The Dispute Over Perpetual Conservation Easements Just Got Worse

With the recent filing of a petition for certiorari in Oakbrook Land Holdings LLC v. Commissioner,¹ the long-running saga over the charitable contribution deduction for conservation easements has entered a new, and potentially damaging, chapter. At the core of the controversy is the so-called proceeds regulation.² Generally, no charitable contribution deduction is available under IRC section 170 for gifts of partial interests in property. One important exception to this general prohibition covers gifts of “qualified conservation contributions” — a category that includes restrictions on the use of real property commonly referred to as “conservation easements.”³ There are requirements to qualify a conservation easement gift for the deduction. For example, the easement must be granted exclusively for a “conservation purpose,” and it must be held by a qualified organization, typically a land trust or a governmental organization.⁴ A further requirement — of central import in Oakbrook — is that the conservation easement be perpetual.⁵

The proceeds regulation indicates how a conservation easement can satisfy the statutory perpetuity requirement notwithstanding that the easement may be subject to extinguishment in state court proceedings when the associated conservation purpose becomes impossible or impractical. To preserve deductibility, the donor of a conservation easement to a qualified organization must agree at the time of the easement grant that following any extinguishment of the easement, a requisite amount of proceeds from a sale, exchange, or involuntary conversion of the once-burdened real property must flow to the donee organization, which then must devote those proceeds in a manner consistent with the easement’s original conservation purpose.⁶ The determination of the donee’s share of proceeds under the proceeds regulation, and the question whether the proceeds regulation itself is valid, has generated extensive litigation.⁷ The IRS has taken the position that failure to agree to a correct calculation of the donee’s portion of proceeds causes the donation to fail the requirements of section 170, in which case any claimed deduction will be disallowed in its entirety.

A simple numerical example will assist here. Suppose a landowner places a conservation easement on a parcel of real property and everybody agrees that the value of the easement is $100,000 and the value of the fee simple interest without restrictions is $1 million. The regulation indicates that the donee organization must be entitled to proceeds from a monetization event following judicial extinguishment in an amount that reflects a constant “proportionate value,” using the time of donation as a baseline.⁸ This requirement has generated two types of interpretive questions and associated litigation disputes.

First, does the proceeds regulation require the donee to be entitled to a constant absolute amount equal to the proportionate amount of the property’s total value at the time of grant ($100,000 in this example), or does the regulation require entitlement to a constant share equal to the proportionate share at the time of grant (10 percent in this example)? I’ll refer to this as the proportionate value interpretive issue. These two interpretations of the proportionate value issue would entitle the donee organization to different amounts of the gross proceeds in any case in which the property’s underlying value fluctuates because of overall market conditions (not considering any changes made to the property) from the time of easement creation until some subsequent monetization event.

Second, does the proceeds regulation permit the value of any donor improvements to the retained interest to be subtracted from a donee organization’s portion of proceeds? Suppose the fee holder in the example had constructed a house on the property (the construction assumed to be consistent with the terms of the conservation easement) at a cost of $500,000. May the donee’s share of proceeds be adjusted downwards to reflect that the gross proceeds will in part relate to the post-donation real property improvements? I’ll refer to this as the improvements interpretive issue.

The petitioner in Oakbrook has requested that the Court grant certiorari on the question whether the proceeds regulation is procedurally invalid under the Administrative Procedure Act because of Treasury’s failure to properly address comments to the proposed regulations⁹ when promulgating its final regulatory package.¹⁰ The Tax Court rejected the claim of procedural invalidity (and substantive invalidity under Chevron, though this issue is not presented in the petition).¹¹ The Sixth Circuit affirmed this holding.

In Hewitt, however, the Eleventh Circuit reversed the Tax Court and found the proceeds regulation to be procedurally invalid.¹² These disparate outcomes generate the ostensible circuit split on which the petitioner grounds its request. Petitioner observes that not only is there a circuit split on the question whether the proceeds regulation is invalid under the APA but also the issue is of widespread national importance, as the asserted fatal flaw in Oakbrook’s donation, which is based in part on model language drafted by one of the major land conservation umbrella groups, could well affect many other conservation easements. Further, the precise question under the APA is whether some comments received in the rulemaking process were “significant” and thus demanded a response.

In Section I, I explain why certiorari is not warranted in Oakbrook. Further, the stakes transcend conservation easements and the proceeds regulation: A grant of certiorari in this case could lead down a path that would destabilize tax regulations generally and greatly hinder effective tax code enforcement. To argue against cert grant is not to say that the status quo is optimal. IRS challenges to easements under the proceeds regulation seem to have involved instances with suspiciously high valuations. There is nothing wrong with that strategy from a litigation standpoint; we should expect the IRS to focus its scarce resources on high-value cases, and the agency has won cases bringing challenges under the proceeds regulation. Even so, this litigation at least raises the prospect of casting a cloud over existing, or future, easement transactions that are not abusive and are within the set of transactions that Congress plausibly wanted to encourage. The status quo is thus not obviously the best outcome in terms of the law applicable to the tax treatment of conservation easements under section 170. For this reason, in Section II, I will consider alternatives to the status quo.

I. The Case Against Certiorari

A. Certiorari Grant

To see why a grant of cert — and subsequent determination of procedural invalidity — in Oakbrook would be particularly problematic, one must set the asserted conflict with the APA in context. Oakbrook raised two arguments before the Tax Court and the Sixth Circuit regarding procedural invalidity under the APA. The first was that Treasury failed to include a “concise statement of basis and purpose” in the promulgation of its final regulations.¹³ The second was that Treasury failed in its duty to respond to “significant points raised by the public.”¹⁴ Oakbrook’s petition states that the most important procedural issue under the APA in this case is that “the agency ‘must consider and respond to significant comments received during the period for public comment.’”¹⁵

The petition cites Hewitt in this regard, which is important. Hewitt generates the ostensible circuit split because the Eleventh Circuit, unlike the Sixth Circuit in Oakbrook, held the proceeds regulation to be procedurally invalid. Hewitt’s analysis is grounded in Treasury’s failure to respond to some (claimed to be significant) comments rather than on the distinct concise statement aspect of the claim. Oakbrook has likewise elevated the significant comments issue in its petition, presumably to zero in on the described circuit split.

There has also been dispute over whether the proceeds regulation is substantively invalid under Chevron, but Oakbrook has not raised this issue in its petition. For purposes of this report, which I have written in the wake of the petition, I will similarly focus on procedural validity and the significant comments issue. For the reasons described below, the record in this case presents an exceedingly weak basis for asserting agency failure to respond to significant comments. If this case concerns Treasury’s failure to respond to significant comments, then it is difficult to see how this will not also be the case for many other tax regulations. Although Treasury has engaged in greater compliance with APA notice and comment procedures required since Mayo,¹⁶ its historical position (still espoused in the Internal Revenue Manual) has been that most Treasury regulations were interpretive, and therefore did not have to comply with these procedures.¹⁷ The result is that many longtime regulations could be vulnerable to procedural challenge for failure to abide by APA notice and comment procedures.

Whether or not disputes over the proceeds regulation generate a circuit split worthy of Supreme Court resolution, obviously the federal judiciary does not speak with a unified voice on the procedural validity of the regulation. Two judges (Judge Karen Nelson Moore and Judge Julia Smith Gibbons) in the Sixth Circuit rejected the challenge of procedural invalidity in Oakbrook. The third judge (Judge Ralph B. Guy Jr.) on the panel concurred in the judgment denying the claimed deduction (on the ground that Oakbrook’s conservation easement deed did not comply with section 170’s statutory requirements) but would have found the proceeds regulation procedurally invalid. All three judges on the Eleventh Circuit panel in Hewitt found procedural invalidity. In the Tax Court, 13 judges found there to be no procedural invalidity. Judge Emin Toro (in concurrence) and Judge Mark V. Holmes (in dissent), however, concluded that the proceeds regulation was procedurally invalid. Given this split of judicial opinion, one might reasonably conclude that this is at least a close case.

