Oakbrook Land Holdings, LLC, William Duane Horton, Tax Matters Partner v. Commissioner

T.C. Memo. 2020-54
UNITED STATES TAX COURT
OAKBROOK LAND HOLDINGS, LLC, WILLIAM DUANE HORTON,
TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5444-13. Filed May 12, 2020.
David M. Wooldridge, Michelle A. Levin, Ronald A. Levitt, and Gregory P.
Rhodes, for petitioner.
W. Benjamin McClendon, Bruce K. Meneely, Robert W. Dillard, and
William W. Kiessling, for respondent.
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[*2] MEMORANDUM FINDINGS OF FACT AND OPINION
HOLMES, Judge: In recent years the Commissioner has attacked a popular
form of charitable contribution--the donation of conservation easements.1 Many
of these attacks are surgical strikes on what he believes are gross exaggerations of
the value of particular easements. But he has also launched three sorties--all
predicated on the requirement that such easements be “perpetual”--that he hopes
will cause more widespread casualties:
! an attack on the power of donor and donee to change the terms of the
easement after its contribution;
! an attack on the retained right of the donor to add improvements to
the property described in the easement; and
! an attack on a clause commonly found in easements, particularly in
the southeastern part of the country, that divides between donor and
donee future hypothetical proceeds from a future hypothetical
extinguishment of the easement in a way that he claims violates one
of his regulations.
In Pine Mountain Pres., LLLP v. Commissioner, 151 T.C. 247, 280-82
(2018), we held that the retained power of all parties to all contracts to change
contractual terms does not by itself deprive a deed of easement of its required
perpetuity. We also held there that a donor’s retained right to add improvements
1
See, e.g., I.R.S. News Release IR-2005-129 (Oct. 27, 2005) (referring to
certain conservation easements as abusive).
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[*3] “appurtenant to residential development” does violate the perpetuity
requirement as a matter of law when the precise location of those improvements is
not set forth in the deed of easement. Id. at 275-79.
In this case, the Commissioner seeks to destroy any charitable-contribution
deduction for an easement whose deed contains an extinguishment clause that he
argues does not meet the requirements of one of his regulations, section 1.170A-
14(g)(6)(ii), Income Tax Regs. This case appears to be the first one in which the
donor fights back by challenging the validity of that regulation.
What the regulation means and whether it’s valid are questions whose
answers will affect a great many such donations. There’s a difference of opinion
in the Court on the question of the regulation’s validity; there is not on the
factfinding and application of the regulation to those facts.
FINDINGS OF FACT
In 2007 a couple was driving on a country road about fifteen minutes
outside Chattanooga in search of the perfect place for a new home. They stopped
at a briar-covered for-sale sign on a 143-acre piece of land on White Oak
Mountain. The property was significantly larger and considerably more
overgrown than what they wanted, but they thought it could be the diamond in the
rough for which they had been prospecting.
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[*4] To understand why requires understanding who the husband in this couple
is. Duane Horton grew up in Chattanooga, earned a degree in construction from
Georgia Tech, and moved back to his home town. He started his career there in
1998, and in 2002 he formed a construction company. Horton proved to be a
talented entrepreneur, and his company grew and became quite successful. In
2007 Horton and a number of his subcontractors, suppliers, and past clients
formed a real-estate development company and a real-estate investment fund. The
development company excels in “working with larger pieces of property that are
* * * usually in high-growth sectors of the area that may have challenges,
* * * [such as] lack of infrastructure, access issues, rezoning issues, or topography
issues, * * * and solv[ing] those problems and unlock[ing] the potential value of
the property.” So when Horton drove past the property in 2007, he was uniquely
able to see its potential, and he quickly contacted various investors to plan how to
buy and develop it.
Horton and these investors formed Oakbrook Land Holdings, LLC in
August 2007 and four months later it bought the property for $1,700,000.
Oakbrook planned at first to develop the subject property with “higher-end, single-
family residences with a commercial service area.” But before that vision could be
realized, Oakbrook had to overcome a number of thorny obstacles, briars the least
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[*5] among them. It started by building a bridge across the “Hurricane Creek;”
this alone created access to more than 80% of the previously inaccessible property.
It then installed a high-pressure sewer-pump station and won rezoning of a portion
of the property from A-1 Agricultural District to C-2 Local Business and
Commercial District.
As 2007 turned into 2008, Horton learned about a conservation easement on
an entirely unrelated property in North Georgia. He was intrigued and began to do
some research. At some point in 2008 he started to think about placing a
conservation easement on the Oakbrook property. He met with James Wright,
executive director of the Southeast Regional Land Conservancy, who gave him a
short course on the easement process and told him that the Conservancy’s lawyers
would draft the legal paperwork should Oakbrook want to give it an easement.
Horton took what he learned to the other Oakbrook investors who, despite some
early opposition, agreed to the idea. Oakbrook’s next move was to transfer some
of the acreage to related entities in mid-December 2008, which enabled it to be
developed without restriction. This left Oakbrook with approximately 106 acres.
Later that month Oakbrook donated a conservation easement on all 106
acres to the Conservancy through a document called “Conservation Easement and
Declaration of Restrictions and Covenants” (Deed). Because of its unfamiliarity
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[*6] with conservation easements, Oakbrook and its members relied heavily on the
Conservancy to draft this Deed. We specifically find that Horton, acting on behalf
of Oakbrook, was reasonable in inferring that the Conservancy’s experience meant
that the deeds it had drafted conformed to the Code and regulations.
The Deed’s key section for this opinion is Article VI, Section B(2). It
governs how Oakbrook and the Conservancy will divide between themselves any
proceeds if the easement is extinguished by changed circumstances or
condemnation:
This Conservation Easement gives rise to a real property right
and interest immediately vested in [the Conservancy]. For purposes
of this Conservation Easement, the fair market value of [the
Conservancy]’s right and interest shall be equal to the difference
between (a) the fair market value of the Conservation Area as if not
burdened by this Conservation Easement and (b) the fair market value
of the Conservation Area burdened by this Conservation Easement, as
such values are determined as of the date of this Conservation
Easement, (c) less amounts for improvements made by O[akbrook] in
the Conservation Area subsequent to the date of this Conservation
Easement, the amount of which will be determined by the value
specified for these improvements in a condemnation award in the
event all or part of the Conservation Area is taken in exercise of
eminent domain as further described in this Article VI, Section B(3)
below. If a change in conditions makes impossible or impractical any
continued protection of the Conservation Area for conservation
purposes, the restrictions contained herein may only be extinguished
by judicial proceeding. Upon such proceeding, [the Conservancy],
upon a subsequent sale, exchange or involuntary conversion of the
Conservation Area, shall be entitled to a portion of the proceeds equal
to the fair market value of the Conservation Easement as provided
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[*7] above. [The Conservancy] shall use its share of the proceeds in a
manner consistent with the conservation purposes set forth in the
Recitals herein.
