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Friday September 24, 2021

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Façade Easement Fails Perpetuity Requirement

901 South Broadway Ltd. Partnership v. Commissioner; No. 14179-17

901 South Broadway Limited Partnership, Standard Development, LLC, Tax Matters Partner, Petitioner v.
Commissioner of Internal Revenue, Respondent

United States Tax Court


ORDER


In this case, we review a notice of final partnership administrative adjustment in which respondent denied a deduction reported by 901 South Broadway Limited Partnership (partnership) for its contribution to the Los Angeles Conservancy (Conservancy) of a facade easement on a building located at 901 South Broadway Avenue, Los Angeles, California (Building).

Section 170(a)(1)1 allows a deduction for "any charitable contribution * * * payment of which is made within the taxable year." Section 170(c) defines the term "charitable contribution" to mean "a contribution or gift to or for the use of" a specified organization. As a general rule, a taxpayer is not allowed a deduction for a contribution of part of the taxpayer's interest in property. See sec. 170(f)(3). That general rule does not apply, however, to "a qualified conservation contribution". Sec. 170(f)(3)(B)(iii).

To meet the definition of "qualified conservation contribution" provided in section 170(h)(1), a contribution must meet three requirements. First, the contributed property must be "a qualified real property interest". Sec. 170(h)(1)(A). Second, the contribution must be to a qualified organization, as defined in section 170(h)(3). Sec. 170(h)(1)(B). And third, the contribution must be "exclusively for conservation purposes." Sec. 170(h)(1)(C).

The term "qualified real property interest" includes "a restriction (granted in perpetuity) on the use which may be made of * * * real property." Sec. 170(h)(2)(C). Section 170(h)(4)(A)(iv) defines "conservation purpose" to include "the preservation of * * * a certified historic structure", as defined in section 170(h)(4)(C). Under section 170(h)(5)(A), however, the contribution of a qualified real property interest will not be treated as having been made exclusively for conservation purposes "unless the conservation purpose is protected in perpetuity."

Petitioner has moved for partial summary judgment seeking a ruling that "the perpetuity requirements of sections 170(h)(2)(C) and 170(h)(5)(A) of the Code" had been satisfied.2 After petitioner filed its motion, the parties stipulated that "[t]he contributed easement is a 'qualified real property interest' within the meaning of I.R.C. 170(h)(2)(C)." The parties also stipulated that the Conservancy "is a qualified organization within the meaning of I.R.C. 170(h)(3)." And the parties stipulated that the Building "is a 'certified historic structure' within the meaning of I.R.C. 170(h)(4)(C)(ii)."

The parties' stipulation rendered moot that portion of petitioner's motion for partial summary judgment that seeks a ruling on whether the easement is a qualified real property interest within the meaning of section 170(h)(2)(C). The question before us is whether to grant or deny the remainder of petitioner's motion — that is, the portion of the motion that seeks a ruling that the contribution's conservation purpose is protected in perpetuity, as required by section 170(h)(5)(A).

Summary judgment expedites litigation. It is intended to avoid unnecessary and expensive trials. It is not, however, a substitute for trial and should not be used to resolve genuine disputes over issues of material facts. E.g., RERI Holdings I, LLC v. Commissioner, 143 T.C. 41, 46-47 (2014). "The party moving for summary judgment has the burden of demonstrating that no genuine issue as to any material fact exists, and that he is entitled to judgment as a matter of law." Casanova Co. v. Commissioner, 87 T.C. 214, 217 (1986). For those purposes, we afford the party opposing the motion the benefit of all reasonable doubt, and we view the material submitted by both sides in the light most favorable to the opposing party. That is, we resolve all doubts as to the existence of an issue of material fact against the movant. E.g., Estate of Sommers v. Commissioner, 149 T.C. 209, 215 (2017).

For the reasons explained below, we conclude that petitioner has not demonstrated that it is entitled to judgment as a matter of law that the partnership's contribution of the easement satisfies the requirement of section 170(h)(5)(A). In particular, because proceeds from the condemnation of the Building attributable to the easement could be used to satisfy indebtedness owed by the partnership, any conservation purpose served by the contribution is not "protected in perpetuity." Accordingly, we will deny petitioner's motion for partial summary judgment.

The Easement Deed and Subordination Agreements


Section 3.1 of the deed of easement (Deed) prohibits the partnership, as Grantor, from making changes to the Building without the "prior express written approval" of the Conservancy (the Grantee). Section 3.2(c) of the Deed requires the Conservancy to act within 30 days of a request by the partnership and provides that the Conservancy's failure to act within that period "shall be deemed to constitute approval of the Grantor's request."

Section 9.7 of the Deed acknowledges that the Building is subject to five mortgages held by three different lenders. That section further provides:

Concurrently herewith, each of * * * [the lenders] have agreed, by separate instrument (in the forms set forth in Exhibit C, Exhibit D, and Exhibit E attached hereto) which shall be recorded concurrently with the recordation of this Easement, to subordinate its rights in the Project to this Easement to the extent necessary to permit Grantee to enforce the purpose of the Easement in perpetuity and to prevent any extinguishment of this Easement by the lien holder thereof.

In section 11.2 of the Deed, the partnership and the Conservancy express their "recogni[tion] that circumstances may arise that may make the continued ownership or use of the Property in a manner consistent with the Purpose of this Easement impossible and that extinguishment of the Easement may be necessary." The parties give as an example of those circumstances the "partial or total destruction of the Building resulting from casualty." Extinguishment of the easement would require "a judicial proceeding in a court of competent jurisdiction." If the property is sold after the termination or extinguishment of the easement, the partnership and the Conservancy, subject to specified conditions and exceptions, "shall share in any net proceeds resulting from such sale in accordance with their respective percentage interests in the fair market value of the Property, as such interests are determined under the provisions of section 11.1". Deed sec. 11.2. Section 11.1 of the Deed provides that the percentage interests in the property held by the partnership and the Conservancy "shall be determined by the ratio of the Easement's value on its effective date to the value of the Property, without deduction for the value of the Easement, on the effective date of th[e] Easement."

The Deed includes a separate provision, section 11.3, dealing with condemnation. That section provides:

If all or any part of the property is taken under the power of eminent domain by public, corporate, or other authority, or otherwise acquired by such authority through a purchase in lieu of a taking, and subject to the rights of any Lender, Grantor and Grantee shall join in appropriate proceedings at the time of such taking to recover the full value of those interests in the Property that are subject to the taking and all incidental and direct damages resulting from the taking. After satisfaction of prior claims and net of expenses reasonably incurred by Grantor and Grantee in connection with such taking, Grantor and Grantee shall be respectively entitled to compensation from the balance of the recovered proceeds in conformity with the provisions of Sections 11.1 and 11.2 unless otherwise provided by law.

Section 1 of each of the subordination agreements attached as exhibits to the Deed provides the terms of the contemplated subordination. Among other things, that section provides: "Lender and its assignees which are the holder or beneficiary of the Deeds of Trust (together with Lender, a "Beneficiary") shall have a prior claim to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the Property and all proceeds of condemnation proceedings, and shall be entitled to same in preference to Grantee until the Deeds of Trust are paid off and discharged".