To see why I reject that conclusion requires granular consideration of the comments in the record. Oakbrook states in its petition that 13 (out of 90) commentators on Treasury’s proposed regulatory package “expressed concern” with the proceeds regulation specifically.¹⁸ Holmes similarly listed 13 commentators in his Tax Court dissent.¹⁹ However, it appears that about half of these did not address either the proportionate value issue or the improvements issue. Accordingly, the Sixth and Eleventh Circuits identified seven out of these 13 comments for examination as potentially significant. The taxpayer likewise has included only these seven comments in its petition appendix and so presumably does not mean to argue that any of the other six comments that referenced the proceeds regulation required response. Even so, Treasury did not explicitly mention the seven remaining comments in its final regulatory package. The question is whether these comments were sufficiently “significant” for Treasury’s action to have been fatal under the APA’s procedural requirements.

As Toro noted in his Tax Court concurrence, it is important not to eliminate a comment as requiring specific agency response just because it is made by only one party or is made in a concise or brief manner.²⁰ Thus one should be skeptical of approaches that attempt to assess significance based on simple bean counting, whether tallying the absolute number of commentators who raise an issue, the fraction of overall commentators who raise an issue, the fraction of total words or pages in the aggregate comments dedicated to a particular issue, or any other similar metric.

It is possible that this cuts both ways. One might say that the substance of a comment regarding a provision does not demand a response simply because multiple actors commented on the same provision. If a series of comments do not individually merit or demand response, then the fact that there are multiple comments on a provision arguably does not change anything. One can’t create significance by adding together a lot of insignificant comments. Also, comments often overlap or can simply repeat the same point or be alternate statements of the same underlying concern.²¹ Yet, if many commentators are troubled by the same issue, it is not implausible to conclude that a final regulation with unmodified and unexplained language may lead to widespread interpretive problems among taxpayers. Perhaps mere quantity of comments can tell us something of import (though going down this road may simply invite coordinated campaigns to generate numerous submissions of the same comment).

The Eleventh Circuit seemed to flirt with that sort of logic in Hewitt in a statement quoted directly in Oakbrook’s petition highlighting the aggregate number of comments submitted on the proceeds regulation: “Treasury did not discuss or respond to the comments made by NYLC [the New York Landmarks Conservancy] or the other six commentators concerning the extinguishment proceeds regulation.”²² To similar effect, the Eleventh Circuit described the basic question before it as follows:

How important is it that there were seven comments mentioning the proceeds regulation? In the end, both the Sixth and Eleventh circuits focused on a single commentator — the New York Landmarks Conservancy. I will largely do so as well. However, since we cannot rule out that the Supreme Court will give credence to the absolute number of comments submitted on the provision, it is instructive to say more and to categorize the seven comments on the proceeds regulation that were referenced by both appeals courts.

One should begin by observing that all seven comments were submitted by various conservation or preservation organizations — that is, by potential donees of conservation easements rather than by donors. This observation allows one to make an initial, important division in the seven comments. The Eleventh Circuit lumps the commentators together with the vague indication that all their comments were “criticizing or urging caution” regarding the proceeds regulation. But the seven commentators were not of like mind regarding the proceeds regulation. Three were explicit in their concern about the effect the proposed rules would have on the interests of prospective donors. Although the comments were submitted by donee organizations, the essential concern was that an overly onerous regulation would deter potential donations of conservation easements.²⁴ Conversely, three of the seven commentators had the opposite concern — that the proposed rule was insufficiently protective of donees.²⁵

It is important to consider these two groupings separately. The taxpayer in Oakbrook (a conservation easement donor, not a donee) insists that it was incumbent on Treasury to address comments that were “significant” for these purposes insofar as they raised the concern that the proposed rule’s division of proceeds allocable to donor-constructed post-donation improvements would unduly favor donees and thus deter contributions. It would be perverse, though, to find procedural invalidity on the grounds that the three commentators seeking even greater donee protections were not appropriately given responses in the challenged final regulatory package on the basis that Treasury failed to consider that excessive benefits to donees generated a deterrence problem. Even if one were to give credence, then, to the argument that multiplicity of comments hints towards significance, these three comments should be removed from the analysis. A fourth comment could be read to imply that the proposed regulations were unduly onerous for donors because the tax benefit rule would be sufficient to roll back an undeserved deduction when an easement is extinguished, but this comment did not reference deterrence effects.²⁶ And then there were three.

As noted, the Eleventh and Sixth Circuits only discussed the significance of the comment submitted by the NYLC. This is not surprising because this is the only comment that raised the issue — treatment of post-donation donor improvements — under which Oakbrook’s deed allegedly failed the proceeds regulation requirements. The other two comments flagging deterrence concerns discussed the possibility of the donor having to pay real estate transfer taxes and the possibility of a donor receiving less than an equitable share of post-extinguishment proceeds because of third-party loans.²⁷ Neither of these circumstances was an issue in Oakbrook, and none of the judges who found procedural invalidity relied on the content of these comments (as opposed to the fact that they should be included in the tally of comments that discussed the proceeds regulation). If the Court were to grant certiorari and find the proceeds regulation to be determined procedurally invalid on the record in Oakbrook, then, it would appear this determination would have to stand almost entirely on the content of a single comment — that submitted by the NYLC.

The NYLC comment covered five numbered comments running over six pages.²⁸ Only comment no. 2 addressed the proceeds regulation. The essence of this comment is that the proposed regulation’s requirement that the donee have the right to constant proportionate value would give donees a windfall share of post-donation donor improvements, thus deterring donations in the first place, in contravention of the stated congressional purpose of encouraging conservation easements. The NYLC illustrated with an ostensibly troubling numerical example, which posited a pre-easement Greenacre worth $100,000 and the creation of a conservation easement on that land worth 10 percent of the aggregate value. At some point after the creation of the easement the donor constructs housing units (in a manner consistent with and permitted by the easement restrictions) at a cost of $2 million. The NYLC notes that under the proceeds regulation the donee organization would be entitled to 10 percent of any future sales price post-extinguishment, including 10 percent of the value of the $2 million housing units. The NYLC observed that this “would obviously be undesirable to the prospective donor.” The NYLC’s comment evidences concern that this sort of potential division of proceeds under “unknown circumstances” would deter donations.

The split of judicial opinion on whether this issue is significant is perhaps best captured by the rival conclusions in Moore’s majority opinion in the Sixth Circuit and Guy’s concurrence. Moore’s opinion stresses that there are no general rules to determine significance, but rather that the question is context dependent.²⁹ One must consider the fit between what a proposed rule would do and the statutory goals of Congress. A comment that shows the fit to be a bad one because of an issue that the agency has not considered would be significant and would demand response. A comment that is not directed to the statutory ends that the agency is attempting to administer would miss the mark. It might be relevant to future statutory modification, but not to the rulemaking process at hand.

Considering this, the split of judicial opinion can be shrunk to one, essential point of disagreement. Moore considers the relevant statutory goal here to be satisfaction of the requirement that only perpetual conservation easements generate a deduction.³⁰ The proceeds regulation is closely tied to that goal because it addresses how to handle the case when an otherwise perpetual interest in real property ceases to be perpetual under state law extinguishment proceedings. The NYLC’s comment failed to clear the significance threshold on this account because it made no indication of how its points undermined Treasury’s attempt to satisfy the perpetuity goal.

