Charitable Contributions

In Palmolive Building Investors, LLC v. Commissioner, 149 T.C. No. 18, the Tax Court denied a charitable contribution deduction of a donated façade easement because the easement deed failed to satisfy the perpetuity requirement of section 170.

Background – Perpetuity Requirement

A contribution of a qualified real property interest is deductible as a qualified conservation contribution if, among other requirements, the contribution is exclusively for conservation purposes. The “exclusivity” requirement is only satisfied if the conservation purposes are protected in perpetuity. To be protected in perpetuity, the interest in the property retained by the donor must be subject to legally enforceable restrictions that will prevent uses of the retained interest inconsistent with the conservation purposes of the donation. The Regulations provide rules for many of these legally enforceable restrictions.

When donated property is subject to a mortgage, the mortgagee must subordinate its rights in the property to the right of the easement holder to enforce the conservation purposes of the gift in perpetuity. If the mortgagee fails to actually subordinate its rights in the property, the perpetuity requirement is not satisfied. Further, if an unexpected change in conditions makes the property’s continued use for conservation purposes impossible or impractical, then the restrictions required to protect the conservation purpose may be extinguished by judicial proceedings. In the event an easement is extinguished and the donor subsequently conveys the property and receives proceeds for it, the donee organization must be guaranteed to receive a certain portion of the proceeds.

Why Deed Failed to Satisfy Perpetuity Requirement in Palmolive Building Investors

In Palmolive Building Investors, Partnership PB (“Partnership”) transferred a façade easement by executing an easement deed (“Deed”) in favor of the Landmarks Preservation Council of Illinois (“LPCI”), a qualified organization. The purpose of the deed was to preserve the exterior perimeter walls of a building’s façade. At the time of the execution of the Deed, two mortgages encumbered the building. Before executing the Deed, Partnership secured an ostensible agreement from both mortgagees to subordinate their mortgages in the property to LCPI’s rights to enforce the purposes of the easement. However, the mortgagees’ subordination was limited by a provision in the Deed that gave the mortgagees a prior claim to any insurance and condemnation proceeds until the mortgage was paid off. This limitation proved to be fatal, as certain interests of the mortgagees were not actually subordinated to the interests of LPCI.

The IRS filed a motion for partial summary judgment, arguing that the easement deed did not satisfy the perpetuity requirement because it gave the mortgagees prior claims to extinguishment proceeds in preference to LPCI. The Tax Court agreed, holding that the easement deed failed to satisfy the perpetuity requirement for two reasons: (1) the mortgages on the building were not fully subordinated to the easement, and (2) LPCI was not guaranteed to receive its requisite share of proceeds in the event that the easement was extinguished and the donor subsequently conveyed the property and received proceeds for it.

It is worth noting that the Tax Court continued to strictly construe the requirement that the donee must be guaranteed to receive a certain portion of proceeds upon extinguishment, as it did in Kaufman v. Commissioner, 134 T.C. 182 (2010) – if a donee is not absolutely entitled to its requisite share of extinguishment proceeds, then the contribution’s conservation purpose is not protected in perpetuity. The First Circuit Court of Appeals has previously expressed its disagreement with this restrictive interpretation. In Kaufman v. Shulman, 687 F.3d 21 (1st Cir. 2012), the First Circuit explained that if any owner donates a facade easement and thereafter fails to pay taxes, a lien on the property arises in favor of the Government, and such lien would not be subordinated to the easement donee’s interest. Because this is always a possibility, a donee will never have an absolute entitlement to proceeds, so the perpetuity requirement will never be satisfied. The Tax Court refused to follow the First Circuit’s interpretation, explaining that it analyzes “conservation restrictions on the basis of property rights and interests that exist when the easement is granted, rather than conducting an analysis based on speculations of property interests that might arise in the future…”

This case illustrates the importance of ensuring that all requirements of section 170 are satisfied when a conservation easement is granted, as the Tax Court also held that the defects in the easement deed were not cured by a provision that sought to retroactively amend the deed to comply with section 170, because the requirements set forth in section 170 must be satisfied at the time of the gift.

You can read the full opinion here, and you can find more discussion on charitable contribution deductions for conservation easements here and here.

August brought three wins for taxpayers who donated conservation easements that were challenged by the IRS.  In all of the cases, terms of the conservation easement deed document carried the day. 

  • In BC Ranch II, L.P. v. Comm’r, No. 16-60068, 2017 BL 282040 (5th Cir. Aug. 11, 2017), the Fifth Circuit overturned a Tax Court decision finding that an easement deed allowing for small boundary adjustments violated the perpetuity requirement of Section 170(h)(2)(C).  The perpetuity requirement provides that, in order to qualify for a charitable contribution deduction for a conservation easement donation, a taxpayer must restrict, in perpetuity, the use which may be made of the real property.  The Fifth Circuit held that the Tax Court’s reliance in Belk  v. Comm’r, 140 T.C 1 (2013), aff’d 774 F.3d 2210 (4th Cir. 2014), to hold that the conservation easement restrictions violated the perpetuity requirement was misplaced because Belk involved a provision where the easement land could be substituted in its entirety for a new parcel of land.  The Fifth Circuit looked at similar cases where small adjustments to the easement were permitted to promote the underlying conservation purpose.  Because that was the case here, the court found that the perpetuity requirement was met.  Addressing the IRS alternative theory that the partners entered into disguised sales for partnership property, the court also determined that the portions of capital contributions made by partners, other than those attributable to the parcels that were distributed to them, were not disguised sales of partnership assets.  
  • Next, in 310 Retail, LLC, v. Comm’r, T.C. Memo 2017-164, and Big River Development, L.P. v. Comm’r, T.C. Memo 2017-166, the Tax Court held that the conservation easement deeds at issue met the contemporary written acknowledgement requirement set forth in Section 170(f)(8)(B).  The contemporary written acknowledgement provision requires that, in order to claim a charitable contribution deduction, the donor is required to obtain from the charity a written statement that describes the donation, states whether the charity provides goods and services in exchange for the donation, and, if goods and services were provided, the fair market value of those goods and service.  This documentation must be obtained before the earlier of the due date of the return or the date the return in filed.  In both cases, the donor did not obtain from the charity separate documentation that is traditionally sent to donees with this specific language.  However, because the conservation easement deeds contained language discussing the consideration given and stating that the deed was the complete agreement of the parties (known as a merger clause), the deed itself acknowledged that the charity did not provide goods and services to the donor and therefore satisfied the contemporaneous written acknowledgement requirements. 
  • In all three cases, while the taxpayers now presumably have established the right to claim the charitable contribution deduction, the next step of determining the value of the conservation easement will be a separate battle.