Relevant Caselaw


In Kaufman v. Commissioner (Kaufman I), 134 T.C. 182, 186 (2010), vacated in part sub nom. Kaufman v. Shulman (Kaufman III), 687 F.3d 21 (1st Cir. 2012), we addressed a case in which a bank that held a mortgage on property subject to a facade easement "retained a 'prior claim' to all proceeds of condemnation and to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the property." "[T]he bank was entitled to those proceeds 'in preference' to * * * [the easement's donee] until the mortgage was satisfied and discharged." Id. We granted partial summary judgment in the Commissioner's favor on the ground that the contribution of the easement failed to satisfy either section 170(h)(5)(A) or section 1.170A-14(g)(6), Income Tax. Regs. Section 1.170A-14(g)(6)(i), Income Tax Regs., provides:

If a subsequent unexpected change in the conditions surrounding the property that is the subject of a donation under this paragraph can make impossible or impractical the continued use of the property for conservation purposes, the conservation purpose can nonetheless be treated as protected in perpetuity if the restrictions are extinguished by judicial proceeding and all of the donee's proceeds (determined under paragraph (g)(6)(ii) of this section) from a subsequent sale or exchange of the property are used by the donee organization in a manner consistent with the conservation purposes of the original contribution.

Section 1.170A-14(g)(6)(ii), Income Tax Regs., provides:

[F]or a deduction to be allowed under this section, at the time of the gift the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right immediately vested in the donee organization, with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift, bears to the property as a whole at that time. * * * For purposes of this paragraph (g)(6)(ii), the proportionate value of the donee's property rights shall remain constant. Accordingly, when a change in conditions give[s] rise to the extinguishment of a perpetual conservation restriction under paragraph (g)(6)(i) of this section, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction, unless state law provides that the donor is entitled to the full proceeds from the conversion without regard to the terms of the perpetual conservation restriction.

In Kaufman III, the Court of Appeals for the First Circuit vacated our grant of partial summary judgment in the Commissioner's favor in Kaufman I. The First Circuit interpreted section 1.170A-14(g)(6), Income Tax Regs, to require only that a donee's right to proceeds be absolute against the donor.

In Palmolive Bldg. Inv'rs, LLC v. Commissioner, 149 T.C. 380, 394-395 (2017), we addressed a charitable contribution deduction claimed for a facade easement created by a deed that provided that each holder of a mortgage on the subject property "shall have a prior claim to * * * insurance and condemnation proceeds and shall be entitled to same in preference to Grantee until the mortgage is paid off and discharged, notwithstanding that the mortgage is subordinate in priority to" the conservation right granted by the easement. The Commissioner argued that the deed in issue did not satisfy the requirement of section 170(h)(5)(A) that the conservation purpose of the contribution must be "protected in perpetuity." In addition to the statutory requirement, the Commissioner cited two provisions of the regulations in support of his position. Section 1.170A-14(g)(2), Income Tax Regs., provides that "no deduction will be permitted under this section for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity." The Commissioner argued that the lenders' priority right to insurance or condemnation proceeds "render[ed] the subordinations of * * * [the mortgagees] insufficient to satisfy section 1.170A-14(g)(2)". Palmolive Bldg. Inv'rs, LLC v. Commissioner, 149 T.C. at 393. The Commissioner also argued that the donee did not have a guaranteed right to a proportionate share of any proceeds resulting from the extinguishment of the easement, as required by section 1.170A-14(g)(6), Income Tax. Regs.

We agreed with both of the Commissioner's arguments. "The easement donee," we wrote, "is * * * not assured in perpetuity of its right to insurance or condemnation proceeds, but instead is given a contingent prospect of receiving proceeds only if the eventual value of the property permits it or if the mortgagee agrees to suffer loss, to forfeit the repayment of its loan, and to gratuitously let the donee move to the front of the line." Id. at 404-405. In accepting the Commissioner's interpretation of section 1.170A-14(g)(6), Income Tax Regs., we "reaffirm[ed] our holdings in Kaufman v. Commissioner." Id. at 394.

In Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180 (2020), we rejected a challenge to the validity of section 1.170A-14(g)(6), Income Tax Regs. The easement at issue in that case did not comply with the regulatory requirement "because the donee's share of the proceeds, in the event the property were sold following a judicial extinguishment of the easement would be (1) determined according to a fixed historical value rather than a proportionate share of the proceeds and (2) reduced by the value of any improvements made by the donor." Id. at 181.

We accepted that section 1.170A-14(g)(6), Income Tax Regs., is a "legislative rule" subject to the "notice-and-comment rulemaking procedures" prescribed by the Administrative Procedure Act (APA). Id. at 189-190 (citing 5 U.S.C. sec. 553(b) (2018)). As we explained,

To issue a legislative regulation consistently with the APA an agency must: (1) publish a notice of proposed rulemaking in the Federal Register; (2) provide "interested persons an opportunity to participate * * * through submission of written data, views, or arguments"; and (3) "[a]fter consideration of the relevant matter presented * * * incorporate in the rules adopted a concise general statement of their basis and purpose."

Id. at 190 (citing 5 U.S.C. sec. 553(b) and (c)).

The argument of the tax matters partner in Oakbrook Land Holdings, LLC (whom, for the sake of simplicity, we will refer to as the taxpayer) centered on the third requirement quoted above. The taxpayer claimed that, before adopting the regulation in final form, the Treasury Department (Treasury) had not adequately considered comments on the proposed regulations and had not included in the Treasury Decision adopting the final regulations the required statement of the regulation's basis and purpose.

We observed that "an agency cannot reasonably be expected to address every comment it received." Id. at 192. We reasoned that Treasury had "clearly considered" comments on the rule requiring donees to receive a proportional share of proceeds upon the extinguishment of an easement because "it substantially revised the text of section 1.170A-14(g)(6)(ii), Income Tax Regs., in response to those comments." Id. And the only commenter who addressed the issue of donor improvements "offered no suggestion about how the subject * * * might be handled". Id. at 193. "Our review of the administrative record," we wrote, "le[ft] us with no doubt that Treasury considered the relevant matter presented to it." Id.

In regard to the basis and purpose of section 1.170A-14(g)(6), Income Tax Regs., we concluded that no "concise general statement" was necessary because "[t]he purpose of the 'judicial extinguishment' rule is plain on its face — to provide a mechanism to ensure that the conservation purpose can be deemed 'protected in perpetuity' notwithstanding the possibility that the easement might later be extinguished." Id. at 194. We thus held "that Treasury satisfied all applicable APA requirements when promulgating" section 1.170A-14(g)(6), Income Tax Regs.

In considering the substantive validity of section 1.170A-14(g)(6), Income Tax Regs., in Oakbrook Land Holdings, LLC, we applied the two-part test the Supreme Court had adopted in Chevron, U.S.A, Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837 (1984). As the Court explained in Chevron, 467 U.S. at 842-843:

When a court reviews an agency's construction of the statute which it administers, it is confronted with two questions. First, always, is the question whether Congress has directly spoken to the precise question at issue. If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress. If, however, the court determines that Congress has not directly addressed the precise question at issue, the court does not simply impose its own construction on the statute, as would be necessary in the absence of administrative interpretation. Rather, if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute.

In regard to the first step of the Chevron inquiry, we noted in Oakbrook Land Holdings LLC v. Commissioner, 154 T.C. at 195-196, that "Congress does not appear to have considered the possibility that the easement might be judicially extinguished, and the statute does not address how that possibility would affect a taxpayer's ability to satisfy the 'perpetuity' requirement." We therefore concluded that Congress had not spoken "directly to the question at issue." Id. at 196.

