For the past couple years, the state of the law has been fuzzy around whether a landowner granting a deductible conservation easement can reserve the right to excavate sand and gravel through so-called“ borrow pits.” A sizzling new Tax Court opinion in JL Minerals LLC v. Commissioner holds that such borrow pits are indeed compatible with a deductible easement.

Let’s start with a quick review of the statute and regs: Section 170(h)(5) prohibits “the extraction or removal of minerals by any surface mining method.” The applicable Regulation, § 1.170A-14(g)(4), states that "a deduction under this section will not be denied in the case of certain methods of mining that may have limited, localized impact on the real property but that are not irremediably destructive of significant conservation interests." Clear as gravel?

For decades, landowners interpreted the Regulation to allow small borrow pits in deductible conservation easements. Typically, a donor would reserve the right to excavate sand and gravel on no more than an acre or two at a time, so long as the material was used only on the protected property and the surface was restored upon the cessation of use. There was a funky case out of the Court of Federal Claims in 1997 holding that the Regulation was in violation of the statute, and that sand and gravel extraction was a prohibited surface mining method. See Great Northern Nekoosa Corp. v. United States, 38 Fed. Cl. 645 (1997), based right here in Maine. But over the ensuring years the IRS didn’t raise any challenges based on borrow pits, and land trusts and donors continued to include limited sand and gravel extraction as a reserved right, especially in agricultural and working forest easements. All was well…

…Until it wasn’t. I was on a southbound Amtrak Crescent train from the Big Apple to the Big Easy, on my way to Rally 2022, when the IRS issued an internal counsel memorandum that dusted off the Great Northern Nekoosa holding and declared even limited sand and gravel extraction to be impermissible in a deductible easement. The ruling seemed to signal a renewed focus on borrow pits, and sure enough, the IRS began adding this line of attack to its denials of conservation easement deductions.

Two years later, in JL Minerals, we have our first published Tax Court opinion interpreting the statute and the Regulation. It is a resounding victory for common sense. The Court cited the Regulation and found that the IRS resorted to “sophistry” in seeking to deny a deduction based on a one-acre borrow pit on a65-acre protected property. In a footnote, the Court observed “in passing” that it did not consider digging material from a borrow pit to be “mining.” (At the same time, the IRS won the case on valuation grounds, and the taxpayer rightfully was called to the carpet for grossly inflating the deduction.)

In the wake of this opinion, what should a prudenteasement donor and land trust do for current and future projects? Well, this isonly one Tax Court judge’s opinion, and it was not fully reviewed by the entirepanel of judges, as sometimes happens. But most judges are happy to followanother judge on a matter of first impression, and this first take will likelycarry considerable weight.

Overall, the JL Minerals case greatly reduces, but does not entirely eliminate, the risk of allowing a borrow pit reserved right in a deductible easement. A donor who is highly risk averse or doesn’t really need to reserve a borrow pit might want to keep it out of the easement. For atypical donated easement project on residential property, the land trust probably doesn’t even want to allow a borrow pit in the first place. In contrast, for an agricultural or working forest easement project, where the donor is willing to accept a modest degree of risk, then a small borrow pit with restoration obligations (and possibly with prior written approval of holder as to the location) probably makes sense.

Of course, the land trust shouldn’t be interpreting case law and providing legal advice to landowners or their attorneys. As always, the best course of action is to inform landowners of the issue(including by sharing relevant information, such as this E-Bulletin), and urge them to consult their independent legal and tax advisors.

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