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T.C. Memo. 2012-35

UNITED STATES TAX COURT

ESGAR CORPORATION, E AL. ,1 Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 23676-08, 23688-08,

23689-08.

Filed February 6,

2012.

Ps granted qualified conservation easements to a

qualified conservation orgsnization in 2004, reporting

noncash charitable contribttions on their respective

2004 tax returns. R detern.ined deficiencies in income

tax, based in part on R' s c etermination that Ps had

overstated the value of the conservation easements.

also determined sec . 6662 (E.) , I . R . C. , accuracy-related

penalties against the Holmeses and the Tempels.

Held: Ps are liable for the income tax

deficiencies to the extent redetermined herein as the

result of overvaluing the contributed conservation

easements.

10n Aug. 28, 2009, cases of the following petitioners were

consolidated herewith for purposes of trial, briefing, and

opinion: Delmar L. and Patricia A. Holmes, docket No. 23688-08;

and George H. and Georgetta Tempel, docket No. 23689-08.

SiRVED ÆB -6 2012

- 2 Held, further, the Holmeses and the Tempels are not

liable for sec. 6662(a), I.R.C., accuracy-related penalties.

James R. Walker, Justin D. Cumming, and Christopher D.

Freeman, for petitioners.

Sara Jo Barkley and Tamara L. Kotzker, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

WHERRY, Judge:

Petitioners are:

Esgar Corp.

(Esgar), a

Colorado corporation which filed Forms 1120, U.S. Corporation

Income Tax Return, for the 2004, 2005, and 2006 tax years; Delmar

L. and Patricia A. Holmes (the Holmeses); and George H. and

Georgetta L. Tempel (the Tempels).

The Holmeses and the Tempels

both filed joint Forms 1040, U.S. Individual Income Tax Return,

for the 2004, 2005, and 2006 tax years.

In 2004 Esgar,

the

Holmeses, and the Tempels each donated a qualified conservation

easement, reporting on Forms 8283, Noncash Charitable

Contributions, fair market values of $570,500, $867,500, and

$836,500, respectively.

Because of the limitations of section

170(b) (1) (A) and (2) (A), petitioners deducted only a portion of

the reported contributions on their 2004 tax returns and carried

the rest forward.2

2Unless otherwise indicated, all section references are to

the Internal Revenue Code of 1986, as amended and in effect for

the years at issue, and all Rule references are to the Tax Court

(continued...)

As a result of the donations

petitioners each also received

transferable Colorado State inc me tax credits (State tax

credits) .

2004.

They all sold a port on of their State tax credits in

Esgar and the Tempels re orted the proceeds from the sale

of their State tax credits as c pital gain; the Holmeses reported

their proceeds as ordinary inco e.

Respondent issued Esgar an

the Tempels notices of

deficiency dated June 26, 2008, and issued the Holmeses a notice

of deficiency dated June 27, 20 8.

In the notices of deficiency

respondent determined, inter alia,

that the conservation

easements were valueless and th t any proceeds from the sales of

the State tax credits should be reported as ordinary income .

The determined tax deficierhcies,. additions to tax, and

penalties were as follows

E gar

Year

Deficiency

Penalty

Sec. 6662(a)

Addition to Tax1

Sec. 6651(a)(1)

2004

$9,741

---

$488.70

2005

11,990

$2,398.0

1,199.02

2006

10,626

2,125.2

---

1Respondent concedes Esgar i not liable for the sec. 6662(a)

penalty for the 2005 and 2006 ax years, and Esgar concedes it

is liable for the sec. 6651(a) 1) addition to tax for the 2004

and 2005 tax years.

2 (. . . continued)

Rules of Practice and Procedure.

- 4 -

The Holmeses

Year

Deficiency

Penalty

Sec. 6662(a)

2004

$31,830

$6,366.00

2005

24,572

4,914.00

2006

25,894

5,178.80

The Tempels

Year

Deficiency

Penalty

Sec. 6662(a)

2004

$69,389

$13,877.60

2005

24,292

4,858.40

On August 3, 2009, respondent filed a motion for partial

summary judgment in Tempel v. Commissioner, docket No. 23689-08.

On August 31, 2009, the Tempels filed a cross-motion for partial

summary judgment.

The issue was whether the gain from the sale

of the State tax credits should be reported as ordinary income or

as capital gain and if capital gain, whether the Tempels had any

basis in their State tax credits.

This Court held, in Tempel v.

Commissioner, 136 T.C. 341 (2011), inter alia, that the State tax

credits were capital assets, the Tempels did not have any basis

in their State tax credits, and that the Tempels' holding period

in the State tax credits was insufficient to qualify for longterm capital gain treatment.

We do not address any issues in this opinion that were

resolved by our opinion in Tempel.

left for decision are:

After concessions, the issues

(1) The fair market value (FMV) of the

qualified conservation easements petitioners granted;

(2) whether

the Holmeses are liable for section 6662(a) accuracy-related

penalties for their 2004, 2005, and 2006 tax years; and (3)

whether the Tempels are liable for section 6662(a) accuracyrelated penalties for their 2004 and 2005 tax years.

As more

thoroughly explained infra, in deciding the FMV of the

conservation easements, we must determine whether the land on

which the easements were grante

was better suited for gravel

mining or for agriculture.

FINDINGS OF FACT

Some of the facts have been stipulated, and the stipulated

facts and accompanying exhibits are hereby incorporated by

reference into our findings.

the time it filed its petition,

Esgar's principal place of busi ess was in Colorado.

At the time

they filed their petitions, the Holmeses and the Tempels resided

in Colorado.

Holly Property

In 1987 Esgar, the Holmeses, the Tempels,. and Kelling Fine

Foods, Inc.

(Kelling Fine Foods,', each acquired an undivided,

one-fourth interest in just ove^ 2,200 acres of real property

near Holly, Colorado (Holly property).

As of 1998 the Colorado

Division of Minerals and Geolog

had granted permission for

mining gravel, rock, and sand o

1,479 acres of the Holly

property (1998 gravel permit).

Jensen Property

On January 20, 1998, petitioners and Kelling Fine Foods sold

661.75 acres of the western portion of the Holly property along

with 455 shares of Buffalo Mutual Irrigation Co.

C. and Tanya Jensen for $500,000

(BMIC) to Robert

(Jensen property).3

substantial portion of the acreage approved for mining by the

1998 gravel permit was on the Jensen property.

In the sale,

petitioners and Kelling Fine Foods reserved all of the gravel,

sand, and mineral rights in the Jensen property, subject to a

January 20, 1998, repurchase agreement (repurchase agreement).

Pursuant to the repurchase agreement, if petitioners or

Kelling Fine Foods elected to mine any portion of the Jensen

property before January 20, 2003, they had to repurchase the

portion mined for $1,250 per crop acre.

If they elected to mine

any portion after January 20, 2003, they had to repurchase the

portion mined at a price "determined by a licensed Colorado

appraiser plus thirty percent (30%), but never more than

$1,500.00 per crop acre."

3Water rights are the right to the use of water. Under

Colorado water law, the right to use the waters of the State is

based on the priority of a party's appropriation for a specified

amount of water, at a specified location, for specified uses.

Water rights may be held, as here, by a mutual irrigation company

or a ditch company in which the users of the water own shares

entitling them, unless otherwise expressly provided, to a pro

rata portion of the company's water on the basis of the number of

shares owned as a percentage of all the shares in the company.

Midwestern Farms Proper y

The Holly property less. the Jensen property is referred to

by the parties and this Court as the "Midwestern Farms

Property".4

The Midwestern Farm

property consists of

approximately 1,560 acres and is in Prowers County, Colorado,

west of Holly, Colorado, between U.S. Highway 50 and the Arkansas

River.

Prowers County is in so theastern Colorado, approximately

200 miles southeast of Denver.

There is public access to

he Midwestern Farms property via

Prowers County Road, farm roads, and U.S. Highway 50.

The

Burlington Northern Santa Fe (BFSF) railroad traverses the

Midwestern Farms property, and

here is a rail spur on the

Midwestern Farms property.

II.

Midwestern Farms Gravel Pi

A portion of the Midwestern Farms property and the Jensen

property is operated as an allu ial gravel pit (Midwestern Farms

4In April 2002 the Holmese transferred title to their

undivided 25-percent interest ib the Midwestern Farms property to

the Delmar L. Holmes Trust and the Patricia A. Holmes Trust. As

a result, the Delmar L. Holmes rust owned an undivided oneeighth interest in the Midwestern Farms property and the Patricia

A. Holmes Trust owned an undivided one-eighth interest in the

Midwestern Farms property. We continue to refer to these

interests as the Holmes proper y.

- 8 Gravel Pit).'

The Midwestern Farms property and the Midwestern

Farms Gravel Pit are managed by the Midwestern Farms Partnership.

Eastern Colorado Aggregates, RLLLP (E. Colorado Aggregates),

has operated the Midwestern Farms Gravel Pit, pursuant to a lease

with the Midwestern Farms Partnership, since at least 1999.

Originally, the royalty rate paid to the Midwestern Farms

Partnership by E. Colorado Aggregates was 35 cents per ton for

all rock and gravel sold and 17.5 cents per ton of any sand and

fill dirt sold.

By an agreement dated February 28, 2004, and effective

January 1, 2004, the Midwestern Farms Partnership renewed its

lease agreement with E. Colorado Aggregates (E. Colorado

Aggregates lease).

The E. Colorado Aggregates lease allowed E.