Guy suggested that the majority was improperly treating perpetuity as a “trump card.”³¹ He found error in this because the committee reports evidence dueling statutory goals: Congress wanted deductible easements to be perpetual, but it also wanted to encourage the donation of conservation easements. These goals would seem to be in tension. A perpetual restriction is one that a landowner may be less willing to impose. Guy concluded that the NYLC’s comment on the proceeds regulation spoke to this deterrence issue, and that Treasury was therefore required to address it and was not free to simply ignore the congressional desire to encourage conservation easements.³²

Despite the judicial disagreement on this point, there is a clear resolution of the issue. The NYLC’s comment is not significant for these purposes. Guy’s argument against the majority’s “trump card” analysis fundamentally misunderstands the connection between the substantive content of a particular tax subsidy and the general goal of every subsidy to encourage something. The substantive content of a given tax subsidy is highly particularized — the contours will be set out by Congress, and Treasury will typically write regulations to clarify application in particular cases. The fact of subsidization or encouragement is not particular; it is general.

It is true of every tax expenditure that Congress is attempting to encourage something. This is crucial because every Treasury regulation will make some interpretive calls. It will always be possible to have written a regulation that is incrementally more favorable to the government or to the taxpayer. Thus, every proposed regulation may be subject to the critique that the rule could have encouraged more or deterred less if it had been written to be more favorable to the taxpayer.

But how could Treasury possibly balance such a concern? It can’t. The question is fundamentally legislative: It is the role of Congress to determine how much it wants to encourage something through the tax system. Congress insisted that deductible easements be perpetual. This will result in fewer donations than if Congress had permitted term conservation easements. The proceeds regulation is a sensible attempt to apply the concept of perpetuity considering state law extinguishment. Not only is the concern about deterrence insignificant in this sense, but I would go one step further: It would be improper for Treasury to put a thumb on the scale to reduce deterrence because doing so would increase the cost of the tax expenditure, and that’s a call for Congress, not Treasury. Moore’s opinion embeds this point about the institutional role of Congress, even if she voices the point from the perspective of the judiciary rather than from the perspective of the executive. Her opinion thus states: “The concurrence accuse[s] us of treating the perpetuity requirement . . . as a trump card. But we did not decide that perpetuity should play a vital role in the statutory scheme. Congress did.”³³

We can see the point even more clearly if we hypothesize a different, but analogous, rule. Suppose Congress decided it only wanted to encourage easements below a specified value, say $500,000. This might be a highly sensible conclusion. Perhaps it would be too costly for the government to encourage more valuable easements, or perhaps we would end up inefficiently subsidizing the wealthy, who have preexisting preferences for keeping open space around their homes. Suppose further that the statute gives no guidance on how to value easements, and Treasury must write regulations to guide valuation, a process that is complicated and subject to interpretive calls. On promulgating a regulation, a party submits a comment urging a different valuation technique that would tend to deflate valuations. This alternate technique would bring some easements that would be valued at, say, $600,000 under the proposed rule, down to a $500,000 valuation, thereby making them deductible. The commentator justifies its proposed amendment on the following grounds: The alternate technique should be adopted because it furthers the congressional goal of encouraging the contribution of easements.

Is this a significant comment? Must Treasury respond? I would say clearly not. Treasury’s task here is to write a regulation that is a reasonable approach to drawing the line between easements worth $500,000 or less and those worth more. This will have whatever incentive effects that the market will bear. It is not Treasury’s task, or within its power, to write a valuation rule to bring effect to some competing congressional goal to “incentivize the contribution of easements.” Requests that it do so should not count as significant in this context, and Treasury ought not be required to address a comment that asks it to take account of considerations that it could not consider even if it wanted to. This argument runs exactly the same way if we substitute “only deduct the contribution of easements worth less than $500K” with “only deduct the contribution of easements that are perpetual.”³⁴

The taxpayer might respond by citing Chenery,³⁵ which generally limits the justifications for agency action to those asserted by the agency at the time. Even if my argument is sound, it was up to Treasury to make it at the time. But calling on Chenery is to miss my point. Chenery would say that Treasury is not off the hook if we make after-the-fact justifications for how it adjusted or did not adjust a rule in the face of significant comments. My point is that no comment asking an agency to take account of a consideration that may not guide agency action in the first place can surpass the significance bar.³⁶

The reasons underlying my basic claim that certiorari grant and reversal would be a bad outcome should now be clear. The petition is well drafted and perhaps will be compelling to an audience of nontax specialists. The idea that an agency must take account of multiple statutory considerations is settled. The case closest on point here (relied upon by Oakbrook and by Guy in his Oakbrook concurrence) is Carlson,³⁷ which is instructive. The agency’s proposed regulations would have raised the price of stamps by 5 cents with the aim of satisfying a statutory mandate under 39 U.S.C. section 3622(c)(6) that the agency take account of “simplicity of structure.” A commentator objected that this was inconsistent with the enumerated statutory objective under section 3622(b)(8) to “establish and maintain a just and reasonable schedule for rates.” The D.C. Circuit found the comment to be “significant,” thus requiring agency response, because the agency was required to take account of the “several relevant statutory objectives and factors.”³⁸ This may seem analogous to Oakbrook and the proceeds regulation, which ostensibly involves both “perpetuity” and “encouragement/non-deterrence of easement contributions.”

It is not analogous. Carlson involved two enumerated statutory provisions, each of which the agency would have had to consider in writing implementing regulations. By contrast, “non-deterrence of conservation easements” is not an enumerated statutory objective or factor. Rather, encouragement/non-deterrence is a meta principle that applies generally to subsidies. The hard question — which must be left to Congress — is, how much encouragement do we want?

I’ve offered a technical analysis above for why I think the challenge is flimsy and the chief identified comment insignificant for these purposes. The asserted flaw in Treasury’s handling of the deterrence issue invites it to do something that is not a proper regulatory task. This is a technical argument. Let’s step back for a moment and consider the larger picture. The basic procedural invalidity claim rests on Treasury’s failure to respond to the point that the regulation’s handling of the improvements issue would deter conservation easements. This was 40 years ago. What has happened in the interim? There has been such a massive uptake of the conservation easement deduction that there have been Senate Finance Committee hearings addressing abusive arrangements and bipartisan proposed legislation to cut back on the benefit.³⁹ Deterrence of conservation easements because of the content of the proceeds regulation is a red herring.

Oakbrook is an extreme case — one in which a single comment has become the focal point even though that comment involved an implicit request that Treasury consider issues that it ought not take account of. If the proceeds regulation is invalid on such a thin record, many other Treasury regulations would seem to be in danger of a similar outcome. This prospect of widespread invalidation of regulations, many of them long-standing, will destabilize the administration of federal tax laws and is to be lamented.

My analysis above has assumed that if the Supreme Court granted certiorari it could well reverse the Sixth Circuit in Oakbrook. A grant followed by an affirmance would be a better outcome, but also not without problems. Although a reversal could destabilize a broad swath of Treasury regulations, the inverse is not true. I consider it unlikely that a Court decision upholding the Sixth Circuit’s ruling would bring assurance or stability to the area. This follows from the same point driving the prospect of instability. Oakbrook is an extreme case. A determination that Treasury did not need to respond to the isolated NYLC comment, which clearly fails the significance bar, would tell us only that litigants seeking to challenge procedural validity of regulations on the theory that Treasury failed to respond to comments will lose in extreme cases. Even if the Court were inclined to articulate a general statement of the significance standard that goes in the direction of stabilizing the regulatory space (a highly unlikely output from the current Court in any event), the extreme nature of the facts in Oakbrook would leave room for future litigants with slightly stronger facts to distinguish the precedent.

