Tax Court reverses course on conservation easement extinguishment regs.

A company’s donation of a land conservation easement met the requirements under Secs. 170(h)(2) (C) and (5)(A) that it be granted and its conservation purpose protected “in perpetuity,” the Tax Court held, upholding the company’s charitable deduction. Reversing its previous holding, the court also held that Regs. Sec. 1.170A-14(g) (6)(ii), requiring that an easement’s deed must guarantee the donee a share of proceeds from any subsequent sale, exchange, or involuntary conversion of the property at least equal to the proportion of the value of the easement to the value of the entire property at the time of the gift (the “proceeds provision” of the “extinguishment regs.”), was promulgated in violation of the Administrative Procedure Act (APA) and was therefore invalid.

Facts: In 2016, Valley Park Ranch LLC, a limited liability company treated as a partnership for tax purposes, conveyed by deed a conservation easement on approximately 45 acres in Oklahoma to the Compatible Lands Foundation (CLF). The deed stated that the easement’s purpose was to “assure that the Property will be retained forever predominantly in its natural, scenic, and open space condition and to prevent any use of the Property that will significantly impair or interfere” with its conservation values. It further specified that the easement could be terminated or extinguished only by judicial proceedings in a court of competent jurisdiction, when the amount of proceeds CLF would be entitled to from any sale, exchange, or involuntary conversion of all or any part of the property would be determined by the court, “unless otherwise provided by State or Federal law at the time.” If the extinguishment occurred by the exercise of eminent domain, the relative shares of the compensation from the entity exercising eminent domain that Valley Park and CLF would be entitled to would be determined by a “qualified appraisal.”

Valley Park claimed a $14.8 million charitable contribution deduction for the easement on its 2016 short-year partnership return. The return showed Valley Park acquired the property in 1998 and that its cost or adjusted basis was $91,610.

The IRS examined the return, issuing a final partnership administrative adjustment in July 2020 disallowing the deduction in full because, it stated, Valley Park had not satisfied the requirements under Sec. 170(h) and associated regulations. In October 2020, Valley Park, through its tax matters partner, petitioned the Tax Court for review. Both sides moved for partial summary judgment.

Issues: Valley Park argued that the proceeds provision of the extinguishment regs. was procedurally invalid because Treasury and the IRS did not adequately respond to significant comments they received in response to the regulations’ 1983 proposal. The company pointed to Hewitt, 21 F.4th 1336 (11th Cir. 2021), rev’g and remanding T.C. Memo. 2020-89, in which the Eleventh Circuit invalidated Regs. Sec. 1.170A-14(g)(6) (ii) on those grounds, reversing the Tax Court. The Eleventh Circuit found that the IRS’s interpretation of the regulation in that case was arbitrary and capricious because it had failed to comply with the APA’s procedural requirements.

The IRS argued that the easement’s conservation purpose was not protected in perpetuity within the meaning of Sec. 170(h)(5)(A) and that the proceeds provision of the extinguishment regulations was not satisfied.

Holding: Regarding the procedural validity of Regs. Sec. 1.170A-14(g)(6)(ii), the Tax Court acknowledged that, subsequent to the Eleventh Circuit’s holding in Hewitt, the Sixth Circuit upheld the regulation as valid, affirming the Tax Court in Oakbrook Land Holdings, LLC, 28 F.4th 700 (6th Cir. 2022). The Tax Court also acknowledged that, as Valley Park’s case is appealable to the Tenth Circuit, neither Hewitt nor Oakbrook controlled. But the Tax Court said it was obliged to reconsider its holding in Oakbrook in light of Hewitt, and as a result, it was changing its position. As a four-year-old decision, Oakbrook “is not entrenched precedent,” and departing from it still respects principles of stare decisis and will not cause instability in the law, the court said. “Respectfully, we must revisit our decision in Oakbrook precisely because the law is already unstable,” the court stated.

The APA requires federal agencies issuing regulations subject to notice-and-comment procedures to first issue a notice of proposed rulemaking, usually by publication in the Federal Register. Interested persons must have an opportunity to submit data, views, or arguments, and the agency must consider and respond to significant comments so received. Then, in promulgating final regulations, the agency must include a concise general statement of the regulations’ basis and purpose, with adequate reasons for its decisions and sufficient information to allow a court to review them. The agency must respond to comments that could be considered to challenge a fundamental premise of the decisions or that cast doubt on the regulations’ reasonableness.

In the case of Regs. Sec. 1.170A-14(g)(6)(ii), Treasury and the IRS received more than 700 pages of comments, the court noted, a number of which could be considered significant and some challenging its fundamental premise or reasonableness. For example, the New York Landmarks Conservancy (NYLC) urged Treasury and the IRS to delete the proceeds provision because its requirement of a ratio of value of the easement and underlying property that is “fixed at the time of the donation and [remaining] in effect forever thereafter” could cause the easement’s donee to realize a windfall from any improvements the property owner made after the donation, potentially deterring would-be donors. By the same token, the provision could work against the donee organization if changes in surrounding land made the easement proportionately more valuable than the retained interest, another commenter pointed out. Other commenters likewise urged caution or criticized the provision, the court noted.

Despite that input, Treasury and the IRS “did not discuss or respond to the comments made by NYLC or the other six commenters concerning the extinguishment provision,” the court stated. Nor did the agencies revise the regulations in response to the comments, beyond changes that were clarifying, “editorial,” or that only “re-articulat[ed] the formula.” Thus, the Tax Court agreed with the Eleventh Circuit in Hewitt and Valley Park that the regulation is procedurally invalid under the APA and set it aside.

The court also held that Valley Park’s easement deed satisfied the requirements of Secs. 170(h)(2)(C) and (5)(A) that an easement be granted and protected in perpetuity. Besides its restrictions noted above, the deed stipulated that Valley Park would not perform or knowingly allow others to perform any activities on the property inconsistent with the deed’s purposes and included a nonexhaustive list of such activities. These included putting any residential, commercial, recreational, or industrial facilities on the land or carrying out any surface mining or quarrying of soil, sand, or other minerals. Because these restrictions broadly limited use of the property, the deed satisfied the statute’s test, the court said, citing another Eleventh Circuit case, Pine Mountain Preserve, LLLP, 978 F.3d 1200 (11th Cir. 2020).

In addition, nothing in the easement’s grant “envisions a reversion” of its interest to Valley Park or its heirs or assigns, the court stated (quoting Pine Mountain Preserve, 978 F.3d at 1206). For its part, CLF was obligated to maintain the property in a manner consistent with its native condition. Thus, the court held that the easement extended these restrictions in perpetuity.

The IRS argued that a phrase in the deed conditioning extinguishment proceeds on the satisfaction of “prior claims” could apply to claims asserted after the date of execution of the deed, defeating the perpetuity requirement. The Tax Court, however, found this interpretation “implausible” in its context and that no evidence had been introduced of any prior claims from before the date of the deed. Having held the proceeds provision of the extinguishment regulations invalid and further finding that Valley Park fulfilled the statutory perpetuity requirements, the court denied the IRS’s motion for summary judgment and granted Valley Park’s.

■ Valley Park Ranch, LLC, 162 T.C. No. 6 (2024)

— To comment on this column, contact Paul Bonner, the JofA’s tax editor.