Taxation of proceeds of contract to not complain........

Technical topics regarding tax preparation.
#41
Nilodop  
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Jeff-O, I have neither scanned nor perused that treatise, but I noticed a major theme of it seems to be that perpetual may not really be perpetual. Or something like that.

But the legislative and regulatory history I hoped someone would review is why the conservation easement deduction requires the easement to be perpetual. Was it fiscal (revenue considerations), or political, or technical (substantively different tax aspects of a peretual easemnt and a non-perpetual one). I hope someone looks at that.
 

#42
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This is just from memory, but I believe the exclusive use for conservation purposes requires "protection of the properties" in the easement in perpetuity. But, you do get a deduction for donating a mere partial interest.

Reg 1.170A-14 makes for fascinating reading as do the Tax court cases. There are enough legal issues involved to make the subject matter akin to estates and trusts.
 

#43
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There's little doubt that a 40-year easement is a property right, even if it's taxed as a lease under tax law, so the earlier emphasis on that may well be misplaced. Or at least not key to our issue (rent vs. sale).

This typically does not happen, but suppose it does: Landowner agrees on a lease for a long number of years (30, 40, 99, maybe just 10 or 15) at a rent amount that is discounted for two factors in return for a prepayment of the entire rent for the term of the lease One factor is the cost of money, i.e., the interest income that the owner expects to earn on the cash received, which upon negotiation is the same as the interest cost the lessee expects to pay. The other factor is the combo of less risk of bad debt loss during the lease and added opportunity for using the advance rent for the owner, with the contra to the lessee. Inflation predictions enter the picture too.

Now suppose the property values and therefore the fair rent values rise rapidly and greatly after the lease is signed. The lessee made a good deal, and the owner/lessor didn't. In fact the value of the property will have declined while the lease is in place, and the owner would have to take a lower price or buy out the lessee if he wanted to sell the property.

Let's say the value decline from the too-low-rental lease happened almost right away But that value change is temporary, and it's well settled that a temporary decline in value of property is not deductible absent some event such as a sale or abandonment. So the owner can't deduct that loss of value. The lease is property but that temporary loss in value not only is not deductible, but it is also not added to basis of the property. If it were, then maybe the advance rent received could be recharacterized as compensation for the loss in value, i'e', a sale of the property.

And if that lease were perpetual (is there such a thing?), I think the whole transaction including the advance rent payment would be viewed as a sale of the property. In fact, any years ago, a client of mine sold a strip mall at a combo of a fixed up front amount, essentially the approximate FMV of the property, plus a perpetual obligation to pay a percentage of the retail sales of the stores in the strip mall (a typical rent override). We concluded that there was a sale of the property at a contingent price on the installment method, with imputed interest under sec 483.

So with that long-winded intro, my point is that a perpetual easement is tantamount to a sale of the part of the property subject to the easement, whereas a temporary easement is analogous to a lease. The tax treatment should follow. Rent.
 

#44
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If rent - would a cash-basis taxpayer have to (or be allowed to) apply 467-type rules and amortize the one-time payment over the life of the lease?
 

#45
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Not sure because we'd have to apply all the tests. But whether the income gets spread out over the term of the lease, or taxed up front under reg. 1.61-8, if it's rent it's not applied to basis.
 

#46
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So with that long-winded intro, my point is that a perpetual easement is tantamount to a sale of the part of the property subject to the easement, whereas a temporary easement is analogous to a lease. The tax treatment should follow. Rent.


So, where does the concept of a “mere” basis reduction come into play? It wouldn’t come into play with a temporary easement (since that’s a lease). It would only come into play only with a perpetual easement…and, it seems, only in limited situations, depending on the nature of the easement. What would one of those situations be?
 

#47
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Not clear why you raise "mere" basis reduction, with or without the quotation marks.

But I'll take a stab at your last question. RR 68-291 and Inaja Land.
 

#48
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Not clear why you raise "mere" basis reduction, with or without the quotation marks.

