Browning v. Commissioner

*304 HALPERN, JUDGE: These consolidated cases involve the following determinations by respondent of deficiencies in petitioners' Federal income taxes:

The issue in dispute is the amount (if any) of petitioners' charitable contribution on account of petitioners' conveyance to Howard County, Maryland, in 1990 of an easement relating to certain real property.

Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

INTRODUCTION

Some facts have been stipulated and are so found. The stipulation of facts filed by the parties, along with accompanying exhibits, is incorporated herein by this reference.

Petitioners resided*72 in Woodbine, Maryland, at the time the petitions herein were filed.

SUBJECT PROPERTY

The real property that is the subject of this case is a 52.44 acre tract of land located at 1874 Florence Road, Woodbine, Howard County, Maryland (the land and Howard County or the county, respectively). The land has been in Mrs. Browning's family for six generations and was acquired by petitioners in 1987 following the death of Mrs. Browning's parents. The principal use of the land is agricultural. The land is situated between tracts of land owned by William Barnes, to the north (the Barnes tract), and by Gene Mullinix, to the south (the Mullinix tract).

*305 CONVEYANCE

By deed of easement dated December 14, 1990 (the conveyance date), petitioners conveyed to Howard County an easement restricting development of the land (the easement). In consideration thereof, petitioners received $30,000 in cash immediately and Howard County's agreement to make installment payments of an additional $279,000 over a period of approximately 30 years (for a total sales price of $309,000). The bulk of the sales price ($235,000) is to be paid at the end of the 30-year installment period. Interest on the*73 unpaid balance of the sales price is payable at a minimum rate of 8 percent a year.

LAND PRESERVATION PROGRAM

Howard County acquired the easement pursuant to the county's Agricultural Land Preservation Program (the Program). The Program is the county's primary tool for preserving farmland. Pursuant to the Program, the county purchases development rights from landowners and holds those rights in perpetuity. The only permissible use of land in the Program is agricultural use. A landowner's participation in the Program is voluntary. The objective of the Program is to support the agricultural community by helping to keep the county's land base available for farming and by minimizing the impact of residential development in agricultural areas.

Prior to 1989, Howard County was limited in that, by law, the most it could pay for development rights was 50 percent of the fair market value of the subject land. In 1989, Howard County invigorated the Program by removing the purchase price limitation and by adopting a new financing mechanism involving installment purchase agreements. The installment purchase agreements were to have a term of approximately 30 years, which the county believed allowed*74 it to leverage its accumulated funds over an extended period. The county's obligation to make installment payments was described by the county as a general obligation of the county. The county advised interested landowners that potential benefits of a sale to the county included tax-exempt interest on the installment obligation, the deferral of taxes on capital gains, and a charitable contribution deduction.

*306 Although, after 1988, Howard County was not limited by law in what it could pay for development rights, the county initially adopted a policy of paying no more than $6,500 an acre (later increased to $6,600) (the limitation). The maximum price was paid for the best qualified farmland as determined by a formula adopted by the county, and lesser amounts were paid for lesser qualified farmland. The limitation was adopted as a budgetary constraint because the county had limited funds to purchase development rights to the 20,000 to 30,000 acres it wished to encumber. Given Howard County's knowledge of the value of farmland in the county, the limitation was fixed so as to produce a price equal to only a portion (50 to 80 percent) of the maximum expected fair market value of*75 development rights. In the case of each acquisition of development rights pursuant to the Program, before an offer was made by Howard County, the county obtained an appraisal of the value of the subject property both encumbered and unencumbered by the development restriction. The price offered by the county was always less than the reduction in fair market value indicated by the appraisal.

MARKET FOR DEVELOPMENT RIGHTS

During 1990, the only purchaser of development rights to farmland in Howard County was the county, under the Program.

PETITIONERS' CHARITABLE CONTRIBUTION DEDUCTIONS

With respect to petitioners' participation in the Program, Howard County obtained an appraisal by Edward A. Griffith of the E.A. Griffith Real Estate Co., Towson, Maryland. Mr. Griffith is an experienced real estate appraiser. Mr. Griffith conducted his appraisal as of April 10, 1990, and concluded that the fair market value of the land was $771,600, the agricultural value of the land was $173,052, and the value of the easement was $598,500.

