Could buyers of a transferred land-preservation credit avoid interest because Virginia later reduced the easement value or the seller promised indemnity?

Subject

Interest due after transferred land credit reduction

Plain-English summary

Virginia denied a refund of interest after a transferred land-preservation credit was reduced. An LLC donated a conservation easement, transferred part of the credit to the husband, and later agreed with the Department to a lower property value. Virginia assessed the credit recipients for the resulting tax difference.

The assessment was issued within the ordinary three-year period measured from the later of the return due date or filing date. State law made interest on an underpayment mandatory and did not allow waiver unless the related tax was adjusted.

The couple argued that the LLC should bear the interest under an indemnification clause. Virginia rejected that as a basis for state relief because the agreement was between the husband and LLC, not the Department. Any reimbursement claim had to be pursued against the transferor.

The ruling also emphasized Virginia's self-assessment system: taxpayers compute, file, and pay their own liability, while the Department may later assess tax and required interest when a return proves incorrect.

What this means for you

• A transferred credit can be reduced after transfer when the underlying easement value is revised.
• Interest can run even while the Department reviews the valuation, so transfer pricing and reserves matter.
• Indemnity rights are private contractual remedies unless the taxing authority is a party.

Common questions

Q: Was the assessment too late?
A: No. It was issued within the three-year statutory period.

Q: Could Virginia waive only the interest?
A: No. The ruling said underpayment interest was mandatory unless the associated tax was adjusted.

Q: Who could the couple pursue under the indemnity?
A: The LLC that transferred the credit, not the Department.

Citations and references

• Va. Code §§ 58.1-312, 58.1-512, 58.1-513, and 58.1-1812.
• IRC § 170(h).
• Public Documents 12-190 and 13-29.

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 14-32

Original ruling text

March 7, 2014

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, 2010.

FACTS

The Taxpayers, a husband and wife, were Virginia residents during the taxable year at issue. In June 2010, * (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 husband based on an appraisal submitted with the registration. The Taxpayers claimed the Credit on their 2010 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 paid the assessment and filed an appeal, contending they should not be held liable for the interest assessed because the assessment was issued after a lengthy period and VLLC is responsible for any assessment in accordance with an indemnification agreement.

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.

Interest

The Taxpayers contend that the accrued interest was excessive due to the lengthy time it took for the bill to be issued. 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. 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. In the Taxpayers' case, the assessment was issued within the three-year limitations period.

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. See Public Document (P.D.) 13-29 (3/11/2013).

Indemnification

The Taxpayers assert the Department should seek payment of the interest from VLLC because the transfer agreement requires VLLC to defend and indemnify credit holders. According to the transfer agreement, however, the indemnification clause is between the husband and VLLC.

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 transferor of such Credit. See P.D. 12-190 (11/26/2012) and P.D. 13-29. Because the Department is not a party to the transfer agreement, the Taxpayers will need to pursue recourse against VLLC.

CONCLUSION

Based on the foregoing, the assessment of interest issued to the Taxpayers for the 2010 taxable year was proper. Accordingly, the Taxpayer's request for the refund of interest paid pursuant to the assessment issued for the taxable year ended December 31, 2010 is denied.

The Code of Virginia sections and public documents 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/1-5531200286.B