Palmer Ranch Holdings LTD v. Comm'r of Internal Revenue Serv.

• Decision Date: 05 February 2016
• Docket Number: No. 14–14167.,14–14167.
• Citation: 812 F.3d 982
• Parties: PALMER RANCH HOLDINGS LTD, Palmer Ranch Holdings, Inc., Tax Matters Partner, Petitioners–Appellants Cross–Appellees, v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent–Appellee Cross–Appellant.
• Court: U.S. Court of Appeals — Eleventh Circuit

812 F.3d 982

PALMER RANCH HOLDINGS LTD, Palmer Ranch Holdings, Inc., Tax Matters Partner, Petitioners–Appellants Cross–Appellees,

v.COMMISSIONER OF INTERNAL REVENUE SERVICE, Respondent–Appellee Cross–Appellant.

No. 14–14167.

United States Court of Appeals, Eleventh Circuit.

Feb. 5, 2016.

Debra J. Albin–Riley, Arent Fox, LLP, Los Angeles, CA, Mark F. Hearne, II, Meghan Sue Largent, Arent Fox, LLP, Clayton, MO, for Petitioners–Appellants Cross–Appellees.

Patrick J. Urda, Gilbert Steven Rothenberg, Francesca Ugolini, U.S. Department of Justice, William J. Wilkins, Chief Counsel–IRS, Washington, DC, for Respondent–Appellee Cross–Appellant.

Before ROSENBAUM and JULIE CARNES, Circuit Judges, and GOLDBERG,^* Judge.

GOLDBERG, Judge:

As recently as 2007, Southwestern Florida served as a proud home to the American, or bald, eagle. One bald eagle nest, SA–010, was located on the eastern side of an 82.19 acre parcel of land known as B–10, in Sarasota County. To the west of B–10 lies Sarasota Bay, where the eagles would fly to feed. To allow the eagles to reach their feeding grounds safely, B–10 sported a nest-to-coast flyway in the form of a "wildlife corridor." The wildlife corridor also provided a habitat to small urban animals of considerably less patriotic interest.

Freedom isn't free. Concern over the eagle nest, wildlife corridor, and wetlands on B–10 thwarted plans by the parcel's owner, Palmer Ranch, Inc. ("Palmer Ranch") to sell B–10 and the adjacent B–9 for residential development. Ever resourceful, Palmer Ranch turned around and donated a conservation easement on B–10 to Sarasota County in 2006, a strategy that allowed the corporation to deduct the easement's value from that year's tax returns. But Palmer Ranch's backup plan fell prey to a sharp-eyed IRS, who disallowed the deduction on grounds that Palmer Ranch had overvalued B–10 in calculating the associated easement's worth. Palmer Ranch had valued B–10 at $25,200,000 on the assumption that B–10's highest and best use was residential development, with development of 360 dwelling units being reasonably probable. The IRS did not share Palmer Ranch's optimism.

Palmer Ranch challenged the IRS's decision in tax court. There, Palmer Ranch insisted that B–10's highest and best use was residential development under a Moderate Density Residential ("MDR") zoning designation, which would allow between two and five units per acre, or 164 to 410 units total. Based on this highest and best use, Palmer Ranch stuck to its initial $25,200,000 valuation. The IRS countered with a maximum highest and best use of 100 units and a corresponding valuation of $7,750,000.

The tax court held in favor of Palmer Ranch on B–10's highest and best use, but nonetheless revalued B–10 at $21,005,278, instead of $25,200,000. The parties cross-appealed. The IRS argues that the tax court ballooned B–10's highest and best use, and that the tax court's valuation was therefore too rosy. Palmer Ranch likes the tax court's highest-and-best-use analysis, but is not on board with the revaluation. For the reasons that follow, we affirm the tax court's determination of B–10's highest and best use, but reverse the tax court's $21,005,278 valuation. We remand for further proceedings consistent with this opinion.

BACKGROUND

The reader might wonder, Why is the value of B–10 itself, or B–10's highest and best use, at issue? After all, Palmer Ranch's deduction was for the value of a conservation easement on B–10–not for the value of the underlying parcel-and it was that deduction that the IRS disallowed and the parties litigated in tax court.

The answer lies in the method Palmer Ranch used to determine the conservation easement's value: the "before and after" method. Under 26 C.F.R. § 1.170A–14(h)(3)(i) (2015),

[T]he fair market value of a perpetual conservation restriction [in this case, a conservation easement] is equal to the difference between the fair market value of the property it encumbers before the granting of the restriction [the "before" value] and the fair market value of the encumbered property after the granting of the restriction [the "after" value].

