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PBBM-Rose Hill, Limited v. Commissioner of Internal Revenue

United States Court of Appeals, Fifth Circuit

August 14, 2018

PBBM-ROSE HILL, LIMITED; PBBM CORPORATION, Tax Matters Partner, Petitioners-Appellants
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee

          Appeal from a Decision of the United States Tax Court

          Before KING, SOUTHWICK, and HO, Circuit Judges. [*]

          KING, Circuit Judge.

         For the 2007 tax year, PBBM Rose Hill, Ltd., claimed a charitable contribution deduction of $15, 160, 000 for its donation of a conservation easement to the North American Land Trust. Subsequently, the Commissioner of Internal Revenue issued a final partnership administrative adjustment that determined PBBM Rose Hill, Ltd., was not entitled to the deduction and assessed a penalty for the overvaluation of the conservation easement. PBBM Rose Hill, Ltd., and its tax matters partner, PBBM Corp., filed a petition for readjustment in tax court. The tax court concluded that the contribution was not exclusively for conservation purposes because it (1) did not protect any of the conservation purposes under 26 U.S.C. § 170(h)(4)(A)(i)-(iii) and (2) failed to satisfy the perpetuity requirement of § 170(h)(5)(A). Consequently, the tax court disallowed the deduction. The tax court also concluded that the value of the easement was $100, 000 and PBBM Rose Hill, Ltd., was subject to a gross valuation misstatement penalty. We hold that while the contribution protected the conservation purpose of preserving land for outdoor recreation by the general public under § 170(h)(4)(A)(i), it did not meet the perpetuity requirement of § 170(h)(5)(A). Accordingly, the donation did not qualify for a deduction. We also find no error in the tax court's valuation of the easement or its determination of a penalty. Thus, we AFFIRM.

         I.

         A.

         In 1996, Rose Hill Plantation Development Company Limited Partnership ("RHP Development") conveyed 241.48 acres of real property (the "Property") to Rose Hill Country Club, Inc. ("RHCC"). The Property is located in Beaufort County, South Carolina. The deed that conveyed the Property to RHCC contained a use restriction, which required the Property to "be utilized only for recreational facilities or open space for a period of thirty (30) years." In 2002, RHCC conveyed the Property to PBBM Rose Hill, Ltd. ("PBBM")-the taxpayer in this case-for $2, 442, 148. The deed that conveyed the Property to PBBM contained the use restriction. When PBBM was the owner, the Property consisted of primarily a 27-hole golf course and also included facilities such as a club house for the neighboring residential community. As the golf course was not profitable, PBBM closed it in January 2006. Two months later, it filed for voluntary Chapter 11 bankruptcy. In October 2006, PBBM initiated an adversary proceeding before the bankruptcy court against RHP Development, RHCC, Red Star Capital, L.P., [1] and the Rose Hill Plantation Property Owners Association, Inc. ("POA"), seeking, inter alia, to invalidate the use restriction.

         In July 2007, PBBM entered into a settlement agreement with the POA, which the bankruptcy court approved. Specifically, the POA agreed that it would not contest or interfere with PBBM seeking invalidation or removal of the use restriction in any proceeding before the bankruptcy court. However, PBBM agreed that any final judgment rendering the use restriction invalid and removing it would not have a binding or preclusive effect as to the POA for purposes of res judicata or collateral estoppel. The POA also agreed to forbear from enforcing the use restriction until the 180th day that any such judgment became final, unless there was an attempt to develop the Property. Further, the POA obtained an option to purchase the Property.

         In August 2007, the POA decided to exercise its purchase option, and PBBM filed a motion in the bankruptcy court to approve the sale of the Property for $2.3 million. The bankruptcy court approved the sale in mid-September 2007. A couple of weeks later, the bankruptcy court entered an order that confirmed the taxpayer's plan of reorganization under Chapter 11. In early December 2007, the bankruptcy court entered judgments that invalidated and removed the use restriction on the Property as to RHCC, RHP Development, and Red Star Capital. PBBM closed on the sale of the Property to the POA in early January 2008.

         B.

         Prior to the closing of the sale to the POA, on December 17, 2007, PBBM conveyed a conservation easement of about 234 acres of the Property ("Conservation Area") to the North American Land Trust ("NALT"). The Conservation Area consisted of the 27-hole golf course; the seven acres of the Property that were not conveyed included two acres of golf course maintenance areas and the five acres that held the club house. In the easement deed, PBBM "voluntarily, unconditionally and absolutely" granted NALT and its successors and assigns the "easements, covenants, prohibitions and restrictions" set forth in the deed "in perpetuity" in order to accomplish the "Conservation Purposes." The deed lists four "Conservation Purposes":

Preservation of the Conservation Area for outdoor recreation by, or the education of, the general public; and
Preservation of the Conservation Area as a relatively natural habitat of fish, wildlife, or plants or similar ecosystem; and
Preservation of the Conservation Area as open space which provides scenic enjoyment to the general public and yields a significant public benefit; and
Preservation of the Conservation Area as open space which, if preserved, will advance a clearly delineated Federal, State or local governmental conservation policy and will yield a significant public benefit . . . .

