Appellate Court Agrees With IRS on Deemed Approval Provisions
A couple years ago I wrote about the Hoffman case, where the Tax Court upheld the IRS’ denial of a deduction for a historic preservation easement due to an automatic approval provision. This is a clause stating that if the holder does not reply to a request for approval of a particular land use activity within a specified time frame, the request is deemed automatically approved. Now the Sixth Circuit Court of Appeals has affirmed the Tax Court’s decision, finding that an automatic approval provision undermines the perpetual protection of the property. As the court pointed out, rightly in my opinion, even a simple mistake by the easement holder could lead to the evisceration of the easement’s restrictive terms. Although technically the appellate decision is binding only in the handful of Midwestern states within that circuit, the winds are blowing strongly in one direction on this issue. Moreover, beyond the deductibility issue, automatic approval provisions are a terrible idea for programmatic reasons. Would you (dear stewardship newbie, longtime executive director, or volunteer Board president) want to wake up on the 46th day of a hard and fast 45-day response period and find that request letter buried on your desk, knowing that the bulldozers were about to descend on the property?
Fortunately, the Maine model easement does not include such language, and instead uses an automatic denial provision. (See the last two sentences of Section 11.C.) That said, occasionally I still see easements that stray from the model by including some version of an automatic approval provision. Land trusts and government agencies should scour their templates to make sure there is not even a whiff of an automatic approval. And for landowners and their attorneys who object to automatic denial provisions, now you can point to the Hoffman case and make the IRS the bad cop.
Other Eye Opening Tax Court Cases
While we’ve all been distracted by other news that shall not be named, some other notable tax cases are working their way through the court systems. Here are some capsule updates to keep you apprised of the latest happenings:
- Pine Mountain Preserve and Carter – I first wrote about Pine Mountain Preserve, a doozy of a case, in March 2019, and the ultimate outcome is still pending. It is currently on appeal before the 11th Circuit Court of Appeals. There are several key issues, including: (1) Whether an amendment provision prohibiting amendments that are inconsistent with the conservation purposes is compliant with the perpetuity requirements of 170(h); and (2) Whether the adjustability and scope of building areas and other reserved rights are compliant with those same perpetuity requirements. I was honored to work with the Land Trust Alliance on preparing two separate amicus briefs to the 11th Circuit. As if Pine Mountainwere not confounding enough, in February a Tax Court judge handed down a related and equally confusing decision regarding building areas in Carter v. Commissioner, which also looks to be appealed to the 11th Circuit. Carterinvolved a fully floating building area, but the language of the opinion is unclear as to whether it applies to fixed building areas as well. I suggest that land trusts make landowners aware of the heightened risks around building areas in deductible easements, at least until the appeals conclude. Resolution of either of these cases is likely still at least many months away, if not a year or two. Meanwhile, this excellent summary of the issues from the Alliance is well worth your careful perusal.
- TOT Property Holdings – The IRS proffered a new and aggressive argument in this case before the Tax Court. The IRS claimed that the easement’s forest management provisions were inconsistent reserved rights under the Treasury Regulations for deductible conservation easements because they would allow for the destruction of wildlife habitat and would harm scenic views. The argument is especially disconcerting because the forest management restrictions in the easement were rather robust. In particular, the easement allowed sustained-yield commercial forest management pursuant to a forest management plan. The plan had to: (a) accord with the Tennessee Division of Forestry’s Best Management Practices; (b) be consistent with conservation purposes; and (c) be approved by the holder land trust. Moreover, the holder could prohibit all forest management within any sensitive habitat areas that it identified at the time of the easement’s granting or in the future. Although the Tax Court did not spend any time on this aggressive argument and instead ruled on other grounds, land trusts should be aware of the IRS’ attempt to create another barrier to a deduction. In response to this case, the Land Trust Alliance has issued essential guidance for commercial forest management provisions in donated easements.
- Termination Proceeds Cases – As I’m sure you will recall, in the October 2018 E-Bulletin I wrote about another case in which the Tax Court and an appellate court struck down a common-sense phrase included in most conservation easement termination proceeds provisions. The crux of the matter concerns what percentage of sale or condemnation proceeds must be shared with the holder in the event that the easement is terminated. The disputed phrase allows the landowner to keep all proceeds for the value of a property that is attributable to buildings and other improvements established after the easement was granted. Several recent Tax Court cases agree with the earlier case in finding that this phrase does not comply with the Regulations, and for better or worse we should now consider the matter settled law. As a result of the earlier decisions, lawyers in Maine got together and changed the Maine model easement in late 2018 to delete the disputed phrase from Section 14.G.3. So it’s important that your land trust use the 2018 version of the model and not any earlier versions. To be crystal clear, if the landowner is seeking a deduction, the easement must notinclude any version of this sentence in the termination proceeds provision: “Such reduction shall not include value attributable to permitted improvements made to the Protected Property by Grantor after the effective date hereof.”