Smith Lake, LLC, David Hewitt, Tax Matters Partner v. Commissioner , 2020 T.C. Memo. 107 ( 2020 )

T.C. Memo. 2020-107UNITED STATES TAX COURT
SMITH LAKE, LLC, DAVID HEWITT, TAX MATTERS PARTNER, Petitioner
v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4980-17. Filed July 13, 2020.
Ronald A. Levitt, Gregory P. Rhodes, Michelle A. Levin, and David Mace
Wooldridge, for petitioner.
Shannon E. Craft, Rebeccah L. Bower, and John T. Arthur, for respondent.
MEMORANDUM OPINION
KERRIGAN, Judge: This case is before the Court on the parties’ cross-
motions for partial summary judgment. On January 4, 2017, respondent issued a
notice of final partnership administrative adjustment (FPAA) for tax year 2013 to
David Hewitt as the tax matters partner for Smith Lake, LLC (Smith Lake). In the
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[*2] FPAA respondent disallowed a $6,524,000 deduction for a noncash charitable
contribution and asserted a gross valuation misstatement penalty pursuant to
section 6662(h), or in the alternative, a penalty pursuant to section 6662(a).1
Respondent contends that the merger and extinguishment clauses in Smith
Lake’s deed of conservation easement violate section 170(h)(2)(C) and (5)(A),
respectively. Petitioner, by contrast, contends that the deed meets the
requirements of section 170(h)(2)(C) and (5)(A) because the deed provides that
the restriction is granted in perpetuity and that the conservation purposes are
protected in perpetuity. Petitioner further contends that respondent’s
interpretation of section 1.170A-14(g)(6)(ii), Income Tax Regs., is incorrect or,
alternatively, if respondent’s interpretation is found to be correct, that the
regulation is invalid.
Background
There is no dispute as to the following facts drawn from the parties’ motion
papers and attached declaration and exhibits. When the petition was filed, Smith
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the year at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure. All monetary amounts are
rounded to the nearest dollar.
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[*3] Lake was a Georgia limited liability company, and its principal place of
business was in Alabama.
On July 29, 2008, Rockefeller Holdings, LLC (Rockefeller), owned in part
by Mr. Hewitt, purchased 21.89 acres of property on Lewis Smith Lake in Winston
County, Alabama (property), for $200,000. Rockefeller transferred the property to
Smith Lake. Mr. and Mrs. Hewitt each owned a 50% interest in Smith Lake at the
time of the transfer.
On December 20, 2013, Mr. and Mrs. Hewitt each sold and assigned
49.75% of their interests in Smith Lake to Smith Lake Investment Partners, LLC
(Smith Lake Investments). On December 23, 2013, Smith Lake conveyed a deed
of easement for the 21.89 acres, to the Pelican Coast Conservancy, LLC, by and
through its sole member, Atlantic Coast Conservancy, Inc. (ACC), a Georgia
nonprofit corporation. ACC was a “qualified organization” for purposes of
section 170(h)(3). The deed was recorded with the Superior Court of Winston
County on December 27, 2013. At the time of the conservation easement donation
Smith Lake was owned by Smith Lake Investments, which owned a 99.5%
interest, and the Hewitts, who each owned a 0.25% interest.
Smith Lake claimed a $6,524,000 noncash charitable contribution deduction
for its contribution of the conservation easement to ACC on its 2013 Form 1065,
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[*4] U.S. Return of Partnership Income. It attached to its partnership return Form
8283, Noncash Charitable Contributions, which reported the donor’s adjusted
basis for the conservation easement as $200,000 and the appraised fair market
value as $6,524,000.
The deed includes provisions for the distribution of proceeds in the event of
extinguishment or condemnation. The deed provides that the easement
“constitutes a real property interest vested in” ACC. Section 15.2 of the deed
explains the stipulation the parties agreed to regarding proceeds. This section
provides:
[T]he parties stipulate that this Easement shall have at the time of
Extinguishment a fair market value determined by multiplying the
then fair market value of the Property unencumbered by the Easement
(minus any increase in value after the date of this grant attributable to
improvements) by the ratio of the value of the Easement at the time of
this grant to the value of the Property, without deduction for the value
of the Easement, at the time of this grant. The values of this
Easement at the time of this grant shall be the donation value used to
calculate the deduction for federal income tax purposes allowable by
reason of this grant, pursuant to Section 170(h) of the Code. * * *
[T]he ratio of the value of the donated Easement to the value of the
Property unencumbered by the Easement shall remain constant.
