Condemning Conservation Easements Protecting the Public Interest & Investment in Conservation

1. Condemning Conservation EasementsProtecting the Public Interest & Investment in Conservation IRWA’s 55th Annual International Education Conference June 28 - July 1, 2009 Nancy A. McLaughlin Robert W. Swenson Professor of Law University of Utah College of Law www.law.utah.edu mclaughlinn@law.utah.edu ©2009 by Nancy A. McLaughlin. All rights reserved

2. Who should get what when land encumbered by a conservation easement is condemned in whole or in part? Conservation Easement-Encumbered Land

3. U.S. Constitution Takings Clause of 5th Amendment “…nor shall private property be taken for public use without just compensation”

4. When land encumbered by a conservation easement is taken… 1) Does the conservation easement constitute compensable “property”? 2) How should the conservation easement be valued for purposes of compensating its holder?

5. Does a Conservation Easement Constitute Compensable Property? U.S. v. General Motors 323 U.S. 373 (1945) “The constitutional provision [the Takings Clause] is addressed to every sort of interest the citizen may possess” • leasehold interests, interests of mortgagees, life estates, • remainders, and reversions, • affirmative and negative easements, whether held • appurtenant or in gross, • in a majority of states and at federal level, restrictive covenants • (negative restrictions on the development and use of land) Caveats: (i) a few easement-enabling statutes, (ii) minority rule

6. How should a conservation easement be valued for purposes of compensating its holder?

7. First Eminent Domain Valuation PrincipleThe Meaning of “Just Compensation” Normal Standard: “Fair Market Value” Willing Buyer/Willing Seller Open and Competitive Market FMV is not an absolute standard No Open and Competitive Market Other Valuation Methods are Employed U.S. v. Commodities Trading 339 U.S. 121 (1950) “Just compensation” must be fair and equitable to all parties involved

8. Valuation of Non-Possessory Partial Interests in Land(traditional easements and restrictive covenants) No open and competitive market so FMV is generally not the appropriate standard “Before & After Method” is used

9. Second Eminent Domain Valuation PrincipleMajority Rule -- Just Compensation for the Taking of Property Held Subject to a Restriction on its Useis the Property’s Unrestricted Value Fairfax County Park Auth. v. Virginia Dep’t of Transp. 247 Va. 259 (1994) FMV as park: $ 2,000/acre FMV at HBU: $125,000/acre (residential development) Board of County Commissioners v. Thormyer 169 Ohio St. 291 (1959)

10. Second PrincipleHolder should be entitled to unrestricted valueof CE Condemnation of Conservation Easement First Principle No open and competitive market FMV is not the appropriate standard “Before & After Method”

11. Total Taking

12. Total Taking At the Time of the Condemnation FMV of land if not encumbered by the easement: $5 million FMV of land encumbered by the easement: $3 million Unit Rule (aka the Undivided Fee Rule) 1) Property valued as unencumbered whole = Total Comp. Award 2) Total Comp. Award apportioned among owners of interests in the land in accordance with value of their respective rights Step 1: Total Compensation Award = $5 million Owner of encumbered land $3 million (FMV of the encumbered land) Holder of easement $2 million (value of CE/B&A method)

13. Treasury Regulations § 1.170A-14(g)(6)(ii) “when a change in conditions give rise to the extinguishment of a [conservation easement]…, the donee organization…must be entitled to a portion of the proceeds at least equal to the [Donation %] of the [conservation easement]” • The greater of: • 1) the Donation % • or • 2) The Extinguishment %

14. Partial Taking At the Time of the Condemnation FMV of land if not encumbered by the easement: $5 million FMV of land encumbered by the easement: $3 million 60% Value of the easement: $2 million 40%

15. Partial Taking At the Time of the Condemnation FMV of land if not encumbered by the easement: $5 million FMV of land encumbered by the easement: $3 million 60% Value of the easement: $2 million 40% Unit Rule (aka the Undivided Fee Rule) 1) Total Comp. Award: Before & After/Severance Damage Method **Value Property as Unencumbered Whole** 2) Total Comp. Award apportioned btwn owners of interests in the land in accordance with value of their respective rights Step 1: Total Compensation Award = $2.5 million 60% ($1.5 million) Owner of encumbered land 40% ($1 million) Holder of easement

16. Partial Taking

17. Partial TakingConservation Purpose Destroyed

18. Valuation on Front End Value of deduction = fair market value (FMV) of conservation easement at time of donation

19. Prescribed Valuation Methods Sales Prices of Comparable Easements But see Browning v. Comm’r, 109 T.C at 312 (1997)

20. Prescribed Valuation Methods • Before & After Method • Value of Easement = Difference Between: • FMV of the land immediately before the donation, and • FMV of the land immediately after the donation FMV: “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 a reasonable knowledge of relevant facts.”

