J L Minerals, LLC, Beasley Timber Management, LLC, Tax Matters Partner ( 2024 )

United States Tax Court
T.C. Memo. 2024-93J L MINERALS, LLC, BEASLEY TIMBER MANAGEMENT, LLC,
TAX MATTERS PARTNER,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
__________
Docket No. 17076-21. Filed October 8, 2024.
__________
L, an LLC organized by two real estate
professionals, bought 645 acres of land in rural Georgia in
December 2015 for $1.6 million (about $2,481 per acre).
Later on the day of acquisition, L contributed 64.7 acres of
the property (easement property) to J, another LLC entity
that the real estate professionals had organized. The
easement property previously had been subject to a ten-
year mineral lease that granted a mining company and its
successor the right to explore the property and extract a
mineral called kaolin, which was abundant in the area. No
mining, however, had occurred during the period of the
lease.
In January 2016 P, a timber company, purchased a
98% interest in (i) J for $167,837 (about $2,647 per acre)
and (ii) L for $3,132,163. J donated, by deed in December
2017, a perpetual conservation easement (constituting a
“qualified real property interest” under I.R.C.
§ 170(h)(1)(A)) on the easement property to H (a “qualified
organization” under I.R.C. § 170(h)(1)(B)) for “conservation
purposes” under I.R.C. § 170(h)(1)(C). Relying on a
professional appraisal, J claimed a charitable contribution
deduction of $16,745,000 (about $258,810 per acre) for a
Served 10/08/24
2
[*2] “qualified conservation contribution” under I.R.C. § 170(h)
on its tax return.
R examined J’s return and issued a notice of final
partnership administrative adjustment (FPAA)
determining to disallow the charitable contribution
deduction. P timely filed a petition in this Court
challenging the FPAA.
Held: J made a qualified conservation contribution
under I.R.C. § 170(h) and attached to its return a qualified
appraisal by a qualified appraiser under I.R.C. § 170(f)(11)
and Treas. Reg. § 1.170A-13(c)(3).
Held, further, the amount of the charitable
contribution deduction is $93,690.
Held, further, the I.R.C. § 6662(h) gross valuation
misstatement penalty is applicable.
__________
David D. Aughtry and Jasen D. Hanson, for petitioner.
Elizabeth C. Mourges, Kimberly B. Tyson, Scott A. Hovey, Daniel K.
McClendon, Robert J. Braxton, and Alexandra E. Nicholaides, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
URDA, Judge: In 2016 petitioner, Beasley Timber Management,
LLC (Beasley Timber), paid $167,837 to buy a 98% interest in J L
Minerals, LLC (JL Minerals), a limited liability company that owned a
single asset, 64.7 acres of land in Wilkinson County, Georgia. This
transaction was part of a broader acquisition of timberland totaling
1,116 acres, with Beasley Timber valuing the timber, land, and
improvements at $3.3 million, the price it ultimately paid. During
discussions, the seller highlighted that the purchase would open the
door to many millions of dollars in possible tax deductions through the
donation of conservation easements—a vehicle well known to both buyer
and seller.
3
[*3] And so it followed. The next year JL Minerals donated a
conservation easement on the 64.7-acre property to Heritage
Preservation Trust (Heritage). On its 2017 tax return JL Minerals
claimed a charitable contribution deduction of $16,745,000 relating to
this donation. The Internal Revenue Service (IRS) issued a notice of
final partnership administrative adjustment (FPAA), which, among
other things, disallowed the deduction and determined penalties.
The parties have rounded up some of the usual suspects in this
Court: (1) whether JL Minerals had donative intent; (2) whether the
contribution was made “exclusively for conservation purposes,” see
I.R.C. § 170(h)(1)(C), (4), (5)(A); 1 and (3) whether JL Minerals obtained
a qualified appraisal by a qualified appraiser, see I.R.C. § 170(f)(11)(D)
and (E). Although JL Minerals scrapes by each of these requirements,
we find that the deduction amount was an outrageous overstatement.
Given that the value claimed on JL Minerals’s tax return ($16,745,000)
exceeded the correct amount ($93,690) by more than 200%, JL Minerals
is also liable for the 40% gross misstatement penalty, see I.R.C. § 6662(a)
and (h).
FINDINGS OF FACT
The following facts are derived from the pleadings, stipulations of
facts with attached exhibits, and the evidence admitted at trial. JL
Minerals is a Georgia limited liability company organized on December
23, 2015, and classified as a TEFRA partnership. 2 JL Minerals’s
principal place of business has been Georgia during all times relevant to
this case, including when its petition was filed. Beasley Timber is its
tax matters partner with respect to its 2017 taxable year.
1 Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C. (I.R.C. or Code), in effect at all relevant times, regulation
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and Rule references are to the Tax Court Rules of Practice and
Procedure. We round all monetary values to the nearest dollar.
2 Before its repeal, the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. No. 97-248, §§ 401–407, 96 Stat. 324, 648–71, governed the tax
treatment and audit procedures for many partnerships, including JL Minerals.
4
[*4] I. Overview of the Property at Issue and Georgia Kaolin Industry
A. Location and Topography
This case revolves around 64.7 acres of undeveloped land in
Wilkinson County, Georgia (easement property). The easement
property comprises a 61.65-acre tract and 3.05-acre tract, separated by
a large pond. As of the time of donation, a hunting lodge overlooked the
pond.
The easement property is directly off Georgia State Route 112, a
rural area of forests and mines with little residential development. The
forested areas comprise mostly mesic hardwood forest, as well as mixed
pine/hardwood successional forest, managed pine forest, bottomland
hardwood forest, and a pecan orchard.
The easement property has varied topography with a series of
deep ravines and steep slopes throughout. The southern part features
the highest elevation at 465 feet above sea level, with the northernmost
part the lowest, dropping to 240 feet above sea level.
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[*5] B. Georgia Kaolin
1. Introduction
The easement property is in a geologic province called the Fall
Line, which is known to host significant deposits of kaolin (also referred
to as clay). Kaolin is an alumina-silicate mineral that historically has
been used in the production of paper, plastics, rubber, paints, and other
products. Kaolin is one of the most ubiquitous silicate minerals in the
world and is mined in many countries including Brazil, the United
Kingdom, and Australia.
For more than 100 years, Georgia has been the nation’s dominant
source of kaolin, accounting for approximately 90% of domestic
production. According to the Washington County, Georgia, website,
kaolin deposits in Georgia are “found in a relatively narrow ‘belt’ along
the Fall Line,” commonly referred to as the Georgia Clay (or Kaolin)
Belt. See Kaolin Capital of the World, https://washingtoncountyga.gov/
228/Kaolin-Capital-of-the-World (last visited Aug 15, 2024). The home
of the Georgia kaolin industry is Sandersville, Georgia, in the county
over (Washington County) from the easement property (Wilkinson
County).
The U.S. kaolin industry has faced headwinds since 2000. Data
from the U.S. Geological Survey (USGS) Commodity Summaries show
that the amount of kaolin mined dropped from 8.8 million metric tons in
2000 to 5.7 million metric tons in 2016. 3 Nat’l Mins. Info. Ctr., Clays
Statistics and Information, Mineral Commodity Summaries,
https://www.usgs.gov/centers/national-minerals-information-center/
clays-statistics-and-information (last visited Aug. 15, 2024). This
decline in production stemmed from factors including increased
competition from abroad and from other minerals, such as calcium
carbonate.
3 We take judicial notice of this decline in domestic production as documented
by the USGS, a source relied upon by both parties in various ways and whose accuracy
cannot be reasonably challenged. See Fed. R. Evid. 201(b). To be clear, the USGS
measures the amount of kaolin produced by reference to short dry tons of kaolin. This
measure is slightly different from that used in kaolin mining, which refers to wet tons
of kaolin. It takes approximately 1.66 crude wet tons of kaolin to produce one short
dry ton of kaolin product.
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[*6] 2. Processing
The kaolin industry is built around processing raw kaolin into
various end products. As of 2017 the industry was dominated by four
major processing companies: Imerys Kaolin, Inc. (Imerys), BASF Corp.
(BASF), KaMin Performance Minerals (KaMin), and Thiele Kaolin Co.
These major companies were joined by a few “minor” processors which
tended to focus on lower cost and lower revenue methods.
Kaolin can be processed in a few different ways. Calcined kaolin
processing involves processing the raw kaolin with water for refinement
and heating in a kiln, i.e., calcining, to remove all crystalline structural
water from the product. Hydrous processing also processes using water,
but it allows the products to retain their crystalline structural water.
Air-float processing is a dry processing that “floats” the kaolin clay from
the interburden (referring to waste or spoil within an ore deposit) with
no water and no removal of crystalline structural water from the
product. Calcined kaolin has historically fetched the highest prices per
ton, followed by hydrous and finally air-float. 4
Not all kaolin is suitable for processing into all end products,
however. Kaolin is not homogenous and features differences in
important physical and chemical qualities including brightness/color,
viscosity, PH level, particle size distribution, and metal levels. The
numerous kaolin end products sold by industry participants each
require different volumes and types of kaolin meeting precise
specifications. As credibly explained by Doral Mills, a former chief
geologist at Imerys, “only a very small portion of . . . kaolin meets or
exceeds all the specifications and requirements that any particular
kaolin company requires. Most of it, its highest and best use is just to
hold the earth together.”
As of 2017 each of the processors owned its own plants that
specialized in manufacturing their respective lines of kaolin end
products. The types of kaolin needed by a given plant varied according
to the end products generated by that plant.
4 Kaolin could also be processed into proppants, small beads used for oil and
gas drilling. The proppant market suffered a severe decline in the 2010s because of
changes in the oil and gas industry.
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[*7] 3. Testing, Exploration, and Mining
The major processors obtained at least 95% of the kaolin that they
processed from land that they owned or over which they had a mineral
lease giving them a right to mine. A processor’s need to obtain kaolin
with defined specifications, as required for use at a particular plant,
shaped the contours of the kaolin industry.
Each of the four major processors invested in its own testing
laboratory to determine whether a particular sample of kaolin met its
specifications. Given the importance of determining whether the kaolin
met the requirements for one of a given company’s end products, none
of the processing companies farmed out its testing or relied on outside
representations as to quality.
The processing companies and their many predecessors had
actively explored land in the Georgia Clay Belt (including Washington
and Wilkinson Counties) for decades looking for kaolin meeting their
respective specifications. When a processor came across a property with
potential, the processor generally would enter into a preliminary drilling
agreement or an option agreement with a landowner that would allow
the company to conduct exploratory drilling and testing before entering
into a long-term lease or purchasing the property. This exploratory
drilling would involve prospecting or wildcat drilling with relatively
wide spacing (400–800 feet) between drillholes. The samples were then
tested to estimate the quantity and quality of the kaolin.
If the testing showed kaolin meeting required specifications that
could be used at a particular plant, the processors would open
negotiations to lease or buy the property. Before 2017, leases, rather
than land purchases, were the norm. When leasing, a processor would
pay a royalty rate based on tonnage, with proximity to a particular plant
playing an important role in determining the rate.
After securing rights to either lease or purchase, a processor
would do further drilling and testing. The processors uniformly used a
grid method, the tried-and-true method for evaluating kaolin deposits.
Over periods extending as much as five to eight years, the processors
would drill with ever-tighter space between drillhole centers, going from
400 feet to 200 down to 100 or even 50 feet. After testing those samples,
the processors were able to identify with certainty the types of kaolin on
the property (i.e., whether the kaolin met their unique specifications)
and estimate the volumes of the various types of usable kaolin.
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[*8] As a processor’s certainty about the exact specifications of the
kaolin on the property grew, the processor would catalog the amounts of
the various types in a reserve report. The major companies strove to
have at least 15 to 20 years of inventory for each of the types of kaolin
required to process their various end products.
Of course, learning about kaolin specifications and volume on a
piece of property was only one part of the equation, as the processors
had to consider the costs of extracting the kaolin. Generally, the most
significant costs were the removal of overburden, i.e., the soil on top of
a kaolin deposit, and the hauling of the crude kaolin to a processing
plant or a blunging facility (a facility where the processor would turn
mined kaolin into a slurry that could be transported to a processing
plant by pipeline). Other costs included reclamation costs, fuel
surcharges, and royalty rates if the property was leased.
The ratio of overburden to kaolin was a particularly significant
factor, although that ratio might not be uniform across a property. The
processors did not view the ratio in a void, however, with an
understanding that an objective amount of overburden was meaningful.
Thus, a 6:1 overburden ratio at 10 feet of depth had a considerably
different complexion from a 6:1 ratio at 100 feet of depth, given the costs
in moving and storing the overburden. As one industry participant
credibly explained, “deeper you go, naturally, the more overburden you
have to encounter and the higher your costs.”
The location of the property and the hauling distance to plant or
blunging sites were also critical cost considerations. Kaolin processors
sought land with kaolin meeting certain specifications relatively near
plants that could use kaolin with those specifications in the manufacture
of end products.
Mr. Mills aptly summarized at trial the proposition facing a
kaolin processor:
[F]irst of all, the kaolin has to meet a set of specific
specifications that are required by that particular company
to make the product that they’re selling to their customers.
So obviously, they would have to find kaolin on that
property that met or exceeded all those specifications.
Then they would have to find a group of holes that joined
without manholes in between them where they could mine
that whole area. And then that area has to be under
9
[*9] acceptable overburden where it doesn’t cost more to get the
clay than it’s worth. And then it’s going to be close enough
to their plant to justify hauling it. So there’s a whole bunch
of variables involved. And if it fails any of them, then it’s
not used.
If the economics permitted, the property would be mined. The
needs of the plant again were paramount. Kaolin processors would
assess the anticipated requirements of a processing plant over a several-
month period and attempt to mine to provide the plant’s necessities for
volumes of various types of kaolin. The processor would strip
overburden from a small portion of the property (generally a three- or
five-acre area, referred to as a cut) to access kaolin needed at a
particular plant, always testing the quality of the kaolin to ensure that
it met the specifications. Economic considerations continued after
opening the mine: The processors would continually evaluate as they
mined property whether the overburden ratio or depth might make
mining unfeasible.
The four major processors focused on various end products, which
provided opportunity for collaboration. They occasionally swapped
kaolin and allowed other processors to test or buy unwanted clay.
4. Contractors
In addition to the processing companies, several mining
contractors played important roles in the kaolin industry, including
overburden removal and crude hauling. The most prominent of these
contractors was Arcilla Mining & Land Co., LLC (Arcilla), founded in
1992. Arcilla provided assorted services to processors (both the four
major companies and assorted minor, primarily air-float processors)
including stripping overburden, hauling crude clay, and mining kaolin
on their behalf. Arcilla also acted as an independent supplier of kaolin,
although the major processors preferred not to buy kaolin from it
because of its higher costs.
Arcilla did at times supply the major processors with kaolin. Joe
McKenzie, who spent 51 years in the kaolin industry until his
retirement from BASF in 2016, credibly testified to the process: “Arcilla
does not just mine clay and take it to a customer. They go to a kaolin
company, the kaolin company will do drilling, testing, and would make
sure there’s a clay that they would be willing to have.”
10
[*10] Aside from Arcilla, it was exceedingly rare for kaolin companies
to purchase kaolin from individual landowners that opened their own
mines.
II. Scaly Knob
A. Royce Lawrence
In January 1995 the easement property was acquired by Royce
Lawrence as part of a $500,000 purchase of more than 400 acres from
the Anglo-American Clays Corp., a kaolin mining company then in
operation. As relevant here, Mr. Lawrence ultimately assembled 645
total acres (including the easement property), which we will refer to as
the Scaly Knob property.
Both before and during Mr. Lawrence’s ownership, at least three
kaolin companies, as well as Mr. Lawrence himself, conducted
exploratory drilling to assess the Scaly Knob property’s potential for
kaolin mining. Specifically, contemporaneous logs reflect drilling in
1981, 1995, and 1998.
In 1997 a kaolin company named Englehard Corp. (Englehard),
which ultimately became part of BASF, entered into a lease with Mr.
Lawrence to mine the portion of the Scaly Knob property that had been
drilled in 1995. After mining of this area ended, Englehard reclaimed
this land as the pond that now separates the two tracts of the easement
property. Mr. Lawrence wanted to construct his own private hunting
reserve, with a cabin overlooking the reclamation pond.
B. Scaly Knob, LLC
Mr. Lawrence did not live to see his dream come true, sadly
passing away. Twelve of his friends, who shared a passion for the
outdoors and wished to commemorate Mr. Lawrence, picked up the
torch, forming Scaly Knob, LLC (Club), and buying the Scaly Knob
property from Mr. Lawrence’s estate in 2001. The Club members were
successful businesspeople, including Mr. Mills, who as Imerys’s chief
geologist headed the exploration and development department of the
largest kaolin company at the time. The Club planned to use the
property primarily for hunting and fishing.
Two years after purchasing the Scaly Knob property, the Club
began exploring its kaolin mining potential, turning, inter alia, to Mr.
Mills, whose job for most of the 30 years that he worked in the kaolin
11
[*11] industry was “determin[ing] where a mineral may be.” As Mr.
Mills credibly testified at trial, he “was intimately familiar with the
kaolin deposits in the area,” knowing “what possibility was there.” He
knew for example that a kaolin company had “found a deposit of clay [on
the Scaly Knob property] and mined it out,” while other companies that
had drilled the property “found no clay that they wanted to use.”
Mr. Mills and his colleagues focused their attention on what
would later become the easement property because it sat between two
kaolin mines, i.e., Englehard’s mine and a mine bordering the property
operated by J.M. Huber Corp. (Huber). Mr. Mills believed that there
would be limited interest in the easement property from most kaolin
companies because “there would have been too much overburden for [a
mining company] to consider unless they had the adjoining property.”
Given that Englehard had elected to close its mine rather than
expand onto the easement property, the Club representatives believed
that it would be unlikely to pursue further mining activities. The Club
accordingly concentrated on Huber, with Mr. Mills reasoning that “it
was highly likely that a small amount of clay would go from the Huber
side onto [the Scaly Knob property] side, and it might be possible that
Huber could come across the property line and mine that clay and
benefit both [the Club] and Huber.”
