Opinion
13248-20
02-08-2023
SN Worthington Holdings LLC f.k.a. Jacobs West St. Clair Acquisition LLC, MM Worthington Inc., Tax Matters Partner, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Ronald L. Buch Judge
SN Worthington Holdings LLC (SN Worthington) deducted the value of a conservation easement it donated to the Historic Warehouse District Development Corporation of Cleveland (HWDDC). The Commissioner disallowed the deduction and determined penalties. For SN Worthington to be entitled to a deduction under section 170, the easement's conservation purpose must be protected in perpetuity. The parties have filed cross-motions for partial summary judgment regarding whether the easement satisfies the perpetuity requirement. Because the Deed of Historic Preservation and Conservation Easement (Deed) does not satisfy Treasury Regulation § 1.170A-14(g)(2) and (6), the easement is not protected in perpetuity and does not satisfy the requirements for deduction under section 170(h).
Unless otherwise indicated, all statutory references are to the Internal Revenue Code, Title 26 U.S.C., in effect at all relevant times, all regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar.
Background
SN Worthington is a limited liability company organized under Ohio law and classified as a partnership for federal income tax purposes. MM Worthington Inc. (MM Worthington) is the tax matters partner (TMP). SN Worthington's mailing address and primary place of business were in Michigan when the TMP filed the petition in this case.
In 2016, SN Worthington acquired three historic buildings in Cleveland, Ohio: (1) the Joseph and Feiss Building, (2) the Gilcrest Building, and (3) the George Worthington Company Building (collectively, "Worthington Square"). SN Worthington acquired Worthington Square by purchasing the equity of the entity that owned the buildings, Jacobs LLC, for $10,715,000 on August 31, 2016. To finance the acquisition, SN Worthington obtained a $6,250,000 mortgage loan from Civista Bank. The loan is secured by Worthington Square and an assignment of rents and income from Worthington Square. The mortgage deed and assignment evidencing Civista Bank's security interests were recorded in the record of the Fiscal Officer of Cuyahoga County, Ohio, on September 1, 2016.
Worthington Square is in the Cleveland Warehouse Historic District (Warehouse District). The Warehouse District was listed on the National Register of Historic Places in 1982 and is a "registered historic district" under section 47(c)(3)(B). The Secretary of the Interior certified that each of the Worthington Square buildings contributes to the Warehouse District's significance and is a "certified historic structure for a charitable contribution for conservation purposes."
I. Easement Donation
SN Worthington granted a façade easement in Worthington Square to HWDDC, a qualified organization within the meaning of section 170(h)(3). HWDDC is a nonprofit corporation that operates primarily for historic preservation and conservation purposes. Their operations relate to "sites, buildings, and objects of local and national significance," and include "accepting preservation easements on buildings having historical or architectural importance." SN Worthington, HWDDC, and Civista Bank executed the Deed establishing the easement and recorded it on December 22, 2016. The Deed describes the easement's purpose: to maintain the historic features of Worthington Square's façade and prevent development in the surrounding air space for "conservation and preservation purposes." The Deed includes documents describing Worthington Square's historic features and requires SN Worthington to maintain and preserve them. It also gives HWDDC the right to enforce the easement. SN Worthington granted the easement to HWDDC "in perpetuity."
HWDDC is tax-exempt under section 501(a) based on its status as a section 501(c)(3) organization. It is a "qualified recipient of qualified conservation contributions under Section 170(h)" that "is authorized to accept historic preservation and conservation easements in accordance with Treasury Regulation § 1.170A-14(c)(1)."
II. Relevant Deed Sections
The Deed includes provisions regarding the respective rights of HWDDC, SN Worthington, and Civista Bank. The provisions that are central to this Order concern allocation of proceeds in the event of extinguishment or condemnation, and subordination of Civista Bank's mortgages. We also consider provisions relating to interpretation of the Deed.
A. Provisions Concerning Proceeds
Section 9 contemplates a situation in which the value of Worthington Square, as real property is reduced to cash or other property following judicial extinguishment of the easement or condemnation of the property. This section defines SN Worthington's and HWDDC's percentage interests in the fair market value (FMV) of Worthington Square for purposes of allocating proceeds in such an event.
