Mortgage on Property Prevented Conservation Easement from Qualifying for a Deduction

In the published decision of Kaufman v. Commissioner, the Tax Court indicated that the existence of a pre-existing mortgage that had a superior right to proceeds of a condemnation, or from insurance for a casualty, meant that the conservation easement granted could not qualify for a deduction.

A specific requirement under Reg. §1.170A-14(g)(6)(ii) for a donation to be a qualified conservation easement is that the charity must be entitled to a portion of any proceeds from a sale, exchange or involuntary conversion that is proportionate the value of the conservation easement as compared to the total value of the property at the time the easement was created.  In the case in question, there was a preexisting mortgage on the property.  The lender in that case retained a prior claim to all proceeds of condemnation and all insurance proceeds from any casualty, hazard or accident occurring to or about the property.

The Tax Court held that the existence of the mortgage holder’s prior claim to these proceeds caused the donation to fail the requirement that the charity must be entitled to its proportionate share of the proceeds.  The Court disagreed with the taxpayers that this was a question of fact, and that they could show it was exceedingly probable the charity would get its proceeds.  The Court argued that it wasn’t enough to show the charity might obtain the proceeds—the regulation clearly required that it must receive the proceeds.

Failing to be a qualified conservation easement, the entire amount of the donation was disallowed since it now represented a gift of a partial interest, generally prohibited under §170(f)(3), and was not rescued by §170(h)(1) qualified conservation easement exception.  Effectively, the Court’s holding would deny a deduction any time a mortgage existed on property unless the lender agreed to allow its interest to become second to the charity—not something likely to happen on an existing mortgage, especially after the events of the recent past.

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