Mr. Griffith updated his appraisal of the land for petitioners on February 27, 1991, and concluded that the fair market value of the land as of December*76 1, 1990, remained $771,600. In accordance with Mr. Griffith's appraisal of the easement at $598,500, petitioners claimed a charitable contribution of*307 $289,500 during 1990, which is the difference between the appraised value of $598,500 and the $309,000 received for the easement from Howard County. Because of annual limitations on the amount of the deduction that may be claimed by an individual on account of charitable contributions, petitioners claimed deductions on account of the conveyance of the easement to the county as follows:

Respondent disallowed those deductions on the grounds that petitioners had failed to substantiate the charitable contribution resulting from the conveyance of the easement.

EXPERT TESTIMONY

PETITIONERS' EXPERTS

STANLEY O. BENNING

Petitioners presented the expert testimony of Stanley O. Benning, president of Benning & Associates, Inc., land planning consultants. Mr. Benning is registered as a landscape architect in Maryland and other States and is an experienced land planner. Mr. Benning has opinions as to the number of 3-acre estate lots that could*77 be developed on the land under three alternative scenarios: (1) development of the land in conjunction with both the Barnes and Mullinix tracts, (2) development of the land in conjunction with only the Barnes tract, and (3) development of the land alone. Mr. Benning is of the opinion that, under the first two scenarios, 16 lots could be developed on the land and, under the third scenario, 15 lots could be developed on the land. Mr. Benning's opinions are expressed in a report dated September 16, 1996 (the Benning report).

*308 GARY LEE SAPPERSTEIN

Petitioners presented the expert testimony of Gary Lee Sapperstein of Sapperstein & Associates, real estate appraisers. Mr. Sapperstein is a certified general real estate appraiser in Maryland and other States. Mr. Sapperstein has opinions as to the fair market value of the easement as of the conveyance date. Mr. Sapperstein believes that, as of the conveyance date, the highest and best use of the land was for development into single family residential lots. Mr. Sapperstein has reviewed the Benning report and, apparently, accepts its conclusions as to lot yield:

The * * * Benning report illustrates that the subject property's size, shape and*78 topography is capable of being developed with 15 single family residential lots. It should be noted that there is a potential for an increase in the yield to 16 lots if the property were to be jointly developed with the adjacent property owners.

Mr. Sapperstein believes that the highest and best use of the land after conveyance of the easement is as a farm (subject to the restrictions of the easement).

Mr. Sapperstein was aware of previous conveyances of development rights to Howard County under the Program, but he concluded that there did "not exist a substantial record of 'fair market value' transfers that present a meaningful or valid comparison to the subject property." As a disadvantage, he mentions the initial limit of 50 percent of fair market value of the subject land and the subsequent per acre cap of $6,600. Mr. Sapperstein chose to estimate the value of the easement by using the "Before and After" approach, comparing market data for comparable properties sold with development rights intact to market data for properties sold for agricultural use. Mr. Sapperstein concludes that the value of the development rights that were sold to Howard County is the difference between*79 the "before" and "after" values.

Based on his assumptions as to highest and best use and lot yield, Mr. Sapperstein reached the conclusion that (1) if 15 lots could be developed on the land, the fair market value of the easement on the conveyance date was $518,000, and (2) if 16 lots could be developed on the land, the fair market value of the easement on the conveyance date was $563,000. *309 Mr. Sapperstein provides the following tables to illustrate his calculations (the entries for improvements reflect a dwelling on the land):

RESPONDENT'S EXPERT

Respondent presented the expert testimony of M. Ronald Lipman of Lipman Frizzell & Mitchell, LLC, real estate appraisers and consultants. Mr. Lipman is a certified general real estate appraiser in Maryland and other States. Mr. *80 Lipman has an opinion as to the fair market value of the easement as of December 1, 1990. Mr. Lipman believes that, as of that date, the highest and best use of the land was for development into single family residential lots. As was true for Mr. Sapperstein, Mr. Lipman believes that the highest and best use of the land after conveyance of the easement is as a farm (subject to the restrictions of the easement).

