Summary

In Butler v. Commissioner, the Tax Court allowed deductions for contributions of several conservation easements, despite the taxpayers having reserved limited development rights. The Court also accepted a "percentage diminution" method for valuing the easements.

Extended Summary

In 2003, husband and wife contributed easements over largely undeveloped acreage in rural Georgia to a land trust the husband helped create. In 2003 and 2004, a limited liability company, of which the taxpayers were the only members, contributed easements over other largely undeveloped acreage elsewhere in rural Georgia to another land trust.

In each case, the taxpayers reserved limited development rights with respect to the underlying property. The Commissioner challenged the claimed deductions on the ground that the easements did not qualify under Section 170(h), and argued alternatively that the easements were overvalued.

The Tax Court first ruled the taxpayers had introduced sufficient credible evidence that the easements did have the effect of protecting natural habitats. This evidence placed the burden of proof to the contrary on the Commissioner, who offered no evidence on the matter.

In each case, the easement had the effect of limiting possible development on the underlying acreage. Absent the easement, a substantial portion of the two properties could have been developed as a subdivision with as many as two hundred houses on one-acre lots. The easement had the effect of limiting the owner of the land to developing eleven two-acre homesites, leaving the remaining acreage undeveloped.

In a similar manner, the highest and best use of the property owned by the limited liability company, both before and after the contribution of the easement, was as a working farm and shooting plantation. The easement on this land limited the subdivision of the property to no more than fifteen tracts of at least 200 acres each. Based on testimony by environmental consultants who had created the baseline studies against which the land trust would measure future management and monitoring practices, the Tax Court ruled that these limitations sufficiently protected natural habitats.

The bulk of the 145-page opinion was taken up with a detailed discussion of valuation issues. The court entirely disregarded the testimony of one of the taxpayers' experts and accepted only portions of the conclusions of each of the others. While the court accepted many of the conclusions of the government's sole expert witness, it disagreed with some, and ultimately made its own determination of value.

In determining the amount by which the imposition of the easement diminished the market value of the underlying property, one of the taxpayers' experts and the government's expert himself each used what the court characterized as a "percentage diminution" method. This method discounted the fair market value of the property without the easement by a percentage derived from a review of comparable sales of properties burdened by easements.

The court acknowledged that it had recently rejected a "benchmark" diminution method of valuing a conservation easement in Scheidelman v. Commissioner, where the appraiser had based his estimate of the difference in value on allowed deductions in prior cases. However, the court also noted that it had allowed a "percentage diminution" method in several earlier cases, Hughes v. Commissioner (2009), Strasburg v. Commissioner (2000), Johnston v. Commissioner (1997), and Losch v. Commissioner (1988).

The "percentage diminution" method involves a comparison of sales of properties encumbered by easements, taking into account the highest and best use of the comparable properties, both before and after the easement is imposed, and taking into account differences in the restrictions imposed by the easements.

"When estimating a percentage reduction associated with an easement on a given property," the court emphasized, "it is essential that an appraiser provide adequate explanation and analysis to justify the percentage." It was on this point that the "benchmark" diminution method employed in Scheidelman was ruled insufficient.

CPC Commentary

In Scheidelman, the Tax Court rejected a valuation based on the appraiser's understanding of what the IRS allowed in previous cases, rather than on a reasoned analysis of comparable sales (see our earlier commentary). That decision is pending cross appeals to the 2nd Circuit federal appeals court. Briefing is complete, the case was argued in December, and we are awaiting the appeals court's decision.

Butler is a helpful case in the area of easements and valuation, distinguishing clearly the rationale for decisions in other cases.

Relevant Documents

	Tax Court: James E. Butler, Jr., and Susan C. Butler	3/19/12
	CPC Commentary: Tax Court Disallows Facade Easement Deduction	7/15/10
	Scheidelman.TCM.WPD	7/15/10
	Tax Court: Nick R. Hughes	5/6/09
	Tax Court: S.K. Johnston, III and Julie N. Boyle f.k.a. Julie N. Johnston, et al.	10/20/97
	Tax Court: Katherine Strasburg	3/20/00
	Section 170: Charitable, etc., contributions and gifts	3/24/10