Tax Court Clarifies Deductibility and Valuation of Conservation Easement Charitable Contributions

In Zarlengo v. Comm’r, Mr. Zarlengo (Z) and Ms. Sandin-Zarlengo (S) donated a conservation easement to National Architectural Trust and obtained a qualified appraisal effective July 2004. The conservation deed was finalized the following September but not recorded until January 2005. Z and S filed returns in 2004 each including a charitable deduction equaling one-half of the donated conservation easement. Each took the maximum charitable contribution deduction and carried forward the remainder. The IRS disallowed the contribution and carryforward deductions and imposed applicable accuracy-related penalties. The court determined (1) whether Z and S are entitled to section 170 deductions for the conservation easement donation and (2) whether petitioners are liable for accuracy-related penalties.

Permitted Deductions
Z: Section 170 permits a deduction for a “qualified conservation contribution” and requires the restriction to be granted in perpetuity. The conveyance had to be recorded to have legal effect so this deed was not effective until recorded in January 2005. Z is not entitled to the deduction in 2004.

S: S was found to have “substantially complied” with the substantiation requirements detailed in the 170 regulations which require a qualified appraisal of the easement. The court noted that required information not in the appraisal report was attached in other documents. Also, the July 2004 appraisal not being timely (more than 60 days before the January 2005 recording) was insubstantial. The easement was revalued based on unbiased witness testimony. The court determined a reasonable value of the townhouse before the easement and applied a reasonable diminution rate to determine the easement’s value. S is entitled to one-half of that amount as a 2005 deduction.

For substantial valuation misstatement penalties, taxpayers could previously avoid the penalties if they made a valuation misstatement in good faith and with reasonable cause. The court found that Z and S met the standard for 2004 and 2005 because neither was a financially sophisticated taxpayer and they consulted and reasonably relied on a competent CPA with sufficient expertise. Reporting the deduction in 2004 was out of a good faith belief that it was the year in which the gift was complete. Z and S are not liable for accuracy penalties in 2004 or 2005.

The good faith exception was removed for returns filed after July 25, 2006. For S’s 2006 and 2007 returns, the defense cannot be raised because the gross valuation misstatement penalty is now a strict liability penalty with respect to a charitable deduction property.

Posted by Ryan Moore, Associate Editor, Wealth Strategies Journal