Farmers Weren’t “Farmers” for Purposes of Conservation Easement Donation Deduction

August 8, 2017 | Kristine A. Tidgren


The tax code allows an enhanced deduction for the donation of a qualified conservation easement. IRC § 170(b)(1)(E). This deduction is generally limited to 50% of the donor's “contribution base,” which is the taxpayer's adjusted gross income (computed without regard to any net operating loss carryback for the taxable year), less the value of other charitable contributions for the year. IRC § 170(b)(1)(G).

A special rule applies to “qualified farmers and ranchers.” These taxpayers may deduct the value of the donation up to 100% of their adjusted gross income, less the amount of all other charitable contributions. IRC § 170(b)(1)(E)(iv). The PATH Act made the enhanced conservation easement donation deduction permanent.

But the definition of “qualified farmers and ranchers” may not be as it appears. A recent tax court case held that the statute’s “narrow” definition of “qualified farmers” prevented two full-time farmers from taking a 100 percent deduction. Instead, they were limited to the 50 percent deduction applicable to other taxpayers.


The taxpayers were brothers who farmed 1,455 acres in 2009 through various entities. They were the sole members of an LLC that owned a 355-acre parcel of land that was leased to a partnership, through which the brothers conducted farming operations. The LLC that owned the land was also taxed as a partnership. The brothers planted and harvested wheat on the 355-acre parcel. During 2009 (the tax year at issue), the brothers each rendered at least 2,500 hours of physical labor and management services in growing and harvesting corn, barley, wheat, and soybeans on all of their properties, which comprised seven parcels. They also enrolled in USDA-FSA farm programs.

In 2009, the brothers’ LLC conveyed a conservation easement attached to the 355-acre parcel to a land conservancy that qualified as a public charity. The easement restricted the development rights attached to the property. The charity paid a bargain price of $1,505,057 for the easement. The FMV of the property was appraised at $4,970,000 before the conveyance and at $2,130,000 after the conveyance. As such, the LLC calculated a noncash charitable contribution for the conservation easement of $1,335,040.

The issue before the tax court was whether the brothers were “qualified farmers” entitled to a 100% deduction or whether they were restricted to the 50% deduction allowed to other taxpayers. The brothers had taken a 100% deduction, but the tax court agreed with the IRS and found that they were not “qualified farmers” under the statute’s “narrowly-tailored” provision.

IRC §170(b)(1)(E)(v) defines the term “qualified farmer or rancher” as an individual whose gross income from the trade or business of farming (within the meaning of IRC § 2032A(e)(5)) is greater than 50% of the individual's gross income for the taxable year. IRC § 2032A(e)(5) defines "farming purposes" as follows:

(A) Cultivating the soil or raising or harvesting any agricultural or horticultural commodity (including the raising, shearing, feeding, caring for, training, and management of animals) on a farm;

(B) Handling, drying, packing, grading, or storing on a farm any agricultural or horticultural commodity in its unmanufactured state, but only if the owner, tenant, or operator of the farm regularly produces more than one-half of the commodity so treated; and

(C) The planting, cultivating, caring for, or cutting of trees OR the preparation (other than milling) of trees for market.

Immediately after the LLC conveyed the easement, the LLC sold the land to a third party for $1,995,040. The LLC reported the various transactions as follows:

  • The LLC reported its total basis in the property as $1,745,885.
    • It allocated $240,828 of this amount to the conservation easement and $1,505,057 to its remaining interest in the property.
  • The LLC reported a capital gain of $1,754,115 from the sale of the property:
    • $1,264,132 from the sale of the conservation easement, and
    • $489,983 from the sale of its remaining property interest.
  • The LLC reported a noncash charitable contribution for the conservation easement of $1,335,040.

As 50 percent members of the LLC (which was taxed as a partnership), the brothers each reported a $667,520 charitable contribution deduction on their respective Form 1040, Schedule As. They each also reported their 50% share of the LLC’s $1,754,115 capital gain from the sale of the easement and the parcel as long-term capital gain on their respective Form 1040, Schedule Ds. In 2009, one brother had wage income of $16,800, interest income of $453, and loss from partnerships and S corporations of $177,524. The other brother (who filed a joint return with his wife) had wage income of $28,745, interest income of $586, and loss from partnerships and S corporations of $177,526.

Tax Court Opinion

To determine whether the brothers were "qualified farmers" entitled to the 100% charitable donation deduction, the tax court looked to the brothers’ reported gross income to calculate the percentage that was derived from the trade or business of farming. Because the LLC was taxed as a partnership, the court used the brothers' reported income for this determination. Partners take into account separately their respective distributive shares of a partnership’s charitable contributions.

