                              T.C. Memo. 2020-107



                        UNITED STATES TAX COURT



SMITH LAKE, LLC, DAVID HEWITT, TAX MATTERS PARTNER, Petitioner
      v. COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 4980-17.                         Filed July 13, 2020.



      Ronald A. Levitt, Gregory P. Rhodes, Michelle A. Levin, and David Mace

Wooldridge, for petitioner.

      Shannon E. Craft, Rebeccah L. Bower, and John T. Arthur, for respondent.



                          MEMORANDUM OPINION


      KERRIGAN, Judge: This case is before the Court on the parties’ cross-

motions for partial summary judgment. On January 4, 2017, respondent issued a

notice of final partnership administrative adjustment (FPAA) for tax year 2013 to

David Hewitt as the tax matters partner for Smith Lake, LLC (Smith Lake). In the
                                         -2-

[*2] FPAA respondent disallowed a $6,524,000 deduction for a noncash charitable

contribution and asserted a gross valuation misstatement penalty pursuant to

section 6662(h), or in the alternative, a penalty pursuant to section 6662(a).1

      Respondent contends that the merger and extinguishment clauses in Smith

Lake’s deed of conservation easement violate section 170(h)(2)(C) and (5)(A),

respectively. Petitioner, by contrast, contends that the deed meets the

requirements of section 170(h)(2)(C) and (5)(A) because the deed provides that

the restriction is granted in perpetuity and that the conservation purposes are

protected in perpetuity. Petitioner further contends that respondent’s

interpretation of section 1.170A-14(g)(6)(ii), Income Tax Regs., is incorrect or,

alternatively, if respondent’s interpretation is found to be correct, that the

regulation is invalid.

                                     Background

      There is no dispute as to the following facts drawn from the parties’ motion

papers and attached declaration and exhibits. When the petition was filed, Smith




      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the year at issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure. All monetary amounts are
rounded to the nearest dollar.
                                       -3-

[*3] Lake was a Georgia limited liability company, and its principal place of

business was in Alabama.

      On July 29, 2008, Rockefeller Holdings, LLC (Rockefeller), owned in part

by Mr. Hewitt, purchased 21.89 acres of property on Lewis Smith Lake in Winston

County, Alabama (property), for $200,000. Rockefeller transferred the property to

Smith Lake. Mr. and Mrs. Hewitt each owned a 50% interest in Smith Lake at the

time of the transfer.

      On December 20, 2013, Mr. and Mrs. Hewitt each sold and assigned

49.75% of their interests in Smith Lake to Smith Lake Investment Partners, LLC

(Smith Lake Investments). On December 23, 2013, Smith Lake conveyed a deed

of easement for the 21.89 acres, to the Pelican Coast Conservancy, LLC, by and

through its sole member, Atlantic Coast Conservancy, Inc. (ACC), a Georgia

nonprofit corporation. ACC was a “qualified organization” for purposes of

section 170(h)(3). The deed was recorded with the Superior Court of Winston

County on December 27, 2013. At the time of the conservation easement donation

Smith Lake was owned by Smith Lake Investments, which owned a 99.5%

interest, and the Hewitts, who each owned a 0.25% interest.

      Smith Lake claimed a $6,524,000 noncash charitable contribution deduction

for its contribution of the conservation easement to ACC on its 2013 Form 1065,
                                        -4-

[*4] U.S. Return of Partnership Income. It attached to its partnership return Form

8283, Noncash Charitable Contributions, which reported the donor’s adjusted

basis for the conservation easement as $200,000 and the appraised fair market

value as $6,524,000.

      The deed includes provisions for the distribution of proceeds in the event of

extinguishment or condemnation. The deed provides that the easement

“constitutes a real property interest vested in” ACC. Section 15.2 of the deed

explains the stipulation the parties agreed to regarding proceeds. This section

provides:

      [T]he parties stipulate that this Easement shall have at the time of
      Extinguishment a fair market value determined by multiplying the
      then fair market value of the Property unencumbered by the Easement
      (minus any increase in value after the date of this grant attributable to
      improvements) by the ratio of the value of the Easement at the time of
      this grant to the value of the Property, without deduction for the value
      of the Easement, at the time of this grant. The values of this
      Easement at the time of this grant shall be the donation value used to
      calculate the deduction for federal income tax purposes allowable by
      reason of this grant, pursuant to Section 170(h) of the Code. * * *
      [T]he ratio of the value of the donated Easement to the value of the
      Property unencumbered by the Easement shall remain constant.

