Document / Legal Opinion

Sells v. Commissioner

Posted April 27, 2021
Robert H. Levin
About This Legal Opinion

Summary of Facts and Issues: In 1999, Steven Moses bought 398 acres of land in Calhoun County for $2.4 million. After the tech bubble burst in 2001, Moses faced mounting debt and sought to sell the property. He sold a 162-acre parcel but was left with the remaining 236 acres. He and seven other individuals formed a limited liability company to buy the 236 acres for $1.4 million in August 2002 and then donate a conservation easement on it to Chattowah Open Land Trust in December 2003. The LLC claimed a deduction of $5.4 million for the easement, and an additional deduction of $275,000 for the value of donated 'timber,' presumably for the value of the standing timber on the protected property. The IRS challenged both the easement deduction and the timber value deduction.
Holding: In line with several recent cases, the Tax Court denied the easement deduction in its entirety based on the inclusion of an improvements clause in the easement's termination proceeds provision. On procedural grounds, the Tax Court ruled that it was acceptable for the IRS to raise the proceeds provision flaw for the first time after the trial, because it was a new argument but not a new issue. The Tax Court also rejected an argument by the taxpayers that Alabama law precludes a conservation easement holder's entitlement to any proceeds, and thus did not trigger the exception in Reg. § 1.170A-14(g)(ii) that the holder's share of any termination proceeds is required 'unless state law provides that the donor is entitled to the full proceeds from the conversion without regard to the terms of the prior perpetual conservation restriction.' Next, the Tax Court addressed the timber donation, holding that it did not qualify for a deduction. Noting the IRS' confusing presentation of the issue, the Tax Court held that the donation of timber was not qualified conservation contribution under § 170(h), nor did it qualify under the general § 170 section because it was a partial interest in real estate and therefore nondeductible under § 170(f)(3)(A). Alternatively, if it were treated as a future interest in tangible personal property, then it would be deductible only when the timber was severed from the real property. As to penalties, the Tax Court found the IRS not to comply with the approval requirements of § 6751(b) with respect to most of the taxpayers. For those penalties that did satisfy the procedural requirements, the Court found that the reasonable cause defense for the negligence and substantial mis valuation penalties did apply to excuse the improvements clause mistake, following Oakbrook Land Holdings, LLC v. Commissioner. And although the Court found that the conservation easement was overvalued by more than 200%, the overvaluation did not come close to the 400% required for the gross valuation misstatement penalty to apply.
Analysis and Notes: The timber donation issue is a curious aspect of this case. It seems that the taxpayers and their appraisers made an original mistake in claiming a separate deduction for the value of the timber rights that were extinguished by the easement; instead, this value should have been folded into the overall easement valuation. The IRS then compounded this mistake by analytical confusion in its presentation of the issue to the Tax Court. The Tax Court ultimately seems to have reached the proper outcome in deeming the timber donation, in and of itself, nondeductible. But along the way the opinion contains some inapposite and confusing citations to § 170(h) and the accompanying Regulations. Read together with the TOT Property Holdings case, this opinion may be read as a warning that the IRS and the Tax Court may be receptive to arguments that weak forest management restrictions may render conservation easements vulnerable to deductibility challenges.