Article VI, Section B(3) goes on to state:
Whenever all or part of the Conservation Area is taken in
exercise of eminent domain * * * so as to abrogate the restrictions
imposed by this Conservation Easement, * * * [the] proceeds shall be
divided in accordance with the proportionate value of [the
Conservancy]’s and O[akbrook]’s interests as specified above; all
expenses including attorneys fees incurred by O[akbrook] and [the
Conservancy] in this action shall be paid out of the recovered
proceeds to the extent not paid by the condemning authority.
According to Wright, the above language is standard among the
Conservancy’s conservation easements. And although he couldn’t say with
absolute certainty, Wright was “pretty sure” the language was adopted from
numerous other model agreements, including those produced by the Land Trust
Alliance.2
Wright explained that, as with the regulation, this extinguishment clause
starts by defining the fair market value (FMV) of the easement as the difference
between the property’s value without the easement and the property’s value with
2
Wright suggested that the Conservancy has 85 easements with similar
language. According to amici in another case, however, there is reason to believe
thousands of conservation easements have similar language. Brief for Land Trust
Alliance, Inc. et al. as Amici Curiae Supporting Petitioners at 6, PBBM-Rose Hill,
Ltd. v. Commissioner, 900 F.3d 193 (5th Cir. 2018) (No. 17-60276).
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[*8] the easement. Wright stressed that he viewed this language as securing a
fixed amount for the Conservancy. He explained that the Conservancy expected
that Oakbrook would exercise its right to improve the property within the limits
set by the Deed, but did not think it right for the Conservancy to share in any
condemnation award or extinguishment proceeds attributable to any
improvements: The Conservancy, Wright credibly testified, “did not pay for those
improvements” and shouldn’t have a “property interest in those improvements.”
He also had a view on what the regulation required: “[R]ather than having a
proportion * * * -- the Treasury regulation requires at a minimum that a proportion
-- * * * our language establishes fair value a[s] an absolute -- it’s not a proportion;
therefore, it is [al]ways going to exceed * * * the minimum required by the IRS.”
While Oakbrook worked toward closing on the easement, it also started to
look for an appraiser to value the conservation easement for purposes of claiming
a charitable deduction. Oakbrook picked Dave Roberts, who valued the easement
at $9,545,000. This is the amount Oakbrook claimed on its Form 1065, U.S.
Return of Partnership Income, as a charitable contribution.3
3
Roberts initially valued the easement at approximately $19,500,000.
Horton asked for a second appraisal because “a number of consultants and
investors * * * didn’t feel comfortable with that high of a value.”
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[*9] To prepare its 2008 return Oakbrook hired Henderson Hutcherson &
McCullough, PLLC (HHM), an accounting firm familiar with Oakbrook and the
requirements for conservation-easement deductions. Horton was unfamiliar with
conservation easements and under intense scrutiny by Oakbrook’s investors, so he
discussed Oakbrook’s 2008 tax return with HHM multiple times. This assured
him that the easement deduction was proper.
HHM’s assurance did not extend to the Commissioner, who timely issued an
FPAA4 to Oakbrook for its 2008 tax year. In it, the Commissioner completely
disallowed Oakbrook’s charitable contribution and asserted an accuracy-related
penalty under section 6662 for negligence, disregard of regulations, or substantial
4
FPAAs are notices of final partnership administrative adjustment. Before
its repeal, see Bipartisan Budget Act of 2015, Pub. L. No. 114-74, sec. 1101(a),
129 Stat. at 625, part of the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. No. 97-248, secs. 401-407, 96 Stat. at 648-71, governed the tax
treatment and audit procedures for certain partnerships. TEFRA partnerships are
subject to special tax and audit rules. See secs. 6221-6234. When the IRS audits a
TEFRA partnership return and determines an adjustment is necessary, it sends the
partnership an FPAA. The FPAA describes all the proposed changes at the
partnership level. TEFRA partnerships designate a partner to act as the tax matters
partner to deal with the IRS. Sec. 6231(a)(7). (Unless otherwise indicated, all
section references are to the Internal Revenue Code in effect at all relevant times.)
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[*10] understatement. Oakbrook timely petitioned this Court, and we tried the
case in Birmingham, Alabama.5
The Code requires a conservation easement to be “perpetual”. Sec.
170(h)(2)(C), (5)(A). The Commissioner disallowed Oakbrook’s deduction in part
because he concluded that the Deed’s extinguishment clause would split the
proceeds from the property’s condemnation or the easement’s termination in a way
that failed to protect the contribution’s conservation purpose in perpetuity. See
sec. 170(h)(1)(C), (5)(A). He points to section 1.170A-14(g)(6)(ii), Income Tax
Regs.--part of a bigger set of regulations that more comprehensively fences in the
Code’s perpetuity requirement. The problem these regulations try to solve stems
from the fact that perpetuity can be a very long time: What happens if a local
government condemns part of the property for a road, or a local power authority
floods the property as part of a hydropower project, or anything else happens to
the property that would destroy its conservation purpose? Under common law
such events can “extinguish” the easement; the Commissioner’s regulation is
meant to regulate the division of any compensation for this extinguishment
5
Oakbrook’s principal place of business was in Chattanooga, Tennessee, at
the time the petition was filed. This case is therefore appealable to the Sixth
Circuit. See sec. 7482(b)(1)(E).
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[*11] between the donor and donee so that the donee can continue to pursue the
easement’s conservation purpose elsewhere and into the future.
The Commissioner attacks the Deed’s extinguishment clause with two
related arguments. The first is that the clause’s formula to distribute
extinguishment proceeds doesn’t correctly track the regulation, because it would
distribute to the Conservancy a fixed amount, and not a proportion, of any such
proceeds. The second is that the clause would subtract from those proceeds the
value of improvements that Oakbrook could make after the donation. Oakbrook
responds that the extinguishment clause complies with the regulation but, if it does
not, the regulation is invalid.6
OPINION
I. Qualified Conservation Contributions
Conservation easements are supposed to preserve properties with natural,
historical, or cultural significance through perpetual restrictions on their use.
They also allow donors to take charitable deductions, some of which can be quite
sizable.
6
In his brief the Commissioner also claimed that Oakbrook is liable for a
gross-valuation misstatement penalty under section 6662(h), a substantial-
valuation misstatement penalty under section 6662(e), or in the alternative, a
substantial-understatement-of-tax penalty under section 6662(d). He has since
conceded that these penalties do not apply.
