In these trying times, it’s important to focus on anything that might bring you a little comfort or even, imagine, joy. Sometimes that comes in the form of self-care, taking the time to slow down, get outside in nature, and take a few deep breaths in an attempt to find some peace among the chaos. Other times, it comes in the form of food, as we seek out tasty treats that provide both nourishment and pleasure. And then there are tax cases: when so many lately have delivered confusing and unproductive opinions about conservation easement donations, we have to find time to celebrate when one goes our way. Enter the next decision in the Pine Mountain Preserve v. Commissioner saga, an appellate opinion that came down on October 22, 2020, in which the Eleventh Circuit actually reminds us all to take a deep breath.
The court had three main issues to decide: (1) whether allowing building envelopes to move within a conservation easement area violated the Tax Code’s requirement that a conservation easement be “granted in perpetuity” (IRC § 170(h)(2)(C)); (2) whether the inclusion of an amendment clause precluded the easement’s conservation purposes from being “protected in perpetuity” (IRC § 170(h)(5)(A)); and (3) whether the Tax Court properly valued the conservation easement at issue by applying a “split-the-difference” approach to valuation. Fortunately, on the first two issues, the court provided a little bit of comfort for conservation easement donors.
Just the Facts, Ma’am
We’ve written about the Pine Mountain Preserve case before, which has been winding its way through the appeals process for a few years, so if you’re fuzzy on the details, take a look at the earlier articles here and here. If you’re familiar with the facts already, feel free to scroll down and skip this summary.
The case involves three separate donations of conservation easements to North America Land Trust (NALT) in 2005, 2006, and 2007 on 559, 499, and 224 acres, respectively, of the 6,224-acre Pine Mountain Preserve property. The donors of those easements (the members of the Pine Mountain Preserve LLC) claimed deductions for those donations in the amounts of $16,550,00, $12,726,000, and $4,100,00, respectively.
In all three easements, the owner retained the right to conduct limited development on the easement property. In the 2005 and 2006 easements, the owner reserved the right to construct a limited number of residences and outbuildings within designated building areas and to undertake other minor development on the property. In the 2005 easement, the locations of the designated building areas were determined at the outset, but the parties (the LLC members and NALT) could agree to modify the locations so long as (1) the building areas’ total acreage remained unchanged and (2) NALT didn’t conclude that a modification would “result in any material adverse effect on any of the Conservation Purposes.” In the 2006 easement, the locations were not determined at the time of the easement grant, but the easement gives NALT the right to approve in advance where the owner would place the building areas and to determine whether the chosen locations would adversely affect the easement’s conservation purposes. In the 2007 easement, the owner did not reserve any residential homesites, but was allowed to construct one water tower on the property on a site subject to NALT’s prior approval.
All three easements also contained an amendment clause to allow the parties to amend the easement’s terms. In particular, the clause specifies that both the owner and NALT “mutually have the right, in their sole discretion, to agree to amendments to th[e] Conservation Easement”; provided that the changes are “not inconsistent” with the easement’s conservation purposes and would not result in the easement failing to qualify as a qualified conservation contribution under Section 170(h).
And, finally, regarding valuation of the 2007 easement, when the Tax Court was faced with wildly divergent valuations for the three easements, it chose a value almost exactly midway between the parties’ numbers.
First Up: Court Delivers Good News about Building Envelopes and Waxes Eloquent about Cheese
In rendering its decision, the Eleventh Circuit first turned to the question of whether the movable homesites violated the Internal Revenue Code’s requirement that a deductible conservation easement be “a restriction (granted in perpetuity) on the uses which may be made of the real property.” This requirement, found in IRC section 170(h)(2)(C), the court explained, seeks to ensure that the restrictions in the conservation easement are imposed “in perpetuity,” as that term is understood in the common law, i.e., that nothing in the grant will cause the easement, either automatically or upon the happening of some event, to revert back to the owner or its successors. In explaining this requirement, the court rejected the Tax Court’s conclusion that the movable building areas rendered the restrictions not granted in perpetuity:
The Tax Court constructed a “Swiss cheese” analogy—the entire conservation area serving as the slice and the development zones the holes. As the Tax Court saw it, § 170(h)(2)(C) demands that the entire slice (the conservation area) be protected from development in perpetuity, such that the landowner cannot under any circumstances relocate any of the holes (reserved rights).
Unlike in Belk and other cases in which the landowner was permitted to “swap” land outside the easement area with land within it, the allowance to move building areas entirely within the easement area, the Eleventh Circuit said, did not run afoul of IRC section 170(h)(2)(C). Instead, this was more akin to Pepper Jack:
We agree with Pine Mountain that the better cheese analogy is to Pepper Jack. Here, the reserved rights don’t introduce holes into the conservation-easement slice, because the entire slice remains subject to “a restriction”—i.e., the conservation easement. Instead, the reserved rights are embedded pepper flakes, and, so long as they don’t alter the actual boundaries of the easement,
§ 170(h)(2)(C) is satisfied.
