140 T.C. No. 17



                  UNITED STATES TAX COURT



  LAWRENCE G. GRAEV AND LORNA GRAEV, Petitioners v.
   COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 30638-08.                         Filed June 24, 2013.



       Petitioner husband (“P-H”) contributed cash and a conservation
easement to N, a charitable organization. Before the contribution, N
at P-H’s request issued to P-H a side letter which promised that, in the
event R disallows Ps’ charitable contribution deductions, N “will
promptly refund your entire cash endowment contribution and join
with you to immediately remove the facade conservation easement
from the property’s title”. Ps claimed charitable contribution
deductions for the cash and easement donations. R contends the side
letter made those contributions conditional gifts that are not
deductible under I.R.C. sec. 170, since the likelihood that N would be
divested of the cash and easement was not negligible.

      Held: Ps’ charitable contribution deductions are not allowed
because at the time of P-H’s contributions, the possibility that the
deductions would be disallowed and, as a result, that N would return
the contributions was not “so remote as to be negligible”, under 26
                                                           -2-

         C.F.R. secs. 1.170A-1(e), 1.170A-7(a)(3), and 1.170A-14(g)(3),
         Income Tax Regs.



         Frank Agostino, Eduardo S. Chung, Jeremy M. Klausner, and Reuben G.

Miller, for petitioners.

         Shawna A. Early, for respondent.


                                                    CONTENTS


FINDINGS OF FACT. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4

         NAT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
         The property. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
         Increased IRS scrutiny of easement contributions. . . . . . . . . . . . . . . . . . . . . 6
         NAT’s solicitation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
         The side letter. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
         Appraisal. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
         Noncash contribution to NAT.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
         Cash contribution to NAT.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
         Subsequent communications from NAT.. . . . . . . . . . . . . . . . . . . . . . . . . . . 15
         2004 and 2005 Federal income tax returns.. . . . . . . . . . . . . . . . . . . . . . . . . 16
         Notice of deficiency. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

OPINION. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

         I.       Charitable contributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

                  A.        Generally.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   18
                  B.        Conditional gifts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .       19
                  C.        Partial interests in general. . . . . . . . . . . . . . . . . . . . . . . . . . . .           22
                  D.        Conservation easements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .             24
                                                     -3-

             E.       Construing “so remote as to be negligible”. . . . . . . . . . . . . . . 27

      II.    Analysis.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

             A.       The possibility of disallowance by the IRS. . . . . . . . . . . . . . . 28

                      1.        The possibility of disallowance as a matter of fact. . . . 28

                                a.       Increased IRS scrutiny. . . . . . . . . . . . . . . . . . . . . 29
                                b.       The side letter.. . . . . . . . . . . . . . . . . . . . . . . . . . . 33

                      2.        Disallowance as a subsequent event. . . . . . . . . . . . . . . 35

             B.       The possibility of return of the contributions. . . . . . . . . . . . . 39

                      1.        Conservation easements under New York law. . . . . . .                                40
                      2.        Merger doctrine. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .          45
                      3.        Nullity.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .   47
                      4.        Voluntary removal of the easement. . . . . . . . . . . . . . . .                      51

      III.   Conclusion. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52


      GUSTAFSON, Judge: Pursuant to section 6212(a),1 the Internal Revenue

Service (“IRS”) determined deficiencies in tax for petitioners, Lawrence and

Lorna Graev, in the amounts of $237,481 for 2004 and $412,620 for 2005,

resulting from the disallowance of charitable contribution deductions the Graevs

claimed for those years. The IRS also determined that Mr. and Mrs. Graev are


      1
       Unless otherwise indicated, all section references are to the Internal
Revenue Code (26 U.S.C.; “the Code”), as amended, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
                                        -4-

liable for accuracy-related penalties under section 6662(h) and alternatively under

section 6662(a) for 2004 and 2005. Mr. and Mrs. Graev petitioned this Court,

pursuant to section 6213(a), for redetermination of these deficiencies and

penalties. The issue for decision at present is whether the deductions that the

Graevs claimed for charitable contributions of cash and a conservation easement

they donated to the National Architectural Trust (“NAT”) should be disallowed

because they were conditional gifts.2 We hold that the Graevs’ contributions were

conditional, non-deductible gifts.

                               FINDINGS OF FACT

      The parties submitted this issue fully stipulated pursuant to Rule 122,

reflecting their agreement that the relevant facts could be presented without a




      2
       In January 2010 the parties entered into a stipulation to be bound, by which
they agreed that if in this case the Court decides the conditional gift issue in the
Graevs’ favor, the outcome of some the other issues in this case (chiefly, the
valuation of the contributed easement) will follow the outcome of a then-pending
case. That case was decided in favor of respondent in July 2010, appealed to the
U.S. Court of Appeals for the Second Circuit, vacated and remanded, and decided
again in favor of respondent in January 2013. See Scheidelman v. Commissioner,
T.C. Memo. 2010-151, vacated and remanded, 

 (2d Cir. 2012),
remanded to T.C. Memo. 2013-18. Decision in that case was entered April 12,
2013, and the time to appeal has not yet expired; but we are able to resolve the
issue addressed herein without awaiting the resolution of the Scheidelman issues.
We do not resolve here the issue of the Graevs’ liability for the penalties, which
will be a subject of future proceedings.
                                        -5-

trial.3 The stipulated facts are incorporated herein by this reference. Mr. and

Mrs. Graev resided in the State of New York when they filed the petition.

NAT

      The parties have stipulated that, “[f]or purposes of the Court’s decision

regarding” the conditional gift issue, NAT is a “qualified organization” under

section 170(h)(3), to which a charitable contribution can be made that is

deductible for tax purposes. NAT’s stated mission is to preserve historic

architecture in metropolitan areas across the United States. NAT solicits the

contribution of facade conservation easements by owners of property with historic

significance as determined by the National Park Service. When NAT solicits

potential donors, it features the potential charitable deductions that owners may

receive by contributing a facade conservation easement and a corresponding cash

endowment to NAT. In addition, NAT considered it “standard Trust policy”,

regarding donors of easements and cash, to return a cash contribution to the extent




      3
       The burden of proof is generally on the taxpayer, see Rule 142(a)(1), and
the submission of a case under Rule 122 does not alter that burden, see Borchers v.
Commissioner, 

, 91 (1990), aff’d, 

 (8th Cir. 1991).
However, the burden of proof can be shifted when the Commissioner’s position
implicates “new matter” not in the notice of deficiency, see note 8 below,
addressing the Graevs’ contention about supposed “new matter” in this case.
                                         -6-

the IRS disallowed a deduction therefor. In numerous instances NAT issued

“comfort letters” assuring donors of this policy.

The property

        In 1999 Mr. Graev purchased property in a historic preservation district in

New York, New York, for $4.3 million. The property is listed on the National

Register of Historic Places. During the years at issue Mr. Graev was the sole fee

simple owner of the property, and he held the property subject to a mortgage.

Increased IRS scrutiny of easement contributions

        On June 30, 2004, the IRS released IRS Notice 2004-41, 2004-2 C.B. 31,

which addressed charitable contributions and conservation easements and stated in

part:

               The Internal Revenue Service is aware that taxpayers who (1)
        transfer an easement on real property to a charitable organization, or
        (2) make payments to a charitable organization in connection with a
        purchase of real property from the charitable organization, may be
        improperly claiming charitable contribution deductions under § 170
        of the Internal Revenue Code. The purpose of this notice is to advise
        participants in these transactions that, in appropriate cases, the
        Service intends to disallow such deductions and may impose penalties
        and excise taxes. * * *

               *        *        *        *         *      *        *

              Some taxpayers are claiming inappropriate charitable
        contribution deductions under § 170 for cash payments or easement
                                        -7-

      transfers to charitable organizations in connection with the taxpayers’
      purchases of real property.

             In some of these questionable cases, the charitable organization
      purchases the property and places a conservation easement on the
      property. Then, the charitable organization sells the property subject
      to the easement to a buyer for a price that is substantially less than the
      price paid by the charitable organization for the property. As part of
      the sale, the buyer makes a second payment, designated as a
      “charitable contribution,” to the charitable organization. The total of
      the payments from the buyer to the charitable organization fully
      reimburses the charitable organization for the cost of the property.

            In appropriate cases, the Service will treat these transactions in
      accordance with their substance, rather than their form. Thus, the
      Service may treat the total of the buyer’s payments to the charitable
      organization as the purchase price paid by the buyer for the property.

Thus, the IRS publicly announced its awareness of abuses related to easement

contribution deductions, putting potential donors and donees on notice that

easement contribution deductions might be examined and challenged. We find

that there was at least a non-negligible possibility that the IRS would challenge an

easement contribution deduction thereafter claimed by Mr. Graev.

