Palmer Ranch v Commissioner II

Palmer Ranch made a qualified conservation contribution and secured a qualified appraisal. The IRS disallowed the deduction, claiming the donation was not worth as much as Palmer claimed. Palmer's assessment was based on a claim that the highest and best use was as multifamily dwellings. The IRS disagreed, claiming, at best, the property could be used for single family dwellings. The court found that the taxpayer's estimate was closer to a reasonable estimate.

Palmer Ranch Holdings (PRH) owned an undeveloped 82-acre parcel in Sarasota County. The County had designated a portion of the parcel as a 'wildlife corridor' for bald eagles and other animals. In addition, an active eagle's nest was located on the parcel. In 2006, PRH donated a conservation easement on the parcel and claimed a $24 million charitable contribution. The IRS disallowed all but $7 million of the deduction, and PRH filed suit. PRH's appraiser found a before-easement value of $25.2 million, after determining that the highest and best use was a 360-unit single-family and townhouse subdivision. This 360-unit scenario was based on the likelihood that the County would approve a rezoning to allow a higher development density, in part because the County's comprehensive plan potentially allowed this greater density. The IRS' appraiser determined a before value of $7.7 million based on 100 single-family units. The IRS' appraiser found that a variety of factors (wildlife corridor restrictions, neighborhood opposition, road access challenges, and the County's earlier denial of a rezoning application on an abutting parcel) made it unlikely that any such rezoning would be approved.

Holding: After a detailed analysis, the Tax Court largely agreed with PRH's appraiser and found it reasonably probable that the County would have approved a rezoning of the parcel. The Court next found that a 2006 downturn in the real estate market resulted in a before value of $21 million, somewhat lower than the $25 million stated by PRH's appraiser. Finally, the Court agreed with PRH that the highest and best use after the easement was for recreational purposes, and the shallow buyer pool resulted in a 95% reduction in value, to $1 million, for a net easement value of $20 million. Finally, the Court found that PRH met the reasonable cause exception to the section 6662(a) accuracy-related penalty because it had hired and relied on qualified professional advisors, did not withhold any material information from these advisors, and acted in good faith.

March 2016 Update: In a colorful decision (see in particular footnote 1 on page 8), the 11th Circuit affirmed the Tax Court's determination of the property's highest and best use, but reversed with respect to the $21 million valuation. The 11th Circuit found that the County's handling of the earlier rezoning applications indicated a reasonable probability that it would approve a rezoning of the property. Next, the appellate court held that the Tax Court erred by not conducting an analysis of whether the market would support a 360-unit subdivision, but also found the error harmless because available evidence did in fact support such a level of housing demand as of 2006. Third, the 11th Circuit held that a before-easement value need not factor in a risk discount (i.e., a lowering of value due to the risk that a property cannot be developed at its highest and best use) where that risk had already been accounted for in the highest and best use analysis. Finally, the 11th Circuit found the Tax Court's before-value adjustment from $25 million to $21 million problematic because it departed from the comparable-sales method and relied on evidence from outside the record. Thus, the 11th Circuit remanded to the Tax Court for another take on the before value.

November 2016 Update: On remand from the 11th Circuit, the Tax Court found that the IRS failed to demonstrate the market softening effect using sales or other data for 2006 and 2007 and followed the 11th Circuit in accepting PRH's qualitative adjustment argument. Thus, the Tax Court sustained the value that PRH claimed at trial.

Analysis and Notes: The reasonably probable standard for determining highest and best use comes from Hilborn v. Commissioner, 85 T.C. 677 (1985), one of the earliest conservation easement valuation cases. For a more recent case in which the Tax Court also found it reasonably probable that a rezoning would be approved in a conservation easement deduction context, see Butler v. Commissioner, T.C. Memo 2012-72 (U.S.T.C. 2012).

March 2016 Update: (From Leslie Ratley Beach) The protected property is one of the last tracts of undeveloped land in this rapidly developing community and is now used for conservation, public recreation and a community garden. The 11th Circuit's decision is very favorable to conservation and helpful in how it addresses highest and best use and gives some good detail about how to corroborate and substantiate reasonable probability.