Tax Court Denies Conservation Easement Deduction Because Property Did Not Constitute a “Qualified Real Property Interest”

In Balsam Mountain Investments, LLC,[1] the Tax Court took a very restrictive view of what qualifies as a “qualified real property interest” under Section 170(h)(2)(C), in granting summary judgment in favor of the IRS disallowing a charitable contribution deduction for a conservation easement. In 2003, Balsam Mountain Investments, LLC executed a perpetual conservation easement agreement with the North American Land Trust (the “Trust”), a non-profit corporation.  Pursuant to the easement agreement, the Taxpayer was restricted “in perpetuity” from developing or altering the land in the “Conservation Area.”  The “Conservation Area” was defined in the easement agreement as a specific 22-acre parcel of land in Jackson County, North Carolina, the exact boundaries of which were described in a plat attached to the easement agreement.  However, the easement agreement also reserved to the Taxpayer the right to make minor alterations to the boundary of the Conservation Area subject to certain specified requirements.  These requirements allowing the Taxpayer to make minor alterations to the boundary of the Conservation Area were as follows:

1. The calculated area of land within the Conservation Area after alteration of the boundary could not be reduced from that which was made subject to the conservation easement at the time the conservation easement was granted (22 acres).
2. Any land added to the Conservation Area had to be contiguous with and connected by an area of substantial width to the Conservation Area as it exists on the date the conservation easement was granted.
3. Any land added to the Conservation Area had to be, in the Trust’s reasonable judgment, land which makes an equal or greater contribution to the Conservation Purposes from that which was removed from the Conservation Area. The term “Conservation Purposes” was defined in the easement agreement as (1) the preservation of the Conservation Area as a natural habitat, and (2) the preservation of the Conservation Area as open space.
4. The aggregate land removed from the Conservation Area (and substituted with other contiguous land) as the result of all boundary line alterations could not exceed 5% of the area within the Conservation Area as of the date the conservation easement was first granted.
5. No boundary line adjustments within the Conservation Area could be made after the 5th anniversary of the date the conservation easement was originally granted.
6. The proposed boundary lines were required to be surveyed in a proposed survey plan form by the Taxpayer but were subject to prior review and approval of the Trust.
7. The location and reconfiguration of a boundary of the Conservation Area would not be approved by the Trust, if in the Trust’s judgment, it directly or indirectly resulted in any material adverse effect on the Conservation Purposes.
8. The new Conservation Area boundary had to be set forth in a written amendment to the original conservation easement.

In essence, the Taxpayer’s right to change the boundary of the Conservation Area was limited to a 5-year period and could not reduce the total area restricted by the easement below the original 22 acres and at least 95% of the original 22-acre parcel had to remain within the boundary of the original Conservation Area. On its 2003 partnership tax return, the Taxpayer reported its grant of the conservation easement as a charitable contribution deduction.  In 2011, the IRS issued the partners of the Taxpayer a notice of final partnership administrative adjustment disallowing the charitable contribution deduction on the basis that the easement granted by Taxpayer was not a “qualified real property interest” of the type described in Section 170(h)(2)(C).  As discussed below, the court concluded that there was no genuine dispute as to any material fact and that the easement was not a “qualified real property interest” as a matter of law, and consequently, granted summary judgment in favor of the IRS. The value of any charitable contribution made during the tax year is allowed as a deduction under Section 170(a)(1).  If the charitable contribution is of a partial interest in property, a deduction is allowed only in limited circumstances.[2]  One circumstance in which a taxpayer is allowed a deduction for a charitable contribution of a partial interest in property is if the contributed interest is a “qualified conservation contribution.”  A “qualified conservation contribution” is defined in Section 170(h)(1) as a contribution of a qualified real property interest, to a qualified organization, exclusively for conservation purposes.  Section 170(h)(2)(C) defines a qualified real property interest as including a restriction (granted in perpetuity) on the use which may be made of the real property.  Citing Belk[3], the court held that the easement was not a qualified real property interest of the type described in Section 170(h)(2)(C) because the taxpayer had the right to change the boundaries of the real property subject to the conservation easement.  In Belk, the court held that a conservation easement was not a qualified real property interest of the type described in Section 170(h)(2)(C) if the easement permits the grantor to change what property is subject to the easement.  This is because an interest in real property is a qualified real property interest under Section 170(h)(2)(C) only if it is an identifiable, specific piece of real property.  The court therefore concluded that since the easement granted by the Taxpayer permitted the Taxpayer to change the boundaries of the Conservation Area, the easement was not an interest in an identifiable, specific piece of property. The Taxpayer argued that the Belk case was distinguishable because the easement agreement in Belk allowed the taxpayer to substitute other land for all of the land initially subject to the easement.  By contrast, the easement granted by the Taxpayer allowed substitution for only 5% of the land initially subject to the easement.  The court stated that this difference did not matter as the easement granted by the Taxpayer was not an interest in an identifiable, specific piece of real property, and for five years after 2003, the Taxpayer could change the boundaries of the Conservation Area burdened by the easement.  Therefore, the easement did not constitute a qualified real property interest of the type described in Section 170(h)(2)(C).  Alternatively, the Taxpayer argued that the Tax Court should overrule Belk, which the Tax Court declined to do.

Observation.  The Balsam case demonstrates both the IRS’s and the Tax Court’s restrictive position on allowing charitable contribution deductions for conservation easements.  In the case, the Tax Court took a very narrow view of what constitutes a qualified real property interest for which the taxpayer may take a charitable contribution deduction.  Consequently, this is an area in which very close attention to detail must be given in order to obtain a charitable deduction for a conservation easement.

[1] TCM 2015-43.

[2] A partial interest in property is “an interest in property which consists of less that the taxpayer’s entire interest in such property.”  Section 170(f)(3).

[3] 140 TC 1 (2013), supp. by TCM 2013-154, aff’d 774 F.3d 221 (CA-4, 2014).

About the Author:

Stephen R. Looney is the chair of the Tax department at Dean Mead in Orlando. He represents clients in a variety of business and tax matters including entity formation (S and C corporations, partnerships, and LLCs), acquisitions, dispositions, redemptions, liquidations, reorganizations, tax-free exchanges of real estate and tax controversies. His clients include closely held businesses, with an emphasis on medical and other professional services practices. He is a member of the Board of Trustees of the Southern Federal Tax Institute, as well as former Chair of the S Corporations Committee of the American Bar Association’s Tax Section. He is Board Certified in Tax Law by the Florida Bar, as well as being a Certified Public Accountant (CPA).  He may be reached at slooney@www.deanmead.com.