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[*12] The popularity of conservation easements has risen dramatically in recent
years. The National Conservation Easement Database (NCED) has cataloged
167,721 conservation easements in effect throughout the United States, which
affect more than 27,700,000 acres of land. Nat’l Conservation Easement
Database, https://www.conservationeasement.us (last visited February 5, 2020).7
The number of acres conserved under easement is up from the nearly 16,800,000
in 2015, 13,200,000 in 2010, and 6,100,000 in 2005. Land Trust Alliance, 2015
National Land Trust Census Report,
http://s3.amazonaws.com/landtrustalliance.org/2015NationalLandTrustCensusRep
ort.pdf.
As the popularity of conservation easements has increased, so too have the
Commissioner’s suspicions about them. See, e.g., PBBM-Rose Hill, Ltd. v.
Commissioner, 900 F.3d 193 (5th Cir. 2018); BC Ranch II, L.P. v. Commissioner,
867 F.3d 547 (5th Cir. 2017), vacating and remanding T.C. Memo. 2015-130;
Belk v. Commissioner, 774 F.3d 221 (4th Cir. 2014), aff’g 140 T.C. 1 (2013);
7
Even the NCED, which provides the most complete up-to-date census
data, admits that its numbers are significantly understated. The NCED estimates
that it lists only 49% of publicly held easements and 90% of non-profit-held
easements across the United States. Completeness, Nat’l Conservation Easement
Database, https://www.conservationeasement.us/completeness (last visited
May 11, 2020).
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[*13] Glass v. Commissioner, 471 F.3d 698 (6th Cir. 2006), aff’g 124 T.C. 258
(2005); Pine Mountain, 151 T.C. 247. In December 2016 the Commissioner
released a notice in which he characterized syndicated conservation-easement
transactions8 as potential “tax avoidance transactions,” and then proceeded to
include syndicated conservation easements as his newest addition to the list of 35
other “Recognized Abusive and Listed Transactions.” See I.R.S. Notice 2017-10,
2017-4 I.R.B. 544; Recognized Abusive and Listed Transactions, Internal
Revenue Serv., https://www.irs.gov/businesses/corporations/listed-transactions
(last updated Jan. 31, 2020).
The Code, however, makes at least some conservation easements legitimate,
even though section 170(f)(3)(A) generally disallows a charitable-contribution
deduction for any gift of real property that “consists of less than the * * * entire
interest in such property.” The key is for a donor to meet the unusually
complicated rules for a donation of a “qualified conservation contribution.” Sec.
170(f)(3)(B)(iii). A “qualified conservation contribution” is “a contribution--(A)
8
Syndicated conservation easements are transactions in which “a promoter
offers prospective investors in a partnership or other pass-through entity (‘pass-
through entity’) the possibility of a charitable contribution deduction for donation
of a conservation easement.” I.R.S. Notice 2017-10, 2017-4 I.R.B. 544, 545. The
easement at issue in this case is not a syndicated conservation easement.
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[*14] of a qualified real property interest, (B) to a qualified organization, (C)
exclusively for conservation purposes.” Sec. 170(h)(1). Although a contribution
must satisfy each of these requirements, our focus in this opinion is on the third
requirement--that the contribution be “exclusively for conservation purposes,” sec.
170(h)(1)(C), which the Code defines in the negative: “A contribution shall not be
treated as exclusively for conservation purposes unless the conservation purpose is
protected in perpetuity,” sec. 170(h)(5)(A) (emphasis added).
We begin with a bit of a refresher on the common law of servitudes. A
servitude is “a legal device that creates a right or an obligation that runs with land
or an interest in land.” 1 Restatement, Property 3d (Servitudes), sec. 1.1(1)
(2000). It can be granted either appurtenant--meaning “the rights or obligations of
a servitude are tied to ownership or occupancy of a particular unit or parcel of
land,” id. sec. 1.5(1), or in gross--meaning “the benefit or burden of a servitude is
not tied to ownership or occupancy of a particular unit or parcel of land,” id. sec.
1.5(2). Easements, a form of servitude, may also be appurtenant or in gross, but
because “most conservation and preservation servitudes are granted to
governmental bodies, land trusts, or other charitable entities * * * , the benefit will
usually be in gross.” Id. sec. 1.6 cmt. a.
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[*15] States were wary of simply applying traditional servitude law to
conservation easements. Servitudes, like other contracts, are usually between
private parties, and situations may arise where the parties no longer want to
enforce the restriction or the restriction’s continued enforcement becomes unjust.
Imagine, for example, a homeowners association (HOA) whose members agree to
build ranch-style homes to preserve their views of a nearby mountain, only to have
an office building that blocks those views appear on a lot between the HOA homes
and the mountain. A disgruntled homeowner might sue his HOA and urge that
this change in condition should terminate the restriction. See 2 Restatement,
supra, sec. 7.10. Termination of a servitude for changed conditions benefits all the
property owners that used to be bound by it, so the common law seldom requires
any money damages when one is extinguished. Id. sec. 7.11 cmt. c.
That general rule of implicit compensation for the loss of a servitude
wouldn’t work with conservation easements. And neither would the general
power of parties to servitudes, like parties to every other contract, to change their
terms. See id. sec. 7.1. Conservation easements are usually clothed with
assertions of a significant public interest, not only because their enforcement
preserves valuable land for public benefit, but also because “their creation is
subsidized indirectly by tax deductions and directly through purchases by public
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[*16] agencies and nonprofit corporations.” Id. sec. 7.11 cmt. a. Permitting an
unrestricted right to modify a conservation easement, or terminate one altogether,
could result in a loss of the public’s investment.
Applying the common-law rule--extinguishment without cash
compensation--could also lead to unusual results. A landowner with a black heart
could place a conservation easement on his property, take the associated
deduction, and then pave paradise and put up a parking lot on adjoining property.
He might prove that the easement’s conservation purpose was destroyed and
should no longer restrict development of the subject property, and then sell the
now-unburdened land. See id. cmt. d. The common-law rule of only implicit
compensation for termination of an easement could embolden landowners
(imagine well-financed developers) to use the threat of protracted changed-
conditions litigation to coerce donees (imagine thinly staffed nonprofit
organizations) into modifying or terminating their easements. Id. The cynic, or
even just the realist, can also foresee some probability of collusion between donors
and donees of conservation easements if conservation easements could create
benefits with both their formation and their destruction.
As conservation easements became popular, states enacted statutes to
change this feature of common law. Tennessee is among them. See Tenn. Code
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[*17] Ann. sec. 66-9-306 (West 2020) (conservation easement valid even if no
privity of estate or contract or no benefit to any other land, and “[n]o conservation
easement shall be held automatically extinguished because of violation of its terms
or frustration of its purposes”). These state-law changes help make conservation
easements perpetual, but the mix of statute, regulation, and caselaw that defines
what “perpetual” means can be confusing and might undermine a great many
conservation deeds of easement for reasons their drafters never expected.
