The Fifth Circuit encourages flexibility for conservation easement deductions in Bosque Mountain Ranch, while the Tax Court makes it difficult for farmers in Rutkoske. 

Two important conservation easement opinions were handed down last week.

Bosque Canyon Ranch [1] is noteworthy for the Fifth Circuit’s conservation-friendly language encouraging a flexible interpretation of the myriad statutory and regulatory requirements for easement deductions. This is a stark departure from a recent series of cases denying conservation easement deductions based on what some would call “foot faults.” More specifically, the appellate opinion in Bosque Canyon Ranch: (1) provides some certainty regarding what should be provided in a baseline documentation report, noting that the IRS should not pick apart each component of a report, and (2) holds that the right to relocate homesites that are carved out of an easement does not violate the perpetuity requirement for conservation easements, when the easement holder has approval rights over the final location and the maximum size of the homesites cannot change.

In a much less taxpayer-friendly opinion, the Tax Court in Rutkoske[2] provides the first judicial interpretation of the statutory rule that permits qualified farmers and ranchers to deduct the value of a conservation easement donation against up to 100% of their adjusted gross income. The Tax Court finds that income from the sale of farming property does not count toward qualifying the farmer and rancher for this benefit.

The cases are discussed in detail below.

Bosque Canyon Ranch: Floating homesite boundaries don’t affect easement perpetuity and baseline documentation rules are flexible

Overturning the Tax Court’s denial of $15.9 million of tax deductions based on failure of the conservation easements to be perpetual, a divided Fifth Circuit panel held that the Tax Court’s reliance on Belk v. Commissioner[3] and Balsam Mountain v. Commissioner[4] was improper. In Bosque Canyon Ranch, the subject conservation easements exclude certain pre-identified homesites from the easement, but permit the landowner to relocate those homesites within the footprint of the easement with the land trust’s consent. The Fifth Circuit distinguished this relocation ability from the ability of the landowners in Belk and Balsam Mountain to move the external easement boundaries, since the Bosque Canyon Ranch owners could not change the external boundaries of the easement. The Fifth Circuit finds that the standard of statutory review for conservation easement deductions should be ordinary, rather than strict, and states that “[C]ommon-sense reasoning …, i.e., that an easement may be modified to promote the underlying conservation interests, applies equally here.The need for flexibility to address changing or unforeseen conditions on or under property subject to a conservation easement clearly benefits all parties, and ultimately the flora and fauna that are their true beneficiaries.”[5]

The need for flexibility to address changing or unforeseen conditions on or under property subject to a conservation easement clearly benefits all parties, and ultimately the flora and fauna that are their true beneficiaries.”

The Fifth Circuit also disapproved of the Tax Court’s holding that the baseline documentation materials for the conservation easements were insufficient, stating that “a flexible approach on documentation is appropriate.” Although the Fifth Circuit overturned the perpetuity and baseline rulings from the lower court, it remanded the case so that the Tax Court could determine whether there are any other deficiencies upon which the deduction could be denied and a gross valuation penalty applied.

The dissenting opinion by Judge Dennis disagrees with the majority’s distinguishment from Belk and the majority’s use of an ordinary standard of statutory construction, claiming that the majority has created a circuit split. If that is the case, this story may not be over if the IRS decides to appeal to the Supreme Court.

The full Bosque Canyon opinion can be found here.

Rutkoske: Difficult to qualify as a “qualified farmer or rancher”

In other conservation easement news, on August 7, 2017, the Tax Court issued the first judicial opinion interpreting the special “farmer and rancher rule” in IRC § 170(b)(1)(E)(iv), which was part of the conservation easement incentive package that Congress made permanent in the PATH Act of 2015. The farmer and rancher rule permits qualified farmers and ranchers to deduct the value of a conservation easement donation up to 100% of their adjusted gross income, rather than the general 50% limit provided to non-farmers and ranchers for conservation easements in IRC § 170(b)(1)(G).

