Fourth Circuit Affirms Tax Court' s Disallowance of Conservation Easement Deduction

(Parker Tax Publishing July 2024)

The Fourth Circuit affirmed the Tax Court and held the IRS properly disallowed a deduction for a conservation easement contribution because (1) the taxpayers failed to produce a contemporaneous written acknowledgment that established the amount (if any) of consideration received for the donation of the easement, (2) their baseline report did not demonstrate the status of the property at the time of the contribution, and (3) they misrepresented their basis in the easement property on their tax return. The court also upheld the imposition of a 40 percent penalty for a gross valuation misstatement. Brooks v. Comm'r, 2024 PTC 252 (4th Cir. 2024).

Background

In 2006, Kenneth Brooks and Anita Wolke Brooks, through their family limited liability company, purchased roughly 85 acres of vacant land in southeast Liberty County, Georgia, for $1.35 million and divided it into two parcels of roughly 44 acres and 41 acres, respectively. A year later, they granted Liberty County a conservation easement on the 41-acre parcel "for and in consideration of the sum of ten dollars ($10.00) and other good and valuable consideration." The easement deed did not describe the "other consideration." The deed prohibited development of the property and required that it be preserved in its natural state, albeit subject to the exercise of numerous rights reserved to the Brookses to use the property recreationally. The Brookses attached to the easement deed a "boundary description" of the property, which included two maps, and a "Baseline Survey Summary" of the property, consisting of three pages of substantive text that contained limited information on the general conditions of the donated property at the time.

On their 2007 tax return, the Brookses claimed a $5.1-million charitable deduction for the "41.201 acre tract of vacant land" over which they had granted an easement to Liberty County and stated that the "cost or adjusted basis" for the 41-acre tract was $1.35 million, which was the total amount they had paid for the 85-acre parcel. They attached an appraisal which valued the easement on the 41-acre parcel at $5.1 million, as well as the deed granting the easement, which had been signed by Liberty County. They did not include any other document that purported to be a contemporaneous written acknowledgement of the contribution by Liberty County. The Brookses took a deduction of $748,702 on their 2007 return for the donation and carried forward deductions on their 2009 through 2012 returns. In a notice of deficiency for 2010, 2011, and 2012, the IRS disallowed the carry-forward deductions and assessed 40 percent penalties for gross valuation misstatements under Code Sec. 6662(h). In Brooks v. Comm'r, T.C. Memo. 2022-122, the Tax Court upheld the IRS's action. The Brookses appealed to the Fourth Circuit.

Code Sec. 170(f)(8) provides that "no deduction shall be allowed" for a charitable contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgement of the contribution by the donee organization. The contemporaneous written acknowledgement must include (1) the amount of cash and a description of any property contributed; (2) whether the donee organization provided any goods or services in consideration, in whole or in part, for any property donated; and (3) a description and good faith estimate of the value of any goods or services provided as consideration.

Reg. Sec. 1.170A-14(g)(5) requires a conservation easement donor to provide documentation to the donee describing the baseline status of the property so as to fix the scope of the easement at the time of the donation and therefore enable its enforcement later against encroachment. This documentation requirement may be satisfied with maps and photographs demonstrating the scope and nature of the conserved areas. The donee is required, at the time of the donation, to confirm that the documentation is accurate. In addition, Reg. Sec. 1.170A-13(c)(2) provides that the taxpayer must obtain a qualified appraisal and attach a "fully completed appraisal summary" to their Form 8283, Noncash Charitable Contributions. The appraisal summary is required under the regulation to include the cost or other basis of the property.

In disallowing the Brookses' deductions, the Tax Court held (1) that the Brookses had failed to satisfy the contemporaneous written acknowledgment requirement; (2) that the Brookses' baseline report included with the easement was insufficient to fulfill the requirement of demonstrating the status of the property at the time of the contribution, as required by Reg. Sec. 1.170A-14(g)(5); and (3) that the Brookses had misrepresented their basis in the easement property on their Form 8283 in violation of Reg. Sec. 1.170A-13(c), and had not provided reasonable cause to excuse doing so.