One part of the solution is to limit the ability of donors and donees to
declare “changed circumstances” all by themselves. Conservation easements
typically have clauses, like the one here between Oakbrook and the Conservancy,
that provide “[i]f a change in conditions makes impossible or impractical any
continued protection of the Conservation Area for conservation purposes, the
restrictions contained herein may only be extinguished by judicial proceeding.”
Deed, Article VI, Section B(2). Getting a judge involved means there will be a
third party to monitor whether conditions really have changed.
But there’s a special problem with what happens to an easement that simply
cannot be preserved forever. If a conserved building is obliterated in a disaster, or
a conserved open space is condemned for public use, then insurance money or a
condemnation award may be substituted for the property. The original easement is
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[*18] no more, but how can money preserve the easement’s conservation purpose
“in perpetuity?” In this situation the law causes the conservation purpose to jump
into the money into which the easement has been converted. If part of that money
goes to the easement holder, the conservation purpose is considered to have
survived. That’s in the Deed here, too, in the section that says the Conservancy
“shall be entitled to a portion of the proceeds equal to the fair market value of the
Conservation Easement as provided above.” Id.
Then there’s the particular problem that arises when the donor reserves the
right to build various structures on the conservation area. For example, if the
donor reserves and subsequently exercises his right to build a home on the land,
and the entire property is later condemned, the condemnation award will
necessarily include that added value. But is it the donor or the donee who is
entitled to the proceeds attributable to the value of the home?
The Code doesn’t answer these questions--it just says that the conservation
purpose of a conservation easement must be preserved “in perpetuity.” Sec.
170(h)(5)(A). But the Treasury Department issued a regulation that more
precisely defines the term. There we find that a conservation purpose is not
perpetual if the donee organization that holds the easement is unable to carry on
the conservation purpose following judicial extinguishment. See sec.
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[*19] 1.170A-14(g)(6)(i), Income Tax Regs. To avoid this, the regulation
provides that if
a subsequent unexpected change in the conditions surrounding the
property * * * make[s] impossible or impractical the continued use of
the property for conservation purposes, the conservation purpose can
nonetheless be treated as protected in perpetuity if the restrictions are
extinguished by judicial proceeding and all of the donee’s proceeds
(determined under paragraph (g)(6)(ii) of this section) from a
subsequent sale or exchange of the property are used by the donee
organization in a manner consistent with the conservation purposes of
the original contribution.
Id. (emphasis added).
But just how much of the “proceeds” must the donee receive upon
extinguishment, either by judicial decree of changed circumstances or by
condemnation? For that answer, we look to paragraph (g)(6)(ii), which reads:
at the time of the gift the donor must agree that the donation of the
perpetual conservation restriction gives rise to a property right,
immediately vested in the donee organization, with a fair market
value that is at least equal to the proportionate value that the
perpetual conservation restriction at the time of the gift, bears to the
value of the property as a whole at that time. See
§ 1.170A–14(h)(3)(iii) relating to the allocation of basis. * * * [T]hat
proportionate value of the donee’s property rights shall remain
constant. Accordingly, when a change in conditions gives rise to the
extinguishment of a perpetual conservation restriction * * * the donee
organization, on a subsequent sale, exchange, or involuntary
conversion of the subject property, must be entitled to a portion of the
proceeds at least equal to that proportionate value of the perpetual
conservation restriction, unless state law provides that the donor is
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[*20] entitled to the full proceeds from the conversion without regard to the
terms of the prior perpetual conservation restriction.
Id. subdiv. (ii) (emphases added).
It is the meaning and application of this regulation that the parties dispute.
II. Application of the Regulation
Both the regulation and the relevant section of the Deed are densely written,
and the parties disagree about what they mean. We therefore need to
! interpret the regulation,
! construe the Deed’s extinguishment clause, and
! analyze whether the extinguishment clause meets the requirements of
the regulation.
A. Interpreting the Regulation
Our first chore is to analyze what this regulation means. We have already
done this in Coal Property Holdings, LLC v. Commissioner, 153 T.C. 126 (2019).
We held there that the regulation requires the grantee’s proportionate share upon
extinguishment of a conservation easement to be a percentage determined by a
fraction, the numerator of which is “the fair market value of the conservation
easement on the date of the gift,” and the denominator of which is “the fair market
value of the property as a whole on the date of the gift.” Id. at 137 (quoting
Carroll v. Commissioner, 146 T.C. 196, 216 (2016)).
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[*21] We issued Coal Properties while deliberating on this case, and Oakbrook
makes arguments here that Coal Properties didn’t, so we’ll briefly review them.
Oakbrook points out that the regulation doesn’t say proportionate share but
proportionate “value”--which it contends means a “fixed value,” i.e., a whole
number, and not a fraction at all. And a whole number that as of the donation date
is equal to the difference between the FMV of the property before and after the
easement goes into effect. This reading, Oakbrook contends, means that upon
extinguishment the Conservancy must be entitled to at least that fixed value. And
because the regulation requires that the value be fixed as of the donation date, the
donee is not entitled to any proceeds attributable to the value of postdonation
improvements. The Commissioner tells us that it is the donee’s property right that
must at least equal the “proportionate value” of the restriction to the FMV of the
property as a whole. That would be similar to a fractional interest in the property
and would mean that the donee would be entitled to any extinguishment proceeds
multiplied by that fraction.
Oakbrook tells us that the donee’s property right must have a fair market
value that must at least equal the “proportionate value” of the restriction to the
FMV of the property as a whole. If Oakbrook is right, then the only reason to
figure out the proportion of the FMV of the easement to the value of the property
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[*22] as a whole is to make a one-time calculation as of the date of the easement to
fix the amount that the Conservancy would be entitled to upon any future
condemnation or extinguishment.
We noted in Coal Properties that there has also been one circuit court that’s
looked at the problem. See PBBM-Rose Hill, 900 F.3d at 205-07. That court
found the regulation ambiguous, and observed that if “proportionate value”
modifies “property right,” it equals a fraction, but if it modifies “fair market
value,” it equals “the dollar amount of the value of the conservation easement at
the time of the gift.” Id. at 206.
Notice that both these conflicting readings require tinkering with the actual
language of the regulation. The Commissioner would be happier with a regulation
that said “proportionate share” instead of “proportionate value,” and Oakbrook
would be happier with a regulation that deleted the word “proportionate” from the
phrase “proportionate value.” It argues that we should hold that an easement’s
conservation purpose would be protected in perpetuity so long as the FMV of a
donee’s property interest equals the value of the perpetual conservation restriction
at the time of the gift. But “proportionate” isn’t the only part of the regulation that
Oakbrook’s reading would have us cut out--it would also force us to excise the
rest of the key sentence--“bears to the value of the property as a whole at that
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[*23] time.” Sec. 1.170A-14(g)(6)(ii), Income Tax Regs. This reading would
have us allocate proceeds through the use of subtraction, not multiplication.