B. Status Quo

We have just seen why a grant of certiorari in Oakbrook is to be lamented. And the status quo under the proceeds regulation is not the disaster that the petitioner in Oakbrook seems to suggest. Future parties can plan around the issue in affected circuits. It is important to emphasize that parcels already conserved under extant conservation easements that generated prior tax deductions are not at risk of somehow losing their conservation protections. Oakbrook seems to suggest the contrary in its petition, quoting from the legal press as follows: “The split in the circuits is undeniable, and millions, if not billions, of tax dollars are at stake. Also at stake are millions of acres of land and species of birds and animals that may or may not be protected pending the outcome of this issue.”⁴⁰

Tax dollars are certainly at stake (though the magnitude is impossible to know and the prospect of the IRS recovering billions of dollars through litigation strikes me as quite remote). But the second part of this statement is simply false, whether it is meant to refer to existing easements or future ones: The land and the birds and the animals that are protected under current restrictions are not at risk — at least not from the IRS or federal courts adjudicating tax deductions. The result of deduction denial is just that. The taxpayer loses a federal tax deduction because it granted some interest that does not meet the qualifications of the federal tax regulations regarding conservation easements for claiming a deduction. This, of course, does not somehow invalidate the taxpayer’s deed or agreement under state law to restrict the property’s use. State law blessing conservation easements is not made conditional on the federal tax treatment of the easements, and it would be odd for a deed to be made conditional on this treatment. Model easements that I have reviewed take exactly the opposite approach: They explicitly disavow the offering of tax advice, state that there is no assurance of a tax deduction, and note that the field is uncertain and always evolving.⁴¹

But the fact that the status quo is not a disaster does not mean that it’s optimal or to be applauded. One should begin by acknowledging the elephant in the room, if not in the Oakbrook petition. The specifics regarding valuation of the claimed deduction in the case are troubling.⁴² At issue is a 143-acre parcel of land in Tennessee that was purchased for $1.7 million in 2007. A little over a year later, Oakbrook placed 106 acres of that land under a conservation easement, thereby limiting development of those acres, while preserving the right to develop the remaining 37 acres. Based on an appraiser’s evaluation, Oakbrook claimed a deduction of $9.545 million regarding the easement. The same appraiser had originally proposed a valuation of $19.5 million for the easement, but the taxpayer rejected this number as too high. Even with the lower amount of approximately $9.5 million this would represent extraordinary appreciation in value in a little over 12 months and at a time when the real estate market generally was declining.

It is entirely predictable that the IRS would object to the taxpayer’s valuation of over $9.5 million. The IRS could, and does, challenge valuation of conservation easements directly. The regulations on conservation easement valuation indicate that the preferred way to value easements is by reference to comparables⁴³ — that is, land trusts and government organizations sometimes purchase conservation easements, and these purchases would provide a benchmark for valuation. But the market for conservation easements is ordinarily thin, and each parcel and the restrictions thereon will often have unique attributes that would make a comparables-based analysis difficult even in thick markets.

For this reason, valuation in this context typically involves application of the regulatory “before-after” method. Rather than assessing the value of the easement directly, we can infer its value by comparing the value of the fee interest in real property before the restrictions created by the easement with the value after the adoption of restrictions.⁴⁴ The difference between the before-restriction and after-restriction amounts, logically, would seem to be the value of the easement. It would be as if we measured the mass of a slice of pie indirectly by measuring the mass of the whole pie, then weighing the remainder, and then subtracting the latter from the former, rather than measuring the slice of pie directly. The logic is appealing, but the application is elusive. How does one value the “whole pie” and the “partial pie” in the case of a conservation easement?

One method used by appraisers is to compare discounted cash flow analysis for the parcel of land with and without the restrictions. To challenge such an assessment would involve a battle of experts, offering rival assessments of discounted cash flow analysis. This is complicated, expensive, and exceedingly granular in the sense that an expert valuation in one case is likely to be of little to no use in other litigation. As a matter of revenue collection, it is unlikely that any case that made it to litigation would involve the IRS expert concluding that the restriction embodied in the easement had no value. A win for the IRS in such a case would involve some reduction — but not elimination — of the claimed deduction. From a pure litigation strategy standpoint, then, it is not surprising that we have landed where we have with the IRS asserting that deed language formally violates regulatory requirements.

As compared with disputing valuation, a claim that the deed creating a conservation easement fails to comply with the proceeds regulation would involve no need to deploy expert witnesses on valuation, could result in any claimed deduction being denied entirely, may increase the chance of penalties, and could offer a decisive argument in future disputes over conservation easements involving deed language that shared the essential features of the deed found not to comply with the proceed regulation requirements.

Some commentators have called the IRS to task for pursuing “technical” challenges when the real issue is valuation.⁴⁵ Holmes similarly criticized the IRS on these grounds in his Oakbrook dissent, in which he suggested that easement disputes be resolved case-by-case on valuation and run through a “valuation grinder.”⁴⁶ This issue is more complicated than these critiques make it seem.

Congress has blessed a charitable contribution easement deduction and has sought to use the tax expenditure as an important part of a national land conservation strategy. In adopting these rules in 1980, Congress took the “perpetuity” requirement seriously as it explicitly amended law that had permitted deductions for term easements.⁴⁷ The proceeds regulation reflects Treasury’s attempt to make good on the perpetuity requirement considering the possibility of judicial extinguishment of conservation easements. Most federal judges who have considered the issue have found the proceeds regulation to be substantively valid under Chevron and procedurally valid under the APA. And the Fifth Circuit in PBBM-Rose Hill has found the IRS interpretation of that regulation to be reasonable and entitled to Auer deference.⁴⁸ Academic commentators have likewise offered substantive justifications for the interpretation of the proceeds regulation followed in PBBM-Rose Hill.⁴⁹ Perhaps we can agree, then, that the largest abuse in the most egregious cases is one of overvaluation of the easement. But it’s odd to call the IRS to task for attacking merely technical or formal requirements of the regulations. Enforcing the numerous technical and formal requirements in the Treasury regulations is, after all, what the IRS generally should do.⁵⁰

But what about tax policy from the systemic perspective? As almost every student learns early on when studying Crane v. Commissioner in basic income tax, a revenue-maximizing litigation strategy is not necessary a long-run “win” for the system. Is IRS litigation under the proceeds regulation of a piece — a good, narrow strategy to win a few cases, but bad for the system as whole?

One might worry about such a prospect if the litigation and enforcement strategy cast a cloud over non-abusive easement transactions that Congress plausibly would have encouraged. Of note here is the prospect that the model conservation easement deed drafted and endorsed by the Land Trust Alliance (LTA), which has more than 1,000 member land trusts, includes language addressing the proceeds regulation that would be subject to challenge under the IRS interpretation.⁵¹

Regarding the improvements interpretive question, the LTA model deed concludes that a land trust donee ought not be accorded a portion of proceeds attributable to post-donation improvements made to the donor’s land. The IRS has already prevailed on the contrary position before the Fifth Circuit in PBBM-Rose Hill. This would seem to raise the specter that many ostensibly legitimate, non-abusive conservation easement deductions are subject to challenge.

I have hinted above that this is not obviously the wrong outcome. A belief that this outcome is troubling assumes that disallowing a deduction (or the mere threat of disallowance) for a charitable conservation easement with a conservative, unobjectionable valuation (but that is on the wrong side of the resolution of the interpretive debates over the proportionate value issue or the improvements issue) is a bad outcome from the standpoint of broader tax policy in this area. The obvious response is that any easement that fails to comply with a valid regulation and interpretation thereof should be cast under a cloud.

