Tax Court Finds Conservation Easement Extinguishment Reg Invalid; Rule Violated APA

Ruling for the plaintiff in a conservation easement case, the Tax Court on March 28, held that the IRS’ rule governing the contents of the extinguishment clause in conservation easement deeds was “procedurally invalid” under the APA. The case involved a $14.8 million charitable deduction by Valley Park Ranch, LLC (VPR) for a conservation easement conveyed in 2016. (Valley Park Ranch, LLC, (2024) 162 TC No. 6)

The IRS disallowed VPR’s deduction in a Notice of Final Partnership Administrative Adjustment (FPAA) because, in its view, the easement deed didn’t satisfy all the requirements of Code Sec. 170(h) and the regs for deducting a noncash charitable contribution. The IRS particularly took issue with the extinguishment clause in the easement deed claiming the clause didn’t comply with Reg. §1.170A-14(g)(6)(ii).

The easement deed at issue provided that if the conservation easement was terminated, VPR would receive (i) an amount determined by a court, unless otherwise provided by state or federal law, or (ii) in the event of a taking by eminent domain, VPR would receive its respective share of the proceeds from a “qualified appraisal.”

VPR timely petitioned the Tax Court for review of the adjustment claiming, in the alternative, that the deed satisfied Code Sec. 170(h) and Reg. §1.170A-14(g)(6)(ii), the reg was invalid under the APA, or that the deed was ambiguous.

The Tax Court agreed with VPR, finding that the reg violated the APA and, as a result, the deed didn’t need to comply with its requirements.

Note. This is a change from the Tax Court’s holding in Oakbrook Land Holdings, LLC, (2020) 154 TC 180, where the Tax Court upheld the validity of the extinguishment regulation. The Tax Court said it will no longer follow Oakbrook on this issue.

The Court further held that the easement deed satisfied the “restriction granted in perpetuity” requirement in Code Sec. 170(h)(2)(C) and the “protected in perpetuity” requirement of Code Sec. 170(h)(5).

The Tax Court agreed with VPR that, during the rulemaking process, Treasury failed to adequately respond to significant comments in the final reg’s “basis and purpose statement” in violation of the APA’s procedural requirements. For example, Treasury didn’t discuss or respond to comments made by the New York Landmark Commission or six other commentators regarding the extinguishment provision, including comments by the NYLC that the formula for divvying up extinguishment proceeds failed to consider that a property owner may make improvements that should “properly alter the ratio” in the reg.

For more information about the requirement that the conservation purpose of an easement be protected in perpetuity, see Checkpoint’s Federal Tax Coordinator ¶ K-3506.