In Pine Mountain Preserve LLLP v. Commissioner, 2020 WL 6193897 (11th Cir. Oct. 22, 2020), the Eleventh Circuit was asked whether a grantor’s reservation of limited development rights prevents a conservation easement from satisfying the requirements to claim a charitable deduction under the qualified conservation contribution rules of section 170(h) of the Internal Revenue Code. In an opinion by Judge Newsom, the court reasoned that a limited reservation of development rights is not per se fatal to a conservation easement, but may result in the easement failing to “adequately protect” its conservation purposes. The Eleventh Circuit’s conclusion is a welcome result for taxpayers, allowing some flexibility in the self-imposed restrictions of a conservation easement. Taxpayers and practitioners will continue to monitor IRS and court guidance on how the grantor’s reservation of rights impacts the protection of the easement’s conservation purpose.
The case involves three conservation easements granted by Pine Mountain in 2005–2007. In each of the easements, the taxpayer reserved a right to build a small number of structures on the easement property, including a small number of single-family homes (on 1.2%–1.8% of the easement’s acreage), barns, scenic overlooks, roads, ponds, hunting blinds, and a water tower. All of the building areas were either in pre-determined locations or subject to the conservation organization’s approval that the building would not adversely affect the easement’s conservation purpose.
Under section 170(h), taxpayers may deduct the value of a qualified conservation contribution. In order to qualify as a qualified conservation contribution, there must be, among other things, a contribution of a qualified real property interest and a contribution exclusively for conservation purposes. See sections 170(h)(1)(A) (setting forth the “qualified real property interest” requirement) and 170(h)(1)(C) (setting forth the “exclusively for conservation purposes” requirement). The IRS argued that Pine Mountain’s reservation of limited development rights caused the easements to fail both requirements. The court ultimately concluded that the conservations easements were contributions of qualified real property interests as required under section 170(h)(1)(A) and remanded the case to the Tax Court for a determination of whether the contributions were exclusively for conservation purposes as required under section 170(h)(1)(C).
The court first considered the qualified real property interest requirement of section 170(h)(1)(A). A qualified real property interest includes “a restriction (granted in perpetuity) on the use which may be made of the real property.” Section 170(h)(2)(C). Interpreting the plain language of the statute, the court reasoned that section 170(h)(2)(C) presents “a relatively low threshold” and articulated two rules. First, “a restriction” on the use of the real property exists for the purposes of section 170(h)(2)(C) where the easement includes a broad limitation that “burdens what would otherwise be the landowner’s fee-simple enjoyment of—and absolute discretion over—the use of its property . . . even if within that parcel there exist certain narrow exceptions to that limitation.” Second, a restriction is granted “in perpetuity” where the grantor, its heirs, or assigns remain indefinitely subject to the restriction and nothing in the grants will cause the easements, either automatically or upon the happening of some event, to revert back to the grantor. Accordingly, the court concluded that a limited reservation of development rights does not cause an easement to fail the granted-in-perpetuity test under section 170(h)(2)(C).
Next, the court considered the exclusively for conservation purposes requirement of section 170(h)(1)(C). The court explained that the impact of a limited reservation of development rights is properly addressed by the statutory requirement that the contribution be exclusively for conservation purposes. Section 170(h)(5)(A) explains that a contribution is not exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. Analyzing whether the exceptions to restrictions prevent the easement from adequately protecting the conservation purpose under section 170(h)(5)(A) is “where Congress envisioned the heavy lifting—[and rigorous analysis]—should occur.” Because the Tax Court had improperly concluded the easements failed the granted-in-perpetuity test of section 170(h)(2)(C), it did not consider whether the easements protected the conservation purpose in perpetuity under section 170(h)(5)(A). The Eleventh Circuit remanded the question to the Tax Court with respect to the limited reservation of development rights. In a footnote to the remand order, the court noted that the beneficiary of the conservation easements “has extensive advance-approval rights under these easement contracts [and] is well positioned and equipped to look after conservation interests.”
Each of the easements also contained a provision allowing the parties to bilaterally amend the easement’s terms, provided that the changes are not inconsistent with the easement’s conservation purposes and that the amendments do not cause the easement to fail to qualify as a qualified conservation contribution under section 170(h). The Eleventh Circuit affirmed the Tax Court’s conclusion that an express right to amend in a manner not inconsistent with their conservation purposes does not violate section 170(h)(5)(A)’s protected-in-perpetuity requirement—noting that conservation easements are simply bilateral contracts, and all contracts can be mutually amended after the fact.
Lastly, the Eleventh Circuit remanded the issue of valuation of the charitable deductions to the Tax Court with instructions to “apply a discernible methodology” consistent with the governing regulations. Although the Eleventh Circuit was sympathetic to the difficulty of reconciling the parties’ wildly divergent estimates, the Tax Court’s approach of averaging the two estimates was not sufficiently reasoned.