In a lengthy written opinion released on December 9, 2015 under the name Atkinson v. Commissioner, the U.S. Tax Court denied the federal tax deductions claimed for two conservation easements donated on an operating golf course in coastal North Carolina. Specifically, the Tax Court denied these tax deductions on the grounds that the two easements did not have a legitimate conservation purpose. Let’s take a closer look at why these two golf course conservation easements failed to qualify for special tax treatment.
What Is a “Conservation Purpose”?
When it reviews charitable deductions claimed for donations of conservation easements, the Tax Court is essentially trying to make sure that the easement is not a sham easement, and thus undeserving of a tax deduction. In other words, the Tax Court is trying to ferret out (1) easements that do not protect something worth protecting and (2) easements that claim to protect something worth protecting but fail to do so.
This “something worth protecting” is more technically called a “conservation purpose.” The Internal Revenue Code specifies several categories of conservation purposes that conservation easements must protect in order to qualify for tax deductions. A conservation easement must protect at least one of these conservation purposes to qualify.
The landowners in Atkinson alleged that their two easements protected two different conservation purposes. Specifically, the landowners claimed (quoting the Internal Revenue Code) that the easements were for “the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem” and that that they were also for “the preservation of open space … (I) for the scenic enjoyment of the general public, or (II) pursuant to a clearly delineated Federal, State, or local governmental conservation policy, and will yield a significant public benefit.” The Atkinson opinion is a bit unusual in that the Tax Court delved pretty deeply into how the conservation easements at issue did or did not protect the conservation purposes identified in the easement deeds. Let’s take a look at the Tax Court’s analysis regarding each of these conservation purposes.
The “Relatively Natural Habitat” Conservation Purpose
The Tax Court first analyzed whether or not the two conservation easements satisfied the “relatively natural habitat” conservation purpose requirements. The Tax Court devoted most of its written opinion to the first conservation easement, which was donated in 2003, although most of its analysis similarly applied to the second conservation easement, which was donated in 2005 on an adjoining property. The Tax Court considered the following arguments, rejecting each one.
The Easement Terms Did Not Actually Protect the Native Longleaf Pine on the Property, Nor Did the Longleaf Pine Exist in a Relatively Natural Habitat
First, the landowners argued that the 2003 conservation easement protected the forest of longleaf pine along the edges of the property. The Tax Court dismissed this argument, noting that many of these longleaf pines were located within 30 feet of the fairways and that the terms of the easement permitted trees within 30 feet of the fairways to be cut. The terms of the easement also allowed trees, including longleaf pines, to be removed for the construction of certain buildings and structures on the property.
Moreover, the Tax Court found that the longleaf pine on the property did not “currently exist in a relatively natural state worthy of conservation.” Likewise, the terms of the conservation easement did not require a management plan to ensure that the longleaf pine would “reach and maintain a relatively natural state,” nor did the golf course actually have such a management plan in place. For all these reasons, the putative protection of the longleaf pine on the property did not support the granting of a tax deduction for the conservation easement.
The Ponds on the Property Did Not Provide a Relatively Natural Habitat
Next, the landowners argued that the many ponds on the 2003 easement property provided the required relatively natural habitat. However, this argument was also dismissed because the ponds totally or partially lacked a natural edge, which would provide habitat for animals; pesticides were regularly sprayed on the fairways near the ponds, killing many of the species that could have inhabited there; and runoff from fertilizer used on the fairways stimulated plant growth in the ponds, thus decreasing the quality of the ponds as habitat for aquatic animals.
The Golf Course Proper Did Not Provide a Relatively Natural Habitat
The landowners further argued that the rough, fairways, greens, and tees of the golf course could be used by various animal species for foraging, migrating, and feeding. The Tax Court quickly dismissed this argument, noting that there were no natural sources of food on the golf course and that animals would be deterred from the golf course by the high level of human activity on it, including the constant irrigation of the turf. Additionally, the Tax Court found that these areas of the golf course—well over half of the 2003 easement property—did not provide a relatively natural habitat for rare plants because these areas were heavily managed (including the heavy use of pesticides, fertilizers, and other chemicals) and because these areas were planted with nonnative grasses. The Tax Court was so unimpressed with this argument that it noted, with a touch of snark, that the “easement deed requires the owner of the property to exercise the best environmental practices ‘then prevailing in the golf industry,’ not the best environmental practices then prevailing for conservation, as might be expected if conservation was the purpose of the easement.”
