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Easement Donation Disallowed But Penalty May Require Trial

Soddy Creek Preserve LLC et al. v. Commissioner; No. 22271-17

Soddy Creek Preserve, LLC, Environmental Resources Fund, LLC, Tax Matters Partner, Petitioner v. Commissioner of Internal Revenue, Respondent

United States Tax Court


Pending before the Court is respondent's motion for partial summary judgment, filed August 24, 2018, and supplemented on January 15, 2019, (respondent's motion, as supplemented) and petitioner's motion for partial summary judgment, filed August 28, 2020, (petitioner's motion).

Respondent's motion, as supplemented, moves to sustain the disallowance of Soddy Creek Preserve, LLC's (Soddy Creek) noncash charitable contribution deduction of a conservation easement (easement deduction) in its entirety on three alternative grounds.

We hold that there is no genuine dispute as to material fact and respondent is entitled to partial summary judgment on the basis of the deed of easement's failure to satisfy the perpetuity requirement under section 170(h)(5)1. The deed of easement does not allocate proceeds upon an extinguishment of the easement in accordance with section 1.170A-14(g)(6)(ii), Income Tax Regs. (proceeds regulation). Accordingly, we will sustain the disallowance of the easement deduction in its entirety. We do not address respondent's alternative grounds.

Petitioner's motion moves that respondent failed to obtain written supervisory approval of the section 6662 accuracy-related penalties as required by section 6751(b).

Summary Judgment

Either party may move for summary judgment on any or all of the legal issues in controversy. Rule 121(a). We may grant summary judgment where there is no genuine dispute of any material fact and a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). The moving party bears the burden of proving that there is no genuine dispute, and we consider the facts and the inferences drawn from them in the light most favorable to the nonmoving party. FPL Grp., Inc. v. Commissioner, 115 T.C. 554, 559 (2000).


In 2011 Soddy Creek granted a conservation easement to Atlantic Coast Conservancy, Inc. (ACC), and claimed an easement deduction for the short tax period ending December 31, 2011.

In the deed of easement, Soddy Creek reserved the right to locate and construct three residential homes on the easement property as well as make other limited improvements. Under the deed, ACC would receive a portion of the proceeds on a judicial extinguishment of the easement but excluded the value of any post-easement improvements to the property in determining the allocation of proceeds to ACC.

Initial Determination and Communication of Penalties

Revenue Agent Ellie Pennington (RA Pennington) was assigned to the audit and drafted the revenue agent's reports (RAR). On January 13, 2015, and December 7, 2015, RA Pennington provided copies to petitioner of two RARs, the original and revised RAR, respectively. Two closing conferences were held, on February 10, 2015, and December 7, 2015.

Respondent has produced a penalty approval form, signed by RA Pennington's supervisor, on December 15, 2015, for gross and substantial valuation misstatement penalties (valuation penalties), substantial understatement of income tax, and negligence (nonvaluation penalties). Respondent issued a 60-day letter dated June 27, 2016. The revised RAR was later attached to the 60-day letter.

Respondent asserts that RA Pennington prepared the penalty approval form. Respondent also asserts that RA Pennington initially determined the valuation and nonvaluation penalties. Petitioner asserts that RA Pennington did not initially determine the valuation penalties and did not prepare the form.

Enclosed with the revised RAR was Form 870-PT, Agreement for Partnership Items and Partnership Level Determinations as to Penalties, Additions to Tax and Additional Amounts, with which each LLC member may agree to the adjustments including the determined penalties and a request to extend the statute of limitations. Petitioner extended the statute of limitations on November 5, 2015. Form 870-PT was also presented to petitioner at the second closing conference.

Both the RAR and revised RAR (and Form 870-PT) disallow the easement deduction in its entirety on technical issues and state that the easement had a fair market value of $1,310,000, although that amount appears to be a typographical error as the IRS appraisal attached to the RARs determined a fair market value of $2,630,000. Such a value and adjustment would result in a gross valuation misstatement.