Colorado Aggregates to mine up to 1,470 acres of the portion of

the Midwestern Farms property and Jensen property permitted by

the 1998 gravel permit.

Beginning July 1, 2004, the royalty rate

became 45 cents per ton for all rock and gravel sold and 22.5

cents per ton for any sand and fill dirt sold.

sFor our purposes, a gravel pit is a mine where aggregate is

extracted from an open pit. Aggregate is defined as "minerals

such as sand, gravel, and crushed stone. Aggregate is often

divided into two or more sizes including fine and coarse, which

when added to cement and water in appropriate proportions,

produces concrete. Sand is considered a fine aggregate and stone

or gravel a coarse aggregate." Throughout this opinion we will

use aggregate, rock, and gravel interchangeäbly.

The table below lists the tons of aggregate extracted from

the Midwestern Farms Gravel Pit and the amounts of royalties

received by the Midwestern FarmE Partnership from E. Colorado

Aggregates from 1999 through 20C4:

Year

Approximate

Tons Extracted

Royalties Received

1999

---

$80,361.55

2000

---

150,489.88

2001

590,671

196,382.77

2002

519,013

177,017.06

2003

596,479

203,111.63

2004

998,586

390,735.21

III. Other Gravel Pits

Prowers County

The Midwestern Farms Gravel Pit, the J-S Pit, the

Hardscrabble Pit, and the S-C P:.t rank as the four largest wet

gravel pits in Prowers County.

is the largest.

The Midwestern Farms Gravel Pit

The J-S Pit, the Hardscrabble Pit, and the S-C

Pit are operated by Carder, Inc.

Ronald D. Peterson.

(Carder Company), owned by

In addition to these three pits in Prowers

County, the Carder Company also operates a pit in western Kansas,

just over the Kansas-Colorado S:ate line, known as the Coolidge

Pit.

According to Mr. Peterson, the Carder Company sold

approximately 540,000 tons of aggregate in 2002 and 570,000 tons

- 10 -

in 2003 and 2004.

The following table shows the acres permitted

and approximate tons of aggregate extracted from the four major

Prowers County pits in 2003 and 2004.

Acres

Tons Extracted

Pit

Permitted

2003

2004

Midwestern Farms

1,479

596,479

998,586

J-S

120

100,093

45,432

Hardscrabble

2761

47,566

57,116

S-C

665

180,496

179,680

Total

2,540

924,634

1,280,814

10n the basis of Property Declaration Schedules filed by

Mr. Peterson for the Hardscrabble Pit, we conclude that

sometime in 2006 or 2007 the permitted area was extended to

cover 406 acres.

Gravel from Prowers County is used within an approximate

100- to 150-mile radius around Prowers County, in areas including

western Kansas, east-central and northeast Colorado, southwest

Nebraska, northeast New Mexico, and the Oklahoma and Texas

panhandles.

Some gravel is backhauled out of Prowers County on

semi-tractor trucks bringing corn into Prowers County.'

Gravel

was not being transported from Prowers County to the Front Range

'Backhauling occurs when a company hauls a primary commodity

from a point of origin to a point of destination and then is able

to "backhaul" a second commodity on the return trip back to the

original point of origin rather than make a "deadhead" return.

Backhauling helps reduce transportation costs in both directions.

1 -

Corridor, nor was any gravel being backhauled out of Prowers

County via rail in 2004 or 2009, when trial was held.7

District 3

The U.S. Geological Survey keeps estimates of historical

Colorado aggregate production.

It classifies Prowers County,

along with 14 other counties, a . District 3.

The following table

shows District 3's sand and gravel production for 2000-2003:

Year

Tons of Aqqregate

2000

1,499,143

2001

2,171,553

2002

2003

IV.

1,884,952

Donations of the Conservation Easements

Brian Wurst

Brian Wurst, a certif ied p blic accountant (C. P. A. ) ,

assisted petitioners in structu ing the donations of the

conservation easements.

Mr. Wu st has a bachelor of science

degree in business administrati n from Kansas State University.

He is a member of Kennedy & Coe, C.P.A.s (Kennedy & Coe), has

worked as a C.P.A. in southeast rn Colorado since 1984, and has

7The Front Range Corridor ies along the eastern side of the

Rocky Mountains in Colorado and Wyoming and includes most of the

Colorado population and the cities of Cheyenne, Denver, Longmont,

Loveland, Broomfield, Thornton, Aurora, Lakewood, Golden,

Centennial, Fort Collins, Colo do Springs, Boulder, Pueblo,

Colorado City, and Trinidad.

- 12 -

assisted petitioners with their tax matters for approximately 25

years.

Mr. Wurst first became familiar with conservation easements

in 2001 when the State of Colorado passed laws providing for

benefits to.taxpayers who granted qualifying conservation

easements on their property.

Kennedy & Coe's in-house tax

attorneys studied the Federal and State laws regarding

conservation easements and then used an outside law firm to

confirm their understanding on both the Federal and State levels.

Mr. Wurst first discussed the donation of conservation

easements with petitioners in the fall of 2003.

He spent

approximately 8 months talking with petitioners about the

implications of granting conservation easements on their

properties and approximately 4 months putting the conservation

easements in place.

While Mr. Wurst advised petitioners that "in

our professional opinion, we could meet the requirements of the

Code sections and related regulations", he did not.advise that

they make charitable conservation easement contributions.

It was

petitioners who ultimately made the decision to enter into the

conservation.easements.

Transfers of Property

On December 2, 2004, approximately 163 acres of the eastern

portion of the Midwestern Farms property was transferred to

Esgar, the Holmeses, and the Tempels via a series of like-kind

- L3 exchanges and quitclaim deeds.8

Afterwards, Esgar and the

Tempels each owned 54.34 acres End.11-2/3 shares of BMIC, and the

Holmeses owned 54.35 acres and 31-2/3 shares of BMIC

(collectively, the subject properties).

The subject properties were zoned irrigated, agricultural

and had historically been used

farmland.

s irrigated and nonirrigated

There was physical a cess to all three properties, but

only the Holmes property had legal access.

The subject

properties were not permitted for any mining, but the parties

stipulated that absent the donations. it was likely that the

necessary permits to mìne could have been obtained.

Donations

On December 17, 2004, Esga:;, the Tempels, and the Holmeses

(or their revocable trusts) each donated a conservation easement

on the subject properties to the Greenlands Reserve (collectively

the conservation easements).

The terms of the conservation easements grant and convey

easements in perpetuity to the Greenlands Reserve, providing it

with the

rights to preserve th

natural and open space

conditions and protect the wild ife, ecological, and

environmental values and water quality characteristics of the

8The stipulation of facts par. 14 indicates warranty deeds,

but the deeds themselves are quitclaim deeds without warranty.

- 14 property.

The conservation easements specifically prohibit the

mining or extraction of sand, gravel, rock, or any other mineral.

Appraisals

Core Sampling and J.A. Cesare

In September 2004, before the conservation easements were

granted, petitioners retained the geotechnical engineering firm

of J.A. Cesare and Associates, Inc.

(Cesare), to perform core

sampling on the subject properties in order to determine the

potential sand and gravel resources beneath them.

Using Cesare's

findings and reports, Dr. Charles E. Grey and his associate Brett

Schafer of the geological firm of Charles E. Grey and Associates

opined on the quantity and quality of gravel underneath the

subject properties.

William Victor (Bill) Milenski

Petitioners engaged Bill Milenski Appraisal Service, Inc.

(Mr. Milenski), to perform an original appraisal of the

conservation easements to be used to substantiate the reported

charitable contributions on their tax returns.

Mr. Wurst

testified that he had performed due diligence before he hired Mr.

Milenski.

Mr. Wurst concluded Mr. Milenski had an extensive

history in performing appraisals and "a very credible and

conservative reputation" as an appraiser.

Mr. Milenski determined that if the conservation easements

had not been granted, the best use of the land would have been

for gravel extraction.

5 -

On this basis he determined that the FMV

of the Holmes conservation ease ent was $867,500, the FMV of the

Esgar conservation easement was $570,500, and the FMV of the

Tempel conservation easement wa

Petitioners and Mr. Wurst

Milenski prepared.

$836,500.

eviewed the appraisals Mr.

Mr. Wurst w s of the opinion that Mr.

Milenski "took a reasonable app oach to determine the value."

Respondent does not challenge w ether Mr. Milenski was a

qualified appraiser" at the tine he prepared the appraisals or

whether the appraisals were "qualified appraisals" pursuant to

section 170(f) (11) (D).'

VI.

Tax Returns

Esgar filed Forms 1120 for all years at issue.

and the Tempels filed Forms 104

The Holmeses

for all years at issue."

their respective 2004 tax retur s, petitioners reported noncash

charitable contributions and cl imed charitable contribution

deductions subject to the limit tions of section 170(b) (1) and

9Mr. Milenski's license to practice real estate appraisal

was suspended by the State of olorado on May 1, 2008, "FOR

OVERVALUING conservation easements".

Pursuant to sec. 671, al of the income, deductions, and

credits against tax attributab e to the Delmar L. Holmes Trust

and the Patricia A. Holmes Trust are reported on the Holmeses'

individual Federal income tax eturns.

- 16 -

(2), carrying the remainder forward.

The following table shows

the charitable contributions reported and deductions claimed."

