U.S. Tax Court Finds Donative Intent for Conservation Easement

Environmentally minded property owners can sometimes satisfy both charitable and tax planning goals by granting conservation easements on their property to tax-exempt entities. However, a recent case, McGrady v. Commissioner, serves as a good reminder that the IRS may challenge such transactions.

IRS challenges charitable contributions

A pair of taxpayers claimed a noncash charitable contribution deduction of $4.7 million on their federal income tax return. The contribution comprised the following two gifts that were part of a complex conservation plan:

  1. A qualified conservation easement on their 25-acre homestead property to the township where they lived, and
  2. A fee simple interest in an adjoining 20-acre parcel of undeveloped land to a tax-exempt conservation organization.

The IRS disallowed the deductions for these gifts, claiming, among other things, that the taxpayers lacked “donative intent.” The IRS characterized the transactions as quid pro quo exchanges, where a taxpayer receives from the charity property or services equal in value to the donation, meaning no gift or contribution was made. It alleged that the taxpayers were motivated by a desire to protect their privacy and prevent suburban development from spoiling their views.

However, the Tax Court disagreed. It ruled that the transactions were outright gifts that were made “with no strings attached.”

The court noted that the IRS focused not on any specific benefit the taxpayers received for their donations but on their supposed ability to steer the entire set of transactions in a way that benefited them. According to the court, though, whenever a homeowner places a conservation easement on his or her property, “the homeowner in a sense ‘benefits’ by having natural landscapes rather than suburban sprawl in the immediate surroundings.” The township and conservation organization executed the transactions to accomplish their charitable purposes of conserving rural and agricultural land, not to benefit the taxpayers.

Court preserves partial deductions

The court ultimately held that the taxpayers were entitled to deduct their contributions, albeit in smaller amounts. It reduced the deduction because the taxpayers received an easement to use an access road, which constituted a return benefit.

But the court declined to impose accuracy-related penalties. The taxpayers avoided those hefty penalties largely because they’d relied on both the advice of a qualified tax professional and a qualified appraisal performed by a qualified appraiser.

Proceed with caution

Qualified financial professionals can help you make informed decisions when creating conservation easements. And, if the IRS challenges the easements, they can provide the support you need to avoid accuracy-related penalties.

© 2017