In the second step of the Chevron analysis, we rejected the taxpayer's arguments that section 1.170A-14(g)(6), Income Tax Regs., was unreasonable in requiring that the donee receive a proportionate, rather than fixed, share of any proceeds upon the extinguishment of the easement and that the donee's required share be determined without regard to the value of any improvements to the property made by the donor. We noted that "the age of th[e] regulation gives weight to the presumption of reasonableness." Id. at 199. Congress' repeated amendment of section 170 since Treasury adopted the regulation in 1986 without addressing the question of the share of proceeds to which a donee should be entitled upon extinguishment of an easement "strongly suggests that * * * [Congress] did not view Treasury's construction * * * as unreasonable or contrary to the law's purpose." Id. at 200 (quoting SIH Partners v. Commissioner, 150 T.C. 28, 53-54 (2018)).

Respondent's Arguments


Respondent's initial response to petitioner's motion for partial summary judgment focused on the 30-day deemed approval provision in section 3.2(c) of the Deed. In respondent's reading of the Deed, proposals by the partnership to alter the historic character of the Building's facade could be permitted simply because of the Conservancy's failure to deny the partnership's request within the allotted time. Respondent advanced a similar argument in support of a motion for summary judgment in his favor. We denied respondent's motion because, for the reasons explained in our order of November 19, 2020, "we read section 3.2(c) of the Deed as inapplicable to requests to change the Building's exterior in a manner that would alter its historical character".

After we denied respondent's motion for summary judgment, he moved for leave to supplement his response to petitioner's motion for partial summary judgment. Respondent sought to advance "an independent basis", apart from the Deed's deemed approval provision, "upon which the Deed fails to satisfy the perpetuity requirement of I.R.C. 170(h)(5)(A)".

After we granted respondent's motion for leave, he filed a supplement to his response to petitioner's motion for partial summary judgment (respondent's supplement). In that supplement, respondent argues that we should deny petitioner's motion for partial summary judgment for two reasons. First, respondent claims that petitioner has not demonstrated that the subordination agreements attached as exhibits to the Deed were in fact executed contemporaneously with the execution of the Deed. Second, respondent claims that, even if those agreements were timely executed, they are inadequate to effect the subordination required by section 1.170A-14(g)(2), Income Tax Regs. Respondent points to section 1 of each agreement, in which, under his reading, the lender retained a priority right, in preference to the Conservancy, to secure satisfaction of its loan from the proceeds of insurance policies covering the property, in the event of casualty, and to any proceeds paid on the condemnation of the Building. Respondent argues that, "[i]n all material respects," the language of section 1 of the subordination agreements "is the same language found inadequate in Palmolive Building Investors, LLC, in that the Lenders have a prior claim, in preference to the Grantee, to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the Property and all proceeds of condemnation proceedings until the deeds of trust are paid off and discharged."

Petitioner's Arguments


Relevance of Palmolive Bldg. Inv'rs, LLC

Petitioner contends that the relevant facts in its case are "completely and materially different" from those of Palmolive Bldg. Inv'rs, LLC. It describes the deed at issue in Palmolive Bldg. Inv'rs, LLC as having "allowed [the] lenders to take prior claims to insurance proceeds in cases of extinguishment, condemnation, and foreclosure."3

By contrast, in paragraphs 36 and 37 of its response to respondent's supplement, petitioner describes the relevant provisions of the Deed and subordination agreements in its case as follows:

36. The Subordination Agreements at issue here, unlike in Palmolive, are clear that the grantee, here the Los Angeles Conservancy, retains the required priority claim in any case of extinguishment including in cases of "partial or total destruction of the Building resulting from casualty," and including, "without limitation, net insurance proceeds." Deed ¶ 11.2; Subordination Agreements at ¶ 1. "Grantor and Grantee shall share in any net proceeds resulting from such sale in accordance with their respective percentage interests in the fair market value of the Property, as such interests are determined under the provisions of Section 11.1, adjusted, if necessary to reflect a partial termination or extinguishment of this Easement." Deed ¶ 11.2.

37. Each of the Subordination Agreements provides, in relevant part, that "[i]n the event of foreclosure of the liens of the [mortgage] or deed in lieu of foreclosure with respect to the Property, the Easement shall not extinguish and the covenants, conditions and restrictions set forth therein shall survive any foreclosure or deed in lieu of foreclosure, subject to the following: (i) Lender and its assignees which are the holder or beneficiary of the [mortgage] shall have a prior claim to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the Property and all proceeds of condemnation proceedings, and shall be entitled to same in preference to Grantee until the [mortgages] are paid of and discharged . . . provided, however, that if the Easement is extinguished under the circumstances described in Sections 11.2 of the Granting Deed, Grantee shall be entitled to compensation in accordance with the terms set forth therein . . . " (emphasis added). Subordination Agreements at ¶ 1.

Apparently relying on the proviso highlighted in its quotation of section 1 of the subordination agreements, petitioner argues that "the mortgagee's prior claim to condemnation proceeds does not apply if the Easement is extinguished as described in Section 11.2 " of the Deed. Petitioner reasons that "a partial or full extinguishment certainly would occur if the Property were partially or fully condemned."

Authority of Palmolive Bldg. Inv'rs, LLC


Petitioner also asserts that, even if Palmolive Bldg. Inv'rs, LLC were "determinative", it is nonetheless contrary to what petitioner describes as the "higher authority" of Kaufman III. Even though petitioner acknowledges that its case "is appealable to the Ninth Circuit" rather than the First Circuit, petitioner nonetheless argues that the First Circuit's opinion in Kaufman III "precludes Respondent's assertion * * * in this case" of section 1.170A-14(g)(2), Income Tax Regs.

Protections Afforded by California Law


Petitioner observes that California courts have relied on the covenant of good faith and fair dealing implied in any contract to limit a mortgage holder's right to insurance or condemnation proceeds. For example, Milstein v. Sec. Pac. Nat'l Bank, 27 Cal. App.3d 482 (1972), involved the condemnation by the City of Los Angeles of a 10-foot strip of a commercial property. A deed of trust covering the property allowed the mortgagee to either apply condemnation proceeds to the debt secured by the mortgage or instead cause them to be paid to the property owner. The court concluded that the mortgagee's discretion in exercising that choice was limited by the covenant of good faith and fair dealing implied by law. That covenant required the mortgagee to "distribute to * * * [the] borrowers all proceeds in excess of those necessary to recoup any impairment in security caused by the eminent domain proceeding." Id. at 487. Schoolcraft v. Ross, 81 Cal. App.3d 75, 80 (1978), extended the Milstein "principle" to a case involving insurance proceeds. In Schoolcraft, 81 Cal. App.3d at 77, the court held "that the right of the beneficiary to apply insurance proceeds to the balance of a note secured by a deed of trust must be performed in good faith and with fair dealing and that to the extent the security is not impaired the beneficiary must permit those proceeds to be used for the cost of rebuilding."

Petitioner also cites two sections of the California Civil Code, sections 815 and 816, that, in petitioner's description "provide extraordinary protections of California conservation easements". According to petitioner, those provisions "would prevent any lender from ignoring its obligations to protect the conservation easement."

Validity of Sections 1.170A-14(g)(2) and (6), Income Tax Regs.

Finally, while claiming that section 1.170A-14(g)(6), Income Tax Regs., "is not an issue for trial", petitioner judges that both that provision and subparagraph (g)(2) of the same section are "likely" not valid or enforceable. Petitioner argues, first, that "[t]hose Regulations lack the force of law because they were not promulgated in accordance with the procedural requirements of the Administrative Procedure Act".