Reported

Charitable

2004

2005

2006

Contribution

Deduction

Esgar

$570,500

$25,663

$30,745

$28,097

Holmeses

867,500

88,835

92,105

86,006

Tempels

836,500

201,487

78,380

---

Respondent subsequently audited petitioners' returns,

determining that the conservation easements were valueless and

that the charitable contribution deductions should be denied in

their entirety.

Respondent issued notices of deficiency, and

petitioners timely petitioned this Court in response.

Trial was

held November 4, 5, and 6, 2009, in Denver, Colorado.

Also on their 2004 tax returns, Esgar reported an $18,000

capital gain from the sale of its State tax credits; the Holmeses

reported $148,050 in ordinary income from the sale of their State

tax credits, and the Tempels reported a $77,603 short-term

capital gain from the sale of their State tax credits. The

Holmeses had received $164,625 in net proceeds but reduced this

amount by $16,575 for expenses incurred. The Tempels' $77,603

gain was based on an amount realized of $82,500 less "basis" of

$4,897. The Tempels also claimed a $6,233 deduction on Schedule

A, Itemized Deductions, for costs related to the donation of the

Tempel conservation easement. The parties' disagreements over

the characterization of the proceeds from the sales of the State

tax credits were resolved in our previous opinion in Tempel v.

Commissioner, 136 T.C. 341 (2011), and are relevant here only

with regards to respondent's allegation that the Holmeses and the

Tempels are liable for sec. 6662(a) accuracy-related penalties.

7 -

OP NION

Burden of Proof

Deductions are a matter of legislative grace, and a taxpayer

bears the burden of proving ent tlement to any claimed

deductions .

(1992) .

INDOPCO,

Inc . v .

C mmis s ioner ,

503 U. S .

79,

Moreover, the Commissi ner' s determination of value is

normally presumed correct, and

he taxpayer bears the burden of

proving that the determination

s incorrect .

Welch v. Helvering, 290 U.S.

11 ,

115

3 7

(5th Cir.

Commissioner, 46 F.3d 382,

See Rule 142 (a) ;

(1933); Sealy Power, Ltd.

1995),

affg.

in part

and revg. in part T. C. Memo. 19 2-168.

However, pursuant to secti n 7491 (a) , the burden of proof on

factual issues that affect the

axpayer's tax liability may shift

to the Commissioner where the t xpayer complies with all

requirements .

Pe titioners argu

burden of proof to respondent .

section 7491 (a) shif ts the

Respondent argues petitioners did

not meet the requirements for s ction 7491(a) to shift the burden

of proof .

It is unnecessary for us t

address the parties'

disagreement and determine whet er the burden has shifted because

the parties have provided suffi ient evidence for us to determine

the value of .the conservation e sements and that determinatiori is

unaffected by section 7491(a) .

See Estate of Bongard v.

- 18 Commissioner,

124 T.C.

95, 111

(2005); Trout Ranch, LLC v.

Commissioner, T.C. Memo. 2010-283.

This Court has held that

"In a situation in which both parties have satisfied

their burden of production by offering some evidence,

then the party supported by the weight of the evidence

will prevail regardless of which party bore the burden

of persuasion, proof or preponderance. * * *

Therefore, a shift in the burden of preponderance has

real significance only in the rare event of an

evidentiary tie. * * *"

Knudsen v. Commissioner,

131 T.C.

185,

188

Blodgett v. Commissioner, 394 F.3d 1030,

affg. T.C. Memo.

Commissioner,

(2008)

1039

(quoting

(8th Cir. 2005),

2003-212); see also Martin Ice Cream Co. v.

110 T.C.

189,

210 n.16

(1998)

(holding that the

allocation of the burden of proof was immaterial because the

court's conclusions were based on the preponderance of the

evidence).

II.

Applicable Law

Section 170 allows a taxpayer a deduction for a qualified

conservation contribution made during the taxable year.

170(a),

(c),

(f) (3) (B) (iii),

(h).

Sec.

Respondent does not challenge

whether the conservation easements are "qualified conservation

contributions".

Rather, respondent disputes their value and

hence the amounts of the section 170 deduction petitioners are

allowed.

Section 1.170A-14 (h) (3) (i), Income Tax Regs., provides in

relevant part:

- 19 -

The value of the contribut on under section 170 in the

case of a charitable contr bution of a perpetual

conservation restriction i the fair market value of

the perpetual conservation restriction at the time of

the contribution. See sec ion 1.170A-7(c).

If there

is a substantial record of sales of easements

comparable to the donated asement (such as purchases

pursuant to a governmental program), the fair market

value of the donated easem nt is based on the sales

prices of such comparable asements.

If no substantial

record of market-place sales is available to use as a

meaningful or valid compar son, as a general rule (but

not necessarily in all cas s) the fair market value of

a perpetual conservation r striction is equal to the

difference between the fair market value of the

property it encumbers befo e the granting of the

restriction and the fair market value of the encumbered

property after the grantin of the restriction. * * *

The parties agree that the e are no sales of comparable

easements and that the before a d after method is the appropriate

method to use in valuing the conservation easements.

This method

requires us to calculate "the difference, if any, in the value of

the [properties] with and without the easement".

Commissioner,

85 T.C.

677,

688

The parties agree the FMV

Hilborn v.

(1985).

f the Subject Properties after

the conservation easements were granted (after value) was $24,000

for the Esgar and Tempel Proper ies and $27,000 for the Holmes

property.

Their disagreement i

the FMV of the Subject

Properties before the conservat on easements were granted (before

value).

FMV is defined as the "pri e at which the property would

change hands between a willing

uyer and a willing seller,

neither being under any compulsion to buy or sell and both having

- 20 reasonable knowledge of any relevant facts."

1(c) (2), Income Tax Regs.

Sec. 1.170A-

"Valuation is not a precise science,

and the fair market value of property on a given date is a

question of fact to be resolved on the basis of the entire

record."

Kiva Dunes Conservation, LLC v. Commissioner, T.C.

Memo. 2009-145.

The FMV of property must be evaluated considering the

property's highest and best use.

Commissioner,

87 T.C.

389,

and (ii), Income Tax Regs.

400

See Stanley Works & Subs. v.

(1986); sec.

1.170A-14 (h) (3) (i)

While highest and best use can be any

realistic, objective potential use of the property, it is

presumed to be the use to which the land is currently being put

absent proof to the contrary.

Inc.,

991 F.2d 336,

Commissioner,

341

87 T.C.

United States v. L.E. Cooke Co.,

(6th Cir.

892,

896

1993); Symington v.

(1986).

At the center of the

parties' disagreement over the before value is their disagreement

over the highest and best use of the Subject Properties before

the easements were donated.

Petitioners argue that it was gravel

mining, whereas respondent argues that it was agriculture.

Where, as here, an asserted highest and best use differs

from current use, the use must be reasonably probable and have

real market value.

United States v. 69.1 Acres of Land, 942 F.2d

290, 292 (4th Cir. 1991); see also Stanley Works v. Commissioner,

supra; United States v. Consol. Mayflower Mines, Inc., 60 F.3d

-.21 -

1470, 1476-1477 (10th Cir. 1995).

"Any suggested use higher than

current use requires both 'closeness in time' and 'reasonable

probability'".

Hilborn v. Commissioner, supra* at 689.. Any

proposed uses that "depend upon events or combinations of

occurrences which, while within the realm of possibility, are not

fairly shown to be reasonably probable". are to be excluded from

consideration.

Olson v. United States,

292. U..S. 246,

257

(1934).

Where the asserted highest and best use of property is the

extraction of minerals, the preuence of the mineral in a

commercially exploitable amount and the existence of a market

"that would justify its extract::on in the reasonably foreseeable

future" must be shown.

supra at 292.

United States v. 69.1 Acres 'of Land,

"There must be some objective support for the

future demand, including volume and duration.

Mere physical

adaptability to a use does not establish a market."

States v. Whitehurst,

337 F.2d 765, .771-772 a(4th Cir.

also United Stàtes v. 494.10 Ac es of Land,

(10th Cir. 1979)

(stating that

much beyond the 'near future,'

United

1964); see

592 F.2d 1130,

1132

if the 'future' is beyond or very

he use becomes speculative")."

We acknowledge that we are citing cases where the issue

was just compensation in an eminent domain or condemnation

setting.

Fair market value "does not vary according to whether

the taxpayer is seeking a charitable deduction for property

contributed or an adequate and just compensation for property

condemned." Klopp v. Commissioner, T.C. Memo. 1960-185.

- 22 -

III. Expert Opinions

Both parties have offered reports and testimony of expert

witnesses to establish the before value and the highest and best

use of the Subject Properties.

We evaluate expert opinions in light of each expert's

demonstrated qualifications and all other evidence in the

record.= See Parker v. Commissioner, 86 T.C. 547, 561

(1986). Where experts offer competing estimates of fair

market value, we determine how to weigh those estimates by,

inter alia, examining the factors they considered in

reaching their conclusions. See Casey v. Commissioner, 38

T.C.

357,

381

(1962).

We are not bound by an expert's

opinions and may accept or reject an expert opinion in full

or in part in the exercise of sound judgment.

See Helvering

v. Natl. Grocery Co.,

304.U.S.

282,

295

(1938); Parker v.

Commissioner, supra at 561-562. We may also reach a

determination of value.based on our own examination of the

evidence in the record. Silverman v. Commissioner, 538 F.2d

927, 933 (2d Cir. 1976), affg. T.C. Memo. 1974-285.

Evans v. Commissioner, T.C. Memo. 2010-207.

