Navigating IRS challenges to conservation easements.

• Author: Fogarty, Micah G.

The Internal Revenue Service is certainly in attack mode when it comes to deductions of contributions of conservation easements. Since 2010, courts have published at least 60 opinions addressing issues related to conservation easements. Practitioners with clients considering conservation easements or who are defending conservation easement cases must keep current with the influx of rulings and have a good understanding of how these rulings fit within the framework of [section]170(h). (1) This article provides an overview of some of the more recent developments.

Background

In an effort to encourage preservation of the country's natural resources, Congress, in 1976, enacted legislation permitting a deduction for the contribution of a conservation easement. (2) With the enactment of [section]170(h), Congress created an exception to the general rule that taxpayers cannot deduct contributions of partial interests in property. (3)

In a typical case, a landowner grants an easement over real property to a charitable donee (generally a land trust) and is thereafter subject to restrictions on the use and development of the property. At the same time, the charitable donee is granted the right to enforce these restrictions in furtherance of the conservation purposes set forth in the easement. So long as the contribution of the easement is made for prescribed conservation purposes, the donor can take a charitable deduction equal to the value of the easement (often 25 to 50 percent of the value of the unencumbered land). The conservation easement runs with the land and the conservation purposes and restricted uses must be protected and enforced in perpetuity. Under the right circumstances, the contribution of a conservation easement can result in substantial tax savings without meaningfully affecting a taxpayer's ownership or use of the property.4

In recent years, however, the IRS has increased its scrutiny of conservation easements, generally focusing on whether the easement furthers specific conservation purposes, whether the easement would in fact be enforced in perpetuity, and whether the parties have overvalued the easement. In an examination, a taxpayer can expect the IRS to address at least three areas: 1) statutory/regulatory sufficiency; 2) proper substantiation; (5) and 3) valuation. This article examines the first area and addresses recent interpretation of the statutory (and regulatory) elements of a "qualified conservation contribution."

Definition of "Qualified Conservation Contribution"

Taxpayers may deduct the value of a charitable contribution of a partial interest in property only if the contribution constitutes a "qualified conservation contribution." (6) A "qualified conservation contribution" is a contribution that is: 1) a qualified real property interest; 2) made to a qualified organization; (7) and 3) exclusively for conservation purposes. While the requirement that the contribution be made to a qualified organization is rarely an issue, the "exclusively for conservation purposes requirement" has been the subject of substantial litigation. After a few key wins, the IRS seems to have expanded its challenges to include whether the "qualified real property interest requirement" is satisfied.

Exclusively for Conservation Purposes Requirement

A contribution of a conservation easement is deductible only if it 1) achieves a conservation purpose; and 2) that conservation purpose is protected in perpetuity. (8)

The conservation purpose may be any one of the following: 1) the preservation of land areas for outdoor recreation by, or the education of, the general public; 2) the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem; 3) the preservation of open space for the scenic enjoyment of the general public or pursuant to a governmental conservation policy; or 4) the preservation of an historically important land area or a certified historic structure. (9)

Section 170(h)(5)(A) provides that a contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. The Code does not define "protected in perpetuity" or otherwise describe how a taxpayer can satisfy this requirement. The Treasury, however, has promulgated regulations to fill in this statutory gap. Additionally, much of the recent litigation involves the interpretation of this requirement. What follows is a summary of recent, important judicial interpretations.

* Size of Eased Land Does Not Matter. So long as the easement protects a natural habitat (or otherwise satisfies a listed conservation purpose), the size of the eased land does not affect deductibility.

In Glass v. Commr, 471 F.3d 698 (6th Cir. 2006), aff'g 124 T.C. 258 (2005), the taxpayer contributed an easement over a 10-acre parcel of land along the shoreline of Lake Michigan. The IRS argued that the easement was not exclusively for conservation purposes because it neither protected a relatively natural habitat of wildlife or plants nor preserved open space (as described in the easement). The taxpayer...