Mr. Mills accordingly approached Huber, explaining his thinking.
He also enticed Huber with the prospect that it could recover more
kaolin from its own mine if it also had the right to cross over into the
Scaly Knob property.
In July 2003 the Club and Huber agreed to a ten-year mineral
lease contract over the easement property. The lease was structured to
give Huber a three-month “prospecting and option period” that allowed
it to conduct exploratory drilling for an up-front payment of $3,000,
before exercising the option to lease (or abandoning its right to do so).
Under the contract, Huber agreed to pay a royalty rate equal to $1.85
per short wet ton for all the kaolin that they removed from the property
plus an annual payment of $20,000. Although Huber conducted
extensive drilling of the easement property thereafter, Huber did not
proceed to mine it.
In 2008 Huber’s Clay Division was acquired and then
reconstituted as KaMin. As part of this acquisition, Huber assigned its
mineral lease rights over the easement property to KaMin. Like its
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[*12] predecessor, KaMin elected not to mine the easement property at
any point over the next five years because it did not meet its needs.
KaMin chose not to renew the mineral lease when it expired in 2013.
The Club did not enter into a mineral lease with any of the other kaolin
companies after KaMin’s lease expired. Although Mr. Mills obtained
Huber’s drilling data on behalf of the Club (before he separated), he
credibly testified that he “didn’t see anything that [he] could take to a
kaolin company that would convince them to mine the property.”
III. New Neighbors Become New Owners
A. Free-Wil
In August 2014 a company named Free-Wil Holdings, LLC (Free-
Wil), purchased 470.7 acres directly to the south of the Scaly Knob
property for $620,000. Free-Wil was founded as a real estate investment
company in 2003 and was owned in equal part by Marion “Butch” R.
Freeman, Jr., a certified public accountant, and Craig Wilson, a forester.
Messrs. Freeman and Wilson expanded their vision to include
facilitating the donation of conservation easements in order to generate
tax deductions. In addition to using Free-Wil, Messrs. Freeman and
Wilson founded another company, CPG Associates, LLC (CPG), to assist
on these matters. 5 By 2014 Messrs. Freeman and Wilson had been
involved in at least ten conservation easement projects under the
auspices of CPG and other entities.
When Free-Wil purchased the tract south of the Scaly Knob
property, Messrs. Freeman and Wilson were aware that the family from
which it purchased hosted an active kaolin mine on part of the property
that it retained. Later in 2014 Free-Wil contributed the 470.7-acre
parcel to Jackson Lake Plantation, LLC (Jackson Lake), another entity
set up by Messrs. Freeman and Wilson. Free-Wil held a 98%
membership stake in Jackson Lake, with Messrs. Freeman and Wilson
each holding a 1% interest.
B. End of the Club
Meanwhile the Club was beginning to fray. Several of the original
members had left, with Mr. Mills separating under a cloud. They had
been replaced by new members with different ideas, including that the
Club was a business venture rather than a retreat. Some of the new
5 The acronym “CPG” apparently stood for Conservation Professionals Group.
13
[*13] members wished to more actively explore kaolin mining on the
property, with all of the members well aware of the Huber mineral lease.
By 2015 the Club was rife with disputes on a wide variety of
topics. Given the rancor, the Club began to explore a sale of the Scaly
Knob property, spurred by certain members’ financial and health issues.
One member of the Club attempted to buy the Scaly Knob property for
$1.7 million, or to force a sale to a kaolin company, which he believed
could garner between $2.1 and $2.5 million. Both overtures were
rebuffed by the Club.
Having reached an impasse, the Club turned to its new neighbors,
Messrs. Freeman and Wilson, to gauge their interest in purchasing the
Scaly Knob property. Mr. Freeman conducted due diligence, during
which he learned of the Huber mineral lease over the easement
property.
During late fall 2015 Messrs. Freeman and Wilson engaged the
services of Bill Rivers, an experienced local geologist who had worked in
the kaolin industry. As reflected in contemporaneous invoices, Mr.
Rivers met with Messrs. Freeman and Wilson on November 17, 2015, to
discuss “possible conservation use for Scaly Knob and Jackson Lake.”
On December 11, 2015, Mr. Wilson and Mr. Rivers visited the Scaly
Knob property, observing “[k]aolin still in place at old mine.”
Following the examination of the Scaly Knob property, Mr. Rivers
contacted representatives from Imerys, KaMin, and BASF for any
relevant mining data. The representative from KaMin stated that it was
“finished mining the property and is now reclaiming it,” while the BASF
representative expressed willingness to share data so long as Mr. Rivers
provided a letter “stating the conservation purpose and who was
involved, and that we did not plan to mine it.”
On December 17, 2015, the Club agreed to sell the Scaly Knob
property to Jackson Lake for $1.6 million. The Club determined the sale
price based on the members’ general knowledge of prices per acre in
Wilkinson County, with an eye to profit and a fair price.
The sale closed on December 22, 2015, bringing the total acreage
under Jackson Lake’s control to approximately 1,116 acres (470.7 acres
+ 645 acres). The next day Messrs. Freeman and Wilson organized JL
Minerals, with Free-Wil holding a 98% member interest and Messrs.
Freeman and Wilson each holding a 1% interest.
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[*14] Later, on December 23, Jackson Lake contributed the 64.7-acre
easement property to JL Minerals. At trial Mr. Freeman explained that
he and Mr. Wilson took this action in light of “the mineral lease” and
“because of the prospect of that being a conservation option.”
IV. Beasley Timber Enters the Scene
A. Timber Business
While finalizing the deal with the Club, Messrs. Freeman and
Wilson were working to sell all 1,116 acres under their control, with
Beasley Timber already in mind as a potential purchaser. Beasley
Timber is a very successful family timber company owned by Darrell
Beasley and his sister and run by Mr. Beasley and his brother-in-law
Zach Johnson. Mr. Johnson was responsible for all timber acquisitions
whereas Mr. Beasley oversaw the business operation generally,
including approving every purchase made by Mr. Johnson. Under their
leadership, Beasley Timber grew to include over 2,000 employees, 50
logging crews, 40 foresters in four states, and five sawmills.
Beasley Timber’s operation required a considerable, consistent
supply of timber. Beasley Timber purchased a tract almost every day,
making approximately 250 buys a year. When determining whether to
buy timber, Mr. Johnson would undertake his own inspection of the
property, rather than trust seller representations. Primary
considerations included logability and accessibility, as they tried to
harvest within four to six months.
The company usually purchased rights to log timber for its mills
separately from the land, but at times purchased both timber logging
rights and land. Beasley Timber currently holds more than 120,000
acres. Through these land purchases, Messrs. Beasley and Johnson
were aware that rural land in Wilkinson County, and surrounding
counties, went for around $1,200 an acre and never sold for over $50,000
per acre in or before 2017.
Where Beasley Timber purchased land as well as the rights to log
timber, they would plant trees to farm and ultimately harvest. This life
cycle spanned approximately 25 to 30 years, with thinning
approximately once a decade to provide more sunlight and vegetation.
Beasley Timber’s need for trees brought them into contact with
Messrs. Freeman and Wilson. Mr. Beasley first met Mr. Wilson when
working as a logger, with Mr. Wilson as a forestry consultant. Later,
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[*15] Messrs. Freeman and Wilson’s investment in rural real estate led
to a business relationship with Beasley Timber, with timber sales,
rather than land sales, occupying the heart.
B. Initiation into the Mysteries
Messrs. Beasley and Johnson learned of conservation easements
at the knees of Messrs. Freeman and Wilson. The four men, along with
other members of Mr. Beasley’s extended family, purchased a 3,000-acre
ranch in Colorado in 2003 for hunting and other outdoor activities.
Around this time Mr. Freeman heard about state and federal tax
benefits of conservation easements from an acquaintance, informing his
partners about this strategy. Starting in 2003 or 2004 the four men
investigated a conservation easement relating to a coal deposit on the
Colorado property. The pursuit came up dry as they did not control the
mineral rights under Colorado law, thus dooming any potential for a
conservation easement.
The Colorado flirtation was not Beasley Timber’s only foray into
the world of conservation easements. As one of Beasley Timber’s
commercial lenders explained at trial, the placement of conservation
easements was “part of something that [it] do[es] regularly to land that
[it] purchase[s] as part of [its] business.”
C. Purchase of Jackson Lake and JL Minerals
After the acquisition of the Scaly Knob property, Mr. Wilson
arranged a tour for Mr. Johnson of the Jackson Lake and JL Minerals
properties. Mr. Johnson was impressed by both the quality of the timber
and its accessibility, a particularly important consideration for logging
during the winter months.
The four friends got down to brass tacks. As Mr. Johnson
summarized, Messrs. Freeman and Wilson were “trying to get the
highest price,” while their Beasley Timber counterparts were “trying to
buy at the cheapest.” Messrs. Freeman and Wilson’s asking price was a
total of $3.3 million for both properties. On the buyer side, Beasley
Timber estimated the timber value alone at $1.6 million. Mr. Beasley
estimated the value of the bare land at $1,200 per acre (approximately
$1.34 million all told) and the improvements, such as the hunting lodge,
at $400,000 to $500,000.
The deal as conceptualized by Mr. Freeman always included a
conservation easement component. Specifically, Mr. Freeman provided
16
[*16] a chart suggesting a charitable contribution deduction of
$6,456,289, which would result in tax savings of $2,259,701. During the
negotiations, both Beasley Timber and Messrs. Freeman and Wilson
were aware of the existence of the Huber lease in January 2016, and
thus the possibility for kaolin mining on the easement property.
In January 2016 Beasley Timber purchased Free-Wil’s 98% share
in Jackson Lake and 98% share in JL Minerals for a combined purchase
price of $3,300,000. Specifically, Beasley Timber paid $167,837 for the
interest in JL Minerals and $3,132,163 for the interest in Jackson Lake.
At the time, JL Minerals’s sole asset was the 64.7-acre easement
property and Jackson Lake’s sole asset was the remainder of the 1,116
acres (Jackson Lake property). Both Messrs. Freeman and Wilson
retained their respective 1% interests in both entities, although each
entered into option contracts giving Beasley Timber the right, but not
the obligation, to purchase both of their respective 1% interests in JL
Minerals for $15,000 or less.
Beasley Timber used an existing stumpage line of credit with
Southeastern Bank to help fund this acquisition. Before agreeing to
provide the funding, Southeastern Bank retained an experienced local
appraiser, Dan Hester, to appraise the bare land, excluding the timber
value. Specifically, the Bank wanted Mr. Hester to determine “the most
probable price which a property should bring in a competitive and open
market under all conditions requisite to a fair sale, the buyer and seller
each acting prudently and knowledgeably.” Despite knowing that kaolin
was very prevalent in the area, Mr. Hester concluded a fair market value
of approximately $1.4 million for the more than 1,100-acre property.
V. Next Phases
A. Harvesting the Timber
Beasley Timber’s need for logs to fill its mills pushed it to cut
almost immediately following its purchases. Just 12 days after closing,
Beasley Timber began harvesting timber on the Jackson Lake property.
In the first year after acquisition, Beasley Timber’s logging crew
harvested 49% of the timber on the track equating to $907,000 in value.
Beasley Timber did not cut on the easement property, however.
17
[*17] B. Conservation Easement
1. Laying the Groundwork
Meanwhile, Messrs. Freeman and Wilson’s work on a
conservation easement continued apace. Mr. Freeman explained that
the strategy was to “split the property between 2 entities with [the]
intention of executing 2 conservation easements” “[r]ather than hav[ing]
one very large easement deduction in a single LLC.” Mr. Freeman
further noted that “[a]pproximately 64 acres of the subject tract is held
in an LLC, ‘JL Minerals, LLC’ which is the primary area that kaolin is
known to exist.” Mr. Freeman further speculated that the remainder of
the 1,116 acres, i.e., Jackson Lake, could support a highest and best use
(for easement valuation purposes) of a conservation community.
During January and February 2016 Mr. Rivers continued his
pursuit of drilling data from certain of the major kaolin companies. For
example, in January, he wrote to Mr. McKenzie at BASF, explaining
that the “owners hope to place this property into conservation and are
looking for all the drill data and supporting documents that are
available to substantiate the kaolin mineral values for the property.” He
further noted that the “investors are willing to pay for the information,
and it will be used for conservation purposes only.” He also discussed
with Arcilla using its laboratory to test drilling samples from the
property. Throughout February Mr. Rivers also worked on a technical
report about the presence of kaolin on the Scaly Knob property.
By the end of February 2016 the working relationship between
Messrs. Freeman and Wilson and Mr. Rivers changed, however. In an
email to Dale Hayter, the person who would later appraise the easement
at issue, Mr. Freeman observed that “Mr. Rivers has never done any
consulting work related to a conservation easement.” Mr. Freeman
continued that he and Mr. Wilson “attempted to convey the goals of our
project [but Mr. Rivers’s] thought process revolves around commercial
mineral market considerations which . . . don’t necessarily align with
the dynamics of conservation easement considerations.” As Mr.
Freeman credibly explained at trial, Mr. Rivers believed that the kaolin
on the 1,116-acre property could generate approximately $2–4 million in
royalty payments. “Accordingly, we feel Mr. Rivers’ primary
contribution to the project will be to provide estimated mineral (kaolin
and otherwise) tonnages and leave the valuation to another skill set.”
18
[*18] According to invoices that Mr. Rivers sent to Mr. Freeman in
June, he spent March through May assembling drill data and maps from
previous kaolin company drillings of the Scaly Knob property, and, more
specifically, the easement property. After consulting with Messrs.
Freeman and Wilson, Mr. Rivers “propose[d] 21 [drill] holes [to test for
kaolin] based on old drill data.” By early June, Mr. Rivers received the
Huber drill data for the easement property from KaMin officials, which
he then used to prepare maps for drillers.
Although Mr. Rivers had initially considered using Arcilla’s
laboratory to test core samples from the easement property, in May he
ultimately settled on Ginn Mineral Technology (GMT). By late June Mr.
Rivers confirmed with Messrs. Freeman and Wilson that “Michael Ginn
will be coordinating everything from here out” and that Mr. Rivers
“expect[ed] to be involved only in setting drill holes, getting them drilled
and getting the drill core to the Ginn Minerals lab from here on out,
unless informed otherwise.” On June 27, 2016, Mr. Rivers informed
Messrs. Freeman and Wilson that he “delivered all of the research data
that [he] ha[d] compiled and a copy of the attached preliminary report
to Michael Ginn last week.” The material provided to Mr. Ginn
“included all of the Evans [Clay Co. (now Unimin)] and Kamin drill data,
USGS kaolin pricing from 1995-2016, kaolin leases with per-ton pricing,
location maps and drill hole maps.”
2. An Evolving Roster
a. Mr. Freeman’s Run at Andy Sheppard
As Mr. Rivers’s role changed in May and June 2016, Mr. Freeman
was on the hunt for an appraiser. In early May he reached out to a
Georgia appraiser named Andy Sheppard, who had previous experience
with valuing kaolin. Mr. Freeman explained that he was “looking to
develop another solid appraisal resource to utilize on an annual basis
for CE projects” and provided Mr. Sheppard a list of references for CPG
in case Mr. Sheppard “need[ed] to know anything about our business
practices.” Although the record at trial does not disclose that either Mr.
Beasley or Mr. Johnson had previously used CPG in connection with an
easement, both of their names were listed on the first page of a 27-name
reference list.
After Mr. Sheppard expressed interest in potentially working
with CPG, Mr. Freeman sent an email with a list of four 2016
conservation easement projects, including potential easements on JL
19
[*19] Minerals and Jackson Lake. Regarding JL Minerals, Mr.
Freeman wrote that they were “close to having the geologist’s
conclusions regarding mineral quantities and the clay characteristics,”
pointing out that, “[u]ntil recently, Kamin had a long-term lease . . . and
has been gracious enough to share the info with us.” Mr. Freeman
further stated that “[t]o minimize confusion going forward, [he] thought
it would be helpful to provide a snapshot of the prior easements [they
had] completed along with the final diminution amounts so [Mr.
Sheppard could] get a sense of what the numbers look like for projects
very similar to the 4 pending transactions excepting the mineral
considerations.” Attached to the email was a list of 12 transactions from
2008 through 2014, as well as four transactions for 2016, including JL
Minerals’s. Although communications continued with Mr. Sheppard, no
agreement was reached by the end of June.
b. GMT
i. 2016 work
Mr. Freeman had better success with GMT, an established
mineral process laboratory in Sandersville, with particular expertise
and experience in kaolin. GMT was led by Michael Ginn, who had
decades of experience in evaluating minerals, and his daughter, Laura
Ginn Mason.
In August 2016 GMT submitted an engagement proposal, stating
its understanding that Messrs. Freeman and Wilson were “interested in
[GMT’s] providing a range of services to streamline and successfully
complete the mineral based conservation easement.” Specifically, GMT
proposed to identify and retain (1) a “third party qualified geologist” and
(2) a “qualified and certified mineral/real estate appraiser,” further
agreeing to “assist with the ‘independent’ duties and function of the
geologist and appraiser by providing time and resources relating to
mineral exploration and testing, experience relating to mineral
applications/markets and general consulting.” GMT charged $50,000
for its services.
Later that month, GMT hired Waters Drilling Co., LLC (Waters
Drilling), to drill 12 boreholes along the northern and middle portions of
the easement property. Eleven of the boreholes produced core samples
containing kaolin and one drill hole lost circulation. 6 According to Mr.
6 Loss of circulation occurs when the drill has lost the requisite pressure to
bring the core sample to the surface for collection.
20
[*20] Freeman, the results from the 2016 drilling showed evidence of
potential kaolin reserves and overburden within industry norms. Mr.
Beasley remembered that the testing “came back very favorable,”
showing “a lot” of “high quality” kaolin. As he further recalled, “it
needed more testing, a full amount of drilling in order to actually be
conclusive.”
ii. Mr. Sheppard Rebuffs GMT’s Overtures
In late September 2016 GMT contacted Mr. Sheppard to revisit
his willingness to serve as appraiser to assorted mineral conservation
easement projects sponsored by Messrs. Freeman and Wilson. After Mr.