Montgomery County is adjacent to Howard County. Mr. Lipman was aware that, in Montgomery County, sales of development rights, known as "Transferable Development Rights" (TDRs), occur with some frequency. Mr. Lipman testified that a Montgomery County landowner who conveys a TDR gives up the right to residential development and is left with land available only for agricultural or similar use. He believes that sales of TDRs in Montgomery County are at prices that represent "a true indication of arms length negotiations *310 for the totality of the development rights". Mr. Lipman believes that Montgomery County sales of TDRs present "dependable comparable sales in the context of development rights valuation and can be used as direct sales comparisons." Mr. Lipman notes that Howard County's*81 instructions to their appraisers state: "By law, Howard County may not pay more for the easement than fifty (50) percent of the appraised fair market value of the property." (Fn. ref. omitted.) Mr. Lipman recognizes that Howard County landowners may accept a price from the county below the before and after differential in value of their land. He concludes:

Accordingly, while the Montgomery County sales of TDR's adequately represent the totality of monetary award and therefore are dependable vis-a-vis the direct comparison approach, development rights sales in Howard County do not reflect those characteristics. Therefore, the Howard County sales themselves do not constitute full consideration and we cannot use them from a direct comparison perspective. * * *

Mr. Lipman considers data from Montgomery County sales of TDRs that "would suggest development rights values for property in Howard County by direct comparison in the range of $6,000 to $6,500". Nevertheless, he concludes: "After considering this data, we believe that the before and after approach to value is a more accurate measure of the subject's development rights." During his oral testimony, Mr. Lipman agreed that*82 data from Montgomery County sales of TDRs is irrelevant to determining the fair market value of the easement.

Based on his assumptions as to highest and best use, Mr. Lipman reached the conclusion that the fair market value of the easement on December 1, 1990, was $367,000. Mr. Lipman provided the following table to illustrate his calculations (the entries for improvements reflect a dwelling on the land):

*311 OPINION

Petitioners assert that they made a bargain sale of the easement to Howard County and that they are entitled to claim a charitable contribution equal to the difference between the fair market value of the easement and the amount realized from the sale. Respondent contends that petitioners have failed to demonstrate that the fair market value of the easement exceeded the amount realized from the sale. There is no dispute regarding petitioners' satisfaction of any other requirements set forth in section 170 and the regulations thereunder, including whether the contributed*83 property (if any) constitutes a "qualified conservation contribution" under section 170(h)(1). Therefore, the only issues we must address are the fair market value of the easement and the amount realized from the sale.

Section 170(a)(1) provides the following general rule with respect to charitable contributions:

There shall be allowed as a deduction any charitable contribution (as defined in subsection (c)) payment of which is made within the taxable year. A charitable contribution shall be allowable as a deduction only if verified under regulations prescribed by the Secretary.

Section 1.170A-1(c)(1), Income Tax Regs., provides in pertinent part: "If a charitable contribution is made in property other than money, the amount of the contribution is the fair market value of the property at the time of the contribution". Fair market value, as defined by the regulations, "is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." Sec. 1.170A-1(c)(2), Income Tax Regs.

Section 1.170A-7(c), Income Tax Regs., *84 provides that, except as provided in section 1.170A-14, Income Tax Regs., the amount of the deduction under section 170 in the case of a partial interest in property is the fair market value of the partial interest at the time of the contribution.

Section 1.170A-14(h)(3)(i), Income Tax Regs., in part, provides as follows:

*312 The value of the contribution under section 170 in the case of a charitable contribution of a perpetual conservation restriction is the fair market value of the perpetual conservation restriction at the time of the contribution. See section 1.170A- 7(c). If there is a substantial record of sales of easements comparable to the donated easement (such as purchases pursuant to a governmental program), the fair market value of the donated easement is based on the sales prices of such comparable easements. If no substantial record of market-place sales is available to use as a meaningful or valid comparison, as a general rule (but not necessarily in all cases) the fair market value of a perpetual conservation restriction is equal to the difference between the fair market value of the property it encumbers before the granting of the restriction and the fair market value*85 of the encumbered property after the granting of the restriction.

Petitioners, relying principally on the testimony of their experts, contend that the fair market value of the easement on the conveyance date was $563,000. ¹ Petitioners argue that the amount realized on the sale of the easement is $309,000, and, therefore, the amount of the charitable contribution is $254,000.

