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Valuation of a conservation easement for federal tax deduction purposes.

Rose Hill Country Club (Club) owned a 242acre property in South Carolina consisting of a 27-hole golf course and related facilities for a neighboring residential community. The 1996 deed conveying the property to the Club contained a use restriction, requiring the property to be used "only for recreational facilities or open space" for a period of thirty years.

The Club ultimately conveyed the property to PBBM Rose Hill (PBBM) in 2002 for $2.4 million, but because the golf course was not profitable, PBBM closed it four years later in 2006, then filed for Chapter 11 bankruptcy. PBBM initiated a proceeding in the bankruptcy court to invalidate the use restriction, which was ultimately settled with the neighborhood's property owners association (POA). Specifically, the POA agreed it would not contest the removal of the use restriction, but it also obtained an option to purchase the property, which the POA ultimately exercised. The bankruptcy court entered judgments invalidating the use restriction and approving the sale price of $2.3 million.

Prior to the sale closing, PBBM conveyed a conservation easement of about 234 acres of the property to a land trust. The conservation area included the entire golf course but excluded the maintenance areas and clubhouse. In the easement deed, PBBM "voluntarily, unconditionally, and absolutely" granted the trust and its successors an easement in perpetuity to preserve the property for outdoor recreation and open space for the public benefit.

When PBBM filed its partnership tax return for that year, it claimed a charitable contribution deduction of $15.16 million for its donation of the conservation easement. The Commissioner of Internal Revenue (Commissioner) issued an administrative adjustment, which determined that PBBM was not entitled to the deduction and assessed a penalty. PBBM challenged the ruling in tax court, and after a five-day trial, the tax court concluded that the easement was not exclusively for conservation purposes, and that the value of the easement was only $100,000. PBBM appealed to the Fifth Circuit Court of Appeals.

Under the before-and-after valuation approach, the value of an easement is equal to the difference between the fair market value of the property it encumbers before and after the granting of the restriction. In the tax court proceedings, both parties' appraisers agreed that the after-value was $2.3 million. The dispute centered on the before-value, specifically debating whether the property could have been developed.

To support its claimed $15.16 million deduction, PBBM submitted an appraisal that rested on the extraordinary assumption that the property could be rezoned to permit commercial uses, which was in turn based on a letter from an attorney who opined that the neighborhood master plan would have allowed the property to be used as a residential or commercial site.

PBBM's appraiser also opined that the highest and best before-use was to develop the property described in a conceptual plan presented by a land use planner offered by PBBM. That plan proposed developing the property into commercial businesses, single-family homes, and multifamily residences. The plan also rested on the attorney's letter.

The Commissioner's appraiser opined that the highest and best use was the same before as it was after: use as a golf course or other recreational purpose. Because the zoning permitted only recreational uses, "any other uses would be speculative at best." The appraiser spoke with the county zoning administrator and neighboring residents who opposed development in arriving at this conclusion. The validity of the use restriction after the bankruptcy court's judgment also caused uncertainty.

On appeal, PBBM argued that the tax court erred in relying on the use restriction because the bankruptcy court had issued several judgments removing the restriction before PBBM donated the easement. But it was unclear whether the use restriction was enforceable by parties other than those involved in the bankruptcy judgments, and the likelihood of development depended on factors beyond the use restriction, including approval by the county zoning agency and neighborhood opposition.

In sum, the court of appeals held that the tax court did not err in finding that development was unlikely. Accordingly, the highest and best use of the property before the granting of the easement was the same as after; the Commissioner's appraisal was adopted, and the easement was valued at $100,000.

PBBM-Rose Hill Ltd. v. Commissioner of Internal Revenue

US Court of Appeals for the Fifth Circuit

August 20, 2018

900 F.3d 193

Benjamin A. Blair, JD, is a partner in the Indianapolis office of the international law firm of Faegre Baker Daniels LLP, where his practice focuses on state and local tax litigation for clients across the United States. A frequent speaker and author on taxation and valuation issues, Blair holds a juris doctor from the Indiana University Maurer School of Law, where he also serves as an adjunct professor. Contact:
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Title Annotation:Recent Court Decisions on Real Estate and Valuation
Author:Blair, Benjamin A.
Publication:Appraisal Journal
Date:Mar 22, 2019
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