Judgment summary
This is a partnership-level proceeding under the Bipartisan Budget Act of 2015 (BBA) involving a syndicated conservation easement (SCE). Respondent issued a Notice of Final Partnership Adjustment (FPA) for tax year 2018 to David L. Hall, as partnership representative for Piton Holdings, LLC. In the FPA respondent disallowed petitioner's noncash charitable contribution deduction of $42,200,000 under section 170 and determined alternative penalties of $6,220,625 under section 6662(a), (b)(1)-(3), (c), (d), (e), and (h) and section 6662A.
After the parties filed Stipulations of Settled Issues, the remaining issues were the fair market value of the conservation easement, whether petitioner properly allocated its claimed noncash charitable contribution deductions, and whether petitioner is liable for an accuracy-related penalty under section 6662.
The Court held that the fair market value of the land at the time of contribution was $1,440,000, that the value of the conservation easement was $800,000, that petitioner did not properly allocate its noncash charitable contributions, and that petitioner is liable for a 40% gross valuation misstatement penalty under section 6662(h).
Background
Piton Holdings, LLC is an Alabama limited liability company treated as a partnership for federal tax purposes and is subject to the BBA centralized partnership audit regime. Its principal place of business was Alabama when its Petition was filed. Absent stipulation to the contrary, appeal would lie to the U.S. Court of Appeals for the Eleventh Circuit.
On September 13, 2012, DESE Properties, LLC, a disregarded entity of DESE Research, Inc., purchased 662.42 acres of land in Madison County, Alabama (the Parent Parcel) for $1,059,872, or $1,600 per acre. The property at issue is a rural, undeveloped 377.74-acre parcel that is a portion of the Parent Parcel. It is a wooded greenfield site with rock outcroppings, in an unincorporated area not subject to zoning restrictions, and approximately 19 road miles from downtown Huntsville.
Matthew Ornstein and Frank A. Schuler IV are promoters of SCEs and created or directed the creation of many LLCs referred to as OSI-affiliated entities. Petitioner was formed on May 10, 2017 as the property-owning entity. Piton Group, LLC served as the investment company. Sean O'Toole and James Comerford formed 1908 Capital, LLC in 2017, and created 1908 Capital PG, LLC to purchase membership interests in petitioner from OSI and serve as manager.
On or about July 14, 2017, Longleaf Ventures, LLC (an OSI-affiliated entity) and Dr. Kirkpatrick executed a Membership Interest Purchase and Sale Agreement (DESE MIPSA), later amended twice. At closing in late June 2018, DESE Properties contributed the Property for a 99.5% interest and Dr. Kirkpatrick contributed $4,100 for a 0.5% interest. Natural Aggregates Partners, LLC paid DESE Properties $816,000 as consideration for a 98% interest.
Various reports were prepared, including a June 26, 2018 report by Marvin Blethen concluding the Property contained just under 89,750,000 tons of proven mineral resources and had a value of $42,258,000 as a limestone mine, and a June Appraisal by Clayton Weibel stating a before value of $42,190,000 and an easement value of $41,625,000. On December 27, 2018 petitioner recorded a deed of conservation easement in favour of PCC at 3:03 p.m. central time, and two minutes later recorded a warranty deed conveying its fee simple interest to ACCP.
Petitioner claimed a $41,635,000 deduction for the easement donation and a $565,000 deduction for the fee simple donation, for a total of $42,200,000, allocating the deductions among Piton Group (97%), DESE Properties (1.5%), 1908 Capital PG (1%), and Dr. Kirkpatrick (0.5%).
Core dispute
The parties disputed the fair market value of the conservation easement, with petitioner claiming a value of $41,635,000 and respondent contending a far lower value.
The parties disputed whether petitioner properly allocated its claimed noncash charitable contribution deductions, with respondent contending that the four members to whom deductions were allocated did not reflect petitioner's membership at the time of the charitable contributions.
