Glade Creek Partners, LLC v. Comm'r

GLADE CREEK PARTNERS, LLC, SEQUATCHIE HOLDINGS, LLC, TAXMATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

T.C. Memo. 2020-148

Docket No. 22272-17.

UNITED STATES TAX COURT

November 2, 2020

Gregory P. Rhodes, David M. Wooldridge, Ronald A. Levitt, and Michelle A. Levin, for petitioner.

W. Benjamin McClendon, Amber B. Martin, and William W. Kiessling, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GOEKE, Judge: In 2012 Glade Creek Partners, LLC (Glade Creek), donated a conservation easement on 1,313 acres of undeveloped real estate on the Cumberland Plateau in Bledsoe County, Tennessee, and claimed a $17.5 million charitable contribution deduction (easement deduction) for its short tax period November 30 to December 31, 2012 (December 31, 2012, short tax period).¹ The land was part of a failed residential development. Glade Creek acquired the land in a transaction intended to rescue the developers from debt associated with the failed development. The primary issue is whether Glade Creek is entitled to the easement deduction under the technical requirements of section 170. We hold it is not. We hold that the deed of easement does not protect the conservation purposes in perpetuity as required by section 170(h)(5). We hold further that Glade Creek is entitled to deduct a $35,077 cash charitable contribution that respondent denied.²

Respondent asserts a 40% penalty under section 6662(e) and (h) for a gross valuation misstatement on the basis of the reported value of the easement and, alternatively, with respect to Glade Creek's misstatement of the value of the charitable contribution, a 20% penalty under section 6662(a) and (b)(1), (2), and(3) for negligence or disregard of rules or regulations, a substantial understatement of income tax, or a substantial valuation misstatement. We sustain the 20% accuracy-related penalty for a substantial valuation misstatement in excess of the easement's fair market value, which we determine to be $8,876,771. We do not impose a 20% penalty on the remainder of the adjustment.

FINDINGS OF FACT

Glade Creek is a Georgia limited liability company (LLC) and has elected partnership status for Federal tax purposes. When the petition was timely filed, its principal place of business was in Georgia.

I. History of the Property

In January 2006 International Land Co. (ILC) purchased 1,997.25 acres of land in Bledsoe County (Bledsoe property) for over $9 million in a seller-financed arrangement. ILC planned to subdivide and market lots on 1,993 acres of the Bledsoe property in separate phases to out-of-State purchasers for the construction of vacation homes.³ The first phase of ILC's plan was tract I, a 677-acre parcel with 415 lots, and subsequent phases were tracts II and III, noncontiguous parcels connected by tract I, of 630.4 and 685.5 acres, respectively, with 391 more lots.The easement property is 1,312 acres of tracts II and III; 4 acres are not subject to the easement.

When ILC purchased the Bledsoe property, it was undeveloped, with rolling mountains and level, buildable areas, forests, streams, ponds, waterfalls, and four miles of bluffs overlooking the Sequatchie Valley. The property required significant infrastructure to support a residential development, including improved hydraulic capacity for water service, electrical infrastructure, and roads. The property was serviced with one low-current electrical power line typical in rural areas and no interior roads. Also, the local water authority did not have a sufficient water supply to support a residential community. The surrounding area was primarily used for agriculture or recreation. Nearby commercial development was limited; it included restaurants, grocery stores, a pharmacy, a small hospital, service stations, and limited retailers. There was also a State prison nearby.

ILC was owned by a small group of out-of-State developers. Before purchasing the land, ILC sought the advice of a local businessman, James Vincent, on its development potential. Mr. Vincent was a local real estate investor and had contacts with local government officials to facilitate the project from his time as a commissioner of a nearby county where he served on the planning commission and as a State representative. After ILC purchased the land Mr. Vincent became highly involved in the development project. He assisted with procuring permits from State and local governments, utility contracts, and bank financing. He invested a considerable amount of his own money in the infrastructure and personally guaranteed ILC's bank loans. At first Mr. Vincent did not have a financial interest in the development, but ILC later agreed to compensate him for his services and reimburse his expenses with a percentage of its profits.