Section 9.1 provides that HWDDC's percentage interest in Worthington Square's FMV must be determined according to the following fraction:
recording date value of easement / recording date value of Worthinaton Sauare
The values are determined as of the recording date. Thereafter, this fraction, and thus HWDDC's percentage interest in Worthington Square's FMV, must “remain constant, except that (if and to the extent only such is not prohibited by Treas. Reg. 1.170A-14(g)(6)) the value of any improvements made by [SN Worthington] after the Recording Date is reserved to [SN Worthington].”
Section 9.2 addresses judicial extinguishment. It requires HWDDC and SN Worthington to judicially extinguish the easement if an “unexpected change in the conditions . . . make the continued ownership or use of [Worthington Square] in a manner consistent with the purpose of this Easement impossible.” If Worthington Square is sold or otherwise reduced to cash upon extinguishment, SN Worthington and HWDDC must share “net proceeds”-including net sale, net insurance, and condemnation proceeds-after “the satisfaction of prior claims and any costs or expenses associated with such sale.” HWDDC must be allocated net proceeds based on its percentage interest in Worthington Square's FMV on the recording date. Thus, HWDDC's share of the net proceeds is determined according to the following formula:
net proceeds x (recording date value of easements/ recording date value of Worthington Square)
If HWDDC receives an amount of actual proceeds that falls short of the required proportionate share, SN Worthington “agrees to pay” HWDDC the difference, which payment “shall be deemed to be net proceeds.”
Section 9.2 also gives HWDDC some priority in proceeds upon extinguishment. It provides that “the provisions of this Section shall survive extinguishment and shall constitute a lien on [Worthington Square] with the same effect and priority as a construction lien, except that such lien shall not jeopardize the priority of any recorded lien of mortgage or deed of trust” secured by Worthington Square.
Section 9.3 addresses condemnation. A condemnation occurs if any part of Worthington Square is taken or purchased "under the power of eminent domain by public, corporate, or other authority." If Worthington Square is condemned, this section requires that SN Worthington and HWDDC "join in appropriate proceedings" to recover the value of Worthington Square and damages from the taking. The recovered proceeds must be allocated in accordance with the formula above after "the satisfaction of prior claims and net of expenses reasonably incurred . . . in connection with such taking."
Finally, section 9.4 requires HWDDC to use all proceeds it receives under this section in a manner consistent with the easement's original purpose.
B. Provisions Concerning Subordination
Section 12 of the Deed addresses subordination of existing and future mortgages. First, it identifies two existing mortgages that Worthington Square is subject to-namely, the mortgage deed and assignment of rents recorded on September 1, 2016, in connection with the acquisition of Worthington Square. It also identifies two UCC financing statements filed on September 1, 2016 and September 8, 2016, both of which name Civista Bank as the secured party and SN Worthington as the debtor. The Deed refers to all four of these mortgages or security instruments as mortgages and defines Civista Bank as a "mortgagee."
Next, Section 12.1 subordinates Civista Bank's mortgages under certain conditions and stipulations. It provides that:
Each mortgagee . . . joins in the execution of this Deed to evidence Mortgagee's consent to this Deed and its agreement to subordinate the Mortgage to this Deed and to all of [HWDDC's] rights and interests hereunder under the following conditions and stipulations, which conditions and stipulations also shall extend to future lenders/mortgagees/lien holders subsequent to the recording of this Deed (who shall each be deemed to be "Mortgagee" for purposes of this Deed):
(a) If Mortgagee receives an assignment of rents, leases or profits of [Worthington Square] or part thereof as security or additional security for any obligations or indebtedness secured by a Mortgage, then, except to the extent such priority would adversely impact [HWDDC's] right to enforce the conservation purpose of the Easement in perpetuity, Mortgagee shall have a prior claim to the rents of [Worthington Square] or such part thereof and shall be entitled to receive the same in preference to [HWDDC] until the mortgage loan from Mortgagee to [SN Worthington] secured by the Mortgage is paid off or otherwise satisfied, notwithstanding that the Mortgage is subordinate in priority to this Deed.
Section 12.2 addresses future mortgages. It provides that "[a]ny mortgage, security instrument or other lien arising after the Recording Date shall be fully subordinate to this Deed and the terms of the Easement."
Civista Bank signed the Deed beneath an acknowledgement that states that Civista Bank "expressly acknowledges and agrees that each Mortgage . . . with respect to which it is a Mortgagee shall be, and it hereby is, subordinate to this Deed . . . and all of [HWDDC's] rights and interests hereunder. [Civista Bank] also agrees to be bound by this Deed . . . with respect to all of its rights and interests in [Worthington Square]."