      A provision of section 23.13 of the deed states: “Unless the [p]arties

expressly state that they intend a merger of estates or interests to occur, no merger

shall be deemed to have occurred hereunder or under any document executed in
                                        -5-

[*5] the future affecting this grant.” The deed provides that the interpretation and

performance of the easement shall be governed by the laws of the State of

Alabama.

                                    Discussion

      Summary judgment may be granted where the pleadings and other materials

show there is no genuine dispute as to any material fact and a decision may be

rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98

T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). The burden is on the

moving party to demonstrate that there is no genuine dispute as to any material

fact and that the party is entitled to judgment as a matter of law. FPL Grp., Inc. &

Subs. v. Commissioner, 116 T.C. 73, 74-75 (2001). Both parties have moved for

partial summary judgment, and they agree that there exist no genuine disputes of

material fact regarding the questions they have asked us to decide. After

reviewing the pleadings and the motions with accompanying exhibits and

declarations, we conclude that a decision may be rendered as a matter of law.

I.    Qualified Conservation Contribution

      Section 170(a)(1) allows a deduction for any charitable contribution made

within the taxable year. If the taxpayer makes a charitable contribution of

property other than money, the amount of the contribution is generally equal to the
                                         -6-

[*6] FMV of the property at the time the gift is made. See sec. 1.170A-1(c)(1),

Income Tax Regs.

      The Code generally restricts a taxpayer’s charitable contribution deduction

for the donation of “an interest in property which consists of less than the

taxpayer’s entire interest in such property”. Sec. 170(f)(3)(A). However, there is

an exception to this rule for a “qualified conservation contribution.” Sec.

170(f)(3)(B)(iii). This exception applies to a “qualified conservation

contribution”, which is a contribution of a qualified real property interest to a

qualified organization exclusively for conservation purposes. Sec. 170(h)(1).

      Section 170(h)(5)(A) provides that a contribution will not be treated as

being made exclusively for conservation purposes “unless the conservation

purpose is protected in perpetuity.” The accompanying regulation recognizes that

“a subsequent unexpected change in the conditions surrounding the [donated]

property * * * can make impossible or impractical the continued use of the

property for conservation purposes”. Sec. 1.170A-14(g)(6)(i), Income Tax Regs.

In these circumstances the conservation purposes can be treated as protected in

perpetuity if the restrictions are extinguished by judicial proceeding and the

easement deed ensures that the charitable donee, following the sale of property,

will receive a proportionate share of the proceeds and use those proceeds
                                        -7-

[*7] consistently with the conservation purposes underlying the original gift. Id.

This results in the “perpetuity” requirement’s being satisfied because the sale

proceeds replace the easement as an asset deployed by the donee “exclusively for

conservation purposes”. Sec. 170(h)(5)(A); see also Oakbrook Land Holdings,

LLC v. Commissioner, 154 T.C. ___, ___ (slip op. at 8) (May 12, 2020).

      Section 1.170A-14(g)(6)(ii), Income Tax Regs., specifies the donee’s share

of proceeds in the case of extinguishment as follows:

      [F]or a deduction to be allowed under this section, 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. * * * For purposes of this paragraph * * * that
      proportionate value of the donee’s property rights shall remain
      constant. Accordingly, when a change in conditions give rise to the
      extinguishment of a perpetual conservation restriction under
      paragraph (g)(6)(i) of this section, 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 entitled to the full proceeds
      * * *.

      To meet the requirements of section 1.170A-14(g)(6)(ii), Income Tax Regs.

(proceeds regulation), the deed must guarantee that the donee will receive “a

proportionate share of extinguishment proceeds”. Carroll v. Commissioner, 146
                                           -8-

[*8] T.C. 196, 219 (2016); see PBBM-Rose Hill, Ltd. v. Commissioner, 900 F.3d

193, 207 (5th Cir. 2018) (“[T]he ‘proportionate value’ is a fraction equal to the

value of the conservation easement at the time of the gift, divided by the value of

the property as a whole at that time.”).

      Respondent contends that the deed violates the proceeds regulation because

it provides that the portion of proceeds required to be allocated to the donee in the

event of an extinguishment shall be reduced by the value of improvements to the

land made by Smith Lake after the grant of the easement, and that the merger

provision allows the easement to be eliminated through merger of estates.

Petitioner contends that the deed satisfies the regulation because proceeds

attributable to the value of improvements made by the landowner after the

donation of the conservation easement are not immediately vested and are not part

of the easement granted to the donee.

      The proceeds regulation specifically states that the donee “must be entitled

to a portion of the proceeds at least equal to that proportionate value”. Sec.

1.170A-14(g)(6)(ii), Income Tax Regs. The word “must” clearly requires that the

donee receive at least the proportionate value. PBBM-Rose Hill, Ltd. v.