Only portions of the revised RAR are in the record. The revised RAR was 115 pages with 80 pages discussing valuation and included the $2,630,000 IRS appraisal. It contained workpapers labeled “Gross Overvaluation Penalty Lead Sheet” and further identified two penalties “2. Primary position: substantial understatement of tax” and “3. Alternative position: negligence”. The lead sheet and the part of the RARs in the record do not contain a reference to “a 40% penalty” or “section 6662(h).” There is no computation of the penalties on the lead sheet or the other portions of the RARs in the record. The parties represent that the RARs did not contain any computations of the penalties.

The last time entry with hours recorded in RA Pennington's activity record was December 7, 2015. There is an entry dated December 9, 2015, and a handwritten entry of December 15, 2015 with hours recorded as worked on either date. Respondent completely redacted the descriptions in the activity record.

On September 9, 2016, petitioner filed a written protest with the IRS Office of Appeals that protested the valuation and nonvaluation penalties.


Disallowance of the Deduction

Section 170(a)(1) allows a deduction for a charitable contribution made during the tax year that is properly substantiated. Section 170(h) governs the deduction of a qualified conservation contribution defined as a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes.

To qualify for deduction, the conservation purpose must be protected in perpetuity (perpetuity requirement). Id. para. (5)(A). The regulations recognize an unexpected change may make the continued use of the property for conservation purposes impossible or impractical and provides the perpetuity requirement can be met where the easement is judicially extinguished and the donee has the right to a share of the extinguishment proceeds equal to the proportionate value of the easement at the time of its grant in relation to the value of the property as a whole at that time (and uses the proceeds consistent with the conservation purposes) unless applicable State law entitles the owner of the servient estate to the full proceeds. Sec. 1.170A-14(g)(6)(i), (ii), Income Tax Regs.

The deed of easement does not allocate the extinguishment proceeds in accordance with the regulations and thus fails to satisfy the perpetuity requirement. We have rejected the challenges to respondent's interpretation of the proceeds regulation and the validity of the regulations, which petitioner also make in objection to respondent's motion. Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. __, __ (slip op. at 25, 28-31) (May 12, 2020); Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 144 (2019); see also PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d 193, 208 (5th Cir. 2018). Accordingly, Soddy Creek is not entitled to the easement deduction.2

Section 6751(b): Written Supervisory Approval

Section 6751(b)(1) requires the initial determination of certain penalties to be personally approved in writing by the immediate supervisor of the IRS employee who made the determination to assert the penalty. Belair Woods, LLC v. Commissioner, 154 T.C. 1, ___ (slip op. at *14-*15) (2020); Clay v. Commissioner, 152 T.C. 223, 248 (2019). Written supervisory approval must be obtained before the IRS formally communicates the penalty to the taxpayer. Clay v. Commissioner, 152 T.C. at 249.

Petitioner contends the penalty approval form does not satisfy section 6751(b) with respect to the nonvaluation penalties because the revised RAR was a prior formal communication of the initial penalty determination and with respect to the valuation penalties because RA Pennington did not initially determine the valuation penalties.

Respondent's response to these assertions and our recent caselaw appear to support resolution of the section 6751(b) issue in petitioner's favor. It is respondent's position that the original and revised RARs address the valuation and nonvaluation penalties but neither constitute an initial penalty determination or a formal communication of either the valuation or nonvaluation penalties relying on Belair Woods.

Valuation Penalties in the Revised RAR

The RARs are not as clear as they could be about the valuation penalties but it is clear that petitioner understood that the valuation penalties were at issue on the basis of the revised RAR as it addressed the 40% valuation penalty for gross valuation misstatement in its written protest. The revised RAR and 60-day letter provide the same adjustments.

The portion of the RARs in the record do not include a reference to a 40% penalty or section 6662(h). Respondent cites the following facts to establish that the revised RAR addressed the valuation penalties (but did not initial determine or formally communicate them): (1) the lead sheet is labeled “Gross Overvaluation Lead Sheet”, (2) labels on the nonvaluation penalties as “2” and “3” indicating the valuation penalties were “1”, and (3) the Appeals protest contesting the valuation penalties indicating that petitioner understood the RARs to propose the valuation penalties.