Sheppard talked with Mr. Freeman “about the model GMT has
successfully used on several Mineral Conservation Easements in past
years,” Ms. Mason inquired into Mr. Sheppard’s interest in becoming a
member of a “team for three [conservation easements] for 2016 . . . [with]
many scheduled to complete in 2017.”
Mr. Sheppard responded by expressing “some concern regarding
methodology,” as described by Mr. Freeman. Mr. Sheppard sent three
documents that “la[id] out the fundamental aspects of valuing properties
with known (or assumed) mineral reserves, as well as information which
debunks common myths regarding mineral property/valuation.” Mr.
Sheppard emphasized that the “primary tool for valuing raw land, prior
to rezoning and/or prior to obtaining a Surface Mining Permit, is the
Sales Comparison Approach.” He expressly noted that an “[i]ncome
based model is helpful, but ultimately highly subjective without great
data.” “Given that the conservation easement includes the value of the
real estate, and not the business value associated with operating a
quarry, a Royalty Revenue analysis is the only reasonable approach to
value the land being donated in the ‘before’ scenario.” He closed with a
note of caution, stating: “Trust me, I know the temptation to go with a
higher value, . . . but I’m not in the business of getting fined $10k per
report for purporting an illogical valuation.”
GMT did not reach an agreement with Mr. Sheppard to be part of
its team going forward.
iii. 2017 work
In May 2017 Mr. Freeman retained GMT to perform exploratory
drilling on 27 additional acres of the easement property. GMT agreed
to drill approximately nine holes to “give a more accurate depiction of
the volume of commercial kaolin and other mineral resources on your
21
[*21] property,” followed by analysis of the core samples. “A key
objective of the evaluation is to identify the highest and best use of the
potential mineral reserve[s] [for easement valuation purposes].” GMT
wrote that it “expect[s] to discover clay on the property and in some cases
significant volumes of clay . . . based on adjacent mining and previous
drilling records.”
GMT again turned to Waters Drilling, tasking them to drill eight
additional boreholes in the southern part of the easement property. This
drilling was in a part of the easement property different from that
drilled the previous year. As such, it did not involve attempting to
obtain more precise data on the kaolin deposit previously explored by
means of tighter spacing, as is common in the industry. Waters Drilling
found kaolin in four of the drillholes, and its drill lost circulation in the
other four locations.
iv. GMT Report
In October 2017 GMT issued a kaolin and mineral resource
evaluation report that presented GMT’s findings regarding the quality
and quantity of the kaolin on the easement property. Although Waters
Drilling had drilled a total of 20 bore holes, the report referred to only
16 holes.
From the holes it did consider, the GMT report concluded an
average overburden of 92 feet, a clay strata thickness of 40 feet, and an
overburden-to-clay ratio of 2.3:1. The report stated that the drilling
moved the easement property “from a potential mineral resource into
the defined category of ‘Identified Mineral Reserve.’” The report
concluded that the easement property contained over 5,304,000 short
wet tons of average to excellent quality kaolin clay.
The report further concluded that the amount of kaolin could
support mining 150,000 to 250,000 crude wet tons annually for at least
20 years. It then stated that the easement property provided
opportunity for the landowner to operate as a “[kaolin] contractor with
limited competition from other contractors or the actual kaolin
producers.” The report explained that a landowner could successfully
replicate Arcilla’s business model “with experienced contractors and
consultants,” which would improve earnings over a mineral lease or sale
of the property “by $4.00 to $10.00 per wet crude ton.” It stated, finally,
that a capable landowner could make a significant profit by offering
delivered crude clay to a kaolin producer at $14–$22 per ton.
22
[*22] At no point after the 2016 GMT drilling and testing, the 2017
GMT drilling and testing, or the preparation of the GMT report did a JL
Minerals representative contact any kaolin company to gauge interest
in the purchase or lease of the property or whether the kaolin on the
property was economically mineable.
c. Lawyers, Accountants, and Appraiser
As GMT worked away, JL Minerals (primarily acting through Mr.
Freeman) turned to old conservation easement hands to round out its
roster of professionals. In July 2017 JL Minerals secured the services of
McRae Smith Peek & Harman (McRae), to review title issues and
compliance with requirements to claim a federal tax deduction in
connection with a conservation easement donation on the easement
property. McRae had worked with Mr. Freeman and Mr. Hayter on past
conservation easement projects. Another familiar face was Kimberly
Skalski, a certified public accountant whose husband’s law firm had
worked on conservation easements with Mr. Freeman for years.
For its appraiser, JL Minerals picked Mr. Hayter, a Georgia real
estate appraiser with whom Mr. Freeman had been talking since
February 2016. From the very start Mr. Freeman explained to Mr.
Hayter that “a major consideration for the easement is the value of the
kaolin on the property.” In an introductory email Mr. Freeman
emphasized that, as part of any engagement, Mr. Hayter would “provide
the mineral valuation by working with . . . reputable sources to establish
the unit prices and other relevant information needed to establish the
mineral values.”
In April 2016 Mr. Freeman continued the intermittent
discussions with Mr. Hayter, noting that, with respect to JL Minerals,
they were “close to having the geologist’s conclusions regarding mineral
quantities and the clay characteristics.” As was the case with Mr.
Sheppard, Mr. Freeman sent Mr. Hayter a “snapshot” of prior
easements he had completed to give Mr. Hayter a sense of the
expectation for the easement property’s valuation. In addition, Mr.
Freeman provided his team’s “best unofficial estimates of diminution
values for the current projects [including JL Minerals] in advance.”
Around this time Mr. Freeman also drew Mr. Hayter’s attention
to two state court rulings in the condemnation context that valued
kaolin land at approximately $71,000 per acre in one case and more than
$100,000 per acre in another. Mr. Freeman noted that Mr. Sheppard
23
[*23] had testified as an expert in kaolin land value and suggested that
“[i]t may be of some value to have [Mr. Hayter] plan on consulting with
this firm (at [Mr. Freeman’s] cost of course) to utilize some of [Mr.
Sheppard’s] experience in this area.”
Despite these early conversations, Mr. Hayter did not formally
agree to appraise the easement property until August 2017. In the
interim, Messrs. Freeman and Hayter discussed other conservation
easement projects including Jackson Lake, Double Creek Plantation,
and Fish Trap Cup Retreat. 7
3. Talks with Loudermilk
Despite the preparatory work on the conservation easement front,
Mr. Freeman and JL Minerals nonetheless kept their ears open to any
offers for the properties. In 2017 Mr. Freeman was approached by Robin
Loudermilk, a successful Georgia businessman in the real estate field,
whose varied holdings spanned high-rise buildings, development of
single-family housing in rural Georgia, farmland, and timberland. Mr.
Loudermilk owns a property of approximately 7,200 acres in Wilkinson
County. Mr. Loudermilk’s land serves as a wetlands mitigation bank
and borders the easement property and the Jackson Lake property.
Given his knowledge of Georgia real estate, Mr. Loudermilk
expected that he might pay $600–$2,400 per acre, the going rate for raw
land in Wilkinson County. In their discussions, Mr. Freeman described
the kaolin on the property and broached the idea of a conservation
easement. Mr. Loudermilk was uncomfortable with the concept,
explaining his view that conservation easements “value [property] as to
what it could be, not what it is.”
In April 2017 Mr. Freeman offered Mr. Loudermilk three options
to buy the land: (1) $2.9 million for all 1,116 acres including remaining
timber and hard assets, with the sellers retaining mineral rights;
(2) $9.4 million to acquire all 1,116 acres, as well as the mineral rights,
drilling data, and propriety information with respect to the easement
property; and (3) $9.4 million plus future consideration for 1,116 acres
including all mineral rights on the entire 1,116-acre tract.
Mr. Loudermilk responded that the parties were “too far apart in
[their] valuations to have a serious conversation,” as he valued the first
7 On February 15, 2016, Mr. Hayter formally agreed to appraise the Jackson
Lake tract for Mr. Freeman.
24
[*24] option at $1.5 million and the second at $5 million. In concluding
the communication, he expressed appreciation for both positions and his
“feel[ing] [the parties] may have different motivations.”
Mr. Freeman received no other expressions of interest in the
properties from potential buyers.
VI. Conservation Easement
In October 2017 JL Minerals agreed to donate a conservation
easement over the easement property, as well as $40,000, to Heritage.
Heritage agreed to create a baseline documentation report
“documenting [the easement] property’s natural resources and critical
habitat,” to draft the conservation easement documents, and to
“perpetually administer, monitor, and defend the easement.”
On October 31, 2017, Kristina Sorensen issued a baseline
documentation report for the easement property, detailing the easement
property’s natural resources and habitats. In particular, the baseline
documentation reflected that 66% of the property constituted mature
mesic hardwood forest with another 3% of the property bottomland
hardwood forest, both of which had been designated “high priority”
habitats by the Georgia Department of Natural Resources in its 2015
State Wildlife Action Plan (2015 SWAP). Although the report noted that
the easement property itself contained neither permanent nor
intermittent streams, it pointed out that it “lies in an important
groundwater recharge area for the Floridan aquifer.” The report also
noted that Wilkinson County had records of 11 rare or endangered
species, although none had been spotted on the property.
On December 21, 2017, JL Minerals donated a conservation
easement over the easement property to Heritage, which recorded the
deed eight days later. The easement deed identified various purposes,
including retaining the easement property in a relatively natural
condition, protecting the conservation values of the easement property,
“including productive forestry and agricultural resources,” and
preventing any use that would impair or interfere with the conservation
values. The deed defined the term “conservation values” as (1) the
protection of relatively natural habitat and (2) the preservation of open
space for scenic enjoyment of the public or pursuant to a clearly
delineated governmental conservation policy.
In the deed, JL Minerals expressly reserved the right to engage
in agriculture and forestry, subject to specified requirements including
25
[*25] that it be carried out (1) in accordance with state and federal law
and best management practices, (2) pursuant to a land management
plan with the terms of the conservation easement, and (3) in a manner
that does not materially impair or interfere with conservation value.
The deed prohibited active commercial forestry and imposed no-cut
zones in special natural areas of mesic hardwood and bottomland
hardwood, which covered approximately two-thirds of the property.
Although the deed allowed borrow pits for specific uses on the easement
property, it also prohibited “filling, excavation, dredging, mining, or
drilling,” “removal of topsoil, sand, gravel, rock, peat, minerals or other
materials,” and any “change in the topography of the land” except as “is
consistent with Treas. Reg. § 1.170A-14(g)(4)” and “necessary for
construction and maintenance on the [easement property] of roads,
bridges, and culverts.”
VII. Appraisal Report
On February 23, 2018, Mr. Hayter completed his appraisal report
on the easement property. In preparing his appraisal, Mr. Hayter relied
on the GMT report regarding the minerals on the property and the
broader kaolin market.
To value the easement itself, Mr. Hayter used the “before and
after” method. He first valued the easement property before the
granting of the easement and subsequently found the value of the
easement property after the granting of the easement. The difference
between the values equaled the value of the easement. To determine
the “before” and “after” values, Mr. Hayter determined that the highest
and best use for the easement property before the easement was twofold:
development as a kaolin mine on the 61.65-acre tract and as residential-
agricultural on the 3.05-acre tract. In light of this highest and best use,
Mr. Hayter determined that the sales comparison approach was
inapplicable and turned to the income approach (i.e., a discounted
cashflow method), which produced a before value of $16,800,000 for the
kaolin mine portion of the property and $8,500 for the other three acres,
amounting to a rounded before-easement value of $16,810,000. Having
calculated an after-easement value of $65,000, Mr. Hayter concluded
that the value of the conservation easement was $16,745,000
($16,810,000−$65,000).
26
[*26] VIII. Tax Return and IRS Examination
JL Minerals timely filed its Form 1065, U.S. Return of
Partnership Income, for the 2017 tax year. It claimed a charitable
contribution deduction for a conservation easement of $16,745,000. It
also claimed $227,534 for “Other Deductions,” which encompassed
“Professional Fees,” “Appraisals Fees,” and “Mineral Assessment Fees.”
The IRS selected JL Minerals’s 2017 return for examination. On
or about May 19, 2021, the IRS issued an FPAA that disallowed
$16,745,000 of the claimed charitable contribution deduction (the
portion attributable to the easement), determining that JL Minerals had
not established that it made a contribution or gift in 2017 and had
otherwise failed to show that all requirements of section 170 had been
met. The FPAA also disallowed $227,534 in claimed “Other
Deductions,” explaining that JL Minerals had failed to show that this
amount was deductible under the Code. As to the charitable
contribution deduction, the IRS determined a 40% accuracy-related
penalty under section 6662(e) and (h) (applicable in the case of a “gross
valuation misstatement”) and (in the alternative) a 20% penalty under
other provisions of section 6662. 8 The IRS also determined a 20%
accuracy-related penalty on the underpayment of tax resulting from the
“Other Deductions” adjustment under section 6662(c) and (d).
OPINION
I. Burden of Proof
Generally, the IRS’s adjustments in an FPAA are presumed
correct, and the taxpayer bears the burden of proving them wrong. See
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Crescent
Holdings, LLC v. Commissioner, 141 T.C. 477, 485 (2013). The taxpayer
also bears the burden of proving entitlement to any deductions claimed.
INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).
Section 7491 provides that the burden of proof on a factual issue
may shift to the Commissioner if the taxpayer satisfies specified
conditions. To trigger such a shift, a taxpayer must have “introduce[d]
credible evidence with respect to [that] factual issue,” I.R.C.
8 We previously have held that the IRS secured timely supervisory approval to
assert each of these penalties, while granting Beasley Timber’s motion for partial
summary judgment as to the reportable transaction penalty.
27
[*27] § 7491(a)(1), and must have “complied with the requirements
under this title to substantiate any item,” I.R.C. § 7491(a)(2)(A). 9
The resolution of the issues in this case does not depend on which
party has the burden of proof. When each party has satisfied its burden
of production, then the party supported by the weight of the evidence
will prevail, and a shift in the burden of proof has real significance only
in the event of an evidentiary tie. See Knudsen v. Commissioner, 131
T.C. 185, 189 (2008), supplementing T.C. Memo. 2007-340. We do not
perceive an evidentiary tie in this case and are able to resolve the issues
on the preponderance of the evidence. See id.; Schank v. Commissioner,
T.C. Memo. 2015-235, at *16. 10
II. Section 170 Qualified Conservation Contributions
Section 170(a) allows the deduction of a charitable contribution
made within a taxable year. If the taxpayer makes a gift of property
other than money, the amount of the contribution is generally equal to
the fair market value of the property at the time of the gift. See Treas.
Reg. § 1.170A-1(c)(1).
As a general rule, no deduction is allowed for a contribution of
less than a donor’s entire interest in property. I.R.C. § 170(f)(3)(A).
Section 170(f)(3)(B)(iii) excepts from this broad prohibition a deduction
for a contribution of a partial interest in property that constitutes a
“qualified conservation contribution.” This exception applies where
(1) the taxpayer makes a donation of a “qualified real property interest,”
(2) to a “qualified organization,” and (3) the donation is “exclusively for
conservation purposes.” I.R.C. § 170(h)(1).
The Commissioner asserts that JL Minerals’s charitable
contribution does not count as a “qualified conservation contribution” for
four reasons. He first contends that JL Minerals lacked the requisite
donative intent to make a charitable contribution. The Commissioner’s
remaining arguments sound in various prerequisites established by the
9 Section 7491(c) provides that the Commissioner “shall have the burden of
production in any court proceeding with respect to the liability of any individual for
any penalty, addition to tax, or additional amount.” (Emphasis added.) This provision
does not apply to TEFRA partnership-level proceedings (such as this case). See
Dynamo Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 234 (2018). Thus, in a
TEFRA partnership case the petitioner has not only the burden of proof but also the
burden of production, even as to any penalty. Id.10 Consequently, Beasley Timber’s motion to shift the burden of proof, filed on
February 21, 2023, is denied as moot.
28
[*28] Code for a donation to be “exclusively for conservation purposes.”
He asserts that the conservation easement fails to satisfy any
conservation purpose outlined by the Code. See I.R.C. § 170(h)(4). The
Commissioner next argues that the easement fails to protect any
conservation purpose in perpetuity. See I.R.C. § 170(h)(5)(A). He finally
challenges the easement’s explicit permission for borrow pits in light of
the Code’s prohibition of surface mining. See I.R.C. § 170(h)(5)(B). We
reject each of these contentions.
A. Donative Intent
The Commissioner argues that JL Minerals lacked donative
intent because it was primarily motivated to monetize the federal
income tax deduction for Beasley Timber and its partners, Messrs.
Freeman and Wilson. The Commissioner’s challenge is unfounded:
[A] donor motivated by guilt, or by the hope of being
admired, or by the desire for a tax benefit, may still deduct
his contribution. Congress long ago decided to incentivize
charitable contributions by allowing a deduction for those
contributions, and it would be perverse indeed to deny a
deduction to a donor simply because he had responded to
the incentive.
Mill Road 36 Henry, LLC v. Commissioner, T.C. Memo. 2023-129, at *28;
see also Buckelew Farm, LLC v. Commissioner, T.C. Memo. 2024-52,
at *42–43; Oconee Landing Prop., LLC v. Commissioner, T.C. Memo.
2024-25, at *37–38, supplemented by T.C. Memo. 2024-73.
Nor does our “quid pro quo” precedent rescue the Commissioner.
“If a transaction with a charity ‘is structured as a quid pro quo
exchange’—i.e., if the taxpayer receives property or services equal in
value to what he conveyed—there is no ‘contribution or gift’ within the
meaning of the statute.” Oconee Landing, T.C. Memo. 2024-25, at *37
(quoting Hernandez v. Commissioner, 490 U.S. 680, 701–02 (1989)). The
quid received here consisted of a huge tax deduction, which was provided
by the Department of the Treasury, not Heritage. As we have explained
before, we have seen “no case in which the tax benefits associated with
a charitable contribution deduction have been deemed a ‘quid pro quo’
that negates the donor’s charitable intent.” Buckelew Farm, T.C. Memo.
