Tax Court disallows deduction for decrease in property value due to rezoning.

• Author: Brumbaugh, Mark B.

In Lakewood Associates, 109 TC No. 21 (1997), the Tax Court held that a partnership could not take a deduction for the decrease in the fair market value (FMV) of real property caused by restrictions on land use imposed by the Federal government.

In 1987, Lakewood purchased land to build single-family residences. At that time, two-thirds of the land was zoned for agricultural use and one-third was zoned as wetlands under Federal wetland regulations. Lakewood applied to have the land rezoned as residential, which was denied in 1989; in addition, new Federal wetland regulations were issued that resulted in approximately 75% of the land being considered wetlands. To have wetlands rezoned for residential use, Lakewood was required to apply for a permit (a "section 404" permit. Lakewood did not apply, but took a deduction under Sec. 165 in 1989 for the alleged resultant reduction of the FMV of the land. The IRS denied the deduction.

At issue before the Tax Court was whether Lakewood was entitled to a loss deduction in 1989 for a decrease in the FMV of the property allegedly caused by the Federal wetland regulations issued that year.

Facts

When Lakewood applied for rezoning of the property from agricultural to single-family residential, a staff report to the planning commission recommended that the request be denied, citing traffic problems, lack of educational facilities and sewer system deficiencies. In 1989, a voter referendum defeated the rezoning; the Virginia Supreme Court upheld the voter referendum in 1990. (Lakewood made no further attempts to rezone the land after this decision.)

In 1989, the Army Corps of Engineers (Corps) released a new wetland manual that superseded the previous one. In 1990, an engineering firm engaged by Lakewood estimated that, under the 1989 manual, the property was 74% wetlands.

In addition to the new manual, in 1989 the Corps entered into a new memorandum of agreement (MOA) with the Environmental Protection Agency. Effective in February 1990, this new MOA reduced the Corps' flexibility in processing section 404 permits. Lakewood applied for a section 404 permit in 1991, but did not supply the necessary documentation for processing. After two letters requesting the necessary documentation, the Corps withdrew the application. Lakewood did not pursue the section 404 permit further, having been advised that it had little chance for success under the requirements of the 1989 manual.

Lakewood had an adjusted basis in...