We welcome guest blogger Anson Asbury who is the founder and managing partner of Asbury Law Firm, Tax Counsel. Anson writes about a taxpayer win in Champions III, which he writes turned on the determination of the HBU.
I may have forgotten how to blog. In a prior life, it was something I did regularly on topics that had nothing to do with tax, procedure, or even golf. When I was asked to share my thoughts on the Tax Court’s recent opinion in Champion’s Retreat Golf Founders, LLC v. Commissioner, T.C. Memo. 2022-106, I started writing in a style that begged for substantive footnotes, string cites, and artfully chosen adjectives (or adverbs). Then I read a recent post by Les (whose treatise is a brilliantly technical) and recalled that blog posts are supposed to be accessible, informative, and easy to read. So, here are some quick thoughts, a little opinion (and a few parentheticals). Please check in somewhere else if this isn’t enough to scratch your tax geek itch.
I suspect this opinion will be come to known as “Champions III” and, if not, it at least will be for the remainder of this blog post. I also expect (or maybe just hope) that it is the final hole for these taxpayers, that they have filled their scorecards, and are headed for the parking lot. This case about a conservation easement adjacent to a golf course was subject to full Tax Court trial on several issues other than, but including, the valuation of the conservation easement donation. The Tax Court denied the donation based on a lack of conservation purpose. The 11th Circuit Court of Appeals vacated the Tax Court’s determination on that point for findings inconsistent with the record and remanded for an opinion on value. Champions III is that opinion on value.
Anyone who has experienced the first year of law school knows that any case can provide a nearly endless number of observations. Of course, the secret behind that experience is determining which observations matter (it takes some of us three years or more to figure that out, much to the profit of many teaching institutions). With that jeopardy noted, please allow me to offer some observations.
This case is important in the conservation easement space because it is “only” a valuation case. It has been some time since that has happened and that alone may be a takeaway. A series of Tax Court decisions on technical foot faults in conservation easement cases have been reversed by the Courts of Appeals, and one of which that was not, may yet proceed to the Supreme Court. If determinations on value return to the norm in conservation easement cases, then there may be other lessons in Champions III which may help to resolve the hundreds (yes, that number is correct) of docketed conservation easement cases.
If a Tax Court opinion may be considered the culmination of findings of fact and determinations of law (as opposed to a decision which is often just the result), then Champions III emphasizes the importance of the former when it comes to valuation. While value is always within the scope of the Court’s purview, experts routinely offer opinions to help the Court navigate the evidence presented as it applies to the relevant law. Expert testimony also allows the Court to receive technical, statistical, and other specialized testimony in support of its opinion of value. Champions III is clear that without those facts properly in evidence, the Court’s opinion is limited to the record before it.
Unlike other charitable gifts, the regulations for “qualified conservation contributions” require a specific approach to the valuation of a “perpetual conservation restriction.” The first step is to identify comparable sales of other restrictions. For the unfamiliar, this is not a sale of an encumbered property but a sale of the encumbrance itself. These sales are infrequent and often hard to identify as the market consists largely of land trusts and governments. Where those comparable sales do not exist (which is often the case), the regulations specify use of the before and after method.
The before and after method is essentially two valuations: One is the value of the property before imposition of the easement restriction; the other is the value of the property after the easement has been recorded. The difference between the two is the value of the allowed deduction. To determine the impact of the perpetual restriction on the property’s value the regulations also require a consideration of the highest and best use (the “HBU”) of the property with and without the restriction. Neither the statute nor the regulations provide for another method of determining the value of a perpetual conservation restriction.
Champions III turned on the determination of the HBU. This may be the single biggest takeaway from the case. HBU is familiar to any practitioner in the conservation easement space, but it is an approach any experienced appraiser should know. The HBU approach is applied in estate valuation matters (tax and probate), non-tax condemnation matters, bank valuations for site redevelopment, and others. An appraiser would need no specific experience with conservation easements to know how determine HBU correctly. And one would expect any appraiser with substantial experience to have made an HBU analysis many times before.
Three appraisers submitted expert reports in Champions III and all were cross-examined on that testimony (in Tax Court an expert report is considered the expert’s direct testimony). The Court rejected the HBU conclusion of the government’s appraiser (existing use as a 27-hole golf course, not partial residential subdivision development) because it lacked support in the record. His references to sales of nearby lots and the lack of development on sold lots undercut his conclusion that there was “a complete lack of demand for any residential development.” His contrary statements regarding how to value the existing golf course, which differed substantially from his actual method of valuation, also undercut his credibility.
The Court repeatedly referenced the evidence in and absent from the record in its discussion of the HBU, valuation method, and conclusion of value. The government’s failure to do little more than disregard the HBU of the taxpayer’s appraisers on the return and at trial was decisive.
It is also worth noting that the Court applied the income method (specifically the subdivision method) to determine the value of the HBU. The Court notes a general preference for the sales comparison approach but without evidence to support the true comparability of the sale, the income approach is an appropriate method. It is particularly apropos where the HBU involves a degree of entrepreneurial effort (as is almost always the case). Residential developers measure in lots, commercial developers measure in units, business developers measure in cash flow. The Court adopted the expert’s per lot pricing model, made its own adjustments, and applied its opinion of value based on the record before it. It also performed a reasonableness check on its value conclusion with a present value calculation.
The result in Champions III will be regarded by many as a taxpayer victory on value, but it also favors taxpayers on the importance of the facts. Again, considering the volume of valuation cases heard by the Tax Court and the extraordinary volume of pending conservation easement cases this case may be notable for the IRS Independent Office of Appeals – which is charged with settling taxpayer disputes both before and after they reach the Tax Court.
Since the IRS Independent Office of Appeals adopted the Appeals Judicial Approach & Culture in 2014, Appeals has taken note of only the facts in front of it, declined to allow new facts for consideration (without a return to exam), and refrained from adopting new arguments. These changes were adjustments to previous Appeals practices in pursuit of a “quasi-judicial approach” to case evaluation and settlement. Evidence, the weight afforded it, and the lack of evidence are all crucial to a judicial determination. Champions III is an exemplar of that and one that Appeals Teams should be considering in fact intensive valuation matters. Appeals Specialists should consider the credibility of the evidence, or lack thereof, in an administrative file that supports the value put forward by examination, not simply opine on the examination report. The absence of discrete factual support for the parties’ determination of HBU, method, or value should be considered a hazard of litigation under the judicial approach aspects of AJAC.
The lasting impact of Champions III andits role in the ongoing litigation over conservation easement donations will become clearer over time. Ultimately though, the Champions Retreat trilogy stands for the importance of a credible record to support the findings of the Court, especially when it comes to competing expert testimony.