C. Provisions Concerning Effectiveness and Interpretation
Section 10.1 of the Deed provides rules governing the effectiveness, interpretation, and duration of the Easement and the Deed. As relevant here, Section 10.1(a) provides that the Deed "shall be interpreted broadly to effect its purposes and the transfer or rights and the restrictions on use contained herein." Section 10.1(e) further provides:
If any provision of this Deed (or portion thereof) shall be determined to violate the requirements for a qualified conservation contribution under Section 170(h) of the Code and the corresponding regulations and case law thereunder, or the [Ohio Revised Code] and any corresponding regulations and case law thereunder, then such provision (or portion thereof) shall be void and have no effect. Furthermore, to the extent any clarifying guidance with respect to Section 170(h) of the Code or the [Ohio Revised Code] is issued in the form of case law or administrative pronouncement subsequent to the Recording Date, this Deed shall be amended by the parties in form and substance reasonably deemed necessary by the parties to incorporate and be consistent with such clarifying guidance, effective as of the Recording Date, and any provisions or actions that are not consistent with such clarifying guidance shall be considered void and have no effect.
III. Reporting of Easement Donation
SN Worthington filed Form 1065, U.S. Return of Partnership Income, on which it reported the easement donation to the Commissioner. SN Worthington attached Form 8283-V, Payment Voucher for Filing Fee Under Section 170(f)(13), to the partnership return. Line 3 of that form asks the "[n]umber of properties requiring fee," and the instructions for that line tell the taxpayer to "[e]nter the number of contributions made during the year for which you must pay the $500 filing fee." SN Worthington reported that one property required the $500 filing fee and submitted the $500 fee payment with the return.
IV. Notice of Final Partnership Administrative Adjustment
The Commissioner mailed a notice of final partnership administrative adjustment (FPAA) for SN Worthington's taxable year ending December 31, 2016, to the TMP. The Commissioner disallowed deductions for the easement donation and a rental real estate loss. The Commissioner also determined penalties at the partnership level under section 6662 and section 6662A. The TMP filed a petition for readjustment of partnership items under section 6226.
V. Cross-Motions for Partial Summary Judgment
The Commissioner filed a Motion for Partial Summary Judgment in this case, and the TMP filed a response and Cross-Motion for Partial Summary Judgment. While these motions were pending, a case that could potentially affect the outcome of these motions wound its way through the courts. See Oakbrook Land Holdings, LLC v. Commissioner, 154 T.C. 180 (2020), aff'd, 28 F.4th 700 (6th Cir. 2022), cert. denied, No. 22-323, 2023 WL 124412 (Jan. 9, 2023); but see Hewitt v. Commissioner, 21 F.4th 1336 (11th Cir. 2021), rev'g and remanding T.C. Memo. 2020-89.
Discussion
This is a TEFRA partnership-level proceeding brought by the TMP pursuant to section 6226. Pending before us are the parties' cross-motions for partial summary judgment. In those motions, the parties ask us to decide whether the easement donation is a "qualified conservation contribution" within the meaning of section 170(f)(3)(B)(iii) and section 170(h). The specific issue is whether the Deed satisfies section 170(h)(5) and related regulations, which require the easement's conservation purpose to be "protected in perpetuity."
I. Summary Judgment Standard
The purpose of summary judgment is to expedite litigation and avoid unnecessary and expensive trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). Under Rule 121(a), either party may move for summary judgment regarding all or any part of the legal issues in controversy. We may grant summary judgment only if there is no genuine dispute as to any material fact. Rule 121(b); Naftel v. Commissioner, 85 T.C. 527, 528-29 (1985). Partial summary is appropriate if some but not all issues in the case can be disposed of without trial. See Rule 121(b); Turner Broad. Sys., Inc. v. Commissioner, 111 T.C. 315, 323-324 (1998). The moving party bears the burden of demonstrating that there is no genuine dispute as to any material fact. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). In deciding whether to grant summary judgment, we draw factual inferences in the light most favorable to the nonmoving party. FPL Grp., Inc. & Subs. V. Commissioner, 115 T.C. 554, 559 (2000). When a motion for summary judgment is made and properly supported, the nonmoving party may not rest on mere allegations or denials, but instead must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d). Whether the Deed satisfied the perpetuity requirement is a legal question appropriate for summary adjudication. See Palmolive Bldg. Invs., LLC v. Commissioner, 149 T.C. 380, 388-89 (2017).