Commissioner, 900 F.3d at 208. The regulation does not permit that “any amount,

including that attributable to improvements, may be subtracted out” of the
                                        -9-

[*9] proceeds. Id.; see also Coal Prop. Holdings, LLC v. Commissioner, 153 T.C.

126, 138 (2019).

      Petitioner contends the easement deed is governed by the laws of the State

of Alabama and that under Alabama law, the holder of a conservation easement

deed is not entitled to proceeds if the underlying property is converted to public

use through a condemnation, making the proceeds regulation inapplicable in this

case.2 See Burma Hills Dev. Co. v. Marr, 229 So. 2d 776 (Ala. 1969). We reject

petitioner’s arguments. The ACC has a property right granted by a deed of

easement. We concluded in Hewitt v. Commissioner, T.C. Memo. 2020-89, at

*22-*24, that the donor of a conservation easement would not be entitled to the

full amount of the proceeds from a judicial extinguishment under Alabama law.

Therefore, the State law exception included in section 1.170A-14(g)(6)(ii), Income

Tax Regs., does not apply.

      Respondent also argues that the easement is not a qualified real property

interest because the deed allows for the potential removal of the easement through

a merger of estates under section 23.13 of the deed. We have established above

that the contribution does not qualify under section 170 as a “qualified

      2
      Although section 15.1 of the deed reads “unless otherwise provided by
Georgia law” (emphasis added), petitioner’s motion argues that the deed is
governed by Alabama law.
                                        - 10 -

[*10] conservation contribution” because the deed’s extinguishment clause fails to

meet the requirements of the proceeds regulation. Accordingly, we do not need to

address this issue.

II.    Validity of the Proceeds Regulation

       Petitioner contends that respondent’s interpretation of the proceeds

regulation is incorrect. We have decided that respondent’s interpretation is correct

and that the deed does not comply with the regulation. Petitioner further contends

that if respondent’s interpretation is correct then the proceeds regulation is

arbitrary and capricious and is therefore invalid.

       When considering whether a regulation is arbitrary and capricious, we

generally employ the two-part inquiry established by Chevron, U.S.A., Inc. v. Nat.

Res. Def. Council, Inc., 467 U.S. 837 (1984). The first part is to inquire “whether

Congress has directly spoken to the precise question at issue.” Id. at 842. If the

intent of Congress is clear, there is no further inquiry. Id. Pursuant to section

170(h)(5)(A) the conservation purpose must be “protected in perpetuity.”

However, Congress did not address specifically the allocation of extinguishment

proceeds. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___

(slip op. at 26).
                                        - 11 -

[*11] We now consider whether the proceeds regulation “is based on a

permissible construction of the statute.” See Chevron, 467 U.S. at 843. Since the

statute is silent, we must give deference to the interpretation embodied in the

agency’s regulation unless it is “arbitrary, capricious, or manifestly contrary to the

statute.” See United States v. Mead Corp., 533 U.S. 218, 227 (2001); Chevron,

467 U.S. at 844. We will uphold the proceeds regulation if it represents a

“reasonable interpretation” of the law Congress enacted. See Chevron, 467 U.S. at

844; SIH Partners LLLP v. Commissioner, 150 T.C. 28, 50 (2018), aff’d, 923 F.3d

296 (3d Cir. 2019).

      Petitioner does not challenge the validity of the proceeds regulation in its

entirety. Rather, petitioner contests the regulation on two grounds: (1) the

requirement that an easement deed allocate the economic benefit of subsequent

improvements made (and paid for) by the landowner to the donee upon

termination of the easement lacks a rational basis and (2) the “proportionate value”

provision of the proceeds regulation is ambiguous.

      Petitioner contends that there is no rational basis for requiring an easement

deed to share with the donee the economic benefit of subsequent improvements

made and funded by a landowner, because the donee does not contribute toward

the cost of the improvements and the landowner does not receive a deduction for
                                        - 12 -

[*12] any such improvements. Petitioner argues further that it is even more

irrational to require a subsequent landowner to forfeit to the land trust a substantial

portion of the proceeds attributable to the improvements made and owned by the

subsequent owner despite the fact that the subsequent owner did not donate the

easement to the land trust or receive a charitable contribution deduction.

Petitioner asserts that such a result is illogical and inconsistent with the purpose of

the proceeds regulation.

       The regulation does not address donor improvements. The absence of a

provision addressing donor improvements does not render the regulation

“arbitrary, capricious, or manifestly contrary to the statute.” Chevron, 467 U.S.

at 844; see also Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___

(slip op. at 29).

