                              T.C. Memo. 2020-54



                          UNITED STATES TAX COURT



  OAKBROOK LAND HOLDINGS, LLC, WILLIAM DUANE HORTON,
             TAX MATTERS PARTNER, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 5444-13.                       Filed May 12, 2020.



      David M. Wooldridge, Michelle A. Levin, Ronald A. Levitt, and Gregory P.

Rhodes, for petitioner.

      W. Benjamin McClendon, Bruce K. Meneely, Robert W. Dillard, and

William W. Kiessling, for respondent.
                                         -2-

[*2]         MEMORANDUM FINDINGS OF FACT AND OPINION


       HOLMES, Judge: In recent years the Commissioner has attacked a popular

form of charitable contribution--the donation of conservation easements.1 Many

of these attacks are surgical strikes on what he believes are gross exaggerations of

the value of particular easements. But he has also launched three sorties--all

predicated on the requirement that such easements be “perpetual”--that he hopes

will cause more widespread casualties:

       !     an attack on the power of donor and donee to change the terms of the
             easement after its contribution;

       !     an attack on the retained right of the donor to add improvements to
             the property described in the easement; and

       !     an attack on a clause commonly found in easements, particularly in
             the southeastern part of the country, that divides between donor and
             donee future hypothetical proceeds from a future hypothetical
             extinguishment of the easement in a way that he claims violates one
             of his regulations.

       In Pine Mountain Pres., LLLP v. Commissioner, 151 T.C. 247, 280-82

(2018), we held that the retained power of all parties to all contracts to change

contractual terms does not by itself deprive a deed of easement of its required

perpetuity. We also held there that a donor’s retained right to add improvements

       1
        See, e.g., I.R.S. News Release IR-2005-129 (Oct. 27, 2005) (referring to
certain conservation easements as abusive).
                                         -3-

[*3] “appurtenant to residential development” does violate the perpetuity

requirement as a matter of law when the precise location of those improvements is

not set forth in the deed of easement. Id. at 275-79.

      In this case, the Commissioner seeks to destroy any charitable-contribution

deduction for an easement whose deed contains an extinguishment clause that he

argues does not meet the requirements of one of his regulations, section 1.170A-

14(g)(6)(ii), Income Tax Regs. This case appears to be the first one in which the

donor fights back by challenging the validity of that regulation.

      What the regulation means and whether it’s valid are questions whose

answers will affect a great many such donations. There’s a difference of opinion

in the Court on the question of the regulation’s validity; there is not on the

factfinding and application of the regulation to those facts.

                               FINDINGS OF FACT

      In 2007 a couple was driving on a country road about fifteen minutes

outside Chattanooga in search of the perfect place for a new home. They stopped

at a briar-covered for-sale sign on a 143-acre piece of land on White Oak

Mountain. The property was significantly larger and considerably more

overgrown than what they wanted, but they thought it could be the diamond in the

rough for which they had been prospecting.
                                        -4-

[*4] To understand why requires understanding who the husband in this couple

is. Duane Horton grew up in Chattanooga, earned a degree in construction from

Georgia Tech, and moved back to his home town. He started his career there in

1998, and in 2002 he formed a construction company. Horton proved to be a

talented entrepreneur, and his company grew and became quite successful. In

2007 Horton and a number of his subcontractors, suppliers, and past clients

formed a real-estate development company and a real-estate investment fund. The

development company excels in “working with larger pieces of property that are

* * * usually in high-growth sectors of the area that may have challenges,

* * * [such as] lack of infrastructure, access issues, rezoning issues, or topography

issues, * * * and solv[ing] those problems and unlock[ing] the potential value of

the property.” So when Horton drove past the property in 2007, he was uniquely

able to see its potential, and he quickly contacted various investors to plan how to

buy and develop it.

      Horton and these investors formed Oakbrook Land Holdings, LLC in

August 2007 and four months later it bought the property for $1,700,000.

Oakbrook planned at first to develop the subject property with “higher-end, single-

family residences with a commercial service area.” But before that vision could be

realized, Oakbrook had to overcome a number of thorny obstacles, briars the least
                                       -5-

[*5] among them. It started by building a bridge across the “Hurricane Creek;”

this alone created access to more than 80% of the previously inaccessible property.

It then installed a high-pressure sewer-pump station and won rezoning of a portion

of the property from A-1 Agricultural District to C-2 Local Business and

Commercial District.

      As 2007 turned into 2008, Horton learned about a conservation easement on

an entirely unrelated property in North Georgia. He was intrigued and began to do

some research. At some point in 2008 he started to think about placing a

conservation easement on the Oakbrook property. He met with James Wright,

executive director of the Southeast Regional Land Conservancy, who gave him a

short course on the easement process and told him that the Conservancy’s lawyers

would draft the legal paperwork should Oakbrook want to give it an easement.

Horton took what he learned to the other Oakbrook investors who, despite some

early opposition, agreed to the idea. Oakbrook’s next move was to transfer some

of the acreage to related entities in mid-December 2008, which enabled it to be

developed without restriction. This left Oakbrook with approximately 106 acres.

      Later that month Oakbrook donated a conservation easement on all 106

acres to the Conservancy through a document called “Conservation Easement and

Declaration of Restrictions and Covenants” (Deed). Because of its unfamiliarity
                                       -6-

[*6] with conservation easements, Oakbrook and its members relied heavily on the

Conservancy to draft this Deed. We specifically find that Horton, acting on behalf

of Oakbrook, was reasonable in inferring that the Conservancy’s experience meant

that the deeds it had drafted conformed to the Code and regulations.

      The Deed’s key section for this opinion is Article VI, Section B(2). It

governs how Oakbrook and the Conservancy will divide between themselves any

proceeds if the easement is extinguished by changed circumstances or

condemnation:

             This Conservation Easement gives rise to a real property right
      and interest immediately vested in [the Conservancy]. For purposes
      of this Conservation Easement, the fair market value of [the
      Conservancy]’s right and interest shall be equal to the difference
      between (a) the fair market value of the Conservation Area as if not
      burdened by this Conservation Easement and (b) the fair market value
      of the Conservation Area burdened by this Conservation Easement, as
      such values are determined as of the date of this Conservation
      Easement, (c) less amounts for improvements made by O[akbrook] in
      the Conservation Area subsequent to the date of this Conservation
      Easement, the amount of which will be determined by the value
      specified for these improvements in a condemnation award in the
      event all or part of the Conservation Area is taken in exercise of
      eminent domain as further described in this Article VI, Section B(3)
      below. If a change in conditions makes impossible or impractical any
      continued protection of the Conservation Area for conservation
      purposes, the restrictions contained herein may only be extinguished
      by judicial proceeding. Upon such proceeding, [the Conservancy],
      upon a subsequent sale, exchange or involuntary conversion of the
      Conservation Area, shall be entitled to a portion of the proceeds equal
      to the fair market value of the Conservation Easement as provided
                                        -7-

[*7] above. [The Conservancy] shall use its share of the proceeds in a
     manner consistent with the conservation purposes set forth in the
     Recitals herein.