So the reason that the value of B–10 itself (i.e. B–10's before value) is at issue is because it determines the value of the conservation easement. And B–10's highest and best use is in turn at issue because B–10's before value is informed by the parcel's highest and best use. 26 C.F.R. § 1.170A–14(h)(3)(ii) mandates that

the [before value] take into account not only the current use of the property but also an objective assessment of how immediate or remote the likelihood is that the property, absent the restriction, would in fact be developed, as well as any effect from zoning, conservation, or historic preservation laws that already restrict the property's potential highest and best use.

Or, in the words of tax court case law, B–10's before value must take into account the parcel's highest and best "reasonable and probable use that supports the highest present value." Symington v. Comm'r, 87 T.C. 892, 897, 1986 WL 22044 (1986). The "focus [is] on 'the highest and most profitable use for which the property is adaptable and needed or likely to be needed in the reasonably near future.' " Id. (quoting Olson v. United States, 292 U.S. 246, 255, 54 S.Ct. 704, 708–09, 78 L.Ed. 1236 (1934) ). Hence the significance of B–10's highest and best use in resolving this case.

Another concept critical to disposing of this case is the "comparable sales" method for valuing land after the highest and best use has been determined. As 26 C.F.R. § 1.170A–14(h)(3)(ii) makes clear, simply knowing a parcel of land's highest and best use does not automatically result in a value for the parcel: There remains the task of arriving at a figure that "take[s] into account" the parcel's highest and best use. One way to get there is through the comparable-sales method, which entails considering sales of similarly situated parcels. See Wolfsen Land & Cattle Co. v. Comm'r, 72 T.C. 1, 19 (1979) ("The 'comparable sales' method functions by: (1) Locating [parcels] as physically similar (comparable) as possible to the subject [parcel] which (2) have been sold on the open market in noncollusive, nonforced sales for cash or cash equivalent, within (3) a reasonable time of the date for which a value of the subject property is desired."). The relevance of the comparable sales approach will become apparent as we go along, but suffice to say for now that the approach bears on the propriety of the tax court's determination that B–10 was worth $21,005,278, not $25,200,000.

Having explained the concepts of before value, highest and best use, and the comparable-sales approach, we will now turn to the factual exposition necessary to frame our discussion of the issues. We begin by recounting an event that informs B–10's highest and best use: Palmer Ranch's aforementioned attempt to sell B–10.

A. The Failed Sale

In 2003, Palmer Ranch agreed to sell 86.9 acres within B–10 and an adjacent parcel, B–9, to Pulte Homes ("Pulte"), a national home developer, for $8.25 million. Pulte aimed to develop 240 dwelling units across the two parcels, with 84 to be located on B–10. But in order for Pulte to develop this number of units, both B–9 and B–10 would have to be rezoned: B–10 was zoned as Residential Estate–1, which capped development to one unit per two acres, for 41 total units. Pulte would therefore have to submit a rezoning application to the Sarasota Board of County Commissioners ("BOCC"), which would then have to approve the application under the Sarasota County comprehensive plan. The comprehensive plan restricted B–10's top future zoning to MDR.

Another potential hurdle to Pulte's development was the fact that both B–9 and B–10 were part of the Palmer Ranch Development of Regional Impact ("DRI"). So, besides submitting a rezoning application to the BOCC, Pulte would also have to submit a separate development application. The BOCC would have to approve the development application under the DRI's master development order, which protected the bald eagle nest and created the wildlife corridor.

In a word, at the time that Palmer Ranch contracted with Pulte, the odds that Pulte could successfully develop B–9 and B–10 were at least to some degree uncertain.

To hedge for this uncertainty, Palmer Ranch and Pulte agreed that their sale would be contingent on the BOCC approving development and rezoning applications.

The BOCC did not oblige, denying Pulte's development application by a vote of three to two without addressing the rezoning application. Rather than giving up, though, Pulte and Palmer Ranch went back to the drawing board. They redrafted the sales contract to exclude any part of B–10. Pulte would purchase land on B–9 only, albeit at the same $8.25 million price. With the sales contract drawn up, Pulte submitted new development and rezoning applications to the BOCC, this time seeking to develop 184 dwelling units on B–9 only. Palmer Ranch and Pulte eagerly awaited the BOCC's decision.

Unrelenting, the BOCC denied Pulte's development and rezoning applications three to two. With the second denial, the BOCC issued an ordinance offering guidance on the changes that "would be necessary in order to allow for a favorable consideration of the proposal." To be approved, an amended development application would have to "set[ ] forth development plans which include[ ] both Parcel B–9 and B–10 (totaling 86.35 acres+/-) ...; this application should include Parcel B–10 and should endeavor to keep Parcel B–10 [intact] as it relates to the Eagle Preservation Area, the wetlands, and the wildlife corridor." Notwithstanding the BOCC's hint, Pulte declined to submit a third set of applications, instead canceling the sales contract with Palmer Ranch.

B. Palmer Ranch's Altruistic Response

Once the sales contract with Pulte fell through, Palmer Ranch donated a conservation easement on B–10 to Sarasota County.¹ This response allowed Palmer Ranch...