On the basis of the record currently before us for purposes of summary judgment, it appears that RA Pennington was the IRS employee who initially determined the valuation penalties.

Formal Communication of Penalties

Respondent asserts that the first formal communication of the valuation and nonvaluation penalties was the 60-day letter citing Belair Woods. Petitioner asserts that the revised RAR was a formal communication of the nonvaluation penalties but not the valuation penalties.

Belair Woods is easily distinguishable. In that case, we held that a 60-day letter was the formal communication of the penalty determination. We stated that a formal communication is where the IRS “formally notified * * * [the taxpayer] that the Examination Division had completed its work and * * * had made a definite decision to assert penalties.” Id. at *14-*15. The RAR was issued less than 2 months after the audit began. It did not notify the taxpayer that the audit had been completed but instead “launched a lengthy communication and fact — gathering process during which Belair had the opportunity to present its side of the story.” Id. at *9.

In Oropeza v. Commissioner, 155 T.C. ___ (slip op. at 11) (Oct. 13, 2020), we held that a RAR can constitute a formal communication of an initial determination where the RAR made clear that the exam was concluded and the revenue agent had made a definite decision. We stated that the revenue agent's remaining tasks after the RAR would have been ministerial in nature.

Here the RAR did not launch a lengthy fact-gathering process. RA Pennington had completed a 115-page RAR and then revised it after discussions with petitioner at a closing conference. Both RARs included a valuation by an IRS engineer that determined the easement had a $2.6 million fair market value. Significantly, RA Pennington provided Form 870-PT when she sent the revised RAR and again at the second closing conference. These facts indicate that the audit was concluded, RA Pennington had made her initial penalty determinations, the adjustments and penalties in the revised RAR were not tentative proposals as in Belair Woods but definite decisions, and the revised RAR was a formal communication of the initial penalty determination. Additional facts that support a finding that the audit was concluded by the time the revised RAR was issued are the last entry in RA Pennington's activity log is December 5 or 7, 2015, the 60-day letter enclosed the revised RAR, apparently unedited, and the notation in the revised RAR that petitioner reserved the issues for protest.

On the record before us, it appears that the revised RAR was a formal communication of RA Pennington's definite decision to assert the penalties and not tentative proposals. If petitioner or any member signed Form 870-PT, any subsequent supervisor approval of the penalty determination would have been moot. Therefore, section 6751(b) would require approval of the penalties before the revised RAR and Form 870-PT were given to petitioner.3

As explained above, respondent's position and the record produced thus far indicate that RA Pennington initially determined the valuation penalties and formally communicated that determination to petitioner before obtaining written supervisory approval. We place no evidentiary weight on respondent's position objecting to the granting of summary judgment. The factual issues would appear to require ether additional stipulations or testimony. Accordingly, we find that there are genuine issues of material fact with respect to the initial determination of the valuation and nonvaluation penalties.

Pursuant to the above, it is

ORDERED that respondent's motion, as supplemented, is granted on the basis that the deed of easement does not satisfy the perpetuity requirement of section 170(h)(5). It is further

ORDERED that petitioner's motion is denied. It is further

ORDERED that the parties are to submit status reports on or before April 1, 2021, to indicate whether the penalty issues may be resolved by cross-motions for summary judgment or whether a trial is needed.

(Signed) Joseph Robert Goeke


1. All section references are to the Internal Revenue Code in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. Amounts are rounded.

2. Petitioner also argue judicial estoppel and reliance on a 2008 private letter ruling; both are without merit. Coal Prop. Holdings, 153 T.C. at 144. For judicial estoppel, petitioner asserts a stipulation by the government in a proceeding of an unrelated taxpayer of a fact not material to the decision in that case.

3. Such an outcome is inconsistent with petitioner's argument that the RARs did not address the valuation penalties or that RA Pennington did not initially determine the valuation penalties but is in petitioner's favor.

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