Jones Day Argues New Approach To Valuation In Recent Tax Court Cases

Forbes

15-06-2025

Atlanta, Georgia, Jones Day, multinational law firm office building. (Photo by: Jeffrey ... More Greenberg/Universal Images Group via Getty Images)
Tax Court Judge Goeke's opinion in Beaverdam Creek Holdings LLC pairs nicely with Judge Lauber's opinion in Ranch Springs LLC, which I recently covered. Both involve syndicated conservation easements on mining property in the South (Georgia and Alabama respectively) and extensive discussion of the discounted cash flow method of valuation. Another thing they have in common is the law firm representing the petitioner - Jones Day - and an innovative approach to valuation that they have developed and once again failed to sell a Tax Court judge on. Charles E. Hodges II of Jones Day has written me that both cases will be appealed. Most significantly both cases present a theory of valuation that would be game changing if it prevails on appeal.
The property in question was an 85 acre tract in Oglethorpe County Georgia. It was owned by Service Granite Co. Inc (SGC) which had mined granite on it till 2006. It then leased the mine to Lexington Blue Granite Inc. Lexington, which had some ownership in common with SGC stopped mining sometime in 2008. North Ridge Quarries took up a lease and operated from 2008 to 2012. SGC ended up being owned by Lita Miller, who had no experience in the granite business. She was troubled by loans that were associated with SGC.
In 2017, she heard from Lee Ellis of Strategic Seek One LLC expressing interest in the property. Mr. Ellis had identified the property from studying aerial maps. Ultimately they agreed on an effective purchase price of $225,000. Beaverdam was formed on June 29, 2017 with SSO as its manager. SGC contributed the property to Beaverdam in exchange for a 99% interest. SSO contributed $10,000 for a 1% interest. SSO agreed to pay SGC $228,000 for a 97% interest in Beaverdam leaving SGC with 2%. My inference is that these maneuvers were to give Beaverdam a tack on the holding period of the property so that the contribution could be made in 2017.
Beaverdam Creek Investors LLC (BC Investors) was formed on August 23, 2017. The manager of BC investors was Strategic Fund Managers (SFM). Its purpose was to invest in Beaverdam "ostensibly" to either hold for appreciation or contribute a conservation easement. There were 183 units at $25,000 each for a total of $4,575,000. $950,000 of that was designated to be paid for the 97% interest in Beaverdam and $2,260,000 would be contributed to Beaverdam and $150,000 to a BC investors operating reserve. The balance went to offering expenses, consulting fees to Strategic Group and legal and other expenses.
On December 27, 2017, SFM notified the partners that it had determined that the conservation strategy should be followed. The members had one day to affirm or reject the determination. Of those who voted 57 went for conservation and 2 for holding for investment. On December 28, 2017 Beaverdam conveyed an easement on the property to Foothills Land Conservancy. On its return for the short period December 28, 2017 to December 31, 2017 Beaverdam claimed a charitable contribution of $21,972,000 for the easement.
The opinion includes a discussion of burden of proof and whether the appraisal was a qualified appraisal. The burden of proof did not shift from the taxpayer and the appraisal whatever its flaws was a qualified appraisal. The contentious important issue was valuation. Since you generally can't find a lot of buying and selling of easements the valuation is usually done by the before and after method. The value of the property before the easement encumbers it has the value of the property as encumbered subtracted from it. Usually it is the "before" value that is at issue. In this case, both parties agreed that the after value was $106,750.
When it came to the before value Judge Goeke agreed with the taxpayer that the highest and best use was granite mining.
"We agree with BC Investors that operation of a quarry on the easement property was financially feasible in December 2017. Although many of respondent's points are fair, the facts favor BC Investors' position. We are especially persuaded by the long history of quarrying that has taken place on the property, the property's lack of use for other purposes, and Mr. Krasinski's agreement with BC Investors' position."
For the before value the IRS argued $215,000 and the taxpayer was looking for at least $23 million. Judge Goeke was not satisfied with either of those answers. He did not, however, split the difference. When it came to method, IRS was looking at comparable sales, but he did not think the IRS experts included enough information regarding quarry/granite features of the comparable properties. BC Investors argued that "the income method is the sole valuation method that can determine the fair market value of what Beaverdam Holdings sacrificed: the valuable granite that could be extracted and sold".
