Subordination Of Mortgage is Required Before Conservation Easement Donation by KRISTA HARTWELL
Posted by Hochman Salkin Toscher Perez P.C. 
Posted on Friday, August 28, 2015
NINTH CIRCUIT HOLDS SUBORDINATION OF MORTGAGE ON PROPERTY IS REQUIRED BEFORE DONATION TO TAKE A CHARITABLE DEDUCTION FOR A CONSERVATION EASEMENT DONATION – Krista Hartwell
In Minnick v. Commissioner, the Ninth Circuit held that deductions for conservation easement donations are permissible only if any mortgage on the property was subordinated to the easement at the time of the gift. [1]
Must Donate Entire Interest in the Property. Reg. 1.170A-15(a) states that charitable contribution deductions under Section 170 are generally not allowed for a charitable contribution of any interest in property that “consists of less than the donor’s entire interest in the property…” [2] An exception is available under section 170(f)(3)(B)(iii) “for the value of a qualified conservation contribution” if the requirements of Regulation 1.170A-14 are met. [3] A qualified conservation contribution is the “contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes,” and the conservation purpose must be “protected in perpetuity.” [4] Regulation 1.170A-14 defines “qualified real property interest,” [5] “qualified organization,” [6] “conservation purposes,” [7] “exclusively for conservation purposes,” [8] and “enforceable in perpetuity.” [9]
The “enforceable in perpetuity” provision of the 1.170A-14 regulations was at issue in Minnick because there was a mortgage on the donated property at the time of donation. Regulation 1.170A-14(g)(2) “Protection of a conservation purpose in case of a donation of property subject to a mortgage,” states: “In the case of conservation contributions made after February 13, 1986, no deducion [sic] will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity. For conservation contributions made prior to February 14, 1986, the requirement of section 170 (h)(5)(A) [26 USCS § 170 (h)(5)(A)] is satisfied in the case of mortgaged property (with respect to which the mortgagee has not subordinated its rights) only if the donor can demonstrate that the conservation purpose is protected in perpetuity without subordination of the mortgagee’s rights.” [10].
In Minnick, the taxpayers took out a loan secured by an undeveloped plot of land for the purpose of developing the land. The following year, the taxpayers increased the loan amount twice. Two days after receiving final approval to develop the land, the taxpayers donated a conservation easement to Land Trust of Treasure Valley on parts of the land that would not be developed. Although the easement agreement contained warranties that the land was not subject to a mortgage, it was in fact subject to a mortgage at the time of donation, and the taxpayers did not inform the lender of the easement at the of the easement donation. The taxpayers hired an appraiser who appraised the value of the conservation easement at $941,000 and the taxpayers claimed a charitable deduction of $389,517 on their then current year return. They carried forward the remainder of the deduction on their tax returns for the two following tax years.
Subordination of the Mortgage. The IRS issued a Notice of Deficiency for the two carry forward years on the ground that “documentation of fair market value was not provided.” The taxpayers filed a Tax Court petition, and shortly before trial they contacted the lender bank to request a subordination of the mortgage to the easement. After an appraisal and some negotiation, the taxpayers and the bank entered into a subordination agreement. At the same time as the taxpayers entered into the subordination agreement, the IRS argued in its pre-trial memorandum that the taxpayers were not entitled to deduct the conservation easement as a gift because the mortgagee did not subordinate its rights in the property to the rights of the qualified organization to the enforce the conservation purposes of the gift in perpetuity.
Mortgage Must be Subordinated at the Time of the Donation to be Deductible. Before the Tax Court ruled in the taxpayers’ case (but after trial concluded), the Tax Court decided Mitchell v. Commissioner, which held that mortgages must be subordinated at the time of the donation in order to be deductible under Regulation section 1.170A-14(g)(2). [11] The taxpayers in Mitchell moved for reconsideration, which the Tax Court denied. The taxpayers in Mitchell then filed an appeal in the Tenth Circuit and the Tenth Circuit affirmed the Tax Court’s decision. [12] The Ninth Circuit in Minnick followed the Tenth Circuit’s holding in Mitchell that Regulation section 1.170A-14(g)(2) requires that the mortgage be subordinated at the time of the gift for the gift to be deductible.
The Ninth Circuit also found that the mortgage must be subordinated at the time of the gift based on the plain language of Regulation section 1.170A-14(g)(2), reasoning that a strict construction of the language “makes clear that subordination is a prerequisite to allowing a deduction.” The Ninth Circuit also reasoned that even if ambiguity existed in the statutory language, the Court defers to the IRS’s interpretation of Treasury Regulations under Auer v. Robbins, 519 U.S. 452 (1997), so long as it is not “plainly erroneous or inconsistent with the regulation” to do so. The Court noted that the IRS had consistently argued before the Tax Court and Tenth Circuit that the regulation requires subordination at the time of the gift, and that the IRS’s interpretation of the regulation is not plainly erroneous or inconsistent with the regulation. The Ninth Circuit also reasoned, “an easement can hardly be said to be protected “in perpetuity” if it is subject to extinguishment at essentially any time by a mortgage holder who was not a party to, and indeed (as here) may not even have been aware of, the agreement between the Taxpayers and a conservation trust.”
The Ninth Circuit held that in order for the donation of a conservation easement to be protected “in perpetuity” any prior mortgage on the land must be subordinated at the time of the gift.”
KRISTA HARTWELL – For more information please contact Krista Hartwell at Hartwell@taxlitigator.com or 310.281.3200. Ms. Hartwell is a tax lawyer at Hochman, Salkin, Rettig, Toscher & Perez, P.C. and represents clients throughout the United States and elsewhere involving federal and state, civil and criminal tax controversies and tax litigation. Additional information is available at https://www.taxlitigator.com.
[1] Minnick v. Comm’r, 2015 U.S. App. LEXIS 14097 (9 h Cir. 2015).
[2] 26 CFR § 1.170A-14(a).
[3] 26 USC § 170(f)(3)(B)(iii); 26 CFR § 1.170A-14(a).
[4] 26 CFR § 1.170A-14(a).
[5] 26 CFR § 1.170A-14(b).
[6] 26 CFR § 1.170A-14(c).
[7] 26 CFR § 1.170A-14(d).
[8] 26 CFR § 1.170A-14(e).
[9] 26 CFR § 1.170A-14(f).
[10] 26 CFR § 1.170A-14(g)(2).
[11] Mitchell v. Comm’r, 138 T.C. No. 16 (2012), vacated on denial of reconsideration by Mitchell v. Comm’r, 106 T.C.M. 215 (2013).
[12] Mitchell v. Comm’r, 775 F.3d 1243 (10th Cir. 2015).
