                               T.C. Memo. 2012-345



                         UNITED STATES TAX COURT



          WALTER C. MINNICK AND A.K. LIENHART, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 29632-09.                         Filed December 17, 2012.



      Tim Alan Tarter, for petitioners.

      Anne Ward Durning and Michael R. Harrel, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      MORRISON, Judge: In 2006 Walter C. Minnick gave to charity a

conservation easement on his 74-acre parcel of land in the foothills near Boise,

Idaho. On their joint income-tax returns, Minnick and his wife, A.K. Lienhart,

claimed a charitable-contribution deduction of $389,517 for 2006 and carryover
                                         -2-

[*2] charitable-contribution deductions of $148,977 and $402,506, respectively, for

2007 and 2008. In a notice of deficiency for years 2007 and 2008, the IRS

disallowed the carryover deductions. The notice determined deficiencies in federal

income tax for 2007 and 2008 of $42,306.70 and $140,877, respectively, and 20%

accuracy-related penalties under section 6662(a), as increased to 40% under section

6662(h), of $16,922.10 and $56,350.80, respectively. The respondent is referred to

here as the IRS. The petitioners are referred to as Minnick and Lienhart. All

references to sections are to the Internal Revenue Code of 1986, as amended and in

effect at the relevant times.

                                FINDINGS OF FACT

      Minnick and Lienhart resided in Idaho at the time they filed their petition.

      On January 25, 2005, U.S. Bank recorded a mortgage on the 74-acre parcel

of land.

      On September 5, 2006, the Board of Ada County Commissioners permitted

Minnick to subdivide the land into seven single-family residential lots.

      On September 7, 2006, Minnick granted a conservation easement on the land

to the charitable organization Land Trust of Treasure Valley, Inc. (the “Land

Trust”). The terms of the easement prohibited Minnick and any subsequent owner

from building on or altering the portions of the land outside the areas designated
                                        -3-

[*3] as “building envelopes” for each lot. The portions of the land thus restricted by

the easement constituted 80% of the 74-acre parcel. The conservation easement

stated: “Grantor [i.e. Minnick] warrants that * * * [he] owns the Property in fee

simple and has conveyed it to no other person, and that there are no outstanding

mortgages, tax liens, encumbrances, or other interests in the Property that have not

been expressly subordinated to the Easement.” Contrary to this warranty provision,

U.S. Bank’s mortgage was not then subordinated to the conservation easement. The

conservation easement also provided that Minnick and the Land Trust could amend

the terms of the easement if circumstances arose under which an amendment would

be “appropriate”.

      When Minnick and Lienhart filed their original 2006 income-tax return, they

did not claim a charitable-contribution deduction for the grant of the conservation

easement. Minnick had not yet received a written appraisal of the easement.

      On or about December 26, 2007, Minnick and Lienhart filed an amended

income-tax return for 2006. On the amended return, they reported that the value of

the easement was $941,000. This value was taken from an appraisal by G. Joseph

Corlett, who had been hired by Minnick. The amended return reported that the

charitable-contribution deduction for the grant of the easement was limited to
                                          -4-

[*4] $389,517 for 2006. The amended return was prepared by Bruce Stratton, a

certified public accountant (C.P.A.). Both Stratton and Minnick intended that

Corlett’s appraisal be attached to the amended return for 2006, but for some reason

the amended return the IRS received did not have the appraisal attached to it.

Minnick never asked Stratton whether he was entitled to the $941,000 deduction,

and Stratton did not tell him that he was. Minnick had worked for a few months as

a lawyer near the beginning of his career, spending some time in tax law. He later

went into the building-supply business. Lienhart was uninvolved in determining

whether the conservation easement gave rise to a charitable-contribution deduction.

         On their 2007 and 2008 returns Minnick and Lienhart claimed carryover

charitable-contribution deductions of $148,977 and $402,506, respectively, for the

2006 grant of the conservation easement.

         The IRS issued the notice of deficiency on September 17, 2009. The reason

given by the notice of deficiency for disallowing the carryover deductions was lack

of documentation of the value of the contribution. The IRS no longer challenges the

deductions for lack of documentation.