There are three widely accepted methods of estimating the

FMV for any property:

Comparable sales, income capitalization

(or discounted cashflow), and replacement cost.

The parties

disagree as to which method is appropriate.in this case.

Respondent's expert used the comparable sales method, which

calculates FMV by looking for sales of property in the same

market with similar characteristics that were made at arm's

length.

Petitioners' experts used the discounted cashflow (DCF)

method, which calculates FMV by preparing a reasonable estimate

of future income over time and discounting it to present value.

We briefly summarize each expert's opinion.

3 -

Petitioners' Expert--G ne Cruikshank

Mr.

Cruikshank received a

Colorado State University.

egree in agriculture from

as been a real estate broker

since 1980, specializes in farm and ranch sales, and is licensed

in Kansas, Oklahoma, Colorado,

nd New Mexico.

Mr. Cruikshank

belongs to the Realtors Land In titute, a branch of the National

Association of Realtors, and is an accredited land consultant.

He has been an expert witness

042a

proximately seven or eight times

before in both Federal and Stat

court.

Petitioners rely on Mr. Cr ikshank's opinion to argue no

comparable sales existed.

Mr.

ruikshank analyzed small parcel

sales in the Lower Arkansas Val ey to determine whether any were

bought for gravel production."

He determined none were, stating

he could not find "any small pa cel (40-60 acres) sales that were

sold either specifically for gr vel or with the intent of future

gravel development".

He stated "buyers * * * [were] more '

interested in crop production,

than gravel."

ater, soils, and location rather

Mr. Cruikshank p epared a rebuttal report in which

he stated he could not find any gravel-motivated sales for

parcels of 160 acres or less.

"The area in which the Su ject Properties are located is

generally known as the Lower Ar ansas Valley.

Petitioners' Expert--Robert B. Frahme

Mr. Frahme's professional life has spanned 42 years .and

includes geological and appraisal work.

He is a certified

general appraiser in Colorado, a certified professional geologist

according to the American Institute of Professional Geologists,

and a certified mineral appraiser according to the American

Institute of Mineral Appraisers.

He is a member of the Appraisal

Institute with MAI designation and is a member of the Society for

Mining, Metallurgy, and Exploration."

Mr. Frahme has been an

expert witness before in both Federal and State courts.

Mr. Frahme opined that "The ultimate highest and best use"

of the Subject Properties was gravel mining but did not reach

"any conclusion of value".

Mr. Frahme's conclusion was

conditioned on (1) the three properties' being assembled and (2)

deferral of gravel mining to allow time for gravel markets to

mature.

Assemblage was necessary because otherwise it would be

difficult to mine the Esgar and Holmes Properties and "nearly

impossible" to mine the Tempel property.

An adequate deferral

period was necessary "because gravel markets are generally in

equilibrium".

According to Mr. Frahme, demand in Prowers County

"The MAI designation is held by appraisers who are

experienced in the valuation and evaluation of commercial,

industrial, residential, and other types of properties and who

advise clients on real estate investment decisions.

would increase when demand in t e Front

ange Corridor increased

"given the available rail trans ort".

Mr. Frahme's theory was th t gravel could be backhauled to

the Front Range on trains bring ng coal to a coal-fired power

generation plant being built in the vicinity of the Subject

Properties."

Mr. Frahme determ ned rail transport to the Front

Range was possible "By looking

t a railroad map"; however, he

did not consult or talk with an1 railroad employees.

He also did

not consult coal companies to see whether they would consider

backhauling gravel on coal trair.s.

Mr. Frahme failed to analyde supply.

gravel mines closer to the Fron

He never considered

Range than Prowers County or

whether the existing Prowers Co nty mines could handle any

potential increase in demand.

r. Frahme also never opined as to

when demand would mature, despi e his conclusion's resting on an

adequate deferral period to all w for this to happen.

concluded that "In a pessimisti

case"

He simply

(use of a higher discount

rate), the highest and best use ceases to be mining after 14 to

15 years and in an "optimistic

ase"

(use of a lower discount

Mr. Frahme's report inclu ed a list of highway projects,

including the "Ports to.Plains forridor", a proposed highway

route to run from the Texas/Mexico border to Denver, and

potential wind power and gas de elopments projects. The report

seemingly indicated that he tho ght these projects might also

cause an increased demand for a gregate in Prowers County

although there is no indication as to when demand would increase

and by how much.

- 26 -

rate), the highest and best use ceases to be mining after 23 to

25 years.

Petitioners' Expert--Gerald K. Ebanks

Mr. Ebanks has been a geologist since 1985.

He is a

Certified Petroleum Geologist and a member of the American

Association of Petroleum Geologists.

He has previously testified

as an expert in both this Court and U.S. District Courts.

He was

hired to give an opinion on the FMV of the Subject Properties.

According to Mr. Ebanks, gravel resources have intrinsic

value and one need only multiply the quantity by the current

market price to determine FMV.

Mr. Ebanks was unaware that the

before highest and best use of the Subject Properties was even at

1ssue.

Using DCF analysis, Mr. Ebanks calculated the before value

of the Subject Properties as gravel-producing properties instwo

scenarios:

.(1) As three individual gravel-producing properties

and (2) as an assembled gravel-producing property.

He concluded

the following tons of aggregate were minable from each of the

Subject Properties:"

"The amount of gravel that can be mined from a property

depends in part on setbacks and pit walls.

Setbacks are strips

of unmined land between pit walls and property lines, and they

can vary in size. Mr. Ebanks determined the setback and pit wall

steepness on the basis of conversations with Prowers County

gravel operators and by observing Prowers County mining methods,

concluding. a 50-foot setback and 70-degree pit wall were

appropriate.

In a reduced setback scenario, i.e., the Subject

(continued...)

Property

Individual Operation

Assembled Operation

Esgar

1,71 ,235

1,845,537

Holmes

2,49 ,324

2,797,195

Tempel

2,35 ,425

2,968,388

Total

6,566,984

7,611,120

According to Mr. Ebanks, pr duction would begin on May 1,

2005, with the mines operating a

full production by June.

Mr.

Ebanks concluded that approximat ly 10,000 tons of aggregate per

month could be extracted from ea h property during the startup

phase and 41,000 tons of aggrega e per month from each property

in full production.

Mr. Ebanks

sed an effective combined,

blended royalty rate of 43.58 ce ts per ton on the basis of the

figures in the E. Colorado Aggre ates lease and a discount rate

of 9.10 percent."

On the basis of the analysi

described above, Mr. Ebanks

determined the before value of the Subject Properties by

discounting the anticipated roya ty cashflow stream that could be

realized from the operation of a gravel mining operation(s).

His

conclusions were:

(...continued)

Properties were assembled, no se back would be necessary on one

side of the Esgar and Holmes Pro erties and on two sides of the

Tempel property.

"Mr. Ebanks combined the ro alty rates in the E. Colorado

Aggregates lease of 45 cents per ton of rock anticipated to be

sold and 22.5 cents per ton of s nd anticipated to be sold to get

a effective, combined, blended r yalty rate of 43.58 cents per

ton.

- 28 -

Property

50-Foot Setback

Reduced Setback

Esgar

$625,013

$657,711

Holmes

848,321

930,250

Tempel

812,718

¯972,606

Mr. Ebanks did not consider potential problems such as

finding an operator for the gravel pit(s) and admitted he did not

"know who might potentially quarry these pits".

He did not

perform a supply and demand analysis, nor did he know whether

pit(s) on.the Subject Properties could start up and compete

effectively given the existence of other pits in the area.

Petitioners' Expert--John R. Emmerling

At trial petitioners' expert Mr. Emmerling was admitted as

an expert, but respondent objected to the admissibility of his

report.

We allowed the report into evidence, subject to

respondent's objection, reserving ruling on the objection.

Mr.

Emmerling graduated from the University of Colorado Boulder with

a dual degree in real estate and marketing.

He has worked in

real estate for 37 years, including being involved in over 7,500

appraisals, 10 or 12 of which involved sand and gravel property.

He is a Colorado Certified General Appraiser and is a member of

the Appraisal Institute with MAI designation.

Mr. Emmerling's Report

Mr. Emmerling's report summarized, and in certain situations

corrected, the conclusions of petitioners' other experts.

addition to reviewing the other experts' reports, Mr. Emmerling

reviewed the historic productior. records of gravel in Prowers

County between 2000 and 2008 anc the historic.production records

of gravel on the Midwestern Farms Gravel Pit.

Mr. Emmerling concluded gr vel mining was the highest and

best use of the Subject Propert es.

conclusion was contingent on th

Like Mr. Frahme, his

Subject Properties' being

assembled.and allowing for an a equate deferral period in order

for demand in Prowers County to mature.

Mr. Emmerling agreed with

r. Ebanks that approximately 7.6

million tons would be extracted from the Subject Properties as

assembled.

However, while Mr.

Subject Properties would produc

banks concluded each of the

492,000 tons per year, Mr.

Emmerling concluded all three P operties together would produce a

total of 492,000 tons per year.

Like Mr. Ebanks, Mr. Emmer ing used a discount rate of 9.10

percent and an effective royalt

rate of 43.58 cents per ton.

performed a DCF analysis assuming a deferral of 4, 6, or 10

years.

