Do environmental regulations constitute an involuntary conversion?

• Author: York, James P.

Environmental regulations may have the effect of decreasing the value of land. Can a developer claim an involuntary conversion loss when the wetlands regulations prevent development? A district court has recently ruled, in Moore, DC Va., 6/6/96, that a developer could not deduct the reduction in value caused by an involuntary conversion when his plans were obstructed by tougher wetlands regulations. Under different facts and circumstances, the decision might have been different.

On Oct. 1, 1988, the Moores purchased a 59.7 acre parcel of land in Chesapeake, Virginia, for $1,025,000. The parcel was intended for residential development. After acquiring the land, the Moores hired an environmental consultant to perform a wetlands assessment to determine the percentage of the tract protected under the 1987 Wetlands Manual. The consultant concluded that in 1988 the Moores could have reasonably expected to be able to develop the tract. In late 1989, the Army Corps of Engineers and the Environmental Protection Agency (EPA) signed a Memorandum of Agreement, which effectively reinterpreted the EPA guidelines applied when issuing development permits under Section 404 of the Clean Water Act. The 1989 Memorandum Agreement had two principal effects: it established (1) a national policy of no net loss of wetlands (in accordance with a directive from President Bush) and (2) a uniform sequence of analysis for the evaluation of Section 404 permits The 1989 Memorandum Agreement made it almost impossible for the Moores to acquire a development permit The Moores filed their first application for a Section 404 permit in 1991.

The Moores claimed a loss deduction on their 1989 tax return for the regulatory taking of the parcel, which they treated as an involuntary conversion loss under Sec. 1231(a). Under Sec. 165(a), a loss must be (1) evidenced by a closed and completed transaction, (2) fixed by an identifiable event and (3) actually sustained, with no reasonable prospect of recovery for the loss. If these criteria are met, the deduction will be classified as an involuntary conversion loss under Regs. Sec. 1.1231-1 (e). Pursuant to Regs. Sec. 1.1231-1 (e), losses on the complete or partial destruction, theft, or seizure, requisition or condemnation of property are treated as losses upon an involuntary conversion whether there is a conversion of the property into other property or money Under Sec. 1231, the Moores would be permitted to treat the conversion of...