March 17, 2018

Colorado Court of Appeals: Donor and Transferee Are One Entity for Conservation Easement Tax Credit Purposes

The Colorado Court of Appeals issued its opinion in Medved v. Colorado Department of Revenue on Thursday, October 20, 2016.

Conservation Easement Tax Credit—Statute of Limitations—Notice of Disallowance.

The Medveds purchased a conservation easement (CE) tax credit from Whites Corporation (Whites). The appraised value of the tax credit was $130,000. Whites was the CE donor and the Medveds were the CE transferees. On October 23, 2006, the Medveds filed their 2005 Colorado tax returns and claimed a $130,000 credit based on the CE. On October 30, 2007, Whites filed a Colorado State C Corporation income tax return and claimed a $260,000 credit based on the same CE.

On March 4, 2011, the Colorado Department of Revenue (Department) issued a notice of disallowance to Whites and the Medveds, disallowing the credit in its entirety. The Medveds appealed to the district court and argued the notice of disallowance was barred by the four-year statute of limitation in C.R.S. § 39-21-107(2). The Department argued that the Medveds and Whites were subject to the same statute of limitations that was triggered when the donor filed its tax return under C.R.S. § 39-22-522(7)(i). The district court found that the donor and the transferee were a single entity and were bound as to all issues concerning the tax credit to the four-year statute of limitations, which was triggered by the donor’s tax claim. Because Whites filed its return on October 30, 2007, the Department’s notice of disallowance was within the statute of limitations.

On appeal, the Medveds claimed they were not bound by the same statute of limitations as Whites. The court of appeals agreed with the Department that a donor and transferee are considered a single entity under the statute and are bound by the same statute of limitations. The Medveds also argued that the first claim filed triggers the four-year statute of limitations. Finding the statutory language ambiguous, the court considered its legislative intent and purposes and concluded that the General Assembly intended that the first claim filed, either by the donor or transferee, begins the four-year statute of limitations period. Because the Department’s notice of disallowance was beyond the four-year limitations period, the Department’s disallowance was untimely and statutorily barred.

The judgment was reversed and the case was remanded for dismissal.

Summary provided courtesy of The Colorado Lawyer.

Colorado Court of Appeals: Reformation of Conservation Deed Appropriate to Correct Mutual Mistake

The Colorado Court of Appeals issued its opinion in Ranch O, LLC v. Colorado Cattlemen’s Agricultural Land Trust on Thursday, February 26, 2015.

Conservation Easement—Summary Judgment—Reformation of Deed Based on Mutual Mistake.

Craig Walker was the sole manager and 99% membership owner of Walker I-Granby, LLC (LLC). Walker owned certain property that he conveyed to the LLC. Walker and the Colorado Cattlemen’s Agricultural Land Trust (Land Trust) then signed a deed of conservation easement (Conservation Deed) that purported to give the Land Trust a conservation easement on the subject property. The Conservation Deed named Walker as the grantor, but Walker had previously conveyed the subject property to his LLC. The LLC should have been the grantor. Neither Walker nor the Land Trust was aware of this error.

Walker, on the LLC’s behalf, then entered into discussions with Ranch O, LLC’s principal about selling the subject property to Ranch O. Walker informed Ranch O of the Land Trust’s conservation easement.

Ranch O bought the subject property from the LLC. The deed conveying the property noted that the subject property was encumbered by a conservation easement held by the Land Trust and noted the recording information for the Conservation Deed.

Ranch O requested a declaratory judgment that the Conservation Deed was invalid and had no force and effect because Walker had no ownership interest in the subject property at the time the Conservation Deed was signed and recorded. The Land Trust answered, seeking a declaratory judgment that the Conservation Deed was valid and enforceable despite the scrivener’s error and reformation of the Conservation Deed to correct any error regarding the identity of the grantor. The Land Trust claimed any error was the result of mutual mistake. The district court granted the Land Trust’s motion for summary judgment and denied Ranch O’s request.

On appeal, Ranch O argued that the undisputed facts precluded the district court from reforming the Conservation Deed based on a mutual mistake of fact. The Court of Appeals disagreed. It found that the evidence clearly and unequivocally showed that reformation was appropriate because both parties to the Conservation Deed mistakenly believed that it correctly identified the grantor and that the grantor had the authority to convey the conservation easement. The mutual mistake justified reforming the Conservation Deed.

Ranch O also argued that reformation violated the policies and purposes behind Colorado’s race-notice statute. The Court disagreed, noting that Ranch O had actual notice of the Conservation Deed before it purchased the subject property. It was also advised of the Conservation Deed in the LLC’s deed to Ranch O. Ranch O, given its actual knowledge of the Conservation Deed, cannot simply ignore it and then seek to defeat its reformation in this action. Reformation is an equitable remedy and equity demands that the Conservation Deed be reformed. The judgment was affirmed.