NAT’s solicitation

      In the summer of 2004, a representative from NAT contacted Mr. Graev

regarding a potential easement donation to NAT. Mr. Graev became aware that he

had a “neighbor across the street” who had contributed a facade easement to NAT

and who had received from NAT a side letter that promised return of contributions
                                         -8-

if deductions were disallowed. Mr. Graev evidently expressed to NAT an interest

in making an easement contribution like his neighbor’s, but on September 15,

2004, he sent an email to NAT explaining a concern that had arisen:

      My accountants have referred me to Notice 2004-41 * * * issued by
      the IRS on June 30, 2004, in which the IRS has indicated that it will,
      in “appropriate cases”, disallow charitable deductions to
      organizations that promote conservation easements and may impose
      penalties and excise taxes on the taxpayer. They have not advised me
      to abandon this idea, but they have advised me to be very cautious.
      What are your thoughts especially as it relates to the side letter, etc.

(The “side letter” to which Mr. Graev referred was NAT’s comfort letter assuring

that it would refund a contribution in the event that the favorable tax results

anticipated from a contribution were not achieved.) Mr. Graev indicated that he

had consulted his accountants, and in 2004 those accountants would surely have

been aware of published court decisions issued over the past decade that

disallowed deductions claimed for the contribution of facade easements.4 On his

      4
        For pre-2004 cases involving facade easements, see Richmond v. United
States, 

 (E.D. La. 1988) (upholding partial disallowance of
contribution deduction where the taxpayer’s valuation of facade easement was
found excessive); Satullo v. Commissioner, T.C. Memo. 1993-614 (upholding
disallowance of contribution deduction where the facade easement was
unenforceable in the year at issue because it had not been recorded, and where a
mortgage had not been subordinated to the donee’s interest), aff’d without
published opinion, 

 (11th Cir. 1995); Dorsey v. Commissioner, T.C.
Memo. 1990-242 (upholding partial disallowance of contribution deduction where
the taxpayer’s valuation of facade easement was found excessive); Griffin v.
                                                                       (continued...)
                                        -9-

tax returns Mr. Graev listed his occupation as “attorney”, and we infer that he is an

individual of above-average sophistication who, with the help of his accountants,

was capable of identifying tax risks. We find that Mr. Graev did in fact identify

non-negligible risks regarding the deductibility of facade easements, as evidenced

by his September 15 email and subsequent dealings with NAT.

      In a response to Mr. Graev’s concerns, NAT sent him an email dated

September 16, 2004, that stated:

      The IRS notices to which you refer were prompted by recently
      exposed improprieties at the Nature Conservancy, the nation’s largest
      land conservation easement holding organization. The practice the
      IRS is concerned with here is when a non-profit acquires property,
      puts an easement on it and sells it for a reduced price plus a tax-
      deductible contribution. * * *




      4
       (...continued)
Commissioner, T.C. Memo. 1989-130 (same), aff’d, 

 (5th Cir.
1990); Losch v. Commissioner, T.C. Memo. 1988-230 (same); and Hilborn v.
Commissioner, 

 (1985) (same). For pre-2004 cases involving
conservation easements generally, see Strasburg v. Commissioner, T.C. Memo.
2000-94 (upholding partial disallowance of contribution deductions where the
deductions claimed exceeded the taxpayer’s pro rata basis in the property and
valuation of the easement was found excessive); Fannon v. Commissioner, T.C.
Memo. 1986-572 (upholding partial disallowance of contribution deductions
where the taxpayer’s valuation of scenic easement was found excessive); Akers v.
Commissioner, T.C. Memo. 1984-490, aff’d, 

 (6th Cir. 1986) (same);
and Great N. Nekoosa Corp. v. United States, 

, 654 (1997)
(holding that conservation easements were not exclusively for conservation
purposes when the plaintiffs retained the right to extract sand and gravel).
                                        - 10 -

       It is important to distinguish between these activities, which certainly
       warrant scrutiny, and those engaged in by the National Architectural
       Trust. * * * We have been in contact with the IRS since the notices
       were issued and, based upon our discussion with them, have no
       reasons to expect that we or any of the donations we have received
       (easement or cash) will be reviewed.

       Thus far not a single donation made to the Trust has been disallowed
       by the IRS (400+ in New York City alone). * * *

With regard to side letters in particular, NAT wrote:

       [W]e don’t believe they compromise the tax-deductibility of cash
       donations in the present tax year, as they are simply a confirmation of
       standard Trust policy. However, we do not believe this would be the
       case with a legal agreement that explicitly made the cash donation
       contingent on the survival of the deduction. In such a case, we would
       recommend that the cash donation be treated as tax-deductible once
       the contingency period has expired. * * *

That is, it was “standard Trust policy” to refund a cash contribution to the extent

the IRS disallowed the donor’s deduction for the related easement.

       Evidently reassured, Mr. Graev executed a facade conservation easement

application to NAT on September 20, 2004. In a cover letter to NAT transmitting

the application, Mr. Graev stated: “I will also be looking for the NAT to issue the

‘side’ letter we discussed (similar to the one being issued to my neighbor across

the street).”
                                        - 11 -

The side letter

       On September 24, 2004 NAT sent the side letter to Mr. Graev. The side

letter read in pertinent part:

       1.     In the event the IRS challenges the appraisal of your facade
              conservation easement and the tax deductions derived
              therefrom are reduced as a result, we will make a proportionate
              reduction to your cash endowment contribution and promptly
              refund the difference to you.

       2.     In the event the IRS disallows the tax deductions in their
              entirety, we will promptly refund your entire cash endowment
              contribution and join with you to immediately remove the
              facade conservation easement from the property’s title.

Neither the side letter nor any other evidence in our record suggests that, in the

event the IRS disallowed his contribution, Mr. Graev would have to sue NAT in

order to induce it to “remove” the easement. Rather, NAT promised upon

disallowance to “join with [him] * * * to immediately remove the facade

conservation easement from the property’s title”. Mr. Graev took NAT at its

word, and so do we. That is, we find that there was at least a non-negligible

possibility, if the IRS successfully disallowed Mr. Graev’s easement contribution

deduction, that NAT would do what it said it would do.
                                        - 12 -

Appraisal

      Mr. Graev retained the firm of Miller Samuel, Inc. (“MSI”), to prepare an

appraisal of the facade easement. In October 2004, MSI issued its appraisal report

to Mr. Graev appraising the property at $9 million and concluding that the

easement would reduce the value by 11% (or $990,000). Thus, the report

appraised the easement at $990,000.

Noncash contribution to NAT

      In late 20045 Mr. Graev executed a conservation deed granting a facade

easement on the property to NAT. The deed in pertinent part provides:

      The Property constitutes an important element in the architectural
      ensemble of the Treadwell Farms Historic District, and the grant of
      the Easement as set forth in this instrument will, inter alia, assist in
      preserving this certified historic structure and in preserving open
      space for the scenic enjoyment of the general public.

              *        *        *         *        *        *        *

      The Grantor does hereby grant and convey to the Grantee, TO HAVE
      AND TO HOLD, an Easement in gross, in perpetuity, in, on and to
      the Property, the Building and the Facade, being an Open Space and
      Architectural Facade Conversation Easement on the Property * * *

              *        *        *         *        *        *        *

      5
       The deed recites that it was executed October 11, 2004, but Mr. Graev’s
signature on the deed was notarized on December 16, 2004, and he delivered it to
NAT one day later. NAT’s then president, James Kearns, signed the deed on
NAT’s behalf on December 28, 2004.
                                - 13 -

A.    * * * This Easement shall survive any termination of
      Grantor’s or the Grantee’s existence. The rights of the
      Grantee under this instrument shall run for the benefit of
      an may be exercised by its successor and assigns, or by
      its designees duly authorized in a deed of Easement.

B.    Grantee covenants and agrees that it will not transfer,
      assign or otherwise convey its rights under this Easement
      except to another “qualified organization” described in
      Section 170(h)(3) of the Internal Revenue Code of 1986
      and controlling Treasury regulations, and Grantee further
      agrees that it will not transfer this Easement unless the
      transferee first agrees to continue to carry out the
      conservation purposes for which this Easement was
      created, provided, however, that nothing herein
      contained shall be constructed to limit the Grantee’s
      right to give its consent (e.g., to changes in a Protected
      Facade(s)) or to abandon some or all of its rights
      hereunder. [Emphasis added.]

