Hewitt v. Commissioner of IRS

• Decision Date: 29 December 2021
• Docket Number: No. 20-13700,20-13700
• Citation: 21 F.4th 1336
• Parties: David F. HEWITT, Tammy K. Hewitt, Petitioners-Appellants, v. COMMISSIONER OF IRS, Respondent-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

21 F.4th 1336

David F. HEWITT, Tammy K. Hewitt, Petitioners-Appellants,

v.COMMISSIONER OF IRS, Respondent-Appellee.

No. 20-13700

United States Court of Appeals, Eleventh Circuit.

Filed: December 29, 2021

David William Foster, Skadden Arps Slate Meagher & Flom, LLP, Washington, DC, Michelle Abroms Levin, Logan C. Abernathy, Dentons Sirote, PC, Huntsville, AL, Sidney Jackson, IV, Gregory P. Rhodes, David M. Wooldridge, Birmingham, AL, for Petitioners-Appellants.

Ivan Clay Dale, Nathaniel S. Pollock, Sherra Tinyi Wong, Arthur Thomas Catterall, Francesca Ugolini, U.S. Department of Justice, Appellate Section Tax Division, Washington, DC, Michael J. Desmond, Chief Counsel - IRS, Washington, DC, Edwin B. Cleverdon, Horace Crump, Tax Court, Birmingham, AL, U.S. Attorney Service - Northern District of Alabama, U.S. Attorney's Office, Birmingham, AL, for Respondent-Appellee.

George Asimos, Jr., Attorney, Law Office of George Asimos, Chadds Ford, PA, Harry D. Shapiro, Saul Ewing Arnstein & Lehr, Baltimore, MD, for Amicus Curiae North American Land Trust.

Before Wilson, Lagoa, Circuit Judges, and Martinez, District Judge.

Lagoa, Circuit Judge:

David and Tammy Hewitt seek review of the Tax Court's order determining that they were not entitled to carryover a charitable contribution deduction for the donation of a conservation easement (the "Easement"). The Tax Court concluded that the Easement did not satisfy the "protected-in-perpetuity" requirement, see I.R.C. § 170(h)(5), because the Easement deed violated the judicial extinguishment proceeds formula set forth in Treas. Reg. § 1.170A-14(g)(6)(ii). Specifically, in the event of judicial extinguishment, the Easement deed subtracts the value of post-donation improvements to the property from the extinguishment proceeds before determining the donee's share of the proceeds, which the Commissioner asserts violated § 1.170A-14(g)(6)(ii) and, thus, § 170(h)(5)'s protected-in-perpetuity requirement.

On appeal, the Hewitts make several arguments as to why the Tax Court erred. They contend that the Commissioner's interpretation of § 1.170A-14(g)(6)(ii) is incorrect, as subtraction of the value of post-donation improvements from the proceeds allocated to the donee is the "better reading" of the regulation. As to this interpretation argument, we recently determined, in TOT Property Holdings, LLC v. Commissioner , that § 1.170A-14(g)(6)(ii) "does not indicate that any amount, including that attributable to improvements, may be subtracted out." 1 F.4th 1354, 1363 (11th Cir. 2021) (quoting PBBM-Rose Hill, Ltd. v. Comm'r , 900 F.3d 193, 208 (5th Cir. 2018) ).

But, based on the taxpayers' concession in TOT , id. at 1362 & n.13, we did not address whether § 1.170A-14(g)(6)(ii) was procedurally valid under the Administrative Procedures Act ("APA") or substantively valid under the framework in Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc. , 467 U.S. 837, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984). Unlike the taxpayers in TOT , the Hewitts challenge the regulation's validity on appeal. Specifically, the Hewitts argue that the Commissioner's interpretation of § 1.170A-14(g)(6)(ii) —prohibiting the subtraction of the value of post-donation improvements to the property on which a conservation easement exists from the proceeds in the event of judicial extinguishment—is arbitrary and capricious for violating the procedural requirements of the APA, see 5 U.S.C. § 706, because the U.S. Treasury Department failed to respond to significant comments as to the improvements issue in promulgating the regulation. The Hewitts further argue that the regulation is substantively invalid under Chevron as an unreasonable interpretation of the statute.

After careful review, and for the reasons explained below, we conclude that the Commissioner's interpretation of § 1.170A-14(g)(6)(ii) is arbitrary and capricious and violates the APA's procedural requirements.¹ And because we find the Commissioner's interpretation of § 1.170A-14(g)(6)(ii) to be invalid under the APA, the Easement deed's subtraction of the value of post-donation improvements from the extinguishment proceeds allocated to the donee does not violate § 170(h)(5)'s protected-in-perpetuity requirement. Accordingly, we reverse the Tax Court's order disallowing the Hewitts' carryover deduction for the conservation easement and remand for further proceedings.