21. Enhancement Rules Rule #1: Entire Contiguous Parcel Rule   If land contiguous to the land encumbered by the easement is owned by the donor [or] a member of the donor’s family, the value of the easement is equal to the difference between the before-easement and after-easement values of the entire contiguous parcel.

22. Enhancement Rules Rule # 2 If the granting of the easement increases the value of any other property owned by the donor or a “related person,” the amount of the deduction must be reduced by the amount of such enhancement, whether or not the property is contiguous.

23. Incidental Benefit Rule The donor’s charitable income tax deduction must be reduced by an amount equal to the value of any financial or economic benefit that the donor or a related person receives, or can reasonably expect to receive.

24. Valuation Abuse Exaggerating Before-Easement Value Using Subdivision Development Analysis

25. Before & After Method • Value of Easement = difference between: • FMV of the land immediately before the donation, and • FMV of the land immediately after the donation FMV: “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 a reasonable knowledge of relevant facts.”

26. Subdivision Development Analysis • Mimics valuation process employed by prospective purchaser (developer) • Appraiser determines gross proceeds realizable from imagined development • Gross proceeds discounted to reflect: • - Risks/delays • - Time • - Costs • - Expected profit

27. Subdivision Development Analysis • The “highest and best use” of the land is for • subdivision purposes • The sales comparison approach is not • available

28. Subdivision Development Analysis “Because [the SDA] is profit oriented and dependent on the analysis of uncertain future events, it is vulnerable to misuse.” USPAP 2008-2009 “Because of the compounding effects in the projection of income and expenses, even slight input errors can be magnified and can produce unreasonable results.” “[The SDA] is best applied in developing value opinions in the context of one or more other approaches.”

29. Subdivision Development Analysis U.S. Dept. of Justice, Uniform Appraisal Standards (“Yellow Book”) “When comparable sales are available with which to accurately estimate the property’s market value, the [SDA] should not be relied upon as the primary indicator of value, as it is considerably more prone to error.”

30. Subdivision Development Analysis Joe Stephens and David B. Ottaway, Developers Find Payoff In Preservation, Wash. Post, Dec. 5, 2003 A1 “…investors paid about $10 million for the land and shared in a tax write-off ‘in the $20 million range’. . .[t]he deduction was based, in part, on an appraiser’s assessment of how much the land would have been worth had they filled the acreage with 1,400 homes”

31. Subdivision Development Analysis J. D. Eaton, Real Estate Valuation in Litigation (2nd ed.1995) “If all of the land that has been appraised by the [SDA] were actually subdivided, there would be enough subdivision lots on the market to last hundreds of years and little, if any, farmland left in the United States.”

32. Whitehouse Hotel v. Comm’r131 T.C. No. 10 (2008) Before Easement Value P/S’s Expert: $43m IRS Expert: $10.3m Tax Court: $12m Easement Value P/S’s Deduction: $ 7.4m IRS’s Value: $1.15m P/S’s Expert: $10m IRS’s Expert : $ 0 Tax Court’s Value: $1.7 million

33. Bruzewicz v. United States 604 F.Supp.2d 1197 (2009) Orlando Blackmer House

34. Hughes v. CommissionerT.C. Memo 2009-94 TP’s claimed deduction: $ 3.1m IRS’s value: $ 1.9m Bull Mountain Parcel TP purchased for $1.5m in 1999 TP’s expert claims BEV was $3.5m in 2000 (128% appreciation in 14 months) Court determines BEV was $1.7m 2000

35. Kiva Dunes v. Comm’r T.C. Memo 2009-145 TP’s Claimed Deduction: $30.5m Tax Court’s Value: $28.6m