2024-52, at *43; see also Oconee Landing, T.C. Memo. 2024-25, at *38.
29
[*29] B. Exclusively for Conservation Purposes
1. Conservation Purpose
Section 170(h)(4)(A) defines the term “conservation purpose” to
mean, inter alia, “the protection of a relatively natural habitat of fish,
wildlife, or plants, or similar ecosystem,” or “the preservation of open
space . . . where such preservation is . . . pursuant to a clearly delineated
Federal, State, or local governmental conservation policy, [that] will
yield a significant public benefit.” I.R.C. § 170(h)(4)(A)(ii) and (iii).
“Under the statute, each of these . . . prongs is a conservation purpose
in and of itself, and a taxpayer’s satisfaction of one of these prongs
suffices to establish the requisite conservation purpose.” Murphy v.
Commissioner, T.C. Memo. 2023-72, at *39 (quoting Herman v.
Commissioner, T.C. Memo. 2009-205, 2009 WL 2923945, at *6).
We begin by identifying the conservation purposes specified in the
deed. Id. at *42 (“We consider only a conservation purpose that is stated
in the deed.”). The deed includes a paragraph entitled “Purpose,” which
states:
It is the exclusive purpose of the Conservation Easement
to assure that the Property will be retained forever in its
predominantly relatively natural, forested, open space, and
relatively undeveloped condition, and to preserve and
protect the Conservation Values of the Property,
including . . . a variety of significant natural habitats, and
to prevent any use of the Property that will impair or
interfere with the Conservation Values of the Property
(collectively, the [“]Purposes”).
The deed further provides that the right “[t]o preserve and protect the
Conservation Values” was conveyed to Heritage “[t]o accomplish the
Purpose of this Conservation Easement.”
The term “Conservation Values” is defined in a recital that
provides that “the Property in its present state has not been developed
and possesses significant open space, forested, agricultural, watershed,
wildlife, and habitat features (collectively, the ‘Conservation Values’).”
The deed continues that “[i]n particular, said Conservation Values
include:” “1. [p]rotection of [r]elatively [n]atural [h]abitat,” specifically
bottomland hardwood forest and mesic hardwood forest, and
“2. [p]reservation of [o]pen [s]pace (including farmland and forest land)
for [s]cenic [e]njoyment of the [p]ublic or pursuant to a clearly delineated
30
[*30] governmental conservation policy.” As scenic enjoyment, the deed
points to the 265 feet that forms the easement property’s southern
border; for government conservation policy, the deed references “Prime
Farmland Soils and Soils of Statewide Importance, as defined by the
U.S. Department of Agriculture and Natural Resource Conservation
Services,” and protection of the Lower Oconee River Watershed as
designated in the 2005 Georgia Comprehensive Wildlife Conservation
Strategy.
Stitching these provisions together, the deed incorporates the
definition of Conservation Values set forth in the recital as part of its
defined Purpose. The purpose thus includes “to preserve and protect
conservation values,” i.e., (1) relatively natural habitat, (2) open space
for scenic enjoyment, and (3) open space for protection of certain soils
defined by the Department of Agriculture or the Lower Oconee River
Watershed pursuant to the 2005 Georgia Comprehensive Wildlife
Conservation Strategy. Although Beasley Timber attempts to rely on
the 2015 SWAP as a delineated government policy, the deed does not
support this assertion. The deed enumerates as part of its conservation
values preservation of open space in service of two specific government
policies and plainly does not include the 2015 SWAP. What the deed
has not expressed, we will not consider. See Murphy, T.C. Memo. 2023-
72, at *45. 11
Having identified the universe of potential conservation
purposes, we consider whether the easement protects any of these
purposes. Our analysis starts and ends with the preservation of “a
relatively natural habitat of fish, wildlife, or plants, or similar
ecosystem” pursuant to section 170(h)(4)(A)(ii).
As the U.S. Court of Appeals for the Eleventh Circuit, to which
an appeal in this case would ordinarily lie, see I.R.C. § 7482(b)(1), has
recognized, the Department of the Treasury has issued a regulation on
this point that “makes more explicit what one might reasonably construe
the Code to mean anyway,” Champions Retreat Golf Founders, LLC v.
Commissioner, 959 F.3d 1033, 1036 (11th Cir. 2020), vacating and
remanding T.C. Memo. 2018-146. Specifically, Treasury Regulation
11 Of course, had the deed included preservation of open space pursuant to the
2015 SWAP as a conservation value, Heritage would have the right to preserve and
protect open space pursuant to the 2015 SWAP. See Murphy, T.C. Memo. 2023-72,
at *46. As we concluded in Murphy, we find it difficult to believe that a court would
sustain an objection by Heritage based on the 2015 SWAP without any explicit
statement designating it as a conservation value. See id.
31
[*31] § 1.170A-14(d)(3)(i) provides that the habitat being preserved
must be a “significant relatively natural habitat in which a fish, wildlife,
or plant community, or similar ecosystem normally lives.”
“Requiring some level of significance . . . is unobjectionable.”
Champions Retreat Golf Founders, LLC v. Commissioner, 949 F.3d at
1036. “[E]ven without the regulation, the Code would not be construed
to apply to a completely trivial habitat—a few commonly occurring ants
plainly would not do, nor would many other species not in need of
conservation.” Id. To sum up, the Eleventh Circuit in Champions
Retreat “construes the regulation to connote ‘some level of significance’
that is not ‘trivial.’” Mill Road, T.C. Memo. 2023-129, at *34.
Beasley Timber argues that the concept of “significant relatively
natural habitat” as described in the regulation conflicts with the plain
statutory text. Since Beasley Timber turned in its brief, there has been
a sea change in the framework governing how courts interpret the
relationship between statutes and regulations. See Loper Bright Enters.
v. Raimondo, 144 S. Ct. 2244, 2273 (2024). We are not called upon to
determine the fallout in this case, however, because the easement here
satisfies the section 170(h)(4)(A)(ii) requirement of a “relatively natural
habitat” even assuming arguendo that the Code requires a “level of
significance that is not trivial.”
We begin with a quick review of the rest of the key wording. A
habitat is “‘[t]he area or environment where an organism or ecological
community normally lives or occurs’ or ‘[t]he place where a person or
thing is most likely to be found.’” Glass v. Commissioner, 124 T.C. 258,
281–82 (2005) (quoting American Heritage Dictionary of the English
Language (4th ed. 2000)), aff’d, 471 F.3d 698 (6th Cir. 2006). In
distinguishing “relatively natural” from the unadorned “natural” we
have looked to Treasury Regulation § 1.170A-14(d)(3), which notes that
the “fact that the habitat or environment has been altered to some
extent by human activity will not result in a deduction being denied
under this section if the fish, wildlife, or plants continue to exist there
in a relatively natural state.” See, e.g., Murphy, T.C. Memo. 2023-72,
at *50 (“‘[N]atural’ does not necessarily mean untouched by human
hands and feet but can refer to areas somewhat altered by human
activity; and ‘relatively natural’ refers to areas that may be even more
altered but still retain conservation value . . . .”).
The JL Minerals easement protects significant relatively natural
habitats. We first consider whether the property contains a relatively
32
[*32] natural habitat. The baseline documentation report identifies two
habitats in particular, stating that 69% of the easement property is
covered with either mature mesic hardwood forest or bottomland
hardwood forest, with the remainder mixed between managed pine and
succession forest. The Commissioner’s expert agrees with the baseline
documentation report’s conclusion that such habitats exist and does not
suggest that these habitats were anything but relatively natural.
Although the Commissioner observes that there is no water on or
running through the property, he fails to show that water on the
property is a necessary prerequisite for these habitats.
As to significance, the State of Georgia has designated both of
these types of forest high priority habitats in its 2015 SWAP. The 2015
SWAP identifies high priority habitats based on the rarity of the habitat
as well as on whether the habitat supports species in need of
conservation. The Georgia Department of Natural Resources website
defines “high-priority habitats” as “natural habitats that rank highest
for recommended research or other conservation-related matters. For
some, it may be because of their rarity; for others, it may be because
little is known about them or because they face daunting threats, such
as habitat loss or fragmentation.” State Wildlife Action Plan, Ga. Dep’t
of Nat. Res., https://georgiawildlife.com/WildlifeActionPlan (last visited
July 19, 2024). The Commissioner responds that Beasley Timber fails
to explain how the mesic and bottomland hardwood habitat on the
easement property fits within the definitions of the 2015 SWAP. The
baseline documentation report explicitly linked the two, and the
Commissioner offers nothing besides conjecture to suggest that the
baseline documentation report is wrong.
The Commissioner also questions the significance of the habitats
on the property because they do not fit within any of the examples in the
regulation of significant natural habitats and ecosystems. As we have
explained before, Treasury Regulation § 1.170A-14(d)(3)(ii) contains a
nonexhaustive list, which generally “distinguish[es] species that
reasonably warrant protection, on the one hand, from commonly
occurring species for which the loss of habitat is not of significant
concern.” Champions Retreat Golf Founders, LLC v. Commissioner, 959
F.3d at 1036. We believe that Georgia’s designation of mesic and
bottomland hardwood forests as high priority habitats shows “‘some
level of significance’ that is not ‘trivial.’” Mill Road, T.C. Memo. 2023-
129, at *34 (quoting Champions Retreat Golf Founders, LLC v.
Commissioner, 959 F.3d at 1036).
33
[*33] The Commissioner finally points to the small size of the easement
as evidence that it lacks conservation value. The easement property is
64.7 acres (.10 square mile), and the land designated as “Special Natural
Areas” by the easement deed represent roughly two-thirds of the
easement property (.07 square mile), which the Commissioner alleges is
“too small to provide a significant relatively natural habitat.” The
Commissioner seeks to import a size requirement that the Code does not
impose. See Glass v. Commissioner, 471 F.3d at 711 (“[A]s the
Commissioner concedes, there is no provision in I.R.C. § 170(h) or the
implementing regulations that requires a minimum size for a qualifying
conservation contribution.”).
“Under the plain meaning of section 170(h)(4)(A)(ii), all that is
required is that the easement protect ‘a relatively natural habitat of fish,
wildlife, or plants, or similar ecosystem’.” Mill Road, T.C. Memo. 2023-
129, at *34. The easement property “protects plant communities and
ecosystems natural to [Wilkinson] County, which will continue to exist
in a relatively natural state” no matter whether any development occurs
around it. Id. The easement deed thus satisfies the conservation
purpose requirement of section 170(h)(4)(A)(ii). 12
2. Protected In Perpetuity
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.” Given that a qualified
conservation contribution encompasses donations of less than a donor’s
full interest in property, see I.R.C. § 170(f)(3)(A), (B)(iii), (h)(2)(C), we
consider this requirement taking into account rights reserved by the
donor. The Treasury regulations have pondered the same point and
identified three permutations, which we have summarized before:
Altogether, these regulations provide that a donor
(1) may reserve in the easement deed rights to make
continued use of the easement property, provided that
there are enforceable restrictions to prevent uses
12 Given our conclusion that the deed satisfies the conservation purpose
requirement by protecting the relatively natural mesic hardwood forest and
bottomland hardwood forest habitats under section 170(h)(4)(A)(ii), we need not reach
the parties’ wide variety of other arguments relating to this requirement, including
whether a potential habitat for rare, threatened, or endangered species counts as
significant, arguments regarding section 170(h)(4)(A)(ii), and the procedural validity
of various regulations under the Administrative Procedure Act.
34
[*34] inconsistent with conservation purposes, (2) may continue
pre-existing use of the easement property that does not
conflict with the conservation purposes of the gift, and
(3) cannot use the property in such a way that would
destroy other significant conservation interests (unless
pursuant to protecting the conservation purpose of the
easement).
Murphy, T.C. Memo. 2023-72, at *61; see also Mill Road, T.C. Memo.
2023-129, at *39; Treas. Reg. § 1.170A-14(b)(2), (e)(2) and (3), (g)(1).
The rights reserved in the easement deed do not contravene the
protection of its conservation purpose (i.e., the preservation of mesic and
bottomland hardwood forests) in perpetuity. Although the
Commissioner asserts that the unfettered exercise of the reserved rights
could have negative effects on conservation writ large, he misses the
forest for the trees. Each of the reserved rights but one 13 contains
linguistic variations on a common theme: The respective right is allowed
so long as it does “not materially impair or interfere with the
Conservation Values,” or, to put it positively, “preserve[s] the
Conservation Values.” The deed further equips Heritage with the right
to require compliance with the deed’s purpose—to preserve and protect
the Conservation Values—by “bring[ing] an action at law or in equity . . .
to enforce the terms of this Conservation Easement.” See Mill Road,
T.C. Memo. 2023-129, at *40. The reserved rights are married to
enforceable restrictions to prevent uses inconsistent with conservation
purpose, and the deed thus passes muster under the “protected in
perpetuity” requirement of the Code and the regulations.
3. Retention of a Qualified Mineral Interest Under
Section 170(h)(5)(B)
Section 170(h)(5)(B) provides, as a general matter, that the
“protected in perpetuity” requirement is not met “in the case of a
contribution of any interest where there is a retention of a qualified
mineral interest . . . if at any time there may be extraction or removal of
minerals by any surface mining method.” The Code defines a qualified
mineral interest as “subsurface oil, gas, or other minerals, and . . . the
13 The easement deed does not reference conservation values or purpose with
respect to JL Minerals’s reservation of the “right to take action reasonably necessary
to prevent erosion on the [easement property] or to protect public health and safety.”
The Commissioner nonetheless does not object to this reservation of rights or suggest
how it might threaten the perpetual protection of the conservation purpose.
35
[*35] right to access such minerals.” I.R.C. § 170(h)(6); see also Treas.
Reg. § 1.170A-14(b)(1)(i). Treasury Regulation § 1.170A-14(g)(4)
observes in this regard that “a deduction under this section will not be
denied in the case of certain methods of mining that may have limited,
localized impact on the real property but that are not irremediably
destructive of significant conservation interests.”
The deed contains two pertinent provisions. It first specifies:
There shall be no filling, excavation, dredging, mining or
drilling, no removal of topsoil, sand, gravel, rock, peat
minerals, or other materials, and no change in the
topography of the land in any manner except as is
consistent with Treas. Reg. § 1.170A-14(g)(4) and as
necessary for construction and maintenance on [the
easement property] of roads, bridges, and culverts.
The deed later grants the “right to have borrow pits not to exceed a total
of 1 acre, to provide required fill material for use, such as repairing
roads, solely and exclusively on the” easement property. 14
The Commissioner argues that the “borrow pit” carveout is a
violation of section 170(h)(5)(B) because it necessarily involves the
removal of material containing minerals using a surface mining method.
The Commissioner’s own regulation, which allows “certain methods of
mining that may have limited, localized impact on the real property but
that are not irremediably destructive of significant conservation
interests,” belies this sophistry. Treas. Reg. § 1.170A-14(g)(4). The deed
allows for digging up a limited amount of dirt to repair roads solely on
the property, which plainly fits in the permissible kind of localized low-
impact disturbance. 15
III. Qualified Appraisal Requirements
Section 170(f)(11)(D) generally provides that a charitable
contribution deduction claim exceeding $500,000 must be accompanied
by, inter alia, a qualified appraisal by a qualified appraiser. The Code
14 A borrow pit is “an area where material (usually soil, gravel or sand) is dug
for use at another location. The term is literal—meaning a pit from where material is
borrowed.” Mactec, Inc. v. Bechtel Jacobs Co., LLC., 346 F. App’x 59, 69 (6th Cir. 2009).
15 Although we need not go further, we observe in passing that one of the
Commissioner’s own experts distinguished digging material for a borrow pit from
mining, which is consistent with our view of the regulation.
36
[*36] defines both terms. A “qualified appraisal” is one that (1) meets
requirements set forth by “regulations or other guidance prescribed by
the Secretary” and (2) “is conducted by a qualified appraiser in
accordance with generally accepted appraisal standards and any
regulations or other guidance prescribed.” I.R.C. § 170(f)(11)(E)(i)
(emphasis added). The term “qualified appraiser” means an individual
who, as relevant here, “meets . . . requirements as may be prescribed by
the Secretary in regulations or other guidance.” I.R.C.
§ 170(f)(11)(E)(ii)(III). The Commissioner asserts that JL Minerals
failed to obtain a qualified appraisal or to retain a qualified appraiser.
A. Generally Accepted Appraisal Standards
In response to the statutory incorporation of the requirements of
regulations or guidance into the definition of the term “qualified
appraisal,” the IRS issued I.R.S. Notice 2006-96, 2006-2 C.B. 902 (2006
Notice). As most relevant here, the 2006 Notice explained that an
appraisal is “qualified” if it is consistent with the substance and
principles of the Uniform Standards of Professional Appraisal Practice
(USPAP). 16 See 2006 Notice § 3.02(2).
The parties before us joust over the appraisal’s compliance with
USPAP. In particular, the Commissioner asserts that the appraisal
reflected preordained results, displayed overreliance on the GMT report,
inappropriately preferred the income method to the comparable-sales
method for valuing the property, and overall was not credible. He claims
that these defects cause the appraisal to dip below the minimum
USPAP.
As we have noted before, “[a]ppraising is not an exact science and
has a subjective nature.” Gorra v. Commissioner, T.C. Memo. 2013-254,
16 Effective January 1, 2019, Treasury Regulation § 1.170A-17(a)(2) defines
“generally accepted appraisal standards” for purposes of I.R.C. § 170(f)(11)(e) to mean
“the substance and principles” of USPAP. In adopting this standard, the Department
of the Treasury observed: “The Treasury Department and the IRS agree that it is
beneficial to provide some flexibility by requiring conformity with appraisal standards
that are consistent with the substance and principles of USPAP rather than requiring
that all appraisals be prepared strictly in accordance with USPAP.” Substantiation
and Reporting Requirements for Cash and Noncash Charitable Contribution
Deductions, 83 Fed. Reg. 36417-01, 36420 (July 30, 2018) (to be codified at 26 C.F.R.
pts 1, 602). Although the tax year at issue precedes the effective date of this regulation,
it nonetheless provides that “[t]axpayers may rely on the rules of this section for
appraisals prepared for returns or submissions filed after August 17, 2006.” Treas.
