Mill Rd. 36 Henry v. Comm'r of Internal Revenue

• Docket Number: 11676-20
• Decision Date: 26 October 2023
• Parties: MILL ROAD 36 HENRY, LLC, MR36 MANAGER, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: U.S. Tax Court

1

T.C. Memo. 2023-129

MILL ROAD 36 HENRY, LLC, MR36 MANAGER, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 11676-20

United States Tax Court

October 26, 2023

MRP, an LLC organized by real estate professionals and investors to buy and sell land, acquired 117 acres of undeveloped suburban land along a county road for $1.25 million (about $10,700 per acre) in December 2014. BI, an entity owned by another real estate professional, thereafter acquired from MRP a 25% undivided interest in these parcels for $315,000. MRP and BI then partitioned 40 acres of the eastern tract to create a new tract ("Tract"). MRP and BI then contributed Tract to MR36, a TEFRA partnership. MR36's only asset was Tract. MRP then sold the remainder of the 117 acres to two other entities.

In September 2016 an investment fund, IF, acquired a 97% ownership interest in MR36 for $1 million (equivalent to about $25,800 per acre). Under the control of IF, MR36 donated by deed in December 2016 a perpetual conservation easement (constituting a "qualified real property interest" under I.R.C. § 170(h)(1)(A)) on 33 acres of Tract to SCT (a "qualified organization" under I.R.C. § 170(h)(1)(B)) for "conservation purposes" under I.R.C. § 170(h)(1)(C). Relying on a professional appraisal, MR36 claimed a charitable contribution deduction of $8,935,000 (about $270,800 for each of the 33 acres) for a "qualified conservation contribution" under I.R.C. § 170(h) on its tax return.

R examined MR36's return and issued a Notice of Final Partnership Administrative Adjustment ("FPAA") determining to disallow the charitable contribution deduction. MR36's TMP filed a petition in this Court challenging the FPAA.

Held MR36 made a qualified conservation contribution under I.R.C § 170(h) and attached to its return a qualified appraisal by a qualified appraiser under I.R.C. § 170(f)(11) and Treas. Reg. § 1.170A-13(c)(3).

Held further, the value of the easement granted on Tract is $900,000 (about $27,300 per acre)-the amount conceded by R.

Held, further, because Tract had been inventory held for sale to customers in the ordinary course of business by MRP and BI-the partners who contributed it to MR36- the amount of MR36's deduction is limited under I.R.C. § 170(e)(1)(A) to its adjusted basis in Tract, $416,563.

Held, further, the I.R.C. § 6663 fraud penalty is not applicable to MR36, but the I.R.C. § 6662(h) gross valuation misstatement penalty is applicable. To the extent the deduction is disallowed not because of valuation but because of the basis limitation of I.R.C. § 170(e)(1)(A), the penalty for a substantial understatement of income tax under I.R.C. § 6662(b)(2) applies, or, in the alternative, the penalty for negligence under I.R.C. § 6662(b)(1) applies.

Anson H. Asbury, R. Brian Gardner III, Ethan J. Vernon, and Lauren T. Heron, for petitioner.

Olivia Hyatt Rembach, Ashley M. Bender, Kristina L. Rico, Elizabeth C. Mourges, Kimberly B. Tyson, and Matthew T. James, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GUSTAFSON, Judge

TABLE OF CONTENTS

FINDINGS OF FACT ...........................6

Jeff Grant's real estate business ...........................6

Benjamin Helms and Benwood Investments, LLC ...........................7

Dr. Chen, Qin Meng, and Zhen Wang ...........................7

Daniel Carbonara and Old Ivy Capital Partners, LLC ...........................8

Adam Price and Falcon Design Consultants ...........................9

Ron S. Foster &Co., Inc ...........................9

Mill Road Partners ...........................9

The Mill Road Tract ...........................10

Mill Road 36 ...........................10

Falcon Design's concept plan ...........................11

Mill Road 36's zoning application ...........................12

Mr. Grant's other properties ...........................15

MR36 Investments, LLC ...........................15

Sale of interests in Mill Road 36 ...........................16

Mill Road 36's easement donation ...........................16

SCT's baseline report ...........................17

The easement deed ...........................17

Valuing the easement for the 2016 tax return ...........................19

Reporting the easement donation on Mill Road 36's 2016 return ...........................21

