Take-Away: The Tax Court strikes again to deny a charitable income tax deduction because the donor failed to provide a

contemporaneous written acknowledgement that no goods or services were provided by the charity to the donor.

Background: A charitable income tax deduction is allowed for the transfer of a partial interest in property for qualified  conservation easements. [IRC 170(f)(3)(B)(iii).] A qualified real property interest is a restriction granted in perpetuity on the use that may be made of the real property, including an easement or similar interest in real estate. [Regulation 1.170A-14(b)(2).]

Contemporaneous Written Acknowledgement: However, the Tax Code states that no income tax deduction will be allowed for any contribution to a charity of $250 or more unless the donor substantiates the contribution to the charity by a contemporaneous written acknowledgement (herein CWA) of the contribution by the charity that requires, in pertinent part, that the CWA include the amount of the cash and a description of any property other than cash contributed and a statement whether the charity provided any goods or services in consideration for the transferred property. [IRC 170(f)(8).] The failure to meet the specific requirements of this Tax Code section results in a denial of any charitable income tax deduction.

Deeds: Complying with this CWA rule is a bit of a challenge when the subject of the charitable contribution is a conservation easement that is normally documented by a conservation deed from the donor to the charity. The Tax Court has previously held that an easement deed, standing alone, may satisfy the CWA requirement, but in the absence of any language in the deed that no goods or services were provided to the donor, the deed taken as a whole must prove compliance with IRC 170(f)(8)(B)(ii). French v. Commissioner, Tax Court Memo 2016-53. However, the deed in French did not include a provision that stated that the deed was the entire agreement of the parties. Without that provision in the deed, the IRS could not determine by reviewing the conservation easement deed whether the donors received consideration in exchange for their contribution of the conservation easement. Accordingly, the Tax Court in French found that the conservation deed taken as a whole was insufficient to satisfy IRC 170(f)(8)(B)(ii). In a recent Tax Court decision, once again the donor of a conservation easement deed failed to satisfy the CWA requirement, i.e. magic language was missing,  and in this case, the donor lost $5.1 million in charitable deductions, and got wacked with a 40% gross valuation misstatement on top of losing the tax deduction.

Brooks v. Commissioner, Tax Court Memo 2022-122 (December 19, 2022)

Facts: The facts of this case are extensive, so most will be skipped, but a lot had to do with competing valuation experts with regard to the real property that was subject to the conservation easement. The donors claimed a charitable contribution deduction of $5.1 million for the contribution of an easement to Liberty County in 2007. The qualified conservation easement consisted of 41.2 acres of vacant land. The claimed deduction was supported by a qualified appraisal. The charitable contribution was in the form of an Easement Deed, but no other documents were provided when the Form 8283 reported the charitable contribution and deduction.

Notice of Deficiency: The IRS sent a Notice of Deficiency in 2015 (the charitable deductions were being carried forward on subsequent tax returns, for tax years 2010-2012) disallowing the charitable deduction for not complying with the CWA requirement. The IRS also asserted an accuracy related penalty of 40% that resulted from the gross valuation misstatements. [IRC 6662(h).]

Tax Court: Silence in a deed serves as a CWA that the charity provided no goods or services as consideration, in whole or in part, but only if the deed also qualifies that the terms of the deed are the entire agreement. Big River Development v. Commissioner, Tax Court Memo, 2017-166.

Entire Agreement Lacking: The Court noted that the Easement Deed lacked a merger or entire agreement clause, which is necessary to establish that the deed reflects the entire agreement between the parties. Thus, the ‘magic language’ required by the Tax Code was missing in the Deed.

Donation Does not “Cut It:” The donors argued that while the Easement Deed in question lacked a merger or ‘entire agreement’ provision, when taken as a whole it nevertheless qualifies its terms as an entire agreement because the use of the word donation twice in the body of the Deed. The Court responded to this argument stating: “We do not find that use of the word ‘donation’ necessarily implies that there was no consideration given, in whole or in part. Neither to we read ‘herein’ to necessarily mean ‘exclusively herein.’ Even when taken together, these provisions do not qualify the terms of the Easement Deed as the exclusive and entire agreement.”

Missing Language in the Deed: The donors also argued that there were in fact no additional negotiations or agreements with regard to the terms of their contribution outside of the Easement Deed, i.e. no other cash, goods, or services were provided to them by the county recipient of the easement. The Court responded to this argument stating: “Such contentions are irrelevant, however, to determining compliance with the CWA requirement. Proving the facts that should have been included in the CWA cannot replace strict substantiation requirements of section 170(f)(8). The entire deduction must be disallowed.” In sum, the Tax Court found that the Easement Deed, standing alone, could not serve as the CWA that is required by the Tax Code.

Penalty: The Tax Court also found that the value of the real estate as of the effective date before the conservation easement was granted was $1.410 million, which yielded a fair market value for the conservation easement of $470,000. Accordingly, the donors were also liable for the 40% accuracy-related penalty that resulted from a gross valuation misstatement for each of the tax years that were subject to the Notice of Deficiency.

Conclusion:  Technicalities upon technicalities. For a donor to be able to claim an income tax charitable deduction for the grant of a conservation easement, key language must be included in the body of the Deed to satisfy the ‘entire agreement’  requirement and the  ‘no goods or services’ representation. Failing to include that ‘magic language’ in the body of the Deed will cause the entire income tax deduction to be denied, leading to exposure to the 20% penalty for failing to report the correct amount of tax due.