*86 Respondent argues that petitioners' conveyance of the easement to Howard County did not constitute a bargain sale because the amount paid by Howard County to petitioners was in line with the amount that the county paid generally for development rights under the Program and, thus, represented the fair market value of the easement. Respondent relies on section 1.170A-14(h)(3)(i), Income Tax Regs., which prescribes a methodology for determining the fair market value of donated easements of the type conveyed by petitioners to the county. Respondent argues that there is a universe of sales of development rights to the county under the Program, that that universe constitutes a substantial record of sales of comparable development rights, and that there were no other sales of development rights in the county during 1990. Relying on section 1.170A- 14(h)(3)(i), Income Tax Regs., respondent denies the relevance of any appraisal evidence *313 that would support any different (greater) fair market value. Thus, by, in effect, defining the fair market value of the property transferred by what the county paid for it, respondent denies that petitioners made a bargain sale to the county; denying that *87 they made a bargain sale, respondent denies that they made a charitable contribution.

Alternatively, respondent argues that the fair market value of the easement is no greater than $367,000 and that the "valuable benefits" received by petitioners, including the $309,000 and the anticipated charitable contribution deductions, must be subtracted from that figure to determine properly the amount of the charitable contribution. ²

A bargain sale is a transfer of property that is in part a sale or exchange and in part a gift. See section 1.1001-1(e)(2) Example (3), Income Tax Regs., which provides as follows:

A transfers property to his son for $30,000. Such property in A's hands has an adjusted basis of $30,000 (and a fair market value of $60,000). A has no gain and has made a gift of $30,000, the excess of $60,000, the fair market value, over the amount realized, $30,000.

Where the bargain sale is to a charitable organization, the gift generally constitutes a charitable contribution. See sec. 1.170A- 4(c)(2)(ii), Income Tax Regs. "In order for a conveyance to constitute a charitable contribution as a bargain sale the seller must make the conveyance with the requisite charitable intent and the fair market value of the property on the date of the sale must in fact exceed the sales price." Grinslade v. Commissioner, 59 T.C. 566, 577 (1973); accord Waller v. Commissioner, 39 T.C. 665, 677 (1963); see also *314 Stark v. Commissioner, 86 T.C. 243, 255-256 (1986)*89 (taxpayer who makes a bargain sale to charity is entitled to claim a charitable contribution equal to the difference between the fair market value of the property and the amount realized from the sale). It is clear from respondent's briefs that respondent is not challenging petitioners' charitable intent ("respondent would concede that petitioners' evidence as to the subjective beliefs of the parties is persuasive on the issue of donative intent"), but is arguing that the fair market value of the easement did not exceed the amount realized from its sale: "Petitioners bear the burden of showing that what they received in exchange for the deed of easement was not commensurate with the value of the property exchanged." Therefore, we shall first determine the fair market value of the easement on the conveyance date.

The general rule is that the amount of a charitable contribution made in property is the fair market value of the property at the time of the contribution. Sec. 1.170A-1(c)(1), Income Tax Regs.³ That is no less the general rule if the charitable contribution is of a PARTIAL interest in property, sec. 1.170A-7(c), Income Tax*90 Regs., including a perpetual conservation restriction such as the easement. Sec. 1.170A-14(h)(3), Income Tax Regs. The preferred way of determining fair market value is by applying the marketplace standard found in the regulations to the property contributed. See sec. 1.170A-1(c)(2), Income Tax Regs, ("fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts"). In the absence of a well-established market for property of the type contributed, however, the marketplace standard of the regulations may be difficult to apply. See, e.g., Symington v. Commissioner, 87 T.C. 892, 895 (1986) ("Unfortunately, since most open-space easements are *315 granted by deed of gift there is rarely an established market from which to derive the fair market value.").

*91

In the case of a perpetual conservation restriction, if the market for such restrictions is not well established, it is usually necessary to value the restriction by applying a "before and after" analysis; i.e., a comparison of the fair market value of the donor's property unencumbered by the restriction with the fair market value of the property after the conveyance of the restriction, with any diminution of value to be ascribed to the fair market value of the restriction. See, e.g., Symington v. Commissioner, supra at 895 & n.5, which states as follows:

This method has been approved by the Internal Revenue Service, see Rev. Rul. 73-339, 1973-2 C.B. 68, as clarified by Rev. Rul. 76-376, 1976-2 C.B. 53, and endorsed by Congress in connection with the adoption of the Tax Treatment Extension Act of 1980, see S. Rept. 96-1007 (1980), 1980-2 C.B. 599, 606.

Nothing in section 1.170A-14(h)(3)(i), Income Tax Regs. (the PCR valuation regulation), contradicts that analysis; indeed, the PCR valuation regulation adopts the serial approach described: "If *92 no substantial record of market-place sales is available to use as a meaningful or valid comparison", the general rule is a before and after approach.