A provision of section 23.13 of the deed states: “Unless the [p]arties
expressly state that they intend a merger of estates or interests to occur, no merger
shall be deemed to have occurred hereunder or under any document executed in
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[*5] the future affecting this grant.” The deed provides that the interpretation and
performance of the easement shall be governed by the laws of the State of
Alabama.
Discussion
Summary judgment may be granted where the pleadings and other materials
show there is no genuine dispute as to any material fact and a decision may be
rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98
T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). The burden is on the
moving party to demonstrate that there is no genuine dispute as to any material
fact and that the party is entitled to judgment as a matter of law. FPL Grp., Inc. &
Subs. v. Commissioner, 116 T.C. 73, 74-75 (2001). Both parties have moved for
partial summary judgment, and they agree that there exist no genuine disputes of
material fact regarding the questions they have asked us to decide. After
reviewing the pleadings and the motions with accompanying exhibits and
declarations, we conclude that a decision may be rendered as a matter of law.
I. Qualified Conservation Contribution
Section 170(a)(1) allows a deduction for any charitable contribution made
within the taxable year. If the taxpayer makes a charitable contribution of
property other than money, the amount of the contribution is generally equal to the
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[*6] FMV of the property at the time the gift is made. See sec. 1.170A-1(c)(1),
Income Tax Regs.
The Code generally restricts a taxpayer’s charitable contribution deduction
for the donation of “an interest in property which consists of less than the
taxpayer’s entire interest in such property”. Sec. 170(f)(3)(A). However, there is
an exception to this rule for a “qualified conservation contribution.” Sec.
170(f)(3)(B)(iii). This exception applies to a “qualified conservation
contribution”, which is a contribution of a qualified real property interest to a
qualified organization exclusively for conservation purposes. Sec. 170(h)(1).
Section 170(h)(5)(A) provides that a contribution will not be treated as
being made exclusively for conservation purposes “unless the conservation
purpose is protected in perpetuity.” The accompanying regulation recognizes that
“a subsequent unexpected change in the conditions surrounding the [donated]
property * * * can make impossible or impractical the continued use of the
property for conservation purposes”. Sec. 1.170A-14(g)(6)(i), Income Tax Regs.
In these circumstances the conservation purposes can be treated as protected in
perpetuity if the restrictions are extinguished by judicial proceeding and the
easement deed ensures that the charitable donee, following the sale of property,
will receive a proportionate share of the proceeds and use those proceeds
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[*7] consistently with the conservation purposes underlying the original gift. Id.This results in the “perpetuity” requirement’s being satisfied because the sale
proceeds replace the easement as an asset deployed by the donee “exclusively for
conservation purposes”. Sec. 170(h)(5)(A); see also Oakbrook Land Holdings,
LLC v. Commissioner, 154 T.C. ___, ___ (slip op. at 8) (May 12, 2020).
Section 1.170A-14(g)(6)(ii), Income Tax Regs., specifies the donee’s share
of proceeds in the case of extinguishment as follows:
[F]or a deduction to be allowed under this section, at the time of the
gift the donor must agree that the donation of the perpetual
conservation restriction gives rise to a property right, immediately
vested in the donee organization, with a fair market value that is at
least equal to the proportionate value that the perpetual conservation
restriction at the time of the gift, bears to the value of the property as
a whole at that time. * * * For purposes of this paragraph * * * that
proportionate value of the donee’s property rights shall remain
constant. Accordingly, when a change in conditions give rise to the
extinguishment of a perpetual conservation restriction under
paragraph (g)(6)(i) of this section, the donee organization, on a
subsequent sale, exchange, or involuntary conversion of the subject
property, must be entitled to a portion of the proceeds at least equal to
that proportionate value of the perpetual conservation restriction,
unless state law provides that the donor is entitled to the full proceeds
* * *.
To meet the requirements of section 1.170A-14(g)(6)(ii), Income Tax Regs.
(proceeds regulation), the deed must guarantee that the donee will receive “a
proportionate share of extinguishment proceeds”. Carroll v. Commissioner, 146
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[*8] T.C. 196, 219 (2016); see PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d
193, 207 (5th Cir. 2018) (“[T]he ‘proportionate value’ is a fraction equal to the
value of the conservation easement at the time of the gift, divided by the value of
the property as a whole at that time.”).
Respondent contends that the deed violates the proceeds regulation because
it provides that the portion of proceeds required to be allocated to the donee in the
event of an extinguishment shall be reduced by the value of improvements to the
land made by Smith Lake after the grant of the easement, and that the merger
provision allows the easement to be eliminated through merger of estates.
Petitioner contends that the deed satisfies the regulation because proceeds
attributable to the value of improvements made by the landowner after the
donation of the conservation easement are not immediately vested and are not part
of the easement granted to the donee.
