Who bore the tax when a purchased Virginia land-preservation credit was later reduced?

Plain-English summary

Virginia upheld the assessment against purchasers of transferred land-preservation tax credits after the underlying conservation easement's agreed value was reduced. The Department can allow credit only from fair market value and can assess the taxpayers who actually claimed transferred credits that prove excessive.

The purchasers argued that they bought in good faith and that the donor had promised to indemnify them for tax, penalty, interest, and legal-rate interest caused by a credit adjustment. Virginia was not a party to that agreement. The purchasers remained responsible for the assessment and had to seek contractual recourse from the donor.

Virginia did not first demand payment from a tax matters representative because the donor's credit application had not registered one. The assessment was issued within the three-year limitations period, and interest on the underpayment was mandatory unless the tax itself was adjusted.

What this means for you

• Buying a transferred tax credit does not eliminate the risk that its underlying valuation will be reduced.
• Indemnification protects through a private contract, not by shifting the Department's assessment away from the claimant.
• Confirm whether a pass-through donor registered a tax matters representative.
• Review appraisal support and contractual remedies before acquiring conservation credits.
• A timely filed return does not prevent statutory interest on a later, timely assessment.

Common questions

Q: Did good-faith purchase prevent the assessment?
A: No. The Department assessed the taxpayers who claimed credits exceeding the agreed fair-market-value amount.

Q: Could the purchasers use the indemnity?
A: They could pursue the donor under their private agreement, but Virginia was not bound by it.

Q: Why was no demand made on a tax matters representative?
A: The donor's application had not registered one.

Citations and references

• Va. Code §§ 58.1-312, 58.1-512, 58.1-513 F, and 58.1-1812.
• Internal Revenue Code § 170(h).
• Virginia Public Document 12-190.

Subject

Donor and the Department agree on a valuation, Credit holders address devaluation of the Credit with transferors

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 13-29

Original ruling text

March 11, 2013

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of an individual income tax assessment issued to * (the "Taxpayers") for the taxable year ended December 31, 2008.

FACTS

In December 2008, * (VLLC) conveyed a conservation easement to a donee. Pursuant to the conveyance of the easement, VLLC registered its donation with the Department for purposes of the Land Preservation Tax Credit (the "Credit"). Subsequently, VLLC transferred a portion of the Credit to the Taxpayers based on an appraisal submitted with the registration. The Taxpayers claimed the Credit on their 2008 Virginia individual income tax return.

Under examination, the Department determined that the appraisal overvalued the easement. VLLC and the Department entered into an agreement that reduced the value of the easement. Based on this agreement, the Department then issued assessments against all taxpayers that received the Credit from VLLC, including the Taxpayers. The Taxpayers filed an appeal, contending that VLLC should be held liable for their assessment because the Credit was purchased in good faith and there was an indemnification agreement with VLLC. They assert that the Department failed to first seek payment of the assessments from the tax matters representative prior to issuing the assessment against the Taxpayers. The Taxpayers also argue that no interest should be assessed because the 2008 Virginia income tax return was timely filed and the Department issued the assessment after a lengthy period.

DETERMINATION

Credit Adjustment

Virginia Code § 58.1-512 provides a Credit for 40% of the fair market value of real property or an interest in real property donated to an eligible charitable organization or instrumentality of the Commonwealth for qualifying land conservation purposes. In order to qualify for the credit, a donation of an interest in real property must qualify as a charitable deduction under Internal Revenue Code (IRC) § 170(h).

Virginia Code § 58.1-513 provides for the transfer of the Credit. When the Credit has been transferred based on valuation that exceeds fair market value, the Department has the authority to issue assessments against the taxpayers claiming such Credit in accordance with Va. Code § 58.1-1812.

In this case, the Department disputed VLLC's valuation of the easement. After reviewing all the relevant documentation, the Department and VLLC agreed on a valuation that was lower than the original appraised amount, resulting in assessments of tax to transferees of the Credit.

The Taxpayers assert that they purchased an amount of Credit in good faith and that VLLC should be held liable because VLLC agreed to indemnify transferees of the Credit for any devaluation. According to the indemnification clause in the sales agreement between VLLC and the Taxpayer, VLLC agrees to indemnify the Taxpayer for any tax, penalty or interest assessed due to an adjustment of the Credit by paying such assessment in full, plus the legal rate of interest.

As indicated above, the Department may only permit a Credit based on the fair market value of a conservation easement. When a donor and the Department agree on a valuation, Credit holders must address any resulting devaluation of the Credit with the transferors of such Credit. See Public Document (P.D.) 12-190 (11/26/2012).

The sales agreement is between VLLC and the Taxpayer. Clearly, the Department is not a party to this agreement. The Department's position in P.D. 12-190 is consistent with the indemnification clause in the Credit sales agreement. As such, the Taxpayer will need to pursue recourse against VLLC.

Tax Matters Representative

The Taxpayers contend that the Department failed to seek payment from VLLC's tax matter representative before issuing assessments against them. Virginia Code § 58.1-513 F provides that a pass-through entity may appoint a tax matters representative. It further states:

In the event a pass-through tax entity allocates or transfers tax credits arising under this article to its partners, members or shareholders and the allocated or transferred credits shall be disallowed, in whole or in part, such that an assessment of additional tax against a taxpayer shall be made, the Tax Commissioner shall first make written demand for payment of any additional tax, together with interest and penalties, from the tax matters representative .

Under Va. Code § 58.1-513 F, an entity is required to register the tax matter representative with the Tax Commissioner. According to VLLC's application for the Credit, no tax matters representative was registered. As such, there was no tax matters representative from which to demand payment.

Interest

The Taxpayers assert that the interest should not be assessed because the assessment was issued nearly three years after the due date of his 2008 return.

Virginia's taxing system is based largely on the theory of self assessment. The taxpayer is given the responsibility to compute, file and pay their own income tax. Virginia has implemented a self assessment system based on the federal system because it is less intrusive upon the taxpayer, and less costly to the administration of the tax. The Department has the authority to assess the additional tax plus any penalty and interest, as required by law, when it finds that any taxpayer "has failed to make a proper return or to pay in full any proper tax." See Va. Code § 58.1-1812. The Department makes every effort to discover any errors in filed returns and make assessments in a timely fashion.

Virginia Code § 58.1-312 allows the Department to assess omitted taxes within three years of the latter of the due date of the return or the actual date that the return was filed. This is the same amount of time that taxpayers have to make corrections on their own returns. There are exceptions that can extend the period beyond three years, but none apply in this case. In the Taxpayers' case, the assessment was issued within the three-year limitations period. Further, Va. Code § 58.1-1812 mandates the application of interest to any assessment of tax. The application of interest to tax underpayments is mandatory under state law and cannot be waived unless the associated tax is adjusted.

CONCLUSION

Based on the foregoing, the assessment issued to the Taxpayers for the 2008 taxable year is upheld. An updated bill, with interest accrued to date, will be issued

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules and Decisions section of the Department's website. If you have any questions about this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/1-5157051081.B