II. Deduction for Charitable Contributions
Section 170(a)(1) allows a deduction for any charitable contribution made during the tax year. A "charitable contribution" is a "contribution or gift" to certain qualified organizations. I.R.C. § 170(c)(2). If a taxpayer contributes property other than money, the amount of the contribution is generally equal to the fair market value of the property at the time of the contribution. See Treas. Reg. § 1.170A-1(c)(1). Section 170(f)(3)(A) disallows deductions for charitable contributions of partial interests in property, subject to various exceptions.
One such exception is for a "qualified conservation contribution." I.R.C. § 170(f)(3)(B)(iii); Treas. Reg. § 1.170A-14(a). Section 170(h)(1) defines a qualified conservation contribution as a contribution "(A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes." The statute also defines each of these three elements. See I.R.C. § 170(h)(2), (3), (4).
In the parties' cross-motions for summary judgment, the only element in dispute is whether the contribution was "exclusively for conservation purposes." See I.R.C. § 170(h)(1), (5) (emphasis added). If not, then the contribution will not qualify for deduction. If so, an outstanding question exists as to whether the contribution meets the other requirements of a "qualified conservation contribution," which the Commissioner preserved for trial.
The element in dispute has two components, a conservation purpose and exclusivity. The parties do not specifically dispute that historic preservation of Worthington Square's façade is a conservation purpose, but only that the contribution is not exclusively for this purpose. See I.R.C. § 170(h)(4)(A)(iv), (h)(4)(C); Treas. Reg. § 1.170A-14(d)(5)(iii).
A. Section 170(h)(5) and Regulations thereunder
Section 170(h)(5)(A) provides that a "contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity." While neither the statute nor the accompanying regulations define "protected in perpetuity," the regulations provide guidance for satisfying this requirement. See Treas. Reg. § 1.170A-14(a). Treasury Regulation § 1.170A-14(e) reiterates that, "[t]o meet the requirements of this section, a donation must be exclusively for conservation purposes." It then advises us to "[s]ee paragraphs . . . (g)(1) through (g)(6)(ii)." Of those paragraphs, paragraph (g)(2) ("Protection of a conservation purpose in the case of donation of property subject to a mortgage" i.e., "Subordination") and paragraph (g)(6) ("Extinguishment") are central to this Order.
1. Extinguishment
Treasury Regulation § 1.170A-14(g)(6)(i) recognizes that "a subsequent unexpected change in the conditions surrounding the property . . . can make impossible or impractical the continued use of the property for conservation purposes." Despite that possibility, an easement's conservation purpose can "be treated as protected in perpetuity" if, in the event of extinguishment, (1) the restrictions are extinguished by judicial proceeding; (2) the qualified organization is entitled to receive proceeds from a sale or exchange of the property in accordance with Treasury Regulation § 1.170A-14(g)(6)(ii); and (3) the qualified organization uses all its proceeds "in a manner consistent with the conservation purposes of the original contribution." See Treas. Reg. § 1.170A-14(g)(6)(i). The extinguishment regulation is the "single-and exceedingly narrow-exception to the requirement that a conservation easement impose a perpetual use restriction." Belk v. Commissioner, 774 F.3d 221, 225 (4th Cir. 2014), aff'g 140 T.C. 1 (2013). We strictly construe its requirements. Id.; Carroll v. Commissioner, 146 T.C. 196, 212 (2016).
We generally look to the terms of the Deed to determine whether these requirements are satisfied. The parties only dispute whether the Deed entitles HWDDC to the requisite amount of proceeds under Treasury Regulation § 1.170A-14(g)(6)(ii), sometimes referred to as the Proceeds Rule. If the Deed violates the Proceeds Rule, the TMP asks us to hold that the regulation is invalid. Because existing precedent controls the question of the regulation's validity, we address that issue first.
a. Validity of the Extinguishment Regulation
Taxpayers have challenged the extinguishment regulation's validity in Tax Court without success. In Oakbrook, we held that the extinguishment regulation is procedurally valid under the Administrative Procedure Act (APA). Oakbrook Land Holdings, 144 T.C. at 194-95. We also held that the Commissioner's interpretation of the regulation (that the Proceeds Rule prohibits subtraction of donor improvements) was substantively valid. Id. at 199-200. The United States Court of Appeals for the Sixth Circuit-the appellate venue in this case-affirmed and the Supreme Court denied certiorari. Oakbrook, 28 F.4th 700 (6th Cir. 2022), cert. denied, 2023 WL 124412 (Jan. 09, 2023).