C.    In the event this Easement is ever extinguished through a
      judicial decree, Grantor agrees on behalf of itself, its
      heirs, successors and assigns, that Grantee, or its
      successors and assigns, will be entitled to receive upon
      the subsequent sale, exchange or involuntary conversion
      of the Property, a portion of the proceeds from such sale,
      exchange or conversion equal to the same proportion that
      the value of the initial Easement donation bore to the
      entire value of the property at the time of donation * * *.
      Grantee agrees to use any proceeds so realized in a
      manner consistent with the conservation purposes of the
      original contribution.

      *       *        *        *        *        *        *

Citimortgage Inc. (“Mortgagee/Lender”) hereby joins in the execution
of this CONSERVATION DEED OF EASEMENT for the sole and
                                        - 14 -

      limited purpose of subordinating its rights in the Property to the right
      of the Grantee, its successors or assigns, to enforce the conservation
      purposes of this Easement in perpetuity under the following
      conditions and stipulations:

             (a)   The Mortgagee/Lender and its assignees shall have a
                   prior claim to all insurance proceeds * * * and all
                   proceeds from condemnation, and shall be entitled to
                   same in preference to Grantee until the Mortgage/the
                   Deed of Trust is paid off and discharged,
                   notwithstanding that the Mortgage/the Deed of Trust is
                   subordinate in priority to the Easement.

The deed did not expressly refer to the side letter or incorporate its terms. The

City of New York recorded the deed on February 17, 2005.

Cash contribution to NAT

      In conjunction with an easement donation, NAT asks a donor to make a

cash contribution to NAT equal to 10% of the appraised easement value, in order

to pay for NAT’s current operating costs and to fund its long-term monitoring and

administration needs. In compliance with NAT’s request, Mr. Graev made an

initial deposit of $1,000 to NAT on September 15, 2004. On December 17, 2004,

the same day he delivered the signed deed to NAT, Mr. Graev made a $98,000

cash contribution to NAT, bringing his cash contributions to NAT to a total of

$99,000. On January 25, 2005, NAT gave Mr. Graev written acknowledgment of
                                       - 15 -

his 2004 cash and non-cash contributions. That correspondence also included a

copy of Form 8283, executed by the appraiser, MSI, and NAT.

Subsequent communications from NAT

      Also on January 25, 2005, NAT sent a letter to Mr. Graev informing him

that the U.S. Senate Committee on Finance had announced in a press release their

“intent to implement reforms to the tax laws governing facade easements that will

increase and create additional fines and penalties on promoters, taxpayers and

appraisers who participate, aid or assist in the donation of facade easements that

are found to be significantly overvalued.” Several months later, in August 2005,

NAT sent Mr. Graev another letter which read:

      The purpose of this letter is to bring to your attention a development
      that may be relevant to the tax deductibility of the cash contributions
      that you made to the National Architectural Trust * * *

      In connection with your donation of a facade conservation easement
      and cash contribution and per your request, we sent you a letter dated
      September 24, 2004, stating, among other things, that the cash
      contribution would be refunded in whole or in part if your tax
      deduction for the easement were reduced or disallowed by the
      Internal Revenue Service. It has recently been brought to our
      attention by our attorney that this offer of a refund may adversely
      affect the deductibility of the cash contribution as a charitable gift.
      ***

      We urge you to contact your professional tax advisor to determine the
      actual impact of the refund offer. Of course, if you determine that
      you would prefer that we withdraw the refund offer, which according
                                       - 16 -

      to our attorney should restore the deductibility of your cash
      contribution, the Trust will promptly do so. * * *

Mr. Graev did not ask NAT to withdraw the refund offer. We find that NAT’s

formal offer to withdraw the refund offer--made after NAT consulted with its

attorney--further indicates that NAT intended to honor its promises in the side

letter (even if the promises may not have been legally enforceable), unless

Mr. Graev directed otherwise.

2004 and 2005 Federal income tax returns

      Mr. and Mrs. Graev filed joint Forms 1040, U.S. Individual Income Tax

Return, for taxable years 2004 and 2005. On their 2004 return, which they filed

on or around October 10, 2005 (i.e., after the January and August 2005 letters

from NAT, discussed above), Mr. and Mrs. Graev reported a charitable

contribution of $990,000 for the facade easement contribution and $99,000 for the

cash contribution to NAT. Mr. and Mrs. Graev claimed a deduction for the entire

cash contribution in 2004, but because of the limitations on charitable contribution

deductions in section 170(b)(1)(C), they claimed a charitable contribution

deduction with respect to the facade easement of only $544,449 on their 2004

return.
                                       - 17 -

      On their 2005 return, filed on or around October 6, 2006, Mr. and

Mrs. Graev claimed a carryover charitable contribution deduction of $445,551

relating to the facade easement contribution in 2004.

Notice of deficiency

      By a statutory notice of deficiency dated September 22, 2008, the IRS

disallowed Mr. and Mrs. Graev’s cash and non-cash charitable contribution

deductions relating to their contributions to NAT and determined deficiencies in

tax for both 2004 and 2005. In the notice of deficiency the IRS stated: “[T]he

noncash charitable contribution of a qualified conservation contribution is

disallowed because it was made subject to subsequent event(s)”. The notice

disallowed the Graevs’ cash charitable contribution deduction for the same reason.

The IRS also determined that Mr. and Mrs. Graev are liable for accuracy-related

penalties under section 6662 for 2004 and 2005.

                                     OPINION

      The question now before the Court is whether deductions for Mr. Graev’s

contributions of cash and the easement to NAT should be disallowed because they

were conditional gifts. The answer depends on whether NAT’s promises in the

side letter made the gifts conditional and whether the chance that the condition
                                        - 18 -

would occur was “so remote as to be negligible”. See 26 C.F.R. secs. 1.170A-

1(e), 1.170A-7(a)(3), 1.170A-14(g)(3), Income Tax Regs.

      The Graevs argue that under New York law the agreement in the side letter

is unenforceable because conditions in the side letter were not included in the

recorded deed and that under Federal tax law the side letter was a nullity. We

conclude that NAT’s promises in the side letter were not a nullity and were not

extinguished and that NAT could and would honor its promises both as to the

easement and as to the cash contribution.

I.    Charitable contributions

      A.     Generally

      Section 170(a)(1) generally allows a deduction for any “charitable

contribution” made during the taxable year. Section 170(c)(2) defines a

“charitable contribution” for this purpose to include “a contribution or gift to or

for the use of” a trust organized and operated exclusively for charitable or

educational purposes. The parties agree for purposes of the conditional gift issue

that NAT is such an organization.

      Application of the general rule in section 170(a)(1) may be complicated--

especially with regard to the amount and timing of a charitable contribution

deduction--if a donor contributes a property interest to a charity but, at the time of
                                         - 19 -

the contribution, there is uncertainty about the amount of property that will

actually reach the charity--e.g., when a donor contributes a remainder interest in

property to a charity, or (as in this case) the donor contributes property subject to a

condition. Section 170 and the corresponding regulations provide instruction and

limitations that, at least in part, ensure that the donor will be able to deduct only

what the donee organization actually receives. See, e.g., sec. 170(f)(2), (3), (11).

Three such limitations are pertinent in this case: (1) 26 C.F.R. section 1.170A-

1(e), which limits deductions for conditional gifts; (2) section 170(f)(3)(A) and the

corresponding regulations, which limit deductions for contributions of partial

interests in property; and (3) section 170(f)(3)(B)(iii) and corresponding

regulations, which provide special rules for conservation easements.

      B.     Conditional gifts

      The general rule of section 170(a)(1) allows a deduction for a charitable

contribution only when “payment * * * is made within the taxable year.”

(Emphasis added.) Regulations corresponding to section 170(a) clarify this rule

with a limitation particularly relevant in this case:

      If an interest in property passes to, or is vested in, charity on the date
      of the gift and the interest would be defeated by the subsequent
      performance of some act or the happening of some event, the
      possibility of occurrence of which appears on the date of the gift to be
                                        - 20 -

      so remote as to be negligible, the deduction is allowable. [26 C.F.R.
      sec. 170A-1(e).]

That is, the deduction may be considered “made” notwithstanding a possibility

that the contribution will be defeated by a subsequent event, but only if that

possibility is “so remote as to be negligible”. Although the parties agree that the

side letter recited conditions on Mr. Graev’s contributions, the parties disagree

about whether this regulation disallows deductions for those contributions.