Treasury’s regulation writers, however, know how to command subtraction. See,
e.g., sec. 1.422-1(a)(2)(ii), Income Tax Regs. (“[C]apital gain or loss must be
recognized * * * to the extent of the difference between the amount realized from
such transfer and the adjusted basis of such share” (emphasis added)). And
reading “proportionate” out of “proportionate value”--much less effectively
excising an entire chunk of a sentence of the regulation--runs afoul of the
traditional rule that courts should attempt to give meaning to every word of a
regulation. See Rosenberg v. XM Ventures, 274 F.3d 137, 141-42 (3d Cir. 2001).
The Commissioner’s edit--rewrite “proportionate value” to mean
“proportionate share”--is much lighter than Oakbrook’s. But it is still a gloss and
not a plain reading. The Fifth Circuit took a lengthy look at these conflicting
interpretations, and concluded that the regulation was ambiguous. PBBM-Rose
Hill, 900 F.3d at 205-07. Ambiguity then meant that the court felt free to range
outside the regulation to construe it. Id. at 206. It was particularly careful to
observe that when a regulation is ambiguous, courts should defer to the agency
that issued it. Id. at 206-07 (deferring to the Commissioner’s interpretation
- 24 -
[*24] “[b]ecause the extinguishment regulation is ambiguous” and citing Tex.
Clinical Labs, Inc. v. Sebelius, 612 F.3d 771, 777 (5th Cir. 2010)).
It relied, in other words, on Auer deference. See Auer v. Robbins, 519 U.S.
452, 461 (1997). Where a regulation is ambiguous, Auer tells us to give the
agency’s “interpretation ‘controlling’ weight unless it is ‘plainly erroneous or
inconsistent with the regulation.’” Ohio Dep’t of Medicaid v. Price, 864 F.3d 469,
477 (6th Cir. 2017) (quoting Auer, 519 U.S. at 461). We didn’t have occasion to
mention the possible problems of the Fifth Circuit’s reliance on Auer deference
when we looked at the problem in Coal Properties. But, like the Fifth Circuit, we
found some comfort in the consistency of the Commissioner’s interpretation over
many years, as one can see in numerous private letter rulings (PLRs) issued as far
back as 1999. See Priv. Ltr. Ruls. 200836014 (Sept. 5, 2008), 200403044 (Jan.
16, 2004), 200208019 (Feb. 22, 2002), 199933029 (Aug. 20, 1999).9
The Supreme Court recently reaffirmed Auer. Kisor v. Wilkie, 588 U.S.
___, 139 S. Ct. 2400 (2019). But in doing so it restated the principles of that
deference:
9
Of course PLRs aren’t binding on parties, save for the party to whom one
is issued, see sec. 6110(k)(3), but “they may be cited as evidence of administrative
interpretation,” Comerica Bank, N.A. v. United States, 93 F.3d 225, 230 (6th Cir.
1996) (citing Phi Delta Theta Fraternity v. Commissioner, 887 F.2d 1302 (6th Cir.
1989), aff’g 90 T.C. 1033 (1988)).
- 25 -
[*25] ! Auer deference doesn’t apply unless a regulation is genuinely
ambiguous after exhausting “all the ‘traditional tools’ of
construction.” Kisor, 588 U.S. at ___, 139 S. Ct. at 2415 (quoting
Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc.,
467 U.S. 837, 843 n.9 (1984));
! the agency’s reading of an ambiguous regulation must still itself be
reasonable, id.;
! the reading of an ambiguous regulation must also “be one actually
made by the agency,” its authoritative or official position and not one
that is ad hoc, id. at ___, 139 S. Ct. at 2416;
! the agency’s reading must in some way “implicate its substantive
expertise,” id. at ___, 139 S. Ct. at 2417; and
! the reading “must reflect ‘fair and considered judgment’”, id. (quoting
Christopher v. SmithKline Beecham Corp., 567 U.S. 142, 155
(2012)).
In construing this regulation, we see no need to rely on Auer deference
because the “traditional tools of construction” lead us to hold that the
Commissioner’s construction of the regulation is correct even if we look at the
question de novo. We can add to our plain-language analysis in Coal Properties a
couple additional points. Notice the command in the middle of the regulation to
“[s]ee [sec.] 1.170A-14(h)(3)(iii)[, Income Tax Regs.,] relating to the allocation of
basis.” Sec. 1.170A-14(g)(6)(ii), Income Tax Regs. That regulation tells us that
“[t]he amount of the basis that is allocable to the qualified real property interest
shall bear the same ratio to the total basis of the property as the [FMV] of the
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[*26] qualified real property interest bears to the [FMV] of the property before the
granting of the qualified real property interest.” Id. para. (h)(3)(iii) (emphasis
added). This language is clear. It establishes a “ratio”, which is “the quotient of
one quantity divided by another of the same kind, usually expressed as a fraction.”
Webster’s New World College Dictionary 1206 (5th ed. 2016). And it tells us that
the fraction’s numerator is the FMV of the easement, and its denominator is the
FMV of the property unburdened by the easement--effectively the same fraction
that the Commissioner contends is meant by “proportionate value.” What’s more,
to set up the numerator and the denominator for this fraction, it uses the words
“bears to,” which are the same words used in section 1.170A-14(g)(6)(ii), Income
Tax Regs., when defining “proportionate value.” This buttresses our holding that
“proportionate value” means a fraction and not a whole number.
We also observe that this is what “proportionate value” seems to mean
elsewhere in the U.S. Code and in other regulations. For example, the U.S. Code
section that apportions federal funds among the states for animal health and
disease research programs, provides:
48 percent [of federal funds] shall be distributed among the several
States in the proportion that the value of and income to producers
* * * in each State bears to the total value of and income to producers
* * * in all the States. The Secretary shall determine the total value of
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[*27] and income * * * in all the States and the proportionate value of and
income * * * for each State * * * .
7 U.S.C. sec. 3195(c)(4)(B) (emphasis added). This directs the Secretary of
Agriculture to establish a “proportion” for each state equal to the value produced
by each state divided by, or which “bears to,” the value produced in all states. See
id. The next sentence then refers to this “proportion” as “the proportionate value
* * * for each State.” Id. That’s a fraction.
