Over the last several years, the IRS has challenged a number of conservation easement deductions and has continued to conjure ever-more-creative arguments to disallow them. For landowners, land trusts, and other easement holders, understanding these challenges and the ways to avoid them is key. In this article, I’ll discuss two recent challenges: one regarding an easement’s notice/approval clause and one regarding an easement’s amendment clause.
Notice/approval clauses
The Tax Regulations require that a landowner notify the land trust/easement holder prior to exercising any reserved right that may have an adverse impact on the conservation values protected by the easement. Often, the notice/approval clause includes a process by which the landowner provides notice of a certain activity and, if required by the easement, requests the land trust’s approval to carry out the proposed use. This process often provides that, if the land trust fails to respond within the specified time frame, the activity is deemed approved, as long as the activity is not expressly prohibited by the easement and is carried out exactly as described in the notice. This approach, in my opinion, provides a fair balance between the landowner’s desire to carry out the proposed activity and not be held hostage, so to speak, by the land trust’s inaction and the land trust’s obligation to uphold the terms of the easement and protect the conserved property in perpetuity.
However, the IRS challenged the “deemed approval” language, saying that it did not uphold the “perpetuity” requirement in the Tax Code (i.e., that the property’s conservation values be protected in perpetuity). One way that land trusts/easement holders can avoid these activities being considered “deemed approved” is to add a caveat at the end of the notice/approval clause to make sure they are not inadvertently allowing prohibited activities just because they failed to respond in time.
Unfortunately, the case in which this clause was challenged (Hoffman Properties II, LP v. Comm’r (Docket No. 14130-15)) did not contain such a protective caveat, but rather simply stated that approval was deemed given in all instances where the land trust failed to respond in time (even if the proposed activity was prohibited by the easement); hence the adage, “bad facts make bad law.”
This brings us to IRS Memo. No. 202002011, dated November 26, 2019. In that memo, guidance was requested from the IRS as to whether a notice/approval clause that states that the land trust’s non-response is deemed a “constructive denial” is okay. This makes little sense because it seems that the answer is “of course.” It does not provide safe harbor from the Hoffman case disallowing deemed approval, and it would have been much more helpful if someone had asked for guidance about the language being used, i.e., can we say that the proposed activity is deemed approved so long as the activity is not prohibited in the easement? However, that’s not what the person asked, so the answer does us little good.
Given the current state of the case law, it is safest to avoid any semblance of “deemed approval,” which clearly provides the strongest protection for the conserved property but leaves the property owner little other choice but to sue the land trust to compel a response to a request for approval if the land trust fails to respond and to seek attorney fees and costs from the land trust for that action. Not the most efficient outcome, but, for now, the only one that the IRS has deemed compliant with the Code’s “protected-in-perpetuity” requirement.
Amendment clauses
Several recent Tax Court cases have also challenged the inclusion of an amendment clause in a conservation easement. Similar to how the IRS challenged the “deemed approval” language, they also stated that a conservation easement that contains an amendment clause fails the perpetuity requirement because the parties could amend the easement in a way that no longer qualifies under IRC 170(h) — even when the amendment clause itself contains language that the amendment must be consistent with the conservation purpose of the easement.
Happily, in one such case, the court sided with the landowner, stating that an amendment clause with parameters limiting when the parties can amend an easement and requiring that any amendment comply with the easement’s conservation purposes, IRC 170(h), state law, etc. was consistent with the perpetuity requirement and therefore allowed (Pine Mountain Preserve, LLLP v. Commissioner, No. 19-11795 (11th Cir. 2020); see our more detailed blog post on Pine Mountain here).
In IRS Memo. No. AM 2020-001, dated March 17, 2020, the IRS was asked for confirmation that an amendment clause is consistent with the perpetuity requirement. In the memo, the IRS confirmed that it is and provided a sample amendment clause (a “safe harbor” if you will) that the IRS deemed “compliant.” The sample clause states that amendments are allowed that “enhance the Property’s conservation values or add real property subject to the restrictions set forth in this deed to the restricted property” and contains a laundry list of amendment requirements, i.e., that:
no amendment shall (i) affect this Easement’s perpetual duration, (ii) permit development, improvements, or uses prohibited by this Easement on its effective date, (iii) conflict with or be contrary to or inconsistent with the conservation purposes of this Easement, (iv) reduce the protection of the conservation values, (v) affect the qualification of this Easement as a “qualified conservation contribution” or “interest in land[,]” (vi) affect the status of Grantee as a “qualified organization” or “eligible done[,]” or (vii) create an impermissible private benefit or private inurement in violation of federal tax law.
The sample clause is quite restrictive. Some amendments do relax certain provisions while tightening others in an attempt to “enhance the conservation values” overall. Although such an amendment would satisfy the introductory requirement of the IRS’s safe harbor, it may not comply with subsection (ii), which does not permit any use that was originally prohibited (the usual reason for an amendment). This is a shortsighted requirement. Building in some flexibility to adapt a conservation easement to changed conditions makes the easement more resilient over time and more able to persist in perpetuity—particularly in light of climate change. The IRS’s safe harbor prescribes a severely rigid approach that disallows the vast majority of amendments, which may cause desperate landowners to push the envelope on land uses or even opt to violate an easement and test the land trust’s defense resolve and budget.
In any event, although this safe-harbor clause provides a good idea of what language is completely safe vis-à-vis the IRS’s current position on amendments, it doesn’t mean that a slightly different version would not also be compliant. The language used in deductible easements will depend on the risk-tolerance of the landowner/donor and any additional guidance that comes down the pike.