Tax Court Creates Steep Hurdle for Valuating Donated Easements

The key to valuating a conservation easement is showing what the highest and best use of the property could be before the easement is imposed. And it’s the job of the taxpayer’s appraiser to convince a judge of that component to secure the easement’s fair market value.

There usually is little dispute about the after value, but significant difference between the IRS and the taxpayer on the before value. Treasury regulations tell us that determining the fair market value of the property before the contribution of the easement must include “an objective assessment of how immediate or remote the likelihood is that the property, absent the restriction, would in fact be developed, as well as any effect from zoning, conservation, or historic preservation laws that already restrict the property’s potential highest and best use.”

A July 11 US Tax Court opinion in Veribest Vesta v. Commissioner, which found that a quarry easement was grossly overvalued, adds another component to the valuation process. The case illustrates the steep hurdle taxpayers face in determining the value of a donated easement.

The central dilemma facing an appraiser is establishing the hypothetical highest and best use. If there are other successful developments near the property, the issue becomes a little easier, but that is the rare case in most of the litigation. Establishing a highest and best use for the property when there are no successful developments nearby becomes problematic in many instances.

The starting point in a valuation case is defining fair market value, which Treas Reg. 1.170A-1(c)(2)) says is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”

So what does having reasonable knowledge of the relevant facts mean in the context of a conservation easement? If a hypothetical buyer and hypothetical seller view the property as existing farmland or for recreational use, for example, that produces one value. But if we’re looking at the highest best use of property, that may produce an entirely different outcome.

Which is right in the context of the hypothetical highest and best use? Does it depend on the market for available buyers and sellers? Does the buyer have a credible vision for the property? And is the actual market the local market or a regional or national market? What do you choose, and how do you document when the actual market will never come into existence as a result of the easement? It’s difficult to answer these questions or convince a judge of the proper market.

The other issue is the structure of the syndicated conservation easement arrangement itself. Investors typically contribute an agreed amount of cash to a limited liability company, which holds the property. What needs to be addressed by the appraiser, and explained to the court, is that the agreed value has no bearing in determining the fair market value of the easement that is to be donated to a qualified land conservancy tax-exempt organization.

In other words, it needs to be explained why a landowner would give up the property for one value, knowing (or should be knowing) that the property could be valued by an appraiser for a much higher value. There may be good and substantial reasons for the difference, but this needs to be addressed by the appraiser, who must consider any current transactions involving the property.

Case law and appraisal treatises define how to determine the highest and best use of vacant land or an improved property. There are four tests, all of which must be satisfied—legally permissible, physically possible, financially feasible, and maximally productive.

These requirements put tremendous burdens on an appraiser in the context of the hypothetical highest and best use in most instances, particularly in cases where comparable land sales aren’t being made at the claimed highest and best uses. As indicated in Veribest Visa, there is a presumption that the current use of the land is considered its highest and best use, absent proof to the contrary.

Veribest Visa adds another component to the valuation of the property. When an appraiser uses an income capitalization approach, is it really the determination of the property’s value at its claimed highest and best use? Or is the value of the property just a component of that valuation of the hypothetical business at its highest and best use?

Judge Ronald Buch, in his bench opinion, noted that the Tax Court previously held that the use of a discounted cash flow analysis to value the property was erroneous because it “equated the value of the land with the net present value of a hypothetical business [to be] conducted on the land.”

In other words, “no rational businessman would pay the net present value of a business simply to buy the property.” The Tax Court actually quoted harsher words—such an appraisal is “nonsense on its own terms.”

So where does that leave us? Should the value of the existing property as farmland or recreation be ignored because there is a possible higher and best use by a realistic hypothetical buyer with knowledge of potential uses that would raise the property’s value?

The tax appraiser must consider them and explain their lack of relevance to a highest-and-best use fair market value. This requires experts with the experience to establish, and to convince a court, that there is a significantly higher and best use than the current one.

Depending on the appraiser’s method, the property’s valuation usually should be viewed in the context of the current use, and what a hypothetical buyer would pay for the property for that use. This too involves experts with the experience of determining the fair market value of the property component at its highest and best use.

The case is Veribest Vesta LLC v. Commissioner, T.C., No. 9158-23, 7/15/25.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law, Bloomberg Tax, and Bloomberg Government, or its owners.

Author Information

John Barrie is a partner and chair of the tax practice group at McLaughlin & Stern.

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