Esgar v Commissioner (I)

Esgar Corp. v. Commissioner, 744 F.3d 648 (10th Cir. 2014)(Esgar II), affirming T.C. Memo 2012-35 (U.S.T.C. 2012)(Esgar I)

State: Colorado

Procedural Status: Case concluded.

Date: 2014

Keywords: Agriculture; appraisal; appraisal penalty; burden of proof; charitable deduction; enhancement; evidence; highest and best use; Internal Revenue Code; mineral rights; section 170; valuation.

Summary of Facts and Issues: In 1987, Esgar Corporation (Esgar), the Holmeses, the Tempels, and another party each acquired an undivided, one-fourth interest in just over 2,200 acres of property. The majority of the parcel was used for commercial gravel extraction. In 2004, after learning about conservation easements from their accountant, the taxpayers partitioned a portion of their property and each donated a conservation easement on separate and abutting 54-acre parcels to the Greenlands Reserve. The taxpayers claimed charitable contribution deductions based upon an appraisal that determined the highest and best use of the properties before the conservation easements was commercial gravel extraction. Upon examination, the IRS challenged the valuation. The parties agreed on the fair market value of the subject properties after the conservation easements were granted. However, they disagreed on the before value because the IRS contended that highest and best use was for agriculture (with before values of approximately $35,000), while the taxpayers contended it was commercial gravel extraction (with before values of approximately $600,000 - $850,000). At trial, the taxpayers called four different expert witnesses: a real estate broker, a geologist, an appraiser/geologist, and an appraiser.

Holding:

(1) Similar to Whitehouse Hotel Limited Partnership, but unlike Boltar, LLC, the Tax Court denied the IRS’ attempt to strike the taxpayers’ appraiser’s testimony as admissible evidence. The IRS had claimed inadmissibility because this witness based his testimony on the flawed analyses of the previous three witnesses, and had not conducted any independent analysis.

(2) Although the parties disputed whether the enhancement rule (also known as the contiguous parcel rule) should have been applied in valuing the conservation easements, the Tax Court declined to rule on this issue because even if the rule were applied, as the IRS urged, there was no effect on value.

(3) A 1978 access easement burdening the protected properties and a 1989 reservation of mineral rights had both been terminated by a subsequent foreclosure and quiet title action, respectively, and thus had no effect on the value of the conservation easements.

(4) The Tax Court held for the IRS that the highest and best use before the conservation easements was for agriculture and not gravel extraction, because there was no immediate or reasonably foreseeable market for gravel from the protected properties as of the date of the donation.

 (5) Analyzing the IRS appraiser’s comparable sales, the Tax Court found before values of $77,000, $74,000, and $74,000, somewhat higher than the IRS’ appraiser’s figures, but roughly 90% below those of the taxpayers.

(6) The taxpayers acted with reasonable cause and good faith in relying on their accountant (who was competent and conducted extensive research on conservation easements) and therefore the accuracy-related penalties were not assessed.

March 2014 Update: On appeal, the Tenth Circuit held as follows:

(1) It assumed – without deciding – that the taxpayers had presented credible evidence on the before value’s highest and best use for commercial gravel extraction, and therefore the burden of proof on this issue shifted to the IRS under I.R.C. § 7491(a). But this burden shift was immaterial because the Tax Court was not clearly erroneous in finding that the preponderance of evidence favored the IRS’ position.

(2) Quoting the appraisal regulations at Treas. Reg. § 1.170A-13(h)(3)(ii), the Tenth Circuit held that the Tax Court’s highest and best use analysis properly assessed “how immediate or remote the likelihood is that the property . . . would in fact be developed” as a commercial gravel operation.

(3) The Tax Court did not err in using eminent domain valuation concepts and case law to determine highest and best use.

Analysis and Notes: George and Georgette Tempel, two of the taxpayers in this case, were also the taxpayers in Tempel v. Commissioner, 136 T.C. 341 (2011), and the appeal to the Tenth Circuit was a consolidated appeal of both cases.