Controlling precedent holds that the extinguishment regulation is valid. Generally, we follow our own precedent. However "where the Court of Appeals to which appeal lies has already passed upon the issue before us, efficient and harmonious judicial administration calls for us to follow the decision of that court." Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff'd on other grounds, 445 F.2d 985 (10th Cir. 1971), cert. denied, 404 U.S. 940 (1971). We do not face conflicting precedent in this case; both this Court and the Court of Appeals for the Sixth Circuit have upheld the extinguishment regulation as valid. Therefore, we need not revisit the question; the regulation is valid.
b. The Proceeds Rule
The Proceeds Rule governs how proceeds must be allocated upon an easement's extinguishment. Although the Code and regulations fail to define proceeds, it ordinarily means "the total amount brought in." Oakbrook Land Holdings, LLC v. Commissioner, T.C. Memo. 2020-54, at *37-38 (quoting PBBM-Rose Hill, Ltd. V. Commissioner, 900 F.3d 193, 207 (5th Cir. 2018)) (internal quotations omitted). Upon a sale, exchange, or involuntary conversion of the property after extinguishment, the qualified organization "must be entitled to a portion of the proceeds" according to its proportionate share of the overall FMV of the property. Treas. Reg. § 1.170A-14(g)(6)(ii). This proportionate share is determined by a fraction where the numerator is value of the easement, and the denominator is the value of the property as if it were not subject to the easement, both determined as of the donation date. Id.; Carroll, 146 T.C. at 216. The values must remain constant, so the qualified organization's proportionate share must be fixed as of the donation date. Treas. Reg. § 1.170A-14(g)(6)(ii). This rule is more simply illustrated than explained. For example, assume an easement value of $10,000 and a property value (as if the property were not subject to the easement) of $100,000 on the donation date. To satisfy the Proceeds Rule, and thus the extinguishment regulation, the qualified organization must be entitled to receive an amount of the proceeds that is proportionate to its share of the property's FMV, i.e., 10,000/100,000, or 10% of the proceeds.
The Deed in this case includes a formula that comports with the Proceeds Rule to some extent. Section 9.1 of the Deed provides that HWDDC's proportionate share must remain constant, which is consistent with the regulation. However, it also includes a carve out: HWDDC's proportionate share must "remain constant, except that (if and to the extent only such is not prohibited by Treas. Reg. 1.170A-14(g)(6)) the value of any improvements made by [SN Worthington] after the Recording Date is reserved to [SN Worthington]." This carve-out runs afoul of the Proceeds Rule, which prohibits subtraction of any amount from the total proceeds to which a qualified organization is entitled, including amounts attributable to donor improvements. Oakbrook Land Holdings, T.C. Memo. 2020-54, at *40-41; TOT Prop. Holdings, LLC v. Commissioner, No. 5600-17, 2019 WL 11880554, at *5, aff'd, 1 F.4th 1354, 1363 (11th Cir. 2021); Coal Prop. Holdings, LLC v. Commissioner, 153 T.C. 126, 144 (2019); PBBM-Rose Hill, 900 F.3d at 199.
The TMP argues that the Deed nevertheless satisfies the Proceeds Rule because of the conditional language and the carve-out. Those two things essentially say that if and to the extent that reserving the value of post-donation improvements is not prohibited by the extinguishment regulation, SN Worthington reserves the value of post-donation improvements to itself. The TMP contends that this is not an "unenforceable condition subsequent" or "savings clause," but is rather a "condition precedent" to a departure from strict compliance with the Proceeds Rule that is essentially a nullity because it can never be satisfied.
