Improvement carveouts invalidate conservation easement deductions

Plain-English summary

The Chief Counsel advised that a conservation easement deed fails Section 170(h) when its extinguishment clause subtracts the value of post-donation improvements, or appreciation attributable to those improvements, before calculating the donee's share of proceeds. The governing regulation gives the donee a vested property right based on the easement's proportionate value at the time of the gift, and that proportion must remain constant. Reducing the donee's proceeds by an improvement value therefore violates the perpetuity requirement. The only stated exception applies when state law gives the donor the full proceeds from the conversion. The memorandum also provides sample deed language that tracks the regulation.

Ruling snapshot

• Question: May a conservation easement deed subtract post-donation improvement value from the donee's extinguishment proceeds?
• Outcome: Advice given: no, unless state law entitles the donor to all conversion proceeds.
• Key authorities: IRC § 170(h); Treas. Reg. § 1.170A-14(g)(6); Carroll v. Commissioner; PBBM-Rose Hill, Ltd. v. Commissioner; Coal Property Holdings, LLC v. Commissioner

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       Memorandum
       Number: 202130014
       Release Date: 7/30/2021
       CC:ITA:B02
       POSTN-106353-21

UILC: 170.14-03

date: June 16, 2021

 to:   James C. Fee, Jr, Senior Level Counsel
       (Large Business & International CC:LB&I)

       Robert W. Dillard, Area Counsel
       (Small Business/Self-Employed CC:SB:3)

from: Bridget E. Tombul, Chief, Branch 2
(Income Tax & Accounting CC:ITA:2)

subject: Section 170(h) and Conservation Easement Deed Extinguishment Clauses

       This Chief Counsel Advice responds to your request for assistance. This document
       should not be used or cited as precedent.

       ISSUE

       Does a conservation easement fail to satisfy the requirements of section 170(h) of the
       Code if the deed contains language subtracting from the donee’s extinguishment
       proceeds the value of post-donation improvements or the post-donation increase in
       value of the property attributable to improvements?

       CONCLUSION

       Yes. Decreasing the portion of the proceeds that is required to be allocated to the
       donee upon extinguishment under Treas. Reg. § 1.170A-14(g)(6)(ii) causes the
       easement to fail to satisfy the requirements of section 170(h) unless, as provided in
       Treas. Reg. § 1.170A-14(g)(6)(ii), state law provides that the donor is entitled to the full
       proceeds from the conversion.

       LAW AND ANALYSIS

       Section 170(a) of the Code provides the general rule that a deduction is allowed for a
       charitable contribution made within the taxable year. The deduction is allowed only if

POSTN-106353-21 2

the charitable contribution is verified under regulations prescribed by the Secretary.
See also Treas. Reg. § 1.170A-1.

Section 170(f)(3)(A) provides the general rule that a contribution (not made by a transfer
in trust) of an interest in property that consists of less than the taxpayer's entire interest
in such property will generally not qualify as a charitable contribution. This rule is
commonly referred to as the “partial interest rule.” See also Treas. Reg. § 1.170A-7.
Section 170(f)(3)(B)(iii) provides an exception to the partial interest rule for a “qualified
conservation contribution.” See also Treas. Reg. § 1.170A-7(b)(5).

Section 170(h)(1) defines the term “qualified conservation contribution” as a contribution
(A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for
conservation purposes. Section 170(h)(2) defines the term “qualified real property
interest” as any of the following interests in real property: (A) the entire interest of the
donor other than a qualified mineral interest, (B) a remainder interest, and (C) a
restriction (granted in perpetuity) on the use which may be made of the real property.
Section 170(h)(4) defines the term “conservation purpose.” Section 170(h)(5)(A)
provides that a contribution shall not be treated as exclusively for conservation
purposes unless the conservation purpose is protected in perpetuity. A conservation
easement must meet both of these perpetuity requirements, meaning the property
interest must be granted in perpetuity under section 170(h)(2)(C) and enforceable in
perpetuity under section 170(h)(5)(A).