         On December 14, 2009, Minnick and Leinhart timely filed a petition with this

Court.
                                         -5-

[*5] On September 12, 2011, Minnick and U.S. Bank executed an agreement

under which U.S. Bank subordinated its mortgage to the conservation easement.

The effect of this subordination agreement is that the conservation easement will

remain in force if U.S. Bank becomes the owner of the land by foreclosure.

      The IRS’s September 19, 2011 pretrial memorandum asserted that no

carryover charitable-contribution deductions should be allowed for the grant of the

conservation easement. It asserted the following reasons: (1) the grant of the

conservation easement was a condition of receiving permission from the county to

subdivide the land; (2) the conservation easement was not protected in perpetuity

because (a) the terms of the easement allowed Minnick and the Land Trust to amend

the easement by agreement, (b) U.S. Bank’s mortgage on the land was not

subordinated at the time of the grant, and (c) the easement failed to provide for the

allocation of proceeds to the Land Trust in the event the easement was extinguished;

(3) Minnick and Lienhart’s deduction for the contribution of the easement is limited

to the basis allocated to the easement; and (4) the easement was overvalued.

      This case was tried in Boise, Idaho, on October 4, 2011. At trial, the IRS

moved to amend its answer. The Court took the motion under advisement. On

January 5, 2012, the Court granted the motion, allowing the IRS to amend its
                                         -6-

[*6] answer to assert that the claimed deductions are not permitted because the

requirements of section 170 and the corresponding regulations have not been

satisfied and because Minnick and Lienhart have not established that the value of

the easement was $941,000.

                                      OPINION

1.    Because U.S. Bank’s mortgage was not subordinated to the conservation
      easement when it was granted, no deduction is permitted for the grant of the
      conservation easement.

      A contribution of a conservation easement is deductible only if the

requirements of 26 C.F.R. sec. 1.170A-14 are met. See sec. 170(f)(3)(A), (B)(iii);

26 C.F.R. sec. 1.170A-14(a) (2012). 26 C.F.R. sec. 1.170A-14(a) (2012) requires

that the easement be contributed to “a qualified organization exclusively for

conservation purposes.” 26 C.F.R. sec. 1.170A-14(g)(2) (2012) provides that “no

deduction will be permitted under this section [i.e., 26 C.F.R. sec. 1.170A-14

(2012)] for an interest in property which is subject to a mortgage unless the

mortgagee subordinates its rights in the property to the right of the qualified

organization to enforce the conservation purposes of the gift in perpetuity.”

Because U.S. Bank had a mortgage on Minnick’s land that was not subordinated to

the conservation easement when the easement was granted, the IRS contends

Minnick and Lienhart cannot deduct the value of the conservation easement
                                         -7-

[*7] granted to the Land Trust. This contention about the mortgage was not raised

by the IRS in the notice of deficiency; it was raised in the amended answer, and

therefore the IRS has the burden of proof regarding all factual issues underlying the

contention. See Tax Ct. R. Pract. & Proc. 142(a)(1).

      Minnick and Lienhart argue that the September 2011 subordination agreement

with U.S. Bank satisfies the subordination requirement in the regulation. The

argument is unavailing. In Mitchell v. Commissioner, 138 T.C. 324, 332 (2012), we

held that a subordination agreement must be in place at the time that the

conservation easement is granted.

      Minnick and Lienhart argue that Mitchell is distinguishable because the

warranty provision in the easement demonstrates that Minnick intended that the

mortgage be subordinated at the time he granted the conservation easement. They

also contend that U.S. Bank would have been willing to freely subordinate its

mortgage at the time the conservation easement was granted. We are not persuaded

by these attempts to distinguish Mitchell. Intention and willingness are not what

matters. The regulation required a subordination agreement. Without a

subordination agreement, U.S. Bank would have been able to seize the land in the

event of default on the mortgage, thus owning the land free of the conservation

easement. See id. at 332. For the sake of completeness, we add that we do not
                                          -8-

[*8] agree with Minnick and Leinhart that the warranty provision demonstrates that

