gee six sub two

By: Russell A. Willis III, J.D., LL.M.

IRS has won yet another skirmish in its permanent war against perceived abuses of the tax incentives for conservation and facade easements. Whether they can hold this turf on appeal remains to be seen, but this case is likely not the vehicle.

On May 12, a divided Tax Court issued a reviewed opinion in Oakbrook Land Holdings, LLC v. Commissioner, upholding not only

• the validity of reg. section 1.170A-14(g)(6)(ii), which requires that the donee be entitled to receive, in the event the easement is later extinguished, proceeds at least equal to the "proportionate value" of the restriction as a component of the value of the entire property, but also
• the agency's interpretation of that regulation, which would allow no compensation to the holder of the servient estate for any improvements it may have made to the property in the interim.

Eleven judges concurred in a majority opinion authored by Judge Lauber, to whom quite a number of these cases have been assigned.

The majority acknowledged that this is a "legislative" regulation, i.e., not merely "interpretive," for which notice and public comment were required, but found that in finalizing this reg the Treasury had adequately addressed concerns that were raised in the notice and comment period.

Judge Toro, concurring in the result only, i.e., that the taxpayer should be denied a deduction, disagreed with that finding. He argued at length that in finalizing the regs the Treasury had in fact ignored comments questioning the proposed rule that at least implicitly would not allow the holder of the servient estate to recover its investment in improvements.

However, Judge Toro said, the court should not even have reached this question, because even without the "improvements" clause the agreement here froze the donee's share at its value on the date of the initial transfer. And this, he said, failed the requirement of section 170(h)(2) that the easement be an interest in the real property itself, which of course would participate in any appreciation in its value.

Judge Holmes, who had actually heard the case, dissented, echoing several of Judge Toro's arguments. It was in fact his memorandum decision denying the claimed deduction, issued the same day, that had necessitated a reviewed decision on the validity of the reg.

"particularly in the southeast"

Back in 2008, IRS released a letter ruling, PLR 200836014, that seemed to countenance an "improvements" clause in a conservation easement, but

• of course a letter ruling is not precedent, and
• the clause was not itself at issue in the ruling request.

And in the particular case, the agreement did provide that the donee would participate in any appreciation, net of the adjustment for improvements.

Still, the partnership here was able to cite the letter ruling as "substantial authority" to support the "reasonableness" of its reporting position and escape negligence and understatement penalties.

As Judge Holmes noted in his memorandum decision, the "improvements" clause was apparently already a fairly widespread practice when the letter ruling was issued, "particularly in the southeast."

What he did not mention is that many of these involve the same land trusts, and the same promoters, who are among the targets of a Justice Department lawsuit in federal court in Atlanta to shut down an easement syndication operation, drive its proponents out of business, and require them to "disgorge" every nickel they have made on these projects over the past ten years.

And as he warned in his dissent to the reviewed opinion, there are "a great many" of these cases now pending before the Tax Court, which will be appealable in "multiple circuits." Implying that if the question of the validity of this reg is properly preserved, we may see a divergence of views among the circuit courts.

But apparently not just yet.

The taxpayer did try to raise the issue to the 5th Circuit in PBBM-Rose Hill Ltd. v. Commissioner, but that court declined to take it up as it had not been argued below.

What promises to be an avalanche of decisions denying very large claimed deductions for conservation or facade easements involving "improvements" clauses was launched last October in Coal Property Holdings, LLC v. Commissioner, a reviewed opinion also authored by Judge Lauber.

As in PBBM-Rose Hill, however, the taxpayer did not challenge the validity of the regulation, not even in its motion for reconsideration. Thus, while it appears that case will likely be appealed to the 6th Circuit after the question of penalties has been resolved, the appeals court probably will decline to take up the validity of the regulation.

Similarly, in Woodland Property Holdings, LLC v. Commissioner, in a memorandum decision issued the day after the two decisions in Oakbrook, Judge Lauber granted IRS a partial summary judgment in another case involving an "improvements" clause.

Appeal in that case would lie to the 11th Circuit, but as in Oakbrook, the easement agreement also froze the value of the donee's share at its value on the date of transfer, and again, the taxpayer did not challenge the validity of the reg. So also probably not a good vehicle for testing the validity of the reg on appeal.

But eventually we will get there. Judge Toro makes a good argument, which is well worth reading. The heart of the matter is at pages 52 and following: is this a reasonable reading of (g)(6)(ii). Though technically this is Auer deference, not Chevron step two.