Article VI, Section B(3) goes on to state:

            Whenever all or part of the Conservation Area is taken in
      exercise of eminent domain * * * so as to abrogate the restrictions
      imposed by this Conservation Easement, * * * [the] proceeds shall be
      divided in accordance with the proportionate value of [the
      Conservancy]’s and O[akbrook]’s interests as specified above; all
      expenses including attorneys fees incurred by O[akbrook] and [the
      Conservancy] in this action shall be paid out of the recovered
      proceeds to the extent not paid by the condemning authority.

      According to Wright, the above language is standard among the

Conservancy’s conservation easements. And although he couldn’t say with

absolute certainty, Wright was “pretty sure” the language was adopted from

numerous other model agreements, including those produced by the Land Trust

Alliance.2

      Wright explained that, as with the regulation, this extinguishment clause

starts by defining the fair market value (FMV) of the easement as the difference

between the property’s value without the easement and the property’s value with


      2
        Wright suggested that the Conservancy has 85 easements with similar
language. According to amici in another case, however, there is reason to believe
thousands of conservation easements have similar language. Brief for Land Trust
Alliance, Inc. et al. as Amici Curiae Supporting Petitioners at 6, PBBM-Rose Hill,
Ltd. v. Commissioner, 900 F.3d 193 (5th Cir. 2018) (No. 17-60276).
                                         -8-

[*8] the easement. Wright stressed that he viewed this language as securing a

fixed amount for the Conservancy. He explained that the Conservancy expected

that Oakbrook would exercise its right to improve the property within the limits

set by the Deed, but did not think it right for the Conservancy to share in any

condemnation award or extinguishment proceeds attributable to any

improvements: The Conservancy, Wright credibly testified, “did not pay for those

improvements” and shouldn’t have a “property interest in those improvements.”

He also had a view on what the regulation required: “[R]ather than having a

proportion * * * -- the Treasury regulation requires at a minimum that a proportion

-- * * * our language establishes fair value a[s] an absolute -- it’s not a proportion;

therefore, it is [al]ways going to exceed * * * the minimum required by the IRS.”

      While Oakbrook worked toward closing on the easement, it also started to

look for an appraiser to value the conservation easement for purposes of claiming

a charitable deduction. Oakbrook picked Dave Roberts, who valued the easement

at $9,545,000. This is the amount Oakbrook claimed on its Form 1065, U.S.

Return of Partnership Income, as a charitable contribution.3




      3
        Roberts initially valued the easement at approximately $19,500,000.
Horton asked for a second appraisal because “a number of consultants and
investors * * * didn’t feel comfortable with that high of a value.”
                                        -9-

[*9] To prepare its 2008 return Oakbrook hired Henderson Hutcherson &

McCullough, PLLC (HHM), an accounting firm familiar with Oakbrook and the

requirements for conservation-easement deductions. Horton was unfamiliar with

conservation easements and under intense scrutiny by Oakbrook’s investors, so he

discussed Oakbrook’s 2008 tax return with HHM multiple times. This assured

him that the easement deduction was proper.

      HHM’s assurance did not extend to the Commissioner, who timely issued an

FPAA4 to Oakbrook for its 2008 tax year. In it, the Commissioner completely

disallowed Oakbrook’s charitable contribution and asserted an accuracy-related

penalty under section 6662 for negligence, disregard of regulations, or substantial




      4
        FPAAs are notices of final partnership administrative adjustment. Before
its repeal, see Bipartisan Budget Act of 2015, Pub. L. No. 114-74, sec. 1101(a),
129 Stat. at 625, part of the Tax Equity and Fiscal Responsibility Act of 1982
(TEFRA), Pub. L. No. 97-248, secs. 401-407, 96 Stat. at 648-71, governed the tax
treatment and audit procedures for certain partnerships. TEFRA partnerships are
subject to special tax and audit rules. See secs. 6221-6234. When the IRS audits a
TEFRA partnership return and determines an adjustment is necessary, it sends the
partnership an FPAA. The FPAA describes all the proposed changes at the
partnership level. TEFRA partnerships designate a partner to act as the tax matters
partner to deal with the IRS. Sec. 6231(a)(7). (Unless otherwise indicated, all
section references are to the Internal Revenue Code in effect at all relevant times.)
                                       - 10 -

[*10] understatement. Oakbrook timely petitioned this Court, and we tried the

case in Birmingham, Alabama.5

      The Code requires a conservation easement to be “perpetual”. Sec.

170(h)(2)(C), (5)(A). The Commissioner disallowed Oakbrook’s deduction in part

because he concluded that the Deed’s extinguishment clause would split the

proceeds from the property’s condemnation or the easement’s termination in a way

that failed to protect the contribution’s conservation purpose in perpetuity. See

sec. 170(h)(1)(C), (5)(A). He points to section 1.170A-14(g)(6)(ii), Income Tax

Regs.--part of a bigger set of regulations that more comprehensively fences in the

Code’s perpetuity requirement. The problem these regulations try to solve stems

from the fact that perpetuity can be a very long time: What happens if a local

government condemns part of the property for a road, or a local power authority

floods the property as part of a hydropower project, or anything else happens to

the property that would destroy its conservation purpose? Under common law

such events can “extinguish” the easement; the Commissioner’s regulation is

meant to regulate the division of any compensation for this extinguishment




      5
        Oakbrook’s principal place of business was in Chattanooga, Tennessee, at
the time the petition was filed. This case is therefore appealable to the Sixth
Circuit. See sec. 7482(b)(1)(E).
                                        - 11 -

[*11] between the donor and donee so that the donee can continue to pursue the

easement’s conservation purpose elsewhere and into the future.

      The Commissioner attacks the Deed’s extinguishment clause with two

related arguments. The first is that the clause’s formula to distribute

extinguishment proceeds doesn’t correctly track the regulation, because it would

distribute to the Conservancy a fixed amount, and not a proportion, of any such

proceeds. The second is that the clause would subtract from those proceeds the

value of improvements that Oakbrook could make after the donation. Oakbrook

responds that the extinguishment clause complies with the regulation but, if it does

not, the regulation is invalid.6

                                      OPINION

I.    Qualified Conservation Contributions

      Conservation easements are supposed to preserve properties with natural,

historical, or cultural significance through perpetual restrictions on their use.

They also allow donors to take charitable deductions, some of which can be quite

sizable.

