11th Circ. Dealt A Serious Blow To The IRS by Striking Down The Treasury Conservation Easement Reg.

According to Law360, The Eleventh Circuit in David F. and Tammy K. Hewitt v. Commissioner of Internal Revenue, case number 20-13700, U.S. Court of Appeals for the Eleventh Circuit, struck down a Treasury rule governing the proceeds from judicial extinguishment of conservation easements that has spoiled many such tax breaks for donors, overturning a U.S. Tax Court decision denying a couple's
$2.8 million deduction.

The U.S. Department of the Treasury failed to sufficiently address public feedback in finalizing the rule governing what happens with proceeds from a potential judicial extinguishment of a conservation easement, the Eleventh Circuit said in an opinion dated Dec. 29, 2021. A three-judge panel reversed a Tax Court decision finding David and Tammy Hewitt couldn't claim the deduction over several years. 

The rule doesn't pass muster under the Administrative Procedure Act, which requires that agencies respond adequately to significant public comments when finalizing regulations, according to the opinion. Those Treasury regulations essentially require that deeds cannot allow for proceeds given to an easement recipient in the event of a judicial extinguishment of the easement to be reduced by any post donation improvements to the property.

The Regulation "Is Arbitrary And Capricious Under The APA For Failing To Comply With The APA's Procedural Requirements And Is Thus Invalid," The Opinion Said.

The Eleventh Circuit opinion dealt a serious blow to the Internal Revenue Service in its efforts to scrutinize conservation easement deductions, which were created to encourage land preservation but some say have been prone to abuse. The Tax Court has consistently sided with the agency in finding that taxpayers who ran afoul of the judicial extinguishment rule under Section 1.170A-14(g)(6)(ii) of Treasury Regulations cannot claim the corresponding tax deduction, affirming the validity of that rule in May 2020 in a case brought by Oakbrook Land Holdings LLC.

One of those cases included the challenge brought by the Hewitts, who claimed the tax deduction for their easement split between 2012, 2013 and 2014. The IRS issued a deficiency notice in 2017 that nullified the deduction, which the Tax Court affirmed in a June 2020 opinion that said the couple's violation of the judicial extinguishment rule means their easement wasn't protected in perpetuity as required under Internal Revenue Code Section 170.

The Hewitts have since argued that Treasury, in finalizing the rule in 1986, failed to account adequately for comments sent in by groups such as the New York Landmarks Conservancy that urged the agency to do away with the extinguishment provision or otherwise raised concerns with the rules proposed by the agency. When Treasury addressed comments it received on the regulations in the final comments, it didn't acknowledge those made by the NYLC or others that addressed the extinguishment regulation, according to the opinion.

The IRS has argued that the comment from the NYLC was not significant enough to warrant it being addressed in the final rules, according to the opinion.

But the Eleventh Circuit found that the conservancy's comment raised issues concerning the regulation's ability to undermine the intent of the conservation easement statute and warranted an acknowledgment by Treasury.

"NYLC's comment was significant and required a response by Treasury to satisfy the APA's procedural requirements," the opinion said. "And the fact that Treasury stated that it had considered 'all comments,' without more discussion, does not change our analysis."

The Eleventh Circuit cited its decision in the case Lloyd Noland Hosp. and Clinic v. Heckler, in which the appeals court invalidated an insurance rule whereby the U.S. Department of Health and Human Services failed to heed public comments. Under that precedent, Treasury's judicial extinguishment rule doesn't pass muster under the APA, according to the opinion. 

The Eleventh Circuit sent the case back to the Tax Court for further proceedings. 

While the appeals court found the regulation is procedurally invalid under the APA, it didn't decide whether the IRS' interpretation of the regulation is substantively incorrect, as argued by the Hewitts.

"Both the IRS and taxpayers benefit when the IRS meaningfully engages in the rulemaking process," Levin said. "Compliance with the APA's rulemaking process is essential because it provides taxpayers with notice as to what is required by the rules and gives the IRS valuable input as to the rules it is proposing."     

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