The proceeds regulation specifically states that the donee “must be entitled
to a portion of the proceeds at least equal to that proportionate value”. Sec.
1.170A-14(g)(6)(ii), Income Tax Regs. The word “must” clearly requires that the
donee receive at least the proportionate value. PBBM-Rose Hill, Ltd. v.
Commissioner, 900 F.3d at 208. The regulation does not permit that “any amount,
including that attributable to improvements, may be subtracted out” of the
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[*9] proceeds. Id.; see also Coal Prop. Holdings, LLC v. Commissioner, 153 T.C.
126, 138 (2019).
Petitioner contends the easement deed is governed by the laws of the State
of Alabama and that under Alabama law, the holder of a conservation easement
deed is not entitled to proceeds if the underlying property is converted to public
use through a condemnation, making the proceeds regulation inapplicable in this
case.2 See Burma Hills Dev. Co. v. Marr, 229 So. 2d 776 (Ala. 1969). We reject
petitioner’s arguments. The ACC has a property right granted by a deed of
easement. We concluded in Hewitt v. Commissioner, T.C. Memo. 2020-89, at
*22-*24, that the donor of a conservation easement would not be entitled to the
full amount of the proceeds from a judicial extinguishment under Alabama law.
Therefore, the State law exception included in section 1.170A-14(g)(6)(ii), Income
Tax Regs., does not apply.
Respondent also argues that the easement is not a qualified real property
interest because the deed allows for the potential removal of the easement through
a merger of estates under section 23.13 of the deed. We have established above
that the contribution does not qualify under section 170 as a “qualified
2
Although section 15.1 of the deed reads “unless otherwise provided by
Georgia law” (emphasis added), petitioner’s motion argues that the deed is
governed by Alabama law.
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[*10] conservation contribution” because the deed’s extinguishment clause fails to
meet the requirements of the proceeds regulation. Accordingly, we do not need to
address this issue.
II. Validity of the Proceeds Regulation
Petitioner contends that respondent’s interpretation of the proceeds
regulation is incorrect. We have decided that respondent’s interpretation is correct
and that the deed does not comply with the regulation. Petitioner further contends
that if respondent’s interpretation is correct then the proceeds regulation is
arbitrary and capricious and is therefore invalid.
When considering whether a regulation is arbitrary and capricious, we
generally employ the two-part inquiry established by Chevron, U.S.A., Inc. v. Nat.
Res. Def. Council, Inc., 467 U.S. 837 (1984). The first part is to inquire “whether
Congress has directly spoken to the precise question at issue.” Id. at 842. If the
intent of Congress is clear, there is no further inquiry. Id. Pursuant to section
170(h)(5)(A) the conservation purpose must be “protected in perpetuity.”
However, Congress did not address specifically the allocation of extinguishment
proceeds. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___
(slip op. at 26).
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[*11] We now consider whether the proceeds regulation “is based on a
permissible construction of the statute.” See Chevron, 467 U.S. at 843. Since the
statute is silent, we must give deference to the interpretation embodied in the
agency’s regulation unless it is “arbitrary, capricious, or manifestly contrary to the
statute.” See United States v. Mead Corp., 533 U.S. 218, 227 (2001); Chevron,
467 U.S. at 844. We will uphold the proceeds regulation if it represents a
“reasonable interpretation” of the law Congress enacted. See Chevron, 467 U.S. at
844; SIH Partners LLLP v. Commissioner, 150 T.C. 28, 50 (2018), aff’d, 923 F.3d
296 (3d Cir. 2019).
Petitioner does not challenge the validity of the proceeds regulation in its
entirety. Rather, petitioner contests the regulation on two grounds: (1) the
requirement that an easement deed allocate the economic benefit of subsequent
improvements made (and paid for) by the landowner to the donee upon
termination of the easement lacks a rational basis and (2) the “proportionate value”
provision of the proceeds regulation is ambiguous.
Petitioner contends that there is no rational basis for requiring an easement
deed to share with the donee the economic benefit of subsequent improvements
made and funded by a landowner, because the donee does not contribute toward
the cost of the improvements and the landowner does not receive a deduction for
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[*12] any such improvements. Petitioner argues further that it is even more
irrational to require a subsequent landowner to forfeit to the land trust a substantial
portion of the proceeds attributable to the improvements made and owned by the
subsequent owner despite the fact that the subsequent owner did not donate the
easement to the land trust or receive a charitable contribution deduction.
Petitioner asserts that such a result is illogical and inconsistent with the purpose of
the proceeds regulation.