      A brief discussion of the history of 26 C.F.R. section 1.170A-1(e) is helpful

in understanding the regulation’s application in this case. The Secretary

promulgated the first version of this regulation in1959 to correspond to

section 170(a) of the 1954 Code.6 The operative language in that 1959 regulation


      6
          26 C.F.R. section 1.170-1(e), Income Tax Regs. (1959), provided:

      If as of the date of a gift a transfer for charitable purposes is
      dependent upon the performance of some act or the happening of a
      precedent event in order that it might become effective, no deduction
      is allowable unless the possibility that the charitable transfer will not
      become effective is so remote as to be negligible. If an interest passes
      to or is vested in charity on the date of the gift and the interest would
      be defeated by the performance of some act or the happening of some
      event, the occurrence of which appeared to have been highly
      improbable on the date of the gift, the deduction is allowable. The
      deduction is not allowed in the case of a transfer in trust conveying a
      present interest in income if by reason of all the conditions and
      circumstances surrounding the transfer it appears that the charity may
      not receive the beneficial enjoyment of the interest. * * *
                                         - 21 -

was identical to an older regulation that had limited deductions for estate tax

purposes for certain conditional charitable bequests. See 26 C.F.R. sec. 81.46(a),

Estate Tax Regs. (1949).7 Given this similarity, we consider interpretations of 26

C.F.R. section 20.2055-2(b), Estate Tax Regs., and its history instructive in

construing 26 C.F.R. section 170A-1(e). See Briggs v. Commissioner, 

, 657 (1979), aff’d without published opinion, 

 (9th Cir. 1981).

      The Supreme Court in Commissioner v. Estate of Sternberger, 

,

194 (1955), discussed the estate tax regulations at length, stating:

      The predecessor of [26 C.F.R.] s[ec.] 81.46 confined charitable
      deductions to outright, unconditional bequests to charity. It expressly
      excluded deductions for charitable bequests that were subject to
      conditions, either precedent or subsequent. While it encouraged
      assured bequests to charity, it offered no deductions for bequests that

      7
          26 C.F.R. sec. 81.46(a), Estate Tax Regs. (1949), provided:

      If as of the date of decedent’s death the transfer to charity is
      dependent upon the performance of some act or the happening of a
      precedent event in order that it might become effective, no deduction
      is allowable unless the possibility that charity will not take is so
      remote as to be negligible. If an estate or interest has passed to or is
      vested in charity at the time of decedent’s death and such right or
      interest would be defeated by the performance of some act or the
      happening of some event which appeared to have been highly
      improbable at the time of decedent’s death, the deduction is
      allowable.

The current version of this regulation is in 26 C.F.R. sec. 20.2055-2(b)(1), Estate
Tax Regs.
                                        - 22 -

      might never reach charity. Subsequent amendments have clarified
      and not changed that principle. Section 81.46(a) today yields to no
      condition unless the possibility that charity will not take is
      “negligible” or “highly improbable.” * * *

Similarly, a fundamental principle underlying the charitable contribution

deduction is that the charity actually receive and keep the contribution. 26 C.F.R.

section 1.170A-1(e) clarifies that principle: no deduction for a charitable

contribution that is subject to a condition (regardless of what the condition might

be) is allowable, unless on the date of the contribution the possibility that a

charity’s interest in the contribution “would be defeated” is “negligible”.

      Accordingly, under section 1.170A-1(e) of the regulations (construing the

statutory requirement of section 170(a)(1) that a gift actually “is made”), the

Graevs’ deductions are not allowable unless the possibility that NAT’s interests in

the easement and cash would be defeated was “so remote as to be negligible”.

      C.     Partial interests in general

      Logically related to but distinct from the disallowance of deductions for

conditional gifts is the limitation in section 170(f)(3) on deductions for

contributions of partial interests in property. One is generally allowed a deduction

only for the contribution of one’s entire interest in property. Congress enacted

what is now section 170(f)(3)(A) as part of the Tax Reform Act of 1969, Pub. L.
                                           - 23 -

No. 91-172, sec. 201, 83 Stat. at 549. Section 170(f)(3)(A) allows a deduction for

a charitable contribution “of an interest in property [not made in trust] which

consists of less than the taxpayer’s entire interest in such property” only to the

extent it would be allowable under section 170 “if such interest had been

transferred in trust”. This is a narrow allowance, since the rules that allow

charitable contribution deductions for partial interests transferred in trust allow

deductions only for interests that can be valued using prescribed methods (e.g.,

actuarial tables promulgated in the regulations) and that have assurances that the

charity will receive payments from the trust. See, e.g., sec. 170(e)(2); 26 C.F.R.

sec. 1.170A-6, Income Tax Regs.

      In this case, since Mr. Graev reserved the right to have NAT return the

easement and the cash if certain events occurred, the contributions of both the

easement and the cash were less than Mr. Graev’s entire interest in the contributed

property. Accordingly, Mr. Graev’s contributions appear subject to the limitation

in section 170(f)(3). However, 26 C.F.R. section 1.170A-7(a)(3) provides the

following mitigation of this limitation:

      A deduction shall not be disallowed under section 170(f)(3)(A) * * *
      merely because the interest which passes to, or is vested in, the
      charity may be defeated by the performance of some act or the
      happening of some event, if on the date of the gift it appears that the
                                         - 24 -

      possibility that such act or event will occur is so remote as to be
      negligible. * * *

Thus, under this regulation, even though the contributions did not consist of

Mr. Graev’s entire interest in the cash and the easement, the Graevs’ deductions

for contributions would not be disallowed under section 170(f)(3)(A) if the

likelihood that NAT’s interests in the cash and the easement would be defeated

was “so remote as to be negligible”.

      D.     Conservation easements

      An easement is “[a]n interest in land owned by another person, consisting in

the right to use or control the land, or an area above or below it, for a specific

limited purpose”. Black’s Law Dictionary 585-586 (9th ed. 2009). Consequently,

an easement--whether or not it is subject to any condition--is by definition a partial

interest in property, and it would therefore be non-deductible under

section 170(f)(3)(A), apart from any further statutory provision. However, further

provision is made in subsections (f)(3)(B)(iii) and (h) of section 170, the history of

which we briefly survey:

      The disallowance of a deduction for partial interests was added to the Code

as section 170(f)(3) by the Tax Reform Act of 1969. In that provision’s original

form, the only exceptions to disallowance of a deduction for contributions of
                                        - 25 -

partial interests were for contributions of “a remainder interest in a personal

residence or farm” and “an undivided portion of the taxpayer’s entire interest in

property”. That is, no exception was made for a qualified conservation

contribution. However, the Staff of Joint Committee on Taxation opined in its

General Explanation of the Tax Reform Act of 1969, at 80 (J. Comm. Print 1970),

that “a gift of an open space easement in gross is to be considered a gift of an

undivided interest in property where the easement is in perpetuity.”

      Congress made explicit an exception for (i.e., permitted a deduction for)

certain easements in the Tax Reform Act of 1976, Pub. L. No. 94-455, sec.

2124(e), 90 Stat. at 1919, which amended section 170(f)(3)(B) to provide in clause

(iii) that a donor may claim a deduction for the contribution of an “easement with

respect to real property of not less than 30 years’ duration granted to * * * [a

charitable organization] exclusively for conservation purposes”. The following

year Congress revised that exception, eliminating the “30 years’ duration”

provision and limiting deductibility to an “easement with respect to real property

granted in perpetuity”. (Emphasis added.) Tax Reduction and Simplification Act

of 1977, Pub. L. No. 95-30, sec. 309(a), 91 Stat. at 154. In the Tax Treatment

Extension Act of 1980, Pub. L. No. 96-541, sec. 6(a), 94 Stat. at 3206, Congress

amended section 170(f)(3) and added subsection (h), which have remained in
                                         - 26 -

effect since then and work in tandem to keep the perpetuity requirement for

conservation easement donations.

      Section 170(f)(3)(B)(iii) exempts, from the general disallowance of

deductions for contributions of partial interests, contributions of “a qualified

conservation contribution”--a term defined in section 170(h)(1) as a contribution

of a “qualified real property interest,” to a “qualified organization”, “exclusively

for conservation purposes.” A “qualified real property interest” must have “a

restriction (granted in perpetuity) on the use which may be made of the real

property.” Sec. 170(h)(2)(C) (emphasis added).8 Regulations describing the

perpetuity requirement provide:

      A deduction shall not be disallowed under section 170(f)(3)(B)(iii)
      * * * merely because the interest which passes to, or is vested in, the
      donee organization may be defeated by the performance of some act

      8
        In his reply brief, Mr. Graev complains that an IRS argument invoking the
perpetuity requirement is “new matter” as to which the IRS should bear the burden
of proof under Rule 142(a)(1). We do not believe that the burden of proof affects
the resolution of this issue, since the material facts are not actually in dispute, and
the outcome is the same no matter which party has the burden. See Dagres v.
Commissioner, 

, 279 (2011). More important, however, the argument
that the gifts were subject to a subsequent event--an issue plainly stated in the
notice of deficiency--is by its nature an argument that the gifts failed to be
perpetual. One reason a conservation easement may fail to be a perpetual gift to
the donee, and may thus fail to be deductible, is that it is subject to a condition that
creates a non-remote possibility that the easement may revert to the donor. See 26
C.F.R. sec. 1.170A-14(g)(3), Income Tax Regs. The issue of perpetuity is not new
matter in this case.
                                         - 27 -

      or the happening of some event, if on the date of the gift it appears
      that the possibility that such act or event will occur is so remote as to
      be negligible. * * * [26 C.F.R. sec. 1.170A-14(g)(3).]

