T.C. Memo. 2018-45
UNITED STATES TAX COURT
WENDELL FALLS DEVELOPMENT, LLC, GREGORY ALAN FERGUSON, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3494-14. Filed April 4, 2018.
David M. Wooldridge and Thomas Allen Worth, for petitioner.
Scott Lyons and Johnny Craig Young, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: Wendell Falls Development, LLC was a limited
liability corporation treated as a partnership for federal tax purposes. For Wendell
Falls’ 2007 taxable year, the respondent (hereinafter “the IRS”) issued a notice of
final partnership administrative adjustment. The notice disallowed a charitable-
contribution deduction of $1,798,000 for the contribution of a conservation -2-
[*2] easement by Wendell Falls. The notice determined a 40% penalty under
section 6662(a),1 (b)(3), and (h); or, in the alternative, a 20% penalty under section
6662(a) and (b)(1), (2), or (3). A timely petition for readjustment of partnership
items was filed by Greg Ferguson, the tax matters partner of Wendell Falls.2 See
sec. 6226(a). The Court has jurisdiction under section 6226(f).
We hold that no charitable-contribution deduction is allowable for the
donation of the conservation easement by Wendell Falls. We hold that no penalty
is applicable.
1 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986, as amended and in effect for the appropriate times. 2 Sec. 7482(b) governs the venue for appeal from a decision of this Court. Where our decision involves a partnership-level determination, such as in this case, the appellate venue is the U.S. Court of Appeals for the circuit in which the partnership’s principal place of business is located at the time of the filing of the petition. Sec. 7482(b)(1)(E). If, however, the partnership has no principal place of business when the petition is filed, the appellate venue will be the U.S. Court of Appeals for the D.C. Circuit. Sec. 7482(b)(1) (flush language); AHG Invs., LLC v. Commissioner, 140 T.C. 73, 82 (2013). The petition was filed on February 24, 2014. Two years before, on January 12, 2012, Wendell Falls was dissolved. Wendell Falls therefore had no principal place of business on February 24, 2014, when Ferguson filed the petition. Therefore, the appellate venue for this case will be the U.S. Court of Appeals for the D.C. Circuit (unless the parties stipulate another circuit under sec. 7482(b)(2)). -3-
[*3] FINDINGS OF FACT
The Court adopts the stipulations of fact entered into by the parties.
Wendell Falls was organized as a North Carolina LLC by two individual
land developers--Greg Ferguson and Mike Jones--and a corporation based in
Myrtle Beach, South Carolina. These were the only three members of Wendell
Falls. Ferguson and Jones were primarily responsible for the day-to-day operation
of Wendell Falls, while the Myrtle Beach corporation was a passive investor.
Between 2004 and 2007, Wendell Falls bought 27 contiguous parcels of
unimproved land, comprising 1,280 acres. The 1,280 acres is in Wake County,
North Carolina. When Wendell Falls bought the parcels, they were outside the
boundaries of the town of Wendell. The town of Wendell is roughly 15 miles east
of Raleigh, North Carolina.
Wendell Falls planned to subdivide the 1,280 acres into a master-planned
community with residential areas, commercial spaces, an elementary school, and a
park. Wendell Falls planned to then sell the residential lots to homebuilders and
commercial lots to commercial builders.
Wendell Falls identified 125 acres of the 1,280 acres as the land upon which
the park would be placed. The 125 acres is on the eastern shore of Lake Myra, a -4-
[*4] man-made lake owned by a landowner other than Wendell Falls. The 125
acres includes both sides of Marks Creek, a creek that runs into Lake Myra.
In mid-2005, Wendell Falls and Wake County began discussing the
possibility of Wake County’s purchasing the 125 acres for use as a county park.
Wendell Falls planned to have the remainder of the 1,280 acres annexed by the
town of Wendell before it was developed.
Sometime after discussions regarding the purchase of the 125 acres began,
Wendell Falls proposed placing a conservation easement on the 125 acres before
the sale. Wendell Falls wanted the easement, which would be held by a
conservation organization, in order to restrict the 125 acres to park use.
Throughout much of 2006, Wendell Falls and Wake County exchanged emails
regarding what restrictions the conservation easement would include and which
charitable organization would hold the easement.