       In Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at ___ (slip

op. at 29), we reasoned that Treasury’s goal in prescribing the proceeds regulation

was to ensure satisfaction of the statute’s “protected in perpetuity” requirement.

This requirement is deemed satisfied under Treasury’s interpretation of the

proceeds regulation because the sale proceeds replace the easement as an asset

employed by the donee “exclusively for conservation purposes”.

Sec. 170(h)(5)(A); see also Oakbrook Land Holdings, LLC v. Commissioner, 154
                                        - 13 -

[*13] T.C. at ___ (slip op. at 8). There may be scenarios, such as a decline in land

values, in which reducing the donee’s proceeds by the value of landowner

improvements would frustrate the goal of the sales proceeds’ replacing the value

of the easement. Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at

___ (slip op. at 29-30).

      We stated in Oakbrook that “Treasury’s overarching goal was to guarantee

that the donee, upon judicial extinguishment of the easement, would receive the

full share of proceeds to which it was entitled.” Id. at ___ (slip op. at 31). We

concluded that Treasury exercised reasoned judgment in its efforts to reach the

goal of section 170(h)(5)(A). Id.

      Petitioner also contends that the “proportionate value” provision of the

proceeds regulation is ambiguous. Pursuant to section 1.170A-14(g)(6)(ii),

Income Tax Regs., the donee’s share is determined by multiplying the sale

proceeds by a fraction, the numerator of which is the FMV of the easement at the

time it was granted, and the denominator of which is the FMV of the entire

property at that time. In Oakbrook Land Holdings, LLC v. Commissioner, 154

T.C. at ___ (slip op. at 28), we concluded that the proceeds regulation’s

“proportionate value” approach is not “arbitrary, capricious, or manifestly contrary

to the statute” as examined under the two-part inquiry.
                                         - 14 -

[*14] III.   Judicial Estoppel

      Petitioner argues that respondent should be judicially estopped from

asserting that the section 15.2 of the deed is inconsistent with the proceeds

regulation. Petitioner cites a District Court case in which the United States

stipulated that the proceeds regulation’s perpetuity requirement was satisfied in a

clause containing the same text as section 15.2 of the deed in the instant case. See

Joint Stipulation of Facts for Purposes of Summary Judgment, at 4, DMB Realco,

LLC v. United States, Civil No. 16-1585-NVW (D. Ariz. Feb. 24, 2017).

Respondent argues that judicial estoppel is inapplicable because the United States

conceded the issue in DMB Realco, LLC and because the parties settled the case.

      “The doctrine of judicial estoppel focuses on the relationship between a

party and the courts, and it seeks to protect the integrity of the judicial process by

preventing a party from successfully asserting one position before a court and

thereafter asserting a completely contradictory position before the same or another

court merely because it is now in that party’s interest to do so.” Huddleston v.

Commissioner, 100 T.C. 17, 26 (1993). Although judicial estoppel requires a

court’s acceptance of a party’s prior position, acceptance “does not mean that the

party being estopped prevailed in the prior proceeding * * * but rather only that a

particular position or argument asserted by the party * * * was accepted by the
                                        - 15 -

[*15] court.” Id.; see Fazi v. Commissioner, 105 T.C. 436, 446 (1995). The Court

in Huddleston v. Commissioner, 100 T.C. at 26, further stated that, in cases that

settle, “an argument can be made that the court did not affirmatively accept any of

the underlying positions reflected in the settlement and that judicial estoppel

should not apply.”

      In DMB Realco, LLC the United States conceded the issue with respect to

the proceeds clause and did not persuade the court to accept its position. That case

was resolved through a settlement by the parties. We find that judicial estoppel is

inapplicable to this case.

IV.   Conclusion

      The deed granting the conservation easement reduces the donee’s share of

the proceeds in the event of extinguishment by the value of improvements (if any)

made by the donor. Accordingly, petitioner has not satisfied the perpetuity

requirements of section 170(h)(5)(A). Furthermore, we reject petitioner’s

challenge to the validity of the proceeds regulation and find that the construction

of section 170(h)(5) set forth in section 1.170A-14(g)(6), Income Tax Regs., is

valid under Chevron. See Oakbrook Land Holdings, LLC v. Commissioner, 154

T.C. at ___ (slip op. at 25, 28-33).
                                       - 16 -

[*16] Accordingly, we will grant respondent’s motion for partial summary

judgment and deny petitioner’s cross-motion for partial summary judgment. We

have considered all of the arguments made by the parties, and to the extent not

mentioned above, we conclude that they are moot, irrelevant, or without merit.

      To reflect the foregoing,


                                                An appropriate order will be issued.