The phrase “proportionate value” also pops up in two other Treasury
regulations. Section 20.2107-1, Estate Tax Regs., provides that if a nonresident
expatriate decedent owns or is considered to own a certain amount of the voting
shares in a foreign corporation at the time of his death, his gross estate must
include an amount based upon the FMV of his percentage ownership interest in
the foreign corporation and the portion of the foreign corporation’s total assets
situated in the U.S. See id. para. (b)(1). It then refers to the includible amount as
the “proportionate value” and directs us to “example (2) in subparagraph (2).” Id.
subdiv. (iii)(c). That example tells us that the “proportionate value” includible in
the gross estate is an amount which results from multiplying fractions and FMVs.
See id. subpara. (2), Example (2).
- 28 -
[*28] The only other Treasury regulation that uses “proportionate value” is section
25.2515-1(d)(2)(ii), Gift Tax Regs., which deals with the effect of an exchange of
real property held by tenants in common. It provides that such an exchange will
not terminate a tenancy so long as the tenant-spouses hold title in the exchanged
property “in an identical tenancy.” Id. The next sentence states that “a tenancy is
considered identical if the proportionate values of the spouses’ respective rights
(other than any change in the proportionate values resulting solely from the
passing of time) are identical to those held in the property which was sold.” Id.
(emphasis added). The regulation doesn’t provide any examples, but the reference
to “proportionate value” seems to mean a fraction of an amount equal to each
spouse’s property right multiplied by the FMV of the property held by the tenancy.
We do not think it could reasonably refer to an amount equal to the difference
between the values of the spouses’ respective rights.
All this also supports our precedent that “proportionate value” means a
fraction, and not a value. This makes us sufficiently confident of our reading to
hold that even without Auer deference, the Commissioner has the better argument
on the meaning of “proportionate value” in the regulation.
- 29 -
[*29] B. Construing the Deed
Before we can apply the regulation to the Deed, we also need to construe
the Deed. This is no easy task, because the drafters of the Deed’s contested
section were trying to solve a cluster of related, but distinct, problems. So we
need to dissect the chunk of language reprinted supra pp. 6-7 to see how it
addresses each of these problems.
The first, as we’ve seen, is to limit the ability of the Conservancy and
Oakbrook to undo the easement by deciding between themselves that changed
circumstances sufficient to undermine the easement’s conservation purpose exist.
They had to do this under Tennessee law as well as the Code, and did so in the
middle of the paragraph: “If a change in conditions makes impossible or
impractical any continued protection of the Conservation Area for conservation
purposes, the restrictions contained herein may only be extinguished by judicial
proceeding.” Deed, Article VI, Section B(2). The Commissioner doesn’t dispute
that this language succeeds in its job of meeting the requirement in section
1.170A-14(g)(6)(i), Income Tax Regs., that the restrictions be ended only in
judicial proceedings if they are to meet the Code’s requirement of perpetuity.
The second problem is what to do with proceeds from extinguishment. The
Deed language gets tangled with itself because it tries to address not just the
- 30 -
[*30] allocation of such proceeds, but the foreseeable contingency that Oakbrook
will exercise its retained right to add improvements to the conserved area. Thus
we see this sentence:
For purposes of this Conservation Easement, the fair market value of
[the Conservancy]’s right and interest shall be equal to the difference
between (a) the fair market value of the Conservation Area as if not
burdened by this Conservation Easement and (b) the fair market value
of the Conservation Area burdened by this Conservation Easement, as
such values are determined as of the date of this Conservation
Easement, (c) less amounts for improvements made by O[akbrook] in
the Conservation Area subsequent to the date of this Conservation
Easement, the amount of which will be determined by the value
specified for these improvements in a condemnation award in the
event all or part of the Conservation Area is taken in exercise of
eminent domain.
Deed, Article VI, Section B(2).
The Commissioner interprets this sentence to mean that the value of the
Conservancy’s property interest equals the value of the easement as of the date of
donation less the value of any subsequent improvements. He argues this clause
actually reduces the Conservancy’s interest in extinguishment proceeds by the
value of such improvements, and the value may fluctuate over time. In the event
those improvements are “quite extensive,” he argues, a situation could arise in
which the Conservancy would receive nothing upon extinguishment.
- 31 -
[*31] Oakbrook responds that the Commissioner isn’t reading the sentence
correctly. It directs our attention to the last few lines of the sentence: “(c) less
amounts for improvements made by O[akbrook] in the Conservation Area
subsequent to the date of this Conservation Easement, the amount of which will be
determined by the value specified for these improvements in a condemnation
award in the event all or part of the Conservation Area is taken in exercise of
eminent domain as further described in this Article VI, Section B(3) below.”
(Emphasis added.)
Oakbrook argues that the Commissioner’s concern about subtracting the
value of any future improvement from what the Conservancy would otherwise get
is overblown. Any such subtraction would occur only if it is “determined by the
value specified * * * in a condemnation award.” In the case of a partial
condemnation of only a little bit of the conservation area not occupied by any
improvement, there would be no subtraction and the Conservancy would get the
entire condemnation award up to the FMV of the easement as of the date of
donation--a better deal, it points out, than the merely fractional part of that
hypothetical award that the Commissioner says is required.
And this leads to the third problem that this language addresses--what to do
when there is a judicial extinguishment of the easement followed by a later
- 32 -
[*32] (possibly much later) sale of the property. Oakbrook says that the
Conservancy would do just fine. The proceeds from such a sale would go to the
Conservancy in an amount equal to the FMV of its easement because “upon such
proceeding [, i.e., a judicial extinguishment proceeding], [the Conservancy], upon
a subsequent sale, exchange or involuntary conversion of the Conservation Area,
shall be entitled to a portion of the proceeds equal to the fair market value of the
Conservation Easement as provided above.” Because in this contingency there
would be no specification “for these improvements in a condemnation award,” the
Conservancy would get its money off the top and not have to worry about the
value of any improvements.
Oakbrook also argues more generally that the Commissioner’s readings of
the regulation and Deed would harm the Conservancy if the value of the conserved
land decreases, or if it is partially condemned. Let’s begin with an example where
the value of land decreases following donation of the conservation easement.
Imagine that the donated land at the time of the easement has an unencumbered
FMV of $100,000 and an encumbered FMV of $50,000. Oakbrook adds
improvements of $100,000. Property values then collapse and the easement is
judicially extinguished (or condemned without specification of the value of the
improvements) with proceeds recovered of $60,000. Under the Commissioner’s
- 33 -
[*33] interpretation of the Deed, the Conservancy would receive nothing because
the $100,000 in improvements is greater than the proceeds. And even if the land
went unimproved, the Conservancy would get only 50% of the recovered
proceeds, or $30,000. If Oakbrook is right, however, the Conservancy would in
both situations get its fixed value determined at the date of donation, or $50,000.
And if the land was improved and then partially condemned? Assume again
that the easement was worth $50,000 at the date of donation and Oakbrook added
$100,000 in improvements. Some time later the local highway authority
condemns a sliver of the land that did not include the improvements to widen an
adjoining road. The condemnation award would be small--let’s say $5,000.
