The cardinal tax rule for charitable contributions, including deductions for conservation easements, is that there cannot be a quid pro quo for the donor. If there is any benefit flowing back to the donor, any deduction must be offset by the value of that benefit.
Thus, the donor of a conservation easement should expect no additional benefits or enrichment other than a charitable deduction without complicating or perhaps even forfeiting the tax benefit. A land development partnership found this out the hard way when the U.S. Tax Court upheld the IRS’s denial of a $4.8 million conservation easement deduction because the easement substantially increased the value of the developer’s surrounding land.
‘Quid Pro Quo’ and Tax Law
Quid pro quo essentially means “something for something” in Latin. This legal phrase frequently is used in tax law to determine whether a charitable donation is given with “detached or disinterested generosity” or with the expectation of receiving a substantial benefit in return.
In Wendell Falls Development, LLC. v. Commr., a developer bought 27 contiguous parcels of unimproved land in a North Carolina community for a total of 1,280 acres. The LLC planned to subdivide the property into a master-planned community (by use of a PUD-planned unit development), which was to include residential and commercial areas to be sold to builders, an elementary school and a park. The County later annexed the entire property except for 125 acres on the shore of a lake.
The developer then entered negotiations with Wake County, NC to sell the 125 acres for a county park. The developer placed a conservation easement on the 125 acres to be held by a charitable organization and subsequently sold the land with the easement to the County for $3 million. The PUD stated that the LLC received no preferential zoning in exchange for setting aside the 125 acres for use as a park.
IRS Denies Deduction
The developer deducted what it claimed was the fair market value of the park easement in the amount of $4,818,000 on an amended return (the first return had a reduced easement valuation of $1,798,000). The easement permitted only the following structures to be built on the 125 acres: (1) an environmental education center, (2) an overnight lodge, (3) recreational day-use facilities, (4) sports fields, (5) an elevated wooden walkway and (6) related maintenance facilities. The IRS denied the entire amount of the deduction arguing that Wendell Falls donated the easement with the expectation that the 125-acre public park would increase the value of the rest of the adjoining 1,280 acres.
Tax Court Agrees with the IRS
The U.S. Tax Court agreed with the IRS in denying the entire deduction because of the substantial benefit to the taxpayer. The Court was persuaded by the fact that all of the residential areas of the adjacent planned development would have access to the park through a greenway system. This amenity would increase the value of the development’s lots. The Court also found that the conservation easement did not diminish the value of the 125 acres because it did not prevent it from being put to its best use, which, the Court said, was as parkland. Thus, the value of the easement was zero.
In case after case, the IRS looks for reasons to challenge conservation easements. Valuation is the most common issue, but don’t overlook a challenge based on a perceived value flowing back to the taxpayer donating the easement.
Lucia Nasuti Smeal is a guest blogger on tax topics for Frazier & Deeter. Smeal is an attorney, a tax professor with Georgia State University’s J. Mack Robinson College of Business, and former editor of Tax Notes Today, published by Tax Analysts. Smeal also worked as a legislative analyst for the Congressional Research Service and is a former member of the U.S. House Periodical Press Corps. She is a frequent speaker on current tax developments.