TOT Property Holdings, LLC v. Commissioner

Summary of Facts and Issues: In 2005, George Dixson purchased 652 acres of undeveloped land in rural Van Buren County for $486,000 as part of a larger purchase. Eventually the parcel was transferred into the TOT Property Holdings, LLC (the LLC), and this parcel was its sole asset. In December 2013, an investor purchased 99% of the shares in the LLC for $1,039,000. A few weeks later, the LLC granted a conservation easement to the Foothills Land Conservancy (FLC) on 637 of the 652 acres (excluding three five-acre inholdings). The easement's stated purposes were to protect wildlife habitat, open space (both scenic enjoyment and pursuant to a clearly delineated governmental policy) and a historically important land area. The easement allowed sustained-yield commercial forest management pursuant to a forest management plan. There is minor conflicting language in the easement about the requirements of the plan, but it clearly 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 FLC. Moreover, all of the sensitive habitat areas had special designated protection zones that prohibited forestry. The easement's termination proceeds provision included language that subtracted the value attributable to improvements made after the grant of the easement, the same issue that defeated deductions in several other recent cases. See, e.g. PPBM-Rose Hill and Coal Property Holdings, below. The LLC initially claimed a charitable deduction of $6.9 million. The original appraiser had passed away by the time of the litigation, and the LLC offered the testimony of another appraiser, who valued the easement at $2.7 million.

Holding: Following a trial, the Tax Court issued its decision in a bench opinion. The Court held as follows: (1) Following the reasoning and holding of Coal Property Holdings, LLC, the Court denied the deduction due to the flawed termination proceeds language. (2) In light of the numerous failed residential subdivision projects in the area, the lack of nearby infrastructure, and the lack of resort amenities such as mountain views or lakes, the highest and best use of the protected property both before and after the easement was not residential development, as the taxpayer had claimed, but rather recreational use and timber harvesting. (3) As per the IRS appraiser's testimony, the before-easement value was $1,128,000 and the after-easement value was $632,000, leading to a fair market value of the conservation easement of $496,000, well below the $6.9 million claimed by the taxpayer. (4) The IRS complied with I.R.C. § 6751(b) in order to properly assess the 40% gross misevaluation statement penalty. (5) The Court assessed a 20% negligence penalty on the first $496,000 of the claimed deduction, and the 40% penalty on the remainder, finding no evidence of reasonable cause or good faith on the part of the taxpayer.

Analysis and Notes: Although not addressed at all by the Tax Court, it is worth highlighting a new assertion by the IRS. The IRS claimed that the easement's forest management provisions were inconsistent reserved rights under Reg. § 1.170A-14(e)(2) because they would allow for the destruction of habitat of an at-risk species of bat and would harm scenic views from the road. Although the Court did not spend any time on this aggressive argument, land trusts should be aware of its existence. The Alliance has issued guidance for commercial forest management provisions in donated easements. See https://tlc.lta.org/topclass/topclass.do?expand-OfferingDetails-Offeringid=1011665.