His DCF analysis was based on

simply a what-if, that on delayed production I disagreed

with Mr. Ebanks from the sËandpoint of from my interviews

and other reports that I r ad, that they were not going to

open this pit and start se ling gravel in 2005, that it

would be delayed. You kno , I reported information on, you

know, two, six, and ten ye rs. There was no specific reason

for that, and I could have done 15 and 25 years and just

from my understanding of t e discounted cash flow, that the

value would have still exc eded the value that was placed on

- 30 -

property as far as the conservation easement as I understand

it today.

Mr. Emmerling concluded the following values in his "whatif" scenarios:

2008

2008 (5percent

growth

rate)

2010

2010 (2.5percent

growth

rate)

2014

Esgar

$535,806

$547,600

$456,134

$481,393

$332,962

Holmes

747,771

772,694

633,165

674,184

458,656

Tempel

783,071

806,646

663,870

707,144

479,435

1,427,909

1,554,540

1,217,589

1,367,641

892,441

Property

Assembled

Mr . Emmerling did not analyze supply or opine as to when

demand would mature although he did state realization of income

from sand and gravel production as a revenue source "will not be

experienced in the near-term".

Evidentiary Objection

An expert' s opinions are admissible if they assist the trier

of fact to understand the evidence or to determine a fact in

issue.

147, 168

Fed. R. Evid. 702; ASAT, Inc. v. Commissioner, 108 T.C.

(1997) .

Whether Mr. Emmerling's report and testimony

will be received in evidence and considered in determining the

FMV of the easements depends on the application of principles

expressed in Daubert v. Merrell Dow Pharms., Inc., 509 U.S. 579,

591

(1993), as related to rules 702 and 703 of the Federal Rules

of Evidence .

- 31 Rule 702 of the Federal Rules of Evidence provides that a

qualified expert may testify.

If scientific, technical, or other specialized knowledge

will assist the trier of f ct to understand the evidence or

to determine a fact in iss e, a witness qualified as an

expert by knowledge, skill experience, training, or

education, may testify the eto in the form of an opinion or

otherwise, if (1) the testimony is based upon sufficient

facts or data, (2) the testimony is the product of reliable

principles and methods, anc (3) the witness has applied the

principles and methods reliably to the facts of the case.

In Kumho Tire Co. v. Carmichael,

526 U.S.

137,

148

(1999),

the Supreme Court applied the same standard to expert testimony

that was not "scientific".. The Supreme Court has stressed the

trial court's "gatekeeper" function in excluding evidence that is

not reliable.

597.

Daubert v. Merrell Dow Pharms., Inc., supra at

"The trial court retains

road discretion in assessing an

expert's reliability and making its ultimate determination of

reliability."

Attorney Gen. of Okla. v. Tyson Foods, Inc., 565

F.3d 769,

(10th Cir. 2009).

779

Although special considerations apply to jury trials, the

Daubert analysis is not limited to jury trials.

See id.

("while

Daubert's standards must still be met, the usual concerns

regarding unreliable expert testimony reaching a jury obviously

do not arise when a * * * court is conducting a bench trial); see

also Seaboard Lumber Co. v. UniËed States, 308 F.3d 1283, 1302

(Fed. Cir.

2002).

- 32 -

Respondent argues that Mr. Emmerling's report was

"Essentially * * * based on the opinions and analysis of

Cruikshank, Frahme, and Ebanks, not on independent data and

information".

Respondent asserts Mr. Emmerling "performed no

independent analysis" and that his."reports are not based on a

reliable foundation."

Petitioners argue that "Mr. Emmerling used a generally

accepted methodology, and applied.it in a very straightforward

manner.

His testimony and. report will assist the Court in.

determining the value of the Petitioners' charitable contribution

deduction.". We agree with petitioners and will admit Mr.

Emmerling's report.

See Kumho Tire Co. v. Carmichael, supra at

152 (a "trial judge must have considerable leeway in deciding in

a particular case how to go about determining whether particular

expert testimony is reliable").

We will accord it, however, only

as much credence, if any, as we conclude it deserves after our

analysis of the entire case record.

Respondent's Expert--Kevin McCarty

Mr. McCarty is a real estate appraiser who has appraised

approximately 50 gravel properties and 150 conservation

easements.

He is designated a Certified General Appraiser in

Colorado and in Wyoming.

Mr. McCarty determined that the before highest and best use

of the Subject Properties was agriculture.

He determined mining

was not the most productive use because there was an adequate

supply 'of and no additional dema d for gravel in Prowers County

in the foreseeable future.

He c ncluded:,

"The dominance by the

two major gravel operators leavea little room available either

for expansion by these operators or the entrance of a new

operator".

He estimated that the Midwestern Farms Pit itself had

35 years worth of gravel remaining and the other three large pits

had between 25 and 75 years wort

of gravel remaining.

Mr. McCarty relied on a sal s comparison analysis to

determine the before value of the Subject Properties."

Mr.

McCarty analyzed 22 sales, all within the Arkansas River

bottomland, with sale prices for the land itself (excluding

improvements and water rights) ranging between $155 and $1,813 ·

per acre.

He adjusted the price of each sale to account for

differences in location, size, access, quality of underlying

gravel resources, and timing, and then classified each sale as a

good, fair, poor, or weak comparison to the Subject Properties.

"Mr. McCarty analyzed the Holmes property differently from

the Esgar and Tempel Properties

He calculated the value of the

Holmes property using the contiguous parcel rule because the

Holmes property was adjacent to the Midwestern Farms property and

in the mineral rights in the Jensen property. See sec. 1.170A14 (h) (3) (i), Income Tax Regs.

owever, he fòund that the value

of the Holmeses' interest in th Midwestern Farms property and in

the mineral rights in the Jenseu property did not change as a

result of the donation of the Holmes conservation easement and

therefore this had no effect on value. Mr. McCarty also

differentiated the Holmes property from the Esgar and Tempel

Properties on the grounds that..t had legal,access and was next

to an operating gravel pit, the Midwestern Farms Gravel Pit.

- 34 -

Mr. McCarty determined 3 of the 22 sales--sales 4, 11, and

17--offered "Good" comparisons to the Holmes property."

Using

these comparisons, Mr. McCarty determined that a reasonable land

value was $400 per acre (54.35 x 400 = $21,740, which Mr. McCarty

rounded up to $22,000 total)."

He then determined the BMIC water

shares were worth $1,200 per share (11.66 x $1,200 = $13,992,

which Mr.. McCarty rounded up.to $14,000 total).

In total, Mr.

McCarty determined the before value of the Holmes property was

$36,000.

Mr. McCarty determined 8 of the 22 sales--sales 3, 5,

6, 7,

8, 11, 13, and 16--offered a "Fair" comparison to the Esgar and

Tempel Properties.

These eight sales were of properties adjacent

to the Arkansas River that were close to the Esgar and Tempel

Properties; six occurred within 2 years of the valuation date,

and many had mineral reserves underlying the properties.

After

adjusting for water rights, the sale prices of the underlying

land of the eight properties ranged from $160 per acre to $473

per acre.

Using these comparisons, Mr. McCarty determined that a

reasonable land value was $350 per acre (54.34 x 350 = $19,019,

which Mr. McCarty rounded down to $19,000 total).

As with the

"Sale 4--2,692 acres were sold for $430,700 or $160 per

acre. No water rights or improvements were involved. See infra

pt. V.C.1. for a description of sales 11 and 17.

"We note that on page 117 of Mr. McCarty's report for the

Holmes property he mistakenly states a value of $350 per acre for

the Holmes property.

- 15 -

Holmes property before value, he determined that the BMIC water

shares were worth $14,000.

In t tal, Mr. McCarty"determined the

before value of the Esgar and Te pel Properties was $33,000.

IV.

Subsidiary Issues

Before addressing the parti s' arguments as to the before

highest and best use and FMV of

he Subject Properties, we shall

address three subsidiary issues.

Contiguous Parcel Rule

Respondent used the contiguous parcel rule of section

1.170A-14 (h) (3) (i),

Income Tax R3gs.,

conservation easement.

See supr

use of the contiguous parcel rul

assert it was not.

to value the Holmes

note 18.

Respondent urges that

was appropriate; -petitioners

Section 1.17 A-14 (h) (3) (i), Income Tax Regs.,

provides in part:

The amount of the deduction in the case of a charitable

contribution of a perpetual conservation restriction

covering a portion of the contiguous property owned by a

donor and the donor's familk as defined in section 267(c) (4)

is the difference between the fair market value of the

entire contiguous parcel of property before and after the

granting of the restriction.

If the granting of a perpetual

conservation restriction af;er January 14, 1986, has the

effect of increasing the vaLue of any other property owned

by the donor or a related p3rson, the amount of the

deduction for the conservation contribution shall be reduced

by the amount of the increase in the value of the other

property, whether or not su h property is contiguous. * * *

For purposes of this paragr ph (h) (3) (i), related person

shall have the same meaning as in either section 267(b) or

section 707(b). * * *

Respondent views the Holmeses' interest in the Midwestern

Farms property and in the mineral rights of the Jensen property

- 36 -

as being contiguous to the Holmes property, which is across a

county road.

continuity;

Petitioners contend (1) the county road breaks the

(2) because the Holmeses owned only a 25-percent

interest in the Midwestern Farms property and in the mineral

rights of the Jensen.property, there was no familial crossownership; and (3) the contiguous parcel regulation is invalid.

We do not decide whether respondent's use of the contiguous

parcel rule was appropriate or whether the regulation proffering

the rule is invalid because we agree with respondent that the

issue is moot."