Treasury Regulation § 1.170A-14(g)(6)(i) provides that if conditions surrounding the
property unexpectedly change, and if those changes make continued use of the
property for conservation purposes impossible or impractical, then the conservation
purpose can nonetheless be treated as protected in perpetuity if the easement is
extinguished by judicial proceeding and the donee organization uses all of its proceeds
from the sale or exchange of the property in a manner that is consistent with the original
contribution’s conservation purposes.

Treasury Regulation § 1.170A-14(g)(6)(ii) sets forth requirements for the distribution of
proceeds in the event the easement is extinguished. It provides that, for a deduction to
be allowed, at the time of the gift, the donor must agree that the donation of the
perpetual conservation restriction gives rise to a property right, immediately vested in
the donee organization, with a fair market value that is at least equal to the
proportionate value that the perpetual conservation restriction at the time of the gift
bears to the value of the property as a whole at that time. That proportionate value of
the donee’s property rights must remain constant. As such, if the easement is
extinguished, the donee organization must be entitled to a portion of the proceeds at
least equal to the proportionate value of the perpetual conservation restriction, unless
state law provides that the donor is entitled to the full proceeds from the conversion
without regard to the terms of the prior perpetual conservation restriction. The
regulation states that the donor must agree to these requirements at the time of the
donation for the donor to be eligible to claim a charitable contribution deduction.
POSTN-106353-21 3

The Tax Court has held that the requirements of Treas. Reg. § 1.170A-14(g)(6)(i) and
(ii) are strictly construed; if a grantee is not absolutely entitled to a proportionate share
of extinguishment proceeds, then the conservation purpose of the contribution is not
protected in perpetuity. Carroll v. Commissioner, 146 T.C. 196, 212 (2016). Reducing
the portion of the grantee’s proceeds by the value of any post-donation improvements
or any post-donation increase in value of the property attributable to improvements
reduces the grantee’s proportionate share of proceeds and violates Treas. Reg. §
1.170A-14(g)(6)(ii) unless state law provides that the donor is entitled to the full
proceeds from the extinguishment. See PBBM- Rose Hill, Ltd. v. Commissioner, 900
F.3d 193, 208 (5th Cir. 2018); Coal Property Holdings, LLC v. Commissioner, 153 T.C.
126, 144 (2019).

A judicial proceeding is the exclusive manner in which a perpetual conservation
restriction may be extinguished, and only if a subsequent unexpected change in the
conditions surrounding the property that is the subject of this easement has made the
continued use of the property for conservation purposes impossible or impractical.

Language in a conservation easement deed that closely adheres to the language of
Treas. Reg. § 1.170A-14(g)(6)(ii) generally will not cause a deed to violate the
enforceability in perpetuity requirements. For an example, see the following sample
conservation easement deed language:

   Donor agrees that the donation of the perpetual conservation
   restriction described in this deed gives rise to a property right,
   immediately vested in the donee organization, with a fair market
   value that is at least equal to the proportionate value that the
   perpetual conservation restriction, at the time of the gift, bears to
   the fair market value of the property as a whole at that time. For
   purposes of this paragraph, the proportionate value of the donee
   organization's property rights shall remain constant.

   On a subsequent sale, exchange, or involuntary conversion of the
   subject property, the donee organization will be entitled to a portion
   of the proceeds at least equal to that proportionate value of the
   perpetual conservation restriction.

   All of the donee organization’s proceeds from a subsequent sale or
   exchange of the property must be used by the donee organization
   in a manner consistent with the conservation purposes of the
   original contribution.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.
POSTN-106353-21 4

If there are any questions, please call Joshua Klaber of IT&A at (202) 317-4624.

                                    Bridget E. Tombul
                                    Branch Chief, Branch 2
                                    (Income Tax & Accounting)




                             By:    _____________________________
                                    Jason D. Kristall
                                    Senior Technician Reviewer
                                    Office of Associate Chief Counsel
                                    (Income Tax & Accounting)