Summary and full case available here, courtesy of The Colorado Lawyer.

Tenth Circuit: Plain Language of Regulation Requires Mortgage Subordination at Date of Conservation Easement Donation

The Tenth Circuit Court of Appeals issued its opinion in Mitchell v. Commissioner of Internal Revenue on Tuesday, January 6, 2015.

Ms. Mitchell and her late husband purchased property from Mr. Sheek subject an agreement to pay the balance to Mr. Sheek in yearly installments. In 2003, they granted a conservation easement on part of their property to the Montezuma Land Conservancy. At the time of the donation, the Mitchells did not obtain a mortgage subordination agreement from Mr. Sheek, but they did obtain one in 2005. The Mitchells claimed a charitable contribution deduction on their 2003 tax return.

In 2010, the Commissioner of the IRS mailed a notice of deficiency to Ms. Mitchell disallowing the charitable contribution for failure to meet certain Code requirements, specifically for not obtaining a mortgage subordination agreement at the time of the donation. Ms. Mitchell challenged the Commissioner’s determination in Tax Court, but the Tax Court denied the claimed charitable contribution, concluding the Code and its implementing regulations mandated that the mortgage be subordinated on the date of the donation. Ms. Mitchell appealed to the Tenth Circuit.

The Tenth Circuit first analyzed the applicable Code provisions, in particular noting the Code mandates that a contribution shall not be treated as exclusively for contribution purposes unless the contribution is protected in perpetuity. The Commissioner developed the mortgage subordination provision as a means to protect the conservation in perpetuity. The Tenth Circuit accordingly focused its inquiry on whether the regulations can be interpreted to entitle Ms. Mitchell to the deduction despite the undisputed fact that the mortgage was not subordinated on the date of the donation.

The Tenth Circuit first turned to Ms. Mitchell’s claim that, because the regulations are silent on the date of subordination, she is entitled to the deduction because the mortgage was eventually subordinated. The Tenth Circuit disagreed, finding the plain language of the regulation precluded her interpretation, and even if they were to view the regulation as ambiguous, they would defer to the Commissioner’s reasonable interpretation.

Ms. Mitchell next argues that strict compliance with the regulation was unnecessary because the risk of foreclosure was so remote as to be negligible, and because of a Deed provision that allegedly protected the property in perpetuity. The Tenth Circuit found that the plain language of the regulation required it to reject Ms. Mitchell’s arguments.

The Tenth Circuit affirmed the Tax Court’s decision.

Tenth Circuit: Tax Court Did Not Err in Concluding Highest and Best Use for Property Was Agriculture Before Conservation Easement Was Granted

The Tenth Circuit Court of Appeals published its opinion in Esgar Corporation v. Commissioner of Internal Revenue on Friday, March 7, 2014.

On December 17, 2004, the Taxpayers (Esgar Corporation, George and Georgetta Tempel, and Delmar and Patricia Holmes) each donated a conservation easement over their respective property to the Greenlands Reserve. The donations granted a perpetual easement over the properties, giving Greenlands the right to preserve the natural condition of the land and protect its biological, ecological, and environmental characteristics.

The Taxpayers claimed charitable deductions on their 2004, 2005, and 2006 tax returns for “qualified conservation contributions” under I.R.C. §170(f)(3)(B)(iii). The Taxpayers engaged William Milenski to appraise their contributions. Mr. Milenski concluded that, had the conservation easements not been granted, the properties would have realized their greatest potential as a gravel mining operation. Based on the value of that relinquished use, Mr. Milenski valued each of the Taxpayers’ conservation easements. Also as a result of their donations, the Taxpayers received transferable tax credits from the State of Colorado. Within two weeks of receiving the credits, the Taxpayers sold portions of their credits to third parties.

After an audit of the Taxpayers’ 2004, 2005, and 2006 returns, the Commissioner determined that the Taxpayers’ conservation easements were in fact valueless and that the sales proceeds from their state tax credits should be reported as ordinary income. The Commissioner issued notices of deficiency for the 2004, 2005, and 2006 tax years.

A trial was held where the only issue was the highest and best use of  property before the easement. The Commissioner argued it was agriculture and the Taxpayers argued it was gravel mining. The Tax Court sided with the Commissioner and this appeal followed.

The Taxpayers first argued that the Tax Court erred by placing on them the burden of proving the before value of their properties. Generally, deductions are a matter of legislative grace, and a taxpayer bears the burden of proving entitlement to any claimed deduction. However, Section 7491(a) of the I.R.C. shifts the burden of proof to the Commissioner on any factual issue that the taxpayer supports with credible evidence. The Taxpayers argued that they introduced credible evidence that gravel mining was their properties’ highest and best use, thus shifting the burden to the Commissioner. However, the Tenth Circuit held that Section 7491 does not require burden shift when, as here, both parties produced evidence and the evidence weighed in the Commissioner’s favor.