      6
        In his brief the Commissioner also claimed that Oakbrook is liable for a
gross-valuation misstatement penalty under section 6662(h), a substantial-
valuation misstatement penalty under section 6662(e), or in the alternative, a
substantial-understatement-of-tax penalty under section 6662(d). He has since
conceded that these penalties do not apply.
                                      - 12 -

[*12] The popularity of conservation easements has risen dramatically in recent

years. The National Conservation Easement Database (NCED) has cataloged

167,721 conservation easements in effect throughout the United States, which

affect more than 27,700,000 acres of land. Nat’l Conservation Easement

Database, https://www.conservationeasement.us (last visited February 5, 2020).7

The number of acres conserved under easement is up from the nearly 16,800,000

in 2015, 13,200,000 in 2010, and 6,100,000 in 2005. Land Trust Alliance, 2015

National Land Trust Census Report,

http://s3.amazonaws.com/landtrustalliance.org/2015NationalLandTrustCensusRep

ort.pdf.

      As the popularity of conservation easements has increased, so too have the

Commissioner’s suspicions about them. See, e.g., PBBM-Rose Hill, Ltd. v.

Commissioner, 900 F.3d 193 (5th Cir. 2018); BC Ranch II, L.P. v. Commissioner,

867 F.3d 547 (5th Cir. 2017), vacating and remanding T.C. Memo. 2015-130;

Belk v. Commissioner, 774 F.3d 221 (4th Cir. 2014), aff’g 140 T.C. 1 (2013);


      7
          Even the NCED, which provides the most complete up-to-date census
data, admits that its numbers are significantly understated. The NCED estimates
that it lists only 49% of publicly held easements and 90% of non-profit-held
easements across the United States. Completeness, Nat’l Conservation Easement
Database, https://www.conservationeasement.us/completeness (last visited
May 11, 2020).
                                         - 13 -

[*13] Glass v. Commissioner, 471 F.3d 698 (6th Cir. 2006), aff’g 124 T.C. 258

(2005); Pine Mountain, 151 T.C. 247. In December 2016 the Commissioner

released a notice in which he characterized syndicated conservation-easement

transactions8 as potential “tax avoidance transactions,” and then proceeded to

include syndicated conservation easements as his newest addition to the list of 35

other “Recognized Abusive and Listed Transactions.” See I.R.S. Notice 2017-10,

2017-4 I.R.B. 544; Recognized Abusive and Listed Transactions, Internal

Revenue Serv., https://www.irs.gov/businesses/corporations/listed-transactions

(last updated Jan. 31, 2020).

      The Code, however, makes at least some conservation easements legitimate,

even though section 170(f)(3)(A) generally disallows a charitable-contribution

deduction for any gift of real property that “consists of less than the * * * entire

interest in such property.” The key is for a donor to meet the unusually

complicated rules for a donation of a “qualified conservation contribution.” Sec.

170(f)(3)(B)(iii). A “qualified conservation contribution” is “a contribution--(A)




      8
        Syndicated conservation easements are transactions in which “a promoter
offers prospective investors in a partnership or other pass-through entity (‘pass-
through entity’) the possibility of a charitable contribution deduction for donation
of a conservation easement.” I.R.S. Notice 2017-10, 2017-4 I.R.B. 544, 545. The
easement at issue in this case is not a syndicated conservation easement.
                                        - 14 -

[*14] of a qualified real property interest, (B) to a qualified organization, (C)

exclusively for conservation purposes.” Sec. 170(h)(1). Although a contribution

must satisfy each of these requirements, our focus in this opinion is on the third

requirement--that the contribution be “exclusively for conservation purposes,” sec.

170(h)(1)(C), which the Code defines in the negative: “A contribution shall not be

treated as exclusively for conservation purposes unless the conservation purpose is

protected in perpetuity,” sec. 170(h)(5)(A) (emphasis added).

      We begin with a bit of a refresher on the common law of servitudes. A

servitude is “a legal device that creates a right or an obligation that runs with land

or an interest in land.” 1 Restatement, Property 3d (Servitudes), sec. 1.1(1)

(2000). It can be granted either appurtenant--meaning “the rights or obligations of

a servitude are tied to ownership or occupancy of a particular unit or parcel of

land,” id. sec. 1.5(1), or in gross--meaning “the benefit or burden of a servitude is

not tied to ownership or occupancy of a particular unit or parcel of land,” id. sec.

1.5(2). Easements, a form of servitude, may also be appurtenant or in gross, but

because “most conservation and preservation servitudes are granted to

governmental bodies, land trusts, or other charitable entities * * * , the benefit will

usually be in gross.” Id. sec. 1.6 cmt. a.
                                        - 15 -

[*15] States were wary of simply applying traditional servitude law to

conservation easements. Servitudes, like other contracts, are usually between

private parties, and situations may arise where the parties no longer want to

enforce the restriction or the restriction’s continued enforcement becomes unjust.

Imagine, for example, a homeowners association (HOA) whose members agree to

build ranch-style homes to preserve their views of a nearby mountain, only to have

an office building that blocks those views appear on a lot between the HOA homes

and the mountain. A disgruntled homeowner might sue his HOA and urge that

this change in condition should terminate the restriction. See 2 Restatement,

supra, sec. 7.10. Termination of a servitude for changed conditions benefits all the

property owners that used to be bound by it, so the common law seldom requires

any money damages when one is extinguished. Id. sec. 7.11 cmt. c.

      That general rule of implicit compensation for the loss of a servitude

wouldn’t work with conservation easements. And neither would the general

power of parties to servitudes, like parties to every other contract, to change their

terms. See id. sec. 7.1. Conservation easements are usually clothed with

assertions of a significant public interest, not only because their enforcement

preserves valuable land for public benefit, but also because “their creation is

subsidized indirectly by tax deductions and directly through purchases by public
                                        - 16 -

[*16] agencies and nonprofit corporations.” Id. sec. 7.11 cmt. a. Permitting an

unrestricted right to modify a conservation easement, or terminate one altogether,

could result in a loss of the public’s investment.

      Applying the common-law rule--extinguishment without cash

compensation--could also lead to unusual results. A landowner with a black heart

could place a conservation easement on his property, take the associated

deduction, and then pave paradise and put up a parking lot on adjoining property.

He might prove that the easement’s conservation purpose was destroyed and

should no longer restrict development of the subject property, and then sell the

now-unburdened land. See id. cmt. d. The common-law rule of only implicit

compensation for termination of an easement could embolden landowners

(imagine well-financed developers) to use the threat of protracted changed-

conditions litigation to coerce donees (imagine thinly staffed nonprofit

organizations) into modifying or terminating their easements. Id. The cynic, or

even just the realist, can also foresee some probability of collusion between donors

and donees of conservation easements if conservation easements could create

benefits with both their formation and their destruction.

      As conservation easements became popular, states enacted statutes to

change this feature of common law. Tennessee is among them. See Tenn. Code
                                        - 17 -

[*17] Ann. sec. 66-9-306 (West 2020) (conservation easement valid even if no

privity of estate or contract or no benefit to any other land, and “[n]o conservation

easement shall be held automatically extinguished because of violation of its terms

or frustration of its purposes”). These state-law changes help make conservation

easements perpetual, but the mix of statute, regulation, and caselaw that defines

what “perpetual” means can be confusing and might undermine a great many

conservation deeds of easement for reasons their drafters never expected.