Petitioner disputed the constitutionality of the accuracy-related penalty under section 6662 in light of SEC v. Jarkesy, arguing that the Seventh Amendment guarantees a right to trial by jury.
The parties disputed whether the section 6662(d)(2)(B)(ii) disclosure exception applied to the section 6662(e) and (h) valuation misstatement penalties. Petitioner contended it could apply; respondent contended it was limited to the section 6662(d) substantial understatement penalty.
Court findings
On valuation, the Court held the highest and best use of the Property was recreational with all future development rights and mineral rights, being its current use, and that petitioner failed to demonstrate closeness in time or reasonable probability that the Property would be used as a limestone mine. The Court found petitioner had not met its burden to show the presence of the mineral in a commercially exploitable amount that would justify its extraction in the reasonably foreseeable future, and that petitioner failed to prove a mine's financial feasibility or the existence of a market.
The Court accepted the comparable property sales approach used by respondent's expert Mr. Ball, who determined a before value of $3,800 per acre for a value of $1,440,000. It found this supported by the June 2018 sale of partnership interests. The Court rejected the income method used by petitioner's expert Mr. Catlett, holding it equated the value of raw land with the net present value of a hypothetical limestone business and relied on speculative inputs.
The Court held that the before value of the Property was $1,440,000 and, subtracting the stipulated after value of $640,000, the value of the easement was $800,000.
On allocation, the Court held that petitioner had four variations in its 2018 tax year and that the terms of the respective MIPSAs, not the company agreements, governed when 1908 Capital PG and Piton Group became members. The earliest 1908 Capital PG could have become a member was December 27, 2018 at 3:26 p.m. central time, and the earliest Piton Group could have become a member was December 28, 2018 at 3:23 p.m. central time. Because the charitable contributions were incurred on December 27, 2018 at 3:03 p.m. and 3:05 p.m. central time, petitioner had five members at that time: TOFT, Province, DESE Properties, Dr. Kirkpatrick, and OS LLC. The Court held the contributions were extraordinary items under Treasury Regulation section 1.706-4(e)(2)(i) and that petitioner's allocation of deductions to 1908 Capital PG and Piton Group was improper as a matter of law.
On the penalty, the Court held that because the claimed value of $41,635,000 exceeded the correct value by far more than 200%, the valuation misstatement was gross and the reasonable cause defence was not available. Following Riddle Aggregates, LLC v. Commissioner, the Court held the public rights exception to the Seventh Amendment applies to the section 6662 accuracy-related penalty and to such penalties for BBA partnerships. The Court held that the section 6662(d)(2)(B)(ii) disclosure exception does not apply to the section 6662(e) substantial valuation misstatement penalty nor to the section 6662(h) gross valuation misstatement penalty, based on the plain statutory text.
Outcome
The Court held that the value of the conservation easement on the Property is $800,000. Petitioner improperly allocated its charitable contribution deductions. Petitioner is liable for a 40% gross valuation misstatement penalty under section 6662(h).
Because the gross valuation misstatement penalty applies, the Court did not reach the alternative penalties determined by respondent. Decision will be entered under Rule 155.
Major issues / areas of contention
- The fair market value of the donated conservation easement, determined using the before and after valuation method.
- Whether the highest and best use of the Property was as a limestone quarry or recreational with future development and mineral rights.
- Whether the comparable property sales approach or the income (owner-operator) method properly valued the Property.
- Whether petitioner properly allocated its noncash charitable contribution deductions among its members under section 706 and the varying interest rule.
- Whether the MIPSAs or the company agreements governed when new members were admitted to the partnership.
- Whether petitioner is liable for a gross valuation misstatement penalty under section 6662(h) and whether the reasonable cause defence was available.
- Whether the accuracy-related penalty under section 6662 is unconstitutional under the Seventh Amendment in light of SEC v. Jarkesy.
- Whether the section 6662(d)(2)(B)(ii) adequate disclosure exception applies to the section 6662(e) and (h) valuation misstatement penalties.