On March 17, 2006, Wendell Falls submitted for approval to the town of
Wendell a planned unit development (“PUD”) on the 1,280 acres. When the PUD
was originally submitted, Wendell Falls did not yet own all 1,280 acres. Some of
the acreage Wendell Falls did not yet own was under contract; the rest it
anticipated buying in the short term. The PUD was revised on four occasions
between March and October 2006 to reflect Wendell Falls’ acquisitions of the rest -5-
[*5] of the 1,280 acres. At some point, the town of Wendell annexed the 1,280
acres except for the 125 acres.
On October 9, 2006, the PUD was approved by the town of Wendell. The
PUD documented the proposed master-planned community, including: the
subdivision plan, installment sites for utilities, and amenities. As described in the
PUD, the master-planned community, when completed, would have up to 4,000
residential lots. The PUD stated that the 125 acres would be dedicated to the
creation of “Wendell Falls Park”. There was a map of the 125 acres in the PUD.
The 125 acres was labeled on the map as Wendell Falls Park. However, a portion
of the PUD other than the map inadvertently stated that the area of Wendell Falls
Park was 160 acres. The approval of the PUD by the town of Wendell meant that
the town would permit under its zoning ordinances the uses of the land described
by the PUD. The only part of the 1,280 acres unaffected by the town’s approval of
the PUD was the 125 acres described as Wendell Falls Park, which, even though
described in the PUD, was outside the boundaries of the town and therefore not
subject to the town’s zoning ordinances. The PUD stated that Wendell Falls
received no preferential zoning in exchange for setting aside the 125 acres for use
as a park. This statement is consistent with the rest of the record. -6-
[*6] On November 27, 2006, an appraiser named C.P. Shaw appraised the 125
acres at $3,219,000. Shaw had been hired by Wake County to inform itself of the
value of the 125 acres in connection with its negotiations with Wendell Falls to
buy the land. Because the PUD inadvertently referred to 160 acres, rather than
125 acres, Shaw incorrectly valued the land as if it were 160 acres rather than 125.
On December 4, 2006, the Wake County Board of Commissioners
authorized the county to buy land for a future park facility. The minutes of the
board meeting recorded the decision. It appears that the county intended to
authorize the purchase of the 125 acres identified in the map in the PUD as
Wendell Falls Park. However, because of the incorrect reference in the PUD to
160 acres, or perhaps because of Shaw’s using the incorrect acreage in his
appraisal, the minutes reflect that the county commissioners authorized the
purchase of 160 acres rather than 125 acres. The minutes state:
Interest has been expressed for a future public park facility on approximately 60 acres of this 160.41 acre parcel. The proposed park would over look [sic] the privately owned Lake Myra. This request is for approval of acquisition of 160 acres of open space on Lake Myra/Marks Creek from in [sic] Wendell Falls Development, LLC. [sic] with a sale price of $3,186,000 with a restriction that the property be developed only for park use.
Upon motion by Commissioner Bryan, seconded by Commissioner Brown, the Board of Commissioners voted unanimously to authorize the County Manager to execute a purchase agreement for the Wendell -7-
[*7] Falls Open Space tract of 160.41 acres for $3.186 million, subject to terms and conditions acceptable to the County Attorney.
On December 14, 2006, Wake County and Wendell Falls entered into a
purchase agreement regarding the 125 acres. The purchase agreement described
the land by reference to the map in the PUD, which accurately depicted the 125
acres. However, because of the incorrect reference in the PUD to 160 acres (or
perhaps because of either Shaw’s using the incorrect acreage in his appraisal or the
reference in the county board minutes to 160 acres rather than 125 acres), the
purchase agreement inadvertently stated that the acreage of the mapped land was
160 acres. The purchase agreement stated that placing a mutually agreeable
conservation easement on the land was a precondition to the sale. Under the
purchase agreement, Wake County agreed to buy the land for $3,186,000. This
amount was very close to Shaw’s appraised value of $3,219,000.
After they executed the purchase agreement, Wendell Falls and Wake
County discovered the mistake about the acreage. To correct this mistake, the
county ordered a new appraisal of the 125 acres. This time, the county turned to
the appraisal firm of Cushman & Wakefield. -8-
[*8] On May 20, 2017, Cushman & Wakefield prepared its appraisal of the 125
acres. It appraised the land as a fee simple interest, unrestricted by any
conservation easement. It valued the land at $3,020,000.