(The “so remote as to be negligible” phrase is the familiar term first used in the

1949 estate tax regulations cited above.) Accordingly, a conservation easement

fails to be “in perpetuity”--and is therefore not excepted from the general rule of

section 170(f)(3)(A) disallowing deductions for contributions of partial interests--

if, on the date of the donation, the possibility that the charity may be divested of its

interest in the easement is not so remote as to be negligible.

      E.     Construing “so remote as to be negligible”

      Each of the issues discussed above--i.e., whether a charitable contribution

was effectively “made”, whether it consisted of an “entire interest”, and whether it

was a “qualified conservation contribution”--essentially turns on the same

question: At the time of Mr. Graev’s contributions, was the possibility that NAT’s

interest in the cash and the easement would be defeated “so remote as to be

negligible”? In prior cases, we have defined “so remote as to be negligible” as “‘a

chance which persons generally would disregard as so highly improbable that it

might be ignored with reasonable safety in undertaking a serious business

transaction.’” 885 Inv. Co. v. Commissioner, 

, 161 (1990) (quoting

United States v. Dean, 

, 29 (1st Cir. 1955)). Stated differently, it is “a
                                        - 28 -

chance which every dictate of reason would justify an intelligent person in

disregarding as so highly improbable and remote as to be lacking in reason and

substance.” Briggs v. Commissioner, 72 T.C. at 657. What is determinative under

the section 170 “remote” regulations is the possibility, after considering all the

facts and circumstances, that NAT’s reception and retention of the easement and

cash would be defeated.

II.   Analysis

      The side letter provides that the occurrence that would defeat NAT’s

interest in the easement and cash is the IRS’s successful disallowance of the

Graevs’ charitable contribution deductions and NAT’s consequent promised

“removal” of the easement and return of the cash. We hold that at the date of the

contribution the possibility that the IRS would disallow the deductions and that

NAT would return the cash to Mr. Graev and “remove” the easement was not “so

remote as to be negligible”.

      A.     The possibility of disallowance by the IRS

             1.    The possibility of disallowance as a matter of fact

      The Graevs argue that as of December 2004, the caselaw supported an

easement valuation of 10% to 15% of Mr. Graev’s property and that it was

therefore reasonable to conclude that Mr. Graev’s easement donation had a value
                                        - 29 -

of $990,000 (i.e., 11% of the appraised value of the property). They assert that the

possibility the IRS would disallow their deductions was so remote as to be

negligible. However, on the undisputed facts of this case, it is self-evident that the

risk of IRS disallowance was not negligible.9 A substantial risk obviously arose

from the IRS’s then-announced intention to scrutinize charitable contribution

deductions for facade easement contributions, and that risk is evident

from Mr. Graevs’ insistence on NAT’s issuing the side letter. We need not

wonder how a donor or donee would have responded to this risk if he had foreseen

it; we know how Mr. Graev did respond when he did foresee it: He did not

“disregard” or “ignore[]” it, see 885 Inv. Co. v. Commissioner, 95 T.C. at 161;

Briggs v. Commissioner, 72 T.C. at 657, but rather went out of his way to address

it and hedge against it.

                    a.     Increased IRS scrutiny

      The Graevs note that at the time of their contribution in December 2004, no

charitable contribution deduction arising from a contribution to NAT had been

disallowed (to their knowledge). However, the enforcement landscape regarding

deductions for facade easement donations was visibly changing at the time of his

      9
       We do not address the circumstance in which a hyper-cautious donor
conditions his gift on non-disallowance where there is no non-negligible
possibility of disallowance.
                                       - 30 -

contribution. As is discussed above, the IRS released Notice 2004-41, supra, on

June 30, 2004. In that notice the IRS stated:

             The Internal Revenue Service is aware that taxpayers who (1)
      transfer an easement on real property to a charitable organization, or
      (2) make payments to a charitable organization in connection with a
      purchase of real property from the charitable organization, may be
      improperly claiming charitable contribution deductions under § 170
      of the Internal Revenue Code. The purpose of this notice is to advise
      participants in these transactions that, in appropriate cases, the
      Service intends to disallow such deductions and may impose penalties
      and excise taxes. * * *

Notice 2004-41 goes on to give a specific example of the second instance, i.e., a

taxpayer makes a cash contribution to a charitable organization in addition to

purchasing (at a discount) from the same organization real property that was

subject to a conservation easement, where the total amount of contribution and

purchase price equals the charity’s initial cost of the real property. The Graevs

argue that since Notice 2004-41 specifically described a transaction that did not

apply in their case, the notice was not applicable to them.

      We disagree. While Notice 2004-41 did list one specific transaction that the

Commissioner had determined was inappropriate, the Commissioner’s general

warning against “improperly claiming charitable contribution deductions”

connected with transfers of conservation easements to charities was still very

much applicable to the Graevs. Notice 2004-41 made clear before Mr. Graev’s
                                       - 31 -

transfer that his transaction with NAT would be subject to heightened scrutiny and

that if any of the Graevs’ positions were susceptible to challenge, the

Commissioner would likely enforce a contrary position. Mr. Graev’s

September 15, 2004, email to NAT reflects his understanding of this possibility,

stating that in light of Notice 2004-41 his accountants “have advised [him] to be

very cautious.”

      The Graevs argue that their valuation of the contributed easement was

reasonable. Since the valuation issue will be resolved by the parties’ stipulation to

be bound by the outcome of another case that is still pending, see note 2 above, we

do not decide valuation now but assume that the Graevs’ valuation was

reasonable. However, the fact that a valuation is reasonable does not mean that it

is correct; a reasonable but incorrect valuation may be challenged and disallowed;

consequently, someone who assigns a reasonable value to his donation may

nonetheless face a non-negligible risk of disallowance.

      Moreover, valuation is not the only potential issue faced by a taxpayer

claiming a deduction for a contributed easement, and it was not the only issue as to

which NAT promised to return Mr. Graev’s contributions. The first numbered

paragraph of the side letter did address valuation (“In the event the IRS challenges

the appraisal”), but the second numbered paragraph made the distinct promise to
                                        - 32 -

return the contributions “[i]n the event the IRS disallows the tax deductions in

their entirety”. There are multiple requirements in section 170 and the

corresponding regulations that, if not followed, may lead to disallowance--and

valuation is only one of them. For example, an easement contribution may be

disallowed where--

      •      The donee fails to be a “qualified organization” described in section
             170(h)(3).

      •      The property subject to the easement fails to be of a “historically
             important land area” or a “certified historic structure.” Sec.
             170(h)(4)(iv); see Turner v. Commissioner, 

, 316 (2006).

      •      The taxpayer fails to contribute a “qualified real property interest”.
             Sec. 170(a)(2); see Belk v. Commissioner, 140 T.C. __ (Jan. 28,
             2013).

      •      The easement fails to preserve conservation purposes “in perpetuity”.
             Sec. 170(h)(5); see Carpenter v. Commissioner, T.C. Memo. 2012-1;
             Herman v. Commissioner, T.C. Memo. 2009-205.

      •      The parties fail to subordinate the rights of a mortgagee in the
             property “to the right of the qualified organization to enforce the
             conservation purposes of the gift in perpetuity.” 26 C.F.R. sec.
             1.170A-14(g)(2); see Mitchell v. Commissioner, 

, 331-
             332 (2012).

      •      The taxpayer fails to “[a]ttach a fully complete appraisal summary
             * * * to the tax return”. 26 C.F.R sec. 1.170A-13(c)(2)(B). But see
             Kaufman v. Shulman, 

, 28-30 (1st Cir. 2012), aff’g in
             part, vacating in part, and remanding in part Kaufman v.
             Commissioner, 

 (2011), and 

 (2010).
                                       - 33 -

      •      The appraisal fails to be a “qualified appraisal”. 26 C.F.R. sec.
             1.170A-13(c)(3); see Friedberg v. Commissioner, T.C. Memo. 2011-
             238.

      •      The appraiser fails to be a “qualified appraiser”. 26 C.F.R. sec.
             1.170A-13(c)(5); see Rothman v. Commissioner, T.C. Memo. 2012-
             218 (reserving the question on whether an appraiser was “qualified”).