I. FACTUAL AND PROCEDURAL BACKGROUND

David and Tammy Hewitt² reside in Randolph County, Alabama, near Alabama's border with Georgia. David's father moved to Alabama in the early 1950s, acquiring land there to raise cattle, farm, and harvest timber. In the early 1990s, his father transferred a portion of this land to David's sister.

David subsequently acquired 257.2 acres of land in Randolph County (the "Property") in four transactions. His sister transferred approximately 232 acres to David through a series of three warranty deeds dated January 27, 1997, January 23, 1998, and July 1, 1998. In 2001, David purchased 25 more acres of adjected land and bought out the interest of two unrelated persons who co-owned a 400-acre parcel with his father. By 2012, David and his sister owned approximately 1,325 acres in Randolph and Cleburne Counties, Alabama. The cumulative property owned between the two siblings had no zoning ordinances at the time of the Easement's grant and consisted of pastureland along a county road and wooded areas with steep topography, rough terrain, and limited road access. David has used, and continues to use, portions of the Property as a cattle ranch.

On December 28, 2012, David donated the Easement on the Property to and for the benefit of Pelican Coast Conservancy, Inc., a wholly owned subsidiary of the Atlantic Coast Conservancy, Inc. (collectively, "the Conservancy"), through a document entitled Deed of Conservation Easement, which was recorded with the Probate Judge for Randolph County the same day. The Easement deed provides that the Easement's purpose is "to assure that the Property will be retained forever predominately in its natural condition and to prevent any use of the Property that will impair or interfere with the Conservation Values as set forth in this Easement." The Easement deed sets forth a list of "prohibited uses" and permits the Conservancy the right to enter upon the Property at reasonable times to preserve and protect the conservation features. The deed also contains a "permitted uses" section, which reserved to the Hewitts the right to build certain types of improvements on certain areas of the Property.

Additionally, section 15 of the deed governs judicial extinguishment of the Easement. Subsection 15.1 provides:

Extinguishment. If circumstances arise in the future such as render the purpose of this Easement impossible to accomplish, this Easement can only be terminated or extinguished, whether in whole or in part, by judicial proceedings in a court of competent jurisdiction, and the amount of the proceeds to which Conservancy shall be entitled, after the satisfaction or prior claims, from any sale, exchange, or involuntary conversion of all or any portion of the Property subsequent to such termination or extinguishment (herein collectively "Extinguishment") shall be determined to be at least equal to the perpetual conservation restriction's proportionate value unless otherwise provided by Alabama law at the time, in accordance with Subsection 15.2 ....

In turn, subsection 15.2 provides:

Proceeds. This Easement constitutes a real property interest immediately vested in Conservancy. For the purposes of this Subsection, the 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.... For the purposes of this paragraph, the ratio of the value of the Easement to the value of the Property unencumbered by the Easement shall remain constant.

(emphasis added).

As stipulated by the parties, the Conservancy provided David with a contemporaneous written acknowledgement within the meaning of I.R.C. § 170(f)(8), and the Conservancy was a "qualified organization" within the meaning of I.R.C. § 170(h)(3) at the time of the Easement donation. The Commissioner also does not contest that the Property complied with the requirements of I.R.C. § 170(h)(4)(A)(ii)–(iii).

While David is the sole owner of the Property, the Hewitts jointly filed their tax returns for the relevant tax years at issue—2012, 2013, and 2014. For the 2012 tax year, the Hewitts reported a noncash, charitable contribution for the donation of the Easement in the amount of $2,788,000. An appraisal of the Easement was attached to their 2012 return, which the Commissioner—only for the purposes of this appeal—does not contest was a qualified appraisal prepared by a qualified appraiser as required by I.R.C. § 170(f)(11)(E). However, the Hewitts and the Commissioner do not stipulate to the appraisal's contents. Due to limitations on charitable contribution deductions, the deduction for the Easement contribution was $57,738.

The Hewitts timely filed their federal income tax returns for the 2013 and 2014 tax years. The 2013 return claimed a noncash, charitable contribution carryforward deduction from the 2012 charitable contribution deduction for the Easement in the amount of $1,868,782, and the 2014 return carried the same deduction in the amount of $861,480.

On August 16, 2017, the Commissioner timely mailed a statutory notice of deficiency ("NOD") for the 2013 and 2014 taxable years to the Hewitts. The NOD provided that the Hewitts owed: (1) a $336,894 tax deficiency and an I.R.C. § 6662 penalty of $134,757.60 for the 2013 year; and...