Reg. § 1.170A-17(c).
37
[*37] at *48. The Commissioner attacks Mr. Hayter primarily for
overreliance on GMT, from which most of his other purported errors
flow, from the Commissioner’s point of view. Mr. Hayter, however,
disclosed his heavy reliance on GMT from the start of his report and
included as an extraordinary assumption that the GMT information was
accurate. The Commissioner further critiques Mr. Hayter’s selected
appraisal methodology (the use of the income approach) and his failure
to sufficiently reconcile the extraordinary results in the GMT report
using the comparable sales method. We are not convinced that Mr.
Hayter’s work is inconsistent with the substance and principles of
USPAP. Although the Commissioner has identified significant
weaknesses in the appraisal, any failures to comply with USPAP “go
more to the credibility and weight of the appraisal and not to whether
the appraisal complies with generally accepted appraisal standards.”
Buckelew Farm, T.C. Memo. 2024-52, at *49; see also Whitehouse Hotel
Ltd. P’ship v. Commissioner (Whitehouse I), 131 T.C. 112, 127–28 (2008),
vacated and remanded, Whitehouse Hotel Ltd. P’ship v. Commissioner
(Whitehouse II), 615 F.3d 321 (5th Cir. 2010); T.D. 9836, 2018-33 I.R.B.
291, 294 (“[T]he final regulations do not adopt the recommendation to
require strict compliance with USPAP and retain the requirement of
consistency with the substance and principles of USPAP.”).
B. Qualified Appraiser
The Code’s definition of a qualified appraiser, another necessary
element of a qualified appraisal, incorporates “requirements as may be
prescribed by the Secretary in regulations or other guidance.” See I.R.C.
§ 170(f)(11)(E)(ii). Again, we look to the 2006 Notice, which states that
“[t]he requirements of [Treasury Regulation] § 1.170A-13(c) . . .
concerning qualified appraisals and qualified appraisers continue to
apply to all taxpayers.” 2006 Notice § 3.04(1), 2006-2 C.B. at 903.
As relevant here, Treasury Regulation § 1.170A-13(c)(5)(ii)
provides that an appraiser is not qualified if “the donor [here, JL
Minerals] had knowledge of facts that would cause a reasonable person
to expect the appraiser [here, Mr. Hayter] falsely to overstate the value
of the donated property.”
[I]t is not the appraisal that may become disqualified, but
rather the appraiser. . . . [T]he appraiser does not become
disqualified simply because (1) the appraiser
incompetently or carelessly overstated the value, and/or
(2) the donor knew that the appraiser overstated the value,
38
[*38] and/or (3) the donor knew facts about the property that
caused the value to be overstated. Rather, this
disqualification occurs when the donor knows facts that do
or should cause him to expect the appraiser to falsely
overstate the value. Such facts will be facts about the
appraiser, and the resulting expectation is not just an
incorrect overstated value but a “falsely” overstated value.
Mill Road, T.C. Memo. 2023-129, at *42; see also Oconee Landing, T.C.
Memo. 2024-25, at *39 (“The ‘knowledge’ requirement in Treasury
Regulation § 1.170A-13(c)(5)(ii) implicates the donor’s actual and/or
constructive knowledge.”). The Treasury regulation provides an
example sounding in collusion to illustrate this knowledge requirement:
“[T]he donor and the appraiser make an agreement concerning the
amount at which the property will be valued and the donor knows that
such amount exceeds the fair market value of the property . . . .” Treas.
Reg. § 1.170A-13(c)(5)(ii).
“In gauging a partnership’s ‘knowledge’ for this purpose, we look
to the knowledge of the person(s) with ultimate authority to manage the
partnership.” Oconee Landing, T.C. Memo. 2024-25, at *40; see also
Buckelew Farm, T.C. Memo. 2024-52, at *45. Although Messrs.
Freeman and Wilson took an active role in the business dealings of JL
Minerals, including coordinating the conservation easement, ultimate
authority over JL Minerals rested with Messrs. Johnson and Beasley.
Even assuming arguendo that Messrs. Freeman and Wilson’s extensive
work for a 1% ownership stake each in JL Minerals put their much
greater knowledge at issue, we conclude that a reasonable person would
not expect Mr. Hayter to falsely overstate the property’s value even
considering the full facts before Messrs. Freeman and Wilson.
To be clear, the Commissioner’s case is not insubstantial.
Summarizing the brief, Mr. Freeman picked a compliant appraiser
(willing to tweak his numbers to please a client) and pointed him as to
the questionable method to be employed and as to the general values
that he desired. And Mr. Freeman knew that a false overstatement
would result, given the repeated warnings of Mr. Sheppard about the
use of the income method as a means of manipulation.
These facts also can be read as a relatively normal back-and-forth
between client and appraiser. The client first retains someone who has
experience and skill with mineral valuations, and then gives samples of
what the client has found appropriate in the past. So far, so good. The
39
[*39] client trusts the appraiser to pick an acceptable method and
believes that the income method makes sense given the uniqueness of
the property. And the appraiser, although responsive to feedback,
explicitly aims to stay within the bounds of reasonableness.
On the record before us, we do not conclude that a reasonable
person with Mr. Freeman’s knowledge would expect Mr. Hayter to
falsely overstate the value nor that there was a meeting of the minds on
a predetermined result. This case presents a markedly different
situation from Oconee Landing, T.C. Memo. 2024-25, at *45, where the
donor intimately understood the fair market value of the property and
reached an implicit agreement with the appraiser as to a value that he
knew to be false. We thus conclude Mr. Hayter is a qualified appraiser
within the meaning of section 170(f)(11)(E). 17
IV. Valuation
A. General Principles
Generally, the amount of a charitable contribution deduction
under section 170(a) for a donation of property other than money is the
“fair market value” of the property at the time of the donation. Treas.
Reg. § 1.170A-1(c)(1). Treasury Regulation § 1.170A-1(c)(2) defines fair
market value to be “the price at which the property would change hands
between a willing buyer and a willing seller, neither being under any
compulsion to buy or sell and both having reasonable knowledge of
relevant facts.” “This definition, a fixture in the Treasury Regulations
since 1972, is universally acknowledged by professional appraisers
when valuing charitable contributions of property.” Corning Place Ohio,
LLC v. Commissioner, T.C. Memo. 2024-72, at *27; see also Value,
Black’s Law Dictionary (4th ed. 1968) (defining ‘“value’ of land for
purpose of taxation” as the “price that would probably be paid therefor
after fair negotiations between willing seller and buyer”); Interagency
Land Acquisition Conference, Uniform Appraisal Standards for Federal
Land Acquisitions 3 (1971) (defining fair market value as “the amount
in cash, or on terms reasonably equivalent to cash, for which in all
probability the property would be sold by a knowledgeable owner willing
but not obligated to sell to a knowledgeable purchaser who desired but
is not obliged to buy”).
17 Given our finding that JL Minerals complied with the substantiation
requirements set forth in section 170, it is unnecessary to address the Commissioner’s
argument that the failure to comply was due to willful neglect.
40
[*40] The value of a property on a certain date is a question of fact to
be resolved on the basis of the entire record, see, e.g., Kaplan v.
Commissioner, 43 T.C. 663, 665 (1965), and the parties retained experts
to assist in our inquiry. We evaluate their opinions in light of each
expert’s qualifications and the evidence in the record, and we may accept
an “opinion in toto or accept aspects . . . that we find reliable.” Oconee
Landing, T.C. Memo. 2024-25, at *58; see also Savannah Shoals, LLC v.
Commissioner, T.C. Memo. 2024-35, at *35. We also “may determine
fair market value on the basis of our own examination of the evidence in
the record.” Savannah Shoals, T.C. Memo. 2024-35, at *35; see
Buckelew Farm, T.C. Memo. 2024-52, at *51.
As there is no substantial record of comparable sales of easements
comparable to the JL Minerals easement, the parties agree that the
easement should be valued by calculating the difference between the fair
market value of the easement property before and after JL Minerals
granted the easement. See, e.g., Esgar Corp. v. Commissioner, T.C.
Memo. 2012-35, 2012 WL 371809, at *7, aff’d, 744 F.3d 648 (10th Cir.
2014); Treas. Reg. § 1.170A-14(h)(3)(i). In deciding the “before value,”
we must take into account not only the actual use of the easement
property when the easement was given in December 2017, but also its
highest and best use. See Stanley Works & Subs. v. Commissioner, 87
T.C. 389, 400 (1986); Treas. Reg. § 1.170A-14(h)(3)(ii). Although this
“concept ‘is an element in the determination of fair market value, . . . it
does not eliminate the requirement that a hypothetical willing buyer
would purchase the subject property for the indicated value.’” Excelsior
Aggregates, LLC v. Commissioner, T.C. Memo. 2024-60, at *47 (quoting
Boltar, L.L.C. v. Commissioner, 136 T.C. 326, 336 (2011)); see also
Corning Place, T.C. Memo. 2024-72, at *41.
B. Highest and Best Use
1. Legal Grounding
“To determine a property’s highest and best reasonably probable
use, the court focuses on ‘[t]he highest and most profitable use for which
the property is adaptable and needed or likely to be needed in the
reasonably near future.’” Palmer Ranch Holdings Ltd. v. Commissioner,
812 F.3d 982, 996 (11th Cir. 2016) (quoting Symington v. Commissioner,
87 T.C. 892, 897 (1986)), aff’g in part, rev’g and remanding in part T.C.
Memo. 2014-79; accord Olson v. United States, 292 U.S. 246, 255 (1934).
We have defined highest and best use as “[t]he reasonably probable and
legal use of vacant land or an improved property that is physically
41
[*41] possible, appropriately supported, and financially feasible and
that results in the highest value.” Oconee Landing, T.C. Memo. 2024-
25, at *59 (quoting Whitehouse Hotel Ltd. P’ship v. Commissioner
(Whitehouse III), 139 T.C. 304, 331 (2012); see also Savannah Shoals,
T.C. Memo. 2024-35, at *37. “The highest and best use inquiry is one of
objective probabilities.” Esgar Corp. v. Commissioner, 744 F.3d at 657.
“While highest and best use can be any realistic, objective
potential use of the property, it is presumed to be the use to which the
land is currently being put absent proof to the contrary.” Esgar Corp. v.
Commissioner, 2012 WL 371809, at *7. Where “an asserted highest and
best use differs from current use, the use must be reasonably probable
and have real market value.” Id. (citing United States v. 69.1 Acres of
Land, 942 F.2d 290, 292 (4th Cir. 1991)).
If different from the current use, a proposed highest and best use
requires both “closeness in time” and “reasonable probability.” Hilborn
v. Commissioner, 85 T.C. 677, 689 (1985); see also Savannah Shoals,
T.C. Memo. 2024-35, at *37. Any proposed uses that “depend upon
events or combinations of occurrences which, while within the realm of
possibility, are not fairly shown to be reasonably probable” are to be
excluded from consideration. Olson, 292 U.S. at 257; see also Excelsior
Aggregates, T.C. Memo. 2024-60, at *30; Oconee Landing, T.C. Memo.
2024-25, at *65.
“Where, as here, the parties proposed different uses, we consider
‘[i]f there is too high a chance that the property will not achieve the
proposed use in the near future,’ in which case ‘the use is too risky to
qualify.’” TOT Prop. Holdings, LLC v. Commissioner, 1 F.4th 1354, 1369
(11th Cir. 2021) (quoting Palmer Ranch Holdings Ltd. v. Commissioner,
812 F.3d at 1000). “The principle can also be articulated in terms of
willingness to pay. If a proposed use is too risky for ‘a hypothetical
willing buyer [to] consider [the use] in deciding how much to pay for the
property,’ then the use should not be deemed the highest and best
available.’’ Palmer Ranch Holdings Ltd. v. Commissioner, 812 F.3d at1000 n.14 (quoting Whitehouse II, 615 F.3d at 335).
On several occasions, we have applied these general principles to
the mining context:
Where the asserted highest and best use of property is the
extraction of minerals, the presence of the mineral in a
commercially exploitable amount and the existence of a
42
[*42] market “that would justify its extraction in the reasonably
foreseeable future” must be shown. United States v. 69.1
Acres of Land, supra at 292. “There must be some objective
support for the future demand, including volume and
duration. Mere physical adaptability to a use does not
establish a market.” United States v. Whitehurst, 337 F.2d
765, 771–772 (4th Cir. 1964); see also United States v.
494.10 Acres of Land, 592 F.2d 1130, 1132 (10th Cir. 1979)
(stating that “if the ‘future’ is beyond or very much beyond
the ‘near future,’ the use becomes speculative”).
Esgar Corp v. Commissioner, 2012 WL 371809, at *8; 18 see also Excelsior
Aggregates, T.C. Memo. 2024-60, at *35.
2. Analysis
Beasley Timber argues that the highest and best use of the
property is a landowner-operated kaolin mine, positing a business model
similar to that of Arcilla. The cornerstone for this conclusion is the GMT
mineral report, which was relied upon not only by Mr. Hayter’s
appraisal but by each of JL Minerals’s experts. Specifically, Benjamin
Black (author of the GeoLogic report) started from GMT’s drilling data
and then offered his own analysis of the kaolin bed and how a mine could
be operated on the property to recover the maximum amount of the
deposit, a point assumed but left unsaid in the original GMT report.
Building on GMT and Mr. Black, Dr. Criss Capps produced a “resource
valuation report,” which concluded the kaolin “meets all industry
specifications” for a kaolin reserve with a net present value between
$17.6 and $21.5 million. Two appraisers, Douglas Kenny and Thomas
Spears, each appraised the easement property, concluding that the
mineral deposit described by GMT made the property unique and
deriving value from sales of comparable properties impossible. They
accordingly both used a discounted cashflow analysis to value the
property, assuming a highest and best use of a landowner-operated
kaolin mine along the lines of Arcilla.
For his part, the Commissioner turns to a three-member team of
experts from SRK Consulting, a consulting firm specializing in mining.
18 As we have noted, although the cited cases involved eminent domain or
condemnation, “[f]air market value ‘does not vary according to whether the taxpayer
is seeking a charitable deduction for property contributed or an adequate and just
compensation for property condemned.’” Esgar Corp. v. Commissioner, 2012 WL
371809, at *8 n.12 (quoting Klopp v. Commissioner, T.C. Memo. 1960-185).
43
[*43] Bart Stryhas testified with respect to deficiencies in GMT’s
methods and report. Dr. Stryhas further explained that, even assuming
the reliability of GMT’s data, its conclusions as to the amount of kaolin
that could be mined were vastly overstated. Dr. Silver Miller testified
about practical questions bearing on topics such as mine pit walls,
topography, and overburden that cast doubt on the viability of a mine
on the easement property. Finally, Matthew Sullivan explained that the
GMT report did not permit declaring the deposit either a mineral
resource or reserve 19 as necessary for the evaluation of the economic
viability of a mining project. Consistent with the conclusions of these
experts that there was insufficient data to presume a viable mine on the
easement property, the Commissioner’s appraisal expert concluded that
the highest and best use in 2017 was its then-current use, i.e.,
agricultural/residential/recreational use with knowledge of mineral on
19 According to guidelines from the Society for Mining, Metallurgy, and
Exploration (SME Guide), a “[m]ineral [r]esource is a concentration or occurrence of
solid material of economic interest in or on the Earth’s crust in such form, grade, or
quality and quantity that there are reasonable prospects for eventual economic
extraction.” “The term ‘reasonable prospects for eventual economic extraction’ implies
a judgment . . . with respect to the technical and economic factors likely to influence
the prospect of economic extraction, including the approximate mining parameters.”
“Portions of a deposit that do not have potential for eventual economic extraction . . .
cannot be included,” which implies that resources “are constrained within pit shells for
surface mining methods.”
Mineral resources range in order of increasing confidence into inferred,
indicated, and measured classes. An “inferred” resource is “part of a [m]ineral
[r]esource for which quantity and grade or quality are estimated on the basis of limited
geological evidence and sampling” and reasonably assumed, but not verified,
“geological and grade or quality continuity.” “Caution should be exercised if [inferred
resources] are considered in technical and/or economic studies. This class of material
should not be used to economically support Mineral Reserves.” An “indicated” resource
means that part of a resource for which “grade or quality, densities, shape and physical
characteristics are estimated with sufficient confidence to allow the appropriate
application of [m]odifying [f]actors [i.e., technical and economic parameters including
mining, processing, metallurgical, economic marketing, legal, environmental,
infrastructure, social and governmental factors] in sufficient detail to support mine
planning and evaluation of the economic viability of the deposit.” A “measured”
resource is the part of a mineral resource “for which quantity, grade or quality,
densities, shape, and physical characteristics are estimated with confidence sufficient
to allow the application of [m]odifying [f]actors to support detailed mine planning and
final evaluation of the economic viability of the deposit.”
A mineral reserve is the economically mineable part of a measured or indicated
resource. Like a resource, a reserve has varying levels of confidence, i.e., probable or
proven, depending on the confidence in the modifying factors.
44
[*44] the site and the opportunity to obtain legal entitlements allowing
mining.
In addition to the gaggle of experts on both sides, the parties (and
we) place heavy reliance on information gleaned from industry
participants given the small and cloistered nature of the kaolin industry.
We are treating industry information and data at a relatively high level
of abstraction (and have sealed certain parts of the record) to preserve
confidential information provided by the industry.
The extensive record before us leaves no doubt—kaolin mining
was not the highest and best use of the easement property in 2017.
a. Behavior of Market Participants
We start with the real world. To put it bluntly, multiple kaolin
processors had taken a close look at the easement property and, in at
least two cases (Huber and then its successor, KaMin) decided that it
was not worth mining or even keeping it as part of a long-term reserve.