      •      The parties fail to record the easement or otherwise fail to effect
             “legally enforceable restrictions”. 26 C.F.R. sec. 1.170A-14(g)(1);
             see Satullo v. Commissioner, T.C. Memo. 1993-614, aff’d without
             published opinion, 

 (11th Cir 1995).

      •      The taxpayer fails to “[m]aintain records” necessary to substantiate
             the charitable contribution. 26 C.F.R. sec. 1.170A-13(c)(2)(C),
             Income Tax Regs.

      Mr. Graev’s September 15, 2004, correspondence with NAT reflects his

clear understanding that charitable contribution deductions for contributions “to

organizations that promote conservation easements” were going to be the subject

of IRS scrutiny and could be disallowed for failing to satisfy any one of the

requirements in section 170. Mr. Graev’s accountants advised him “to be very

cautious” with such transactions. Clearly, the risk that the IRS might disallow a

deduction for the contribution of an easement was well above “negligible”.

                   b.     The side letter

      Informed by his accountants’ warning, Mr. Graev initially asked NAT about

the possibility of a side letter from NAT that promised the return of contributions
                                        - 34 -

if deductions were disallowed. NAT eventually gave Mr. Graev such a letter on

September 24, 2004. The mere fact that he required the side letter is strong

evidence that, at the time of Mr. Graev’s contribution, the risk that his

corresponding deductions might be disallowed could not be (and was not)

“ignored with reasonable safety in undertaking a serious business transaction.”

885 Inv. Co. v. Commissioner, 95 T.C. at 161.

      Mr. Graev was not alone in his assessment of the risk of disallowance.

NAT considered it “standard Trust policy” to return a cash contribution to the

extent a deduction therefor was disallowed by the IRS. In numerous instances

NAT issued “comfort letters” assuring donors of this policy. The very essence of

a comfort letter implies a non-negligible risk; and the author uses the letter to

induce the recipient to enter into a transaction. In this case the risk was either

partial or complete disallowance of Mr. Graev’s claimed charitable contribution

deductions. NAT’s course of dealing confirms that the possibility that the IRS

might disallow Mr. Graev’s deductions was not “so remote as to be negligible”.

See 26 C.F.R. secs. 1.170A-1(e), 1.170A-7(a)(3), 1.170A-14(g)(3).
                                        - 35 -

             2.     Disallowance as a subsequent event

      The Graevs argue:

      Forty-four years ago, this Court ruled that the [subsequent] events
      referred to by Treas. Reg. §1.170A-l(e) do not include contingencies
      created by Respondent’s examination or contingencies within
      Respondent’s control. O’Brien v. Commissioner, 

, 592
      (1966), acq., 1968-1 C.B. 2.[10]

O’Brien v. Commissioner, 

 (1966), did involve a charitable

contribution that was contingent on subsequent favorable tax treatment; but the

Graevs’ characterization of our ruling in O’Brien is flatly incorrect, and their

reliance on it is therefore mistaken.

      O’Brien addressed two issues--a charitable remainder trust issue (which we

describe here first) and a related but distinct tax-treatment contingency issue. The

taxpayers created a charitable remainder trust in June 1964--of which they made

themselves trustees with broad powers to manage the trust--and then made

contributions to the trust in December 1964. Id. at 584. The Commissioner

argued that the taxpayers were not entitled to charitable contribution deductions

derived from the taxpayers’ contributions to the trust because the complete

      10
          The Graevs also cite an IRS private letter ruling. We decline to consider
it, in light of section 6110(k)(3), which provides: “(3) Precedential status.--Unless
the Secretary otherwise establishes by regulations, a written determination may not
be used or cited as precedent.” See Abdel-Fattah v. Commissioner, 

,
202 (2010); Vons Cos., Inc. v. United States, 

, 12 (2001).
                                        - 36 -

management power given to the donor-trustees enabled them to defeat the

remainder interests and therefore prevented the deduction. Id. at 591. We rejected

that argument and concluded--

      that it is highly improbable that the petitioners in their fiduciary
      capacity will ever perform an act which will defeat the charitable
      remainders they have created in the trust. All of the conditions and
      circumstances surrounding the transfers of property interests to the
      trust persuade us that the named charities, or other qualified ones, will
      eventually receive the beneficial enjoyment thereof. * * * [Id. at 596;
      emphasis added.]

We thus decided this remainder trust issue under “[t]he guidelines * * * set forth

in section 1.170-1(e), Income Tax Regs.”11 Id. at 594.

      The Commissioner’s tax contingency argument (discussed first in O’Brien)

was based on paragraph 16 of the trust instrument, under which contributions to

the trust were “subject to the condition that such contribution shall be repaid to the

contributor by the Trustees * * * only in the event and to the extent that the

Commissioner of Internal Revenue does not allow [it] as a deduction”. Id. at 588.

In the notice of deficiency issued in September 1965, the Commissioner had

disallowed the charitable contribution deductions (for the sole reason that the


      11
         For the remainder trust issue we cited 26 C.F.R. section 1.170-1(e) (1961)
(see note 6 above for the 1959 version which was identical to the 1961 regulation);
but the limitations now set forth in 26 C.F.R. sections 1.170A-1(e),
1.170A-7(a)(3), and 1.170A-14(g)(3), Income Tax Regs., are equivalent.
                                         - 37 -

donor-trustees had power over the trust). We “disposed of [the contingency issue]

summarily”, id. at 591, so it is not entirely clear what the Commissioner had

argued; but it appears that the Commissioner’s contention was simply that “the

literal meaning of paragraph 16”, id., called for return of the contributions upon

the mere act of disallowance by the Commissioner, whether or not the

Commissioner’s position was valid or was upheld. This position would have put

the contingency “‘within the control * * * of the Commissioner’”, O’Brien v.

Commissioner, 46 T.C. at 591(quoting Surface Combustion Corp. v.

Commissioner, 

, 655 (1947), aff’d, 

 (6th Cir. 1950)),12

without regard to the merits of the Commissioner’s decision. We held, to the

contrary, that despite “the narrow wording of the trust instrument”, “[t]he

petitioners have a right to litigate respondent’s determination”, so that the

contributions would not be subject to return “unless the petitioners are

unsuccessful in this litigation.” Id. at 592.




      12
        In Surface Combustion Corp. v. Commissioner, 

 (1947), aff’d,

 (6th Cir. 1950), we held that a provision in an employee trust
allowing an employer to reclaim his contributions to the trust if the contributions
were determined to be nondeductible did not prevent the employer from deducting
his contributions to the trust since the contingency was in the control of the
Commissioner. Surface Combustion did not involve charitable contributions,
section 170, nor any regulations with a “so remote as to be negligible” standard.
                                       - 38 -

      That is, in O’Brien the Commissioner evidently argued that the charitable

contribution deductions were improper simply because, under the trust instrument,

the charitable contributions were defeated by the IRS’s mere disallowance

(whether or not that disallowance was upheld in litigation). We held, however,

that if the taxpayers successfully challenged that disallowance, then the

contributions were not defeated (and the contribution deductions could therefore

be allowed). We thus held that a contingency expressed in terms of

“disallowance” of a deduction actually looked to the merits of the deduction.

Contrary to the Graevs’ argument, our O’Brien Opinion did not analyze the tax

contingency issue under the section 170 regulations,13 and we did not hold that a

tax-treatment contingency can never be a subsequent event that will defeat a

contribution and a deduction. We simply did not address that issue.




      13
         Our Opinion in O’Brien v. Commissioner, 

, 592 (1966),
indicates that the Commissioner also cited--but we distinguished--Jones v. United
States, 

 (N.D. Ohio 1966), aff’d in part, rev’d in part, 

 (6th Cir. 1968), a case not involving a tax-treatment-contingent contribution,
in which (as we noted) the District Court held that the possibility that a
contribution at issue there would be defeated “was not ‘so remote as to be
negligible’ under section 1.170-1(e), Income Tax Regs.” This description of Jones
includes our only mention of that regulation in our discussion of this issue in the
O’Brien Opinion, and our discussion does not address any relation between the
regulation and the tax-treatment-contingent deduction at issue in O’Brien.
                                         - 39 -

      This case, unlike O’Brien, clearly presents the issue of whether the

promised return of a charitable contribution upon the disallowance of the

charitable contribution deduction can constitute a subsequent event the possibility

of which, if not negligible, renders the deduction not allowable. O’Brien sheds no

light on that question.

