Article on Tax-Deductible Conservation Easements
The Internal Revenue Service’s victory in Carpenter v. Commissioner represented an important step in the agency’s ongoing efforts to both address abuses and establish precedent consistent with congressional intent in the conservation easement donation context. While Congress has clearly favored providing a charitable income tax deduction under Internal Revenue Code section 170(h) to encourage the donation of conservation easements, Congress also has been willing to do so only if the easements are “granted in perpetuity” to government and nonprofit holders “exclusively for conservation purposes,” and the conservation purposes of such easements are “protected in perpetuity.”
In Carpenter, the Tax Court addressed a key aspect of the protected-in- perpetuity requirement – the circumstances under which government and nonprofit holders can agree to extinguish tax-deductible conservation easements. This is a critically important issue. Federal taxpayers are investing billions of dollars in conservation easements intended to permanently protect unique or otherwise significant land areas or structures. Astounding amounts of governmental and judicial resources are also being expended to ensure that the easements are not overvalued, that they satisfy the elaborate conservation purposes and other threshold requirements, and that the donations are properly substantiated. For example, as indicated in Appendix A, which lists the cases to date involving challenges to deductions claimed with respect to easement donations, thirty-two such cases (more than half), have been decided since 2005, and the IRS has indicated that there are more than 200 additional cases in the litigation pipeline. This enormous up-front investment of foregone revenues and government and judicial resources will be for naught, however, if the purportedly permanent protections prove to be ephemeral because government and nonprofit holders fail to enforce the easements, or agree to improperly release, modify, or extinguish the easements.
Both Congress and the Treasury Department were aware of this danger, and they built significant safeguards into section 170(h) and the regulations to ensure that the conservation purposes of tax-deductible conservation easements would, in fact, be “protected in perpetuity.” One of those safeguards is Regulation section 1.170A- 14(g)(6) (the extinguishment and proceeds regulation), which addresses both the circumstances under which a tax-deductible conservation easement can be extinguished and the payment of proceeds to the holder to be used for similar conservation purposes in such event. A related safeguard is Regulation section 1.170A-14(c)(2) (the restriction on transfer regulation), which mandates that the holder be prohibited from transferring the easement, whether or not for consideration, unless the transfer is either to another qualified holder that agrees to continue to enforce the easement or pursuant to an extinguishment that complies with the extinguishment and proceeds regulation.
Carpenter provides significant guidance regarding compliance with the extinguishment component of the regulations, as well as the role of state law in ensuring that conservation easements are properly administered and enforced over the long term. The case also, however, has created confusion with respect to the state law cy pres doctrine and has caused some to argue that the process for extinguishment set forth in the regulations should be viewed as optional, and states, localities, and even holders should be free to adopt their own extinguishment procedures in lieu of satisfying federal tax law requirements.
This Article examines Carpenter against the backdrop of the legislative history of section 170(h), state law, and public policy. It clarifies the manner in which the state law cy pres doctrine and its general charitable intent requirement should be analyzed with regard to tax-deductible conservation easements. It offers suggestions as to how best to comply with the extinguishment regulation given the Tax Court’s rulings in Carpenter and other relevant cases. It discusses the court’s holding that the tax-deductible conservation easements at issue in Carpenter constitute restricted charitable gifts under state law and the importance of this status in ensuring that easements are administered in accordance with their terms and purposes over the long term. It also explains that Congress enacted section 170(h) to subsidize the acquisition of perpetual conservation easements, or those that are extinguishable by a court only upon frustration of their purposes, and Congress specifically did not defer to states, localities, or easement holders regarding transfer, release, or other extinguishment of tax-deductible easements. Also examined are the reasons underlying the restriction on transfer, extinguishment, and proceeds regulations, as well as the policy reasons supporting the application of uniform rules in this context.
Two recent Circuit Court decisions, Simmons v. Commissioner and Kaufman v. Commissioner, are also discussed. Although those decisions do not directly address the extinguishment regulation, this Article explains that they undermine the IRS’s efforts to enforce the perpetuity requirements in section 170(h) and the regulations, and open the door to loss of the federal investment in conservation easements and significant abuse.
This Article concludes that the IRS’s strategy of relying on litigation to establish clear rules consistent with Congressional intent in this context appears unlikely to be successful, and another approach is needed. The Article recommends that the Treasury Department and the IRS clarify the regulations and issue other forward-looking guidance regarding the manner in which taxpayers must satisfy the critically important protected-in-perpetuity requirements if they wish to continue to benefit from generous (generally six-figure) deductions. Without clear uniform rules addressing the transfer, amendment, and extinguishment of tax-deductible conservation easements, the purportedly perpetual protections provided by such easements will erode over time, and the enormous public investment in these instruments will be lost.