The actions of kaolin experts with skin in the game torpedo JL
Minerals’s contention that the kaolin on the easement property “would
justify . . . extraction in the reasonably foreseeable future.” Esgar Corp.
v. Commissioner, 2012 WL 371809, at *8 (quoting 69.1 Acres of Land,
942 F.2d at 292); see also Palmer Ranch Holdings Ltd. v. Commissioner,
812 F.3d at 998 n.12 (“Determining the properties’ highest and best use
necessitated a look at market demand, so the tax court could not be
faulted for taking that look.”); Esgar Corp. v. Commissioner, 744 F.3d at
658 (“The Tax Court was not bound to accept . . . mining as the
properties’ highest and best use if that use was not reasonably probable
to manifest in the reasonably near future.”).
By way of refresher, the market for crude kaolin in Georgia at the
end of 2017 primarily involved four major kaolin processors, which
sought various types of kaolin meeting precise specifications, as well as
a few minor processors that focused on lower grade kaolin suitable for
air-float processing. See supra pp. 6–10. Given the need for categories
of kaolin meeting extremely precise requirements, the major processors
mined 95–100% of their own supply and held decades of inventory
(either through lease or purchase) for each of the types of kaolin needed
for their various end products. These majors only occasionally turned to
Arcilla, which had higher costs and required additional layers of quality
control by the processors. And it was exceedingly rare for the major
45
[*45] processors to buy kaolin from a landowner that had mined the
kaolin itself.
As part of the century-long odyssey to find sources of kaolin in the
Georgia Kaolin Belt, multiple kaolin companies drilled and tested the
Scaly Knob property, of which the easement property was part. From
1980 until the Club took over in 2001, the Scaly Knob property was
drilled and tested four times by both forerunners to the major companies
(which inherited the data) and air-float processors. This land, in other
words, was terra very much cognita.
Only one of the companies during this period, Englehard (later to
become part of BASF), decided to mine the Scaly Knob property based
on what they had found. As Mr. Mills, who “was intimately familiar
with the kaolin deposits in the area,” explained, the other companies
“found no clay that they wanted to use.”
Englehard’s mine separated the two tracts of what later became
the easement property, with the mine itself ultimately reclaimed as the
pond over which the hunting lodge sat. Englehard opted to close its
mine rather than expand onto the part of the Scaly Knob property that
was to become the easement property. Given the inherent advantages
stemming from expanding an already-operating mine rather than
opening a mine afresh, the closing of the mine (without any lease for
future mining) is a strong indication that mining kaolin on the easement
property was not economically viable, either because none of the
deposits met the specifications for processing into Englehard’s products
or because of the costs attendant on mining an area of steep slopes and
deep ravines, as Ms. Sorenson put it.
Of course, on the other side of what became the easement
property was Huber’s mine, making it a logical partner for the Club’s
kaolin dreams. In fact, as Mr. Mills explained, in his experience no other
kaolin company would be interested because “there would have been too
much overburden for [a mining company] to consider unless they had
the adjoining property.” Mr. Mills, acting on the Club’s behalf, was able
to entice Huber into exploratory drilling and then a mineral lease over
the easement property given the proximity to its mine and possibility of
kaolin deposits similar to the ones that Huber already was mining.
Huber performed exploratory drilling and testing in the northern
half of the easement property, an approach consistent with Mr. Mills’s
observation that the overburden in the southern half was “too great to
46
[*46] justify removing it.” Despite its exploratory drilling, however,
Huber took no further action. The decision not to move forward with
mining the kaolin on the property again suggests that it was not usable
by Huber. As Mr. Mills put it, a kaolin company that left a valuable
deposit in the ground “wouldn’t be in business very long . . . because it
costs a lot of money to lease a property and to drill it and to test it and
to run it through all the special testing that’s required.”
Mr. Mills did not disagree with Huber’s conclusion. As part of the
mineral lease, Mr. Mills obtained, on the Club’s behalf, Huber’s drilling
data with an eye to marketing the property to other kaolin companies
using that data if Huber did not mine. Mr. Mills testified, however, that
he “didn’t see anything [in the drill data] that [he] could take to a kaolin
company that would convince them to mine the property.”
KaMin acquired the rights to drill the easement property as part
of its acquisition of Huber’s kaolin arm in 2008. It too elected not to
mine the property from 2008 through 2013, or to keep the property
under lease as part of its reserves thereafter. The evidence before us
shows that KaMin took this course because other properties that it
controlled contained kaolin meeting the same specifications, but at more
favorable locations. Moreover, the evidence demonstrates that KaMin’s
data indicated that the portion of the easement property kaolin that
could be used in its operations was a small fraction of the purported
GMT’s 5.3-million-ton estimate.
This is not the only real-world evidence suggesting that
familiarity with the easement property bred lack of interest. In 2016
Mr. Rivers sought Scaly Knob drilling data from Imerys, BASF, and
KaMin, explaining that the owner was interested in conserving the
property. Although a conservation easement would mean the kaolin on
the easement property would be off the market forever, none of the
major kaolin companies—who, again, planned for their needs decades in
the future and had drilling data from their predecessors about the
deposit—offered to buy or lease the property to preserve the ability to
mine at some point. If the data before them showed untapped potential,
the industry would have come calling. We draw the appropriate
conclusion from its decision not to do so.
We also are aware that the major processors often entered into
agreements amongst themselves that allowed for buying or swapping
unwanted kaolin. This course of practice would suggest that if Huber or
KaMin had believed that the kaolin on the easement property would be
47
[*47] of interest to any of the other processors, either would have
approached them. They did not do so.
The market spoke plainly about the economic viability of a kaolin
mine. Market choices suggest that the kaolin on this property fits within
Mr. Mills’s experience having drilled thousands of properties for kaolin
companies: “the majority of the properties . . . drilled during [his] work
there did not find viable kaolin deposits. They may have had kaolin on
the property, but it wasn’t worth mining, and it wasn’t worth keeping
the lease in hopes of future mining.”
b. Expert Testimony
Beasley Timber nonetheless holds fast to its conclusion that
kaolin mining was the highest and best use of the easement property,
relying on the conclusions in the GMT report as supplemented by the
GMT supplemental report and Beasley Timber’s other experts. The
evidence before us shows that GMT’s reports cannot bear the weight
placed on them and that Beasley Timber has not demonstrated a
commercially exploitable amount of kaolin and the existence of a market
that would justify its extraction in the reasonably foreseeable future.
Esgar Corp. v. Commissioner, 2012 WL 371809, at *8; see also Excelsior
Aggregates, T.C. Memo. 2024-60, at *35.
i. GMT Credibility
We start by noting our considerable skepticism about GMT’s
credibility. We acknowledge that Mr. Ginn and the company that he
built were experts in mineral analysis, particularly in the field of kaolin.
Starting in 2016, however, GMT aggressively pursued work
supporting mineral-based conservation easements. Working on
conservation easements, of course, does not call into question one’s
credibility. Our concerns stem from the fact that on at least eight
occasions to our knowledge GMT concluded that a property in rural
Georgia had an extremely large kaolin deposit (ranging between 3.6 and
6.4 million tons of kaolin), which was later used to support a very large
charitable contribution deduction (between $14.6 and $22 million
dollars). If GMT were correct, the entire kaolin industry has failed to
appreciate hundreds of millions of dollars of valuable kaolin right under
its feet, despite decades of drilling and testing and buying and selling.
Occam’s razor suggests a different result: GMT repeatedly overstated
the amount of commercial-grade kaolin in its reports.
48
[*48] We have more specific concerns about GMT’s original report in
this case. In the original report, GMT stated that it had directed drilling
of 16 drillholes on the easement property in 2016 and 2017. It then laid
out its analysis based on the results from those 16 samples. But that
description was not correct. As both parties agree, GMT (using Waters
Drilling) drilled 20 drillholes, with four of them losing circulation before
hitting kaolin. The omission from the report of information related to
20% of the total drillholes raises questions about the thoroughness of
the report’s analysis (to be charitable) or selective use of data (to be less
so).
ii. Kaolin Deposit
Even setting these doubts aside, we are unpersuaded that the
GMT report, together with the various experts’ reports Beasley Timber
commissioned for trial, shows the existence of a commercially
exploitable amount of kaolin, as well as a market that would justify its
extraction in the reasonably near future. See Excelsior Aggregates, T.C.
Memo. 2024-60, at *35; Esgar Corp. v. Commissioner, 2012 WL 371809,
at *8. The GMT report is simply too preliminary and too vague to
provide a sure foundation for Beasley Timber’s position, lacking the kind
of analysis that industry participants engage in when deciding whether
mining a property makes economic sense. And none of the expert
reports, each of which relies on the GMT report, cures its failings.
By way of review, GMT concluded from its analysis of the drilling
samples that the easement property contained over 5,304,000 short wet
tons of average to excellent quality kaolin clay that was well within
desirable clay reserve parameters. The GMT report further concluded
an average overburden of 92 feet, a clay strata thickness of 40 feet, and
an overburden-to-clay ratio of 2.3:1. The report stated that the results
of the drilling moved the easement property “from a potential mineral
resource into the defined category of ‘Identified Mineral Reserve.’”
The report also examined economic prospects for mining the
kaolin. After noting that the amount of kaolin could support mining
150,000 to 250,000 crude wet tones annually for at least 20 years (using
simple division), GMT opined that JL Minerals could operate as a
“contractor with limited competition from other contractors or the actual
kaolin producers.” The report mused that JL Minerals could replicate
Arcilla’s business model “with experienced contractors and consultants,”
which could fetch a price of $14–$22 per ton. We have multiple problems
with these conclusions, but we will concentrate on three major issues.
49
[*49] a) Sufficiency of Data
We start with the drilling of the property, which was meant to
gather sufficient data to obtain a reasonable indication of the quality
and size of a deposit on the property. As explained by Dr. Miller, the
State of Georgia recorded that kaolin companies usually drill 50–100
drillholes for every 100 acres of property, which would equate to
approximately 30–60 drillholes on the easement property. The 16
drillholes that GMT analyzed here are barely more than half the low
end of the number of drillholes the kaolin industry itself uses, raising
questions about the adequacy of the data.
Deepening these questions is the manner in which drilling was
conducted. The kaolin industry witnesses all told a common story on
this point. When first exploring a property, a kaolin company would
engage in sporadic drilling or drilling with relatively wide spacing (400–
800 feet) between drillholes. When more information about the size and
the qualities of the deposit became necessary, the drilling changes to a
grid system with ever-tightening space (400 to 200 to 100 to 50 feet, in
some cases) between drillholes sometimes over years of testing.
The industry uses the grid method because it is the most reliable
way to gather information about the types of kaolin on a property. This
information is critical given the need to feed specific plants kaolin
meeting precise specifications. As Mr. McKenzie explained, the grid
method “makes it easier to do the calculation knowledge [because] . . .
you know the area of influence.” He further testified that, in the absence
of a grid, “certain areas extend out further,” which “would affect [the]
calculations for different types of clay and different parts of the grid.”
The progress from wide-spaced, sporadic exploratory drilling to
more regularized grid-based drilling aligns with the SME Guide, which
explicitly differentiates exploratory results from the category of a
mineral resource or reserve. Even in the category of mineral resources,
these guidelines caution that an “inferred” resource, (i.e., one “for which
quantity and grade or quality are estimated on the basis of limited
geological evidence and sampling” and reasonably assumed, but not
verified, “geological and grade or quality continuity”) “should not be used
to economically support Mineral Reserves.”
Despite having the benefit of KaMin’s drilling data, GMT
performed sporadic, wide-spaced drilling of the easement property
concentrated on roads and the boundaries of the property. The results
50
[*50] of this drilling are best understood as exploratory and
preliminary, lacking the hallmarks of reliability developed by the
industry. As the SME Guide explains, exploratory results “do not form
part of a declaration of Mineral Resources or Mineral Reserves,” and are
“common in the early stages of exploration when the quantity of data
available is generally not sufficient to allow any reasonable estimates of
Mineral Resources.” At best, the GMT drilling results could be
categorized under SME Guide as an “inferred” resource, too uncertain
to be used to economically support a mineral reserve.
To sum up, the haphazard and cursory GMT drilling program
failed to provide the quantum of reliable data necessary to conclude that
a mine was reasonably probable in the reasonably near future. There is
nothing in the preliminary results produced by the drilling program that
might suggest the industry had previously incorrectly evaluated the
easement property’s mining potential.
b) The Market
The GMT report, as well as the reports of Dr. Capps, Mr. Spears,
and Mr. Kenny, further fails to identify a market that would justify
extraction in the reasonably near future. The GMT report concludes at
a very high level of abstraction that the property contains “average to
excellent” kaolin that was “well within desirable clay reserve
parameters” and these “reserves would easily integrate into a modern
kaolin processing facility for manufacturing kaolin and kaolin based
products.” Dr. Capps took the baton from there, opining that the
demand for kaolin was moderate to high, that the “high quality” reserve
would be absorbed by the market, and that the kaolin on the property
could support a mine lasting decades. The baton was then passed to the
valuation experts who relied on “market demand for the resources due
to their quality as referenced by the geological studies, independent lab
results, various market information, and [Dr. Capps’s report].” In
essence, Beasley Timber’s position is that the “average to excellent”
quality of the kaolin would plainly find a market and justify extraction.
The problem is that this is not how the kaolin market works.
Every kaolin industry witness who testified at trial agreed on this point:
Specifications for processing drive the market. In the kaolin industry,
customers (i.e., the processors) define their needs for different types of
kaolin meeting assorted technical specifications to be processed into a
set end product at a particular plant. The companies then source the
types and volumes of kaolin required. Unsurprisingly, the major kaolin
51
[*51] processors fulfill 95–100% of their needs from their own supply,
which stretches decades into the future for each category of kaolin
necessary for a product. In other words, major kaolin processors are not
looking for the platonic form of “good” kaolin but kaolin with very precise
characteristics to fulfill technical needs at a given time.
We struggle with the common conclusion of the GMT report and
the supporting experts that a kaolin deposit vaguely categorized as
“average to excellent” would find a place in this specialized market. The
testimony establishes that major kaolin processors are not looking to
outside suppliers for their kaolin needs, except as a last resort and with
considerable reluctance. This reluctance is rooted in the fact that the
processors need to assure themselves that any kaolin meets their
demanding requirements, which entails testing outside supply
themselves and tight quality control. Additionally, relying on outside
suppliers was more costly than relying on one’s own kaolin reserves.
The testimony shows that this aversion to outside supply even stretches
to Arcilla, a longstanding industry participant.
The demanding technical requirements and decades worth of
preexisting inventory of all types of kaolin are only part of the problem
with Beasley Timber’s assumption that a market would snap up JL
Minerals’s kaolin. Timing is also an issue. The testimony at trial
demonstrates that the major processors look to their sales of end
products as well as their plants to determine what kaolin is needed over
the following few months. Assuming that JL Minerals could identify a
particular type of kaolin on the easement property that would be of
interest to a processor, there is no indication that the timelines would
sync up. And, if they did, JL Minerals would then be faced with
competing to convince the processor to buy JL Minerals’s kaolin rather
than using the processor’s own abundant, well-verified inventory or the
already established Arcilla.
We see absolutely no indication that the segment of the kaolin
market represented by the major processors would support extraction of
the little understood kaolin on the easement property in the reasonably
near future, much less support a landowner-operated kaolin mine.
Although we have addressed only one segment of the kaolin
market, we believe that the issues inherent in failing to identify with
any specificity the markets for the various types of kaolin on the
easement property span all segments. The GMT report does not
demonstrate that kaolin from the easement property would be suitable
52
[*52] for air-float processing or manufacturing into proppants or
refractory material. Of course, these are all lower end parts of the kaolin
market with less revenue that might not justify extraction.
The GMT report and the economic experts point to Arcilla as
evidence that a market exists for kaolin generated by a landowner-
operated mining business. Arcilla is not comparable. It has been in
existence since 1992 and during that time has conducted extensive
exploratory drilling throughout the Georgia Kaolin Belt, culminating in
leasing or purchasing land. Arcilla thus replicates the major processors
in having a firm understanding of the precise types of kaolin on the
properties it controls, as well as the particular applications that the
kaolin can be used for by processors. According to Mr. McKenzie, most
of the kaolin that Arcilla mines is sold for air-float processing and
manufacturing into proppants. We see no support for the idea that
Arcilla would have succeeded with a mine-first, customer-later strategy
that JL Minerals assumed. We also question whether declining
domestic market demand would support a competitor to Arcilla. Absent
more analysis regarding the types of kaolin on the property and the
market segments in which Arcilla is active, we are hard pressed to draw
any conclusions from its example.
As Mr. McKenzie credibly testified, a new mining company would
face particular challenges in entering the kaolin industry. Competing
in this market required mining equipment and a lab to analyze the
kaolin, as well as people to run both. As Mr. McKenzie put it, in 2016
and 2017 “[t]here just weren’t people available and it was just a
complicated business.”
Telescoping out somewhat, trends in the international kaolin
market also cast doubt on the market prospects for this kaolin.
Domestic kaolin production declined 35% within the period from 2000
through 2017, per the U.S. Geological Survey. As illustrated by the
careers and testimony of Messrs. McKenzie and Mills, the kaolin
industry went through decades of consolidation and acquisition as the
market tightened. We credit Dr. Miller’s belief that, as of 2017, the
kaolin market was at an equilibrium where demand equaled supply
because of the already established market and the sheer amount of
mining that already existed in the area. Given the structure of the
market and the equilibrium, we simply do not believe a new mine,
especially of the type that JL Minerals hypothesizes, would find a
market for the kaolin.
53
[*53] To sum up, by sticking to generalities about the types of kaolin on
the property, the GMT report, and its valuation acolytes, have failed to
establish the existence of any market for this kaolin, much less one that
would justify the extraction of the kaolin in the reasonably near future.
