• Tax Court denies charitable deduction for conservation easements—In 2004, Douglas Eddleman and his father began acquiring tracts of land outside of Birmingham, Ala. They also established Pine Mountain Preserve, LLLP (the LLLP) and, over time, conveyed the parcels of undeveloped land to the LLLP.
In December 2005, 2006 and 2007, the LLLP conveyed a conservation easement to the North American Land Trust (NALT), a charitable organization, each affecting several different parcels of the land.
The 2005 easement stated its charitable purposes and generally prohibited residential, commercial and industrial development in certain conservation areas, but permitted recreational and agricultural activities. In addition, the LLLP reserved certain rights in the easement. Among others, the easement established 10 “Building Areas” where development was permitted (the location and size of these weren’t specifically designated by the language of the easement), and the boundaries of those Building Areas could be modified. Various other types of developments and buildings were also permitted, including overlooks, riding stables, ponds, boat storage buildings and piers.
The 2006 easement similarly stated its charitable purposes and prohibited development but similar to the 2005 easement, the LLLP reserved many rights, including the ability to develop designated Building Areas.
The 2007 easement recited the same conservation purposes and generally prohibited development. The LLLP reserved rights within the 2007 easement but, in contrast to the 2005 and 2006 easements, it didn’t designate any Building Areas and didn’t permit any residential construction anywhere in the affected parcels; the LLLP didn’t have any rights to construct scenic overlooks, riding stables, ponds, boat storage buildings or piers.
The LLLP filed timely income tax returns for 2005, 2006 and 2007. On those returns, it claimed charitable contribution deductions of $16.55 million, $12.726 million and $4.1 million respectively, per appraisals. The Internal Revenue Service acknowledged that the returns included the requisite “qualified appraisals” and properly completed Forms 8283. However, on audit, the IRS determined that the easements didn’t meet the requirements for conservation easements.
The issue before the court in Commissioner v. Pine Mountain Preserve LLLP (151 T.C. No. 14, Dec. 27, 2018) was whether the easements met the requirements of Internal Revenue Code Section 170(h), which provides a charitable deduction for a donation of a “qualified real property interest” to a qualified organization exclusively for conservation purposes. A qualified real property interest is defined to include a restriction (granted in perpetuity) on the use of the real property. In addition, the Treasury regulations provide that any rights reserved by the donor of the perpetual conservation restriction must conform to IRC Section 170(h).
The court majority held that the 2005 and 2006 easements didn’t qualify as a perpetual restriction on the real property because the LLLP retained the right to build Building Areas, the locations of which weren’t defined. They could be placed anywhere with approval by NALT. In addition, the boundaries and location could be modified. As a result, the court found it was impossible to define what real property would actually be restricted from development. This meant that the easements didn’t attach to a defined parcel of real property and didn’t meet the requirement of a “qualified real property interest.”
However, the 2007 easement didn’t include the broad reserved rights of the 2005 and 2006 easements, and the court held that it was a “qualified real property interest.” The Commissioner argued, however, that the right to amend the easement prohibited it from qualifying for the charitable deduction because the restriction wasn’t perpetual if it could be amended. The court wasn’t convinced because NALT had to consent to any amendment.
In a separate opinion (T.C. Memo. 2018-214), the court determined the value of the 2007 easement at about $4.8 million, which is near the midpoint between Pine Mountain’s litigating position of $9.1 million (this exceeded the value of the easement originally declared on the partnership return by the LLLP) and the IRS’ estimated value of $450,000.
The court’s opinion wasn’t unanimous: A dissenting opinion interpreted the terms of the 2005 easement more restrictively and reasoned that only the 2006 easement shouldn’t qualify for the charitable deduction because its terms weren’t consistent with charitable purposes.
• Second Circuit upholds taxpayers’ transactions involving IRAs and DISCs—The U.S. Court of Appeals for the Second Circuit is now the third federal circuit court to uphold the Benenson family’s transactions involving individual retirement account investments in domestic international sales corporations (DISCs) (Benenson v. Comm’r, No. 16-2953 (2d Cir. 2018)). The Tax Court sided with the IRS and had held that the transactions resulted in excess contributions being made to the IRAs. However, the First Circuit and Sixth Circuit reversed the Tax Court holding for the Benenson sons and the family-owned company, Summa Holdings (discussed in our Trusts & Estates column in June 2018). Now, the Benenson parents received a favorable ruling on the tax effect of the transactions for them in the last related appeal. Another case involving similar transactions (reported in our May 2018 column), Mazzei v. Comm’r, is on appeal in the Ninth Circuit.
• Court holds that trustee-beneficiary’s interest may be applied to satisfy breach of trust claims—An Oregon court recently applied Nevada law to determine whether a trustee-beneficiary’s interest could be applied to a judgment in a breach of trust claim against her (In re Will of David F. King v. Sandra L. King, 295 Or. App. 176 (2018)). Sandra King was the sole trustee of a testamentary trust established under her late husband David’s will. Sandra was the sole income beneficiary during her lifetime. David’s children, the remainder beneficiaries, sued Sandra, as trustee, alleging that she breached the trust by making loans to herself, her son and a winery in which she had an interest and treating certain distributions to the trust improperly as income. In addition, there were claims that she failed to account properly.
The trial court held that under Nevada law, Sandra had committed breaches of trust, and it removed her as trustee, appointed a bank as trustee in her place, imposed constructive trusts on two properties, surcharged Sandra over $900,000 and awarded the children their attorneys’ fees. The children requested that the new bank trustee pay the surcharge and money judgment from trust income before distributing any further income to Sandra. However, the trial court agreed with Sandra that the spendthrift provision of the trust prohibited applying her beneficial interest in the trust to satisfy the claims against her.
The Oregon Court of Appeals disagreed. It held that the spendthrift clause doesn’t prevent the application of a beneficiary’s interest when the beneficiary is serving as trustee and when the application is in favor of the other beneficiaries. The spendthrift clause protects a beneficiary’s interest against third-party, external creditors, but under the Restatement (Third) of Trusts and Nevada law, it’s only equitable for the other beneficiaries to be made whole by application of his interest.