The Tax Court disallowed a taxpayer’s charitable contribution deduction of a conservation easement because the taxpayer failed to show the easement had any value. According to the court, the taxpayer did not show that the highest and best use of the contributed property changed as a result of the contribution.
Taxpayers may deduct the fair market value of a conservation easement as a charitable contribution. Because comparable sales of easements are rare, the fair market value of an easement is often determined by comparing the fair market value of the property subject to the easement before and after the date the easement is created, considering its highest and best use. The highest and best use is its most profitable use and is presumed to be its current use. A proposed highest and best use may be used if the proposed use is reasonably probable in the near future, considering its economic feasibility and all existing laws and restrictions at the time of the contribution.
Michael Mountanos owned 882 acres of mostly undeveloped land in Lake County, Calif., which he used for recreational purposes. Because the property was landlocked, mostly by federal land managed by the Bureau of Land Management, access to the property required easements from the surrounding property owners. The Bureau of Land Management easement that provided access across the federal land restricted access to the property to single-family residential use. The property was also under a contract that limited its use and development under the Williamson Act, a California law designed to preserve agricultural and open space land. In 2005, Mountanos granted a conservation easement to the Golden State Land Conservancy and claimed a charitable contribution of $4,691,500 on his 2005 federal income tax return. The taxpayer deducted only $1,343,704 in 2005 because of the Sec. 170(b)(1)(B) limitation and carried the unused deduction over to his 2006, 2007, and 2008 returns. The IRS disallowed the deductions for 2006–2008, and the taxpayer petitioned the Tax Court for relief.
The taxpayer argued that the highest and best use of the property before the easement was as a 287-acre vineyard and a 595-acre residential development, and its highest and best use after the easement was as recreational property, resulting in a $4,691,500 difference in value. According to the court, neither the vineyard nor the residential development was a reasonably possible use of the property; therefore, neither could be the property’s highest and best use before the easement. Therefore, the easement had no value.
The court held that a vineyard use was not reasonably probable because the taxpayer did not show that (1) the federal easement could be modified to permit access to a vineyard instead of single-family use, (2) there was enough water on the property to support a vineyard, (3) sufficient demand existed for 287 acres of vineyard-suitable property in Lake County, and (4) a vineyard was economically viable. In addition, the court held the property’s use as a subdivision was not reasonably probable in the near term, because such use would violate the Williamson Act.
The court also upheld the 40% gross valuation misstatement penalty for all three years, since Mountanos’s valuation of $4,691,500 was considered to be 400% or more of the correct valuation, in this case, zero.
Mountanos, T.C. Memo. 2013-138
By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.