Minnick intended that the mortgage be subordinated when he granted the

conservation easement. The warranty provision means only that Minnick falsely--

although we think unintentionally--represented to the Land Trust that the U.S. Bank

mortgage had been subordinated to the conservation easement at the time he granted

the easement. We also cannot agree with Minnick and Lienhart that U.S. Bank

would have been willing to agree to freely subordinate its mortgage in 2006. There

are two reasons we do not make such a finding. First, Minnick and Lienhart failed

to propose this as a finding of fact in their opening brief, as required by our rules of

procedure. Tax Ct. R. Pract. & Proc. 151(e)(3). Second, the idea that U.S. Bank

would have subordinated its mortgage in 2006 is contradicted by the record. A loan

manager at U.S. Bank testified that shortly before trial Minnick asked him to sign a

letter stating that U.S. Bank would have been willing to agree to subordinate its

mortgage to the conservation easement in 2006 had it known about the conservation

easement. The loan manager refused to sign such a statement and he did not make

the statement under oath when he testified. Furthermore, the bank required

Minnick to pay down a portion of the loan as consideration for the bank signing

the subordination agreement in 2011. Thus, the bank did not freely
                                          -9-

[*9] subordinate its mortgage in 2011. This suggests that it would not have freely

subordinated its mortgage in 2006.

      Minnick and Lienhart argue that Mitchell is inapposite because it did not

consider the effect of the Uniform Conservation Easement Act (“Act”), Idaho Code

Ann. secs. 55-2101 to 55-2109 (2012). They contend that the Act imposes the

doctrine of cy pres on all conservation easements in Idaho and that the cy pres

doctrine has the effect of subordinating the U.S. Bank mortgage to the

conservation easement.1 The Act does not support this theory. The Act allows

      1
          The operation of the cy pres doctrine has been summarized as follows:

      If property is given in trust to be applied to a particular charitable
      purpose, and it is or becomes impossible or impracticable or illegal to
      carry out the particular purpose, and if the settlor manifested a more
      general intention to devote the property to charitable purposes, the trust
      will not fail but the court will direct the application of the property to
      some charitable purpose which falls within the general charitable
      intention of the settlor.

Restatement, Trusts 2d, sec. 399 (1959). The operation of the cy pres doctrine can
be illustrated by the following example. A person bequeathed property in trust to
establish a hospital in a particular town. Before the hospital could be built, a similar
hospital was established in the same town. No useful purpose would be
accomplished by having two hospitals. Cy pres would require a court to direct the
trust funds to some other way of assisting the town’s sick--if the person who made
the bequest had a general intent to provide for the town’s sick. Id. cmt. k.

       Thus, the cy pres doctrine allows the property owned by a trust to be directed
to a use different from that directed by the instrument that established the trust. The
                                                                          (continued...)
                                        - 10 -

[*10] actions regarding conservation easements to be brought in court. Idaho Code

Ann. sec. 55-2103 (“An action affecting a conservation easement may be brought”.)

But once an action was brought, U.S. Bank’s mortgage would have been protected,

for Idaho Code Ann. sec. 55-2102(4)--part of the Act--provides: “An interest in real

property in existence at the time a conservation easement is created is not impaired

by it unless the owner of the interest is a party to the conservation easement or

consents to it.” U.S. Bank’s mortgage on Minnick’s land is an “interest in real

property” that was “in existence at the time” Minnick created the conservation

easement. See, e.g., Suchan v. Suchan, 741 P.2d 1289, 1298 (Idaho 1986) (a

mortgage interest can exist in real property capable of being transferred). U.S. Bank

was not a party to the conservation easement when it was created, and it did not

consent to the easement. Therefore, under Idaho Code Ann. sec. 55-2102(4), the

mortgage was not impaired by the 2006 conservation easement.

      Minnick and Lienhart also contend that there was only a remote possibility

that Minnick would default on the U.S. Bank loan. But we held in Mitchell v.