The Taxpayers also argued that the Tax Court erred by drawing an adverse factual inference against them. The Tax Court stated: “Neither [the Taxpayers] nor their experts provided us with an estimate of remaining aggregate. [The Taxpayers] own the land on which the Midwestern Farms Pit is situated and chose not to provide information on the amount of aggregate remaining. Their failure to introduce evidence “which if true, would be favorable to . . . [them], gives rise to the presumption that if produced it would be unfavorable.”

The Taxpayers argued that it was impermissible to use this “missing evidence” inference against them, given that the burden of proof rested with the Commissioner. The Tenth Circuit disagreed. It is the function of the Tax Court to draw appropriate inferences, and choose between conflicting inferences in finding the facts of a case.

Next, the Taxpayers argued that the Tax Court applied erroneous legal standards to value their conservation easements. They made two arguments: (1) that the Tax Court erred by adopting the properties’ current use as its highest and best use rather than taking a “development-based approach,” and (2) that the Tax Court erred by citing eminent domain principles in reaching its valuation determination.

Valuation does not depend on whether the owner actually has put the property to its highest and best use. Rather, courts must focus 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. After taking into account the properties’ current use and the fact that the likelihood of development was remote, the Tax Court certainly could find that the properties’ current use, agriculture, was its highest and best use. The Tax Court applied the correct highest and best use standard, looking for the use that was most reasonably probable in the reasonably near future, and it did not clearly err by concluding that use was agriculture.

The Taxpayers argued that eminent domain principles—standards used to value property to determine just compensation—were inapplicable when valuing conservation easements. Just compensation valuation requires an identical finding, i.e., the “highest and most profitable use” for which the property was suited before the taking. The objective assessment that the Treasury Regulations require do not materially differ from those used to determine the highest and best use of property for just compensation valuation.

Finally, the Taxpayers argued that their state tax credits, which they held for about two weeks, were long-term capital assets. However, the Tenth Circuit held that the Tax Court correctly concluded that the Taxpayers had no property rights in a conservation easement contribution State tax credit until the donation was complete and the credits were granted. The credits never were, nor did they become, part of the Taxpayers’ real property rights. Instead, the Taxpayers’ holding period in their credits began at the time the credits were granted and ended when petitioners sold them. Since petitioners sold their State tax credits in the same month in which they received them, the capital gains from the sale of the credits were short term.


SB 13-281: Expediting the Resolution of Disputes Related to Tax Credits for Donation of a Perpetual Conservation Easement

On Thursday, April 18, 2013, Sen. Larry Crowder introduced SB 13-281 – Concerning the Expeditious Resolution of Disputed Claims for State Income Tax Credits Allowed for the Donation of a Perpetual Conservation Easement. This summary is published here courtesy of the Colorado Bar Association’s e-Legislative Report.

Taxpayers may claim a state income tax credit for a portion of the value of a perpetual conservation easement that the taxpayer donates. If the executive director of the department of revenue disputes the claim of the credit, current law sets forth procedures for resolving the claim administratively or through an appeal process in the courts. In the past, a significant number of claims have been disputed and are in the process of being resolved.

The bill requires all disputes for tax credits claimed prior to July 1, 2008, to be resolved by July 1, 2014, and prohibits the state from using any funds, resources, or personnel to continue to litigate these disputed claims after that date.

The bill was introduced on April 18 and assigned to the State, Veterans, & Military Affairs Committee. The bill is scheduled for committee review on May 1 at 1:30 p.m.

HB 13-1183: Imposing a Cap on the Amount of Tax Exemption that May Be Claimed for Donations of Conservation Easements

On January 31, 2013, Rep. Claire Levy and Sen. Kent Lambert introduced HB 13-1183 – Concerning the Imposition of a Cap of 45 Million Dollars on the Total Amount of State Income Tax Credits that May Be Claimed by All Taxpayers Each Year for the Donation of a Conservation Easement in GrossThis summary is published here courtesy of the Colorado Bar Association’s e-Legislative Report.

Taxpayers are allowed to claim a state income tax credit for donating a conservation easement. Current law caps the total amount of credits that may be claimed by all taxpayers each year for a three-year period. The amount of the cap is $22 million for 2011 and 2012 and $34 million for 2013. Credits that exceed the amount allowed for each year are placed on a wait list for a future year.

The bill extends the cap for 2014 and later years and increases the annual amount of the cap for these years to $45 million. Clarifying amendments on the process of administering the cap are made. On March 15, the House approved the bill on 2nd Reading; the bill is scheduled for 3rd and final Reading in the House on Monday, March 18.

Since this summary, the bill passed the 3rd Reading in the House.