Federal Circuit Courts Split on Validity of Conservation Easement Regulation
Two federal circuit courts have recently split on the validity of Treasury Reg. §1.70A-14(g)(6)(ii) regarding the determination of proceeds from a judicial extinguishment of a conservation easement, including any post-donation improvements made by the donor. The Eleventh Circuit held the regulation was invalid by failing to meet the notice-and-comment requirement of the Administrative Procedure Act (APA) (Hewitt). The Sixth Circuit upheld the regulation as meeting the notice-and-comment requirement, and a reasonable interpretation of Internal Revenue Code (Oakbrook Land Holdings, LLC).
Charitable Deduction for Conservation Easements
A charitable contribution deduction is generally not allowed for a contribution of property that consists of less than the donor’s entire interest. An exception is provided for the contribution of real property, including an easement, to a charitable organization exclusively for conservation purposes provided that such purposes are protected in perpetuity.
Regulations for this exception (qualified conservation contributions) were proposed in 1983 and adopted as final in 1986. They include guidance under Reg. §1.170A-14(g)(6) if there is an unexpected event that makes it impossible or impractical for the continued use of the property for conservation purposes in perpetuity.
Protected in Perpetuity
In the case of an unexpected event (for example, involuntary conversion), the regulation provides that the perpetuity requirement is met if:
- the easement or other restriction is extinguished in a judicial proceeding, and
- the charitable donee’s proceeds from a subsequent sale or exchange of the property are used in a manner consistent with the conservation purposes of the original contribution.
The proceeds are determined based on the fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time the gift bears to the value of the entire property. The regulation does not permit the subtraction of any post-donation improvements made by the donor from the proceeds. This allows the charitable donee to ‘share’ in the value of any such improvements. A deed that fails to meet these requirements results in the donor being unable to claim a charitable deduction for the donation of the conservation easement.
Administrative Procedure Act (APA)
The Administrative Procedure Act (APA) provides that whenever a federal agency proposes new guidance such as regulations that have the force of law (legislative rules as opposed to interpretative rules) it must engage in a notice-and-comment process before finalizing the rules. The federal agency is not required to respond to every comment submitted, only significant comments. The significance of a comment depends on the proposed rule and whether it serves the purpose of the statute.
11th Circuit and Hewitt
In December 2021, the Eleventh Circuit Court of Appeals held that the Treasury Department failed to meet the notice-and-comment requirement of the APA in issuing Reg. §1.170A-14(g)(6)(ii) regarding the calculation of judicial extinguishment proceeds (Hewitt). The court held that the Treasury should have specifically responded to comments on the calculation of the proceeds, including not allowing the subtraction for post-donation improvements by the donor. The court found these to be significant comments since the regulation would discourage potential donors from making conservation easements, one of the principal purposes of the statute. However, the court did not consider the issue of whether the regulation was nonetheless a reasonable interpretation of the statute.
6th Circuit and Oakbrook Land Holdings, LLC
In March 2022, the Sixth Circuit Court of Appeals held that the regulation did meet the APA notice-and-comment requirement, thus creating a conflict with the Eleventh Circuit’s decision (Oakbrook Land Holdings, LLC). The Sixth Circuit found any comments regarding judicial extinguishment proceeds were not significant because they did not address the perpetuity requirement of the statute.
While the encouragement of the donation of conservation of easements is one of the goals, the statute also conditions the donation that the conservation purpose be protected in perpetuity. The court found that the proceeds calculation is a reasonable interpretation of that requirement because allowing donors to retain the value of post-donation improvement would be a detriment to the charitable done and leave them with fewer proceeds to advance the conservation purpose in the unlikely event of a judicial extinguishment.
Will the Supreme Court Resolve the Split?
The Eleventh Circuit’s Hewitt decision invalidating the extinguishment proceeds regulation only impacts taxpayers in the Alabama, Florida, and Georgia. Taxpayers elsewhere must continue to follow the regulation because the Sixth Circuit’s opinion upheld the underlying Tax Court case validating the rule for all taxpayers.
There is no indication yet of one of the parties appealing to the Supreme Court in the hopes of resolving this split. However, some tax practitioners would be interested in seeing the Supreme Court take up the issue. The application of the conservation easement regulations remains a very litigious area between taxpayers and the IRS, and a ruling could provide some clarity. In addition, these cases are just a few recent examples of taxpayers challenging tax guidance from the Treasury tax guidance based on the APA.