      1
        (...continued)
doctrine does not expand the property interests owned by the trust. Thus, it is
difficult to see how the cy pres doctrine, if it somehow governed the easement on
Minnick’s land, would defeat U.S. Bank’s mortgage on the same land.
                                         - 11 -

[*11] Commissioner, 138 T.C. at 333, 337, that the likelihood of default is

irrelevant. Further, the factual allegation that there was only a remote possibility

that Minnick would default on the U.S. Bank loan was not set forth in Minnick and

Lienhart’s proposed findings of fact. We do not make a finding that the allegation is

correct. See Tax Ct. R. Pract. & Proc. 151(e)(3).

      The value of the conservation easement is not deductible as a charitable

contribution because Minnick and Lienhart failed to meet the subordination

requirement set forth in the regulation. We therefore need not reach the IRS’s

alternative arguments for denying the deduction, i.e. that the easement did not serve

conservation purposes, that the conservation easement was not protected in

perpetuity because it could be amended by agreement of Minnick and the Land

Trust, that the Land Trust would not receive a proportionate share of the proceeds if

the easement was extinguished, and that any charitable deduction is limited to the

amount of basis of the land allocated to the easement.

2.    Minnick and Lienhart are liable for penalties.

      Section 6662 imposes an accuracy-related penalty if any part of an

underpayment of tax required to be shown on a return is due to, among other

things, negligence or disregard of rules or regulations (hereinafter referred to,

without distinction, as “negligence”), a substantial understatement of income tax,
                                         - 12 -

[*12] or a substantial valuation misstatement. Sec. 6662(a) and (b)(1), (2), and (3).

The penalty is 20% of the portion of the underpayment of tax to which the section

applies. Sec. 6662(a). In the case of a gross valuation misstatement, section

6662(h) increases the penalty to 40%.

      Section 6664(c) provides a reasonable-cause exception to the accuracy-

related penalty. Generally, under section 6664(c)(1), no penalty is imposed under

section 6662 with respect to any portion of an underpayment if it is shown that there

was reasonable cause for such portion and that the taxpayer acted in good faith with

respect to such portion. In determining whether such a showing has been made,

“the most important factor is the extent of the taxpayer’s effort to assess the

taxpayer’s proper tax liability.” 26 C.F.R. sec. 1.6664-4(b)(1) (2012). Reliance on

a professional tax-return preparer or an appraiser can constitute reasonable cause

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

taxpayer acted in good faith.” Id.

      Under section 7491(c), the IRS bears the burden of production with regard to

penalties and must come forward with sufficient evidence indicating that it is proper

to impose penalties. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

However, once the IRS has met the burden of production, the burden of proof

remains with the taxpayer, including the burden of proving that the penalties are
                                        - 13 -

[*13] inappropriate because of reasonable cause. Id. at 446-447. Minnick and

Lienhart argue that the IRS has the burden of proof with respect to the subordination

requirement to the extent it relates to penalties. The IRS does not take a position

on which party has the burden of proof. We base our findings regarding penalties

on the preponderance of the evidence. Therefore, we need not determine which

party has the burden of proof.

      The IRS had initially determined that, on account of its disallowance of

Minnick and Lienhart’s carryover charitable-contribution deductions for the grant

of the conservation easement to the Land Trust, they underpaid the tax required to

be shown on their 2007 and 2008 returns and were (1) liable for the accuracy-

related penalty on one or more of three grounds (negligence, substantial

understatement of income tax, or substantial valuation misstatement), and (2)

liable for the section-6662(h) increase in the penalty from 20% to 40% for a gross

valuation misstatement. This determination was reflected in the notice of

deficiency. The IRS now concedes that “if petitioners’ claimed deduction fails to

satisfy the legal requirements of I.R.C. § 170 or the Regulations thereunder, or both,

respondent concedes that neither of these [substantial valuation misstatement or

gross valuation misstatement] penalties would apply.” As we hold here, the
                                         - 14 -

[*14] deductions fail to satisfy the subordination requirement; this means that the

IRS does not assert that the substantial valuation misstatement and gross valuation

misstatement components of the accuracy-related penalty apply.

      Negligence, for section-6662 purposes, is the lack of due care or the failure to

do what a reasonably prudent person would do under like circumstances. Hofstetter

v. Commissioner, 98 T.C. 695, 704 (1992). Negligence includes failing “to make a

reasonable attempt to comply with the provisions of the internal revenue laws or to

exercise ordinary and reasonable care in the preparation of a tax return.” 26 C.F.R.

sec. 1.6662-3(b)(1) (2012); see also sec. 6662(c).