Again, under the Commissioner’s interpretation of the Deed, the Conservancy
would get nothing because the condemnation award was less than the value of the
improvements; and under his interpretation of the regulation, Oakbrook should
receive just $2,500, which is the Conservancy’s proportionate share of the
unimproved property’s value. But under Oakbrook’s interpretation, because there
would be no condemnation of any improvements, and because $5,000 is less than
$50,000, the Conservancy would get the entire condemnation award whether or
not there had been improvements.
- 34 -
[*34] State law defines property interests. Case v. United States, 633 F.2d 1240,
1246 (6th Cir. 1980); Howard v. United States, 566 S.W.2d 521, 525 (Tenn.
1978). And Tennessee law, following the usual common-law rule, allows for the
admission of parol evidence to inform the meaning of a contract’s ambiguous
language if not introduced to contradict it. Burlison v. United States, 533 F.3d
419, 429 (6th Cir. 2008). So we asked the Conservancy’s representative, Wright,
how the Deed’s proceeds clause would operate when the easement was
extinguished after improvements were made. We found his answer entirely
credible:
[A]s long as there’s a condemnation award and if the award were to
specifically identify those improvements being the value of them,
those would be deducted from the proceeds, because they aren’t
relevant to the valuation of the easement. [Emphasis added.]
And again:
[A]s long as the condemnation award specifically identifies those as
subsequent additions, because if they were not, then the land trust
would [in]ure [to] a benefit for which it is not entitled. They did not
pay for those improvements. They have no property interest in those
improvements. Therefore, if we were to keep the award that took
those improvements into consideration, the land trust would be
getting unjust compensation because we didn’t pay for those. We
have to strip those away, get back to the matter at hand, and that is the
value of the donation at the time of the donation.
And finally, in the case of a partial condemnation:
- 35 -
[*35] [A certain conservation easement is] a small part of a big property but
nevertheless a utility came in and obtained a judgment to put a
pipeline in the [easement] property. Of course, the owner didn’t want
it. He supported it but it’s a utility, and we’re going to lose and so,
therefore, we’ve already gotten the judgment and was in the process
of settling it. The award coming out of that -- no questions asked,
there’s no argument over it, the land trust is a hundred percent of the
condemnation reports.
We also asked Wright about scenarios where this construction would not
favor the Conservancy. Consider an increase in land values. If there were ‘70s-
era inflation, the easement was extinguished, and the property then sold for
$200,000, what would the Conservancy get? When we asked Wright at trial about
this very scenario, he confirmed that the Conservancy would be entitled only to its
initial fixed value.
We conclude from this that Oakbrook’s reading of this section of the Deed
is correct. The value of any improvements would be subtracted from any
condemnation award only if it was specified in that award. The Conservancy
would get the FMV of the easement as of the date of donation, and it would get the
entire amount of any award for a partial condemnation not affecting any
improvements or a future sale after judicial extinguishment, up to that FMV. It
would not, however, be protected from inflation either in local land prices or the
- 36 -
[*36] economy more generally; and it would not get the entire FMV if prices
collapsed before a later condemnation or extinguishment.
C. Applying the Regulation to the Deed
The Commissioner argues that Oakbrook’s Deed, even if we interpret it the
way Oakbrook wants us to, violates the regulation twice. First, he reiterates that it
fails to define a fraction to be multiplied by the amount of any future proceeds.
The Commissioner has to win on this argument--once we interpret the regulation
to require a fraction multiplied by future proceeds, Oakbrook can’t argue that the
Deed conforms to the regulation. But the Commissioner argues that the Deed also
fails because the regulation prohibits any scenario in which a donor gets to
recover, either through condemnation or sale after extinguishment, any
compensation for its improvements in excess of a share of the proceeds defined by
the before-and-after-easement value of the unimproved land at the time of
donation. We are left with the distinct sense that there are some plausible
scenarios where Oakbrook’s construction of “proportionate value” would protect
an easement’s conservation purposes in perpetuity better than the Commissioner’s
would. The Commissioner’s construction might not compensate a donee as well
as Oakbrook’s, should property values decrease or if the property were only
partially condemned. But our task here is to see how the Deed squares with the
- 37 -
[*37] regulation, not whether there are plausible scenarios where the Deed would
compensate the Conservancy better than the regulation.
This is where Oakbrook’s argument fails. The regulation prohibits any
scenario in which Oakbrook gets to recover compensation other than a
proportionate share of the proceeds, with the proportion defined by the easement’s
FMV over the FMV of the unencumbered and unimproved property.
It also doesn’t matter that the value fixed by the Deed “will almost
universally be more than the percentage of proceeds the IRS claims the land trust
is entitled to under the language” of section 1.170A-14(g)(6)(ii), Income Tax
Regs., as Oakbrook argues. In other words, Oakbrook argues the Deed
“substantial[ly] compli[es]” with the regulation. On this point, we need only cite
Kaufman I, where we held that a donor must show strict, and not substantial,
compliance with the perpetuity requirements of the regulation. See Kaufman I,
134 T.C. 186 (petitioners “cannot avoid the strict requirement in section
1.170A-14(g)(6)(ii), Income Tax Regs., simply by showing that they would most
likely be able to satisfy” their obligation to the land trust).
We agree again with the Fifth Circuit in PBBM-Rose Hill, 900 F.3d at 207.
It held that “[t]he ordinary meaning of ‘proceeds’ is ‘the total amount brought in,’
such as ‘the proceeds of sale.’” Id. (alterations in original) (citations omitted). It
- 38 -
[*38] also noted that the fact that the regulation explicitly contemplates that a
donor may reserve the right to make improvements, see sec. 1.170A-14(g)(5)(i),
Income Tax Regs., “but chose not to carve out an exception for the allocation of
proceeds in the event of extinguishment when such improvements have been
made,” suggests no such carve-out was intended, PBBM-Rose Hill, 900 F.3d at
208. Substantial compliance does not work here.
Oakbrook also argues that it’s unfair for a donee to receive extinguishment
proceeds attributable to the value of improvements made solely by the donor--it
would amount, says Oakbrook, to an unintended charitable donation for which it
receives no deduction. While we might otherwise be sympathetic to this
argument, we have identified as a purported purpose of the regulation the
avoidance of windfalls to donors, not donees, if an easement is extinguished. See
Kaufman III, 687 F.3d at 26.