The Entire Deduction Is Disallowed if a Significant Portion of the Property Does Not Qualify
As previously noted, much of the Tax Court’s written opinion was devoted to analyzing the 2003 conservation easement, but the landowners raised similar arguments regarding the 2005 conservation easement. The Tax Court was not persuaded by these arguments for the same reasons as for the 2003 easement—even though more than half of the 2005 easement property consisted of wetlands and other wild areas. The Tax Court expressly noted that the “partial provision of a proper place for growth [of rare species] is insufficient to justify protecting the entire easement area …” In other words, grievously failing to protect the claimed conservation purpose on a large part of the easement property is not counterbalanced by protecting the conservation purpose on the rest of the easement property, and no tax deductions will be allowed.
The Golf Course Did Not Provide a Natural Buffer to Nearby Conservation Areas
The landowners also argued that both golf course conservation easements provided a natural buffer to nearby conservation areas—thus contributing to the protection of the nearby conservation areas’ conservation purposes—and that the tax deductions should be upheld for that reason. The Tax Court quickly dismissed this argument, concluding that the easement properties could not act as a natural buffer for many of the same reasons that the easement properties did not provide a relatively natural habitat. Additionally, the easement properties could not serve as a natural buffer because they were mostly surrounded by residential development and thus were isolated from the nearby conservation areas. Consequently, the tax deductions for these conservation easements could not be sustained on those grounds.
The “Open Space” Conservation Purpose
Finally, the Tax Court considered whether the two golf course conservation easements qualified as effecting “the preservation of open space … (I) for the scenic enjoyment of the general public, or (II) pursuant to a clearly delineated Federal, State, or local governmental conservation policy, and will yield a significant public benefit.”
The Tax Court found that the conservation easements were not “for the scenic enjoyment of the general public” mainly because the two easement properties were located within a gated community and thus were not visible to the general public. Furthermore, houses were located along the edges of the easement properties and thus blocked any scenic view that the general public might have had. The Tax Court described the easement properties as follows:
While there are patches of native vegetation and wildlife, golf courses and the homes surrounding much of each easement area interrupt the natural scenic character. The easement areas are primarily man made and are neither natural nor historic.
The landowners did not point to any clearly delineated governmental policies, and so the Tax Court did not consider whether or not the two conservation easements might have satisfied that prong of the conservation purpose requirements.
What Does This Mean for Golf Course Conservation Easements?
In its opinion, the Tax Court expressly declined to decide whether or not conservation easements placed on operating golf courses, in and of themselves, fail to qualify for federal tax deductions. However, the Tax Court’s determination that these conservation easements did not satisfy the most basic of all requirements—that the easements be for conservation—and the reasons that it gave for doing so strongly suggest that golf course conservation easements will almost never qualify for federal tax deductions. After all, what golf course does not use pesticides and nonnative grasses? What golf course does not use heavy amounts of fertilizer and constant irrigation? What golf course does not have a steady stream of human activity on it? Using the analysis set forth by the Tax Court in Atkinson, it seems clear that a run-of-the-mill golf course cannot qualify as providing a “relatively natural habitat.”
Perhaps a conservation easement placed on a golf course not located in a gated community might qualify under the “open space” conservation purpose, but even that would be like the proverbial camel passing through the eye of a needle. This is because IRS regulations separately require that, even if the conservation easement adequately protects one conservation purpose, a landowner’s retained rights—for example, the right to operate a golf course—cannot be destructive of other significant conservation interests. This means that the tax deduction for a golf course conservation easement that is intended to protect open space might still be disallowed if it permits destruction of an important natural habitat for a rare species found on the property. Even if the easement passes IRS muster, the vigor and thoroughness with which the IRS has been auditing tax deductions claimed for conservation easements on golf courses indicates that anyone wishing to claim these tax deductions will likely face an uphill battle.
And here is a good place to draw a distinction that I often make in cases like this: A dispute over the conservation purpose requirement is something entirely different than a valuation dispute. In a valuation dispute—a “battle of the appraisals”—the judge will review the landowner’s appraisal and the IRS’s appraisal, and oftentimes the judge will assign an intermediate value to the easement. In other words, the landowner might be entitled to a smaller tax deduction, but the landowner will still be entitled to a tax deduction.
If, however, a judge finds that a conservation easement does not have a valid conservation purpose, the landowner’s tax deduction is entirely disallowed. The landowner receives no tax deduction at all. In addition to not receiving the benefit of a tax deduction, the landowner will usually have to pay penalties and interest to the IRS. The landowners in Atkinson were fortunate in that the Tax Court declined to impose penalties on them; the Tax Court found that they had acted “with reasonable cause and in good faith” because they had relied on appropriate advisors in donating and valuing their conservation easements.
As always, stay tuned for more updates as they happen.