In a landmark case, the Tax Court finds IRS conservation easement rules violated the Administrative Procedure Act.

The Tax Court has dealt a significant blow to the IRS’s enforcement of conservation easement regulations. In a March 28 ruling, the court determined that the extinguishment regulation under Reg. §1.170A-14(g)(6)(ii) is “procedurally invalid” under the Administrative Procedure Act (APA). This decision, which favored Valley Park Ranch, LLC (VPR), marks a departure from the court’s earlier position in Oakbrook Land Holdings, LLC (2020).

Background of the Case

Valley Park Ranch, LLC claimed a $14.8 million charitable deduction for a conservation easement it granted in 2016. The IRS issued a Notice of Final Partnership Administrative Adjustment (FPAA), disallowing the deduction. The agency argued that the extinguishment clause in the easement deed did not satisfy the requirements of Code Sec. 170(h) and its accompanying regulations.

The deed’s extinguishment clause stated:

1. In cases of termination, a court would determine the compensation amount unless overridden by state or federal law.
2. In cases of eminent domain, proceeds would be distributed based on a “qualified appraisal.”

The IRS contended that these provisions failed to align with the formula prescribed in Reg. §1.170A-14(g)(6)(ii).

Tax Court’s Findings

The Tax Court ruled in favor of VPR, asserting that:

1. The regulation is procedurally invalid under the APA. The IRS failed to respond adequately to public comments during the rulemaking process.
2. The easement satisfied the perpetual restrictions under Code Sec. 170(h).

Key Issues with the Regulation

During the rulemaking process, commentators, including the New York Landmark Commission (NYLC), highlighted flaws in the extinguishment formula. They argued that the formula failed to account for property owner improvements, which could alter the ratio of proceeds distribution. Treasury, however, neglected to address these concerns in its final rule’s “basis and purpose statement.”

This lack of engagement with significant feedback constituted a violation of the APA’s procedural requirements.

A Shift from Oakbrook Precedent

The ruling overturns the court’s previous decision in Oakbrook Land Holdings, LLC (2020), where it upheld the extinguishment regulation’s validity. The Tax Court explicitly stated it will no longer follow Oakbrook on this issue, signaling a new era for conservation easement litigation.

Implications for Conservation Easement Donors

This decision provides much-needed clarity and relief for conservation easement donors. It sets a precedent that certain IRS regulations may be subject to invalidation if they do not meet procedural standards.

However, the IRS is likely to appeal, leaving some uncertainty. Donors should consult legal and tax professionals to assess how this ruling may impact their filings.

Looking Ahead

The ruling highlights the importance of regulatory compliance with procedural laws. Tax professionals anticipate increased scrutiny of IRS rulemaking processes, particularly as conservation easement disputes remain a hot-button issue in tax law.

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