Beasley Timber lacks any “objective support for future demand,
including volume and duration” and relies on “[m]ere physical
adaptability to a use.” Esgar Corp. v. Commissioner, 2012 WL 371809,
at *8 (quoting United States v. Whitehurst, 337 F.2d 765, 771–72 (4th
Cir. 1964)). This is not enough to establish a market. See Excelsior
Aggregates, T.C. Memo. 2024-60, at *35; Esgar Corp. v. Commissioner,
2012 WL 371809, at *8.
c) Mining Issues
We are also unconvinced of the existence of a commercially
exploitable amount of kaolin on the easement property. Even assuming
that drilling data was sufficient to categorize the kaolin deposit as an
“indicated” mineral resource or mineral reserve for which economic
analysis would be appropriate, we have no confidence that the numbers
would make any sense.
The GMT report estimated that the property has 5.3 million tons
of kaolin but makes no provision whatsoever for how exactly to mine the
property. To fill in the gap, Beasley Timber turns to Mr. Black at
GeoLogic, who uses the GMT data to estimate a “resource” on the
property of 7.9 million tons, of which 3.9 million tons were declared a
“reserve.” Mr. Black noted that the mine plan models with slopes inside
the property lines would now allow the recovery of the 5.3 million tons
of kaolin calculated by GMT, but an “expanded, backcut slope starting
on the neighboring property . . . consistent with industry practices . . .
would increase estimated mineable kaolin reserve values . . . to
approximately 6.4 million short tons.”
Although the experts basically agree on the raw numbers
generated from the GMT data, they have strenuous disagreements over
the amount of kaolin that could actually be mined, focusing on questions
of pit slope walls and overburden. In our view, the most critical insight
comes not from the retained experts, but from the testimony of the
industry witnesses. They explained that kaolin mining was an iterative
process in which the company mining a property routinely compares
(1) the costs of removing the overburden and hauling the kaolin to a
processing plant with (2) the value of the kaolin obtained. Given the
steep topography and vastly varying overburden amounts on the
54
[*54] easement property, we believe that sooner or later the equation
would militate in favor of closing the mine rather than expanding into
an area with high overburden, thus undermining Mr. Black’s conclusion
as to the amounts of kaolin that could be extracted.
Moreover, the industry witnesses emphasized the critical
importance of location in determining the value to be derived from a
kaolin property. Crude kaolin meeting required specifications must be
transported to a plant that needs kaolin of that type or a blunging site
to be made into slurry and transported by pipeline. The lack of
information regarding the types of kaolin on the property and thus the
potential buyers make it impossible to evaluate the crucial hauling costs
and determine whether kaolin mining would, in fact, be economically
feasible.
c. Conclusion
In summary, we reject Beasley Timber’s argument that the
highest and best use of the easement property in December 2017 was as
a kaolin mine. Although the property contained a kaolin deposit, the
conduct of informed market participants over decades convinces us that
mining was not reasonably probable in the reasonably near future.
Beasley Timber has failed to show otherwise, relying on preliminary and
generalized information that suggests no particular market and a report
that engenders no confidence. Although we grant its point that future
innovations might have transformed the deposit into a thing of value,
this outcome “depend[s] upon events or combinations of occurrences
which, while within the realm of possibility, are not fairly shown to be
reasonably probable.” Olson, 292 U.S. at 257; see also Excelsior
Aggregates, T.C. Memo. 2024-60, at *30. As is, there is simply “too high
a chance that the property will not achieve the proposed use in the near
future,’’ in which case “the use is too risky to qualify.” TOT Prop.
Holdings, LLC v. Commissioner, 1 F.4th at 1369 (quoting Palmer Ranch
Holdings, Ltd. v. Commissioner, 812 F.3d at 1000). The highest and best
use accordingly remains the easement property’s current use,
agricultural/residential/recreational use with knowledge that some
mineral exists on the site.
C. Valuation of the Easement Property
1. Legal Framework
Having determined the highest and best use of the property, we
next turn to determining its value before the grant of the easement.
55
[*55] Unsurprisingly, “[t]his Court has repeatedly affirmed that actual
arm’s-length sales occurring sufficiently close to the valuation date are
the best evidence of value, and typically dispositive, over other valuation
methods.” Buckelew Farm, T.C. Memo. 2024-52, at *56; see also Corning
Place, T.C. Memo. 2024-72, at *28; Excelsior Aggregates, T.C. Memo.
2024-60, at *31 (“The best evidence of a property’s FMV is the price at
which it changed hands in an arm’s-length transaction reasonably close
in time to the valuation date.”); ES NPA Holding, LLC v. Commissioner,
T.C. Memo. 2023-55, at *14. For these purposes, both we and the
Eleventh Circuit have “f[ou]nd the purchase [of a partnership interest]
reflective of the price that the market would pay for the Subject
Property, especially when the ownership interest was nearly 100% and
the only asset held by the Partnership was the Subject Property itself.”
Buckelew Farm, T.C. Memo. 2024-52, at *56; see also TOT Prop.
Holdings, LLC v. Commissioner, 1 F.4th at 1368 (finding that the sale
price for a 98.99% interest in a partnership, whose only meaningful
asset was property on which an easement was granted shortly
thereafter, was representative of the “before” value of the property);
Oconee Landing, T.C. Memo. 2024-25, at *71–72.
In addition to previous sales, we often draw on one or more of
three common approaches to determine the fair market value of a piece
of real property: (1) the market, or comparable sales approach; (2) the
income approach; and (3) a cost, or an asset-based approach. See, e.g.,
Excelsior Aggregates, T.C. Memo. 2024-60, at *32; see also Bank One
Corp. v. Commissioner, 120 T.C. 174, 306 (2003), aff’d in part, vacated
in part, and remanded on another issue sub nom. JPMorgan Chase &
Co. v. Commissioner, 458 F.3d 564 (7th Cir. 2006). Our decision on
which approach (or approaches) to use is a question of law, and the
utility of the various approaches can vary according to the type of
property at issue. See Chapman Glen Ltd. v. Commissioner, 140 T.C.
294, 325–26 (2013); see also Corning Place, T.C. Memo. 2024-72, at *31–
32; Savannah Shoals, T.C. Memo. 2024-35, at *35–36. The approaches
provide a valuable sanity check for each other and for the value
indicated by previous sales. See Excelsior Aggregates, T.C. Memo. 2024-
60, at *32.
2. Analysis
The parties each rely on different champions. For his part, the
Commissioner looks to previous sales of the easement property,
complemented by the comparable sales approach. Beasley Timber turns
to the income approach, asserting that the results of the GMT testing
56
[*56] meant that this property was unique and income producing,
rendering irrelevant any reference to other sales.
Before engaging with the parties’ respective analyses, we first
reject Beasley Timber’s contention that the GMT report transformed the
easement property into something unique. As we have explained at
length, the GMT report is, at best, a vague and preliminary analysis of
exploratory drilling results. A knowledgeable buyer and seller would
take this report with a grain of salt, establishing the possibility that a
kaolin deposit of undefined quality exists on the easement property. Of
course, it was no secret that the property was in the heart of the Georgia
Kaolin Belt, kaolin companies had drilled on or around the easement
property multiple times, and, as seen in public records, a lengthy
mineral lease over the easement property passed between two
processors, neither of whom chose to open a mine.
Nor do we believe that GMT’s word alone would move the needle.
The trial testimony establishes that at least two kaolin processors
elected not to mine properties touted by GMT (despite receiving
favorable testing data), consistent with general industry practice for
processors to rely on their own testing.
The GMT report, in short, does little to distinguish the easement
property or render inapposite prior sales of the easement property or
sales of other properties that might contain kaolin.
a. Actual Transactions Involving Property
The results of the actual transactions involving the property
provide consistent and compelling evidence of the easement property’s
value. We first consider the arm’s-length sale of the Scaly Knob property
from the Club to Free-Wil for $1.6 million in December 2015, which
works out to $2,481 per acre. Beasley Timber argues that this was a
distressed sale, noting that relations inside the Club were collapsing and
some of the members were in need of money. The record before us
establishes that the Club, comprising almost exclusively successful and
knowledgeable businesspeople, sought and believed that they had
received a fair price for the property. The facts before us further show
that both the Club and Free-Wil were well aware of the Huber lease, and
thus the potential for kaolin mining. Even the Club member who
believed most strongly in kaolin mining offered approximately the same
price ($1.7 million, a per-acre value of $2,636) to purchase the Scaly
Knob property and believed that the easement property’s maximum
57
[*57] value was $2.5 million ($3,875 per acre). The $2,481 price per acre
for the Scaly Knob property accordingly provides strong evidence of the
value of the easement property.
We next look to the January 2016 sale of a 98% interest in JL
Minerals (which held the easement property as its only asset) by Free-
Wil to Beasley Timber for $167,837. Doing some simple math, the 98%
interest in the partnership (with the easement property as its only asset)
suggests a total property value of $171,262 (calculated by dividing
$167,837 by 98%). This amount, in turn, reflects a per-acre value of
$2,647, which is largely consistent with the sale from the Club a few
months earlier.
We note that the buyer and the seller were both aware of the
existence of the Huber lease in January 2016, and thus the possibility
for kaolin mining. Underscoring this point, we believe that savvy
businessmen like Messrs. Beasley and Johnson understood that the 64.7
acres covered by the Huber mineral lease were spun off from the rest of
the total 1,116 acres for a reason. Beasley Timber was buying timber to
be cut and, as a cherry on top, a property ready made to support a
lucrative conservation easement deduction to offset its earnings.
One other, unconsummated, transaction catches our eye. In 2017
Mr. Freeman was approached by Mr. Loudermilk, a very experienced
Georgia real estate buyer, to gauge his interest in purchasing all 1,116
acres that Beasley Timber owned through Jackson Lake and JL
Minerals. Mr. Freeman pitched to Mr. Loudermilk the 2016 drilling
data on the easement property and attempted to entice him with the
prospect of a lucrative conservation easement deduction in addition to
the value of the land itself. Mr. Loudermilk, aware that vacant land in
Wilkinson County went for $600–$2,400 per acre, broke off discussions
because he refused to go above $5 million ($4,480 per acre) even in light
of the drilling data and the potential for a sizable tax deduction.
The record before us provides strong evidence that the true value
of the easement property—even inflated with the prospect of tax
benefits—was a tiny portion of the $259,815 per-acre value that JL
Minerals claimed as a deduction.
b. Comparable Sales Approach
The comparable sales approach “values property by comparing it
to similar properties sold in arm’s-length transactions around the
valuation date.” Savannah Shoals, T.C. Memo. 2024-35, at *36 (first
58
[*58] citing Estate of Spruill v. Commissioner, 88 T.C. 1197, 1229 n.24
(1987); and then citing Wolfsen Land & Cattle Co. v. Commissioner, 72
T.C. 1, 19 (1979)). “Because no two properties are ever identical, the
appraiser must adjust the sale prices of the comparables to account for
differences between the properties (e.g., parcel size, location, and
physical features) and the terms of the sales (e.g., proximity to valuation
date and conditions of sale).” Id. (citing Wolfsen Land & Cattle Co., 72
T.C. at 19); see also Excelsior Aggregates, T.C. Memo. 2024-60, at *33.
The reliability of a comparable sales analysis depends on the
comparability of the properties selected as comparables and the
reasonableness of the adjustments made to the prices to establish
comparability. Wolfsen Land & Cattle Co., 72 T.C. at 19–20.
“In the case of vacant, unimproved property . . . the comparable
sales approach is ‘generally the most reliable method of valuation.’”
Oconee Landing, T.C. Memo. 2024-25, at *67 (quoting Estate of Spruill,
88 T.C. at 1229 n.24); see also Excelsior Aggregates, T.C. Memo. 2024-
60, at *38; Savannah Shoals, T.C. Memo. 2024-35, at *35. “The
comparable sales approach is usually the most reliable indicator of value
when sufficient information exists” because “the market place is the best
indicator of value, based on the conflicting interests of many buyers and
sellers.” Corning Place, T.C. Memo. 2024-72, at *32 (quoting Estate of
Spruill, 88 T.C. at 1229 n.24).
Sales of properties similar to the easement property generally
confirm the values seen in the previous transactions. Operating from
the idea that the GMT report rendered the easement property unique,
Mr. Hayter and the Beasley Timber experts did not analyze comparable
properties. The Commissioner’s expert, Mr. Sheppard, thus has the field
to himself, aside from Beasley Timber’s attacks on him. We find his
results persuasive.
Mr. Sheppard concluded that sufficient sales data existed in the
primary trade area for similarly configured tracts with a similar highest
and best use (i.e., agricultural/residential/recreational use with
knowledge of mineral on the site and the opportunity to obtain legal
approvals to allow mining). Out of a pool of several hundred sales, Mr.
Sheppard found 12 sales of properties that he deemed “comparable”
because of exploratory-stage knowledge of kaolin on the respective
properties. Mr. Sheppard focused on transactions sold or purchased by
a known kaolin operator that involved land sales of “active mines,
adjacent land area for expansion of an existing mine, land intended for
(observable using current aerials, views from the street, press releases,
59
[*59] etc.) immediate or short-term mine development, and land
speculatively purchased but not mined (also observable using aerials,
views from the street, lack of press releases, etc.).”
From the 12, Mr. Sheppard ultimately selected 4 that he believed
to be “the most similar in terms of size/acres, location, and date of sale:”
●Comparable #1: This sale involved a 161.62-acre parcel in
Wilkinson County, Georgia, which was purchased by
Cascadas de Agua Azul, LLC (Agua Azul), in August 2016
for $332,775 ($2,059 per acre). At the time of sale, the
property was adjacent to a large BASF kaolin mining pit
and plant, had proximate highway access, and was not
zoned for a specific use. The seller, an individual, retained
rights to 50% of any royalties paid from mining on the
property.
●Comparable #2: This sale involved a 79.09-acre parcel in
Wilkinson County, Georgia, which also was purchased by
Agua Azul in August 2016, for $197,564 ($2,498 per acre).
This property likewise abutted the large BASF kaolin
mining pit and plant, had proximate highway access, and
was not zoned for a specific use. The seller of this property
(a limited liability company) also reserved rights to 50% of
any royalties paid from mining the property.
●Comparable #3: This sale involved a 101.76-acre parcel
near Wilkinson County, Georgia, which was purchased by
Redsprings Properties, LLC, in May 2015 for $150,000
($1,474 per acre). The seller, a limited liability company,
transferred the property in fee simple. The property was
in an area with a major concentration of kaolin processing
plants but along an interior road as opposed to a highway.
●Comparable #4: This sale involved a 191.13-acre parcel in
Wilkinson County, Georgia, which was purchased by
Imerys in February 2015 for $382,000 ($1,999 per acre).
KaMin, the seller, transferred the property in fee simple.
The property was located a similar distance from major
kaolin processing plants as the easement property on an
interior road and was not zoned for a specific use.
As part of his analysis, Mr. Sheppard made upward adjustments
to the sale prices of the four properties to account for characteristics
60
[*60] inferior to those of the easement property, including reservation
of rights, highway access, location, property infrastructure, and
topography. After the adjustments were made, Mr. Sheppard concluded
that the “before value” of the easement property was between
$1,862/acre and $2,639/acre with Comparable #2 being the most similar
overall giving a fair market value indication for the easement property
at $2,563/acre. On the basis of these facts and all the sales data, Mr.
Sheppard concluded that the fair market value of the entire easement
property, as of December 2017, was “$162,000, rounded ($2,500/acre for
the 64.70 acre subject property).”
At trial and in brief, Beasley Timber critiques Mr. Sheppard’s
valuation, pointing out that in previous takings litigation he had opined
that a property containing kaolin had a value in excess of $90,000 per
acre. This point is unpersuasive. The property at issue in the previous
litigation was at a wholly different stage in development, with KaMin
already leasing the property and having conducted extensive drilling
(e.g., 36 drill holes on approximately 20 acres) that provided precise
information regarding the exact type of kaolin on the property, which
supported actual market analysis. In this case, there is little more than
a guesstimate that there might be commercially exploitable kaolin on
the property, with the actions of market participants providing strong
suggestions to the contrary.
We believe that Mr. Sheppard’s analysis and conclusions are
sound and conclude that they generally confirm the results of the actual
transactions involving the easement property.
c. Income Approach
The income method values a property by computing the present
value of projected future income from the property. Chapman Glen Ltd.,
140 T.C. at 327; Marine v. Commissioner, 92 T.C. 958, 983 (1989), aff’d,
921 F.2d 280 (9th Cir. 1991) (unpublished table decision); see also
Excelsior Aggregates, T.C. Memo. 2024-60, at *33; Savannah Shoals,
T.C. Memo. 2024-35, at *36. “The theory behind an income approach is
that an investor would be willing to pay no more than the present value
of a property’s anticipated future net income.” Savannah Shoals, T.C.
Memo. 2024-35, at *36 (citing Trout Ranch, LLC v. Commissioner, T.C.
Memo. 2010-283, aff’d, 493 F. App’x 944 (10th Cir. 2012)); see also
Excelsior Aggregates, T.C. Memo. 2024-60, at *33.
61
[*61] Beasley Timber argues that the income approach best captures
the value of the easement property, given its view that the GMT report
made the property unique and a landowner-operated kaolin mine
represented the highest and best use. We disagree on both points.
GMT’s work on eight conservation kaolin easement cases, finding
approximately the same quantity of purportedly valuable kaolin worth
approximately the same belies the contention that this property is
unique. And, for reasons that we already have detailed, the highest and
best use of the property is not a kaolin mine. Our issues with the use of
the income approach in this context run deeper than just highest and
best use, however, and would require rejection of this approach even if
we were to agree that kaolin mining was plausible.
“The income capitalization [approach] is most reliable when used
to determine the value of an existing business with a track record of
income, expenses, profits, and growth rates. A historical track record
provides real-world inputs that supply a plausible basis for projecting
future revenue.” Excelsior Aggregates, T.C. Memo. 2024-60, at *43–44
(citing Whitehouse III, 139 T.C. at 325 (noting that the income approach
“has been judged an unsatisfactory valuation method for property that
does not have a track record of earnings”)).