To resolve this tension, we should consider the effects on the overall conservation goals of section 170. The concern here is real, but not exactly for the reasons that have been suggested. The IRS litigation strategy, coupled with its wins in the Sixth Circuit in Oakbrook and in the Fifth Circuit in PBBM-Rose Hill, could cast a cloud over a large number of existing and future easements. This may seem in conflict with the congressional interest in promoting conservation through the deduction for conservation easements, but this concern is more apparent than real. Existing easements are in place and not revocable. Regarding future easements, parties can easily draft deeds that follow even the strictest interpretations of the proportionate value issue and the improvements issue. And though there have been suggestions that potential donors will be scared off by having to share proceeds from improvements with donee organizations, this concern is of questionable magnitude given that the prospect of judicial extinguishment, at least so far, has been remote.⁵² In any event, substantial donor improvements are likely to be in tension with a parcel’s conservation purpose, even if they’re consistent with reserved rights under an easement. If donors place under restriction only acreage where they do not intend to place substantial improvements but opt not to take a deduction regarding acreage where they do, query how large a problem this actually is.⁵³

Even so, there is still a cost to the status quo under PBBM-Rose Hill and Oakbrook. This cost has less to do with judicial extinguishment and the proceeds regulation, narrowly, and more to do with general reputational issues and donor willingness to make contributions that are at least partially motivated by the charitable contribution deduction. The fact that the IRS has challenged easement deductions, and won, based on a legal theory that would apply broadly to cases in which there is no underlying valuation abuse can be expected to percolate into land trust easement efforts and negotiations. If the belief that the IRS wants to challenge easements regarding technical or formal flaws that happen to be widespread or universal were to become pervasive, this would likely create a meaningful hurdle to land trusts reaching agreements on conservation easement donations. I consider this cost to be a real one that should be avoided.

II. Alternatives to the Status Quo

Let’s suppose it is possible to dodge the certiorari bullet. This would be welcome from an administrative law standpoint. But the status quo is not an optimal equilibrium position in terms of the narrower issue of the boundaries of the charitable contribution deduction for conservation easements. In this section, I consider alternatives.

A. Negotiated Solutions to the Judicial Extinguishment Issue

The procedural posture in Oakbrook involves a petition presenting only the question of procedural validity of the proceeds regulation. Although Toro found it useful to flip the typical order of analysis and consider the substance of the regulation to be a precursor to understanding what comments are significant, he acknowledged that this is atypical.⁵⁴ One can predict that if there is further judicial consideration of the procedural APA challenge it will proceed before additional analysis of the interpretive issues that arise under the ambiguous text of both the proposed and final regulations. And yet, I believe, much of the consternation over the proceeds regulation would disappear under a sounder reading of its substance than has been given to date.

One should begin here by drawing a distinction that courts and commentators have been frustratingly sloppy about eliding. This is the distinction between judicial extinguishment of a conservation easement and condemnation through the state’s exercise of eminent domain. Under the law of eminent domain, the state generally takes property that it condemns in fee simple absolute.⁵⁵ For example, if there were a traditional right-of-way easement on a parcel of land that the state condemns, the act of condemnation will erase that easement. As a matter of plain English, it does not seem wrong to say that a judicial order of condemnation produces the extinguishment of a conservation easement that burdens a parcel. But we must be careful here because extinguishment and condemnation have different meanings in the conservation easement space generally, and in the proceeds regulation particularly.⁵⁶

An extinguishment is a state law proceeding in which a judge lifts the restrictions on use or development that otherwise burden a real property interest because the conservation of the property as contemplated in the conservation deed is no longer possible or practicable. This is not a condemnation proceeding. Crucially, it need not be brought by the state. The holder of the restricted fee interest could bring the action in anticipation of the sale of the parcel to a private party. Accordingly, although a judicial extinguishment proceeding could involve a judge’s order regarding proceeds, this is not necessarily the case. There are no constitutional rights to just compensation at stake in the case of a private action to extinguish restrictions because the state has not taken anything for itself. And there may be no proceeds on the table to distribute until some later sale or exchange of the unrestricted parcel, which might not occur for a long time, if ever. By contrast, condemnation proceedings come with distinctive constraints. They generally involve constitutional requirements that property be taken only for public use and that the property owner be afforded just compensation.⁵⁷

As a temporal matter, this means that extinguishment and condemnation can interact in two basic fact patterns. In one scenario an extinguishment would occur first, only to be followed by a condemnation proceeding. In that case, post-extinguishment, the owner of the previously restricted fee interest would hold the property in fee simple absolute. The condemnation proceeding would involve a taking of that fee simple interest by the state. In the second scenario, the state would simply exercise its powers of eminent domain over a parcel of real property subject to a conservation easement. In that case there would be no need for a subsequent state law judicial extinguishment proceeding because the state would have already taken the interest in fee simple absolute. The theory of the dissipation of the conservation easement in that case is not that it would no longer be practicable or possible to conserve the property. The state need not make that showing or meet that burden. The state need only satisfy the requirements of public use and just compensation.

This distinction has crucial implications for the proceeds regulation that seem to have been ignored in prior discussions. Importantly, by its plain terms the proceeds regulation deals only with the first scenario described above. Thus, it refers to the grantee’s proceeds in the case of judicial extinguishment and a “subsequent sale, exchange or involuntary conversion.”⁵⁸ The references to “sale” and “exchange” are clearly meant to cover the possibility of subsequent voluntary private market transactions, whereas the reference to “involuntary conversion” implies a state taking of the post-extinguishment property. The proceeds regulation makes no reference to the case of a condemnation proceeding involving property with a conservation restriction in place. We can now draw a few conclusions about the soundest application of the proceeds regulation to deed challenges in conservation easement cases.

First, deeds often deal with both scenarios in separate clauses. Indeed, this is the case with the deed in Oakbrook, the relevant language of which is reproduced in the Tax Court opinion. Article VI(B)(2) of the deed addressed the situation of an initial extinguishment followed by subsequent sale, exchange, or involuntary conversion. The following section of the deed, Article VI(B)(3), addressed the case in which the state exercises eminent domain over a parcel regarding which the conservation easement has not been extinguished.⁵⁹ To the extent that the IRS were to challenge deed language involving condemnation of property still under conservation easement (that is, Article VI(B)(3) of Oakbrook’s deed), this challenge should be rejected. The proceeds regulation has nothing to say about this case. Second, drawing the necessary distinction between extinguishment and condemnation suggests that parties and courts have arguably been misreading the regulation more generally.

Reference to my numerical example and the analysis of the court in PBBM-Rose Hill is instructive. Recall that in my example, the assumption was an easement worth $100,000 at the time of donation and an unrestricted fee interest worth $1 million. The supposed ambiguity in the proceeds regulation is whether the requirement that the grantee’s share of proceeds reflect a constant “proportionate value” means a constant entitlement to $100,000 (the constant value theory) or rather a constant entitlement to 10 percent (the constant share theory). The proceeds regulation requires that at the time of easement creation the grantor acknowledge the existence of a “property right” in the hands of the donee.

The Fifth Circuit analyzed the constant value theory versus constant share theory in terms of what is required to be true of that property right over time. This led the court to analyze the meaning of the regulatory requirement at the time of grant (as that is what would have to remain constant). Here the court found “ambiguity as to whether the phrase ‘that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the value of the property as a whole at that time’ modifies ‘property right’ or ‘fair market value.’” In other words, if the proportionality requirement modifies “property right” this would carry the meaning that the grantee must be given a right akin to a fractional interest, or share, in the real property, or a 10 percent real property interest in this case. But if the proportionality requirement modifies “fair market value” this would mean the grantee must be given a right with value equal to the relevant fractional part of the total FMV, or $100,000 in this case. The Fifth Circuit resolved the seeming ambiguity in favor of the government’s constant share theory — that is, the Fifth Circuit reads the proceeds regulation so that proportionate value is taken to modify property right rather than FMV.