ILC obtained permits and approvals with respect to all three tracts. However, development was limited to 50 acres at any time of residential construction by individual lot buyers to minimize the disruption to the land. The approval process involved testing the soil for its suitability for construction, including water absorption. ILC obtained a 25-year contract from a nearby water authority for a water supply sufficient to support development of all three tracts. It spent $1.2 million to construct a pump station to provide hydraulic pressure to transport the water to the Bledsoe property and $2 million to install water main pipes from the pump station throughout tract I. It paved roads throughout tract I. It installed electrical infrastructure that could service a residential development on all three tracts. Electricity would be connected to individual lots when home construction began. The improved water lines, roads, and electrical lines extended to the borders of tracts II and III for the later planned development of those tracts. Overall, ILC spent approximately $6 million on the infrastructure and approval process.

In March 2007 ILC recorded the planned lots on tract I and easements along creeks and waterfalls and placed restrictions on the cutting and clearing of timber. It did not record the lots on tracts II and III. It planned to market tracts II and III after tract I lots sold out. Mr. Vincent believed that recording the lots would increase property tax. ILC began sales of tract I lots in March 2007, selling 75 lots in 2007 and 46 lots in 2008. Lots with bluff views sold for as much as $150,000. Sometime in 2009 ILC stopped marketing the lots because it ran out of money, causing sales to slow dramatically; it sold only nine lots in 2009. Facing slow sales, a depressed real estate market, and substantial debt, the investors faced enormous pressure and uncertainty. One investor walked away. The remaining investors and Mr. Vincent devised a plan to transfer the unsold lots in tract I and all of tracts II and III to Mr. Vincent and two members of ILC. Mr. Vincent was not a member of ILC but had invested substantial amounts of time and money in the project and had personally guaranteed ILC's bank loans.

In April 2010 the three men organized Hawks Bluff Investment Group, Inc. (Hawks Bluff), an S corporation, as equal owners, and acquired the remaining unsold land by warranty deed in exchange for the assumption of ILC's liabilities. Initially, the three men made equal monthly payments on the debt (Hawks Bluff debt), which totaled $33,000 per month. A short time later one stopped making payments and surrendered his interest in exchange for the two remaining members, Mr. Vincent and Mr. Tague, assuming his share of the debt and releasing him from liability. The prospects of the development continued to worsen. Messrs. Vincent and Tague struggled to make debt payments. Without any marketing Hawks Bluff sold only two lots during 2010 and 2011 and no lots in 2012. In April 2011 Hawks Bluff entered into a mortgage modification agreement that paid off $2.1 million of the remaining $5.2 million unpaid purchase price to the original seller of the Bledsoe property through a land transfer to the mortgagee and the issuance of two promissory notes and the mortgagee's agreement to reduce the outstanding debt by an additional $1.3 million "in consideration of the downturn in the economy and the difficulty encountered * * * in marketing the Hawks Bluff Subdivision". After this modification, Hawks Bluff owed $1.8 million to the original seller and had approximately $3.3 million in total debt. Mr. Vincent worried about the possibility that Mr. Tague would stop paying his share of the Hawks Bluff debt especially since Mr. Vincent had personally guaranteed a considerable portion of the loans for the infrastructure. Mr. Vincent was not certain that he could fund the monthly debt payments for an extended time if Mr. Tague stopped making payments.

In his efforts to find a financing solution, Mr. Vincent learned about conservation easements from the president of the bank that held the infrastructure loans. At the bank president's suggestion, Mr. Vincent sought advice from Matthew Campbell about donating a conservation easement on the Bledsoe property to raise money to repay the debt. Mr. Vincent also considered harvesting timber from the land and selling the land to a developer, most likely through fire sales of 5- to 15-acre parcels. He believed that these two options would have raised enough money to repay the Hawks Bluff debt. However, for Mr. Vincent, neither option would satisfy his desire to protect the Cumberland Plateau and the natural beauty of the Bledsoe property. He did not want to sell to a developer who would use it for a mobile home community, recreational vehicle park, or other environmentally insensitive development. He believed that these types of developments would negatively affect the development on tract I, which Hawks Bluff would continue to own and market the unsold lots. He also felt a duty to the individuals who had purchased tract I lots to maintain the original vision of ILC's plan. He had no desire to...