Editor: Mark G. Cook, CPA, CGMA
The IRS has heavily scrutinized syndicated conservation easements and has listed them as abusive tax-avoidance transactions since 2016. Promoters of these transactions typically inflate the appraisal value of the conservation easement and find investors to syndicate the ownership interests in the real property through partnerships. Investors are willing to participate in these partnership structures to claim their share of a large charitable contribution deduction when the partnership donates the conservation easement to a land trust or other qualified not-for-profit organization. The IRS has increased enforcement of these abusive transactions over the years, and many Tax Court cases focused on this issue are pending. On June 25, 2020, the IRS announced time-limited settlement offers, requiring tax benefit concessions and assessing penalties, to eligible taxpayers with pending cases.
Qualified conservation contribution: Sec. 170(h)
Taxpayers can obtain federal tax benefits while protecting land or preserving historic landmarks by donating conservation easements on property they own. A charitable deduction generally is not allowed for contributions of partial interests in properties. However, an exception is made for qualified conservation contributions, per Sec. 170(f)(3)(B)(iii). If the donation of a conservation easement meets the requirements to be a qualified conservation contribution, the taxpayer can take a charitable deduction for the donation.
Under Sec. 170(h)(1), a qualified conservation contribution must be a contribution of a qualified real property interest to a qualified organization, exclusively for conservation purposes. A qualified real property interest can be the entire interest of the property, a remainder interest, or a perpetual restriction on the property's use, such as an easement (Sec. 170(h)(2)). The contribution must have been made for conservation purposes, which are defined in Sec. 170(h)(4)(A) as:
- The preservation of land areas for outdoor recreation by, or the education of, the general public;
- The protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem;
- The preservation of open spaces (including farmland and forest land), where such preservation is for the scenic enjoyment of the general public or will yield a significant public benefit pursuant to a clearly delineated federal, state, or local governmental conservation policy; or
- The preservation of a historically important land area or a certified historic structure.
Regs. Sec. 1.170A-14(d) goes into further detail of specific factors and illustrations of these conservation purposes.
Most importantly, the conservation purpose must be protected in perpetuity for it to meet the "exclusively for" conservation purpose requirement (Sec. 170(h)(5)(A)). As such, the donee qualified organization must commit to protecting the conservation purposes and have the resources to enforce the restriction, as outlined in Regs. Sec. 1.170A-14. Appropriate agreements and documentation must be provided between the donor and the donee.
Valuing the conservation easement to determine the charitable deduction amount is often a complex and subjective process. The best support for the fair market value (FMV) of a conservation easement is the sales price of a comparable easement (Regs. Sec. 1.170A-14(h)(3)(i)). However, "before and after" is an acceptable alternative method of determining the FMV of an easement in the absence of a substantial record of sales of comparable easements. Under this method, the value of the contribution is the difference between the FMV of property before the easement and the FMV after the easement (Regs. Sec. 1.170A-14(h)(3)(ii)).
History of tax abuse of syndicated conservation easements
As some taxpayers are unable to fully utilize the charitable contribution deduction by themselves, the syndication of conservation easements gained in popularity. By using a partnership structure, the original owner of the property can share and allocate the charitable deduction of the donated conservation easement in exchange for money provided by the other investors. In certain scenarios, investors may receive a tax benefit that exceeds their original investment.
While syndicating the deduction for a qualified conservation easement contribution through a partnership can be legitimate for tax purposes, the IRS has found many of these transactions to be abusive. In many transactions, promoters of these syndicated deals exaggerate the FMVs of conservation easements, leading to claims of excessive charitable deductions by the syndicate investors when the partnership donates the easement. In other cases, no deduction is allowable because the donated easements fail the requirement to preserve the stated conservation purpose in perpetuity or the property is developed after the easement contribution in ways that violate the easement's terms. The transactions also frequently are found to run afoul of the partnership anti-abuse rules and the economic substance doctrine.
Because of continuing abuse by promotors, the IRS issued Notice 2017-10, which identified certain syndicated conservation easements as an abusive listed transaction, effective Dec. 23, 2016. A transaction is listed if promotional materials suggest the charitable contribution deduction equals or exceeds 2½ times the amount invested. Once identified, listed transactions must be properly disclosed per Regs. Sec. 1.6011-4, typically by filing Form 8886, Reportable Transaction Disclosure Statement.
Over the years, the IRS has announced increased enforcement of these transactions. On Sept. 10, 2018, the Large Business and International Division (LB&I) announced syndicated conservation easement transactions as one of five additional compliance campaigns. In March 2019, syndicated conservation easements made the IRS's 2019 Dirty Dozen list of scams to avoid. On Dec. 20, 2019, the IRS highlighted its win a week earlier on a syndicated conservation easement transaction case, when the Tax Court ruled in the IRS's favor in TOT Property Holdings, LLC, No. 5600-17 (12/13/19) (bench opinion). On July 9, 2020, the Tax Court struck down syndicated conservation easement transactions in four cases: Englewood Place, LLC, T.C. Memo. 2020-105; Maple Landing, LLC, T.C. Memo. 2020-104; Riverside Place, LLC, T.C. Memo. 2020-103; and Village at Effingham, T.C. Memo. 2020-102. The IRS has also recently created two offices, the Promoter Investigation Coordinator and the Office of Fraud Enforcement, to help investigate abuse.
Time-limited settlement offer
The IRS Office of Chief Counsel announced on June 25, 2020, that a limited-time settlement was being offered to certain taxpayers with pending litigation on syndicated conservation easement transactions. Eligible taxpayers were notified of the terms by letter. Taxpayers and their advisers are encouraged to review their pending cases and settlement offers, as the IRS believes the settlement offer provides the best option, given their circumstances.
The settlement offer allows taxpayers to resolve pending litigation on standardized terms. Key terms of the settlement include:
- The deduction for the contributed easement is disallowed in full;
- All partners must agree to settle, and the partnership must pay the full amount of tax, penalties, and interest before settlement;
- Investor partners can deduct their cost of acquiring their partnership interests and pay a reduced penalty of 10% to 20%, depending on the ratio of the deduction claimed to the partnership investment; and
- Partners who provided services in connection with any syndicated conservation easement transaction must pay the maximum penalty asserted by the IRS (typically 40%) with no deduction for costs.
The IRS stressed that taxpayers should not expect better outcomes than what was provided in their settlement offer. Based on the tax law and court cases encountered to date, the IRS's determinations have for the most part been sustained by the Tax Court. Those who refuse the settlement should expect the IRS to continue to "vigorously" litigate their cases.
The IRS plans to maintain its aggressive enforcement and its position of disallowing any claimed tax benefit, assessing civil penalties to the fullest, deliberating whether criminal sanctions are appropriate, and pursuing litigation as needed. Before entering a syndicated conservation easement transaction, taxpayers should consult with independent counsel for an unbiased opinion. Although the IRS recognizes the importance of conservation easements as charitable deductions to encourage preservation for future generations, the Service has made clear it will not tolerate abusive syndicated conservation easement transactions.
Mark G. Cook, CPA, CGMA, MBA, is the lead tax partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or email@example.com.
All contributors are members of SingerLewak LLP.