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November 6, 2019

Tax Court holds IRS properly denied charitable deduction because purpose of conservation easement wasn't protected in perpetuity

In a T.C. Opinion (Coal Property Holdings, LLC, et al. v. Commissioner), the Tax Court has sustained the Service's denial of a charitable contribution deduction for a conservation easement donated to a qualified organization, concluding that the conservation purpose of the easement was not protected in perpetuity as required under IRC Section 170(h)(5)(A).


In September 2013, Coal Property Holdings LLC (Coal Holdings) acquired approximately 3,700 acres in Tennessee that had previously been subject to strip mining. On October 17, 2013, Coal Holdings conveyed an open space conservation easement over the acreage in Tennessee to Foothills Land Conservancy, an IRC Section 501(c)(3) exempt organization and a "qualified organization" for purposes of IRC Section 170(h)(3).

A qualified organization is (1) a government unit or an organization that normally receives a substantially amount of its support from a governmental unit or from direct or indirect contributions from the general public or (2) an organization that is described in IRC Section 501(c)(3), meets the requirements of IRC Section 509(a)(2) or IRC Section 509(a)(3), and is controlled by a government unit, an organization receiving substantial support from a governmental unit or contributions from the general public, or an IRC Section 501(c)(3) organization meeting the requirements of IRC Section 509(a)(2).

Terms of the easement deed. The easement deed would prevent all surface mining on the property in perpetuity, with two exceptions: (1) natural gas wells under the terms of a preexisting lease and (2) exploration for minerals to the extent that Coal Holdings owns mineral rights in the property.

If the conservation purposes of the easement became impossible to accomplish at some future point, the deed stated that the easement could only be terminated or extinguished in judicial proceedings in an appropriate court. If the property were sold after a judicial action, the IRC Section 501(c)(3) Foothills Land Conservancy (the grantee) would be entitled to the fair market value of the easement, after prior claims had been satisfied. If the property were condemned, the grantee would be entitled to a share of the proceeds determined under the same formula.

Specifically, the formula calculated the grantee's share, starting with the property's fair market value (FMV) at the time of sale, reduced by any increase in value attributable to improvements to the property after the date of the grant, multiplied by the following fraction provided in Reg. Section 1.170A-14(g)(6)(ii):

FMV of the easement on the date of the gift

FMV of the property on the date of the gift as a whole

When the easement was granted, there were improvements made to the property which included 20 natural gas wells, two cell phone towers, roads, and electrical installations.

Coal Holdings' tax return. On the Form 1065 partnership return filed for tax year 2013, the company claimed a $155.5 million charitable contribution deduction for the easement, allocating the deduction among the partners in proportion to their capital and profits interests.

Coal Holdings submitted an appraisal with the tax return that valued the easement based on the value of the land before and after the donation. The appraisal determined that the highest and best use of the property, absent the easement, would be an owner-operated subsurface coal mine and would carry a before-donation value of approximately $160.5 million. To determine the after-donation value of the property, the appraisers assumed that the restrictions imposed by the easement would not allow any subsequent development or coal mining on the property, making the highest and best use of the property agricultural or recreational, and estimated the after-donation value of the property at $5 million. The difference between the before-donation value and the after-donation value placed the value of the easement at $155.5 million, according to the appraiser.

The IRS disallowed the charitable deduction in a final partnership administrative adjustment, and Coal Holdings filed a Tax Court petition.

Generally, to qualify as a deductible charitable contribution, a conservation easement must contain a perpetual-use restriction on the real property so that the property will always be used for the intended charitable use. A narrow exception to this general rule can be found in case law (Belk v. Commissioner, 774 F.3d 221 (4th Cir. 2014), aff'g 140 T.C. 1 (2013)). However, in Carroll v. Commissioner, 146 T.C. 196 (2016), the Tax Court upheld the Service's disallowance of a charitable contribution deduction, stating that if the charitable grantee "is not absolutely entitled to a proportionate share of extinguishment proceeds, then the conservation purpose of the contribution is not protected in perpetuity."

Tax Court decision

The IRS moved for partial summary judgment, asserting alternative grounds for denying the claimed deduction, but the Tax Court only addressed one argument — that the easement did not meet the requirements for a charitable contribution deduction because the conservation was not protected in perpetuity, as required under IRC Section 170(h)(5)(A). The court agreed with the IRS "because the charitable grantee was not absolutely entitled to a proportionate share of the proceeds in the event the property was sold following a judicial extinguishment of the easement."

Specifically, the Tax Court noted that the language of the easement deed reduced the multiplicand (the sale proceeds at extinguishment) by any increase in value attributable to improvements, which included several gas wells, cell phone towers, and roads. The court also noted that the easement allowed the grantor to continue to make additional improvements to the property. Furthermore, the easement deed reduced the grantee's proportionate share by any prior claims. Accordingly, any hypothetical sale under the terms of the easement deed would result in the grantee receiving a smaller share of the proceeds than it would have received under the formula provided in Reg. Section 1.170A-14(g)(6)(ii).

The Tax Court cited two cases as precedent for its strict and narrow interpretation of the regulations, including PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193 (5th Cir. 2018)), in which the Fifth Circuit held that the language of the regulations precluded any adjustments that would provide the donee with less than the proportionate value of the proceeds.

Finally, the Tax Court dismissed the grantor's argument that the existence of a "Treasury Regulation override" clause in the easement deed would essentially remedy the issue. The court held that this provision in the deed constituted a "condition subsequent" and therefore would not be enforced by the courts.

Noting that the easement deed at issue limits the amount that the grantee may receive if the easement is extinguished, and that the regulation is to be "strictly construed," the Tax Court concluded, as it had in Carroll, "that the charitable contribution must be denied in its entirety because 'the conservation purpose of the contribution is not protected in perpetuity.'"


In recent years, the IRS has increased scrutiny of conservation easements as a vehicle for charitable contribution deductions. (See Tax Alert 2018-1830.) Taxpayers that are considering creating and conveying a conservation easement should take care to ensure that the easement meets all the requirements of IRC Section 170(h)(5) and Reg. Section 1.170A-14(g)(6)(ii), including the formula used to calculate the exempt organization's rights in the property upon judicial extinguishment. Based on this and similar rulings, the Tax Court continues to uphold a very strict interpretation of the formula outlined in Reg. Section 1.170A-14(g)(6)(ii).

As evidenced in the present case, if the easement provides that the exempt organization will receive less from the potential judicial extinguishment of the easement and sale of the underlying property than it would receive pursuant to Reg. Section 1.170A-14(g)(6)(ii), then this will result in a denial of a charitable contribution deduction for the donor. Taxpayers should thus utilize the specific formula outlined in the regulations in their easement deed. Given the strict construction of the regulations, any deviations from this formula are at risk of being determined to be noncompliant. Taxpayers should likewise not rely on provisions purporting to remediate any deficiencies in the easement deed formula, as these are at risk of not being enforced.


Contact Information
For additional information concerning this Alert, please contact:
Exempt Organization Tax Services
Terence Kennedy(216) 583-1504
Melanie McPeak(813) 225-4950
Scott Tidwell(704) 331-0380
Vickus DeKock(512) 542-7756