Petitioner observes that, when the regulations were first proposed, they did not include a rule requiring the subordination of mortgages on the property subject to a conservation easement. Because Treasury did not provide another round of notice and comment proceedings before adopting the regulations in final form, "commentators did not have the opportunity to comment" on the mortgage subordination rule.

Petitioner also complains that the Treasury Decision that adopted the final regulations did not provide an adequate explanation of that rule. That Treasury Decision states: "In response to comments, the final regulations clarify that when a contribution of mortgaged property is made to a qualified organization, the mortgagee must subordinate its rights under the mortgage to the right of the qualified organization to enforce the conservation purposes in perpetuity." T.D. 8069, 51 Fed. Reg. 1496-01, 1498. Petitioner argues: "The IRS provided no explanation of what would or would not satisfy the standard, why the agency has taken this approach, what it had considered, the basis or purpose of this provision, or anything."

Regarding the rules that appear in section 1.170A-14(g)(6), Income Tax Regs., petitioner asserts that Treasury did not adequately consider the comments made on the rule in its proposed form and provide a reasoned response to those comments. Petitioner acknowledges that the Treasury Decision that adopted the regulations in final form stated that the final rules had been adopted "[a]fter consideration of all comments regarding the proposed amendments and of the revision made by the Tax Reform Act of 1984". T.D. 8069, 1986-1 C.B. at 90. Petitioner dismisses what it describes as "boilerplate" language that, in its view, "is functionally identical to that rejected as insufficient by the Supreme Court" in Encino Motorcars, LLC v. Navarro, 136 S. Ct. 2117 (2016).

Petitioner also acknowledges that this Court, in Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at 195, held that "Treasury satisfied all applicable APA requirements when promulgating the[ ] [judicial extinguishment] rule [provided in section 1.170A-14(g)(6), Income Tax Regs.]." Petitioner describes our reasoning in that case, however, as having "relied on changes that the agency made to th[e] formula [regarding the apportionment of proceeds provided in section 1.170A-14(g)(6)(ii), Income Tax Regs.], as opposed to addressing the basis ab initio of the regulation." Petitioner also contends that our holding in Oakbrook Land Holdings, LLC was "inconsistent with the law as expressed in such decisions as Encino Motorcars and took no account of Ninth Circuit precedent that would be applicable here." Petitioner relies on Encino Motorcars, 136 S. Ct. at 2125, for the proposition that an agency must provide a "minimal level of analysis", sufficient to allow the basis for its determination to be understood. As the Court explained in that case: "It is not the role of the courts to speculate on reasons that might have supported an agency's decision." Id. at 2127. And petitioner lists three Ninth Circuit opinions purportedly "applicable here" that we did not consider in Oakbrook Land Holdings: Linoz v. Heckler, 800 F.2d 871 (9th Cir. 1986), Mt. Diablo Hospital Dist. v. Bowen, 860 F.2d 951 (9th Cir. 1988), and Organized Village of Kake v. Dep't of Agric., 795 F.3d 956 (9th Cir. 2015).

Regarding the substantive validity of section 1.170A-14(g)(6), Income Tax Regs., petitioner "point[s] out" that that section "finds no basis in the statutory provision that it purports to implement." Although petitioner contends that section 1.170A-14(g)(6), Income Tax Regs., "fails to satisfy either step" of the Chevron analysis, its argument focuses on the second step.4 Petitioner describes the extinguishment rules provided in section 1.170A-14(g)(6), Income Tax Regs., as "tak[ing] the unusual, and perhaps unprecedented, approach of defining th[e] [statutory perpetual protection] requirement in two opposed and mutually inconsistent ways." Petitioner finds "manifestly unreasonable", and even "utterly bizarre", the prospect that a donee's required share of proceeds from a sale of the burdened property upon the extinguishment of an easement could turn on applicable state law. As noted above, while section 1.170A-14(g)(6)(ii), Income Tax Regs., generally requires that the donee receive a share of the proceeds equal to its share of the property's overall value, that section also provides that no proceeds need be paid to the donee if state law requires that they be paid in full to the donor. "If zero suffices to satisfy the statute," petitioner reasons, "then the proportionate-value requirement is obviously not necessary to ensure that a donation is 'protected in perpetuity.'"

Analysis


Introduction


In its opposition to respondent's motion for leave to supplement his response to petitioner's motion for summary judgment (petitioner's opposition), petitioner advised the Court that the mortgage subordination issue respondent sought to raise "includes a completely new nucleus of factual considerations that have undergone no development whatsoever." The issue, petitioner said, would raise a "myriad of new factual questions". Among those "complex factual issues", petitioner listed "whether certain agreements were executed, when that occurred, whether they took legal effect as a matter of California law, and what they mean." We found that a curious assertion at the time, given petitioner's burden, as the party seeking summary judgment, to "demonstrat[e] that no genuine issue as to any material fact exists".5 See Casanova Co. v. Commissioner, 87 T.C. at 217.

Petitioner's continued pursuit of partial summary judgment suggests that those "myriad" "complex" factual questions have resolved themselves in a matter of weeks, without the need for any joint stipulations of facts. Petitioner offers us no explanation for that turn of events.

One possible explanation is that several of the questions petitioner listed are not factual questions but questions of law. Certainly, the questions of whether the subordination agreements were executed and, if so, when, are questions of fact.6 But the meaning and legal consequence of those agreements under applicable State law are questions of law.

Petitioner advises us that, should we disagree with its interpretation of the Deed provisions under California law, "summary judgment would not be appropriate for either party." And petitioner assures us that, at trial, it would, "if necessary, provide a California real estate expert * * * to assist * * * [us] with the interpretation under California law of the language of the Deeds and related applicable California laws." The issue of respondent's entitlement to summary judgment, however, is not presently before us. Petitioner seems to be responding to a motion respondent has not made. Moreover, we would have expected that the arguments petitioner has advanced in support of its own motion for partial summary judgment — the one pending before us — already reflects petitioner's best understanding of the relevant California law. And, contrary to petitioner's apparent supposition, we would not at trial entertain testimony from a supposed expert on questions of California law. Again, those are legal questions — not factual ones. Hearing "expert" testimony on those questions would be inappropriate. See Estate of Carpenter v. Commissioner, T.C. Memo. 1993-97, 1993 WL 80583, at *2 (declining to permit a taxpayer's expert witness "to instruct the Court as to applicable principles of State law").7

Authority of Palmolive Bldg. Inv'rs, LLC


We start by rejecting petitioner's assertion that the First Circuit's opinion in Kaufman III is "higher authority" for purposes of this case than our own precedent in Palmolive Bldg. Inv'rs, LLC. We have already had occasion to remind petitioner of the extent to which opinions by appellate courts in various circuits constitute precedents binding on this Court.8 It appears that we must repeat that lesson. Unlike, say, a Federal District Court located in the First Circuit, the Tax Court is a court of national jurisdiction. Therefore, in the interests of promoting a uniform application of the tax law across the country, we generally follow our own precedents rather than contrary precedents of particular courts of appeals. See Lawrence v. Commissioner, 27 T.C. 713, 716-718 (1957), rev'd, 258 F.2d 562 (9th Cir. 1958). In Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971), we crafted a "narrow exception" to that principle, applicable only when circumstances indicate that adhering to our own precedent would result in "inevitable" reversal. See Lardas v. Commissioner, 99 T.C. 490, 494-495 (1992). Petitioner acknowledges that its case "is appealable to the Ninth Circuit" — not the First — and that the Ninth Circuit "has not yet ruled" on the issues before us. Consequently, the circumstances do not indicate that, were we to adhere to our precedent in Palmolive Bldg. Inv'rs, LLC, the Ninth Circuit would inevitably reverse our decision. We could, of course, choose to follow the interpretation of section 170(h)(5)(A) adopted by the First Circuit in Kaufman III if we found that interpretation persuasive. See, e.g., Lawrence v. Commissioner, 27 T.C. at 716 (acknowledging the need to "thoroughly reconsider" issues on which this Court is reversed and "if convinced" by the appellate court's reasoning, "to follow" that court). We declined to follow Kaufman III, however, in Palmolive Bldg. Inv'rs, LLC v. Commissioner, 149 T.C. at 394, choosing instead "to reaffirm our holdings in Kaufman v. Commissioner". We do so again here.

