Tax Court Ignores IRS’s Commercial Timber Assault and CCLT Carbon Working Group Raises Policy Issues with State Agencies
A couple of updates you may find interesting: (1) the Tax Court denied the taxpayer’s deduction in TOT Property Holdings, LLC v. Commissioner last month on grounds of the proceeds clause, not the IRS’s latest argument regarding commercial timber; and (2) the California Council of Land Trusts submitted a letter to the state’s environmental agencies outlining several areas in which the carbon and conservation goals in the state are not aligning at the intersection of carbon projects and conservation easements.
TOT Property Holdings Fails on Proceeds Clause, Not Commercial Timber Rights
As our firm wrote in last month’s federal update, the IRS’s latest arrow in its quiver against abusive syndications appears to be the argument that including the right to commercially harvest timber in a conservation easement means the property is not protected exclusively for conservation purposes and thus, the donation is not deductible. Unfortunately, the addition of this argument to the IRS’s scattershot litigation approach throws legitimate conservation projects under the bus, since sustainable commercial timber harvest is permitted in many legitimate, non-syndicated conservation easements. Luckily, Judge Gustafson of the Tax Court did not provide support for the IRS’s timber argument in his bench opinion TOT Property Holdings, LLC v. Commissioner, issued on December 13, 2019.
In TOT Property Holdings, the Tax Court denied the taxpayer’s charitable deduction on other grounds entirely. There, the taxpayer claimed a deduction of $6,900,000 for a conservation easement on 637 acres in an economically depressed region of Tennessee. The easement was donated in 2013 and the TOT LLC was formed earlier that year when investors paid in $1,039,200 to acquire 99% of the LLC from the original owner earlier that year. As the court notes, given that purchase price, the property value at the time of LLC formation was likely approximately $1.5 million, so the conservation easement over a portion of the property was grossly overvalued at $6.9 million. Rather than reduce the deduction based on the appraisal overvaluation, the court and the IRS went the route of denying the deduction entirely by focusing on the proceeds clause that most donors have used over the past two decades. More on the problems with that argument can be found in our original articles regarding Carroll v. Commissioner in 2016, PBBM-Rose Hill v. Commissioner in 2018, and Coal Property Holdings in 2019.
While we disagree with a holding on the grounds of excluding improvements from the proceeds clause, we are pleased that the Tax Court did not give credence to (nor really even discuss) the IRS’s claim that forestry cannot be undertaken in a manner that promotes conservation. Venerable and successful national and state conservation organizations permit sustainable timber harvest on properties protected by conservation easements they hold. Generally, sustainable timber land is held by conservation buyers and other sustainable forestry operators, who will manage the land for the good of future generations, and will not cut timber in a greater amount than what will grow over a certain period of time (often twenty or more years). Long-term family owners are able to continue sustainably managing their forestland with the assistance of conservation easements that suppress the property value in the face of development pressure, while sustained harvest continues to cover the carrying cost of the property.
If timber property does go on the market, it will typically be developed or may be purchased by a timber company that is more interested in extracting as much value out of the land as quickly as possible, rather than sustainably harvesting timber over the decades to come. In response to this threat, many conservation organizations attempt to find a sustainable timber operator as a buyer. This type of buyer generally cannot contemplate purchasing such a property at fair market value in the face of development pressure or in the face of a more exploitive and cash-flush timber operator, if the property purchase price is not somewhat offset by the charitable deduction that will be garnered in exchange for the buyer’s agreeing to record a conservation easement on the property, thereby perpetually limiting the development rights and harvest rights to certain sustainable levels.
In sum, we sincerely hope the IRS will take a nuanced approach to the commercial timber issue and will not paint with too broad a brush in this arena, as it has been wont to do in other areas, such as the proceeds clause argument. We will continue to monitor the issue.
Carbon Comment Letter to California Natural Resources Agencies and Governor’s Office
On the state news side, you may be interested to learn about some of the work I am spearheading at the Carbon Working Group at the California Council of Land Trusts. We prepared and submitted a letter to the state’s environmental agencies and the Governor’s Office of Planning & Research, outlining several areas in which the Carbon Offset Protocols for Improved Forest Management are falling short and failing to dovetail with conservation easements, contrary to the language in the governing documents indicating compatibility between these tools. A copy of the letter can be found here.
Briefly, we are asking the state agencies to work together to find solutions to the following issues:
- Innocent third parties, such as conservation easement holders, face liability for carbon project reversals due to the broad definition of “Forest Owner,” joint and several liability, and vague negligence standard.
- Cap-and-Trade buffer pool credit reductions meant to encourage land conservation through conservation easements are not attainable in practice due to interagency conflict between the California Air Resources Board and the California Wildlife Conservation Board and impossible timing constraints.
Aside from these policy concerns, the Carbon Working Group also includes as part of its purpose to educate members of the land trust community and to serve as a resource for members. We will be presenting a panel at CCLT’s Land Conservation Summit on March 23 at Yosemite regarding the funding opportunities available to land trusts through the carbon markets. If you are interested in joining the Carbon Working Group’s email list or one of our quarterly calls, please let me know.