      One part of the solution is to limit the ability of donors and donees to

declare “changed circumstances” all by themselves. Conservation easements

typically have clauses, like the one here between Oakbrook and the Conservancy,

that provide “[i]f a change in conditions makes impossible or impractical any

continued protection of the Conservation Area for conservation purposes, the

restrictions contained herein may only be extinguished by judicial proceeding.”

Deed, Article VI, Section B(2). Getting a judge involved means there will be a

third party to monitor whether conditions really have changed.

      But there’s a special problem with what happens to an easement that simply

cannot be preserved forever. If a conserved building is obliterated in a disaster, or

a conserved open space is condemned for public use, then insurance money or a

condemnation award may be substituted for the property. The original easement is
                                        - 18 -

[*18] no more, but how can money preserve the easement’s conservation purpose

“in perpetuity?” In this situation the law causes the conservation purpose to jump

into the money into which the easement has been converted. If part of that money

goes to the easement holder, the conservation purpose is considered to have

survived. That’s in the Deed here, too, in the section that says the Conservancy

“shall be entitled to a portion of the proceeds equal to the fair market value of the

Conservation Easement as provided above.” Id.

      Then there’s the particular problem that arises when the donor reserves the

right to build various structures on the conservation area. For example, if the

donor reserves and subsequently exercises his right to build a home on the land,

and the entire property is later condemned, the condemnation award will

necessarily include that added value. But is it the donor or the donee who is

entitled to the proceeds attributable to the value of the home?

      The Code doesn’t answer these questions--it just says that the conservation

purpose of a conservation easement must be preserved “in perpetuity.” Sec.

170(h)(5)(A). But the Treasury Department issued a regulation that more

precisely defines the term. There we find that a conservation purpose is not

perpetual if the donee organization that holds the easement is unable to carry on

the conservation purpose following judicial extinguishment. See sec.
                                       - 19 -

[*19] 1.170A-14(g)(6)(i), Income Tax Regs. To avoid this, the regulation

provides that if

      a subsequent unexpected change in the conditions surrounding the
      property * * * make[s] impossible or impractical the continued use of
      the property for conservation purposes, the conservation purpose can
      nonetheless be treated as protected in perpetuity if the restrictions are
      extinguished by judicial proceeding and all of the donee’s proceeds
      (determined under paragraph (g)(6)(ii) of this section) from a
      subsequent sale or exchange of the property are used by the donee
      organization in a manner consistent with the conservation purposes of
      the original contribution.

Id. (emphasis added).

      But just how much of the “proceeds” must the donee receive upon

extinguishment, either by judicial decree of changed circumstances or by

condemnation? For that answer, we look to paragraph (g)(6)(ii), which reads:

      at the time of the gift the donor must agree that the donation of the
      perpetual conservation restriction gives rise to a property right,
      immediately vested in the donee organization, with a fair market
      value that is at least equal to the proportionate value that the
      perpetual conservation restriction at the time of the gift, bears to the
      value of the property as a whole at that time. See
      § 1.170A–14(h)(3)(iii) relating to the allocation of basis. * * * [T]hat
      proportionate value of the donee’s property rights shall remain
      constant. Accordingly, when a change in conditions gives rise to the
      extinguishment of a perpetual conservation restriction * * * the donee
      organization, on a subsequent sale, exchange, or involuntary
      conversion of the subject property, must be entitled to a portion of the
      proceeds at least equal to that proportionate value of the perpetual
      conservation restriction, unless state law provides that the donor is
                                         - 20 -

[*20] entitled to the full proceeds from the conversion without regard to the
      terms of the prior perpetual conservation restriction.

Id. subdiv. (ii) (emphases added).

      It is the meaning and application of this regulation that the parties dispute.

II.   Application of the Regulation

      Both the regulation and the relevant section of the Deed are densely written,

and the parties disagree about what they mean. We therefore need to

      !      interpret the regulation,

      !      construe the Deed’s extinguishment clause, and

      !      analyze whether the extinguishment clause meets the requirements of
             the regulation.

      A.     Interpreting the Regulation

      Our first chore is to analyze what this regulation means. We have already

done this in Coal Property Holdings, LLC v. Commissioner, 153 T.C. 126 (2019).

We held there that the regulation requires the grantee’s proportionate share upon

extinguishment of a conservation easement to be a percentage determined by a

fraction, the numerator of which is “the fair market value of the conservation

easement on the date of the gift,” and the denominator of which is “the fair market

value of the property as a whole on the date of the gift.” Id. at 137 (quoting

Carroll v. Commissioner, 146 T.C. 196, 216 (2016)).
                                        - 21 -

[*21] We issued Coal Properties while deliberating on this case, and Oakbrook

makes arguments here that Coal Properties didn’t, so we’ll briefly review them.

Oakbrook points out that the regulation doesn’t say proportionate share but

proportionate “value”--which it contends means a “fixed value,” i.e., a whole

number, and not a fraction at all. And a whole number that as of the donation date

is equal to the difference between the FMV of the property before and after the

easement goes into effect. This reading, Oakbrook contends, means that upon

extinguishment the Conservancy must be entitled to at least that fixed value. And

because the regulation requires that the value be fixed as of the donation date, the

donee is not entitled to any proceeds attributable to the value of postdonation

improvements. The Commissioner tells us that it is the donee’s property right that

must at least equal the “proportionate value” of the restriction to the FMV of the

property as a whole. That would be similar to a fractional interest in the property

and would mean that the donee would be entitled to any extinguishment proceeds

multiplied by that fraction.

      Oakbrook tells us that the donee’s property right must have a fair market

value that must at least equal the “proportionate value” of the restriction to the

FMV of the property as a whole. If Oakbrook is right, then the only reason to

figure out the proportion of the FMV of the easement to the value of the property
                                         - 22 -

[*22] as a whole is to make a one-time calculation as of the date of the easement to

fix the amount that the Conservancy would be entitled to upon any future

condemnation or extinguishment.

      We noted in Coal Properties that there has also been one circuit court that’s

looked at the problem. See PBBM-Rose Hill, 900 F.3d at 205-07. That court

found the regulation ambiguous, and observed that if “proportionate value”

modifies “property right,” it equals a fraction, but if it modifies “fair market

value,” it equals “the dollar amount of the value of the conservation easement at

the time of the gift.” Id. at 206.

      Notice that both these conflicting readings require tinkering with the actual

language of the regulation. The Commissioner would be happier with a regulation

that said “proportionate share” instead of “proportionate value,” and Oakbrook

would be happier with a regulation that deleted the word “proportionate” from the

phrase “proportionate value.” It argues that we should hold that an easement’s

conservation purpose would be protected in perpetuity so long as the FMV of a

donee’s property interest equals the value of the perpetual conservation restriction

at the time of the gift. But “proportionate” isn’t the only part of the regulation that

Oakbrook’s reading would have us cut out--it would also force us to excise the

rest of the key sentence--“bears to the value of the property as a whole at that
                                        - 23 -

[*23] time.” Sec. 1.170A-14(g)(6)(ii), Income Tax Regs. This reading would

have us allocate proceeds through the use of subtraction, not multiplication.