Relevance of Palmolive Bldg. Inv'rs, LLC


Petitioner's efforts to distinguish Palmolive Bldg. Inv'rs, LLC rest on a proviso included in section 1 of the subordination agreements executed by the holders of mortgages on the Building. Petitioner, while accusing respondent of having "cherry picked from the subordination agreement", itself resorts to a selective and misleading quotation of section 1 of that agreement to advance its claim about the scope and effect of the proviso. Here, again, is how petitioner quotes section 1 of the subordination agreements in paragraph 37 of its response to respondent's supplement:

In the event of foreclosure of the liens of the [mortgage] or deed in lieu of foreclosure with respect to the Property, the Easement shall not extinguish and the covenants, conditions and restrictions set forth therein shall survive any foreclosure or deed in lieu of foreclosure, subject to the following: (i) Lender and its assignees which are the holder or beneficiary of the [mortgage] shall have a prior claim to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the Property and all proceeds of condemnation proceedings, and shall be entitled to same in preference to Grantee until the [mortgages] are paid off and discharged. . . . provided, however, that if the Easement is extinguished under the circumstances described in Sections 11.2 of the Granting Deed, Grantee shall be entitled to compensation in accordance with the terms set forth therein . . .

On the basis of that quotation, an unsuspecting reader might conclude that the underscored proviso appears in and limits the scope of clause (i) of section 1 of each subordination agreement, which addresses the lenders' prior claims to condemnation or insurance proceeds. Relying on that premise, petitioner suggests that the lenders' claims to condemnation or insurance proceeds are subject to the Conservancy's right to compensation — at least in cases in which the easement is extinguished under the terms of section 11.2 of the Deed.

The material petitioner omits from its quotation from section 1 of the subordination agreements (indicated by the ellipsis that appear in the body of the quote) is critical to understanding the real import of the provision. Section 1's full text reads as follows:

In the event of foreclosure of the liens of the Deeds of Trust or deed in lieu of foreclosure with respect to the Property, the Easement shall not extinguish and the covenants, conditions and restrictions set forth therein shall survive any foreclosure or deed in lieu of foreclosure, subject to the following: (i) Lender and its assignees which are the holder or beneficiary of the Deeds of Trust (together with Lender, a "Beneficiary") shall have a prior claim to all insurance proceeds as a result of any casualty, hazard, or accident occurring to or about the Property and all proceeds of condemnation proceedings, and shall be entitled to same in preference to Grantee until the Deeds of Trust are paid off and discharged, notwithstanding that the Deeds of Trust are subordinate in priority to the Easement; (ii) if a Beneficiary receives an assignment of the leases, rents, and profits of the Property as security or additional security for a loan secured by the Deeds of Trust, then the Beneficiary shall have a prior claim to the leases, rents, and profits of the Property and shall be entitled to receive same in preference to Grantee until the Beneficiary's debt is paid off in full or otherwise satisfied, notwithstanding that the Deeds of Trust are subordinate in priority to the Easement, provided, however, that if the Easement is extinguished under the circumstances described in section 11.2 of the Granting Deed, Grantee shall be entitled to compensation in accordance with the terms set forth therein; and (iii) a Beneficiary or purchaser in foreclosure shall have no obligation, debt, or liability under the Easement until the Beneficiary or a purchaser in foreclosure owns the Property. Nothing contained in this Agreement shall be construed to give any Lender or Beneficiary the right to violate the terms of the Easement or to extinguish this Easement by taking title to the Property by foreclosure or otherwise.

As the full quotation shows, the proviso on which petitioner relies appears in clause (ii) — not in clause (i). Because the proviso appears only in the second of three numbered clauses within section 1, we interpret the proviso as applying to, and limiting the scope of, only the rule appearing in clause (ii). Therefore, as we read the subordination agreements, the lenders' priority right to condemnation or insurance proceeds to the extent necessary to discharge the indebtedness secured by the mortgages is not subject to or limited by the right of the Conservancy to compensation as provided in section 11.2 of the Deed.

Indeed, section 11.2 of the Deed itself provides that, in the event that the Building is sold after the termination or extinguishment of the easement, the Conservancy's right to proceeds is subject to "the satisfaction of prior claims".9 Moreover, the Deed provides a separate section, numbered 11.3, that addresses condemnation. The right accorded to the partnership and the Conservancy by that section to join in the condemnation proceeding and recover the value of their interests in the property is expressly "subject to the rights of any Lender". And section 11.3, like section 11.2, provides that the proceeds in which the partnership and the Conservancy are entitled to share are those remaining "[a]fter the satisfaction of prior claims and net of expenses reasonably incurred by Grantor and Grantee in connection with * * * [the] taking".

Protections Afforded by California Law


We find nothing in the provisions of California statutes or the caselaw of courts applying California law that limits the priority right of the lenders who hold mortgages on the Building to condemnation or insurance proceeds to the extent necessary to discharge the partnership's indebtedness. California courts have relied on the covenant of good faith and fair dealing to inform any discretion allowed to a lender under the relevant agreements to use the proceeds of insurance or partial condemnation to pay off debt secured by a mortgage on the subject property or instead allow the property owner to use those proceeds to repair or rebuild the property. But the courts generally recognized that the implied covenant could not override the express terms of the parties' agreement. Indeed, in Milstein, 27 Cal. App.3d at 486, the court indicated that the result in that case would have been different had the deed of trust simply "stat[ed] that in the event of an eminent domain proceeding the condemnation shall be paid to the beneficiary to be applied upon the secured debt." Instead, the deed of trust at issue in that case allowed the mortgagee to choose between "apply[ing] the proceeds to the debt or caus[ing] them to be paid to the trustor, the debtor." Id. Similarly, the deed of trust at issue in Schoolcraft, 81 Cal. App.3d at 78, provided that the lender could, at its option, apply the insurance proceeds to reduce the indebtedness secured by the mortgage or instead release all or part of those proceeds to the property owner. In both Milstein and Schoolcraft, the court looked to the implied duty of good faith and fair dealing to limit the discretion allowed to the mortgagee in choosing to use the condemnation or insurance proceeds to either pay down the debt secured by the mortgage or instead allow those proceeds to be distributed to the debtor to repair the subject property.

The California legislature has since confirmed by statute the principle that the implied duty of good faith and fair dealing cannot override the express terms of a deed of trust. As petitioner acknowledges, section 2924.7(b) of the California Civil Code states:

The provisions of any deed of trust or mortgage on real property which authorize any beneficiary, trustee, mortgagee, or his or her agent or successor in interest, to receive and control the disbursement of the proceeds of any policy of fire, flood, or other hazard insurance respecting the property shall be enforceable whether or not impairment of the security interest in the property has resulted from the event that caused the proceeds of the insurance policy to become payable.

