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Carpenter v. Commissioner: A reminder that conservation easements must be perpetual

January 11, 2012

By: Robert J. Allen

            On January 3, 2012, the United States Tax Court issued its opinion in Carpenter v. Commissioner, T.C. Memo 2012-1, and reminded taxpayers and conservation easement professionals that an easement must be granted in perpetuity to qualify for a federal tax deduction. The opinion addressed three consolidated cases involving nearly identical conservation easement deeds.

             Treasury Regulation § 1.170A-14(a) provides that: “To be eligible for a deduction under this section, the conservation purpose must be protected in perpetuity.” Similarly, section 170(h)(5)(A) of the Tax Code provides that: “A contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity.” 

            The taxpayers in Carpenter donated conservation easements over property in Colorado to a qualified easement holder, a section 501(c)(3) organization, and they claimed a charitable contribution against their income taxes for the donation. The conservation easement deeds provided that the easements could be terminated by judicial proceeding or by mutual agreement of the parties if circumstances rendered the purposes of the easement impossible to accomplish. The IRS issued notices of deficiency to the taxpayers disallowing the charitable deduction, and each taxpayer filed a petition with the U.S. Tax Court.
 
            The Court granted summary judgment against the taxpayers, finding that the easements did not protect the property in perpetuity because the easements could be extinguished by mutual agreement between landowners and the easement holder. The Court rejected the taxpayers’ argument that the possibility of extinguishment of the easement was so remote as to be negligible, see Treas. Reg. § 1.170A-14(g)(3), and instead focused on the fact that the easement provided that it could be extinguished by agreement. The taxpayers also argued that the easement created a charitable trust which implicated the cy pres doctrine which would require a judicial proceeding to extinguish the easement. The Court, in part relying on commentator Nancy A. McLaughlin, held that the easement was a restricted gift  under Colorado law. The Court found that “[e]xtinguishment by mutual consent of the parties does not guarantee that the conservation purpose of the donated property will continue to be protected in perpetuity.” Therefore, the Court held that the easements were not qualified conservation contributions and denied the taxpayers’ charitable contribution deductions.
 
            The perpetuity requirement does not mean that an easement will necessarily last forever. Section 1.170A-14(g)(6)(i) states that an easement may be treated as protecting conservation purposes in perpetuity even though it may be extinguished by judicial proceeding in the event that subsequent, unexpected changes in the conditions surrounding the property make it impossible or impracticable to continue using the property for its conservation purposes.  In such an event, the proceeds from the sale or exchange of the property must be used by the easement holder in a manner consistent with the conservation purposes of the original easement.
 
            The Virginia Outdoors Foundation’s easement template contains the following required provision:

Notwithstanding the provisions of Section 10.1-1704 of the Open-Space Land Act, should an attempt be made to extinguish this Easement in whole or in part, such extinguishment can be carried out only by judicial proceedings and only if in compliance with Section 10.1-1704 and IRC Section 170 (h) and applicable Treasury Regulations. In a sale or exchange of the Property subsequent to and resulting from an extinguishment, Grantee shall be entitled to a portion of the proceeds at least equal to the proportionate value of this Easement computed as set forth in Section V Paragraph 12 above, but not to be less than the proportion that the value of this Easement at the time of extinguishment bears to the then value of the Property as a whole. Grantee shall use all its share of the proceeds from the sale of the Property in a manner consistent with the conservation purpose of this Easement and the Open-Space Land Act.

            The Carpenter Court, following the lead of the Court in Kaufman v. Commissioner, 136 T.C. 294 (2011), declined to create an absolute rule that a conservation easement deed may only be extinguished by judicial proceeding in order to be considered perpetual. Rather, the Court explained that extinguishment by judicial proceeding is “a guide, a safe harbor” by which to ensure that the conservation purposes are protected in perpetuity. The Virginia Outdoors Foundation easement template would appear to fall squarely within this safe harbor by requiring a judicial proceeding to extinguish an easement and otherwise requiring compliance with Treasury Regulation § 1.170A-14(g)(6)(i).
 
            For more information about this case or conservation easements generally, please contact Robert J. Allen at rallen@spottsfain.com or (804) 697-2187.