But why does it follow that just because proportionate value modifies property right, we must interpret proportionate value to mean a share rather than an absolute amount? It would seem to follow only if one reads property right to mean a real property right rather than a personal property right. Following my numbers above, it would be odd to think of a grantee as receiving a real property right that has constant value of $100,000. This is not how real property rights generally work. Instead, real property involves a bundle of rights that have the value that they do in a market. If one were to search the many millions of deeds in the various land recording offices across the country, I believe one would search in vain to find a deed that conveyed a real property interest that is demarcated in a constant, absolute dollar amount (excepting perhaps deeds that involve faulty attempts to track the proceeds regulation). Personal property is different; there is nothing odd at all about holding personal property that embodies a right to a fixed dollar amount.

The Fifth Circuit is not alone in reading the reference to a “property right” in the proceeds regulation to mean real property right. Indeed, the deed in Oakbrook uses the term “real property right” in the clause meant to track the proceeds regulation.⁶⁰ But I believe this reading is incorrect. There seems to be widespread conflation of the term “qualified real property interest,” the donation of which is a prerequisite to deductibility under the statute,⁶¹ with the requirement that the donor contemporaneously acknowledge a “property right” in the proceeds regulation. These are different concepts.

The distinction drawn above between extinguishment and condemnation shows why. If one were concerned with the scenario in which the government exercises eminent domain and pays just compensation in a condemnation proceeding regarding a parcel burdened by a conservation easement, then there would be no problem with collapsing the donee organization’s real property right (generated by the easement) and the organization’s right to proceeds upon dissolution of that right. But as noted above, the proceeds regulation has nothing to say about this scenario. The concern, rather, is with judicial extinguishment followed by a monetization event, which could occur many years later and which could be a private market transaction (sale/exchange) or not (involuntary conversion through condemnation). Treasury clearly wanted to preserve some sense of “perpetuity” in that case.

But there’s an obvious drafting challenge: If one were simply to require by regulation that the deed generating the donee’s real property interest include rights to share in post-extinguishment proceeds, this right would be unlikely to survive extinguishment. Suppose the donor brings a state law judicial extinguishment proceeding in year 1 and prevails. The deed generating the donee organization’s real property interest is essentially wiped off the books. Now suppose that in year 10 the donor sells the now unrestricted property for $1 million. The donee organization wants to assert a right to share in the proceeds. But to what right would it point? The rights embedded in the initial conservation easement grant have been extinguished. It seems like the best reading of the proceeds regulation, then, is that Treasury tried to draft around this problem by insisting that the donor grant the donee organization some right that would survive the judicial extinguishment proceeding. Thus, the explicit reference to a “property right” rather than a “real property right.” The best analogy for this sort of right is something like a chose in action — it would give the donee organization the right to sue for a share of the proceeds arising from a post-extinguishment liquidation.⁶²

There is further support for this interpretation in a regulation regarding basis allocation, which is cross-referenced in the proceeds regulation.⁶³ The basic premise of the basis allocation rule is that the donee’s easement should draw some of the aggregate basis of the pre-donation real property. This makes sense: If the donor were to sell the restricted property, then it should be entitled to recover only a proportionate share of basis when calculating gain. But the language Treasury used to accomplish this is telling. The regulation says the donor’s basis must be reduced by the amount of basis allocable to the “qualified real property interest” granted.⁶⁴ That is, Treasury reverts to the statutory term, including its reference to real property. Treasury understood how to denote real property when that was the intent; the proceeds regulation does not do so.

We can now return to the interpretive issue regarding the constant value theory versus the constant share theory. The Fifth Circuit approach in PBBM-Rose Hill leads one to a dead end. If property right does not mean real property right, then there is no reason to couple a reading in which proportionate value modifies property right with a constant share theory. A property right in the nature of a chose in action could equally be stated in terms of a constant share or a constant value. The proceeds regulation is equally consistent with each reading.

Further, in addressing the interpretive question regarding constant share versus constant value, it is important that neither of these interpretations systematically favors the interests of grantee organizations. Several illustrative examples in these debates have involved donated property that then appreciates. These examples show that the constant value theory will deliver a smaller amount of post-extinguishment proceeds to the grantee organization than the constant share theory. But the interests will run in the opposite direction with depreciated property — in that case, the constant amount theory will deliver more funds to a donee organization than the constant share theory.

More generally, we ought not assume that restricted property always, or even typically, appreciates. This is especially the case because judicial extinguishment should only arise if something rather extreme has changed, rendering conservation that was once feasible, and desired, now impractical or impossible. Those drastic changes might occur with rapidly appreciated land values, as in the case of a stranded conserved parcel that is now boxed in by many acres of high-value development, thus providing little open space benefit. But it’s just as possible that the drastic changes might greatly reduce value, as in the case of conserved land with a conservation purpose of natural habitat protection becoming surrounded by environmental decay and spoliation.⁶⁵ We should remember that the proceeds regulation is addressing a low-probability event, the interests of which ultimately could go one way or the other.

Considering flexibility of the proceeds regulation to accommodate either a constant share or constant value theory and that there is no ex ante reason to conclude that one interpretation systematically favors preservation of conservation purpose, the most sensible way to read the regulation is that it does not exclusively require or mean either constant value or constant share. One could think of this as a “negotiated solution” approach to the extinguishment issue.

A grantee organization might prefer to negotiate a deed with one or the other provision. It might, for example, prefer to lock in a fixed value if it worries land values will go down. Or it might prefer to negotiate for a constant share if it thinks values will go up. If a grantee organization believes values will go up and wants a proportionate share but the grantor objects that it should not have to share the value of post-donation improvements, then the parties could negotiate to subtract proceeds because of improvements from gross proceeds before applying the proportionate share.

It is difficult for me to see on what basis the regulation precludes the parties from negotiating these outcomes. The language does not require this. The regulation’s purpose does not require one or the other interpretation given variation in how future values may settle. One cannot even say that if we force the regulation into one meaning or another it might give a grantee organization the “stick” of lost deduction to elevate its interests in negotiation with would-be donors. That logic would ignore that each situation is unique, and one of the basic premises of adopting a conservation strategy of this form — one that uses a general public subsidy to encourage private giving and nongovernment-actor stewardship — is that local circumstances vary. But if we can’t generalize across all cases, then we would not even know how to interpret the regulation to convert it into such a stick.

My argument here is consistent with the requirement of “constancy” in the proceeds regulation. I read this simply to mean that the parties are required to stick to their ex ante bargain from the time of grant all the way through any post-extinguishment monetization. Thus, if a grantor attempted to renegotiate for a different split of proceeds in anticipation of bringing an extinguishment action, this would violate the regulations and should cause a donor inclusion under tax benefit rule principles.⁶⁶

In sum, I have offered a novel “negotiated solution” reading of the proceeds regulation under which negotiated language about division of post-extinguishment proceeds should generally be respected, so long as the terms incorporate a reasonable interpretation of “proportionate value” as of the time of grant (that is, constant share or constant value) and the arrangement is “constant” in the sense that the rights may not be renegotiated after easement creation.

Not everyone would be happy with this proposed outcome. To be sure, it would remove the cloud over what I’ve assumed are a range of non-abusive easements (regarding value), but it would also mean that the range of easements regarding which the IRS has actually won under a proceeds regulation challenge should actually have survived that challenge (though they may have been subject to other challenges). Even so, I believe it is the soundest reading of the proceeds regulation. Notice also that if we had followed this interpretation from the outset, it would seem to moot the procedural objection to the proceeds regulation that is the subject of the Oakbrook petition — that is, the concern about donor improvements voiced chiefly in the NYLC comment would seem to pose no concern if we interpret the regulation to give parties the flexibility to negotiate this term as they’d like.