Mr. McCarty determined that the Holmeses'

interest in the Midwestern Farms property and in the mineral

rights of the Jensen property did not change because of the

donation of the Holmes conservation easement.

Therefore, use of

the contiguous parcel rule did not affect respondent's value. of

the Holmeses' charitable contribution deduction ln any way.

In his report, Mr. McCarty, using the contiguous parcel

rule, concluded the before value of the 1,281 acres he treated

for this purpose as the Holmes property was $460,000 and the

after value of the same property, which included the 54.35 acres

subject to the conservation easement, was $451,000.

Respondent

has since conceded the after value of the Holmes property was

$27,000. We note respondent's concession to a $27,000 after

value and his argument that the use of the contiguous parcel was

correct are seemingly in conflict with each other. We also note

that since the trial and filing of the briefs in this case, Natl.

Muffler Dealers Association, Inc. v. United States, 440 U.S. 472

(1979), on which petitioners in part rely, has been supplanted by

Mayo Found. for Med. Educ. & Research v. United States, 562 U.S.

__, 138 S. Ct. 704 (2011), which grants substantial deference to

the regulation in this context.

Access Easement

The Federal Land Bank of Wi hita (FLBW) obtained a Deed of

Trust on the Subject Properties

rom the prior owners, Gene and

Darla Hammit (the Hammits) on De ember 4, 1978.

granted an access easement over

The Hammits

he Subject Properties to Holly

Flood Control, Drainage and Sani ation District on November 30,

1979.

The Hammits' Deed of Trus

was foreclosed by FLBW, which

obtained title via a Public Trustee's Deed on June 14, 1985.

FLBW sold the property to petitioners on February 20, 1987.

According to petitioners, M . McCarty placed "great weight ·

(and assigned significant negative value)" to the potential

access easement .

They assert that under Colorado law, the access

easement was voided as a junior Lien in the foreclosure and that

Mr. McCarty "blindly and unprofe sionally based his· conclusion of

value on an incorrect assumption .

Respondent counters that

while Mr. McCarty considered the access easement as a potential

limit on the use of the properties for'gravel mining, he "did not

determine * * * [the issue alone

was sufficient to preclude or

establish that the highest and b st use * *-* was gravel mining".

Colorado law provides that

a purchaser of property at a foreclosure sale obtains a deed

to the property after the redemption period expires and that

"upon the issuance and deli tery of such deed . . . title

shall vest in the grantee and such title shall be free and

clear of all liens and encu brances recorded or filed

subsequent to the recordin or filing of the lien on which

the sale * * * was±based."

- 38 -

First Interstate Bank v. Tanktech, Inc., 864 P.2d 116, 119 (Colo.

1993)

(quoting Colo. Rev. Stat.

Colo. Rev. Stat. sec. 38-38-501

sec. 38-39-110

(2010).

(1982)); see also

On the basis of this

case and the statute, we agree with petitioners that the

foreclosure sale extinguished the access easement.

We recognize that there is always a potential for litigation

to clear title.

However, we do not think that a potential buyer

of the Subject Properties would have placed emphasis on this

possibility.. There is no evidence that the Holly Flood Control,

Drainage and Sanitation District ever argued that the easement

survived the 1985 foreclosure.

As of 2004 it had been

approximately 19 years since the foreclosure sale extinguished

the access easement.

The easement was extinguished by a statute

whose "plain intent * * * is to extinguish all subordinate liens

upon foreclosure" and has a purpose which "is to allow a

transferee to rely on the state of record title."

First

Interstate Bank v. Tanktech,

Therefore, we

Inc., supra at 119.

conclude that the access easement had no effect on the before

value of the Subject Properties.

Mineral Rights Reservation

The Corporation Special Warranty Deeds issued to petitioners

by FLBW on February 20, 1987, when petitioners purchased the

Subject Properties, reserved to the seller "all of the minerals

and mineral rights it owned prior to January 23, 1982".

On April

14, 1989, the District Court of

rowers County, Colorado, in an

amended order granting partial summary judgment in an action to

quiet title, held that upon FLBW's foreclosure of the Hammits'

deed of trust, any mineral rights held by the Hammits were

extinguished.

Petitioners argue that the

ction to quiet title disposed of

any rights the Hammits might hav

had to sand and gravel on the

Subject Properties.

hat as for FLBW's potential

They argue

interest, Colorado law states that "gravel and sand are not

normally treated as minerals witain the meaning of a general

reservation of minerals clause."

306 (Colo. App. 2005) .

Kinney v. Keith, 128 P.3d 297,

Respondent, as he did with the access

easement, argues that while he considered the potential mineral

rights reservation, he did not t ink it was "sufficient to

preclude or establish that the h ghest and. best use" was gravel

mln1ng .

We agree with petitioners t1at the 1989 order issued by the

District Court of Prowers County foreclosed any rights the

Hammits' might have retained in ninerals on the Subject

Properties.

As for FLBW, the Corporation Special Warranty Deeds

were issued to petitioners in 1937, and FLBW has never asserted

any rights in minerals on the Subject Properties .

We also agree

that "sand and gravel" are not normally considered minerals.

id.

See

As with the access easement, we recognize there is always a

- 40 -

potential for litigation.

And while there is no evidence of any

minerals beneath the Subject Properties, a buyer would prefer

property without any reservations.

But taking all of this into

consideration, we still conclude that the mineral rights

reservation had no or only an irrelevant, infinitely small effect

on the before value of the Subject Properties.

Analysis

Petitioners argue the before highest and best use of the

Subject Properties was gravel mining.

They urge this Court to

sustain the charitable contributions reported on their respective

2004 tax returns and if we do not sustain those claims, to accept

Mr. Emmerling's 4-year deferral scenario values of $511,806,

$720,711, and $759,071 for the Esgar property, the Holmes

property, and the Tempel property respectively."

Respondent

argues the before highest and best use of the Subject Properties

was agriculture and that, after subtracting the stipulated after

values, all three conservation easements are worth $9,000.

We agree with respondent that the before highest and best

use was agricultural.

We agree with respondent that the water

rights were worth $1,200 per share or $14,000 total for each

"Petitioners urge this Court to accept Mr. Emmerling's

values without addressing the fact that Mr. Emmerling

specifically stated he did not make any conclusions as to value.

These values take into account the stipulated after values

of $24,000 for the Esgar and Tempel properties and $27,000 for

the Holmes property.

property before the conservation easements were granted."

find the Esgar and Tempel Proper ies were' worth $1,100 per acre

(or $59, 774) and the Holmes property was worth $1, 150 per acre

(or $62,502.50) before the conse vation easements were granted.

In total, the before value of the Tempel and Esgar properties was

$73, 774 and the before value of

$76, 502 . 50 .

he Holmes property was

Af ter subtracting t e stipulated af ter FMVs, the

Tempel and Esgar conservatior ea ements were worth $49, 774 and

the Holmes conservation easement was worth $49, 502 . 50 .

Gravel Mining. Was Not the Before Highest and Best Use

In deciding whether gravel

ining was the before highest and

best use, the main question we a e faced with is whether it was

reasonable to conclude that a h

othetical willing buyer in 2004

would have considered the Subjec

Properties as the site for

construction of a gravel mine.

he evidence shows they would

not.

(2011)

See Boltar, L.L.C. v. Comm ssioner,

136 T.C.

326,

339

(finding taxpayer's asser ed highest and best use was

"certainly inconsistent with the * * * evidence in this case") .

Petitioners' argument that grave

mining was the before highest

and best use is, inter alia, con itioned on (1) assemblage of the

three Subject Properties and (2) deferral in production.

address each separately.

Petitioners provided and we are aware of no reason to

question Mr. McCarty's valuatio of the .water rights at $1,200

per share .

- 42 -

Assemblage

Petitioners argue they

have been in business together for decades * * * [and] have

long owned land together and were the first operators of the

Midwestern Farms Gravel Pit * * *. Respondent failed to

acknowledge the ease with which the Petitioners could

assemble their three parcels and begin gravel mining, had

they chosen to do so.

Respondent argues no evidence was presented showing

assemblage was "reasonably practicable in the foreseeable

future".

He further argues the evidence presented contradicts

assemblage's being a reasonable possibility.

We agree with petitioners although we question whether a

willing buyer would have thought assemblage to be that. "easy",

considering the three Subject Properties had once been jointly

owned and were partitioned before the conservation easements were

donated.

While we expect the separation of the properties was

for purposes of claiming Federal charitable contribution

deductions and/or State tax credits, petitioners, who knew

exactly why the properties were separated, never explained to the

Court their reasons.

Regardless, we do not decide whether

assemblage was reasonable because petitioners' argument fails as

to their second required condition, deferral in production.

Deferral in Production

Petitioners and their experts Mr. Frahme and Mr. Emmerling

acknowledge gravel could not have feasibly been extracted from

the Subject Properties in 2004.

Mr. Frahme stated:

"Because

gravel markets are generally in equilibrium, not demanding

additional material, as of * * * [December 2004], considerable

time may be required for the ultLmate highest and best use of

mining to be effective."

But ho

long is a "considerable. time"?

While petitioners did "not have to show an imminent demand for

the [aggregate]

from [their] pro erty", they did have "to show

that * * * [it would] be needed

nd wanted at a near enough point

in the future to affect the curr nt value of the property."

United States v. 69.1 Acres of L nd,

942 F.2d at 294.

In the

absence of a market's being established, any projection of income

becomes little more than specula ion and conjecture.