The IRS alleged that the proceeds from the sale of the 355-acre parcel, including the proceeds from the bargain sale of the conservation easement rights, did not constitute income from the trade or business of farming under the definition set forth in IRC § 2032A(e)(5). This income, the IRS reasoned, was not income from “cultivating the soil or raising or harvesting any agricultural or horticultural commodity.” On the other hand, the brothers contended that the income derived from the sales of the land and the easement constituted income from the trade or business of farming because the land was property used in the trade or business of farming. In other words, they argued that proceeds from the sale of real estate used in the business of farming generates income from the trade of business of farming.

The tax court sided with the IRS, finding that the statute was "clear on its face." "Neither the disposal of property nor the disposal of the development rights attached thereto is an activity listed in section 2032A(e)(5)." As such, the court found that more than 50 percent of the brothers' income was not derived from the activities listed in § 2032A(e)(5), and the brothers' were not "qualified farmers." The court found that the statute was "narrowly tailored" and intended to provide a tax benefit for a specific action, namely the contribution of conservation easements by qualified farmers. The court stated that it could not broaden the scope of activities listed in § 2032A(e)(5) because its sole duty was to “interpret the law as written by Congress.” The court acknowledged that the brothers were farmers and that they reinvested the proceeds from the sales in their farming operation. Even so, the court stated that “being a farmer does not make one a ‘qualified farmer’ for purposes of IRC § 170(b)(1)(E)(iv)(1).”

The court also found a second reason for denying the 100% deduction. Although the brothers were each treated as having directly contributed the property from their LLC that was taxed as a partnership, IRC § 702(b) provides that the character of any item of income, gain, loss, deduction, or credit included in a partner’s distributive share…shall be determined as if such item were realized directly from the source from which realized by the partnership or incurred in the same manner as incurred by the partnership.” The court then declared that the LLC, which rented its property to the brothers’ farming partnership, was not in the business of farming, but in the business of leasing real estate.

The court ended the opinion by stating, “We realize that the statute makes it difficult for a farmer to receive a maximum charitable contribution deduction by disposing of a portion of property in a year in which he/she donates a conservation easement, especially in a state with high land values. But it is not our task to rewrite a statute.”

Is that Really What Congress Intended?

The court stated that it relied on the plain meaning of the statute in reaching this opinion; however, the statute seems to reasonably support the alternative interpretation. It is difficult to see why Congress would seek to restrict the definition of a farmer's income so drastically. It is through the sales of farming assets that farmers ofen generate their greatest taxable income. Why should a farmer be penalized for donating a conservation easement in the same year as he disposes of a parcel of land or a fully depreciated combine?

IRC § 170(b)(1)(E) states, “[T]he term ‘qualified farmer or rancher’ means a taxpayer whose gross income from the trade or business of farming (within the meaning of section 2032A(e)(5)) is greater than 50 percent of the taxpayer’s gross income for the taxable year.”

In its opinion, the court paraphrased this statute, by stating, “A qualified farmer, defined as a taxpayer whose gross income from the trade or business of farming (as defined by I.R.C. sec. 2032A(e)(5)) is greater than 50% of his/her total gross income for the year.”

The narrowing of the phrase “within the meaning of” to “as defined by” is not without significance. It also seems the court assumed (without discussion) that "as defined by" modified "gross income from the trade or business of farming" rather than "trade or business of farming" or just "farming." The court stated, “Section 2032A(e)(5) sets forth a list of specific activities, the revenues derived from which constitute farming income.” This statement again narrows the actual language of the statute.

In reality, IRC § 2032A(e)(5) merely defines the phrase “farming purposes.” The definition is part of the special use valuation statute, which allows property with a “qualified use” to receive a lower valuation for estate tax purposes. “Qualified use” means the “devotion of the property to ‘farming purposes.’” In other words, assuming other requirements are met, land devoted to farming purposes (i.e. crop ground) is eligible for special use valuation.

Section 2032A(e)(5) in itself has nothing to do with income, but with whether property is being devoted to “farming purposes.” In this context, “income from the trade or business of farming (within the meaning of section 2032A(e)(5))” would seem to reasonably include income from the disposition of assets used for farming purposes.

We will watch for an appeal.

The case is Rutkoske v. Commissioner, 149 T.C. 6 (August 7, 2017).