Treasury’s regulation writers, however, know how to command subtraction. See,

e.g., sec. 1.422-1(a)(2)(ii), Income Tax Regs. (“[C]apital gain or loss must be

recognized * * * to the extent of the difference between the amount realized from

such transfer and the adjusted basis of such share” (emphasis added)). And

reading “proportionate” out of “proportionate value”--much less effectively

excising an entire chunk of a sentence of the regulation--runs afoul of the

traditional rule that courts should attempt to give meaning to every word of a

regulation. See Rosenberg v. XM Ventures, 274 F.3d 137, 141-42 (3d Cir. 2001).

      The Commissioner’s edit--rewrite “proportionate value” to mean

“proportionate share”--is much lighter than Oakbrook’s. But it is still a gloss and

not a plain reading. The Fifth Circuit took a lengthy look at these conflicting

interpretations, and concluded that the regulation was ambiguous. PBBM-Rose

Hill, 900 F.3d at 205-07. Ambiguity then meant that the court felt free to range

outside the regulation to construe it. Id. at 206. It was particularly careful to

observe that when a regulation is ambiguous, courts should defer to the agency

that issued it. Id. at 206-07 (deferring to the Commissioner’s interpretation
                                        - 24 -

[*24] “[b]ecause the extinguishment regulation is ambiguous” and citing Tex.

Clinical Labs, Inc. v. Sebelius, 612 F.3d 771, 777 (5th Cir. 2010)).

      It relied, in other words, on Auer deference. See Auer v. Robbins, 519 U.S.

452, 461 (1997). Where a regulation is ambiguous, Auer tells us to give the

agency’s “interpretation ‘controlling’ weight unless it is ‘plainly erroneous or

inconsistent with the regulation.’” Ohio Dep’t of Medicaid v. Price, 864 F.3d 469,

477 (6th Cir. 2017) (quoting Auer, 519 U.S. at 461). We didn’t have occasion to

mention the possible problems of the Fifth Circuit’s reliance on Auer deference

when we looked at the problem in Coal Properties. But, like the Fifth Circuit, we

found some comfort in the consistency of the Commissioner’s interpretation over

many years, as one can see in numerous private letter rulings (PLRs) issued as far

back as 1999. See Priv. Ltr. Ruls. 200836014 (Sept. 5, 2008), 200403044 (Jan.

16, 2004), 200208019 (Feb. 22, 2002), 199933029 (Aug. 20, 1999).9

      The Supreme Court recently reaffirmed Auer. Kisor v. Wilkie, 588 U.S.

___, 139 S. Ct. 2400 (2019). But in doing so it restated the principles of that

deference:

      9
        Of course PLRs aren’t binding on parties, save for the party to whom one
is issued, see sec. 6110(k)(3), but “they may be cited as evidence of administrative
interpretation,” Comerica Bank, N.A. v. United States, 93 F.3d 225, 230 (6th Cir.
1996) (citing Phi Delta Theta Fraternity v. Commissioner, 887 F.2d 1302 (6th Cir.
1989), aff’g 90 T.C. 1033 (1988)).
                                         - 25 -

[*25] !      Auer deference doesn’t apply unless a regulation is genuinely
             ambiguous after exhausting “all the ‘traditional tools’ of
             construction.” Kisor, 588 U.S. at ___, 139 S. Ct. at 2415 (quoting
             Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc.,
             467 U.S. 837, 843 n.9 (1984));

      !      the agency’s reading of an ambiguous regulation must still itself be
             reasonable, id.;

      !      the reading of an ambiguous regulation must also “be one actually
             made by the agency,” its authoritative or official position and not one
             that is ad hoc, id. at ___, 139 S. Ct. at 2416;

      !      the agency’s reading must in some way “implicate its substantive
             expertise,” id. at ___, 139 S. Ct. at 2417; and

      !      the reading “must reflect ‘fair and considered judgment’”, id. (quoting
             Christopher v. SmithKline Beecham Corp., 567 U.S. 142, 155
             (2012)).

      In construing this regulation, we see no need to rely on Auer deference

because the “traditional tools of construction” lead us to hold that the

Commissioner’s construction of the regulation is correct even if we look at the

question de novo. We can add to our plain-language analysis in Coal Properties a

couple additional points. Notice the command in the middle of the regulation to

“[s]ee [sec.] 1.170A-14(h)(3)(iii)[, Income Tax Regs.,] relating to the allocation of

basis.” Sec. 1.170A-14(g)(6)(ii), Income Tax Regs. That regulation tells us that

“[t]he amount of the basis that is allocable to the qualified real property interest

shall bear the same ratio to the total basis of the property as the [FMV] of the
                                        - 26 -

[*26] qualified real property interest bears to the [FMV] of the property before the

granting of the qualified real property interest.” Id. para. (h)(3)(iii) (emphasis

added). This language is clear. It establishes a “ratio”, which is “the quotient of

one quantity divided by another of the same kind, usually expressed as a fraction.”

Webster’s New World College Dictionary 1206 (5th ed. 2016). And it tells us that

the fraction’s numerator is the FMV of the easement, and its denominator is the

FMV of the property unburdened by the easement--effectively the same fraction

that the Commissioner contends is meant by “proportionate value.” What’s more,

to set up the numerator and the denominator for this fraction, it uses the words

“bears to,” which are the same words used in section 1.170A-14(g)(6)(ii), Income

Tax Regs., when defining “proportionate value.” This buttresses our holding that

“proportionate value” means a fraction and not a whole number.

      We also observe that this is what “proportionate value” seems to mean

elsewhere in the U.S. Code and in other regulations. For example, the U.S. Code

section that apportions federal funds among the states for animal health and

disease research programs, provides:

      48 percent [of federal funds] shall be distributed among the several
      States in the proportion that the value of and income to producers
      * * * in each State bears to the total value of and income to producers
      * * * in all the States. The Secretary shall determine the total value of
                                        - 27 -

[*27] and income * * * in all the States and the proportionate value of and
      income * * * for each State * * * .

7 U.S.C. sec. 3195(c)(4)(B) (emphasis added). This directs the Secretary of

Agriculture to establish a “proportion” for each state equal to the value produced

by each state divided by, or which “bears to,” the value produced in all states. See

id. The next sentence then refers to this “proportion” as “the proportionate value

* * * for each State.” Id. That’s a fraction.