IRS examination and FPAA ...........................23

Tax Court proceedings ...........................24

The value of the Mill Road Tract easement ...........................24

Petitioner's expert, Mr. Clanton ...........................25

The Commissioner's expert, Mr. Kinney ...........................25

Our findings as to the value of the Mill Road Tract ...........................26

OPINION ...........................26

I. Burden of proof ...........................26

II. Qualified conservation contributions ...........................27

A. Whether Mill Road 36 donated a qualified real property interest ...........................27

1. Donative intent ...........................27

2. The existence of the partnership ...........................28

B. Whether the easement satisfies an enumerated conservation purpose ...........................30

1. Protection of a relatively natural habitat ...........................31

2. Preservation of open space ...........................35

3. The size of the Mill Road easement ...........................36 [*4] C. Whether the easement protects its conservation purposes in perpetuity ...........................39

III. Compliance with the substantiation requirements ...........................40

A summary of the requirements ...........................40

B. The two supposed defects ...........................41

1. Whether Mill Road 36 "had knowledge of facts" . ...........................42

2. Whether necessary signatures are missing...........................45

IV. The value of the easement donation ...........................46

A. The method of valuing a conservation easement ...........................46

B. The value of the Mill Road Tract easement ...........................48

1. Legal permissibility ...........................48

2. Sales comparables ...........................50

3. Sales history of the Mill Road Tract ...........................52

V. The amount of the allowable charitable contribution deduction ...........................53

A. Special rules for inventory property ...........................54

B. The Mill Road Tract as inventory ...........................55

VI. Penalties ...........................56

A. Section 6663 fraud penalty ...........................57

1. General fraud penalty principles ...........................57

2. Liability for the fraud penalty ...........................58

B. Section 6662 accuracy-related penalty ...........................64

1. General accuracy-related penalty principles ...........................64

2. Liability for an accuracy-related penalty ...........................65

3. Whether Mill Road 36 is liable for an accuracy-related penalty ...........................67

VII Conclusion...........................71

APPENDIX...........................72

At issue is a charitable contribution deduction for the donation in 2016 of a conservation easement on 39.68 acres of real property ("Mill Road Tract") by a TEFRA partnership,^1[] Mill Road 36 Henry, LLC ("Mill Road 36"),^2[] to the Southern Conservation Trust, Inc. ("SCT"). Pursuant to section 6223(a)(2),^3[] the IRS issued to Mill Road 36 a Notice of Final Partnership Administrative Adjustment ("FPAA") disallowing the $8,935,000 charitable contribution deduction claimed on Mill Road 36's Form 1065, "U.S. Return of Partnership Income", for the tax year ending on December 31, 2016. MR36 Manager, LLC, as Tax Matters Partner ("TMP") of Mill Road 36, timely filed a petition in this Court challenging the determination.

The issues for decision are: (1) whether Mill Road 36 attached to its tax return a "qualified appraisal" by a "qualified appraiser" within the meaning of section 170(f)(11) and Treasury Regulation § 1.170A-13(c)(3); (2) whether the easement is a "qualified conservation contribution" under section 170(h); (3) the fair market value of the easement; (4) whether Mill Road 36's deduction is limited to its basis in the donated property under section 170(e)(1)(A); and (5) whether the fraud penalty under section 6663, or in the alternative an accuracy-related penalty under section 6662, is applicable to Mill Road 36 for 2016. We hold (1) that the appraisal attached to Mill Road 36's tax return is a qualified appraisal by a qualified appraiser; (2) that the easement donated on the Mill Road Tract is a qualified conservation contribution under section 170(h); (3) that the value of the easement donated by Mill Road 36 was $900,000 (i.e., about $8 million less than the value Mill Road 36 claimed on its return); (4) that the amount of Mill Road 36's deduction is limited to $416,563 (i.e., Mill Road 36's basis in the Mill Road Tract) under section 170(e)(1)(A); and (5) that the section 6663 fraud penalty is not applicable to Mill Road 36 for 2016, but that accuracy-related penalties under section 6662 are applicable.

FINDINGS OF FACT

When MR36 Manager, LLC, filed the petition commencing this case, the principal place of business of Mill Road 36 was in Georgia.^[4]

Jeff Grant's real estate business

Jeff Grant was born and raised in Henry County, Georgia, and he has lived there for most of his life. Mr. Grant started his business in real estate buying timberland in the early 1980s. He has extensive knowledge and experience in the Henry County real estate market. At the time of trial Mr. Grant owned (outright or through a partnership)...