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Tuesday, January 17, 2012

FOREVER IS A LONG TIME

Usually, a taxpayer cannot obtain a charitable income tax deduction for a contribution of property if the taxpayer transfers less than his or her entire interest in the property. However, Code §170(h) does allow for a charitable deduction for a conservation easement granted in property owned by a taxpayer. To qualify, the easement must be granted “in perpetuity” (among other requirements).

In a recent Tax Court case, the taxpayers conveyed a conservation easement in their Colorado property to a charitable organization. The deeds restricted the charity’s use of the gift to “preserve and protect in perpetuity the Conservation Values of the Property for the benefit of this generation and generations to come.” The deeds also provided for the extinguishment of the easement under certain circumstances:

“Extinguishment—If circumstances arise in the future such that render the purpose of this Conservation Easement impossible to accomplish, this Conservation Easement can be terminated or extinguished, whether in whole or in part, by judicial proceedings, or by mutual written agreement of both parties, provided no other parties will be impacted and no laws or regulations are violated by such termination.” (emphasis added)

The IRS sought to deny the deduction since the conservation could be terminated by mutual agreement of the parties, and thus violated the perpetuity requirement (even though the purposes of the easement first had to be rendered impossible to accomplish). The Tax Court agreed with the IRS. Forever means forever, so the retention of a mutual right to terminate violated the perpetuity requirement.

Treas. Regs. §1.170A-14(g)(3) provides that a charitable deduction will not be disallowed merely because the interest which passes to, or is vested in, the donee organization may be defeated by the performance of some act or the happening of some event, if on the date of the gift it appears that the possibility that such act or event will occur is so remote as to be negligible. The taxpayers argued that the likelihood of a mutual termination of the easement was so remote that this regulation should save the charitable deduction. The Court held that this “remoteness” exception was something separate and apart from the perpetuity/extinguishment requirements, and thus could not be applied to override the perpetuity/extinguishment requirements.

So what happens if circumstances change so that the easement no longer makes sense? Does tax law nonetheless require the easement to still go on forever? Treas. Regs. §1.170A-14(g)(6)(i) provide an out:

“If a subsequent unexpected change in the conditions surrounding the property that is the subject of a donation under this paragraph can make impossible or impractical the continued use of the property for conservation purposes, the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding and all of the donee's proceeds *** from a subsequent sale or exchange of the property are used by the donee organization in a manner consistent with the conservation purposes of the original contribution…” (emphasis added)

Thus, a judicial termination under these conditions is allowed, without that violating the perpetuity requirements. Forever is a long time, but under the appropriate circumstances, it need not go on, well, forever.

Kayln M. Carpenter, et al., TC Memo 2012-1

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