On June 4, 2007, the Wake County Board of Commissioners reauthorized
the purchase of the 125 acres for $3,020,000.
Sometime thereafter, Wendell Falls and Wake County amended the
December 2006 purchase agreement. Under the amended purchase agreement,
Wake County agreed to buy the 125 acres from Wendell Falls for $3,020,000. The
donation of a mutually agreeable conservation easement was a precondition to the
sale of the 125 acres under the amended purchase agreement.
On June 7, 2007, the Wake County Register of Deeds recorded the
following two instruments in its deed book: (1) a conservation easement on the
125 acres granted by Wendell Falls in favor of Smokey Mountain National Land
Trust and (2) a general warranty deed transferring ownership of the 125 acres from
Wendell Falls to Wake County. The two instruments were recorded in the deed
book in that order. Each instrument bears a time and date stamp with the same
time and date: 11:30:01 a.m., June 7, 2007. These stamps were presumably made
by the register of deeds. -9-
[*9] The easement permitted only the following structures to be built on the 125
acres: (1) an environmental education center, (2) an overnight lodge, (3) one or
more recreational day-use facilities, (4) sports fields, (5) an elevated wooden
walkway, and (6) related maintenance facilities. The location and size of each
type of structure was also restricted under the terms of the easement.
On October 3, 2008, Wendell Falls filed a timely Form 1065--“U.S. Return
of Partnership Income”--for the 2007 tax year. It attached Schedule K--“Partners’
Distributive Share Items”. On line 13a of Schedule K--a line labeled
“Contributions”--Wendell Falls reported a $1,798,000 charitable-contribution
deduction for its contribution of the conservation easement. Attached to the return
was an appraisal of the conservation easement, which was prepared by Bruce
Sauter. The appraisal valued the easement at $4,818,000. The return reported the
resulting deduction as if Wake County had paid $3,020,000 to Wendell Falls for a
$4,818,000 easement. Therefore, the return reported that the amount of the
deduction was $1,798,000 ($4,818,000 ! $3,020,000 = $1,798,000). In actuality,
Wake County paid the $3,020,000 to Wendell Falls for the land, not the easement.
On April 23, 2009, Wendell Falls filed an amended Form 1065 and an
attached Schedule K. On line 13a of Schedule K, Wendell Falls reported that the
charitable-contribution deduction for the contribution of the conservation - 10 -
[*10] easement was $4,818,000. Wendell Falls also attached a form titled
“Explanation of Changes on Amended Return” to the amended Form 1065. On
this form, Wendell Falls stated that the deduction had been incorrectly reported on
the original Form 1065, and that the correct amount of the deduction was the fair
market value of the conservation easement, $4,818,000.
On November 25, 2013, the IRS sent Ferguson (in his capacity as the tax
matters partner of Wendell Falls) a notice of final partnership administrative
adjustment. In the notice, the IRS determined that the amount of the charitable-
contribution deduction was zero.
Ferguson called Michael Smith as an expert witness to value the easement.
He valued the easement at $5,919,000.
The IRS called Robert Duckett as an expert witness to value the easement.
He valued the easement at $1,600,000.
OPINION
1. Charitable-contribution deduction for the easement
Section 170(a) allows a deduction for a charitable contribution. A
charitable contribution is defined by section 170(c) as a “contribution or gift to or
for the use of” various specified charitable organizations and governments. No
deduction for a charitable contribution is allowed if the taxpayer expects a - 11 -
[*11] substantial benefit from the contribution. United States v. Am. Bar
Endowment, 477 U.S. 105, 116 (1986); see also Elrod v. Commissioner, 87 T.C.
1046, 1075 (1986) (“The charitable contribution deduction is not allowed where a
taxpayer intends to obtain a ‘direct or indirect benefit in the form of enhancement
in the value or utility of the taxpayer’s remaining land or otherwise to benefit the
taxpayer.’” (quoting Sutton v. Commissioner, 57 T.C. 239, 243 (1971))).