      B.     The possibility of return of the contributions

      If the risk of IRS disallowance was non-negligible, then so was the prospect

that NAT would be called on to honor its side letter and “promptly refund * * *

[Mr. Graev’s] entire cash endowment contribution and join with * * * [Mr. Graev]

to immediately remove the facade conservation easement from the property’s

title”. Given that non-negligible risk, Mr. Graev’s contributions fell afoul of the

section 170 regulations implementing the statutory requirements that a gift be

effectively “made”, that it consist of an “entire interest”, and that it be a “qualified

conservation contribution”. The Graevs argue, however, that as a matter of law

NAT could not be held to the promises it made in its side letter, so that there was

in fact no possibility that the property would be returned.

      The Graevs contend that NAT could not be divested of its interest in the

easement because the side letter is not enforceable under New York law and that,
                                         - 40 -

as a result, the contributions were not really conditional.14 In particular, the

Graevs argue that New York’s environmental conservation statutes, N.Y. Envtl.

Conserv. Law secs. 49-0301 to 49-0311 (McKinney 2008 & Supp. 2013), would

prevent the side letter from being enforced, and alternatively, that the common law

doctrine of merger extinguished the side letter upon NAT’s recording the

easement deed. They also contend that under principles of tax law the promises in

the side were a nullity. We disagree.

             1.     Conservation easements under New York law

      In general, property interests are determined by State law. United States v.

Nat’l Bank of Commerce, 

, 722 (1985). In 1983 New York enacted

the New York Conservation Easement Statute. See N.Y. Envtl. Conserv. Law

secs. 49-0301 to 49-0311. For purposes of these statutes a “conservation

easement” is defined as:




      14
        In this argument the Graevs do not distinguish between the contribution of
the easement (which was subject to the statutes that the Graevs cite) and the
contribution of the cash (which was not). Reliance on New York real estate
principles to argue that the side letter is not enforceable as to the cash contribution
is misplaced. Even if the side letter were not enforceable as to the easement, for
the reasons the Graevs advance, so that they could not require NAT to “remove” it,
the Graevs show no reason that the side letter would not be enforceable so as to
require the return of the cash.
                                        - 41 -

      an easement, covenant, restriction or other interest in real property,
      created under and subject to the provisions of this title which limits or
      restricts development, management or use of such real property for
      the purpose of preserving or maintaining the scenic, open, historic,
      archaeological, architectural, or natural condition, character,
      significance or amenities of the real property * * * [Id. sec. 49-
      0303(1).]

Under these New York statutes, a conservation easement is enforceable even

though “[i]t is not appurtenant to an interest in real property” and even though “[i]t

can be or has been assigned to another holder”.15 N.Y. Envtl. Conserv. Law

sec. 49-0305(5). Since an easement with these characteristics would not have

been enforceable under New York common law, see Gross v. Cizauskas, 

 (App. Div. 1976), a conservation easement in New York is

authorized only by statute and thus is subject to several statutory restrictions. We

assume the easement in this case is enforceable only under New York’s

Environmental Conservation Law and (as the Graevs contend) is subject to the

restrictions therein, especially restrictions on how an easement can be

extinguished.




      15
         The legislative history of these provisions suggests that they were included
in the statutes so that the conservation easements would satisfy the perpetuity
requirement of 26 C.F.R. sec. 170A-14(g). See John C. Partigan, “New York’s
Conservation Easement Statute: The Property Interest and Its Real Property and
Federal Income Tax Consequences”, 49 Albany L. Rev. 430, 452 n.87 (1985).
                                       - 42 -

      The manner and circumstances in which parties can modify or extinguish a

conservation easement under New York’s Environmental Conservation statutes

are clear:

      A conservation easement shall be modified or extinguished only
      pursuant to the provisions of section 49-0307 of this title. Any such
      modification or extinguishment shall be set forth in an instrument
      which complies with the requirements of section 5-703 of the general
      obligations law or in an instrument filed in a manner prescribed for
      recording a conveyance of real property pursuant to section two
      hundred ninety-one of the real property law. [N.Y. Envtl. Conserv.
      Law sec. 49-0305(2).]

The Graevs argue that NAT’s promise in the side letter to “remove the facade

conservation easement from the property’s title” purports to retain for Mr. Graev a

right to extinguish the easement that does not comply with the provisions of N.Y.

Envtl. Conserv. Law section 49-0307, and as a result, any attempt to remove the

easement pursuant to the promise in the side letter would be unlawful.

      Pursuant to N.Y. Envtl. Conserv. Law section 49-0307, cross-referenced in

the statute quoted above, a conservation easement held by a “not-for-profit

conservation organization”16 may be modified or extinguished only: (1) “as

provided in the instrument creating the easement”; (2) “in a proceeding pursuant to


      16
       The Commissioner does not dispute that NAT is a “not-for-profit
conservation organization” for purposes of New York’s Environmental
Conservation Law.
                                       - 43 -

section nineteen hundred fifty-one of the real property actions and proceedings

law”; or (3) “upon the exercise of the power of eminent domain.” NAT’s promise

in the side letter to remove the easement, standing alone, does not appear to

comply with any of the three permissible modification or extinguishment methods

provided in N.Y. Envtl. Conserv. Law section 49-0307.

      The Commissioner argues that the side letter should be considered part of

“the instrument creating the easement”. That argument fails because the side letter

was not “subscribed by the person * * * granting [the deed]”, N.Y. Gen. Oblig.

Law sec. 5-703 (McKinney 2012), nor was it recorded, which are both required

under N.Y. Envtl. Conserv. Law section 49-0305 (cross-referencing N.Y. Gen.

Oblig. Law sec. 5-703) in order for a document to be considered an “instrument

creating the easement”.

      However, we hold that NAT had the ability to honor its promises in the side

letter because the subscribed and recorded deed--which clearly is “the instrument

creating the easement”--reserved for NAT the power to do so. Paragraph IV.B. of

the duly recorded deed granting the easement explicitly gives NAT the right to

“abandon” the easement, and that deed does comply with one of the three

permissible methods--i.e., the first (allowing modification or extinguishment “as

provided in the instrument creating the easement”). The recorded deed provides:
                                       - 44 -

      Grantee further agrees that it will not transfer this Easement unless
      the transferee first agrees to continue to carry out the conservation
      purposes for which this Easement was created, provided, however,
      that nothing herein contained shall be constructed to limit the
      Grantee’s right to give its consent (e.g., to changes in a Protected
      Facade(s)) or to abandon some or all of its rights hereunder.
      [Emphasis added.]

      We have found that at the time Mr. Graev made the contribution, NAT

intended to honor its promise to “join with * * * [Mr. Graev] to immediately

remove the facade conservation easement from the property’s title”, and we hold

that NAT had the ability to honor this promise by exercising its right to abandon

the easement as set forth in paragraph IV.B. of the recorded deed.17




      17
         Our holding here is distinguishable from Commissioner v. Simmons, 

, 10 (D.C. Cir. 2011), aff’g T.C. Memo. 2009-208, which looked at similar
abandonment language in an easement deed and concluded “deductions cannot be
disallowed based upon the remote possibility * * * [the charity] will abandon the
easements.” See also Kaufman v. Shulman, 

, 28 (1st Cir. 2012), aff’g
in part, vacating in part, and remanding in part Kaufman v. Commissioner, 

 (2011), and 

 (2010). In Commissioner v. Simmons, 646
F.3d at 10, the Court of Appeals for the D.C. Circuit stated that “the
Commissioner has not shown the possibility * * * [the charity] will actually
abandon its rights is more than negligible. [The charity] * * * has been holding
and monitoring easements in the District of Columbia since 1978, yet the
Commissioner points to not a single instance of its having abandoned its right to
enforce.” In the instant case, however, NAT gave Mr. Graev an explicit, written
promise that it would abandon its rights in the easement if certain events occurred.
We find nothing to indicate that NAT did not intend to comply with its written
promises.
                                         - 45 -

      Accordingly, we find that the Commissioner has shown that the possibility

that NAT would actually abandon its rights was more than negligible.

                    2.     Merger doctrine

      Alternatively, the Graevs argue that the entire side letter was extinguished

under the common law doctrine of merger. This argument is also without merit.

While the doctrine of merger generally extinguishes terms of preliminary contracts

or negotiations upon the recording of a deed, so that only the terms in the recorded

deed remain, there are exceptions to this general rule. 91 N.Y. Jur. 2d Real

Property Sales and Exchanges, sec. 140 (2011). Assuming the doctrine of merger

applies to the side letter, the provisions in the side letter would fall within one of

these exceptions and survive the deed.

      The merger rule does not apply where there is a clear intent evidenced by

the parties that a particular provision of the contract shall survive the deed. See

Novelty Crystal Corp. v. PSA Institutional Partners, L.P., 

, 500

(App. Div. 2008). “Intention of the parties may be derived from the instruments

alone or from the instruments and the surrounding circumstances”. Goldsmith v.