      The phrase “proportionate value” also pops up in two other Treasury

regulations. Section 20.2107-1, Estate Tax Regs., provides that if a nonresident

expatriate decedent owns or is considered to own a certain amount of the voting

shares in a foreign corporation at the time of his death, his gross estate must

include an amount based upon the FMV of his percentage ownership interest in

the foreign corporation and the portion of the foreign corporation’s total assets

situated in the U.S. See id. para. (b)(1). It then refers to the includible amount as

the “proportionate value” and directs us to “example (2) in subparagraph (2).” Id.

subdiv. (iii)(c). That example tells us that the “proportionate value” includible in

the gross estate is an amount which results from multiplying fractions and FMVs.

See id. subpara. (2), Example (2).
                                       - 28 -

[*28] The only other Treasury regulation that uses “proportionate value” is section

25.2515-1(d)(2)(ii), Gift Tax Regs., which deals with the effect of an exchange of

real property held by tenants in common. It provides that such an exchange will

not terminate a tenancy so long as the tenant-spouses hold title in the exchanged

property “in an identical tenancy.” Id. The next sentence states that “a tenancy is

considered identical if the proportionate values of the spouses’ respective rights

(other than any change in the proportionate values resulting solely from the

passing of time) are identical to those held in the property which was sold.” Id.

(emphasis added). The regulation doesn’t provide any examples, but the reference

to “proportionate value” seems to mean a fraction of an amount equal to each

spouse’s property right multiplied by the FMV of the property held by the tenancy.

We do not think it could reasonably refer to an amount equal to the difference

between the values of the spouses’ respective rights.

      All this also supports our precedent that “proportionate value” means a

fraction, and not a value. This makes us sufficiently confident of our reading to

hold that even without Auer deference, the Commissioner has the better argument

on the meaning of “proportionate value” in the regulation.
                                        - 29 -

[*29] B.     Construing the Deed

      Before we can apply the regulation to the Deed, we also need to construe

the Deed. This is no easy task, because the drafters of the Deed’s contested

section were trying to solve a cluster of related, but distinct, problems. So we

need to dissect the chunk of language reprinted supra pp. 6-7 to see how it

addresses each of these problems.

      The first, as we’ve seen, is to limit the ability of the Conservancy and

Oakbrook to undo the easement by deciding between themselves that changed

circumstances sufficient to undermine the easement’s conservation purpose exist.

They had to do this under Tennessee law as well as the Code, and did so in the

middle of the paragraph: “If a change in conditions makes impossible or

impractical any continued protection of the Conservation Area for conservation

purposes, the restrictions contained herein may only be extinguished by judicial

proceeding.” Deed, Article VI, Section B(2). The Commissioner doesn’t dispute

that this language succeeds in its job of meeting the requirement in section

1.170A-14(g)(6)(i), Income Tax Regs., that the restrictions be ended only in

judicial proceedings if they are to meet the Code’s requirement of perpetuity.

      The second problem is what to do with proceeds from extinguishment. The

Deed language gets tangled with itself because it tries to address not just the
                                       - 30 -

[*30] allocation of such proceeds, but the foreseeable contingency that Oakbrook

will exercise its retained right to add improvements to the conserved area. Thus

we see this sentence:

      For purposes of this Conservation Easement, the fair market value of
      [the Conservancy]’s right and interest shall be equal to the difference
      between (a) the fair market value of the Conservation Area as if not
      burdened by this Conservation Easement and (b) the fair market value
      of the Conservation Area burdened by this Conservation Easement, as
      such values are determined as of the date of this Conservation
      Easement, (c) less amounts for improvements made by O[akbrook] in
      the Conservation Area subsequent to the date of this Conservation
      Easement, the amount of which will be determined by the value
      specified for these improvements in a condemnation award in the
      event all or part of the Conservation Area is taken in exercise of
      eminent domain.

Deed, Article VI, Section B(2).

      The Commissioner interprets this sentence to mean that the value of the

Conservancy’s property interest equals the value of the easement as of the date of

donation less the value of any subsequent improvements. He argues this clause

actually reduces the Conservancy’s interest in extinguishment proceeds by the

value of such improvements, and the value may fluctuate over time. In the event

those improvements are “quite extensive,” he argues, a situation could arise in

which the Conservancy would receive nothing upon extinguishment.
                                         - 31 -

[*31] Oakbrook responds that the Commissioner isn’t reading the sentence

correctly. It directs our attention to the last few lines of the sentence: “(c) less

amounts for improvements made by O[akbrook] in the Conservation Area

subsequent to the date of this Conservation Easement, the amount of which will be

determined by the value specified for these improvements in a condemnation

award in the event all or part of the Conservation Area is taken in exercise of

eminent domain as further described in this Article VI, Section B(3) below.”

(Emphasis added.)

      Oakbrook argues that the Commissioner’s concern about subtracting the

value of any future improvement from what the Conservancy would otherwise get

is overblown. Any such subtraction would occur only if it is “determined by the

value specified * * * in a condemnation award.” In the case of a partial

condemnation of only a little bit of the conservation area not occupied by any

improvement, there would be no subtraction and the Conservancy would get the

entire condemnation award up to the FMV of the easement as of the date of

donation--a better deal, it points out, than the merely fractional part of that

hypothetical award that the Commissioner says is required.

      And this leads to the third problem that this language addresses--what to do

when there is a judicial extinguishment of the easement followed by a later
                                        - 32 -

[*32] (possibly much later) sale of the property. Oakbrook says that the

Conservancy would do just fine. The proceeds from such a sale would go to the

Conservancy in an amount equal to the FMV of its easement because “upon such

proceeding [, i.e., a judicial extinguishment proceeding], [the Conservancy], upon

a subsequent sale, exchange or involuntary conversion of the Conservation Area,

shall be entitled to a portion of the proceeds equal to the fair market value of the

Conservation Easement as provided above.” Because in this contingency there

would be no specification “for these improvements in a condemnation award,” the

Conservancy would get its money off the top and not have to worry about the

value of any improvements.

      Oakbrook also argues more generally that the Commissioner’s readings of

the regulation and Deed would harm the Conservancy if the value of the conserved

land decreases, or if it is partially condemned. Let’s begin with an example where

the value of land decreases following donation of the conservation easement.

Imagine that the donated land at the time of the easement has an unencumbered

FMV of $100,000 and an encumbered FMV of $50,000. Oakbrook adds

improvements of $100,000. Property values then collapse and the easement is

judicially extinguished (or condemned without specification of the value of the

improvements) with proceeds recovered of $60,000. Under the Commissioner’s
                                       - 33 -

[*33] interpretation of the Deed, the Conservancy would receive nothing because

the $100,000 in improvements is greater than the proceeds. And even if the land

went unimproved, the Conservancy would get only 50% of the recovered

proceeds, or $30,000. If Oakbrook is right, however, the Conservancy would in

both situations get its fixed value determined at the date of donation, or $50,000.

