficiency and sought the imposition of penalties, including a 40% substantial understatement penalty.

The Tax Court cited to authority for the proposition that no deduction is allowed where a taxpayer expects to obtain more than an incidental benefit in the form of enhancement to the value of the taxpayer’s remaining land (or otherwise to benefit the taxpayer). No deduction for a charitable contribution is allowed if the taxpayer expects a substantial benefit  from the contribution.³ This proposition is consistent with Treas. Reg. §1.170A-14(h)(3)(i).  However, the regulations go on to make clear that the taxpayer can receive a deduction where, notwithstanding the enhancement to the value of other property, there is a net loss in value. Example 10 of the regulations explains how this is to be done by reducing the charitable deduction by the increase in the taxpayer’s other property.⁴

In this case, there was evidence of the taxpayer’s marketing efforts for the development showing the park as an amenity. However, there was no expert testimony evidencing any enhancement to value of the contiguous property. On the other hand, there was expert testimony by both the taxpayer and the IRS showing a substantial loss in the value of the 125-acre parcel. In Footnote 5, the Tax Court dismissed this issue by citing to the authority to disregard expert testimony when it is contrary to the evidence.⁵

It is important in this case that the Tax Court denied the deduction based on enhancement to the value of other property without any expert testimony to support either (a) that such enhancement actually was realized, or (b) the value of any such enhancement to value. Certainly, fact evidence may have been presented giving the Tax Court reason to believe the taxpayer expected to realize an enhancement to value of its planned development. However, how did the Tax Court determine whether such increase in value was more than incidental? How did the Tax Court determine that the value of the other property increased by more than the diminishment in value to the 125-acre parcel?

Without any expert testimony on point, it appears that the Tax Court merely rendered its own opinion as to value. This is reminiscent of Estate of Elkins v. Comm’r, 767 F.3d 443 (5th Cir. 2014). In Elkins, the Fifth Circuit was faced with a situation where the taxpayer claimed valuation discounts on factional interests of artwork owned by a decedent. The IRS presented no expert testimony as to value, rather merely relying on arguments that discounts should not apply. The Tax Court did not agree with either party. Rather, the Tax Court agreed fractional interest discounts should apply, but to a lesser degree than claimed by the taxpayer. The Fifth Circuit reversed the Tax Court and rendered an opinion in favor of the fractional interest discounts claimed by the taxpayer. Significant to the Fifth Circuit was that the Tax Court had no expert opinions upon which to base any valuation other than the taxpayer’s purported value. The Tax Court simply had no basis upon which to arbitrarily determine value without expert opinion to support that determination.

Although Elkins was an estate tax case, a similar logic would seem applicable here. In Wendell Falls, the Tax Court appears to come to its own conclusions of value without any expert testimony. There may have been fact testimony to support the Tax Court’s conclusions, but no expert testimony about the effects of those facts on underlying value. Wendell Falls is appealable to the D.C. Circuit. Therefore, even if the logic of Elkins could be argued to apply, it is persuasive at best. It will be interesting to see whether the taxpayer appeals Wendell Falls and how the D.C. Circuit resolves these questions. Affirming the ability of the Tax Court to render its own expert valuation opinions, in addition to being the trier of fact, would be significant.

Another way to view the Tax Court’s opinion is to see the presence of facts indicating benefits to the taxpayer from the gift as a burden shifting event. If there are facts showing the taxpayer expected to receive benefits as a result of the contribution, then the burden shifts to the taxpayer to show those benefits are merely “incidental” or to prove the value of the benefits is less than the loss experienced by making the claimed charitable gift. Some of the law cited by the Tax Court views the issue as one of donative intent. The Tax Court, in Wendell Falls, did not discuss issues of burden shifting or donative intent. However, from viewing the cases cited in Wendell Falls and Footnote 3 indicating there must have been a dispute among the parties about the burden of proof, it may be that those issues provide support for the Tax Court’s ruling. Even viewed this way, this case may give the IRS an issue to raise on examination. That said, it will be important for taxpayers and their counsel to know the law surrounding the issue (i.e. valuation, donative intent, burden shifting, etc.). Wendell Falls does not give clear guidance to answer this question.

As an alternative ground for its opinion, the Tax Court discussed the method for determining the value of a deduction based on conservation easements. That method is to determine the reduction in the value of the property subject to the easement below the property’s highest and best use. Based on the planned development, the Tax Court determined that use as a park is the property’s highest and best use. Therefore, there is no reduction in the value of the property after being bound by the conservation easement restricted to such use. Here, again, this could provide an argument the IRS may use in future examinations.

S. Gray Edmondson, J.D., LL.M.

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1. See US v. Am. Bar Endowment, 477 U.S. 105 (1986).
2. Id.
3. See United States v. Am. Bar Endowment, 477 U.S. 105, 116 (1986); see also Elrod v. Comm’r, 87 T.C. 1046, 1075 (1986) (“The charitable contribution deduction is not allowed where a taxpayer intends to obtain a ‘direct or indirect benefit in the form of enhancement in the value or utility of the taxpayer’s remaining land or otherwise to benefit the taxpayer.’” (quoting Sutton v. Comm’r, 57 T.C. 239, 243 (1971)).
4. Example 10. E owns 10 one-acre lots that are currently woods and parkland.  The fair market value of each of E’s lots is $15,000 and the basis of each lot is $3,000. E grants to the county a perpetual easement for conservation purposes to use and maintain eight of the acres as a public park and to restrict any future development on those eight acres. As a result of the restrictions, the value of the eight acres is reduced to $1,000 an acre. However, by perpetually restricting development on this portion of the land, E has ensured that the two remaining acres will always be bordered by parkland, thus increasing their fair market value to $22,500 each. If the eight acres represented all of E’s land, the fair market value of the easement would be $112,000, an amount equal to the fair market value of the land before the granting of the easement (8 × $15,000 = $120,000) minus the fair market value of the encumbered land after the granting of the easement (8 × $1,000 = $8,000). However, because the easement only covered a portion of the taxpayer’s contiguous land, the amount of the deduction under section 170 is reduced to $97,000 ($150,000-$53,000), that is, the difference between the fair market value of the entire tract of land before ($150,000) and after ((8 × $1,000) (2 × $22,500)) the granting of the easement.
5. Stating “Neither valuation expert witness accounted for the enhancement to the surrounding land created by access to the park. The IRS’s expert’s failure to consider the enhancement is inconsistent with the evidence in this case, which, as the IRS points out, includes a PUD showing that the park was linked to the residential units. A court is not required to accept an opinion of an expert witness that is contrary to the evidence. See Boltar, L.L.C. v. Comm’r, 136 T.C. 326, 335 (2011); see also Estate of Newhouse v. Comm’r, 94 T.C. 193, 244 (1990).”