Tax Court Denies Conservation Easement Deduction
The Tax Court recently found that a taxpayer was not entitled to a charitable contribution deduction for its donation of a conservation easement where the taxpayer expected to receive a substantial benefit in return. See Wendell Falls Development, LLC, T.C. Memo 2018-45.
In general, Section 170(a) provides for a charitable contribution deduction of a “qualified conservation contribution” where certain requirements are met. Nevertheless, where the taxpayer receives a benefit in return for a charitable contribution, the deduction is only allowed where the transfer was made with the intent of making a gift and is limited to the excess of the value transferred over the benefit received. Furthermore, if the taxpayer expects a substantial benefit from the charitable contribution, no deduction is allowed.
In Wendell, the taxpayer placed a conservation easement on a 125-acre parcel of land as part of the planned development of a larger tract, with the intention of using the 125-acre parcel as a park. As part of the overall master-planned community, the county purchased the 125-acre park, subject to a conservation easement, at a “bargain price.” The taxpayer then reported a charitable contribution deduction of $4.8 million, reflecting the value of the donation to the county.
The Tax Court agreed with the Service that the taxpayer received a substantial benefit from the easement because the prospect of a public park on the 125 acres would increase the value of the adjoining property. The Court found that this substantial benefit negated the charitable purpose of the contribution; accordingly, the Court denied the deduction in full.
Wendell demonstrates the Service’s continued scrutiny of conservation easement donations and marks a departure from prior jurisprudence in the area. Based on the reasoning of Wendell, any enhancement in value to the taxpayer’s property could cause the entirety of an easement donation to be nondeductible. Taxpayers should be cognizant of the potential impact of Wendell on conservation easement donation transactions.
Tax Court Held Sale of Land Resulted in Capital Gain
In the recent case of Sugar Land Ranch Development LLC et al. v. Comm’r, T.C. Memo 2018-21, the Tax Court determined that the gain recognized by the taxpayer from the sale of two large parcels of land initially acquired primarily for sale to customers was properly characterized as capital gain.
To qualify for capital gain treatment, the gain must arise from the sale of a capital asset. I.R.C. § 1221 defines a capital asset by what is not a capital asset, and I.R.C. § 1221(a)(1) specifically excludes “property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business” from the definition of a capital asset.
In Sugar Land Ranch Development LLC, the taxpayer was formed in 1998 to develop the land into single family residential building lots and commercial building lots. Ten years later, believing the taxpayer would be unable to develop, subdivide and sell lots from the property due to the effects of the subprime mortgage crisis and the scarcity of financing in wake of the financial crisis, the taxpayer’s managers decided that the taxpayer would not attempt to subdivide or otherwise develop the property. The managers decided that the taxpayer would instead hold the property as investment until the conditions improved sufficiently to sell it. This change of purpose was memorialized in resolutions adopted by the taxpayer.
Between 2008 and 2012, the taxpayer did not develop the property, did not market the property and did not try to sell the property in any way. Ultimately, an unrelated party approached the taxpayer inquiring about a sale and purchased the property essentially as a bulk sale of a single, large and contiguous tract of land.
The IRS challenged the taxpayer’s capital gain treatment of the sale because the property originally was acquired for real estate development, arguing that the land was “held primarily for sale to customer in the ordinary course of the taxpayer’s trade or business.”
However, the Tax Court upheld the capital gain treatment, finding that the evidence showed the financial crisis in 2008 caused the taxpayer to alter its business model and hold the property for investment only rather than subdivide and hold primarily for sale.
This case is significant because the classification of gain from the sale of property is based on the facts and circumstances and the taxpayer was able to successfully establish that the taxpayer abandoned and replaced its initial holding purpose of the property.
IRS Issues Guidance on Blended Tax Rate for Fiscal Year Companies
In Notice 2018-38 and accompanying Information Release, the IRS provided guidance on how a corporation with a fiscal year that includes Jan. 1, 2018 will pay federal income tax (including the alternative minimum tax) using a blended tax rate due to the changes made by the Tax Cuts and Jobs Act (“TCJA”).
Under pre-TCJA law, corporations were subject to graduated tax rates of 15% (for taxable income of $0-$50,000), 25% (for taxable income of $50,001-$75,000), 34% (for taxable income of $75,001-$10,000,000), and 35% (for taxable income over $10,000,000). Personal service corporations paid tax on their entire taxable income at the rate of 35%.
Under the TCJA, for tax years beginning after Dec. 31, 2017, the corporate tax rate is changed to a flat 21% rate under IRC § 11(b). In addition, pursuant to IRC § 55 the corporate AMT is repealed for tax years beginning after Dec. 31, 2017.
Notice 2018-38 provides that corporations operating on a fiscal year schedule can determine their federal income tax by first calculating their tax for the entire taxable year using the rates in effect prior to the TCJA, and then computing their tax using the new 21% corporate rate. Thereafter, the taxpayer should proportion each tax amount based on the number of days in the taxable year that the different rates were in effect, and the sum of the two amounts is the tax due.
Please see Notice 2018-38 for examples illustrating the blended tax computation.