The Commissioner counters that the conditional language is an unenforceable condition subsequent or "savings clause." He argues that the clause is not merely interpretive "because its operation is dependent upon a determination by the court or the Internal Revenue Service about whether a reservation of the value of any post-easement improvements to the grantor is prohibited by Treas. Reg. 1.170A-14(g)(6)." In support of this argument, he cites TOT Property Holdings, 1 F.4th at 1367 (explaining that only a court or the Internal Revenue Service can determine whether a proceeds formula in an easement deed can be interpreted as consistent with the extinguishment regulation) and Belk, 774 F.3d at 221. In Belk, the court declined to enforce a savings clause that was designed to accommodate an evolving interpretation of section 170(h). Belk, 774 F.3d at 230 n.3; see also R.R. Holdings, LLC v. Commissioner, T.C. Memo. 2020-22, at *18 ("A donor cannot reserve in an easement deed a right that section 170(h) does not permit (such as a right to more than his share of extinguishment proceeds) but then save his charitable contribution by mentioning the rule he has violated and calling for that rule to kick in and save the day if his violation subsequently comes to light.").
We must determine whether the Deed, on its face, satisfies the regulations. In interpreting the provisions of a contract, we apply state law (here, Ohio). See Hoffman Props. II, LP v. Commissioner, 956 F.3d 832, 834 (6th Cir. 2020). We must consider a contract as a whole, and the intent of each part must be gathered from the consideration of the whole. Saunders v. Mortensen, 801 N.E.2d 452, 455 (Ohio 2004). "In construing the [contract], we must attempt to give effect to each and every part of it . . . and avoid any interpretation of one part which will annul another part." Foster Wheeler Enviresponse, Inc. v. Franklin Cnty. Convention Facilities Auth., 678 N.E.2d 519, 527 (Ohio 1997). "If possible, every provision in a contract should be held to have been inserted for some purpose and to perform some office, and an attempt must be made to harmonize, if possible, all the provisions of a contract." Mapletown Foods, Inc. v. Motorists Mut. Ins. Co., 662 N.E.2d 48, 49 (Ohio Ct. App. 1995) (quoting 11 Ohio Jurisprudence 2d 399, Contracts, Section 155).
Although the TMP argues that the improvements carve-out has always been a nullity because of the conditional language that precedes it, we must attempt to give effect to every part of a contract. However, we agree with the TMP that "the [conditional language] must be read consistently with Section 10.1(e) and the overarching purpose of complying with section 170(h) and the corresponding regulations and case law." And when we consider Section 10.1(e), the intent of the conditional language in Section 9.1 is clear. Section 10.1(e) provides that if any part of a provision is "determined to violate the requirements . . . [of] [s]ection 170(h) . . . and the corresponding regulations and case law thereunder . . . [the] provision (or portion thereof) shall be void and have no effect." Of course, we have held that clauses that attempt to retroactively reform a Deed to comply with the regulation in the event of an adverse determination, are unenforceable savings clauses. See Palmolive, 149 T.C. at 404-05; Coal Prop. Holdings, 153 T.C. at 143; TOT Prop. Holdings, 1 F.4th at 1366. When read consistently with Section 10.1(e), the effect of the conditional language (regardless of it being drafted somewhat differently than the clauses we have considered in the past) is to cancel the improvements carve-out in the event that it is determined to violate the regulations. See Coal Prop. Holdings, 153 T.C. at 140- 41. Thus, it is unenforceable, and the formula for allocating proceeds in the Deed violates the Proceeds Rule because it reserves the value of post-donation improvements to SN Worthington.
The TMP concedes that Section 10.1(e) is "the type of catch-all provision . . . that would amend or reform the . . . Deed in the future." However, the TMP contends that because the language in Section 10.1 is different than the language in Section 9.1, "this just demonstrates that the [conditional language] was not intended to act as a reformative provision to ensure compliance with legal requirements."
Next, The TMP argues that the Deed guarantees that HWDDC will receive sufficient proceeds notwithstanding the improvements carve-out. The TMP contends that, if HWDDC receives less than its proportionate share of actual proceeds, Section 9.2 requires SN Worthington to separately pay HWDDC the difference. But our precedent holds that the qualified organization must be "absolutely entitled" to its proportionate share of proceeds, and we have held that a grantor's separate contractual obligation to make the qualified organization whole does not satisfy the Proceeds Rule. Coal Prop. Holdings, 153 T.C. at 127, 139; Carroll, 146 T.C. at 212; Palmolive, 149 T.C. at 399-402. Rather, a qualified organization must have priority to the proceeds before the grantor and third parties with interests in the property can access them. Palmolive, 149 T.C. at 399-402.