Sand & Gravel Co.,

(1984)

Inc. v. United States,

6 Cl. Ct.

Cloverport

178,

198-199

(concluding that the exis ence of a market that would

justify extraction in the reason bly foreseeable future must be

shown).

Petitioners assert that "it was reasonable to conclude

that as of 2004, the market for

ggregate in Prowers County was

poised to explode".

According to Mr. Frahme and Mr. Emmerling, demand will

increase and mining will begin w2en (1) demand in the Front Range

increases and (2) gravel can be Jackhauled from Prowers County to

- 44 -

the Front Range."

The evidence does not establish that this was

a possibility in the reasonably foreseeable future.

Increased Demand in the Front Range

There is sufficient evidence that as of 2004, demand in the

Front Range was increasing because of the difficulty in

permitting there.

Yet there is a difference in an increased

demand in the Front Range and an increased demand for aggregate

from Prowers County in the Front Range.

address this.

Petitioners never

Rather, they assume all that must be shown is a

way for gravel to be transported from Prowers County to the Front

Range.

They do not consider gravel mines closer to the Front

"Even though petitioners appear to abandon Mr. Ebanks'

opinion, we briefly address it. Mr. Ebanks fails to recognize

that the establishment of a market is necessary, stating that

gravel resources have intrinsic value and one need only multiply

the quantity by the current market price to determine FMV. Mr.

Ebanks was wrong.

"[L]and having a sand or gravel content may

not be valued on the basis of conjectural future demand for it.

There must be some objective support for the future demand,

including volume and duration." United States v. Whitehurst, 337

F.2d 765, 771-772 (4th Cir. 1964); see also United States v. 69.1

Acres of Land,

942 F.2d 290,

294

(4th Cir.

1991)

(stating that

the taxpayer "has to shdw that there is a reasonable probability

that the sand will be needed and wanted at a near enough point in

the future to affect the current value of property").

Mr. Ebanks assumed production could start immediately after

a 5-month permitting process and that each of the Subject

Properties would produce 10,000 tons per month during a 2-month

startup phase and 41,000 tons per month (or 492,000 tons per

year) once full production was reached in June 2005. Not only

did Mr. Ebanks never address a market; he never explained how the

Subject Properties could produce and sell 1,011,000 tons of

gravel in 2005 and 1,476,000 tons of gravel in 2006 when all

Prowers County gravel pits together produced only 1,450,000 tons

of gravel in 2005.

- 45 -

Range or contradict the statemen; of respondent's rebuttal

expert, Paul T. Banks, Jr.:

even if such rail haul is viable at some point.in the

future there are several lacge, permitted sand and

gravel mines, with very high volumes of remaining

reserves, located adjacent :o [the same rail line going

through Prowers County], in Pueblo County, perhaps 70

or 80 miles closer to the F ont Range.

If rail haul to

the Front Range becomes via le, there are large

permitted sites in Cheyenne Wyoming and near Canon

City, Colorado that have ex sting rail infrastructure

to transport sand and grave products.

In his report, Mr. Frahme a knowledged that the closer to

the Front Range, the better the

uality of aggregate reserves.

His argument for an increased de and in Prowers County relied on

the difficulty in permitting in

he Front Range and the fact that

Prowers County reserves were bet er than those even further away.

While we do not necessarily disagree with Mr. Frahme's

statements, we question why he d d not address reserves adjacent

to the BNSF rail line closer to

County.

he Front Range than Prowers

In conclusion, the reco d contalns no evidence that

mines closer to the Front Range

han those in Prowers County were

not satisfying and could not con inue to satisfy the increasing

Front Range demand.

A related problem with an increased demand for Prowers

County aggregate in the Front Range is that even if demand in

Prowers County did increase, there is no evidence that the

existing Prowers County mines could not handle the increased

demand.

Mr. McCarty estimated t at 39,060,000 tons of aggregate

- 46 -

remained in the four pits, with 23,660,000 tons in the Midwestern

Farms Pit itself."

Petitioners disagree with Mr. McCarty,

stating respondent speculates "as to the amount of gravel

existing in Prowers County.

the market".

Respondent's data does not address

Neither petitioners nor their experts provided us with an

estimate of remaln1ng aggregate.

Petitioners own the land on

which the Midwestern Farms Pit is situated and chose not to

provide information on the amount of aggregate remaining.

Their

failure to introduce evidence "which, if true, would be favorable

to * * * [them], gives rise to the presumption that if produced

it would be unfavorable."

See Wichita Terminal Elevator Co. v.

Commissioner,

1165

6 T.C.

1158,

(1946), affd.

162 F.2d 513

(10th

Cir. 1947).

Additionally, petitioners' experts Mr. Ebanks (and Mr.

Emmerling) calculated that there was approximately 7.6 million

"The Midwestern Farms Gravel Pit had average production

from 2001-04 of 676,000 tons per year. Mr. McCarty estimated

that on the basis of this production, the Midwestern Farms Gravel

Pit had a life of 35 years; 676,000 x 35 = 23,660,000.

The S-C

Pit produced on average 203,000 tons per year from 2001-04; and

on the basis of this, Mr. McCarty estimated it had a life of 50

years (for an estimated total production of 10,150,000 tons).

The J-S Farms Pit produced on average 63,000 tons per year from

2001-04; and on the basis of this, Mr. McCarty estimated it had a

life of 25 years (for an estimated total production of 1,575,000

tons). The Hardscrabble Pit produced on average 49,000 tons per

year from 2001-04; and on the basis of this, Mr. McCarty

estimated it had a life of 75 years (for an estimated total

production of 3,675,000 tons); 23,660,000 + 10,150,000 +

1,575,000 + 3,675,000 = 39,060,000.

tons of mineable aggregate on the Subject Properties, a number

which is not in dispute."

If there was over 7 million ·tons of

estimated aggregate beneath approximately.160 acres, we find it

incredible that petitioners are disputing the statement that over

24 million tons lie beneath more than 1,400 acres.

The

Midwestern Farms Pit has been in operation since the 1990s, and

in its busiest year only 1 milli n tons of aggregate was mined.

Other than petitioners' unsuppor ed statements, the record

contains no evidence that this pit alone, the largest in Prowers

County, does not have enough sup ly to satisfy an increased

demand.

Backhauling Gravel From Prowers County

Petitioners argue coal trai2s traveling to Prowers County on

the BNSF railroad could backhaul gravel to the Front Range on

their return trips.

We address 2hree problems with this logic.

(1)

UnLoading Facility

An unloading facility in th

Front Range ls necessary.

Michael Ray, BNSF Railroad's manager of economic development for

Colorado and Wyoming, testified chere was no facility in the

Front Range capable of unloading aggregate, although Front Range

Aggregates has land where they h ve proposed building an

"Mr. Frahme acknowledged t2at "A supply analysis must be

conducted in order to accuratelv assess the level of competition

expected as an aggregate producer new to the market area. * * *

There were four quarries that.would have been able to serve the

Holly market area -competitively'. Yet he still did not analyze

supply.

- 48 -

unloading facility."

While Mr. Banks stated there were unloading

facilities immediately north of Denver in Commerce City and

perhaps a still active facility east of Denver in Aurora, there

is no evidence on which rail line these unloading facilities. were

situated or whether these facilities still existed in 2004.

(2)

Willing Coal Company

Backhauling gravel requires a willing coal company.

Petitioners rely on coal trains going to (1) the Lamar Power

Plant and (2) the Tri-State Generation Plant.

Mr. Ray testified

that coal trains carrying coal to the Lamar Power Plant and

returning through Denver empty provided an opportunity for

backhauling.

However, the Lamar Power Plant did not begin

burning coal until 2007 or 2008.

According to unsupported

testimony at trial, Tri-State Generation (Tri-State) began

exploring the construction of an electric power generation plant

in the Lower Arkansas Valley in 2001 and authorized the

acquisition of land in 2005. - However, whether Tri-State's

proposed plant would be run on nuclear, coal, or natural gas had

not been.determined even_as recently as 2009, when this case was

tried.

"If the unloading facility is built, Front Range Aggregates

will bear the construction costs.

Petitioners fail to address

how this would affect royalty prices.

(3)

Trains

There are differences betwe n gravel and coal trains.

Mr.

Ray credibly explained that gravel is normally shipped on 90-car

steel open-top gondola trains, while coal is typically shipped on

120-car aluminum open-top hopper trains.

Gravel and coal should

not be commingled; thus the rail cars need to be cleaned between

each load.

The record contains

o evidence as to the time and

cost of this cleaning process."

(4)

Conclusion and Testimony

Testimony at trial establishes that backhauling gravel from

Prowers County to the Front.Range was not a reasonably

foreseeable possibility in 2004.

Ira Paulin, the former owner of

the Carder Company, explained that the Carder Company did not

ship its aggregate by rail because it was not feasible."

"An additional problem is ilhat coal trains typically

average 6 days per round trip oË 60 cycles per year. Backhauling

gravel adds approximately 3 dayL to the trip, allowing the train

to make only 40 cycles per year.

We acknowledge that the cotl train currently bringing coal

to the Lamar Power Plant only mckes two trips per month.

However, this is considered highly unusual, and there is no

evidence as to how long this prLctice will continue.

And if

backhauling on these trains is feasible, we question why it was

not being done as of the time of trial.

"Petitioners, citing Mr. iPaulin's testimony, argue that

"Carder, Inc. did not consider rail-hauling because they sold all

rock and gravel they could prodtce and carried no excess

inventory." Petitioners misconctrue Mr. Paulin's testimony. Mr.