      The IRS contends that Minnick and Lienhart were negligent because they

should have known that a deduction would not be allowed for an easement to which

U.S. Bank’s mortgage was not subordinated. Minnick and Lienhart respond that

Minnick followed a model conservation-easement form given to him by the Land

Trust, that Minnick discussed with his C.P.A. the legal requirements for a

conservation easement, and that he hired an expert appraiser to appraise the

conservation easement. Minnick also contends that he should not be held to the

standard of an experienced tax attorney because he worked only for a few months as

an attorney and that he spent only a fraction of his time practicing tax law.
                                        - 15 -

[*15] It is true that Minnick’s experience as a lawyer did not include substantial tax

work. He worked as a lawyer for only nine months, during which only a portion of

his work involved tax law. After that he operated a business selling building

supplies.2 It is against this background that his efforts should be evaluated. His

wife Lienhart was uninvolved in determining whether the conservation easement

gave rise to a charitable-contribution deduction.

      In determining whether the grant of the conservation easement gave rise to a

charitable-contribution deduction, Minnick did not exercise reasonable care. He did

not seek to subordinate U.S. Bank’s mortgage to the conservation easement until

2011. His failure to comply with the subordination requirement found in the

regulation appears to stem from his failure to solicit advice from his C.P.A. about

the deductibility of the conservation easement, and the failure of the C.P.A. to give

such advice. The C.P.A. explained to Minnick that the value of a conservation

easement is deductible under the Code. However, he did not tell Minnick that the

particular conservation easement Minnick granted to the Land Trust was




      2
       Minnick was also a politician--he served a term in the U.S. House of
Representatives from January 2009 to January 2011--but the details of his political
career are not in the record.
                                        - 16 -

[*16] deductible.3 In the absence of such advice, Minnick could not have

reasonably relied on the C.P.A. when he claimed a deduction for the conservation-

easement contribution. Minnick should have been alerted by the warranty provision

in the conservation easement that there might be a problem with the lack of

subordination. The easement contained a warranty from Minnick that there was no

unsubordinated mortgage on the land. It is true that the form Minnick used to grant

the easement was a “model”, but that does not matter. This model easement form

was not suited to Minnick’s particular parcel of land.

      Although Minnick hired an appraiser to determine the value of the property,

this does not contstitute reasonable cause to avoid imposition of the accuracy-

related penalty. The appraiser’s job was to determine the value of the conservation

easement, not to determine whether other requirements for deducting the

      3
       Note the C.P.A.’s careful response to the following question from Minnick
and Lienhart’s counsel:

      Q      Did you advise Mr. Minnick as to whether the conservation
             easement was deductible or not?

      A      I advised him that a conservation easement, the donation of a
             conservation easement is deductible as a charitable contribution,
             and is specifically provided for in the code.

     We infer that the C.P.A. declined to tell Minnick the grant of the particular
easement was deductible and that Minnick should have recognized this.
                                        - 17 -

[*17] contribution of the easement--for example, the subordination requirement--had

been met.

      We determine that the underpayments of tax for 2007 and 2008 resulting from

the disallowance of the charitable deduction carryovers were due to negligence. We

need not determine whether the underpayments were also due to substantial

understatements of income tax.

      In contending that they have a good-faith-and-reasonable-cause defense,

Minnick and Lienhart reiterate the steps that Minnick took to determine that he was

entitled to a deduction, i.e., using the model form for granting an easement, hiring an

appraiser, and consulting a C.P.A. They also contend that Minnick’s failure to

secure a subordination agreement was inadvertent. This was one of the reasons the

taxpayer in Mitchell was held to have a good-faith-and-reasonable-cause defense.