However, if the benefit received is merely incidental to a charitable purpose, then
a deduction is allowable. See McGrady v. Commissioner, T.C. Memo. 2016-233,
at *25 (citing McLennan v. United States, 24 Cl. Ct. 102, 107 (1991), aff’d, 994
F.2d 839 (Fed. Cir. 1993)). In addressing whether a taxpayer expected a
substantial benefit from the contribution, we look to the external features of the
transaction. See Hernandez v. Commissioner, 490 U.S. 680, 690-691 (1989);
Rolfs v. Commissioner, 135 T.C. 471, 487 (2010), aff’d, 668 F.3d 888 (7th Cir.
2012).
The IRS argues that (1) Wendell Falls’ contribution of the conservation
easement on the 125 acres to Smokey Mountain National Land Trust ensured that
Wake County, as the owner of the underlying land, could practically use the 125
acres only for a county park and (2) Wendell Falls expected a substantial benefit
from the easement because the prospect of a public park on the 125 acres would - 12 -
[*12] increase the value of the rest of the adjoining 1,280 acres owned by Wendell
Falls.
That Wendell Falls expected a substantial benefit from the contribution of
the easement is supported by the record. When it donated the easement, Wendell
Falls owned land adjoining the eased property; i.e., the unencumbered portion of
the 1,280 acres. On the unencumbered portion of the 1,280 acres, Wendell Falls
planned to create a master-planned community, which was designed so that all of
the clusters of residential areas would have access to the 125-acre park through a
system of “greenways”. These plans were evidenced by the PUD approved by the
town of Wendell. As the prospective seller of the residential lots in the clusters,
Wendell Falls would benefit from the increased value to the lots from the park as
an amenity. It is uncontested that the easement restricts the 125 acres to uses
related to establishing a park. Ferguson, one of the two managing members of
Wendell Falls, wrote in an email to Wake County that Wendell Falls “need[ed] to
ensure that the County uses the park for its intended use.” This confirms that
Wendell Falls expected to receive value from the park and intended the easement
to ensure that there would be a park on the 125 acres. - 13 -
[*13] We therefore find that Wendell Falls donated the easement with the
expectation of receiving a substantial benefit.3 A charitable-contribution
deduction is not allowable because of this expectation.
In the alternative, we also consider the value of the easement. The easement
must have value in order for it to generate a charitable-contribution deduction.
See Am. Bar Endowment, 477 U.S. at 118; sec. 1.170A-14(h)(3)(i), Income Tax
Regs. As explained below, the value of the easement is zero.
The amount of the allowable charitable-contribution deduction is the value
of the contributed property. See sec. 1.170A-1(a), (c)(1), Income Tax Regs. This
is also the case when the contributed property is a conservation easement. See sec.
1.170A-14(h)(3)(i), Income Tax Regs. Because there is no evidence in the record
of sales of easements comparable to the easement contributed by Wendell Falls to
Smokey Mountain National Land Trust, the value of the easement is equal to the
value of the land before the easement minus the value of the land after the
easement. See id. (third sentence). The land itself is valued at its highest and best
3 We make this factual determination (and all other factual determinations regarding the allowance of the charitable-contribution deduction) on the preponderance of the evidence. Therefore, we need not resolve the dispute between the parties as to which party has the burden of persuasion. Estate of Turner v. Commissioner, 138 T.C. 306, 309 (2012), supplementing T.C. Memo. 2011-209. - 14 -
[*14] use. Olson v. United States, 292 U.S. 246, 255 (1934); sec. 1.170A-
14(h)(3)(i) and (ii), Income Tax Regs. As evidenced by the plan developed by
Wendell Falls--which owned the entire 1,280 acres, including the 125 acres--the
best use of the 125 acres was as parkland in the midst of a master-planned
community. The conservation easement therefore did not diminish the value of
the 125 acres because it did not prevent it from being put to its best use. See
Mountanos v. Commissioner, T.C. Memo. 2013-138, at *17, aff’d, 651 F. App’x
592 (9th Cir. 2016). The value of the easement is therefore zero.4 Our answer
does not change if the land valued before and after the easement is the entire 1,280
acres rather than the 125 acres. See sec. 1.170A-14(h)(3)(i), Income Tax Regs.
