Sells v. Commissioner: Tax Deduction Leaves Unanswered Questions In Conservation Easement Case

IRS Continues Tax Enforcement Efforts After Recent Conservation Easement Case

The recent court case Sells v. Commissioner of the IRS demonstrates that the IRS will continue to aggressively pursue audits and trials when they believe a tax deduction loophole is being misused. In this situation, an attempt to manipulate tax returns in order to make up for a significant business loss didn’t quite work out as expected.

Conservation Easement Deduction

The backstory of this case begins with a couple, Mr. and Mrs. Moses, who lost money in 2002 when the tech bubble burst, leaving them short $1.4 million. In order to make up for this loss, the Moseses put together a partnership with seven of their friends called Burning Bush Farms. This partnership then purchased a tract of land from Mr. and Mrs. Moses in the amount of $1.4 million, which was the exact amount needed to pay off their business debts.

Several months after the sale, Burning Bush Farms donated the land to an organization run by a former associate of Mr. Moses, Chattoawah Open Land Trust, Inc. (COLT). One of the members of Burning Bush Farms also donated a large amount of timber that had been harvested from the land.

When they filed their taxes, the eight members of Burning Bush Farms claimed two non-cash donations – the land as a conservation easement deduction, and the timber as a noncash charitable contribution. To qualify for a conservation easement deduction, the land must be donated to a land trust or government organization for the purposes of conservation, among other requirements. Under this deduction, the donators can claim up to 50% of the value of their contribution base for up to 16 years, making it a very valuable and even lucrative deduction.

On the tax returns, Burning Bush Farms provided an appraisal valuing the land at just under $5.4 million, quite a bit more than they had purchased the land for and entitling them to very large tax returns that were to be spread out across multiple years of filing.

Audit & Trial

It seemed like everything was going fine until the Commissioner audited the tax filings of Burning Bush Farms. The Commissioner did not believe that this was a genuine donation situation. He disallowed both deductions of land and timber, stating that the taxpayers could not claim two charitable donations from the same property, and questioned the difference between the purchase and donation values. Additionally, the members of Burning Bush Farms were issued penalties for substantial misvalutions on their tax returns.

Things got sticky when a clerical error on the audit paperwork confused whether the members of Burning Bush Farms were being penalized for a substantial misvaluation or a gross misvaluation, two different legal categories with differing descriptions and penalties. A lack of communication over the penalties further clouded the case.

When the case went to trial, the members of Burning Bush Farms shifted the burden of proof to the Commissioner because they had been cooperative. Their appraisals were determined to be accurate and the penalties were waived because the IRS had erred and did not comply with Section 6571(b) on the proposed penalties.

Ongoing Issues & Interpretations

Although the verdict settled the situation for Burning Bush Farms, this case is interesting because it left unanswered questions, such as whether the members of Burning Bush Farms were entitled to a conservation easement deduction. There’s also the issue of whether they were entitled to a deduction from the timber instead of or in addition to the land, and whether they should have been penalized had the clerical errors not occurred. Discussion between tax lawyers is ongoing, and opinions vary regarding the case outcome and its implications.

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