It’s also easy enough to imagine scenarios where a fixed value might be
unfair to donees. The other purpose of section 1.170A-14(g)(6)(ii), Income Tax
Regs., that we’ve identified is “to assure that the donee organization can use its
proportionate share of the proceeds to advance the cause of historic preservation
[or other conservation cause] elsewhere.” Kaufman III, 687 F.3d at 26. If this is
true, it would seem that providing a donee with a share of proceeds attributable to
- 39 -
[*39] inflation or rising property values better achieves this purpose. If, for
example, an easement is extinguished years after its donation, during which time
land values have skyrocketed, a donee organization’s entitlement to a portion of
the resulting increased proceeds may likely be the only way that it could afford to
further its conservation purpose elsewhere.
We do note that the Commissioner’s interpretation of improvements in this
case contradicts his position in Priv. Ltr. Rul. 200836014 (Sept. 5, 2008), which
Oakbrook claims has since been adopted by numerous land trusts, and which it
argues would undermine the vast majority of easements. The relevant sentence
states, “the portion of the proceeds of any subsequent sale or exchange (or
condemnation) of the Protected Property payable to the Donee represents a
percentage interest in the [FMV] of the Protected Property (less an amount
attributable to the value of a permissible improvement made by Grantors, if any,
after the date of the contribution of the Easement). Id. (emphasis added). We
don’t need to parse a nonprecedential PLR too closely. But this sentence is
noteworthy for its seeming to construe “proportionate value” to mean “percentage
interest.” This is entirely consistent with the Commissioner’s position in this case
and tends to show continuity in the Treasury’s construction of its own regulation.
- 40 -
[*40] Oakbrook is correct, however, that the parenthetical clause in the PLR that
calls for the amount attributable to the value of improvements made after the
easement to be taken off the top contradicts the Commissioner’s current position.
The Fifth Circuit addressed this exact issue by finding the regulation’s meaning
unambiguous as to improvements--they cannot be subtracted. PBBM-Rose Hill,
900 F.3d at 208. It also noted that “even if the regulation were ambiguous, [the
Court] would not follow the [Commissioner]’s interpretation in the ruling because
it contravene[d] a plain reading of the regulation without an explanation.” Id. at
208-09 (citing Tex. Clinical Labs, Inc., 612 F.3d at 777); see also Salamalekis v.
Comm’r of Soc. Sec., 221 F.3d 828, 832 (6th Cir. 2000) (stating that a court may
defer to an agency’s position when that position “presents a reasonable
construction of an ambiguous provision of * * * the agency’s regulations”). And
PLRs simply aren’t precedential--we therefore agree with the Fifth Circuit that the
language of the regulation is unambiguous on this issue.10
Oakbrook’s Deed violates the regulation because the Conservancy must be
entitled to any proceeds from extinguishment or condemnation that are at least
10
We are also wary of accepting the contention that numerous land trusts
adopted their current deed language that subtracts the value of improvements from
the proportionate value calculation, based upon a sentence of a PLR released in
2008--it seems to us that such language existed in deeds well before 2008.
- 41 -
[*41] equal to the total proceeds (unadjusted by the value of any of Oakbrook’s
improvements), multiplied by a fraction defined by the ratio of the FMV of the
easement to the FMV of the unencumbered property determined as of the date of
the Deed.
Our holding as to the meaning of section 1.170A-14(g)(6)(ii), Income Tax
Regs., doesn’t necessarily doom Oakbrook’s deduction. Oakbrook argues in the
alternative that this regulation is invalid.11 About this there is disagreement within
the Court, and we air that disagreement in a separate opinion that we also release
today. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. ___ (May
12, 2020).
III. Penalty
That leaves only the Commissioner’s determination that a penalty under
section 6662 was applicable to Oakbrook. This penalty is applicable when a
partnership takes a return position that might create a substantial understatement
of tax due at the partner level, sec. 6662(b)(2), or that is negligent or shows
disregard of the rules and regulations, sec. 6662(b)(1). The Code tells us that
11
Despite the Commissioner’s suggestion to the contrary, no court has
directly addressed whether section 1.170A-14(g)(6)(ii), Income Tax Regs., is
invalid. In PBBM-Rose Hill the Fifth Circuit refused to address the issue because
the taxpayer had not first raised it in this Court. See PBBM-Rose Hill, 900 F.3d at
209 n.8.
- 42 -
[*42] negligence is the “failure to make a reasonable attempt to comply with the
[Code]” and that disregard includes “careless, reckless, or intentional disregard.”
Sec. 6662(c). And the Code also tells us that an understatement is substantial if it
exceeds the greater of $5,000 or “10 percent of the tax required to be shown on the
return.” Sec. 6662(a), (b)(2), (d)(1)(A). (The determination of an underpayment
cannot be made at the partnership level because partnerships don’t pay taxes,
partners do. We can still, however, determine the applicability of the
understatement (or negligence, or intentional-disregard) penalty at the partnership
level. See VisionMonitor Software, LLC v. Commissioner, T.C. Memo. 2014-82,
108 T.C.M. 256, 260 (2014).)
These penalties don’t apply to a taxpayer who had reasonable cause for an
underpayment and acted in good faith. Sec. 6664(c)(1); sec. 1.6664-4(a), Income
Tax Regs. The determination of whether a taxpayer acted with reasonable cause
and in good faith is one we make on a case-by-case basis. Sec. 1.6664-4(b)(1),
Income Tax Regs. One circumstance that indicates reasonable cause and good
faith is an honest misunderstanding of fact or law that is reasonable in light of all
of the facts and circumstances. Id. Reliance on certain facts can constitute good
faith if, “under all the circumstances, such reliance was reasonable and the
taxpayer acted in good faith.” Id.
- 43 -
[*43] Here, we deny any deduction for Oakbrook’s donation of the conservation
easement because the provisions in the Deed violated the extinguishment-proceeds
clause in the regulation. But we think Oakbrook’s position was reasonable: There
is the PLR that the IRS itself issued that suggested a clause like the one in the
deed would work. Section 1.6662-3(b)(3), Income Tax Regs., tells us that a return
position generally satisfies the reasonable-basis standard if it is based on, among
other types of authorities, private letter rulings. See secs. 1.6662-3(b)(3), 1.6662-
4(d)(3)(iii), Income Tax Regs.; see also Bunney v. Commissioner, 114 T.C. 259,
267 n.10 (2000) (PLRs may be authorities showing reasonableness of return
position). There is disagreement among us on whether the contested regulation is
valid, and that might also be some indication of the objective reasonableness of
Oakbrook’s position. Trial proved that Horton knew he was unfamiliar with the
mechanics of setting up a conservation easement and relied on what he saw as the
safety of form language that echoed the PLR. We find this was reasonable under
these circumstances, and based on the credibility of his trial testimony, taken
entirely in good faith. Oakbrook’s error--if it turns out to be an error--was
reasonable.
- 44 -
[*44] We therefore also conclude that the penalty that the Commissioner
determined was applicable cannot be sustained.
An appropriate decision will be
entered.