      And if the land was improved and then partially condemned? Assume again

that the easement was worth $50,000 at the date of donation and Oakbrook added

$100,000 in improvements. Some time later the local highway authority

condemns a sliver of the land that did not include the improvements to widen an

adjoining road. The condemnation award would be small--let’s say $5,000.

Again, under the Commissioner’s interpretation of the Deed, the Conservancy

would get nothing because the condemnation award was less than the value of the

improvements; and under his interpretation of the regulation, Oakbrook should

receive just $2,500, which is the Conservancy’s proportionate share of the

unimproved property’s value. But under Oakbrook’s interpretation, because there

would be no condemnation of any improvements, and because $5,000 is less than

$50,000, the Conservancy would get the entire condemnation award whether or

not there had been improvements.
                                       - 34 -

[*34] State law defines property interests. Case v. United States, 633 F.2d 1240,

1246 (6th Cir. 1980); Howard v. United States, 566 S.W.2d 521, 525 (Tenn.

1978). And Tennessee law, following the usual common-law rule, allows for the

admission of parol evidence to inform the meaning of a contract’s ambiguous

language if not introduced to contradict it. Burlison v. United States, 533 F.3d

419, 429 (6th Cir. 2008). So we asked the Conservancy’s representative, Wright,

how the Deed’s proceeds clause would operate when the easement was

extinguished after improvements were made. We found his answer entirely

credible:

      [A]s long as there’s a condemnation award and if the award were to
      specifically identify those improvements being the value of them,
      those would be deducted from the proceeds, because they aren’t
      relevant to the valuation of the easement. [Emphasis added.]

And again:

      [A]s long as the condemnation award specifically identifies those as
      subsequent additions, because if they were not, then the land trust
      would [in]ure [to] a benefit for which it is not entitled. They did not
      pay for those improvements. They have no property interest in those
      improvements. Therefore, if we were to keep the award that took
      those improvements into consideration, the land trust would be
      getting unjust compensation because we didn’t pay for those. We
      have to strip those away, get back to the matter at hand, and that is the
      value of the donation at the time of the donation.

And finally, in the case of a partial condemnation:
                                       - 35 -

[*35] [A certain conservation easement is] a small part of a big property but
      nevertheless a utility came in and obtained a judgment to put a
      pipeline in the [easement] property. Of course, the owner didn’t want
      it. He supported it but it’s a utility, and we’re going to lose and so,
      therefore, we’ve already gotten the judgment and was in the process
      of settling it. The award coming out of that -- no questions asked,
      there’s no argument over it, the land trust is a hundred percent of the
      condemnation reports.

      We also asked Wright about scenarios where this construction would not

favor the Conservancy. Consider an increase in land values. If there were ‘70s-

era inflation, the easement was extinguished, and the property then sold for

$200,000, what would the Conservancy get? When we asked Wright at trial about

this very scenario, he confirmed that the Conservancy would be entitled only to its

initial fixed value.

      We conclude from this that Oakbrook’s reading of this section of the Deed

is correct. The value of any improvements would be subtracted from any

condemnation award only if it was specified in that award. The Conservancy

would get the FMV of the easement as of the date of donation, and it would get the

entire amount of any award for a partial condemnation not affecting any

improvements or a future sale after judicial extinguishment, up to that FMV. It

would not, however, be protected from inflation either in local land prices or the
                                        - 36 -

[*36] economy more generally; and it would not get the entire FMV if prices

collapsed before a later condemnation or extinguishment.

      C.     Applying the Regulation to the Deed

      The Commissioner argues that Oakbrook’s Deed, even if we interpret it the

way Oakbrook wants us to, violates the regulation twice. First, he reiterates that it

fails to define a fraction to be multiplied by the amount of any future proceeds.

The Commissioner has to win on this argument--once we interpret the regulation

to require a fraction multiplied by future proceeds, Oakbrook can’t argue that the

Deed conforms to the regulation. But the Commissioner argues that the Deed also

fails because the regulation prohibits any scenario in which a donor gets to

recover, either through condemnation or sale after extinguishment, any

compensation for its improvements in excess of a share of the proceeds defined by

the before-and-after-easement value of the unimproved land at the time of

donation. We are left with the distinct sense that there are some plausible

scenarios where Oakbrook’s construction of “proportionate value” would protect

an easement’s conservation purposes in perpetuity better than the Commissioner’s

would. The Commissioner’s construction might not compensate a donee as well

as Oakbrook’s, should property values decrease or if the property were only

partially condemned. But our task here is to see how the Deed squares with the
                                          - 37 -

[*37] regulation, not whether there are plausible scenarios where the Deed would

compensate the Conservancy better than the regulation.

      This is where Oakbrook’s argument fails. The regulation prohibits any

scenario in which Oakbrook gets to recover compensation other than a

proportionate share of the proceeds, with the proportion defined by the easement’s

FMV over the FMV of the unencumbered and unimproved property.

      It also doesn’t matter that the value fixed by the Deed “will almost

universally be more than the percentage of proceeds the IRS claims the land trust

is entitled to under the language” of section 1.170A-14(g)(6)(ii), Income Tax

Regs., as Oakbrook argues. In other words, Oakbrook argues the Deed

“substantial[ly] compli[es]” with the regulation. On this point, we need only cite

Kaufman I, where we held that a donor must show strict, and not substantial,

compliance with the perpetuity requirements of the regulation. See Kaufman I,

134 T.C. at 186 (petitioners “cannot avoid the strict requirement in section

1.170A-14(g)(6)(ii), Income Tax Regs., simply by showing that they would most

likely be able to satisfy” their obligation to the land trust).

       We agree again with the Fifth Circuit in PBBM-Rose Hill, 900 F.3d at 207.

It held that “[t]he ordinary meaning of ‘proceeds’ is ‘the total amount brought in,’

such as ‘the proceeds of sale.’” Id. (alterations in original) (citations omitted). It
                                        - 38 -

[*38] also noted that the fact that the regulation explicitly contemplates that a

donor may reserve the right to make improvements, see sec. 1.170A-14(g)(5)(i),

Income Tax Regs., “but chose not to carve out an exception for the allocation of

proceeds in the event of extinguishment when such improvements have been

made,” suggests no such carve-out was intended, PBBM-Rose Hill, 900 F.3d at

208. Substantial compliance does not work here.

      Oakbrook also argues that it’s unfair for a donee to receive extinguishment

proceeds attributable to the value of improvements made solely by the donor--it

would amount, says Oakbrook, to an unintended charitable donation for which it

receives no deduction. While we might otherwise be sympathetic to this

argument, we have identified as a purported purpose of the regulation the

avoidance of windfalls to donors, not donees, if an easement is extinguished. See

Kaufman III, 687 F.3d at 26.