Third, The TMP argues that state law protects HWDDC's right to receive its full proportionate share, citing an Ohio law applicable when private and public agencies appropriate real property. This situation falls within the Deed's definition of condemnation (i.e., if Worthington Square is taken or purchased "under the power of eminent domain by public, corporate, or other authority"). In Ohio, such an appropriation is subject to a bifurcated court proceeding. First, a jury determines the property's value, and the agency deposits that amount with the court. Then, the court decides how to apportion those funds. The TMP argues that an Ohio court would decide how to apportion the proceeds by looking to the Deed, and furthermore, would apply the law prohibiting reservation of post-donation improvement proceeds. This argument is speculative. Furthermore, the TMP has not demonstrated that this law would apply in the event of extinguishment due to something other than an appropriation. Applying Ohio law does not cure the Proceeds Rule violation here.
2. Subordination
Treasury Regulation § 1.170A-14(g)(2) disallows deduction "for an interest in property which is subject to a mortgage unless the mortgagee subordinates its rights in the property to the right of the qualified organization to enforce the conservation purposes of the gift in perpetuity." The rationale underlying the subordination regulation is straightforward. When a grantor donates a conservation easement of mortgaged property, the grantor retains an interest in the property by continuing to use it as collateral for loans. See Palmolive, 149 T.C. at 397-98. To ensure that the grantor's retained interest (and mortgagee claims to it) does not interfere with the qualified organization's right to enforce the easement's conservation purpose in perpetuity, mortgagees must subordinate their rights.
The Deed in this case includes multiple sections that are relevant to subordination. The first is Section 12, which identifies Civista Bank (as mortgagee) and its claims to Worthington Square (recorded mortgages and security interests). Section 12.1 of the Deed generally provides that Civista Bank agrees to subordinate its interests to the Deed and all of HWDDC's rights and interests under the Deed, subject to what the TMP characterizes as "certain specific conditions and stipulations." The first condition or stipulation, Section 12.1(a), provides that a mortgagee that receives an assignment of rents, leases, or profits-such as the one Civista Bank has-shall have a prior claim to rents, "notwithstanding that the Mortgage is subordinate in priority to [the] Deed." The next relevant portion is Civista Bank's acknowledgment on the signature page that it is subordinate to the Deed and all of HWDDC's rights and interests under the Deed. Finally, Section 9.2 provides that, upon the Deed's extinguishment, Section 9 will survive and create a lien upon Worthington Square with the same effect and priority as a "construction lien" but that lien shall not jeopardize the priority of earlier recorded mortgages. Notably, that surviving section also defines proceeds to include net insurance and condemnation proceeds.
Citing Palmolive, the Commissioner argues that Section 9.2 violates the extinguishment regulation and the subordination regulation because extinguishment creates a lien in favor of HWDDC that is subordinate to Civista Bank's earlier recorded mortgages, which could jeopardize HWDDC's absolute entitlement to proceeds. The Commissioner also points to Section 12.1 which identifies Civista Bank's assignment of leases and rents and gives Civista Bank "a prior claim to the rents," and thus argues that the "existence of the prior claim makes clear that" Section 9.2 reduced HWDDC's "extinguishment proceeds by the amount of such prior claim."
The TMP raises various counterarguments. First, the TMP argues that Section 9.2 "does not establish or modify priority among lienholders," but "merely maintains the status quo" established under Section 12 of the Deed, which provides that all existing and future mortgages are subordinate to the Deed (subject to specified conditions and stipulations). The TMP contends that Section 9 "must be read together with the specific provisions of Section 12," even in the event of extinguishment.
This argument fails. Extinguishment generally terminates an easement's restrictions, and only Section 9 of the Deed includes express terms that it will survive. Ohio law would govern interpretation of this provision. Ohio law lacks specific reference to anything called a "construction lien," however, the Ohio Revised Code at § 1311.01, et seq., governs the creation of mechanics' liens. Mechanics' liens include a "lien upon improvements to real property," including "constructing, erecting, altering, repairing, demolishing, or removing any building or appurtenance thereto." OH ST §§ 1311.01, 1311.02. Generally, a mechanic's lien with an effective date that is earlier than the recording date of a mortgage is superior to that mortgage. Guernsey Bank v. Milano Sports Ents. LLC, 894 N.E.2d 715, 729 (Ohio Ct. App. 2008). However, there is an exception to this rule for "construction mortgages," where, if the mortgagee adheres to statutory requirements, a later recorded mortgage will take priority over a mechanic's lien. Id.; see OH ST §§ 1311.13, 1311.14. Whether we read the Deed to refer to a mechanics lien or a construction mortgage is a distinction without difference. Civista Bank's two mortgages secured by Worthington Square were recorded September 1, 2016, before the Deed, and before any hypothetical mechanic's lien or construction mortgage would arise. Thus, HWDDC's lien on Worthington Square for extinguishment proceeds would be subordinate to Civista Bank's earlier recorded mortgages, and its rights to proceeds would not be absolute.