Knapp, 

, 436 (App. Div. 1996). In Seibros Fin. Corp. v. Kirman,

, 499 (App. Div. 1931), a New York court held that because an

agreement giving the purchaser a right to reconvey property that was claimed to be
                                        - 46 -

the “inducing cause which persuaded the plaintiff to purchase the property * * * [,

t]he contract clearly shows that there was no intention on the part of the parties to

merge the contract in the deed. A contract for the sale of real estate is merged in

the deed only when the latter is intended to be accepted in full performance of the

former.”

      Likewise, we find that the side letter was an inducing cause that persuaded

Mr. Grave to contribute the conservation easement and cash to NAT. Before

he even filled out his application to NAT, Mr. Graev emailed NAT asking for its

thoughts on the side letter; and after receiving NAT’s assurances that the side

letter would not affect the deductibility of his contribution, he specifically

requested the side letter. Moreover, after the donation, when NAT recognized that

the side letter might be detrimental to Mr. Graev’s tax deductions, NAT offered to

rescind the side letter and Mr. Graev did not accept NAT’s offer, indicating that

the parties understood the side letter had survived the deed. Accordingly, we find

that NAT’s promises in the side letter to return to the easement and cash were

enforceable because we find a clear intent evidenced by the parties that the side

letter would survive the deed.
                                        - 47 -

                    3.    Nullity

      The Graevs appear to argue that NAT’s side letter is a nullity and should be

disregarded for tax purposes because it provides for the donor’s potential recovery

of the contributions in the event of unwanted tax consequences. In support of this

argument the Graevs rely primarily on Commissioner v. Procter, 

,

827-828 (4th Cir. 1944), rev’g a Memorandum Opinion of this Court. The holding

of the Court of Appeals in Procter, however, is inapposite to this case.

      In Procter the donors assigned to their children gifts of remainder interests

in two trusts, subject to the following clause:

      [I]n the event it should be determined by final judgment or order of a
      competent federal court of last resort that any part of the transfer in
      trust hereunder is subject to gift tax, it is agreed by all the parties
      hereto that in that event the excess property hereby transferred which
      is decreed by such court to be subject to gift tax, shall automatically
      be deemed not to be included in the conveyance in trust hereunder
      and shall remain the sole property of * * * [the taxpayer] * * *. [Id. at
      827.]

Under that clause, if the gifts were held by the courts to be taxable, then the gifts

would be undone, and the donors would then be not liable for the tax for which the

courts had held them liable. The clause purported not only to undo the gifts but

also to undo the judicial decision.
                                        - 48 -

      The Court of Appeals for the Fourth Circuit held that the clause in Procter

was “clearly a condition subsequent and void because contrary to public policy”,

id., for three reasons:

      (1)    Such a clause “has a tendency to discourage the collection of the tax

by the public officials charged with its collection”, thereby discouraging efforts to

collect the tax. Id.

      (2)    “[T]he effect of the condition would be to obstruct the administration

of justice by requiring the courts to pass upon a moot case”. Id.

      (3)    “[T]he condition is to the effect that the final judgment of a court is to

be held for naught because of the provision of an indenture necessarily before the

court when the judgment is rendered.” Id. That is, a final judgment would cause

the condition to be operative, but the condition should not be allowed to operate to

undo the judgment, since the instrument containing the condition was before the

court, and all matters pertaining thereto merged in the judgment. Id. at 827-828.

      None of these three reasons would apply to nullify NAT’s side letter:

      First, the conditions in NAT’s side letter would not discourage the

collection of tax. This Opinion decides that the Graevs are not entitled to

charitable contribution deductions (and that there are therefore deficiencies in their

income tax), and the return of the contributions to the Graevs would not at all
                                        - 49 -

undo or contradict that holding but would instead be consistent with that holding.

In order for the condition in the side letter to be triggered, the deductions must be

disallowed, and income tax will thereafter be owing whether or not the

contribution is returned.

      Second, the possibility of the subsequent return of the contributions does

not render this case moot. The Graevs claimed deductions; the IRS disallowed

them and determined deficiencies of tax; the Graevs challenged that

determination, and we must decide the matter. If we had upheld the deductions,

the condition in the side letter would never have been met, the gift would be

complete, the contribution would be deductible (assuming other qualifications are

met), and we would enter decision in favor of the Graevs to overturn the IRS’s

deficiency determination. Because instead we disallow the deductions and enter

decision in the IRS’s favor, upholding the deficiency determination, the condition

in the side letter is triggered and the gift presumably reverts to the donor.

However, in this case, unlike Procter, the reversion to the donor would not be

inconsistent with the court’s holding--i.e., the tax collector in our case, unlike

Proctor, would collect the tax consistent with the judgment even if the condition

become operative and the gift were returned to the donor.
                                         - 50 -

      Third, although the final judgment in the IRS’s favor would cause the side

letter to be operative, the return of the contribution pursuant to the side letter

would not operate to undo the judgment, as was the case in Procter. The return

would have no effect on the Graevs’ tax liabilities.

      Other cases have similarly distinguished Procter and have held that certain

tax contingency provisions are not void as against public policy. See Estate of

Christiansen v. Commissioner, 

, 8 n.7, 17-18 (2008) (a clause that

“increases the amount donated to charity should the value of the estate be

increased”, “would not make us opine on a moot issue [i.e., the value of the

estate], and wouldn’t in any way upset the finality of our decision in this case”),

aff’d, 

 (8th Cir. 2009); Estate of Dickinson v. Commissioner, 

, 777 (1975) (stating that the “agreement makes no attempt to nullify * * *

[the Court’s] determination” (citing Surface Combustion Corp. v. Commissioner, 

, and O’Brien v. Commissioner, 

)); Estate of Petter v.

Commissioner, T.C. Memo. 2009-280 (“a judgment adjusting the value of each

unit will actually trigger a reallocation of the number of units between the trusts

and the foundation under the formula clause. So we are not issuing a merely

declaratory judgment”), aff’d, 

 (9th Cir. 2011).
                                        - 51 -

             4.     Voluntary removal of the easement

      The event that might defeat the contribution to NAT is the “removal” of the

easement and the return of the cash pursuant to NAT’s side letter. Even if, as a

matter of law, the side letter was not enforceable for any of the reasons the Graevs

advance, the question would remain whether, as a matter of fact, in December

2004 there was a non-negligible possibility that the IRS would disallow the

Graevs’ contribution deduction and NAT would voluntarily remove the easement.

We have found that there was. Mr. Graev evidently concluded that NAT’s

promise should be believed; he took deliberate steps to obtain its promise; and his

conclusion is evidence of what was likely. NAT made such promises to Mr. Graev

and others precisely because it was soliciting contributions from within a

community of potential donors, and the ability of such an organization to obtain

solicitations might well be undermined if it got a reputation for failing to keep its

promises. To decide that there was no non-negligible possibility that NAT would

voluntarily extinguish the easement and return the cash would require us to find

that, in order to induce Mr. Graev to make his contribution, NAT made cynical

promises that it fully intended to break. Our record will not support such a

finding; the stipulated evidence simply shows a non-profit organization going

about accomplishing its purpose. If we speculate (without evidence) that NAT
                                        - 52 -

might have reneged on its promise, or even if we assume that NAT probably

would have reneged on its promise, that still leaves us with at least a non-

negligible possibility that NAT would have done what it said it would do. That

possibility is fatal to the Graevs’ contribution deductions.

III.   Conclusion

       Thus, on the evidence before us, we find that there was a substantial

possibility that the IRS would challenge the Graevs’ easement contribution

deductions. We hold that neither State nor Federal law would prevent

enforcement of the side letter. And we find that apart from any legal

enforceability of the side letter, it reflected what NAT was likely to do in the event

of IRS disallowance.

       For these reasons, we conclude that at the time of Mr. Graev’s contributions

to NAT, the possibility that the IRS would disallow the Graevs’ deductions for the

contributions and, as a result, that NAT would “promptly refund * * * [Mr.

Grave’s] entire cash endowment contribution and join with * * * [Mr. Graev] to

immediately remove the facade conservation easement from the property’s title”

(as it promised) was not “so remote as to be negligible”. Accordingly, under

26 C.F.R. sections 1.170A-1(e) and 1.170A-7(a)(3) the deduction relating to the

cash contributions is disallowed. Likewise, under 26 C.F.R. sections 1.170A-1(e),
                                     - 53 -

1.170A-7(a)(3), and 1.170A-14(g)(3), the easement contribution deductions are

disallowed.

      To reflect the foregoing,


                                                    An appropriate order will be

                                              issued.