In Pesky v. United States,1 the federal District Court of Idaho addressed whether a charitable deduction claimed in connection with the contribution of a conservation easement should be denied because the contribution was part of a larger quid pro quo transaction. The Nature Conservancy (TNC) owned a plot of land in Idaho referred to as the “Hemingway Property,” which abutted the undeveloped “Ketchum Property.” The prior owner of the Hemingway Property had granted the owners of the Ketchum Property an easement over the Hemingway Property to access the Ketchum Property (the Hemingway easement).
On April 2, 1993, TNC paid $50,000 to acquire an option to purchase the Ketchum Property for $1.6 million (the option). Shortly thereafter, TNC assigned the option to the Peskys and agreed to support their applications with the local government regarding the construction of a driveway on the Hemingway easement, and, in exchange, the Peskys paid TNC $50,000 (the assignment agreement). In addition, TNC granted the Peskys an easement over the Hemingway Property to the Ketchum Property (the driveway easement). Further, the Peskys agreed that the height of any structures built on the Ketchum Property wouldn’t exceed 25 feet (the easement agreement). Finally, the Peskys and TNC entered into a pledge agreement, whereby the Peskys “agreed to convey [to TNC] all right to develop or improve the [Ketchum] Property except for one single-family residence at a later date.” The parties entered into four separate agreements memorializing the foregoing transactions. The Peskys then exercised the option and purchased the Ketchum Property for $1.6 million on Sept. 29, 1993.
Around March 7, 2002, the Peskys granted a conservation easement to TNC, thereby fulfilling the terms of the pledge agreement. The conservation easement limited development on the Ketchum Property to one single-family home and a guest house and raised the height restriction on structures built on this property to 30 feet.
Approximately five days later, the Peskys sold the Ketchum Property for $6.9 million. The Peskys claimed a charitable contribution deduction with respect to the conservation easement for the tax years 2002, 2003 and 2004. The appraisal submitted to the Internal Revenue Service provided that the value of the conservation easement was over $3 million. The IRS denied the charitable deduction for tax years 2003 and 2004, and the Peskys brought suit.
The Peskys and the United States asked the court for summary judgment. One of the main issues addressed was whether the Peskys should be denied a charitable deduction for the contribution of the conservation easement because it was part of a larger quid pro quo transaction with TNC.
Quid Pro Quo?
Under Internal Revenue Code Section 170, taxpayers may claim a deduction for any charitable contributions made during the tax year. A charitable contribution is a gift to a charitable organization that’s made with charitable intent and without adequate consideration. If the contribution is part of an overall quid pro quo transaction,where it’s understood that the taxpayer will only make the donation if he receives a benefit in return, and the taxpayer will only receive the benefit if he makes the donation, then the charitable deduction will be denied.
Here, the United States argued that the taxpayers’ contribution of the conservation easement was part of a larger quid pro quo transaction between the Peskys and TNC. It noted that TNC provided the Peskys with the option, the driveway easement and support for the Peskys’ driveway applications. In exchange, the Peskys provided TNC with cash, a restriction on the height of any structures built on the Ketchum Property and the conservation easement. The United States claimed that by breaking the transaction into multiple documents, keeping the pledge agreement secret and recording the conservation easement long after the Peskys received the benefits of the assignment agreement and the driveway easement, the Peskys and TNC “attempted to mask the quid pro quo nature of the transaction.” It was especially significant to the United States that the terms of the pledge agreement provided that it “arises out of and is integral with the Assignment Agreement,” and the pledge agreement and assignment agreement were signed on the same date. In addition, the United States pointed to correspondence and additional documentation that referred to the “Nature Conservancy Transaction” as a singular transaction.
Court Ruling
The court, however, held that this evidence wasn’t sufficient to grant summary judgment in favor of the United States, especially since there was evidence suggesting that the Peskys’ contribution of the conservation easement to TNC wasn’t part of an overall quid pro quo transaction. In particular, the court noted that the assignment agreement doesn’t mention any development restrictions or provide that the benefits that it confers on the Peskys are consideration for the pledge agreement and conservation easement. Instead, the explicit terms of the assignment agreement provide that TNC would assign the option to the Peskys, support the Peskys’ driveway applications and enter into the driveway easement, and, in exchange, the Peskys would pay TNC $50,000. Further, the correspondence between the attorneys during negotiations suggests that the pledge agreement and assignment agreement weren’t drafted as a single document, and the Peskys’ attorney denied that the pledge agreement was negotiated as consideration for the assignment agreement.
The Peskys argued that they merely traded a “promise . . . to give a future undefined land interest which ‘might’ or ‘might not’ be a conservation easement.” This promise, they claimed, didn’t confer sufficient benefits on TNC, and therefore the transaction wasn’t quid pro quo. However, the court noted that other courts had denied charitable deductions when taxpayers transferred property in exchange for promises (for example, a promise to construct schools or rezone property). For instance, in Stubbs v. United States,2the taxpayers agreed to dedicate a portion of their property to the town in exchange for rezoning of their land. The U.S. Court of Appeals for the Ninth Circuit held that this was a quid pro quo transaction and denied the taxpayers’ charitable deduction, as “the ‘gift’ . . . was in expectation of the receipt of certain specific direct economic benefits within the power of the recipient to bestow directly or indirectly, which otherwise might not be forthcoming.”3 Here, the court held that even if the benefit received by TNC was merely a “promise to give a future benefit,” this didn’t “preclude a finding that the transaction was a quid pro quo exchange rather than a charitable contribution.”
While the court disagreed with the Peskys regarding whether a promise could turn a charitable contribution into a quid pro quo transaction, it nonetheless refused to grant the United States’ motion for summary judgment. In particular, the court held that a reasonable juror could find that the assignment agreement constituted a “self-contained transaction” and that the transfer of property as provided in the conservation easement and pledge agreement was a “separate contribution provided without consideration from TNC.” Ultimately, the court denied both parties’ motions for summary judgment and held that there was a genuine issue of material fact as to whether the Peskys contributed the conservation easement to TNC without adequate consideration. It will be interesting to follow this case and see how it’s decided on the merits – such a decision may provide guidance regarding whether a charitable contribution is part of a larger quid pro quo transaction.
Lessons Learned
A charitable contribution must be made with charitable intent and without adequate consideration. Further, under certain circumstances, a promise to give a future benefit may constitute adequate consideration. Taxpayers and their advisors should sure that a charitable contribution doesn’t involve a quid pro quo exchange, as the IRS and the courts may altogether deny the charitable deduction. In addition, if it appears that a taxpayer has “masked” what would otherwise be a quid pro quo transaction, for instance by drafting multiple documents, the taxpayer may face an audit and possibly a long court battle.
Endnotes
1. Pesky v. United States, No. Civ. 1:10-186 WBS (D. Idaho, July 8, 2013).
2.Stubbs v. United States, 428 F.2d 885 (9th Cir. 1970).
3. Ibid. at 887.