The IRS’s interpretation of Reg. §1.170A-14(g)(6)(ii), which disallows the subtraction of post-donation improvements to property on which a conservation easement exists in the event of a judicial extinguishment, was arbitrary and capricious because it violated the procedural requirements of the Administrative Procedures Act (APA). As a result, the Tax Court’s denial of a married couple’s carryforward charitable deduction for the donation of the charitable conservation easement was reversed and remanded.
Donation of the Easement
The couple donated the easement in 2012 and took a deduction on their 2012 income tax return. On their 2013 and 2014 income tax returns, the couple claimed a carryforward charitable deduction from the 2012 easement donation. The Tax Court denied the carryforward charitable deduction because the deed violated Reg. §1.170A-14(g)(6). The couple argued that the Commissioner’s interpretation of the rule was arbitrary and capricious and violated the procedural requirements of the APA.
APA’s Proposed Rulemaking Procedure
The APA sets forth three steps for proposed rulemaking. First, the general notice of proposed rulemaking is issued by an agency and is generally published in the Federal Register. Where notice is required, interested persons are permitted to submit written comments. “Significant comments” must be considered and responded to during the period for public comments. Third, in adopting the final rule, the agency must include a statement of the rule’s basis and purpose within the text.
During the rulemaking process, the couple argued that significant comments were made and that the Treasury Department did not respond to those comments and did not address the comments in the final rule’s basis and purpose statement, as it was required to do by the APA. The couple identified 13 comments on the extinguishment rule, with seven of those comments expressing various concerns about the regulation. In particular, the couple noted comments from the New York Landmarks Conservancy (NYLC), which recommended deleting the rule because “it contained pervasive problems of policy and practical applications.” Because the NYLC’s comments stated that the rule would block the purpose of the statute by deterring conservation easement donations, the comment was significant and required a response from the Treasury Department.