“Income valuation methods are not favored when valuing vacant
land with no income-producing history because they are inherently
speculative and unreliable.” Savannah Shoals, T.C. Memo. 2024-35,
at *36; see also Whitehouse Hotel III, 139 T.C. at 324–25; Ambassador
Apartments, Inc. v. Commissioner, 50 T.C. 236, 243–44 (1968), aff’d per
curiam, 406 F.2d 288 (2d Cir. 1969); Excelsior Aggregates, T.C. Memo.
2024-60, at *33. “The income approach is rarely appropriate when
seeking to determine the value of undeveloped property with no existing
cashflow.” Corning Place, T.C. Memo. 2024-72, at *37; see Excelsior
Aggregates, T.C. Memo. 2024-60, at *44 (“[C]ourts have often noted ‘the
folly of trying to estimate the value of undeveloped property by looking
to its anticipated earnings.’” (quoting Pittsburgh Terminal Corp v.
Commissioner, 60 T.C. 80, 89 (1973), aff’d, 500 F.2d 1400 (3d Cir. 1974)
(unpublished table decision))); see also Chapman Glen, 140 T.C. at 327;
Whitehouse Hotel III, 139 T.C. at 324–25; Ambassador Apartments, 50
T.C. at 243–44; Savannah Shoals, T.C. Memo. 2024-35, at *36. “Absent
a financial track record, every input into the DCF analysis necessarily
involves speculation.” Excelsior Aggregates, T.C. Memo. 2024-60, at *44;
see also Corning Place, T.C. Memo. 2024-72, at *37 (“Lacking reliable
data, the appraiser would have to rely on a lengthy series of
assumptions, estimates, and guesstimates.”). “That problem would be
62
[*62] at its apogee here—attempting to predict the future revenues and
expenses of a nonexistent business for a 30-year period.” Excelsior
Aggregates, T.C. Memo. 2024-60, at *44; see also Corning Place Ohio,
T.C. Memo. 2024-72, at *37–38.
“When the income approach is used, the Court must examine the
plausibility of the critical assumptions made by the appraiser.”
Excelsior Aggregates, T.C. Memo. 2024-60, at *44 (citing Kiva Dunes
Conservation, LLC v. Commissioner, T.C. Memo. 2009-145, 97 T.C.M.
(CCH) 1818, 1820). “Each assumption, whether large or small, carries
with it ‘some risk of error.’” Id. (quoting Whitehouse III, 139 T.C. at 323).
“As interdependent assumptions multiply, the risk of error can increase
exponentially.” Id.
We begin with the simple observation that the evidence before us,
including the testimony of market participants, firmly establishes that
no one involved in the kaolin industry would have paid nearly $17
million for the easement property even if a person were to credit the
GMT report and the discounted cashflow analyses that followed it. To
put it another way, no rational businessperson would pay the net
present value of a business simply to buy the property, as is implicit in
Beasley Timber’s position equating the two values. Savannah Shoals,
T.C. Memo. 2024-35, at *45 (“We are not convinced that a quarry
operator would pay the [mineral’s] net present value for the land as
there would be no means for a profit.”).
This conclusion is underscored by the principle of substitution,
i.e., that “a prudent man will pay no more for a given property than he
would for a similar property.” Mill Road, T.C. Memo. 2023-129, at *51
n.30 (quoting Estate of Rabe v. Commissioner, T.C. Memo. 1975-26, 34
T.C.M. (CCH) 117, 119, aff’d, 566 F.2d 1183 (9th Cir. 1977) (unpublished
table decision)). GMT’s own track record indicates that properties with
similar deposits of kaolin are plentiful in Wilkinson County, and yet
Messrs. Beasley and Loudermilk and various appraisers all noted that
the per-acre values of land in Wilkinson County were somewhere
between $600 and $2,400. No rational businessperson would pay $17
million for a piece of property with possibilities similar to one that could
be purchased for under $200,000.
This example points to the oddity produced by using the income
approach here. JL Minerals is claiming a deduction for donating one
stick in its bundle of property rights. But according to JL Minerals’s
income approach, this one stick has a much greater value than what the
63
[*63] evidence shows a market participant would pay for the fee simple
property, which includes all the sticks in the bundle.
Something is plainly off. We believe the reason for the
counterintuitive result is that the discounted cashflow method is not
valuing the property at all, but what a speculative business could do
with the property. But a discounted cashflow method geared to what a
business could earn is of limited utility in determining what a property
is worth.
Of course, that is not to say that the income approach is flawed.
To the contrary, the income approach is reliable where a historical track
record provides supported inputs. The case before us provides an
illustration of an appropriate use of the income method, in fact. As the
industry participants explained, kaolin mining in 2017 almost always
involved a mineral lease between a processor (or Arcilla) and a property
owner, according to which the property owner received agreed royalties
from tonnage of kaolin mined. This type of well-established royalty
agreement of course was seen in fact in the 2003 mineral lease between
the Club and Huber. With historical royalty information, the use of an
income approach could be used to determine the value of the land,
including the royalty derived.
Where the income approach lacks good inputs, it becomes little
more than fan fiction aimed at generating the highest numbers possible,
no matter how objectively ludicrous. We consider as an example Dr.
Capps’s resource valuation report, which uses a discounted cashflow
method to provide a net present value associated with mining the kaolin
deposit. Without knowing more than the vague information provided by
GMT, Dr. Capps predicts a very happy future for a JL Minerals-operated
mine as of 2017, opining that it would carve a niche in the kaolin market
its first year, then expand to 200,000 tons sold the next two years, and
end with 250,000 tons sold the remainder of its 16- or 25-year mine life.
Using average prices and costs, together with a 7.6% discount rate (at
the top end of the normal discount rate range for kaolin companies), Dr.
Capps saw nothing but success ahead had JL Minerals chosen to mine.
These rosy projections have no connection to the reality of kaolin
mining that we saw at trial. Dr. Capps assumes a market that seems
quite unlikely, as evidenced by the fact that there are no landowner-
operated mines. The major processors have no interest in buying kaolin
from outside suppliers, except as a last resort, which makes
participation in the higher end of the kaolin market unlikely. Even if
64
[*64] they had some interest in outside supply, Dr. Capps does not
explain why that supply would be met by JL Minerals rather than
Arcilla, already a known supplier in the industry with considerable
experience in providing kaolin meeting required specifications.
If, as seems likely, the higher end of the market is not open for
business, then JL Minerals would be competing with Arcilla for a share
of the kaolin market for air-float processing, to the extent that the kaolin
on the property even was suitable for such use. The kaolin used for this
type of processing fetches a lower price. Questions of demand are
heightened given declining domestic production and the apparent
surfeit of kaolin-rich properties as seen in the eight other kaolin
conservation easements that GMT backed.
Keeping company with the uncertain demand are the
unsupported costs. Significant parts of the cost figures (hauling and fuel
surcharges) are contingent on the plant’s processing the kaolin or the
blunging site’s receiving the kaolin. These sites are buyer specific, and
consequently the distance and accompanying costs are not at all defined.
More importantly, we believe that Dr. Capps failed to fully take
into account the risks of the landowner-operated mine model. We
question Dr. Capps’s timeline as we heard from industry representatives
that a drilling and testing program could take five to eight years simply
to determine the specification of the kaolin on the property to be mined.
This is a far cry from his discounted cashflow that anticipated sales from
mining during the first year.
Dr. Capps also seems to have basically assumed that JL Minerals
would immediately be functioning like a processor or Arcilla. But, as
Mr. McKenzie observed, a new business would require a lab with
employees to verify the kaolin specifications, as well as a trained crew
to strip overburden, mine, and haul the product. According to Mr.
McKenzie, experienced hands were in short supply in 2017. To the
extent that Beasley Timber argued at trial that Arcilla could step in and
provide these services, we question why Arcilla would not simply treat
JL Minerals like any other landowner who needed kaolin to be mined
and agree to a royalty rate producing a fraction of what Dr. Capps
estimated.
We could go on (and make similar observations about Messrs.
Hayter’s, Spears’s, and Kenny’s analyses). That is the point: Use of the
discounted cashflow method with so few reliable inputs and so many
65
[*65] variables and unknowns is simply an exercise in imagination. As
such it is altogether unreliable, and we would ignore the laughable
results it generated even if we thought mining were the easement
property’s highest and best use. We caution taxpayers in the future who
choose to use this method without strong support that we will view the
income approach and the discounted cashflow method with skepticism,
particularly in the conservation easement context.
3. Valuation Conclusion
On the record before us, we find that the easement property had
a before value of $2,700 per acre, in light of the actual sales of the
easement property as well as Mr. Sheppard’s persuasive analysis of
sales of comparable properties. The total before value of the property
accordingly is $174,690 ($2,700 × 64.7 acres). Mr. Sheppard found the
lowest “after value,” concluding that the easement property was worth
$81,000 after the granting of the easement. As this value is more
favorable to JL Minerals than the one its own experts determined, we
will treat this as a concession by the Commissioner.
The fair market value of the conservation easement accordingly
is $93,690 ($174,690 − $81,000) at the time JL Minerals contributed the
conservation easement to Heritage.
V. Deduction-Related Expenses
In addition to adjusting the charitable contribution, the IRS
disallowed $227,534 in “other” deductions JL Minerals claimed on its
2017 tax return. The parties agree that the amount at issue is actually
$228,913.
Beasley Timber asserts that all of the enumerated expenses were
incurred in connection with “investigating the values of the property and
documenting the conservation easement contribution.” It posits that the
amounts were deductible either under (1) section 165(a) as a loss
stemming from the abandonment of certain of its rights in the easement
property or (2) section 212(3) as expenses incurred as part of its
reporting of the charitable contribution deduction.
Neither provision fits. As an initial matter, Beasley Timber fails
to show that a donation of rights for which a charitable contribution
deduction has been claimed under section 170 can double as a loss for
section 165(a) purposes. And the text of section 212 limits the claimant
of that deduction to “an individual,” which plainly excludes a limited
66
[*66] liability company such as JL Minerals. See, e.g., Boris I. Bittker
& Lawrence Lokken, Federal Taxation of Income, Estates & Gifts
¶ 20.1.1 (3d ed. 1999). 20
VI. Section 6662 Accuracy-Related Penalties
The Commissioner determined accuracy-related penalties under
section 6662 with respect to both the charitable contribution deduction
and the other deductions JL Minerals claimed. We conclude that the
40% gross valuation misstatement penalty under section 6662(h)
applies to JL Minerals with respect to the former deduction. We
likewise find that the 20% penalty applies with respect to the other
deductions, either on negligence or substantial understatement
grounds. 21
A. Governing Principles
Section 6662(a) and (b)(1), (2), and (3) imposes an accuracy-
related penalty on the “underpayment of tax required to be shown on a
return . . . equal to 20 percent of the portion of the underpayment to
which this section applies” upon a taxpayer who underpays its tax
because of, among other things, “[n]egligence or disregard of rules or
regulations,” a “substantial understatement of income tax,” or a
“substantial valuation misstatement.” An understatement of income
tax is substantial if it exceeds the greater of “10 percent of the tax
required to be shown on the return for the taxable year” or $5,000. I.R.C.
§ 6662(d)(1)(A). For 2017, the year at issue, a substantial valuation
misstatement exists if “the value of any property . . . claimed on any
return . . . is 150 percent or more of the amount determined to be the
correct amount of such valuation.” I.R.C. § 6662(e)(1)(A). None of these
penalties will be imposed where the taxpayer had “reasonable cause.”
20 We recognize that businesses often can deduct expenses under section 162
that an individual might deduct under section 212. Beasley Timber makes no
argument that the expenses are deductible under section 162 and has accordingly
forfeited such an argument. See, e.g., Sepulveda v. U.S. Att’y Gen., 401 F.3d 1226, 1228
n.2 (11th Cir. 2005) (stating an appellant who fails to argue an issue in his brief
abandons it); Rowen v. Commissioner, 156 T.C. 101, 115–16 (2021) (explaining that a
“litigant has an obligation to spell out its arguments squarely and distinctly, or else
forever hold its peace” (quoting Schneider v. Kissinger, 412 F.3d 190, 200 n.1 (D.C. Cir.
2005))); Estate of Spizzirri v. Commissioner, T.C. Memo. 2023-25, at *17 n.9 (“The
[taxpayer] has failed to develop this argument and, consequently, has forfeited the
issue.”).
21 The Commissioner has conceded the reportable transaction understatement
penalty under section 6662A asserted in the FPAA.
67
[*67] I.R.C. § 6664(c)(1). But see I.R.C. § 6664(c)(3) (imposing
heightened requirements for a substantial valuation overstatement).
One possible ground for claiming “reasonable cause” is reliance
on professional advice. Treas. Reg. § 1.6664-4(b). “If a taxpayer alleges
reliance on the advice of a tax professional, that ‘advice must generally
be from a competent and independent advisor unburdened with a
conflict of interest and not from promoters of the investment.’” Oakhill
Woods, LLC v. Commissioner, T.C. Memo. 2020-24, at *29 (quoting
Mortensen v. Commissioner, 440 F.3d 375, 387 (6th Cir. 2006), aff’g T.C.
Memo. 2004-279); see also Gustashaw v. Commissioner, 696 F.3d 1124,
1139 (11th Cir. 2012), aff’g T.C. Memo. 2011-195. “Advice hardly
qualifies as disinterested or objective if it comes from parties who
actively promote or implement the transactions in question.” Stobie
Creek Invs. LLC v. United States, 608 F.3d 1366, 1382 (Fed. Cir. 2010).
“A taxpayer advancing a reliance-on-professional-advice defense must
also show that it actually relied in good faith on the advice it received.”
Oakhill Woods, T.C. Memo. 2020-24, at *29; see also Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 98–99 (2000), aff’d, 299 F.3d
221 (3d Cir. 2002).
In the case of a “gross valuation misstatement”—i.e., where the
value of property claimed on the return is 200% or more of the amount
determined to be the correct valuation—the rate of the accuracy-related
penalty is increased to 40%, I.R.C. § 6662(h)(1) and (2)(A)(i), and no
“reasonable cause” defense is available, I.R.C. § 6664(c)(3). 22
B. Charitable Contribution Deduction
JL Minerals claimed on its partnership return a charitable
contribution deduction of $16,745,000 for its donation of the easement.
We have determined that the correct value of the easement at yearend
2017 was no greater than $93,690. JL Minerals therefore overstated on
its return the value of the easement by much more than 200%, and the
22 Generally, only one accuracy-related penalty may be applied with respect to
any given portion of an underpayment, even if that portion is penalizable on more than
one of the grounds set forth in section 6662(b). Our jurisdiction in a TEFRA
proceeding, as here, extends to the determination of partnership items and the
applicability of any penalty that relates to an adjustment to a partnership item. I.R.C.
§§ 6221, 6226; United States v. Woods, 571 U.S. 31, 39–42 (2013). “There is thus no
limitation on our ability to determine the applicability of more than one accuracy-
related penalty at the partnership level.” Oconee, T.C. Memo. 2024-73, at *3; see also
Mill Road, T.C. Memo. 2023-129, at *70.
68
[*68] 40% penalty under section 6662(h) for a gross valuation
misstatement applies. See I.R.C. § 6662(e)(1)(A), (h)(2)(A)(i). 23
C. Other Deductions
The FPAA asserted accuracy-related penalties with respect to the
other deductions based on substantial understatement and negligence.
See I.R.C. § 6662(a) and (b)(1) and (2).
As to a substantial understatement, any understatement of
income tax attributable to the disallowance of the $228,913 of other
deductions that is substantial (i.e., any understatement that “exceeds
the greater of—(i) 10 percent of the tax required to be shown on the
return for the taxable year, or (ii) $5,000”), I.R.C. § 6662(d)(1)(A), is
subject to penalty at the 20% rate. Beasley Timber does not argue that
JL Minerals had reasonable cause with respect to this penalty.
We hold in the alternative, and to the extent that the
understatement for any partner attributable to the other deductions is
small enough that it does not count as “substantial,” that the
underpayment is attributable to negligence. “Negligence has been
defined as lack of due care or failure to do what a reasonably prudent
person would do under like circumstances.” Mill Road, T.C. Memo.
2023-129, at *70 (citing Ocmulgee Fields, Inc. v. Commissioner, 132 T.C.
105, 123 (2009), aff’d, 613 F.3d 1360 (11th Cir. 2010)). It “includes any
failure to make a reasonable attempt to comply with the provisions of
the internal revenue laws or to exercise ordinary and reasonable care in
the preparation of a tax return.” Treas. Reg. § 1.6662-3(b)(1).
Negligence also “includes any failure by the taxpayer to keep adequate
books and records or to substantiate items properly.” Id.As we have explained, JL Minerals failed to identify proper
grounds for its deduction, pointing to plainly inapplicable provisions. In
any event, the record before us shows that several of the expenses
underlying the catchall deduction were reported for the wrong year and
most of the other expenses lack substantiation. Beasley Timber fails to
23 Since we have sustained the Commissioner’s imposition of the 40% gross
valuation misstatement penalty against JL Minerals (while allowing a charitable
contribution deduction of $93,690), it is not necessary to address whether the
alternative penalties for negligence or disregard of rules or regulations, a substantial
understatement of income tax, or a substantial valuation misstatement should be
imposed.
69
[*69] argue that it had reasonable cause on this point, and so we find
the penalty applicable.
VII. Conclusion
Throughout trial and briefing, Beasley Timber has maintained
that JL Minerals did nothing more than respond to the incentive offered
by Congress to encourage conservation. To be fair, “[t]he issues before
us are influenced by a gentle tension between a defined public policy of
favoring, for the public good, perpetual conservation easements and the
strict requirements imposed on taxpayers when claiming charitable
deductions for granting such easements.” Brooks v. Commissioner, 109
F.4th 205, 222 (4th Cir. 2024), aff’g T.C. Memo. 2022-122.
The value of the deduction claimed in this case, however, “does
not pass any reasonable smell test.” Id. JL Minerals and its coterie of
advisors took Congress’s attempt to promote conservation and cynically
used it as a cover to fleece the public fisc to the tune of nearly $17 million
in baseless deductions. The fault lies not in Congress’s action, but in JL
Minerals itself.
To reflect the foregoing,
Decision will be entered under Rule 155.