(fourth sentence). We believe, as Wendell Falls did, that using the 125 acres as a
park would make the master-planned community more desirable and therefore
increase the value of the residential and commercial lots that Wendell Falls
eventually intended to sell. Taking this enhancement into account, the total value
of the 1,280 acres would be undiminished by the easement, and this undiminished
4 That the easement did not diminish the value of the 125 acres is confirmed by Wake County’s actions. Wake County valued the 125 acres without the easement at $3,020,000; it then bought the 125 acres for that amount even though it was burdened by the easement. - 15 -
[*15] value leads to the conclusion that the value of the easement is zero.5
Because Wendell Falls received a substantial benefit from the donation of the
easement, and because the easement was worth nothing anyway, we hold that no
charitable-contribution deduction for the easement is allowable.
We need not resolve the other arguments the IRS makes against the
deduction.
2. Penalty
We must also consider whether there should be a penalty for the reporting
of the charitable-contribution deduction for the easement. Section 6662(a)
imposes a penalty of 20% on an underpayment of tax attributable to any of the
following: negligence, a substantial understatement of income tax, or a substantial
valuation misstatement. See sec. 6662(b)(1), (2), and (3). Section 6662(h)
increases the penalty to 40% if the underpayment is attributable to a gross
valuation misstatement. The final notice of partnership adjustment determined a
5 Neither valuation expert witness accounted for the enhancement to the surrounding land created by access to the park. The IRS’s expert’s failure to consider the enhancement is inconsistent with the evidence in this case, which, as the IRS points out, includes a PUD showing that the park was linked to the residential units. A court is not required to accept an opinion of an expert witness that is contrary to the evidence. See Boltar, L.L.C. v. Commissioner, 136 T.C. 326, 335 (2011); see also Estate of Newhouse v. Commissioner, 94 T.C. 193, 244 (1990). - 16 -
[*16] 40% penalty for gross valuation misstatement, or, in the alternative, a 20%
penalty for negligence, a substantial understatement of income tax, or a substantial
valuation misstatement. After trial, the IRS conceded the 40% penalty. It also
conceded the 20% penalty to the extent it is based on a substantial valuation
misstatement. The IRS continues to assert a 20% penalty based on either
negligence or a substantial understatement of income tax.
The 20% penalty is not applicable when there was reasonable cause for the
reporting of a deduction and the deduction was reported in good faith. See sec.
6664(c)(1). Ferguson has the burden of proving by a preponderance of the
evidence that there was reasonable cause for Wendell Falls’ reporting of the
charitable-contribution deduction and that the deduction was reported in good
faith. See Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). The most
important factor in determining reasonable cause and good faith is the extent of
the effort to ascertain the proper tax treatment of the transaction in question. Sec.
1.6664-4(b)(1), Income Tax Regs. Our determinations regarding substantial
benefit depend on the resolution of tests for which the factfinder has broad
discretion--(1) whether there was a substantial expected benefit to Wendell Falls,
and if so, (2) whether the benefit was incidental. We do not think that Wendell
Falls’ failure to anticipate the adverse resolution of these tests shows that it did not - 17 -
[*17] make sufficient effort to assess the proper tax treatment of the easement.
See Bunney v. Commissioner, 114 T.C. 259, 266 (2000); Lemishow v.
Commissioner, 110 T.C. 110, 114 (1998), supplemented by 110 T.C. 346 (1998).
As to the value of the easement, Wendell Falls retained two different state-
certified real estate appraisers, Sauter and Smith, to appraise the easement.
Although neither appraiser correctly accounted for the enhancement conferred by
the easement on the unencumbered property, neither did the IRS’s trial expert.
Under the narrow circumstances of this case, we hold that there was reasonable
cause for reporting the charitable-contribution deduction for the easement and that
the deduction was reported in good faith. We therefore hold that the section
6662(a) penalty does not apply to an underpayment of tax resulting from the
adjustment to the partnership item, the charitable-contribution deduction.
On February 8, 2018, the IRS filed a motion to reopen the record to admit
evidence that the initial determination of the section 6662(a) penalty, to the extent
it was based on negligence or a substantial understatement of income tax, had been
approved by a supervisor as required by section 6751(b). Because of our holding
regarding reasonable cause and good faith, reopening the record would not change
the outcome of the case. Therefore, we will deny the motion. - 18 -
[*18] To reflect the foregoing,
Decision will be entered for
respondent on the deduction and for
petitioner on the penalty. An order will be
issued denying respondent’s February 8,
2018, motion to reopen the record.