Mmm, cheese.
This is indeed welcome news to the land trust community, which understands that, when dealing with a document that persists in perpetuity, circumstances may change that would warrant a reconsideration of the building envelope boundaries. Perhaps one of the locations will not perc or even someday in the future will have become a nesting site for a sensitive bird species. As long as the land trust is provided broad latitude to oversee the relocation to verify that any such modification would not result in any material adverse effect on any of the conservation purposes, the allowance to move the building sites provides the flexibility both parties need to protect the property’s important environmental values in perpetuity.
That said, while the court concluded that movable building envelopes did not render the Pine Mountain easements in violation of the granted-in-perpetuity requirement, the court remanded (i.e., sent back for further consideration) on the question of whether such allowance to move the building areas might run afoul of the Code’s protected-in-perpetuity requirement. This will entail a more complicated analysis to determine whether the parameters contained in the 2005 and 2006 easements are sufficient to ensure the protection of the properties’ conservation values in perpetuity. It is encouraging, however, that the court noted in a footnote that the Treasury regulations themselves indicate that the reservation of building areas—even movable ones—does not render an easement non-deductible. (Treas. Reg. § 1.170A-14(f) Examples 3, 4.) And the court further noted that land trusts are best suited to determine a building area location’s suitability and to ensure protection of the conservation purposes of the easement: “NALT has extensive advance-approval rights under these easement contracts. NALT is a sophisticated land-conservation organization, and we have little doubt that when it comes to negotiating conservation easement, it is well-positioned and equipped to look after conservation interests.” We hope the Tax Court, on remand, agrees.
Next Up: Court Delivers Good News about Amendment Clauses
In the next portion of the opinion, the Eleventh Circuit upholds the Tax Court’s conclusion that the mere existence of an amendment clause does not violate the Tax Code’s requirement that the land’s conservation interests must be “protected in perpetuity” under IRC § 170(h)(5)(A). The court notes, as the Tax Court did, that parties to contracts are always free to amend those contracts by separate agreement. In fact, the court emphasized, an amendment clause that constricts the parties’ right to amend only to those amendments that are “not inconsistent” with the easement’s conservation purposes and would not result in the easement “failing to qualify . . . as a qualified conservation contribution under Section 170(h)” actually serves to bolster the protection of the conservation values.
Again, the appellate court’s conclusion is happy news for the land trust community. While amendments of conservation easements are certainly not to be taken lightly and demand the most rigorous analysis to ensure that the changes have only a neutral or beneficial effect on the land’s conservation values and do not result in private inurement or impermissible private benefit, among other factors, we also recognize that, again, in documents that are intended to persist in perpetuity, sometimes modifications are needed to correct errors, clarify the terms, or even revisit the uses of a property, especially in light of climate change and other unpredictable future events and conditions. An amendment clause allowing the parties to consider such modifications thoughtfully and with a strict dictate of furthering the conservation purposes of the agreement best serves those purposes.
And Finally, Valuation – No News
The final issue addressed in the opinion relates to whether the Tax Court properly valued the 2007 easement when it took the parties’ disparate numbers and essentially split the difference. Although the Tax Court seemed to indicate its belief that both the Commissioner and the landowner had relied on faulty assumptions about the property—primarily to what extent it could be developed prior to the easement being imposed—the Tax Court did not provide ample justification for concluding that the appraisals’ respective flaws perfectly offset the other. In fact, the court seemed to imply the opposite, that the discrepancies were not perfectly counterbalanced despite ultimately doing so anyway:
Oddly, the court observed (we think correctly) that “[t]he mere fact that the magnitude of the two experts’ errors vary proportionally does not mean that the magnitudes are equal”—but it nonetheless proceeded to conclude (albeit without explanation) that “on our review of the entire record, we are convinced that the errors are roughly equal in magnitude.”
The Eleventh Circuit therefore remanded the valuation issue to the Tax Court for reconsideration using the Treasury Regulations guidance governing conservation easement valuation.
At the end of the day, I think we can all agree that the Eleventh Circuit decision in Pine Mountain got it mostly right. Land trusts are best suited to oversee the exercise of reserved rights and to ensure the protection of the land’s conservation values. We hope, on remand, the Tax Court agrees and finds that building in flexibility around building envelope locations and the ability to amend easements, both within strict parameters, serves both parties, protects the conservation values in perpetuity, and bolsters the resiliency of the agreements themselves.
Now go have some cheese and breathe a deep sigh of relief, at least until the next Tax Court case (or another 2020 surprise) comes our way.