The basic problem with a negotiated solution interpretation, though, is that there are hurdles to reaching this result judicially. It would likely require a circuit court to adopt the theory in contravention of what the Fifth Circuit has already held in PBBM-Rose Hill. There is a further potential roadblock in the form of Auer deference.⁶⁷ The Fifth Circuit applied Auer deference in following the IRS interpretation of the proceeds regulation to require a proportionate share theory. If that interpretation is deemed reasonable, it could be difficult for a sister circuit to adopt the regulatory reading I have set out here, even if it were otherwise compelled by it.⁶⁸

Judicial hurdles aside, for the reasons discussed above a negotiated solution approach to the judicial extinguishment issue is sound. The approach allows the parties that best understand a parcel’s attributes to bargain over ex ante uncertainty regarding the future prospect of judicial extinguishment and direction of change in land value. If it’s not possible for courts to settle on such an approach as a matter of regulatory interpretation, then the best outcome would be a statutory amendment that directly addresses the extinguishment issue and blesses a negotiated approach.

B. The Statutory Eject Button Under Section 170?

The suggestion that one might resolve issues regarding judicial extinguishment through statutory amendment invites the question whether the existing statutory language might already accomplish this. One way to avoid regulatory destabilization that does not involve reinterpreting the proceeds regulation would be to adjudicate cases involving post-extinguishment proceeds on statutory, rather than regulatory, grounds. Toro raised this issue sua sponte in his concurrence, concluding that Oakbrook’s deed did not meet the minimum requirements of section 170(h)(2)(C) and (5)(A) and thus did not warrant a deduction, regardless of the proceeds regulation. The government raised this issue for the first time on appeal before the Sixth Circuit. The majority declined to address this claim on the ground that the government needed to have raised it before the Tax Court and that resolution of the claim would require factual development absent from the record. Guy in concurrence, nonetheless, addressed the statutory claim and, like Toro, concluded that Oakbrook’s deduction should have been denied on statutory grounds.

In some ways this route seems like an excellent way to avoid the bad outcomes sketched above. Oakbrook loses its deduction, which is questionable in terms of underlying valuation; the IRS can avoid the expense and uncertainty of litigating over value; and the path need not question the underlying validity of the regulation — though, to be accurate, the procedural posture of the case has meant that even the judges favoring the statutory route have felt it important to voice an opinion finding the regulation to be procedurally invalid. Might there be a scenario in which the Supreme Court grants certiorari but then resolves the case on statutory grounds? It seems unlikely to me that the Court would be inclined to follow such a path. Even if it did, there would still be Eleventh Circuit precedent that would support weak (in my view) procedural challenges to future regulations. But there is a larger problem: The statutory argument fails on the merits.

The basic statutory argument is that Oakbrook’s deed creating the conservation easement failed to meet the perpetuity requirements of section 170(h)(2)(C) and (h)(5) because it determined the grantee’s share of proceeds from a monetization event following extinguishment by reference to an absolute amount set at the time of the easement’s creation. As applied to the numerical example introduced above, the Oakbrook deed would calculate the grantee’s proceeds by reference to the $100,000 (not 10 percent), and then reduce that $100,000 to reflect donor improvements. This statutory argument runs regardless of the treatment of improvements. It is based on the proportionality issue only; the basic argument is that section 170 requires the contribution of an “interest in real property” and that one of the rights that must be accorded to a real property interest is the right to be compensated at FMV upon a governmental taking. The asserted fatal flaw in Oakbrook’s contribution, then, is that the grantee organization was transferred a right based on FMV at the time of easement grant, but as a real property interest, whose value could go up or down, it would be necessary to ensure a right to FMV at a later time as proceeds are determined and paid. Thus, Oakbrook failed to convey an “interest in real property” and cannot take a deduction under the requirements of section 170.

To analyze this argument, it is helpful to draw on the discussion of extinguishment versus condemnation introduced above. As we have seen, there are two scenarios in which one could question whether a grantee’s interest is in perpetuity. The first scenario is a condemnation proceeding regarding a parcel of real property that is restricted by a conservation easement. The second is a judicial extinguishment proceeding followed by an involuntary conversion through condemnation. As noted, Oakbrook’s deed dealt with these scenarios separately: Deed Article VI(B)(3) dealt with the first scenario, and Article VI(B)(2) dealt with the second. Arguably Toro only meant to address the second scenario because his concurrence references the failure of Article VI(B)(2), not (B)(3). But it’s not possible to be certain, and even if there is an argument that Article VI(B)(2) is fine under the statute, one would still have to consider Article VI(B)(3). For completeness I will analyze how the statute should apply to Oakbrook’s deed under each of the scenarios.

In the first scenario, in which the state simply condemns the subject property at a time that it is still subject to a conservation easement, it is difficult to see how Oakbrook’s deed fails to create an “interest in real property” under state law. Consider that the Model Uniform Conservation Easement Act (the substance of which is reflected in many enacted state acts) sets out basic guidelines regarding the creation of a state law interest in real property (that is, the easement) by virtue of the placement of restrictions and affirmative obligations attached to some real property. In commentary the act indicates that it “neither limits nor enlarges the power of eminent domain; such matters as the scope of that power and the entitlement of property owners to compensation upon its exercise are determined not by this Act but by the adopting state’s eminent domain and related statutes.”⁶⁹

In other words, compliance with a state’s conservation easement provisions should be sufficient to generate an “interest in real property.” State eminent domain law is a separate matter and would require just compensation for whatever “interest in real property” is taken. A further problem with applying the statutory argument to this first scenario is that it is widely accepted that parties can negotiate over the distribution of compensation from eminent domain proceedings.⁷⁰ This does not mean that a party that forgoes what it would otherwise be entitled to somehow no longer holds an “interest in real property”; the interest would still bear the standard hallmarks of real property under state law. The point is that the state is obligated to pay just compensation for the fee simple absolute, which is what it takes post-condemnation. But the split of these proceeds is a matter of private contractual determination, which does not affect the status of any particular interest as an interest in real property.

To analyze the second scenario, we need to parse the statute more closely. Toro, in concurrence, indicated that Oakbrook’s deed failed to transfer the required interest in real property under the perpetuity requirements of section 170(h)(2)(C) and (5)(A). But these provisions are different for these purposes. Section 170(h)(2)(C) requires a “restriction (granted in perpetuity),” and section 170(h)(5)(A) stipulates no deduction unless an easement’s “conservation purpose is protected in perpetuity.”

It is difficult to see how Oakbrook’s deed language regarding this scenario could be read to violate section 170(h)(2)(C), which involves perpetual grant. After all, Oakbrook granted the maximum temporal rights that it could under state law. It is literally impossible to grant rights that would be immune from judicial extinguishment — it’s not within the power of private parties to strip state law judges of their equitable powers to revise the restrictions. Oakbrook thus granted all that it could grant under state law.

The analysis under section 170(h)(5)(A)’s requirement of perpetual protection of the conservation purpose is more difficult to analyze. Its meaning is genuinely ambiguous. It could mean that to qualify for deduction it must be the case that a successor in interest to the easement (for example, a land trust that acquires the easement from the initial grantee land trust) has the right to enforce the restrictions. This sort of transferability, for example, is dealt with in the Uniform Conservation Easement Act⁷¹ and is addressed in the section of the regulations that immediately precedes the proceeds regulation.⁷² Or, the statute could mean something more. It could mean that in the case of a post-extinguishment monetization even a requisite amount of funds from the event must be directed to the conservation purpose that underwrote the deduction in the first place. Clearly, this is how Treasury read the statute when writing the proceeds regulation.⁷³

At least if interpreted as I’ve argued above, in which case the parties are allowed to negotiate over the content of proportionate value if the ex ante determination is not later amended, the proceeds regulation should constitute a reasonable interpretation of section 170(h)(5)(A) and would be immune to substantive challenge. But I would think it nearly impossible to read any requirements regarding the distribution of post-extinguishment monetizing proceeds directly into the statutory text. Imagine the case in which the proceeds regulation had never been promulgated and the IRS challenged the Oakbrook deed on the grounds that the agreed distribution of post-extinguishment proceeds failed to meet the statutory requirements of section 170(h)(5)(A). I believe the IRS would lose that case hands down. If that’s right, then Article VI(B)(2) of Oakbrook’s deed does not run afoul of the section 170(h)(5)(A) perpetuity requirement.

