In case you missed it, the U.S. Court of Appeals for the Eleventh Circuit challenged the approach, tactics and justifications given by the Internal Revenue Service (IRS) to target partnership conservation in an important case this week. In particular, the court’s ruling undermines one of the IRS’ favored tactics to wrongly disqualify conservation easements by challenging them on alleged technical foot faults.

The court determined that deductions taken by the Pine Mountain Preserve LLLP for land that was donated to the North American Land Trust (NALT) could qualify for a tax deduction under IRC Section 170(h). In its opinion, the 11th Circuit poked holes in the Tax Court’s faulty “Swiss cheese” analogy and rightly sided with the Pine Mountain Preserve’s “Pepper Jack cheese” analogy expressed in the following:

Not only does the Tax Court’s interpretation of § 170(h)(2)(C) defy the provision’s straightforward language, but it also renders § 170(h)(5)(A) superfluous. The Tax Court recognized—correctly—that § 170(h)(2)(C) and § 170(h)(5)(A) impose separate requirements. Even so, in the court’s view, a grant violates § 170(h)(2)(C) if even a single sub-parcel of property is exempted from the overall restriction. 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).

But whether exceptions to restrictions in a conservation easement poke holes in the slice runs, we think, to whether the easement adequately protects the conservation purposes, which is a question to be answered by reference to § 170(h)(5)(A), not § 170(h)(2)(C). Using the Tax Court’s own cheese metaphor, all that § 170(h)(2)(C)’s granted-in-perpetuity condition requires is that the landowner grant a slice (i.e., a restrictive easement) in the first place, which here Pine Mountain plainly did. 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.

Judge Kevin C. Newsom of the 11th Circuit also pushed back against the IRS’ argument that the Pine Mountain Preserve’s easements don’t qualify when he wrote:

… to qualify for a deduction, a conservation easement must grant “a restriction” (meaning at least one) on the use to which the subject property can be put, and must do so “in perpetuity,” as that term has traditionally been used and understood in common-law practice. An easement granted in perpetuity over a defined conservation area clears § 170(h)(2)(C)’s relatively low threshold, even if it reserves targeted development rights for homesite construction. Based on those metrics, the 2005, 2006, and 2007 easements all qualify.

The three-judge panel also slapped down the IRS’ challenge to the amendment clause contained in the easement because simply put: “If the possibility of amendment were a deal-killer, then there could be no such thing as a tax-deductible conservation easement.”

Additionally, the 11th Circuit found it questionable that the Tax Court chose a valuation almost exactly in between what the taxpayer’s appraiser and the IRS appraiser said, and simply “split the baby.” The 11th Circuit ruled that this was not the appropriate methodology and that the Tax Court failed to provide a proper valuation because it did not follow the government regulation that an accurate representation of an easement’s value is the “fair market value of the perpetual conservation restriction at the time of the contribution.”

In short, the 11th Circuit holds as follows:

    1. The 2005 and 2006 easements satisfy I.R.C. § 170(h)(2)(C)’s granted-in-perpetuity requirement;
    1. The existence of an amendment clause in an easement does not violate I.R.C. § 170(h)(5)(A)’s protected-in-perpetuity requirement; and
    1. The Tax Court applied an improper method for valuing the 2007 easement and, on remand, should value the easement using the standards set forth in the governing regulations.

Read the 11th Circuit Court of Appeals in the Pine Mountain Preserve case HERE.

Learn more about the Partnership for Conservation’s mission to strengthen the integrity of all conservation easements while maintaining Americans’ access to participate in critical market-based incentives HERE.


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