Paulin testified that during his time at Carder Company,

approximately half of what was .roduced was backhauled on semitractor trucks that had brought corn into the Lower Arkansas

Valley from Nebraska. He did t stify that "there were times that

(continued...)

- 50 -

Petitioners ignore the Carder Company and rely on the fact that

the Midwestern Farms Pit had shipped gravel before.

This Court

wonders why the Midwestern Farms Pit had ceased shipping gravel

at the time the easements were donated. .Petitioners, as partowners of the Midwestern Farms Pit, could have provided the

evidence to answer this question, yet did not do so.

Conclusion on Highest and Best Use

The before highest and best use of the Subject Properties

was agriculture.

The evidence does not support petitioners'

argument that it was aggregate mining.

While it would have been

physically possible to mine the properties in 2004 (or in the

future)', there was no unfilled demand and there was no unmet

market.

The record contains no evidence to support petitioners'.

assertion that this was to change in the reasonably foreseeable

future.

Olson v. United States, 292 U.S. at 257; United States

v. Whitehurst,

337 F.2d at 771-772.

Having·established the

before highest and best use, we turn to the before value.

*.* * [Carder Company] could have sold more if we could have

produced more", yet when asked when this occurred he stated:

"when the road building was really going good, well, it was

probably a good number of the years in the '80s and early '90s."

While the current owner of the.Carder Company, Ron Peterson, also

testified there were times when the Carder Company carried little

inventory, we give his testimony less weight because it is selfserving as he has placed conservation easements on land he owned

and can potentially benefit from a high valuation.in this case.

Additionally, Mr. Paulin testified that landowners were willing

to lease their land to Carder Company, indicating that. if Carder

Company wanted to extract more gravel, they could have done so.

1 -

Before Value

The comparable sales approa h is generally the most reliable

indicator of value when there is sufficient information about

sales of properties similar to t e subject property.

of Spruill v. Commissioner,

88 T.C.

Estate of Rabe v. Commissioner,

1197,

1229 n.24

See Estate

(1987);

.C. Memo. 1975-26, affd. without

published opinion 566 F.2d 1183 (9th Cir. 1977) .

The comparable

sales approach is based on the p inciple that the prudent

purchaser would pay no more for a property than the cost of

acquiring an existing property with the same utility.

Commissioner, T.C. Memo. 2009-94.

Hughes v.

"Real property may be unique

and the comparable sales too few to establish a conclusive market

price,

'but that does not put ou

scattered sales may have on wha

of hand the bearing which the

an ordinary purchaser would have

paid for the claimant's propert .'"

United States v. Whitehurst,

supra at 775 (quoting United States v. Toronto, Hamilton &

Buffalo Nav. Co.,

338 U.S.

396,

(1949)) .

Comparable sales

require this Court to determine

hether the properties were

sufficiently comparable to the

operty being valued and whether

the buyer and seller were both

formed regarding all of the

factors relevant to the land's

lue.

Commissioner, T.C. Memo. 2007-218.

Terrene Invs., Ltd. v.

- 52 -

Petitioners argue there were no comparable sales.

disagree."

Mr. Cruikshank was the only one of petitioners'

experts who looked at potential comparable sales, opining that as

of 2004 "in dealing with farmland buyers and investors, gravel

has not been a primary consideration and only seems to be an

afterthought if considered at all".

Mr. Cruikshank's testimony

and report reinforces our conclusion that no separate market

existed for gravel properties in 2004.

Gravel was not a "primary

consideration" because there was no separate market.

Two Sales

Two of the sales provided by Mr. McCarty--sale 11 (GP

Ranches property) and 13 (City Farm property), were instrumental

both in our conclusion as to the before value and our conclusion

supra part V.A. that gravel mining was not the highest and best

use.

Petitioners argue that DCF analysis is the only proper

method to use in valuing gravel properties, citing Cloverport

Sand & Gravel Co. v. United States,

6 Cl. Ct.

178

(1984),

and

Terrene Invs., Ltd. v. Commissioner, T.C. Memo. 2007-218, as

their support.

In Cloverport Sand & Gravel Co. v. United States,

supra at 194, the Claims Court stated:

"Because the plaintiff's

property is an income producing property capable of producing a

stream of income derived from what both parties concede is the

property's highest and best use, the income capitalization

approach is a preferable valuation method." Mr. Ebanks was an

expert in Terrene, where DCF analysis was also used. Petitioners

state "Ebanks report in this matter cases follows the methodology

accepted and utilized in the Terrene case, subject to minor

adjustments as recommended by the Court in the Terrene memorandum

opinion".

Petitioners fail to recognize that in both Cloverport

Sand & Gravel Co. and Terrene, highest and best use had already

been established and the DCF analysis reflected that use.

3 -

Sale 11--GP Ranches Property

The 2, 398 acre GP Ranches p operty was bought by GP Ranches,

LLC (GP Ranches), in July 2004 a ong with 3,108 shares of Lamar

Canal water rights for $.2,008,00 .

After subtracting the value

of the water rights, $411 per ac e was attributable to the land

and underlying .gravel.

This property borders the A kansas River, Highway 50, and

the BNSF railroad.

Importantly, the GP Ranches property was core

"At trial Mr. Nyquist, one of the owners of GP Ranches,

testified that the GP Ranches p operty was sold for $2,050,000.

A memorandum was prepared y one of the partners in GP

Ranches before the GP Ranches property was purchased. The

memorandum opens with the statenent that the property has

"several potential profit cente s including traditional

agricultural, recreational hunt .ng, water rights, real estate

development. and conservation ea ements all in one property" . The

memorandum goes on to state:

We anticipate that easemen s will generate cash flow through

out holding period * * *. There has been a recent flurry of

conservation easements in his area that have been placed on

properties protecting them from gravel mining. The

appraisals that have been one placed the value of the

gravel between $14, 000 and $18, 000 per acre * * *. Using

the lower end of the established appraised range per acre at

$14, 000 and subtracting ou; the residual land value of

$1, 000 per acre yields a net $13, 000 per acre value that can

be placed on a conservation easements.

The memorandum lays out the value of the State tax credits and

Federal charitable contribution deductions available to those who

donate conservation easements . This memorandum convinces us that

purchasers of property in 2004 did not anticipate a heightened

demand for gravel anytime in th near future even though

properties such as the GP Ranch s property were "known for * * *

[their] gravel reserves", but r ther placed value on other

attributes such as water rights associated with properties or the

ability to place conservation e sements on property.

- 54 -

sampled before it was bought with significant gravel resources

found beneath the property.

permitted for mining in 2009.

A portion of the property was

We find this property comparable

to the Subject Properties, with the major difference being the

size.

The Subject Properties were a combined 163 acres whereas

the GP Ranches property was 2,398 acres..

Petitioners ignore the 2004 sale of the GP Ranches property.

Instead they place value on (1) Mr. Peterson's, the current owner

of the Carder Company, testimony that in 2008, he offered to mine

the GP Ranches property and (2) Karl Nyquist's, one of GP

Ranches' owners, testimony that as of the date of trial, a

portion of GP Ranches was under a contract to sell for $10,000

per acre, 40 percent being attributable to gravel and 60 percent

to water storage.

Mr. Nyquist further testified, as of trial, GP

Ranches was in final negotiations with Front Range Aggregates

regarding mining the permitted portion.

Mining would begin

sometime in 2010 and once mining began, the gravel would be

transported away from Prowers County via rail.

None of the

above-mentioned contracts were provided to this Court.

Even if

they are as advertised, we are valuing the Subject Properties as

of 2004--and as of 2004, a future demand for gravel was not

affecting market prices.

Sale 13--City Farm Property

The 1,875 acre City Farm property was bought by Mr. Peterson

in December 2004 along with 666 shares of water rights for

$776,000.

After subtracting the value of the water rights, $160

per acre was attributable to the land and underlying gravel

reserves.

The City Farm propert

is adjacent to a'railroad, the

Arkansas River, and the Hardscra ble Pit.

Mr. Peterson testified

he bought the property for agric ltural use and did not core

sample the property before purch se.

Portions of this property

have since been placed in conservation easements.

Like the GP Ranches propert , we find this sale comparable,

with the main difference being t2e size.

We acknowledge that the

seller, the City of Lamar, and t2e buyer, Mr. Peterson, may not

have had actual knowledge of the quantity and quality of gravel

underneath this property.

While petitioners emphasize that none

of Mr. McCarty's comparisons are truly comparable because none

were between "knowledgeable parties", we find this disingenuous.

Mr. Peterson is a gravel pit operator, and governmental entities

generally operate gravel pits.

transactions are presumed to hav

Further,

"parties to such

taken into consideration all

the elements of value to be attributed to the land."

States v. 494.10 Acres of Land,

592 F.2d at 1132.

United

But see

Terrene Inys., Ltd. v. Commissio er, supra (ignoring two sales

because the property was sold before either party knew there was

sand and gravel beneath the property)."

We also looked at sale 17, where the 3,360 acre Butte

Creek property was purchased.as part of a distressed sale in July

2006 along with 1,440 shares of water rights for $1,925,000. The

(continued...)

- 56 -

Large Acreage

Petitioners do not address how the amount of acreage affects

property values, but Mr. McCarty states:

to decrease with increasing size."

Commissioner,

799 F.2d 243,

246

"Per-acre values.. tend