Even if, as petitioner contends, the legislature did not intend "to abrogate the holding of Schoolcraft v. Ross", section 2924.7(b) of the California Civil Code confirms that, when a deed of trust provides for the use of insurance proceeds to satisfy the debt secured by a mortgage, without giving the mortgagee discretion to allow those proceeds to be distributed to the property owner to fund repairs on the property, the terms of the deed of trust will be given effect, without regard to whether the damage to the property impaired the mortgagee's security.

Petitioner appears not to have submitted the deeds of trust that define the terms of the mortgages encumbering the Building. In considering petitioner's motion for partial summary judgment, we must resolve any doubts as to factual questions against petitioner. Accordingly, we assume that the deeds of trust afford the lenders no discretion to allow the proceeds of insurance or partial condemnation to be distributed to the partnership for use in the repair of the Building.

In any event, the prospect of repair or rebuilding would not arise in a case in which the Building is wholly condemned. In that circumstance, any discretion granted to the lenders by the deeds of trust to allow the proceeds of insurance or partial condemnation to be used to repair the Building would be of no consequence. In that situation, the implied duty of good faith and fair dealing imputed into the Deed and subordination agreements would not limit the mortgagee's right to claim the condemnation proceeds to satisfy the debts secured by the mortgages.

Petitioner asserts that, "under California law * * * there is little doubt — unless the lender both meets (i) a high burden of showing 'impairment,' and (ii) also manages to overcome the nearly insurmountable burdens relating to protections of conservation easements set forth in CA 815-16 — that insurance proceeds would be applied to repair any damage." As explained above, however, the California caselaw on which petitioner relies applies the implied duty of good faith and fair dealing to require a lender to demonstrate impairment of its security only when the deed of trust gives the lender the choice between using the proceeds of insurance or partial condemnation to pay down the debt secured by the mortgage or instead allowing the property owner to use those proceeds to fund repair or rebuilding. Petitioner has not demonstrated that the deeds of trust securing the mortgages on the Building grant the mortgagees discretion whose exercise would be governed by the implied covenant of good faith and fair dealing. Moreover, the prospect of allowing proceeds to fund repair or rebuilding would not arise if the Building were wholly condemned.

The shorthand label "CA 815-16" to which petitioner seems to give almost talismanic significance collapses an entire chapter of the California Civil Code that actually includes 11 separate provisions. Petitioner is far from specific in explaining which of those provisions it views as establishing "nearly insurmountable burdens" on a lender's ability to use the proceeds of insurance or condemnation to pay off mortgage indebtedness. Petitioner does assert, however, that, "per CA 815-16, the Los Angeles Conservancy may seek injunctive relief to prevent any lender from taking insurance proceeds to pay down a mortgage under CA 815-816". Petitioner apparently means to refer to section 815.7 of the California Civil Code, which provides: "Actual or threatened injury to or impairment of a conservation easement or actual or threatened violation of its terms may be prohibited or restrained, or the interest intended for protection by such easement may be enforced, by injunctive relief granted by any court of competent jurisdiction in a proceeding initiated by the grantor or by the owner of the easement." Injunctive relief, however, is merely a means of enforcement. We do not read section 815.7 of the California Civil Code to allow the Conservancy to enforce rights it does not have and enjoin the mortgagees from exercising rights to insurance or condemnation proceeds that they do have — rights granted to them under the terms of the applicable agreements. (Moreover, we do not see how section 815.7 could have any bearing on the distribution of proceeds from the condemnation of the property as a whole, which would necessarily terminate the easement.)

Validity of Sections 1.170A-14(g)(2) and (6), Income Tax Regs.

In Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. at 195, we held "that Treasury satisfied all applicable APA requirements when promulgating" section 1.170A-14(g)(6), Income Tax Regs. Petitioner has not convinced us that that holding was incorrect.

Petitioner's reliance on Encino Motorcars is misplaced. That case involved a challenge to a regulation issued by the Department of Labor (Department) interpreting a statutory exemption from the overtime pay rules provided in the Fair Labor Standards Act. For more than 30 years, the Department had interpreted the statutory exemption as covering "service advisors" employed by automobile dealerships. The Department changed its position in a regulation issued in 2011. The Court of Appeals for the Ninth Circuit gave deference to the regulation under Chevron and held that the service advisors who sought overtime pay were not covered by the statutory exemption. See Navarro v. Encino Motorcars, LLC, 780 F.3d 1267 (9th Cir. 2015). Finding the Department's explanation of the 2011 regulation inadequate, the Supreme Court concluded that the appellate court should not have accorded the regulation in issue Chevron deference and remanded the case to allow that court to interpret the statutory exemption without regard to the regulation. The Court made it clear, however, that it evaluated the adequacy of the Department's explanation for the regulation against the prior history of its interpretation of the statute. In doing so, it followed standards it had adopted seven years earlier in FCC v. Fox Television Studios, Inc., 556 U.S. 502, 515-516 (2009). As the Court explained its evaluation of the Department's change in the longstanding overtime rule at issue in Encino Motorcars, 136 S. Ct. at 2126:

[T]he unvoidable conclusion is that the 2011 regulation was issued without the reasoned explanation required in light of the Department's change in position and the significant reliance interests involved. In promulgating the 2011 regulation, the Department offered barely any explanation. A summary discussion may suffice in other circumstances, but here — in particular because of decades of industry reliance on the Department's prior policy — the explanation fell short of the agency's duty to explain why it deemed it necessary to overrule its previous position.

"In light of this background," the Court emphasized, "the Department needed a more reasoned explanation for its decision to depart from existing enforcement policy." Id. Driving home the point again, the Court wrote: "In light of the serious reliance interests at stake, the Department's conclusory statements do not suffice to explain its decision." Id. at 2127. "This lack of reasoned explanation for a regulation that is inconsistent with the Department's longstanding earlier position", the Court concluded, "results in a rule that cannot carry the force of law." Id.

Petitioner provides no explanation of how the three Ninth Circuit opinions it cites apply to the case before us, or how, had we been bound to follow those opinions in Oakbrook Land Holdings, LLC, they might have caused us to invalidate section 1.170A-14(g)(6), Income Tax Regs. Linoz and Mt. Diablo Hospital Dist. invalidated rules promulgated without notice and comment proceedings. The issue before the Ninth Circuit in each case was whether the rule in question was "interpretive", and therefore exempt from the APA's notice and comment requirements, or instead "substantive". In both cases, the court concluded that the rules were substantive and thus procedurally invalid because the agency had not employed notice and comment procedures in issuing them. By contrast, Treasury did provide notice of and allow for comment on section 1.170A-14(g)(6), Income Tax Regs. The adequacy of those procedures — the issue we addressed in Oakbrook Land Holdings — is separate from the question — at issue in Linoz and Mt. Diablo Hospital Dist. — of whether those procedures were required at all. Finally, Organized Vill. of Kake, like Encino Motorcars, involved an agency's failure to adequately explain a change in established policy. The Ninth Circuit applied the heightened standards the Supreme Court had developed in Fox Television Studios.10 Petitioner makes no argument that those standards apply in evaluating Treasury's adoption of section 1.170A-14(g)(6), Income Tax Regs. When Treasury adopted that regulation, it did not take a position contrary to that embodied in a prior regulation.