Next, the TMP argues that Palmolive is distinguishable from this case, because the deed in that case gave mortgagees prior claims to insurance and condemnation proceeds. See Palmolive, 149 T.C. at 384-85, 387. In Palmolive, we explained that receiving insurance and condemnation proceeds is a critical right of mortgagees, and failing to subordinate it undermines the qualified organization's property right to extinguishment proceeds. Id. at 398. By comparison, the TMP contends that the Deed in this case does not give mortgagees a prior claim to proceeds. The TMP acknowledges that the "specified conditions and stipulations" in Section 12 modify the subordination agreement, including Section 12.1(a), which gives certain mortgagees who receive an assignment of rents, leases, or profits a prior claim to rents. However, the TMP argues that Section 12.1(a) only applies to future assignments (not Civista Bank's existing assignment) that are also subject to Section 12.2, which subordinates them. The TMP further argues that an "assignment of rents, leases or profits" is not extinguishment proceeds. Thus, the TMP argues that the conditions and specifications in the Deed "neither diminish [HWDDC's] ability to enforce the conservation purposes of the donated easement in perpetuity nor entitle the holder of a previously filed mortgage or secured interest to any portion of extinguishment proceeds."
This argument also fails. Civista Bank expressly joined in the execution of the Deed subject to Section 12.1(a). And the Deed provides that Section 12.1(a) shall also extend to future lenders after the recording date. If Section 12.1(a) only applied to future lenders, this language would be needless. But we must attempt to give effect to all parts of a contract and if possible, hold that this language was inserted with a purpose. Foster Wheeler Enviresponse, 678 N.E.2d at 527; Mapletown Foods, Inc., 662 N.E.2d at 49. Section 12.1(a), a specific condition and stipulation, applies to Civista Bank's existing assignment and also future assignments. Further, we do not read the general subordination language in Section 12.1 or Section 12.2 (a single sentence dealing with future subordination) to nullify Section 12.1(a). Section 12.1(a) is plainly at odds with those provisions, and when "faced with provisions that are arguably in conflict," we give effect to the more specific provision. Marusa v. Erie Ins. Co., 991 N.E.2d 232, 235 (Ohio 2013). Section 12.1(a) is more specific and trumps the general subordination provisions. Accordingly, Civista Bank is not fully subordinate to HWDDC because it has priority to rents. Although the TMP argues that rents are not proceeds, we need not consider how Civista Bank's or another mortgagee's priority in rents could jeopardize HWDDC's ability to protect and enforce the easement's conservation purpose before extinguishment, or to collect proceeds thereafter. The regulation requires full subordination; a mortgagee must subordinate "its rights in the property"-not merely those sufficiently likely to arise. Treas. Reg. § 1.170A-14(g)(2); 901 S. Broadway Ltd. P'ship v. Commissioner, T.C. Memo. 2021-132, at *47.
Finally, the TMP raises a similar argument regarding Section 12.1(a) as it did regarding the improvements carve-out. The TMP contends that "by its terms, the rights set forth in Section 12.1(a) are limited to the extent [HWDDC's] ability to protect the conservation purposes of the . . . Deed would be adversely impacted." This argument fails. By its terms, Section 12.1(a) also specifically gives SN Worthington a right that adversely affects HWDDC's ability to protect the easement's conservation purpose.
III. Conclusion
The Deed in this case carves the value of post-donation improvements out of HWDDC's proportionate share of extinguishment proceeds. It also fails to fully subordinate mortgagee interests in Worthington Square. Thus, the easement is not protected in perpetuity, and it is not "exclusively for conservation purposes" within the meaning of section 170(h)(5). As a result, the easement is not a qualified conservation contribution, and SN Worthington is not entitled to a charitable contribution deduction under section 170. It is accordingly
ORDERED that the Commissioner's Motion for Partial Summary Judgment, filed July 9, 2021, is granted. It is further
ORDERED that SN Worthington's Cross-Motion for Partial Summary Judgment, filed September 2, 2021, is denied.