         Paragraph 2.1 restricts the Conservation Area from being used "for a residence or for any commercial, institutional, industrial or agricultural purpose or purposes." Paragraph 2.4.1 states that "[t]he Property is and shall continue to be and remain open for substantial and regular use by the general public for outdoor recreation . . ., whether for use in the game of golf . . . or for other outdoor recreation." Paragraph 2.4.1 permits the "charging of fees" as long as "the Property is open for the substantial and regular use of the general public" and the fees do not defeat such use or "result in the operation of the Property as a private membership club." Paragraph 2.4.2 states that if the Property ceases "to be used as a golf course," then the Property "shall be use[d] for passive recreation and no other use."

         In Article 3 of the deed, PBBM reserved several rights including the right to construct, inter alia, a tennis facility, single-family dwellings, driveways, community gardens, parking areas, and fences. It also preserved the right to install "no trespassing" signs in paragraph 3.18.1. Paragraph 3.21.2 states that the reserved rights cannot be exercised unless that exercise "will have no material adverse effect on the Conservation Purposes."

         Paragraph 6.2 states that "[a]ny general rule of construction to the contrary notwithstanding, [the deed] shall be liberally construed in favor of the grant to promote, protect and fulfill the Conservation Purposes" and "[i]f any provision . . . is found to be ambiguous, an interpretation consistent with the Conservation Purposes that would render the provision valid should be favored over any interpretation that would render it invalid." Paragraph 6.5 provides that if "any cause or circumstance gives rise to the extinguishment of [the easement] . . . then [NALT], on any subsequent sale, exchange or involuntary conversion of the Conservation Area, shall be entitled to a portion of the proceeds of sale equal to the greater of" the fair market value of the easement around the date of the deed, or a defined share of the amount of proceeds remaining after both the "actual bona fide expenses" of the sale and the "amount attributable to improvements constructed upon the Conservation Area pursuant to" the reserved rights, if any, are deducted. That defined share is the fair market value of the easement around the date of the deed, divided by the value of the land not burdened by the easement around the date of the deed. Paragraph 6.14 states that "[n]othing in [the deed] shall be construed to create any right of access to the Conservation Area by the public."

         C.

         In 2008, PBBM filed its partnership tax return for the 2007 tax year and claimed a charitable contribution deduction of $15, 160, 000 for its donation of the conservation easement. In 2014, the Commissioner of Internal Revenue ("Commissioner") issued a final partnership administrative adjustment ("FPAA"), which determined that PBBM was not entitled to the deduction and assessed a penalty for overvaluing the conservation easement. PBBM and its tax matters partner, PBBM Corp. (collectively "PBBM"), challenged the FPAA in tax court. After a five-day trial, the tax court concluded that, inter alia, the easement was not exclusively for conservation purposes and therefore no deduction was allowed; the value of the easement was only $100, 000; and PBBM was subject to a gross valuation misstatement penalty.

         PBBM timely appealed.[2]

         II.

         "As a general rule, for charitable gifts of property, a taxpayer is 'not allowed to take a deduction if the charitable gift consists of less than the taxpayer's entire interest in that property.'" Whitehouse Hotel Ltd. P'ship v. Comm'r, 615 F.3d 321, 329 (5th Cir. 2010) (quoting Glass v. Comm'r, 471 F.3d 698, 706 (6th Cir. 2006)). A contribution of a "qualified conservation easement" is an exception to this rule. See id. To constitute such an easement, the contribution must be "(A) of a qualified real property interest, (B) to a qualified organization, [and] (C) exclusively for conservation purposes." 26 U.S.C. § 170(h)(1). "An easement qualifies . . . if it is a 'restriction (granted in perpetuity) on the use which may be made of the real property.'" BC Ranch II, L.P. v. Comm'r, 867 F.3d 547, 551 (5th Cir. 2017) (quoting 26 U.S.C. § 170(h)(2)(C)). The taxpayer (here, PBBM) "has the burden of proving entitlement to [its] claimed deduction." Id.