Respondent, however, argues that the second substantive sentence of the PCR valuation regulation, see supra sec. II., which sets forth the marketplace sales analysis, is the beginning and end of the inquiry into the fair market value of the easement, notwithstanding evidence to support a finding that sales of development rights in Howard County occur in an inhibited market. Respondent, thus, seeks to preclude petitioners from using appraisal evidence to establish a greater value. We believe that respondent's interpretation of the regulation is misguided.

The first substantive sentence of the PCR valuation regulation, see supra sec. II., establishes the general rule that the value of the contribution under section 170 of a perpetual conservation restriction is the fair market value of the restriction at the time of contribution. When there is evidence to support a finding that marketplace sales of such restrictions are unreliable, blind application of the second substantive sentence, which provides a method for determining *316 the amount *93 required by the rule of the first substantive sentence, would ignore the purpose of the regulation. ⁴ Essentially, respondent's interpretation of the PCR valuation regulation narrowly focuses on whether there exists a substantial record of sales of comparable easements, irrespective of whether a comparison of the sale of the subject easement to such sales of comparable easements would yield the proper amount of the deduction under section 170. That misguided approach fails to recognize that a substantial record of sales of comparable easements must provide a "meaningful or valid comparison" to be considered a record of comparable sales. Sec. 1.170A-14(h)(3)(i), Income Tax Regs. (third substantive sentence).

*94 The meaningful or valid comparison standard serves the purpose of determining the proper amount of the deduction under section 170 by establishing the FAIR market value of the contributed property rights and does not serve the function of determining SOME market value of the subject easement as an independent objective. Indeed, other portions of the PCR valuation regulation support that assertion. In the case of a charitable contribution of a perpetual conservation restriction covering a portion of the contiguous property owned by a donor and the donor's family, the amount of the deduction under section 170 is the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the restriction. Sec. 1.170A-14(h)(3)(i), Income Tax Regs. (fourth substantive sentence). Sales of easements comparable to the donated easement covering a portion of the contiguous property owned by the donor and the donor's family and, thus, the market value of such easements are irrelevant.

In conclusion, we must examine the applicability of the second substantive sentence of the PCR valuation regulation in light of its role in determining the proper amount*95 of the *317 deduction under section 170. Therefore, we are not required to accept the substantial record of sales of development rights to Howard County under the Program as determinative of the fair market value of the easement when there is evidence to support a finding that those sales occur in an inhibited market.

Notwithstanding the establishment of a market to which reference may be had for sales data, such data may not yield a demonstration of the fair market value of a particular property (or an interest in property) if general conditions or those affecting particularly the sales that have actually transpired do not "fairly" reflect the circumstances surrounding the specific property to be valued. Estate of Wright v. Commissioner, 43 B.T.A. 551, 555 (1941). That general proposition limiting the use of market data was established early in the development of the tax law by the Court of Appeals for the Third Circuit in Heiner v. Crosby, 24 F.2d 191, 193 (3d Cir. 1928), with respect to shares of stock:

The fair market price or value of stock at a particular time is a question of fact, to be determined from*96 all the circumstances. Market price implies the existence of a market, of supply and demand, of sellers and buyers. Sales are always evidence of a market price, but the statute requires that, in "ascertaining the gain derived from the sale," there must be not simply a "market price," but a "fair market price." Sales made at a particular time and place may be significant, but the price paid is not necessarily decisive of fair market price or value. The fact of sales, in itself and without regard to the circumstances under which the sales were made, does not conclusively establish either statutory fair market price or value. Sales made under peculiar and unusual circumstances, such as sales of small lots, forced sales, and sales in a restricted market, may neither signify a fair market price or value, nor serve as the basis on which to determine the amount of gain derived from the sale. In such cases resort must be had to evidence to determine "fair value." Offers made in good faith and opinions of intelligent men experienced in the business are admissible to show fair value. * * *

Accord, e.g., Berry Petroleum Co. & Subs. v. Commissioner, 104 T.C. 584, 637-638 (1995)*97 (generally, best evidence of value is actual sales: "However, prices obtained at forced sales, at public auctions, or in restricted markets may not be the best criteria of value, particularly when other evidence *318 shows that the property would sell at a higher price under different circumstances.").

We have found sales data not to be indicative of fair market value where p