Two recent Tax Court cases highlight the IRS's focus on charitable contributions of real property conservation easements. The conservation easement is a popular device because it allows the taxpayer a deduction while keeping the property. Many times, the easement restricts the property from uses the taxpayer was never going to do anyway.
North Carolina Golf Course
The first is a North Carolina case, B. V. Belk, Jr., et ux. v. Commissioner, 140 T.C. No. 1. In that case, Mr. Belk (or a company he controlled) owned a golf course near Charlotte called Olde Sycamore. Mr. Belk donated a "conservation easement" on the golf course to Smoky Mountain National Land Trust because of the "recreational, natural, scenic, open space, historic, and educational values" associated with the course. The easement limited the development of the golf course but allowed its use as a golf course.
Mr. Belk's appraiser determined the value of the golf course before the easement to be $10,801,000. The appraiser reached this amount after concluding the highest and best use of the property was a medium-and high-density residential development. After the easement, the appraiser determined the highest and best use of the property was as a golf course and that its value was $277,000. Accordingly, Mr. Belk claimed a charitable deduction for $10,524,000.
In an interesting twist, Mr. Belk retained the right to substitute property for all or part of the golf course. The substitute property would have to be similar in value to the property taken out of the easement. The substitution right would allow Mr. Belk to remove the easement and develop part of the golf course in the future.
The Tax Court held that in order for a donation to constitute a qualified conservation contribution, the contribution must be an interest in real property that is subject to a use restriction granted in perpetuity. However, under the terms of this conservation easement, the taxpayer could remove portions of the golf course and replace them with property currently not subject to the conservation easement. Thus, the taxpayer had not donated an interest in real property which is subject to a use restriction granted in perpetuity. The Court said that to conclude otherwise would permit the taxpayer a deduction for agreeing not to develop the golf course when the golf course actually could be developed by substituting new property subject to the conservation easement.
In short, the court disallowed the deduction and sent Mr. Belk a bill for over $2 million in tax.
New York City Historic Property
In a second case, Lawrence G. Graev, et ux. v. Commissioner, 140 T.C. No. 17, the Tax Court ruled that a taxpayer wasn't entitled to charitable deductions for his contributions of a façade easement on a historic property or his corresponding cash donation to a charitable organization. The Court found that a "side letter," which promised to return the cash contribution and remove the easement in the event that IRS disallowed the deductions, rendered the gifts conditional and thus nondeductible.
As noted, the interest in property conveyed by an easement must be protected in perpetuity for the contribution of the easement to be a qualified conservation contribution.
Lawrence Graev, an attorney, purchased a historic property in New York City in 1999 for $4.3 million. On Sept. 20, 2004, Mr. Graev executed a façade conservation easement for the benefit of the National Architectural Trust. A side letter said NAT would remove the easement if the IRS disallowed his contribution. That is, he conditioned the easement on getting the tax deduction.
IRS disallowed the deduction. The IRS said that the contributions were "made subject to subsequent event(s)"-in other words, the gifts were conditional.
Mr. Graev, on the other hand, claimed that the side letter was unenforceable under New York law because the conditions weren't included in the recorded deed. Therefore, he claimed that the side letter was a nullity.
The Tax Court agreed with the IRS and concluded that NAT's promises in the side letter made the gifts conditional, because the chance that the condition would occur wasn't "so remote as to be negligible."
One note: Now that the deduction is disallowed, does Mr. Graev still think the side letter is unenforceable?