C. IRS Cease-Fire Notice on the Proceeds Regulation

I have argued that the best approach to addressing the extinguishment issue is to allow parties to negotiate over the division of post-extinguishment proceeds and that it may be necessary to amend the statute to get to this result. Further, statutory amendment should not be off the table because of the obstacles of passing any tax legislation in the current political environment. Revision of the statutory provisions regarding conservation easements has already generated rare bipartisan support, and both Democrats and Republicans have endorsed statutory amendment to deal with valuation abuse in syndicated conservation deals.⁷⁴ Were legislation to gain traction, it might be possible to include language clarifying the treatment of judicial extinguishment and the division of post-extinguishment proceeds.

Statutory amendment, however, does nothing to address the shortcomings of the status quo in the interim. As an interim approach, the best overall outcome may be for the IRS to issue a notice indicating what it will and will not challenge under the proceeds regulation. One can expect the IRS to reject any such proposal; the agency is, after all, winning cases under challenges based on the proceeds regulation. There is some precedent, however, of the IRS conceding issues wholesale, even where it could be expected to accrue wins in litigation.⁷⁵ Further, my proposal here would:

1. comport with the best interpretation (as argued above) of section 170(h) and of the proceeds regulation;

2. provide certainty to taxpayers across a multitude of non-abusive cases in which there is concern that the IRS might challenge prior deductions; and

3. pending further legislation, preserve IRS ability to challenge abusive conservation easement transactions on other theories, whether valuation or regulatory challenges under provisions other than the proceeds regulation.

For these reasons, I think this is the best path to balance the range of competing interests.

In terms of content, I propose that the IRS issue a notice that has the following components:

1. Regarding the proportionate value issue, the taxpayer may choose whether to divide post-extinguishment proceeds by reference to a fixed proportionate amount or a fixed proportionate share. A conservation easement deduction will not be challenged under the proceeds regulation solely because the parties agreed to employ one of these methods rather than the other.

2. A conservation easement deduction will not be challenged under the proceeds regulation solely on the grounds that the division of post-extinguishment proceeds is adjusted to reflect post- donation improvements. Reliance on this clause, however, requires that proceeds attributable to post-donation improvements be netted from gross proceeds before determining proportionate entitlement under (i) and not from grantee’s portion of proceeds determined under (i).

3. If, after the date of this notice, a taxpayer agrees with a grantee organization to amend terms of a grant so as to be in compliance with (ii), the IRS will not challenge a deduction based on the content of the arrangements before the amendment. Because any conforming amendments are not amending an interest in real property but rather merely a property right to share in proceeds from liquidation of real property, any amendments under this clause would not be grounds for additional deductions under section 170(h).

I close with a handful of observations about my proposal. First, it would be particularly difficult for the IRS to swallow (i) as it has already achieved a victory in PBBM-Rose Hill on this issue. Recall that in this case the court held that the proceeds regulation was ambiguous on the proportionate value issue but applied Auer deference to conclude that the IRS interpretation requiring a proportionate share rather than a proportionate amount was reasonable and to be upheld. That’s a result that has universally been followed by other courts so far. Also, commentators have advanced substantive arguments for why this interpretation is the superior one.⁷⁶ If the IRS wanted to retain this principle, then it could revise (i) to require parties to agree to determine proceeds by reference to proportionate share rather than amount, but then permit parties to make curing amendments regarding this provision.

Second, the distinction drawn in (ii) regarding the allowed order of subtracting out proceeds attributable to improvements requires explanation. Consider again my numerical example, but suppose the unimproved land (without restrictions) increases in value from $1 million to $2 million, and assume that grantor has added a $200,000 building to the unimproved land, bringing total value (without restriction) to $2.2 million. Now suppose judicial extinguishment and subsequent liquidation proceeds of $2.2 million. Under the proposed notice it would be permissible to calculate grantee proceeds as $2.2 million - $200,000 = $2 million, with the grantee then entitled either to $100,000 (proportionate amount) or $200,000 (proportionate share). The impermissible result would be to calculate grantee’s share initially as $100,000 or $220,000 (that is, 10 percent x $2.2 million) and then subtract out $200,000, leaving grantee either with $0 or only $20,000.

There are several reasons to draw this distinction. The initial agreement was about the unimproved land and the parties’ agreement regarding proceeds should relate to a division of that value. This distinction tracks the language in the Land Trust Alliance model deed⁷⁷ and the position that the IRS voiced in the private letter ruling on the issue.⁷⁸ This distinction is consistent with what I’ve offered as a sound interpretation of the proceeds regulation — that is, in general, the regulation gives parties leeway to agree to different ways of calculating proportionate value, if they don’t deviate from that after the fact. But if one nets proceeds attributable to improvements from grantor’s portion of gross proceeds, then it would be open for the donor to unilaterally erode what would otherwise be grantee’s agreed portion of post-extinguishment proceeds simply by constructing improvements on the land.

Third, although judicial extinguishment of conservation easements appears to have been rare to date, it would be a mistake to assume that this will be the case forever. As more and more land is placed under restriction for perpetuity and more and more time passes, it is reasonable to conclude that eventually we will see more cases in which judges determine that an easement’s conservation purpose is no longer possible or practicable. Perhaps many more cases. This might raise the concern that bad-faith would-be easement donors are just interested in negotiating favorable divisions of post-extinguishment proceeds.⁷⁹ If so, then one might worry that my proposed notice goes too far in allowing grantors to negotiate favorable terms. But I think the appropriate response to this is that it puts the burden of ensuring sound conservation easement practice in the wrong place. The easements are a creature of state law, and the prospect of extinguishment is an act of a state court. It is far better to have the states (whether by amendment to their easement statutes or through stringent judicial application of the “impossible or impractical” standard) police potential abuses than it is to assign that task to ill-suited and ambiguous Treasury regulations.

III. Conclusion

The conservation easement stew that threatens to boil over into Supreme Court adjudication has all the ingredients for a bad outcome. We observe in these cases large revenue consequences, an intersection of broad administrative law ramifications and narrower tax policy considerations surrounding subsidization of land conservation, a mixture of arguably abusive shelters and wholly legitimate transactions, and strenuous disagreement among different members of the federal judiciary. In this report I have attempted to offer a route to sidestep the landmines and worst outcomes here.

First, the Court should deny certiorari in Oakbrook. The legal criterion of “significance” that determines the need for an agency to respond to a comment in rulemaking is already clear. The comment at issue in Oakbrook was not significant. Suggesting that it is even close to the line can only serve to destabilize tax regulatory law generally.

Second, we must not lose sight of the fact that judicial extinguishment is a sideshow to this drama. There is no evidence that judicial extinguishment is common or has occurred to any meaningful extent. If that situation changes, there is no reason to doubt that state courts can adequately assess extinguishment. And given that extinguishment could just as well accompany depreciated property values as appreciated ones, land trusts and donors should be left to negotiate over post-extinguishment proceeds. I have argued that such a negotiated outcome is already condoned under the best interpretation of the proceeds regulation. If that’s wrong, then a statutory amendment should embrace a negotiated solution to the post-extinguishment proceeds issue.

Third, pending regulatory or statutory resolution of the judicial extinguishment issue, the IRS should consider issuing a cease-fire notice on litigating under the proceeds regulation.