Mitchell v. Commissioner, 138 T.C. at 339-340. But, unlike the taxpayer in

Mitchell, Minnick was put on notice by the warranty provision in the conservation

easement that the unsubordinated mortgage posed a problem for the deductibility

of the conservation-easement contribution. Furthermore, Minnick failed to get

an opinion from his C.P.A. that he was entitled to a deduction. There is no

indication that there was such a failure in Mitchell. Id. We have already

explained why we think Minnick and Lienhart did not exercise reasonable care to
                                        - 18 -

[*18] evaluate the deductibility of the easement. The same reasons support our

view that Minnick and Lienhart did not have reasonable cause for claiming a

charitable-contribution deduction.

      We hold that Minnick and Lienhart are liable for the accuracy-related

penalties. The penalty amounts for which they are liable are equal to 20% of the

underpayments attributable to the carryover charitable-contribution deductions, or

half the penalty amounts that were calculated in the notice of deficiency using a

40% rate. Therefore, the amounts for which Minnick and Lienhart are liable are

$8,461.05 for 2007 and $28,175.40 for 2008.

3.    Evidentiary matters

      The parties executed a stipulation of facts stating that all exhibits attached

to the stipulation “may be accepted as authentic” and “are incorporated in this

stipulation and made a part hereof; provided, however, that either party has the

right to object to the admission of any such * * * exhibits in evidence on the

grounds of materiality and relevancy”. The parties agree that the stipulation did

not waive hearsay objections to the attached exhibits. Among the documents

attached to the stipulation were Exhibits 9-J, 10-J, 11-J, 14-J through 34-J, and 41-
                                         - 19 -

[*19] R, 42-R, 43-R, and 45-R.4 At the beginning of the trial Minnick and Lienhart

objected to these documents on the ground that they were relevant to IRS theories

that had not been asserted in the notice of deficiency. The Court took the objections

under advisement. The Court later allowed the IRS to amend its answer to assert

these theories. As we describe, Minnick and Lienhart also objected to Exhibits 41-

R, 42-R, 43-R, and 45-R on grounds other than relevancy. Exhibits 41-R, 42-R, 43-

R, and 45-R are appraisals of the land by Sam Langston for U.S. Bank, dated

February 7, 2006, June 3, 2008, April 8, 2009, and August 1, 2011, respectively.

Minnick and Lienhart objected to these exhibits on hearsay grounds. They also

objected that the exhibits are in substance expert reports and that they were not

exchanged under Tax Court Rule of Practice and Procedure 143. They also

objected that the documents were not exchanged 14 days before trial as required

by the Court’s pretrial order. The Court took these objections to Exhibits 41-R, 42-

R, 43-R, and 45-R under advisement. Minnick and Lienhart clarified that they

did not object to these four exhibits to the extent they support findings of fact

other than the value of the conservation easement, such as U.S. Bank’s state of

mind. During trial, the IRS introduced Exhibit 49-R, an indemnification


      4
      Minnick and Lienhart objected to Exhibit “44-R” during trial. There is not a
44-R. There is a 43-R and a 44-J. They really meant to object to Exhibit 43-R.
                                         - 20 -

[*20] agreement between Minnick and U.S. Bank. Minnick and Lienhart objected

on the ground that it is relevant to IRS theories other than those raised in the notice

of deficiency. The Court also took this objection under advisement.

         Minnick and Lienhart’s relevancy objections lost their force when the Court

permitted the IRS to amend its answer to assert its new theories. However, we

agree with Minnick and Lienhart that Langston’s opinion on the value of the

conservation easement, which is reflected in Exhibits 41-R, 42-R, 43-R, and 45-R,

should not serve as the basis for our decision. For it to do so would contravene Tax

Court Rule of Practice and Procedure 143, which requires that expert opinions be

brought before the Court in the form of an expert report and that the expert report be

exchanged with the other party before trial. We therefore admit Exhibits 41-R, 42-

R, 43-R, and 45-R, but we do not rely on these appraisals to the extent they opine

on the value of the conservation easement. We admit Exhibits 9-J, 10-J, 11-J, 14-J

through 34-J, and Exhibit 49-R without any conditions.

4.       Conclusion

         In reaching our holdings, we have considered all arguments made, and, to the

extent not mentioned above, we conclude they are moot, irrelevant, or without

merit.
                                  - 21 -

[*21] To reflect the foregoing,


                                                 Decision will be entered

                                           for respondent.