Because there’s this idea floating out there that if we have a permanent easement, we might just be able to offset the proceeds against our basis and we stop the accounting there. Let’s say basis is $100k and permanent easement payment is $30k. We offset. That’s it. A “mere” basis reduction. No loss recognition. Perhaps this is accurate, since we still retain the property (a la the Open Transaction doctrine). And if the easement payment was $110k, we still don’t have a sale, yet we have $10k of gain to report. (This reminds me of the S-shareholder who hasn’t disposed of his stock, but has a gain for a distribution in excess of basis).

However, in Post #43, you said:

So with that long-winded intro, my point is that a perpetual easement is tantamount to a sale of the part of the property subject to the easement, whereas a temporary easement is analogous to a lease. The tax treatment should follow.

If we have something “tantamount” to a sale, although not a sale, wouldn’t we maybe have gain OR loss recognition?

It seems that the Rule here is this: If we have a permanent easement and retain the property, we can maybe recognize gain, but never loss. That’s not how a sale works. Yes, perhaps that’s how something “tantamount” to a sale works, but that’s only because we attach the word “tantamount” to the transaction after we determine we have a gain. In other words, if we receive a payment for a permanent easement, and we retain the property, we wouldn’t say we should treat the transaction as “tantamount” to sale if the proceeds are less than our basis. In that case, we simply offset proceeds against basis and do not recognize loss. Only if the proceeds exceed basis would we say the transaction is “tantamount” to a sale.

Thank you.
 

#49
Nilodop  
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OK, so say using an Inaja reasoning, except we have a 10,000 sq ft unimproved square lot on which every single sq ft has a $10 basis and a $6 value. It's an investment property. We grant a perpetual easement on 2,500 of those sq ft, perhaps all along one side, though that's unimportant. We receive $5 per sq ft or $12,500 for the easement. Unlike in Inaja, we easily and correctly know the basis of the easement land, $25,000, and since we have, per you, an economic but not deductible loss, we must have a remaining basis of $87,500. Had we been able to subdivide and sell the easement land, we'd have had a deductible loss of $12,500 and a remaining basis of $75,000. Please check my math and my understanding of what you taught us.

Now change just one fact - we grant a perpetual easement on the entire property. Above I said And if that lease were perpetual (is there such a thing?), I think the whole transaction including the advance rent payment would be viewed as a sale of the property.. I ask also, is it possible to have a perpetual easement on an entire property and would that, like the perpetual lease, be treated as a sale? With a deductible loss? If so, why no deductible loss on the perpetual easement in my example?

You're welcome.
 

#50
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I ask also, is it possible to have a perpetual easement on an entire property and would that, like the perpetual lease, be treated as a sale? With a deductible loss?


Yes, yes and yes.

The Pub that Keiser cites in Post #36 has it right:

If you transfer a perpetual easement for consideration and do not keep any beneficial interest in the part of the property affected by the easement, the transaction will be treated as a sale of property.


As to this comment:

If so, why no deductible loss on the perpetual easement in my example?


Let’s back up. I think we need to clarify something here and also clarify some of the rules we’re trying to create. The something we need to clarify is the nature of the easement. Some key words here, including within the Pub reference above, are “beneficial interest” and whether or not we retain that.

What comes to mind here is our house that sits on a street. There is a land-locked lot behind our house that we also own. If we want to sell that lot so someone can build a house on it (or maybe we build a spec home) we’re gonna need to provide access to that back lot to whoever buys it. One way is to draw up an easement, so that the buyer of the lot can go from the main street, through the edge of our property to get to his. It seems to me that we could use that access even though there’s an easement on it. Now, if the state comes along and says they want an easement so they can build a highway through the side of our yard, well, we can’t really throw the ball with Junior there anymore. No more beneficial interest. In that case, I’m thinking we could take a loss. See Rev Rul 72-255.

Now, as to clarifying the rules, see if you agree:

1. If we grant a non-perpetual easement, it’s a lease.

2. If we grant a perpetual easement, and retain a beneficial interest in the portion so granted, no “sale.” We offset proceeds against basis. If proceeds exceeds basis, we have a gain. We might say we have a transaction that is tantamount to a sale, but for gain recognition purposes only. This is the S-corp distribution in excess of basis type of situation, wherein we retain an interest in our stock.

