Federal Income Taxation

JurisdictionUnited States,Federal
Publication year2021
CitationVol. 72 No. 4

Federal Income Taxation

Nikolai Karetnyi

Ruoxi Zhang

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Federal Income Taxation

by Nikolai Karetnyi*

and Ruoxi Zhang**

In the year 2020, the federal courts within the United States Court of Appeals for the Eleventh Circuit handed down several notable opinions on federal tax issues.1 This Article surveys two of those opinions involving the taxation of conservation easements and the receipt of settlement payments.

I. Pine Mountain Preserve v. Commissioner2

A conservation easement is a unique mechanism that carefully balances private property ownership rights with the public good inherent in conserving land. Under a typical conservation easement arrangement, a real property owner enters into a contractual arrangement with a land trust or government agency that creates permanent restrictions on the use of that real property, while still allowing the owner to hold certain rights over that real property. These permanent restrictions are meant to curtail certain uses of land or other real property that would hinder its conservation value. For example, a large piece of scenic land with delicate ecological systems could be protected through a conservation easement restricting natural resource exploration. Similarly, a conservation easement could also protect a historic building with an original facade from encroaching real estate redevelopment. Conservation easements incentivize property owners to recognize the public utility of privately owned spaces, whether it be natural beauty or historical significance, and

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to take necessary actions to harness such utility. In Pine Mountain Preserve v. Commissioner, the Eleventh Circuit navigated the balance between land conservation rights granted to a donee charitable organization and land development rights retained by a private donor with respect to a contribution of a conservation easement and assessed whether this arrangement would allow the private donor to claim a charitable deduction for the donation of the conservation easement. The Eleventh Circuit ultimately reversed in part and affirmed in part the Tax Court's determination of these issues.3

Section 170 of the Internal Revenue Code (the Code)4 works to further incentivize private property owners to enter into conservation easements by offering tax benefits. Essentially, Section 170 recasts the conservation easement arrangement as a deductible charitable contribution of certain property rights by a property owner. Generally, no charitable contribution deduction is allowed for a contribution of a partial interest in property, where the interest consists of anything less than the owner's entire interest in a property.5 However, through an exception to this general rule, a taxpayer may still retain property rights and be entitled to a charitable contribution deduction for grants of real property that qualify as a "qualified conservation contribution."6 A qualified conservation contribution is a contribution of a "qualified real property interest" to a "qualified organization" that is made exclusively for conservation purposes.7

A qualified real property interest includes an entire interest in real property (other than mineral rights);8 a remainder interest in real property;9 or a restriction on the use of the real property that is granted in perpetuity.10 For the purpose of these rules, "the terms easement, conservation restriction, and perpetual conservation restriction have the same meaning."11

The "in perpetuity" requirement is enforceable in three ways, in that a restriction must be granted,12 protected,13 and enforceable in

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perpetuity.14 First, for a restriction to be granted in perpetuity, a restriction must attach to property and cannot expire at a designated time (the "granted in perpetuity" requirement).15 If at the time of the contribution, the restriction is contingent upon a remote future act or an event ("if on the date of the gift it appears that the possibility [of] such an act or event" is negligible), then such contingency does not prevent that restriction from being granted in perpetuity.16

Second, a restriction is not "exclusively for conservation purposes" (and thus fails the third prong of the qualified conservation contribution test) if the conservation purpose itself is not protected in perpetuity (the "protected in perpetuity" requirement).17 Finally, the donor of the real property must maintain a perpetual right to enforce the restriction upon the property (such as through deed recordation) to prevent the use of the property in a manner "inconsistent with the conservation purposes of the donation" (the "enforceable in perpetuity" requirement).18

For these purposes, a "qualified organization" is either a public charity (or an organization controlled by a public charity) or a governmental unit (or an organization that "receives a substantial part of its support" from a governmental unit).19 A public charity is an organization that is exempt from tax under Code Section 501(c)(3)20 that receives more than one-third of its support for each of its taxable years from gifts, grants, contributions, membership fees, or gross receipts from activities that do not constitute an unrelated trade or business generally from unrelated

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third parties.21 A public charity cannot "receive more than one-third of its support in each taxable year from" gross investment income and the excess of its income from unrelated trades or business over the tax imposed on such income.22

Permitted conservation purposes include the preservation of land areas for outdoor recreation or for the education of the public, the protection of natural habitats and ecosystems, preservation of open spaces for the scenic enjoyment of the general public or pursuant to a clearly delineated governmental mandate, or the preservation of a historically important land area or structure.23 A donation is expected to satisfy one or more of these permitted conservation purposes.24 For a donation to be "exclusively for conservation purposes," the conservation purpose must be protected in perpetuity, as discussed above.25 In other words, the donor's retained interest in the contributed property must be subject to legally enforceable restrictions that will prevent uses of the property inconsistent with the permitted conservation purposes.26 Often, this is accomplished through the recordation of a deed of easement that sets forth the conservation purpose(s), restrictions, and permissible uses of the contributed property.

The general rules applicable to the deductibility of charitable contributions also govern qualified conservation contributions. A qualified conservation contribution must be made with charitable intent and without receipt of adequate consideration.27 Quid pro quo contributions are prohibited as the donor cannot make the contribution with the expectation of direct or indirect benefits.28 The amount of deductions which an individual may take for its charitable contributions of capital gain property is limited to 30% of the individual's contribution

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base (which is generally the individual's adjusted gross income).29 However, a qualified conservation easement contribution is subject to a higher cap of 50% of the individual's contribution base.30 Additionally, while individual and corporate taxpayers may carryover unused charitable contributions for five years,31 the carryover period for conservation easement contributions is fifteen years.32

Pine Mountain, LLLP (Pine Mountain) owned 6,224 acres of contiguous unimproved land near Birmingham, Alabama. "In each of 2005, 2006, and 2007, Pine Mountain granted the North American Land Trust (NALT)" conservation easements representing 559, 499, and 224 acres of land respectively.33 Under the easements, Pine Mountain conceded broad land development rights and granted to NALT land preservation rights.34 In each case, NALT was granted a "perpetual easement in gross" over a specified conservation area "for the purpose of preserving and protecting defined conservation purposes."35 In line with the Code, the easements memorialized the conservation purposes as protecting natural habitats and open areas that provide scenic enjoyment to the public and yield a significant public benefit. NALT was empowered to enforce the litany of covenants and restrictions in the easements in order to prevent Pine Mountain from developing the property for commercial and residential use.36 Pine Mountain became subject to covenants including prohibitions "on building structures, roads and driveways, collecting ground or surface water, removing trees, posting signs, mining, dumping, modifying topography and water courses, introducing non-native plant species, and subdividing the land."37

In each of the easements, Pine Mountain retained a discrete set of certain rights. In the 2005 easement, Pine Mountain retained the right to build a single-family home on each of ten delineated one-acre plots (designated as "Building Areas"), along with a barn within 1,000 feet of each Building Area. Further, Pine Mountain was authorized to modify the location of a Building Area so long as the total cumulative acreage of all Building Areas remained unchanged and NALT did not conclude that

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such modification would be materially adverse to the conservation purposes of the easement. Subject to NALT's approval, Pine Mountain also reserved rights to build an additional barn, two scenic overlooks with ancillary structures, five ponds, and an unspecified amount of hunting blinds. The 2006 easement also granted Pine Mountain the right to build a single-family home on each of six Building Areas, although unlike the 2005 easement, these Building Areas were not clearly marked on a plan. However, Pine Mountain was obligated to notify NALT in advance of where it planned to place these six Building Areas, and any such construction was subject to NALT's ultimate approval. Similarly, NALT...

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