Deductions for Gift of Easement Denied Because of Faulty Formula for Distribution of Extinguishment Proceeds

• Published date: 01 July 2016
• DOI: http://doi.org/10.1002/npc.30211
• Date: 01 July 2016

Bruce R. Hopkins’ NONPROFIT COUNSEL

July 20164THE LAW OF TAX-EXEMPT ORGANIZATIONS MONTHLY

Bruce R. Hopkins’ Nonprofit Counsel DOI:10.1002/npc

DEDUCTIONS FOR GIFT OF

EASEMENT DENIED BECAUSE

OF FAULTY FORMULA

FOR DISTRIBUTION OF

EXTINGUISHMENT PROCEEDS

The US Tax Court, on April 27, disallowed claimed

deductions for a gift of a conservation easement to two

charities because the formula in the easement docu-

ment for distribution of any extinguishment proceeds

does not comply with the requirement in the tax regula-

tions (Carroll v. Commissioner).

Facts

Two individuals contributed a conservation ease-

ment to two qualified charitable organizations. The

easement document provides that, in the event that

the conservation purpose is extinguished because of an

unexpected change in circumstances surrounding the

gifted property, the donees are entitled to a proportion-

ate share of extinguishment proceeds at least equal to

the amount allowable as a charitable deduction for fed-

eral income tax purposes over the fair market value of

the property at the time of the contribution.

Law

For a contribution to be made exclusively for con-

servation purposes, the conservation purpose must

be protected in perpetuity (IRC § 170(h)(5)(A)). The

conservation purpose of a contribution is not protected

in perpetuity unless the contribution “gives rise to a

property right, immediately vested in the donee organi-

zation, with a fair market value that is at least equal

to the proportionate value that the perpetual conser-

vation restriction at the time of the gift bears to the

value of the property as a whole at that time” (Reg. §

1.170A-14(g)(6)(ii)).

This regulation adds that, “[a]ccordingly, when a

change in conditions give [sic] rise to the extinguish-

ment of a perpetual conservation restriction . . ., the

donee organization, on a subsequent sale, exchange, or

involuntary conversion of the subject property, must be

entitled to a portion of the proceeds at least equal to

that proportionate value of the perpetual conservation

restriction.”

Analysis

The court ruled that the regulation involved in this

case was “designed to prevent taxpayers from reaping

a windfall if encumbered property was subsequently

destroyed or condemned,” citing Kaufman v. Com-

missioner (referenced in the September 2012 issue).

It stated that the easement document provided the

donors with a “potential windfall in the event that a

change of conditions extinguishes the conservation

easement.” For example, the court wrote, if the IRS

were to deny the donors’ charitable contribution deduc-

tion for reasons other than valuation and the easement

was subsequently extinguished in a judicial proceeding,

the numerator in this formula would be zero and the

charities would not receive a proportionate share of

extinguishment proceeds.

The court conceded that the requirement in the

regulation is a “technical” one. (This is probably reflec-

tive of the fact that the US Court of Appeals for the First

Circuit, in Kaufman, held that the Tax Court was giving

the conservation regulations an “overly technical” read-

ing.) Nonetheless, the court added, it is a requirement

“intended to preserve the conservation purpose.” After

all, the court noted, the donors “could have avoided this

adverse outcome by strictly following the proportional-

ity formula set forth in the regulation.” (There was no

evidence in the record as to why this provision is in the

easement document.) [9.7(d)] ◆

LEGAL ASSISTANCE

ORGANIZATION DOOMED

ON PRIVATE INUREMENT,

PRIVATE BENEFIT GROUNDS

A nonprofit organization was formed to provide

legal assistance to an unidentified group of individuals.

It defends members of this group against, as the rul-

ing puts it, “injustice in American courtrooms, prisons,

and communities.” The IRS characterized this entity as

a “law center,” focusing on constitutional law issues

“dealing with national security, religious freedoms, and

constitutional torts on the federal level, as well as reli-

giously motivated deportation issues, habeas petitions

on constitutional grounds, and federal violations of

constitutional law in civil cases.”

Two individuals, married to each other, plus one

other individual, comprise this organization’s directors

and officers. They are also equal shareholders in a law

firm. The nonprofit organization has entered into a con-

tract with the firm for legal services. This contract was

negotiated by a charitable entity because of its experi-

ence in this regard, including determination of fair mar-

ket value fees. The nonprofit organization will provide

the firm with 99 percent of its business.

This agreement requires the nonprofit organization

to furnish professional liability insurance for the married

couple, reimburse the firm for bar association due and

continuing legal education expenses, assume the firm’s