In Rutkoske, the Tax Court interpreted the definition of “qualified farmer and rancher” narrowly, holding that the taxpayers in that case did not qualify because the sale of real property is not a farming activity, even if the real property is used as farmland.

Of course, the definitional trail meanders a bit through the Internal Revenue Code. IRC § 170(b)(1)(E)(v) defines “qualified farmer and rancher” to mean a “taxpayer whose gross income from the trade or business of farming (within the meaning of section 2032A(e)(5)) is greater than 50 percent of the taxpayer’s gross income for the taxable year.” IRC § 2032A(e)(5) contains a definition of “farming purpose,” which comprises the following activities:

  • “Cultivating the soil or raising or harvesting any agricultural or horticultural commodity (including the raising, shearing, feeding, caring for, training, and management of animals) on a farm;
  • Handling, drying, packing, grading, or storing on a farm any agricultural or horticultural commodity in its unmanufactured state, but only if the owner, tenant, or operator of the farm regularly produces more than one-half of the commodity so treated; and
  • (1) The planting, cultivating, caring for, or cutting of trees, or (2) the preparation (other than milling) of trees for market.”

Examining the gross income of the Rutkoske taxpayers to determine whether at least 50% of such income was from the trade or business of farming within the meaning of section 2032(A)(e)(5), the Tax Court interpreted “within the meaning of 2032(A)(e)(5)” to mean that the source of income must be derived from the specific activities listed in IRC § 2032(A)(e)(5). Here, the adjusted gross income for the taxpayers in the year in question was primarily derived from the subsequent sale of the ranch over which the conservation easement was placed, and the Tax Court found that such a sale did not fit within the specific activities listed by section 2032(A)(e)(5). Even though the Tax Court does acknowledge that “the taxpayers are in the business of farming,” it goes on to hold that being a “qualified” farmer is different from being a farmer  because of the list in section 2032(A)(e)(5).

Even though the Tax Court does acknowledge that “the taxpayers are in the business of farming,” it goes on to hold that being a “qualified” farmer is different from being a farmer…

This case highlights the difficulty of applying the qualified farmer and rancher rule, particularly because the rule hinges on gross income. On the one hand, a non-farmer taxpayer could buy one farm enterprise to meet the 50% income threshold for a particular year, donate a conservation easement over any piece of property (farm or not) that year, and offset all income for the year, including the taxpayer’s remaining 50% of non-farm income for that year. On the other hand, a legitimate farmer who makes a large real property sale in the year of an easement donation could preclude him or herself from being “qualified” because of the disparate impact of that single sale on the farmer’s income that year.

One questions whether there is a more logical interpretation of the phrase “trade or business of farming (within the meaning of section 2032A(e)(5))” than that made by the Tax Court in Rutkoske. Could the term mean that the activity that is the source of income must have the purpose of farming and ranching, given that section 2032(A)(e)(5) actually provides a definition of “farming purpose”?[6] That may be an issue ripe for appeal at the Third or Fourth Circuit. Perhaps the generous language in Bosque Canyon Ranch could be used as persuasive authority, despite its Fifth Circuit origin.

The full Rutkoske decision can be found here.


[1] Bosque Canyon Ranch LP v. Comm’r, Case Nos. 16-60068 and 16-60069 (5th Cir. Aug. 11, 2017).

[2] Rutkoske v. Comm’r, 149 T.C. No. 6 (Aug. 7, 2017).

[3] Belk v. Comm’r, 140 T.C. 1, 10-11 (2013), aff’d, 774 F.3d 221 (4th Cir. 2014).

[4] Balsam Mountain v. Comm’r, T.C. Memo. 2015-43.

[5] Bosque Canyon Ranch LP v. Comm’r at 10.

[6] For a more detailed analysis, see Farmers weren’t “Farmers” for Purposes of Conservation Easement Deduction, K. Tilgren, Iowa State University Center for Agricultural Law and Taxation (Aug. 8, 2017).