The regulation does not address donor improvements. The absence of a
provision addressing donor improvements does not render the regulation
“arbitrary, capricious, or manifestly contrary to the statute.” Chevron, 467 U.S.
at 844; see also Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___
(slip op. at 29).
In Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___ (slip
op. at 29), we reasoned that Treasury’s goal in prescribing the proceeds regulation
was to ensure satisfaction of the statute’s “protected in perpetuity” requirement.
This requirement is deemed satisfied under Treasury’s interpretation of the
proceeds regulation because the sale proceeds replace the easement as an asset
employed by the donee “exclusively for conservation purposes”.
Sec. 170(h)(5)(A); see also Oakbrook Land Holdings, LLC v. Commissioner, 154
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[*13] T.C. at ___ (slip op. at 8). There may be scenarios, such as a decline in land
values, in which reducing the donee’s proceeds by the value of landowner
improvements would frustrate the goal of the sales proceeds’ replacing the value
of the easement. Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at
___ (slip op. at 29-30).
We stated in Oakbrook that “Treasury’s overarching goal was to guarantee
that the donee, upon judicial extinguishment of the easement, would receive the
full share of proceeds to which it was entitled.” Id. at ___ (slip op. at 31). We
concluded that Treasury exercised reasoned judgment in its efforts to reach the
goal of section 170(h)(5)(A). Id.Petitioner also contends that the “proportionate value” provision of the
proceeds regulation is ambiguous. Pursuant to section 1.170A-14(g)(6)(ii),
Income Tax Regs., the donee’s share is determined by multiplying the sale
proceeds by a fraction, the numerator of which is the FMV of the easement at the
time it was granted, and the denominator of which is the FMV of the entire
property at that time. In Oakbrook Land Holdings, LLC v. Commissioner, 154
T.C. at ___ (slip op. at 28), we concluded that the proceeds regulation’s
“proportionate value” approach is not “arbitrary, capricious, or manifestly contrary
to the statute” as examined under the two-part inquiry.
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[*14] III. Judicial Estoppel
Petitioner argues that respondent should be judicially estopped from
asserting that the section 15.2 of the deed is inconsistent with the proceeds
regulation. Petitioner cites a District Court case in which the United States
stipulated that the proceeds regulation’s perpetuity requirement was satisfied in a
clause containing the same text as section 15.2 of the deed in the instant case. See
Joint Stipulation of Facts for Purposes of Summary Judgment, at 4, DMB Realco,
LLC v. United States, Civil No. 16-1585-NVW (D. Ariz. Feb. 24, 2017).
Respondent argues that judicial estoppel is inapplicable because the United States
conceded the issue in DMB Realco, LLC and because the parties settled the case.
“The doctrine of judicial estoppel focuses on the relationship between a
party and the courts, and it seeks to protect the integrity of the judicial process by
preventing a party from successfully asserting one position before a court and
thereafter asserting a completely contradictory position before the same or another
court merely because it is now in that party’s interest to do so.” Huddleston v.
Commissioner, 100 T.C. 17, 26 (1993). Although judicial estoppel requires a
court’s acceptance of a party’s prior position, acceptance “does not mean that the
party being estopped prevailed in the prior proceeding * * * but rather only that a
particular position or argument asserted by the party * * * was accepted by the
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[*15] court.” Id.; see Fazi v. Commissioner, 105 T.C. 436, 446 (1995). The Court
in Huddleston v. Commissioner, 100 T.C. at 26, further stated that, in cases that
settle, “an argument can be made that the court did not affirmatively accept any of
the underlying positions reflected in the settlement and that judicial estoppel
should not apply.”
In DMB Realco, LLC the United States conceded the issue with respect to
the proceeds clause and did not persuade the court to accept its position. That case
was resolved through a settlement by the parties. We find that judicial estoppel is
inapplicable to this case.
IV. Conclusion
The deed granting the conservation easement reduces the donee’s share of
the proceeds in the event of extinguishment by the value of improvements (if any)
made by the donor. Accordingly, petitioner has not satisfied the perpetuity
requirements of section 170(h)(5)(A). Furthermore, we reject petitioner’s
challenge to the validity of the proceeds regulation and find that the construction
of section 170(h)(5) set forth in section 1.170A-14(g)(6), Income Tax Regs., is
valid under Chevron. See Oakbrook Land Holdings, LLC v. Commissioner, 154
T.C. at ___ (slip op. at 25, 28-33).
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[*16] Accordingly, we will grant respondent’s motion for partial summary
judgment and deny petitioner’s cross-motion for partial summary judgment. We
have considered all of the arguments made by the parties, and to the extent not
mentioned above, we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
An appropriate order will be issued.