IRS Targets Conservation Easements, Offers New Settlement Initiative
As previously published by Jason B. Freeman in Forbes.
The Internal Revenue Service recently announced a settlement program for many cases pending before the United States Tax Court that involve syndicated conservation easement transactions. The new settlement initiative follows years of IRS scrutiny of the transactions and comes on the heels of several recent IRS court victories.
IRS Focus on Syndicated Conservation Easements
The IRS’s focus on syndicated conservation easements is nothing new. In 2017, the IRS issued Notice 2017-10, classifying certain syndicated conservation easement transactions as “tax avoidance transactions” and “listed transactions.” In 2019, syndicated conservation easements made their mark on the IRS’s “Dirty Dozen” list of tax scams—a clear sign that they have become an IRS priority.
The new settlement initiative is the most recent move by the IRS to combat and deal with the perceived problem. As part of its announcement, IRS Commissioner, Charles Rettig, sent an unequivocal message, indicating that the Service will continue to target conservation easements that it views as abusive: “The IRS will continue to actively identify, audit and litigate these syndicated conservation easement deals as part of its vigorous and relentless effort to combat abusive transactions.” “Ending these abusive schemes remains a top priority for the IRS.”
The IRS has established a cross-divisional team to carry out its enforcement strategy. That strategy is particularly focused on the professionals and organizations associated with the transactions at issue: promoters, return preparers, donee organizations, and appraisers. It has even created two new offices that are actively investigating conservation easement transactions: The Promoter Investigation Coordinator and the Office of Fraud Enforcement. And it has established a policy of asserting stringent penalties, which can include, among others, the following penalties:
Separately, the IRS’s Criminal Investigation division is actively pursuing criminal investigations. And the Service has a backlog of conservation easement cases docketed in the Tax Court, a fact that prompted the perceived need for the new settlement program.
What is a Listed Syndicated Conservation Easement Transaction?
In the listed transactions at issue, promoters syndicate ownership interests in real estate through partnerships. That is, professionals solicit investors in a partnership that generally holds real estate as its primary or only asset. In the process, they typically use promotional materials, suggesting that a prospective investor will share in a conservation easement contribution deduction that equals or exceeds 2.5 times the investment amount. In abusive transactions, the promoter solicits an appraisal that the IRS believes significantly inflates the value of the easement in order to obtain the deduction. Once investors are on board, the partnership donates a conservation easement to a land trust and reports charitable deductions to the investor-partners based on the inflated value of the easement.
There are, of course, two sides to the story. And many have argued that the transactions at issue comply with existing laws and IRS standards. In fact, much of the IRS’s recent litigation successes have come about due to technical defects with deeds granting conservation easements. Regardless, the IRS shows no signs of slowing its focus on the transactions.
Taxpayers who participate in a syndicated conservation easement transaction are required to file a Form 8886, Reportable Transaction Disclosure Statement. This, of course, flags the transaction and the taxpayer’s return. And the IRS has developed a habit of carefully scrutinizing those returns. Reports indicate that more than 80% of top-tier pass-through partnerships connected with syndicated conservation easement transactions have been subject to audit in recent years. That is, by any measure, an exceptionally high audit rate, and implies that more litigation cases are in the pipeline.
The Settlement Structure
As part of its enforcement campaign, the IRS Office of Chief Counsel recently announced a settlement initiative for taxpayers with certain docketed Tax Court cases involving syndicated conservation easements. The IRS will be sending settlement offers to eligible taxpayers by mail. The key terms of the settlement offer that are known at this point are set out below:
- The taxpayer must agree that the deduction for the contributed easement will be 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 the cost of acquiring their partnership interests and may pay a reduced penalty of 10 to 20% depending on the ratio of the deduction claimed to partnership investment.
- Partners who provided services in connection with any syndicated conservation easement transaction must agree to pay the maximum penalty asserted by IRS (typically 40%) with no deduction for costs.
As the new settlement initiative is just rolling out, its success rate remains to be seen. But one thing is certain: Expect to see more activity from the IRS focused on what it views as abusive conservation easement transactions.
For those looking for more background on conservation easements and the IRS, follow the link here for podcast episodes with in-depth coverage of several recent Tax Court conservation easement decisions.
If you need assistance in managing the audit process, Freeman Law can help taxpayers navigate state tax laws. We offer value-driven services and provide practical solutions to complex issues. Schedule a consultation or call (214) 984-3410 to discuss our tax representation services.