As petitioner observes, the mortgage subordination rule incorporated in section 1.170A-14(g)(2), Income Tax Regs., did not appear in the proposed version of those regulations. At least one comment letter noted that absence and offered a suggestion for how mortgaged property should be treated.11 As petitioner also observes, however, "because the IRS did not reopen comments after adding Reg. (g)(2), other commenters did not have the opportunity to comment on the regulation in its final form."

Those observations, while accurate, are not arguments. And the argument implied by those observations — that Treasury has to conduct another round of notice and comment proceedings whenever it seeks to add a new rule to a proposed regulation — would be untenable. If the APA procedural requirements were interpreted that rigidly, notice and comment proceedings would endure almost without end, greatly delaying authoritative guidance. As we explained in Schwalbach v. Commissioner, 111 T.C. 215, 226 (1998), "The Commissioner is not required by the APA * * * to include in proposed regulations every precise rule that ultimately appears in final regulations."

The standard for when changes to a proposed regulation require further notice and comment proceedings is not as rigid as petitioner suggests. Petitioner does not acknowledge the relevant caselaw or make any effort to explain how, under the governing standard, the addition of the mortgage subordination rule was so significant as to require "reopen[ing] comments." In our judgment, the addition of the rule did not require further notice and comment proceedings before adoption of the regulation.

In Schwalbach v. Commissioner, 111 T.C. at 226-228 (citations omitted), we summarized as follows "[t]he consensus among the Courts of Appeals":

[A] final rule must differ substantially from a proposed rule in order to require another round of notice and comment, but even when it does differ substantially, the final rule will not require another notice and comment period if it is "in character with the original proposal" and a "logical outgrowth" of the notice and comments on the proposed rule. Whether a final rule meets such a test rests on whether "the purposes of the notice and comment have been adequately served." The critical inquiry is whether commentators have had a fair opportunity to present their views on the final plan in a way that the Commissioner might find convincing. Stated differently, the Commissioner's final regulations are not subject to another round of notice and comment period where the proposed regulations fairly apprise interested persons of subjects and issues that may be addressed in the final regulations. The purpose of notice and comment is not adequately served, on the other hand, where interested persons could not reasonably anticipate the final rules from the proposed rule. Where the final rules deviate too sharply from the proposed rules, notice is inadequate.

Applying those standards to Treasury's promulgation of section 1.170A-14(g)(2), Income Tax Regs., we have no doubt that the agency complied with the APA's procedural requirements. The mortgage subordination rule included in the final regulations was "in character with" and "a logical outgrowth" of the rule on extinguishment included in the proposed regulations. See Schwalbach v. Commissioner, 111 T.C. at 227. That the proposed rule implicated the issue of mortgage subordination is demonstrated by the comments submitted on that issue in response to the proposed regulation. Those comments show that "commentators * * * had a fair opportunity to present their views" on the issue. Id. The proposed extinguishment rule "fairly apprise[d] interested persons" that the final regulations might address the implications of mortgages on property subject to a conservation easement. Id. Thus, contrary to petitioner's suggestion, Treasury's adoption of a rule requiring the subordination of mortgages on the property did not require it to conduct an additional round of notice and comment proceedings.

As noted above, petitioner also complains about the adequacy of the explanation of the mortgage subordination rule that Treasury provided when it adopted section 1.170A-14 in final form. The Treasury Decision that adopted the final regulations describes the mortgage subordination rule but does not provide a detailed explanation of the thinking behind its adoption.

As petitioner observes, the APA requires an agency to include in final rules "a concise general statement of their basis and purpose." 5 U.S.C. 553(c). It would be untenable, however, to require an agency to explain, in detail, the factors it took into account in evaluating each and every rule and its reasoning in choosing the final rule. As we explained in Oakbrook Land Holdings, LLC, 154 T.C. at 194, a statement of basis and purpose need only be sufficient to allow for judicial review. When the purpose of a rule is obvious, that goal can be achieved even when the agency provides little or no explanation. See id. at 190-191.

In our judgment, the purpose of the mortgage subordination rule is obvious. In Oakbrook Land Holdings, LLC, 154 T.C. at 197, we described the "central purpose" of section 1.170A-14(g)(6) as "ensur[ing] satisfaction of the statute's 'protected in perpetuity' requirement by supplying the donee with an asset that replaces * * * the easement that has been lost." As we recognized in Palmolive Bldg. Inv'rs, LLC v. Commissioner, 149 T.C. at 391, however, "[t]he presence of a mortgage can * * * threaten the perpetuity of the donee's interest in property." If the holder of a mortgage on property subject to a conservation easement has a priority right, ahead of the donee, to use the proceeds of insurance or condemnation to satisfy the debt secured by the mortgage, the donee "might in the end receive nothing" if the property is condemned or destroyed. See id. at 397.12 The regulation's central purpose of ensuring the donee's receipt of a replacement asset would be frustrated. We thus conclude that Treasury was not required by 5 U.S.C. sec. 553(c) to provide more of an explanation than it did of the mortgage subordination rule provided in section 1.170A-14(g)(2), Income Tax Regs.

Turning to petitioner's argument concerning the substantive validity of section 1.170A-14(g)(6), we find nothing "unreasonable", much less "utterly bizarre", in the policy choice reflected in that rule. Treasury recognized the possibility that State law might not allow the holder of a conservation easement to receive a share of the proceeds from the sale of the property upon extinguishment of the easement. In that circumstance, the donee would receive nothing upon extinguishment. That prospect would raise a question of whether the conservation purpose of the contribution of an easement governed by the law of such a State could ever be "protected in perpetuity", as required by section 170(h)(5)(A). Rather than disallow any deduction for the contribution of an easement in that circumstance, Treasury chose to bow to the realities of State law: Its regulation requires that donees receive a proportionate share of the proceeds of a sale of the property upon extinguishment of the easement to the extent allowed by State law. Treasury declined to require more than applicable State law allows. We do not read that choice as an indication that "zero suffices". The concession that it may not be possible, under the laws of some States, to fully protect in perpetuity the conservation purpose of an easement's contribution does not require abandoning any effort to mandate greater protection in other States whose laws allow for greater protection.

In short, we conclude that the interpretation of section 170(h)(5)(A)'s perpetuity requirement reflected in section 1.170A-14(g)(6), Income Tax Regs., is not "arbitrary, capricious, or manifestly contrary to the statute." See Chevron, 467 U.S. at 844. Instead, the regulation reflects a "reasonable interpretation" of section 170(h)(5)(A). See id. We thus affirm and extend the conclusion we reached in Oakbrook Land Holdings, LLC. As in that case, we view our conclusion here as supported by Congress' repeated amendment of section 170 during the many years since the regulation's adoption without calling into question the policy choice embodied in the regulation.

Conclusion


For the reasons explained above, we conclude that petitioner has not demonstrated that it is entitled to judgment as a matter of law that the partnership's contribution of the easement satisfies the requirement of section 170(h)(5)(A) that the contribution's "conservation purpose is protected in perpetuity." We view Palmolive Bldg. Inv'rs, LLC as both authoritative and on point. Petitioner's effort to distinguish the governing agreements in its case from those before us in Palmolive Bldg. Inv'rs, LLC rests on a selective and misleading quotation of the terms of subordination implemented in the agreements attached as exhibits to the Deed. Properly read, the subordination agreements and the Deed maintain the lenders' priority right to condemnation or insurance proceeds to the extent necessary to discharge the indebtedness secured by the mortgages on the Building.