3. If we grant a perpetual easement, and do not retain a beneficial interest in the portion so granted, we have what is tantamount to a sale for both gain and loss recognition purposes. Note that a “beneficial interest” would not include bare naked title alone. The gist here is that if we grant an easement that causes our property to become worthless to us, we have a closed transaction for gain/loss realization purposes (and recognition purposes as well, assuming some deferral provision doesn’t apply).

There is a relatively new case, from 1928 (the earth is like 4 billion years old, you know), that said this:

Under the provisions of this instrument it is plain that about the only thing or interest remaining in the petitioner is the bare legal title and that this is of no practical or market value. According to the evidence and findings of fact, the petitioner has been deprived of all beneficial interest in the land, and it is useless for farming or grazing purposes. Under such circumstances, many courts hold that the granting of such an easement is tantamount to a sale of the fee. We have been cited to no case in Texas passing upon this question, but we find the general rule stated by the following authorities and text writers.

H. L. SCALES., 10 BTA 1024

Are we getting closer to understanding all this easement stuff? It’s not so “easy” now, is it…

Perhaps we need to re-read Post #36 in full and see if our set of rules aligns with the Pub.
 

#51
Nilodop  
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We're pretty much in agreement w/o actually saying so. It's, like, tantamount to our being in agreement. I'll make a few comments, definitely NOT in order of importance.

The first is more of a question than a comment. Is there a substantive difference between "bare naked title alone" and "bare legal title"?

The next is this. In #48 you say It seems that the Rule here is this: If we have a permanent easement and retain the property, we can maybe recognize gain, but never loss.. And you say In that case, we simply offset proceeds against basis and do not recognize loss.. And a large part of the reasoning for that is stated thrice in #48. since we still retain the property and we retain the property and and retain the property. Thrice, mind you, although I may have shown them in a different order than you used them.

Now that phrase is subject to some misinterpretation. Is the property the entire property pre-easement, or just the property made subject to the easement? That question becomes important as a way to distinguish my example in #49 as well as your Rev Rul 72-255 (in #50) from facts like in Inaja Land and my Rev Rul 68-291 (in #47).

But I do see redemptive clarification later when you build on this: Some key words here, including within the Pub reference above, are “beneficial interest” and whether or not we retain that. . It still might help to specify whether the impossibility of allocating basis to the easement land is present in the facts, as opposed to the clear ease of such allocation in my example in #49. That also should have been clarified in Rev Rul 72-255, and it's not too late for that.

Another thought I had is whether it matters to our conclusion whether the age of the earth is like 4 billion years old, you know or is it only in the low to mid thousands of years. The ever fun science/religion thingy. I conclude it does not matter.
 

#52
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The first is more of a question than a comment. Is there a substantive difference between "bare naked title alone" and "bare legal title"?


Yes. The former could refer to illegal title as well as legal title.

Now that phrase is subject to some misinterpretation. Is the property the entire property pre-easement, or just the property made subject to the easement?


I think it’s the portion of the property subject to the easement. I don’t put a whole lot of stock into the idea that we can’t figure out basis for a portion of a property (i.e. that it would be impossible or impractical). The fact is, if we were to subdivide the easement portion off of the whole, and then sell the easement portion instead of putting an easement on it, we’d need to know the basis. I do suppose, though, that if we have numerous adjoinging parcels, bought at different times for different prices, and then we run an easement through the whole of them, maybe it’s impractical to figure out basis for the easement portion.

In any case, if you read the Scales case, the guy owned like 6,000 acres. The easement only covered 324.4 acres. The court said:

In view of these authorities and the facts that the petitioner has surrendered perpetual and complete control of the 324.4 acres involved herein to the Levee Improvement District, and that it is useless for purposes of cultivation or grazing because almost always overflowed by water, we must hold, for the purposes of this proceeding and for taxation, that the conveyance to the Levee Improvement District was tantamount to a sale and that petitioner has no beneficial interest therein.

Key word “beneficial interest: and “therein.” All in all, I think the Rules I put forth cover every situation.

I conclude it does not matter.


Very well then.
 

#53
Nilodop  
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All in all, I think the Rules I put forth cover every situation..

As Billy Shakespeare said,
“He was a man, take him for all in all,
I shall not look upon his like again.”


I am loath to end this discussion, but I fear it is the right thing to do, if only for hoping not to beat a dead horse.
 

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