Judge Goeke' overall assessment was harsh: "While we do not completely agree with respondent's position, it is not unreasonable. On the other hand, BC Investors' position is absurd". He goes on "... because the valuation BC Investors argues for is completely untethered from reality, it produced no sales data that remotely supports its DCF analyses. BC Investors asks us to trust speculative, unconvincing business valuation projections over the accumulated knowledge of the market in the 'Granite Capital of the World'."
"BC Investors erroneously equated the (overstated) value of a hypothetical business to the fair market value of the easement property. Respondent advocated use of the comparable sales method, but his experts could have included more information regarding quarry/granite features in their comparable sales data. Considering the evidence, we value the easement property on the basis of our own examination of the record."
Judge Goeke's examination of the record yielded a before value of $300,000. Subtracting the agreed after value makes for a deduction of $193,250. He also ruled that the 40% gross valuation penalty applied. The allowed deduction was about 1% of the claimed deduction of $21,972,000.
When I first heard from people who were planning to syndicate conservation easements, I thought the idea was absurd. If they were going out buying property, they would generally be paying fair market value more or less and an easement is worth a fraction, possibly a large fraction, of the fair market value. The argument that was subsequently made by the industry was that an easement was giving up future value that might not be reflected in what the property would change hands for currently. Until recently, though, as far as I can tell, nobody was making any argument of that sort in court. That is what makes this case and Ranch Springs LLC so special. Jones Day was making an argument that would account for property being valued for a conservation easement at a multiple of the value that it had recently changed hands for.
If you want to dive deeply into this here are two sources. One is an article in Bloomberg Tax - The Tax Tail Can't Wag The Valuation Dog: Five Key FMV Rules. Mr. Hodges is the lead author. The other is the Jones Day brief in the case. The argument is that in order for a sale to be comparable, you have to consider not only the physical characteristics of the property, but also the bargaining posture of the seller and buyer. They use the acronym BATNA (best alternative to a negotiated agreement) to describe the bargaining position. Beaverdam's BATNA was operating a quarry for a present value of $23 million. Lita Miller who let go of the property for less than 1% of that was not in a position to operate quarry so that sale was not comparable. Similar reasoning is applied to the other sales, the IRS put forth as comparable.
In the Tax Tail Can't Wag The Valuation Dog article, the authors discuss the concept of "fair" in "fair market value". They argue that to be fair, both the hypothetical buyer and seller must be participants in each of the markets in which the property could trade.
"Take for example, real property that could be put to use as either farmland (a less valuable use in this hypothetical) or commercial real estate (a more valuable use) and the seller is a farmer and buyer is a developer. The farmer may lack the experience and capital, or otherwise, to exploit that potential commercial use. Thus the farmer - with limited development knowledge and unable to commercially develop the property himself - may accept a price that is indicative of the property's continued use as a farm, or a reduced value because of his inability to commercially develop the property.
In this hypothetical, the price at which the property changed hands does not represent a "fair" approximation of the value of the property."
The implications of this approach are breathtaking. Comparable sales are a preferred valuation method, but if Jones Day is right in Beaverdam and Ranch, comparable sales may be very rare.
Neither of the Tax Court judges who engaged with this is impressed by the theory, but I am impressed that Jones Day managed to come up with anything that supports the easement syndication industry's view of the world. I am looking forward to see what the appellate court makes of it.
Mr. Hodges wrote me that as he sees it the Tax Court with its ruling that discounted cash flow is valuing a business rather than the underlying land has effectively eliminated the highest and best use inquiry.