We accept that, in some circumstances, California caselaw might require a lender, upon a casualty or partial condemnation of mortgaged property, to establish an impairment of the lender's security as a condition to exercising a priority right to insurance or condemnation proceeds. Because petitioner has not provided copies of the deeds of trust, we are unable to determine whether that caselaw would apply. Moreover, impairment of security would not be an issue if the Building were wholly condemned.

Regarding the validity of the relevant regulations, petitioner has not given us grounds to overrule our holding in Oakbrook Land Holdings, LLC, 154 T.C. at 195, "that Treasury satisfied all applicable APA requirements when promulgating" section 1.170A-14(g)(6), Income Tax Regs. The caselaw on which petitioner relies to call that holding into question is readily distinguishable–dealing with cases in which an agency rule either changed a longstanding position or was adopted without any notice and comment proceedings at all. Although the mortgage subordination rule included in section 1.170A-14(g)(2), Income Tax Regs., was not included in the proposed version of the regulations, we are not convinced that the addition of that rule was such a departure from the proposed regulations as to require an additional round of notice and comment. Although Treasury did not provide a detailed explanation of the mortgage subordination rule in the Treasury Decision that adopted the final regulations, we judge the brief explanation it did provide as adequate for purposes of the APA requirements because of the obviousness of the rule's purpose. Finally, we do not view as arbitrary or capricious Treasury's decision to apply different standards in implementing the perpetuity requirement of section 170(h)(5)(A) depending on whether applicable State law allows a donee to share in proceeds upon the extinguishment of an easement.

Because that portion of petitioner's motion for partial summary judgment that seeks a ruling on whether the easement is a qualified real property interest within the meaning of section 170(h)(2)(C) was rendered moot by a subsequent stipulation of the parties, and because petitioner has not demonstrated that it is entitled to judgment as a matter of law that the partnership's contribution of the easement satisfies the requirement of section 170(h)(5)(A) that the contribution's "conservation purpose is protected in perpetuity", it is

ORDERED that petitioner's motion for partial summary judgment is denied.

James S. Halpern

Judge

FOOTNOTES


1. All section references are to the Internal Revenue Code in effect for the year in issue.

2. On August 7, 2019, petitioner submitted a document that purported be both a response to a prior motion for summary judgment filed by respondent and a "Cross-Motion for Partial Summary Judgment" in its own favor. In an order dated August 15, 2019, we ruled that that document and an accompanying legal memorandum were "improper two-part documents". On August 28, 2019, petitioner submitted the motion now before us. Although that motion sought rulings in petitioner's favor on only some of the issues in the case, petitioner submitted its motion as one for (full) summary judgment, and we filed the motion accordingly. In an order dated March 1, 2021, we directed the Clerk of the Court "to recharacterize petitioner's motion for summary judgment filed on August 28, 2019, as petitioner's motion for partial summary judgment."

3. Not all cases of extinguishment would give rise to insurance proceeds and, as far we know, condemnation typically would not.

4. Petitioner makes no effort, as far as we can tell, to explain how sec. 170(h)(5)(A) answers the "precise question" of what happens if a change in circumstances requires the extinguishment of a conservation easement. See Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, 467 U.S. 837, 842 (1984). In fact, petitioner acknowledges that "[t]he statute * * * says nothing about the proceeds resulting from the 'sale, exchange or involuntary conversation' of a subject property". Petitioner suggests that, had Congress intended a particular disposition of proceeds, it would have addressed that question in the statute, without acknowledging the prospect that Congress' silence on the precise question leaves a gap for Treasury to fill by administrative guidance. As we explained in Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180, 195-196 (2020): "Congress does not appear to have considered the possibility that an easement might be judicially extinguished, and the statute does not address how that possibility would affect a taxpayer's ability to satisfy the 'perpetuity' requirement. Congress therefore does not speak directly to the question at issue." Petitioner gives us no reason to revisit that conclusion.

5. For that reason, we noted, in our order granting respondent's motion for leave to supplement his response to petitioner's motion, that petitioner "ha[d] called into question its entitlement to summary judgment on the legal issue of mortgage subordination".

6. Although petitioner has submitted signed copies of the agreements, respondent questions whether the agreements were signed concurrently with the execution of the Deed. Our disposition of the motion before us does not require that we determine whether the timing of execution of the subordination agreements is a genuine question of material fact. Even if we were to accept that the agreements were timely signed, we would conclude that petitioner has not met its burden of demonstrating that it is entitled to judgment as a matter of law.

7. Petitioner also suggests that the expert it envisions would "affirm[ ] the general understanding by real estate lawyers in California" of relevant statutory law. The question of how attorneys in a State generally understand their State's statutes may be a question of fact. But that fact is irrelevant to the case before us. The relevant question is the state of California law, not how that law is commonly understood. We do not resolve legal questions by polling attorneys licensed to practice in the relevant jurisdiction.

8. Petitioner's opposition cited an opinion of the Court of Appeals for the Third Circuit in which it reversed a decision of this Court. See Culnen v. Commissioner, 28 F. App'x 116 (3d Cir. 2002), rev'g T.C. Memo. 2000-139. As we explained in our order February 26, 2021, we found Culnen and other cases cited by petitioner to be "readily distinguishable". We noted as well, however, that, "because appeal of the case before us would normally lie to the Court of Appeals for the Ninth Circuit, see sec. 7482(b)(1)(E), we would follow our own precedent in Culnen, see Lawrence v. Commissioner, 27 T.C. 713 (1957), rev'd, 258 F.2d 562 (9th Cir. 1958), rather than that of the Court of Appeals for the Third Circuit, see Golsen v. Commissioner, 54 T.C. 742 (1970), aff'd, 445 F.2d 985 (10th Cir. 1971)."

9. Petitioner again resorts to selective quotation in its presentation of section 11.2 of the Deed. Paragraph 36 of its response to respondent's supplement quotes section 11.2 of the Deed as providing that "Grantor and Grantee shall share in any net proceeds resulting from such sale in accordance with their respective interests in the fair market value of the Property, as such interests are determined under the provisions of Section 11.1, adjusted, if necessary, to reflect a partial termination or extinguishment of this Easement." Petitioner neglects to mention the text that immediately proceeds the quoted language in section 11.2. The quoted language appears in a sentence that begins: "Unless otherwise required by applicable law at the time, in the event of any sale of all or a portion of the Property (or any other property received in connection with an exchange or involuntary conversion of the Property) after such termination or extinguishment, and after the satisfaction of prior claims and any costs or expenses associated with such sale * * *."

10. Organized Village of Kake v. Dep't of Agric., 795 F.3d 956 (9th Cir. 2015), involved an agency's 2003 decision to exempt the Tongass National Forest from a rule limiting construction and timber harvesting in national forests. Two years earlier, and "[o]n precisely the same record," id. at 967, the agency had reached a contrary conclusion, declining to allow any exemption. The Ninth Circuit reasoned that the agency's 2003 "record of decision" had to "contain the 'more substantial justification' or reasoned explanation mandated by Fox." Id. The court concluded that the 2003 decision fell short of those heightened requirements.

11. According to petitioner, "at least three commenters specifically expressed concern" about the absence from the proposed regulations of a rule addressing mortgaged property. Petitioner cites, and submits with its response to respondent's supplement, a comment letter provided by the Land Trust Exchange that synthesizes comments made by individual land trusts. That letter attributes its comments regarding mortgaged property to two land trusts.

12. Needless to say, we do not accept petitioner's characterization of our opinion in Palmolive Bldg. Inv'rs, LLC v. Commissioner, 149 T.C. 380 (2017), as having "create[d] its rule out of thin air."


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