Important Court Decision on CE Baselines and Boundary Adjustments

A federal appellate court recently issued a noteworthy decision concerning boundary adjustments and Baseline Documentations for tax-deductible conservation easements.  In Bosque Canyon Ranch, LP v. Commissioner, No. 16-60068 (5th Cir. 2017), the Fifth Circuit overturned a Tax Court decision and upheld the deductibility of two easements against an IRS challenge on these two issues.

Let’s look at the Baseline issue first, as that’s the simpler and more wide-ranging impact of the case.  The Tax Court had agreed with the IRS that certain flaws in the Baseline prepared by the land trust rendered the entire conservation easement non-deductible.  The two easements were executed in December 2005 and December 2007, respectively.  In particular, one report included in the Baseline for the December 2005 easement was dated March 2007 and thus was added 15 months after that easement’s closing.  Meanwhile, the Baseline for the December 2007 easement was not signed until November 2008.  Furthermore, much of data in each Baseline was current only as of April 2004, not the date of each easement’s respective conveyance.

The IRS maintained, and the Tax Court agreed, that these flaws rendered the easement ineligible due to a lack of compliance with Treasury Regulation § 1.170A-14(g)(5)(i), which addresses Baselines.  The Fifth Circuit was much more forgiving, first noting that the Regulation’s permissive rather than mandatory language as to what might be included in a Baseline indicated an intent to be “flexible and illustrative rather than rigid.”  The appellate court determined that the wealth of maps, photos, and habitat reports that were included in the Baselines was “more than sufficient to establish the condition of the property prior to the donation.”  In an explicit rebuke, the Fifth Circuit wrote: “The Tax Court’s hyper-technical requirements for baseline documentation, if allowed to stand, would create uncertainty by imposing ambiguous and subjective standards for such documentation and are contrary to the very purpose of the statute. If left in place, that holding would undoubtedly discourage and hinder future conservation easements.”

The Fifth Circuit’s take on the Baseline issue is good news for land trusts and easement donors.  In the hustle to complete an easement transaction, it’s not uncommon for data to become slightly outdated or for certain exhibits to be added later.  To be sure, land trusts should not see this decision as a green light to prepare sloppy Baselines.  Land Trust Standards and Practices 11.B requires that Baselines be completed and signed prior to closing, with an acknowledgment that seasonal conditions might require the submission of additional data after the closing.  However, donors and land trusts can rest a little bit easier that the courts will not wipe out deductions for minor foot faults in the Baselines.

Meanwhile, as for the second major issue, the Fifth Circuit held that limited adjustments to the boundaries of homesites located entirely within the easement’s external boundary did not run afoul of the perpetuity requirements of I.R.C. § 170(h)(2)(C).  The court distinguished this situation from the Fourth Circuit’s decision in Belk v. Commissioner, 774 F.3d 221 (4th Cir. 2014)(Belk III), which held that limited “substitution” changes to the external boundaries of a conservation easement rendered the easement ineligible under § 170(h).

Together, the two easements in Bosque Canyon protected two contiguous parcels comprising 3,482 acres.  The holder was the North American Land Trust (NALT), which has been involved in several easements challenged by the IRS.  Within the protected property there were 47 separate 5-acre homesites, which were entirely excluded from the easements.  The easements contained a provision that the boundaries of the homesite parcels (and by corollary the easement’s internal boundaries with those homesite parcels) could be adjusted, provided that any such adjustment could not “in [the holder’s] reasonable judgment, directly or indirectly result in any material adverse effect on any of the Conservation Purposes” and also provided that the area of each Homesite could not be increased.  The IRS contended, and the Tax Court agreed, that this boundary adjustment provision was similar to the substitution provision that was struck down in Belk (which easement was also held by NALT).

But the Fifth Circuit reversed, finding that allowing limited changes to the internal boundaries was supportive of, and not inconsistent with, the perpetuity requirements of § 170(h).  In a key section citing earlier D.C. Circuit and First Circuit appellate decisions, the Fifth Circuit wrote, “The common-sense reasoning that [Simmons and Kaufman] espoused, i.e., that an easement may be modified to promote the underlying conservation interests, applies equally here. The need for flexibility to address changing or unforeseen conditions on or under property subject to a conservation easement clearly benefits all parties, and ultimately the flora and fauna that are their true beneficiaries.”  The Fifth Circuit also noted approvingly that the homesites were generally clustered in a particular area of the protected properties around the only existing road, and thus it was highly unlikely that the boundary adjustment provision could be abused to allow the homesites to be scattered throughout the protected properties.  (Thus, unlike some of NALT’s golf course easements at issue in other cases, these easements appeared to protect genuinely significant wildlife habitat.)

I welcome this decision on the boundary adjustments.  Having seen first-hand the need for the occasional boundary adjustment for any number of valid reasons (third party encroachments, survey mistakes, a first-time survey that clarifies previously murky boundaries, etc.), I agree with the Fifth Circuit that a certain degree of flexibility is healthy for conservation easement stewardship.  So long as a boundary adjustment provision is made subject to a responsible conservation standard (as was the case here, i.e., the requirements that any boundary adjustment not result in any material adverse effect on the conservation purposes nor reduce the size of the protected property), then I see no reason why it should render the easement ineligible for a federal income tax deduction.  The entire misbegotten premise of the IRS’ argument in this and other cases is that land trusts should not be trusted with these discretionary decisions about amendments.  Although I don’t think land trusts are infallible, they should be accorded the flexibility to make reasonable easement stewardship decisions.

That said, the issue of boundary adjustment provisions and the related question of whether to allow “floating” building rights are far from settled.  The Bosque Canyon decision is binding only within the Fifth Circuit states of Louisiana, Mississippi and Texas, although hopefully it will have persuasive effect on the IRS and the Tax Court.  Moreover, the Fifth Circuit would have been better off openly disagreeing with the Fourth Circuit’s Belk decision, rather than positing a qualitative distinction between internal vs. external boundary adjustments.  And the Fifth Circuit’s decision was split 2-to-1, with a vigorous dissent, perhaps giving the IRS hope to continue its campaign against boundary adjustments.  For all of these reasons, even after Bosque Canyonland trusts and landowners are still advised not to include explicit boundary adjustment provisions or floating easement envelopes in donated conservation easements.  In the vast majority of situations, a general amendment provision could address any scenario in which a boundary adjustment might be considered.  Of course, the IRS is also pressing an attack on general amendment provisions, but that’s a topic for another day.

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New Filing Requirement for Fee Lands

Since 2007, holders of conservation easements in Maine have been required to submit an annual filing in a Conservation Easement Registry maintained by the Department of Agriculture, Conservation and Forestry (DACF).  A little-noticed provision of the final budget bill (P.L. Ch. 284, § TT-1) passed by the Maine Legislature now expands the filing requirement to include “lands owned in fee for conservation purposes.”  Registrants must include in the annual filing the number of acres owned in fee that are exempt from property taxation under 36 M.R.S. § 652 and for which the municipality or county does not receive any payment in lieu of taxes.  The new filing requirement appears to stem from Governor LePage’s unsuccessful attempts to overturn the results of the 2014 Francis Small Heritage Trust, Inc. v. Town of Limington case, which held that land conservation is a charitable purpose eligible for property tax exemption.

DACF has not yet revised the online filing portal, so it’s not clear exactly how the questions and field entries will be worded for the fee portion of the Registry.  Nevertheless, it appears that the fee-related information compiled by the Registry will allow the State (and the public, through a Freedom of Access Act request) to gather comprehensive data on how much conservation land is owned by nonprofit organizations, and what percentage of that land is fully property-tax-exempt.