Tax Court Rejects Tax Savings Clause to Save Conservation Easement (2/9/20)

In Railroad Holdings, LLC v. Commissioner, T.C. Memo. 2020-22 (2/5/20), here, the Tax Court denied a conservation easement deduction because, as stated in the syllabus, “the conservation purpose of the easement was not 'protected in perpetuity' within the meaning of I.R.C. sec. 170(h)(5)(A).” 

I won’t get into the substantive requirements that the particular easement failed to satisfy, but basically the description of the transfer flunked the regulations requirement that, if the easement is later extinguished, the donee receive a proportionate share of the extinguishment proceeds.

I do want to present the Tax Court’s rejection of what I would call a tax saving clause intended to solve the problem of a disqualifying condition by retroactively eliminating the condition through interpretation or construction.  The Court’s discussion of that issue is in outline paragraph V.C. at pp. 16-19 of the Slip Op.  The Court’s holding is crisp, so I will just quote it:

C. “Construction of Terms” 

Article VI.D of the deed provides that the deed “shall be construed to promote * * * the conservation purposes of this Conservation Easement, including such purposes as are defined in Section 170(h)(4)(A)”. See supra pp. 5-6. Petitioner insists on the importance of part D, criticizes the Commissioner for failing to include it in his memorandum, and quotes part D with this portion underlined: 

Any general rule of construction to the contrary notwithstanding, this Conservation Easement shall be liberally construed in favor of the grant to protect the Conservation Values and effect the policies and purposes of SERLC. If any provision of this Conservation Easement is found to be ambiguous, an interpretation consistent with its conservation purposes that would render the provision valid should be favored over any interpretation that would render it invalid. * * *  

However, petitioner does not explain how this provision should affect our interpretation of the extinguishment provision and does not give any other commentary on this provision. In fact, part D of article VI of the deed has no effect on the outcome of this case. 

First, in calling for the deed to be “construed to promote * * * the conservation purposes of this Conservation Easement, including such purposes as are defined in Section 170(h)(4)(A)”, part D refers to paragraph (4)(A) (which defines “conservation purpose”) and not paragraph (5)(A) (which states the “protect[ion] in perpetuity” requirement now at issue).  

Second, part D proposes a cure in the case of “ambiguous” terms, whereas part B(2) is quite clear in establishing its formula for allocating extinguishment proceeds.  

Third, the cure that part D proposes is to result in “an interpretation * * * that would render the provision [of the conservation easement] valid”. But the validity of the conservation easement per se is not at issue here. We assume that the easement was valid and that it conferred on SERLC the rights that are stated in the deed. The cure that petitioner needs (but cannot obtain) is not for the validity of the easement but rather for the non-deductibility of its contribution.  

Fourth, if (contrary to our three points above) this language in part D was actually a saving clause that purported to cure the proceeds formula, then it would be unenforceable and could not salvage what would otherwise be a failure of the formula to provide SERLC with the proportional value of extinguishment proceeds to which it is entitled. See Coal Property Holdings, LLC v. Commissioner, 153 T.C. at __ (slip op. at 27) (citing Belk v. Commissioner, 774 F.3d 221, 229 (4th Cir. 2014), aff’g 140 T.C. 1 (2013)). A donor cannot reserve in an easement deed a right that section 170(h) does not permit (such as a right to more than his share of extinguishment proceeds) but then save his charitable contribution by mentioning the rule he has violated and calling for that rule to kick in and save the day if his violation subsequently comes to light. 

Part B(2) of article VI of the deed contains an unambiguous expression of the formula to apply to the proceeds of an extinguishment. If the terms of part B(2) had never come to light in a tax proceeding, and if later the easement had ever been judicially extinguished, there is no reason to suppose that a court distributing proceeds would have overruled the express terms of part B(2). 