On appeal, the Brookses contended first that they "complied (and certainly substantially complied) with the [tax] law's nuanced requirements" and that therefore their deduction should not have been disallowed. They argued that the deed itself established that Liberty County paid no consideration for the easement, thus providing the information that would otherwise have been included in a separate contemporaneous written acknowledgement. While they recognized that the language of the deed included a statement of consideration - "for and in consideration of the sum of ten dollars ($10.00) and other good and valuable consideration" - they argued that such language was mere "boilerplate" and therefore should be disregarded. Instead, they focused on deed language stating that they agreed to "donate" the conservation easement and argued that it meant they gave the easement without receiving consideration for the transfer.

The IRS contended that the deed, by its language, left open the possibility that additional consideration was provided in exchange for the contribution, which meant that the deed failed to satisfy the requirements of Code Sec. 170(f)(8)(B). But the IRS reached this position by noting that the consideration language in the deed was "boilerplate" and therefore could be "properly disregarded." Thus, the IRS argued that in the absence of any statement as to consideration, the deed did not satisfy the requirements of Code Sec. 170(f)(8)(B).

Analysis

The Fourth Circuit affirmed the Tax Court's disallowance of the Brookses' deduction and the imposition of penalties for gross valuation misstatements.

The Fourth Circuit found that the Brookses' deed did not satisfy the requirements of a contemporaneous written acknowledgement under Code Sec. 170(f)(8) because it failed to state whether Liberty County provided any goods or services in consideration, in whole or in part, for the easement donated. The court found curious the parties' reasoning that the boilerplate deed language regarding consideration could be ignored. The court observed that such language is common in contracts and is understood to mean that, while consideration was given, the specific amount is not stated in the deed. In the court's view, the parties included it in the deed and accordingly it had to be taken into account. The court also found that it was not unfair or overly technical to deny the deduction based on the Brookses' failure to provide a contemporaneous written acknowledgement. The court said that it does not require a strict construction to recognize that Code Sec. 170(f)(8) requires the disallowance of a charitable contribution unless the taxpayer provides the IRS with a contemporaneous written acknowledgement. Moreover, strict enforcement of the charitable contribution requirements is necessary to prevent the abuse of conservation easements.

The court also found that the Brookses' baseline report did not comply with Reg. Sec. 1.170A-14(g)(5) because it provided no specifics about where timber, open fields, special plant life, and habitats were located, such that at a later time a portion of the property could be identified as being impermissibly degraded by the exercise of the rights reserved by the Brookses. The court rejected the Brookses' argument that they substantially complied with the baseline report requirement. In the court's view, their report was "woefully inadequate" because it provided virtually no mechanism by which a reasonable person could delineate their reserved rights from the rights reserved to Liberty County in the easement.

In addition, the court found that the Brookses failed to include the basis of the contributed property on their Form 8283. Their disclosure that they paid $1.35 million for 85 acres of vacant land did not satisfy the requirement, the court found, because the Brookses later subdivided the parcel and the conservation easement they donated covered only a 41-acre parcel. The court found that the Brookses' basis in that parcel was therefore only $652,000, and therefore claiming a basis of $1.35 million could not be considered substantial compliance. The Brookses' misstatement of basis was significant, the court explained, because it worked to conceal just how excessive the valuation of their easement was. By reporting a $1.35 million basis, the Brookses suggested to the IRS that the property's value increased roughly 3.8 times in one year, a facially implausible number but not nearly as egregious as a roughly 7.8-fold increase in value that reporting the correct basis of roughly $652,000 would have revealed.

For a discussion of the rules for conservation easement donations, see Parker Tax ¶84,155. For a discussion of the recordkeeping and substantiation requirements for charitable donations, see Parker Tax ¶84,190.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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