         We review the tax court's conclusions of law de novo and findings of fact for clear error. Id. To the extent that this case involves statutory interpretation of the Internal Revenue Code (i.e., Title 26 of the U.S. Code), we review that interpretation de novo. See Schaeffler v. United States, 889 F.3d 238, 242 (5th Cir. 2018). "We begin 'by examining the plain language of the relevant statute.'" Id. (quoting Stanford v. Comm'r, 152 F.3d 450, 455-56 (5th Cir. 1998)). If the plain language of the statute does not address the issue, then we look to the Internal Revenue Service ("IRS") regulations and legislative history.[3] See Kornman & Assocs., Inc. v. United States, 527 F.3d 443, 451 (5th Cir. 2008); cf. 26 U.S.C. § 170(a)(1) ("A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary."). Only when the statute, the IRS regulations, and legislative history are uninstructive does this court look to the Commissioner's interpretation as reflected in other IRS guidance. See Kornman, 527 F.3d at 452. Further, "we analyze tax deductions for the grant of conservation easements made pursuant to [26 U.S.C. § 170(h)] under [this] ordinary standard of statutory construction," not a strict standard. BC Ranch, 867 F.3d at 554.

         There are several issues on appeal. We begin by deciding whether the "exclusively for conservation purposes" requirement in 26 U.S.C. § 170(h)(1)(C) is met, therefore entitling PBBM to a deduction for its contribution of the conservation easement. We then address the issues related to the valuation of the easement and the applicability of a penalty.

         III.

         Under 26 U.S.C. § 170(h)(1)(C), the taxpayer's contribution must be "exclusively for conservation purposes" in order to constitute a qualified conservation easement. Section 170(h)(4)(A) enumerates five "conservation purpose[s]." They are (1) preservation of land for recreation, (2) protection of a natural habitat, (3) preservation of open space for scenic enjoyment, (4) preservation of open space pursuant to a government conservation policy, and (5) preservation of historic land or structures. 26 U.S.C. § 170(h)(4)(A).[4]The level of public access required to satisfy each conservation purpose is different. See 26 C.F.R. § 1.170A-14(d)(2)(ii), (d)(3)(iii), (d)(4)(ii)(B), (d)(4)(iii)(C), (d)(5)(iv). The taxpayer's contribution is "exclusively" for a conservation purpose only if that purpose is "protected in perpetuity." 26 U.S.C. § 170(h)(5)(A). The tax court determined that PBBM's contribution (1) did not protect any of the conservation purposes under § 170(h)(4)(A)(i)-(iii) and (2) failed to satisfy the perpetuity requirement of § 170(h)(5)(A) because the easement deed's extinguishment provision (paragraph 6.5) does not comply with 26 C.F.R. § 1.170A-14(g)(6). Accordingly, the tax court concluded that the "exclusively for conservation purposes" requirement in 26 U.S.C. § 170(h)(1)(C) was not satisfied and disallowed PBBM's deduction.

         In order for PBBM to prevail on its challenge to the tax court's disallowance of its deduction, it must prove that the tax court erred in both of its determinations. PBBM fails to do so. For the reasons below, we conclude that the contribution protected the conservation purpose of preserving land for outdoor recreation by the general public under § 170(h)(4)(A)(i), but did not meet the perpetuity requirement of § 170(h)(5)(A).

         A.

         PBBM contended in the tax court that the contribution met the conservation purposes enumerated in § 170(h)(4)(A)(i)-(iii). On appeal, the only conservation purpose at issue is "the preservation of land areas for outdoor recreation by . . . the general public." 26 U.S.C. § 170(h)(4)(A)(i). The parties do not dispute that land has been preserved for outdoor recreation; they dispute whether it has been preserved for use by the general public. The plain language of the statute does not signify what such use must look like in order to qualify for a deduction. The accompanying regulation states that recreation on the preserved land must be "for the substantial and regular use of the general public." 26 C.F.R. § 1.170A-14(d)(2)(ii) (emphasis added).

         Below, the tax court noted conflicting provisions in the deed: the deed requires the Property to be open for use by the general public (paragraph 2.4.1), with this requirement to be enforced by NALT in court (paragraph 5.1), but also states that there exists no right of access by the public (paragraph 6.14). Ultimately, the tax court concluded that the contribution failed to protect the public use of the land for outdoor recreation. It based its conclusion on the actual use of the Property after the creation of the easement. After the POA bought the Property, it operated 18 holes of golf, but converted part of the Property into a park. Access to the Property is controlled by a gatehouse. A visitor who gains access is given a restricted pass for his or her vehicle. That pass limits the visitor's access to certain areas, such as the golf course and club restaurant, and warns that access to other areas constitutes trespassing. The public does not have access to the park; a sign on the road to the park states "[p]roperty owners, residents & guests only beyond this point."

         The parties first debate whether the tax court erroneously looked beyond the language of the deed and to the actions of the subsequent owner (i.e., the POA) in determining whether the contribution was exclusively for a conservation purpose. PBBM argues that the tax court should have examined only the terms of the deed in its inquiry. As support for its position, PBBM quotes a regulatory provision concerning the public-access requirement for historic preservation easements:

The amount of access afforded the public by the donation of an easement shall be determined with reference to the amount of access permitted by the terms of the easement which are established by the donor, rather than the amount ...

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