      It’s also easy enough to imagine scenarios where a fixed value might be

unfair to donees. The other purpose of section 1.170A-14(g)(6)(ii), Income Tax

Regs., that we’ve identified is “to assure that the donee organization can use its

proportionate share of the proceeds to advance the cause of historic preservation

[or other conservation cause] elsewhere.” Kaufman III, 687 F.3d at 26. If this is

true, it would seem that providing a donee with a share of proceeds attributable to
                                        - 39 -

[*39] inflation or rising property values better achieves this purpose. If, for

example, an easement is extinguished years after its donation, during which time

land values have skyrocketed, a donee organization’s entitlement to a portion of

the resulting increased proceeds may likely be the only way that it could afford to

further its conservation purpose elsewhere.

      We do note that the Commissioner’s interpretation of improvements in this

case contradicts his position in Priv. Ltr. Rul. 200836014 (Sept. 5, 2008), which

Oakbrook claims has since been adopted by numerous land trusts, and which it

argues would undermine the vast majority of easements. The relevant sentence

states, “the portion of the proceeds of any subsequent sale or exchange (or

condemnation) of the Protected Property payable to the Donee represents a

percentage interest in the [FMV] of the Protected Property (less an amount

attributable to the value of a permissible improvement made by Grantors, if any,

after the date of the contribution of the Easement). Id. (emphasis added). We

don’t need to parse a nonprecedential PLR too closely. But this sentence is

noteworthy for its seeming to construe “proportionate value” to mean “percentage

interest.” This is entirely consistent with the Commissioner’s position in this case

and tends to show continuity in the Treasury’s construction of its own regulation.
                                       - 40 -

[*40] Oakbrook is correct, however, that the parenthetical clause in the PLR that

calls for the amount attributable to the value of improvements made after the

easement to be taken off the top contradicts the Commissioner’s current position.

The Fifth Circuit addressed this exact issue by finding the regulation’s meaning

unambiguous as to improvements--they cannot be subtracted. PBBM-Rose Hill,

900 F.3d at 208. It also noted that “even if the regulation were ambiguous, [the

Court] would not follow the [Commissioner]’s interpretation in the ruling because

it contravene[d] a plain reading of the regulation without an explanation.” Id. at

208-09 (citing Tex. Clinical Labs, Inc., 612 F.3d at 777); see also Salamalekis v.

Comm’r of Soc. Sec., 221 F.3d 828, 832 (6th Cir. 2000) (stating that a court may

defer to an agency’s position when that position “presents a reasonable

construction of an ambiguous provision of * * * the agency’s regulations”). And

PLRs simply aren’t precedential--we therefore agree with the Fifth Circuit that the

language of the regulation is unambiguous on this issue.10

      Oakbrook’s Deed violates the regulation because the Conservancy must be

entitled to any proceeds from extinguishment or condemnation that are at least


      10
         We are also wary of accepting the contention that numerous land trusts
adopted their current deed language that subtracts the value of improvements from
the proportionate value calculation, based upon a sentence of a PLR released in
2008--it seems to us that such language existed in deeds well before 2008.
                                        - 41 -

[*41] equal to the total proceeds (unadjusted by the value of any of Oakbrook’s

improvements), multiplied by a fraction defined by the ratio of the FMV of the

easement to the FMV of the unencumbered property determined as of the date of

the Deed.

       Our holding as to the meaning of section 1.170A-14(g)(6)(ii), Income Tax

Regs., doesn’t necessarily doom Oakbrook’s deduction. Oakbrook argues in the

alternative that this regulation is invalid.11 About this there is disagreement within

the Court, and we air that disagreement in a separate opinion that we also release

today. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. ___ (May

12, 2020).

III.   Penalty

       That leaves only the Commissioner’s determination that a penalty under

section 6662 was applicable to Oakbrook. This penalty is applicable when a

partnership takes a return position that might create a substantial understatement

of tax due at the partner level, sec. 6662(b)(2), or that is negligent or shows

disregard of the rules and regulations, sec. 6662(b)(1). The Code tells us that

       11
         Despite the Commissioner’s suggestion to the contrary, no court has
directly addressed whether section 1.170A-14(g)(6)(ii), Income Tax Regs., is
invalid. In PBBM-Rose Hill the Fifth Circuit refused to address the issue because
the taxpayer had not first raised it in this Court. See PBBM-Rose Hill, 900 F.3d at
209 n.8.
                                        - 42 -

[*42] negligence is the “failure to make a reasonable attempt to comply with the

[Code]” and that disregard includes “careless, reckless, or intentional disregard.”

Sec. 6662(c). And the Code also tells us that an understatement is substantial if it

exceeds the greater of $5,000 or “10 percent of the tax required to be shown on the

return.” Sec. 6662(a), (b)(2), (d)(1)(A). (The determination of an underpayment

cannot be made at the partnership level because partnerships don’t pay taxes,

partners do. We can still, however, determine the applicability of the

understatement (or negligence, or intentional-disregard) penalty at the partnership

level. See VisionMonitor Software, LLC v. Commissioner, T.C. Memo. 2014-82,

108 T.C.M. (CCH) 256, 260 (2014).)

      These penalties don’t apply to a taxpayer who had reasonable cause for an

underpayment and acted in good faith. Sec. 6664(c)(1); sec. 1.6664-4(a), Income

Tax Regs. The determination of whether a taxpayer acted with reasonable cause

and in good faith is one we make on a case-by-case basis. Sec. 1.6664-4(b)(1),

Income Tax Regs. One circumstance that indicates reasonable cause and good

faith is an honest misunderstanding of fact or law that is reasonable in light of all

of the facts and circumstances. Id. Reliance on certain facts can constitute good

faith if, “under all the circumstances, such reliance was reasonable and the

taxpayer acted in good faith.” Id.
                                        - 43 -

[*43] Here, we deny any deduction for Oakbrook’s donation of the conservation

easement because the provisions in the Deed violated the extinguishment-proceeds

clause in the regulation. But we think Oakbrook’s position was reasonable: There

is the PLR that the IRS itself issued that suggested a clause like the one in the

deed would work. Section 1.6662-3(b)(3), Income Tax Regs., tells us that a return

position generally satisfies the reasonable-basis standard if it is based on, among

other types of authorities, private letter rulings. See secs. 1.6662-3(b)(3), 1.6662-

4(d)(3)(iii), Income Tax Regs.; see also Bunney v. Commissioner, 114 T.C. 259,

267 n.10 (2000) (PLRs may be authorities showing reasonableness of return

position). There is disagreement among us on whether the contested regulation is

valid, and that might also be some indication of the objective reasonableness of

Oakbrook’s position. Trial proved that Horton knew he was unfamiliar with the

mechanics of setting up a conservation easement and relied on what he saw as the

safety of form language that echoed the PLR. We find this was reasonable under

these circumstances, and based on the credibility of his trial testimony, taken

entirely in good faith. Oakbrook’s error--if it turns out to be an error--was

reasonable.
                                     - 44 -

[*44] We therefore also conclude that the penalty that the Commissioner

determined was applicable cannot be sustained.


                                              An appropriate decision will be

                                     entered.