Although not cited in Railroad Holdings, the cases it does cite and the general authority in the area go back to Commissioner v. Procter, 142 F.2d 824, 827 (4th Cir. 1944), here.  There the taxpayer argued to lessen the value of the gift subject to gift tax by a saving clause as follows:

"Eleventh: The settlor is advised by counsel and satisfied that the present transfer is not subject to Federal gift tax. However, in the event it should be determined by final judgment or order of a competent federal court of last resort that any part of the transfer in trust hereunder is subject to gift tax, it is agreed by all the parties hereto that in that event the excess property hereby transferred which is decreed by such court to be subject to gift tax, shall automatically be deemed not to be included in the conveyance in trust hereunder and shall remain the sole property of Frederic W. Procter free from the trust hereby created."

The Fourth Circuit responded to the argument (pp. 827-828): 

We do not think that the gift tax can be avoided by any such device as this. Taxpayer has made a present gift of a future interest in property. He attempts to provide that, if a federal court of last resort shall hold the gift subject to gift tax, it shall be void as to such part of the property given as is subject to the tax. This is clearly a condition subsequent and void because contrary to public policy. A contrary holding would mean that upon a decision that the gift was subject to tax, the court making such decision must hold it not a gift and therefore not subject to tax. Such holding, however, being made in a tax suit to which the donees of the property are not parties, would not be binding upon them and they might later enforce the gift notwithstanding the decision of the Tax Court. It is manifest that a condition which involves this sort of trifling with the judicial process cannot be sustained. 

The condition is contrary to public policy for three reasons: In the first place, it has a tendency to discourage the collection of the tax by the public officials charged with its collection, since the only effect of an attempt to enforce the tax would be to defeat the gift. In the second place, the effect of the condition would be to obstruct the administration of justice by requiring the courts to pass upon a moot case. If the condition were valid and the gift were held subject to tax, the only effect of the holding would be to defeat the gift so that it would not be subject to tax. The donor would thus secure the opinion of the court as to the taxability of the gift, when there would be before the court no controversy whatever with the taxing authorities which the court could decide, the only possible controversy being as to the validity of the gift and being between the donor and persons not before the court. Cf. Lord v. Veazie, 8 How. 251, 12 L.Ed. 1067; Van Horn v. Kittitas County, C.C., 112 F. 1. As was well said by Chief Justice Taney in Lord v. Veazie, supra [8 How. 255, 12 L.Ed. 1067]: 

"It is the office of courts of justice to decide the rights of persons and of property, when the persons interested cannot adjust them by agreement between themselves, — and to do this upon the full hearing of both parties. And any attempt, by a mere colorable dispute, to obtain the opinion of the court upon a question of law which a party desires to know for his own interest or his own purposes, when there is no real and substantial controversy between those who appear as adverse parties to the suit, is an abuse which courts of justice have always reprehended, and treated as a punishable contempt of court." 

In the third place the condition is to the effect that the final judgment of a court is to be held for naught because of the provision of an indenture necessarily before the court when the judgment is rendered. It should be remembered that it is not possible to obtain a declaratory judgment from a federal court as to whether the gift in question is subject to the gift tax. 28 U. S.C.A. § 400; Wilson v. Wilson, 4 Cir., 141 F.2d 599. The only way, therefore, in which it could be determined by "final judgment" of a federal court of last resort that any part of a transfer was subject to a gift tax would be for a tax to be assessed by the Commissioner and upheld by such court in the course of legal proceedings instituted for its enforcement or for its recovery after payment. This final judgment would fix the liability of the donor for the tax; and only then could the condition become operative. The condition, however, could not be given the effect of invalidating a judgment which had been rendered when the instrument containing the condition was before the court, since all matters are merged in the judgment. To state the matter differently, the condition is not to become operative until there has been a judgment; but after the judgment has been rendered it cannot become operative because the matter involved is concluded by the judgment.

I searched for some good discussions of the issue (a rather quick search) and found one that looked good (particularly because I know one of the participants):  Structuring Defined Value Clauses in Trust Transfers: Formula Allocations and Price Adjustment Clauses (Strafford 7/19/16), here (with participants Paige Ben-Yaacov, Jonathan Rikoon, and Patrick Duffy.