As published by Jason B. Freeman in Forbes.
The Internal Revenue Service has yet again publicly reiterated its commitment to challenge syndicated conservation easement transactions—transactions that it has, in recent years, labeled as “listed” transactions, tax-speak for “buyer beware.” In a recent press release, the IRS warned yet again that it believes that these easement deductions are “abusive transactions” and hinted that taxpayers can expect to face “new arguments” from its arsenal of legal theories. To add insult to injury, the IRS further cautioned that its newly-established “Office of Fraud Enforcement and the National Fraud Counsel are coordinating . . . to canvas cases for additional fraud considerations,” including civil fraud penalties and referrals to criminal investigation. The stakes, in other words, remain high for participants in syndicated conservation easement transactions.
What are Conservation Easement Transactions?
The conservation easement transactions in the IRS’s crosshairs are fairly straightforward. A taxpayer makes a contribution of an “easement” on his or her property—that is, the taxpayer grants a right to restrict the future use of the property in order to protect its conservation values. The grant of the conservation easement limits the ability of the landowner to subsequently develop the land, often decreasing its market value. Syndicated conservation easement transactions basically involve the use of a pass-through entity (for example, a partnership) to acquire property. After the entity’s promoters bring on investors (for a fee), the entity grants a conservation easement to a third party—typically a land trust. The entity then passes through a tax deduction to the entity’s investor-partners. Often times, the tax deductions exceed the fees investors paid to get in on the action. The IRS is primarily targeting these.
To the uninitiated, the paragraph above kind of “yada yada’d” over the best part: the “passes through a tax deduction.” How does that happen? Well, it’s not magic. Congress specifically enacted a statute that gives a tax deduction for granting certain conservation easements. The reason? It’s simple: Congress wanted to incentivize the conservation of property and these donations accomplish that.
Indeed, Congress carved out a specific little niche, tucked away within the vast stretches of the Internal Revenue Code. While the Code generally prohibits a taxpayer from claiming a charitable contribution deduction for the donation of an interest in property that consists of less than the taxpayer’s entire interest in such property, there is a narrow exception for the donation of a “qualified conservation contribution.” Under that exception, taxpayers are allowed to deduct, as a charitable contribution, the donation of a partial interest in property as long as the donation satisfies the carefully circumscribed definition of a “qualified conservation contribution.” To fall within the definition, a donation must meet a three-prong test: it must be (i) a donation of a qualified real property interest, (ii) to a qualified organization, (iii) exclusively for conservation purposes. What’s the amount of the deduction that is allowed? Under the Treasury Regulations, it is generally equal to the difference between the “highest and best use” of the property (without an easement) and the value of the property once it is encumbered by the easement.
How Does the IRS Feel About Syndicated Conservation Easements?
Spoiler alert: It doesn’t seem to like them. The history is a long one. But let’s look at what’s happened in recent years. In late 2016, the IRS issued a public notice expressing its determination that syndicated conservation easement transactions would be characterized as “listed” transactions, exposing participations to reporting requirements and potential increased penalties.
In November of 2019, the IRS upped the rhetoric, announcing that it intended to prioritize enforcement against syndicated conservation easement transactions. The Service has, in fact, been carrying out a coordinated enforcement strategy that involved the creation of two new offices focused on investigating conservation easement transactions: The Promoter Investigation Coordinator and the Office of Fraud Enforcement. IRS Targets Conservation Easements, Offers New Settlement Initiative. As part of the 2019 announcement, the IRS Commissioner, Charles Rettig, expressed a clear message: “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.”
In June of 2020, facing a swell of easement cases, the IRS announced a limited-time settlement program to resolve syndicated conservation easement transactions pending before the Tax Court. The program was made available to certain partnerships and their partners involved with syndicated conservation easement transactions. It was intended to provide a means to resolve the flood of cases in an efficient, coordinated, and consistent manner.
The terms of the settlement program announced in June of 2020 provided the following basic terms:
- The taxpayer was required to agree that the deduction for the contributed easement would be disallowed in full.
- All partners were required to agree to settle, and the partnership was required to pay, the full amount of tax, penalties, and interest before settlement.
- “Investor” partners were allowed to deduct the cost of acquiring their partnership interests and were required to 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 were required to agree to pay the maximum penalty asserted by the IRS (typically 40%) with no deduction for costs.
Recently, the IRS Office of Chief Counsel issued a Notice providing additional guidance with respect to the settlement program.
What is at Stake?
The IRS has repeatedly warned that partners involved in targeted syndicated conservation easements face the imposition of penalties, which could include:
- An accuracy-related penalty under section 6662 (calculated in many cases at a 40 percent rate)
- Alternatively, an accuracy-related penalty under section 6662A (calculated at either the 20 percent rate or 30 percent rate in the case of a nondisclosed transaction).
- The 75 percent civil fraud penalty under section 6663, in appropriate cases.
Who is Eligible for the IRS Settlement Program and What Does it Provide?
The IRS settlement initiative offers eligible partners an alternative to running the risk of these costly penalties. But it is an “invitation only” program—that is, it is only available to partnerships with cases pending before the Tax Court that received a letter from the IRS initiating a potential settlement. Partnerships with a partner who is under criminal investigation, however, may be ineligible for the program. Partnerships that are currently under examination—and, therefore, are not in a “docketed” status—are not eligible.
Generally, in order to participate in the program, all partners in the partnership must agree to participate under the terms of the program. In the new notice, however, IRS Chief Counsel has advised that in some cases it will entertain offers from groups of fewer that all partners if certain criteria are met: (1) the settling group represents a significant percentage of the interests in the partnership, and (2) all partners (even those not participating in the settlement) agree to waive the right to consistent agreements under the Code. There is, however, a catch for such partnerships—the settlement figure increases and the offer to settle must be made within 30 days from the issuance of the Chief Counsel notice.
Under the settlement terms, the partnership is required to make a lump sum payment—referred to as the “Settlement Amount”—representing the aggregate tax, penalties, and interest due from each partner. The lump sum payment is required to be made at the time of the execution of the final settlement agreement, known as a “closing agreement.” The Settlement Amount is to be paid by the partnership and is technically in lieu of any deficiency in tax or penalties that would have otherwise been assessable against the individual partners.
Can the IRS Assess Additional Penalties After a Settlement?
Generally, the IRS provides that the answer is “no.” But, interestingly, the IRS settlement program leaves the IRS the discretion to subsequently pursue “promoter penalties, material advisor penalties, appraiser penalties, tax return preparer penalties, criminal penalties and other enforcement actions.” The laundry list of penalties appears to be focused on professionals associated with syndicated conservation easement transactions.
Indeed, the settlement comes with more than a bit of fine print. Taxpayers entering into settlement agreements under the program must agree to the following specific caveats:
Neither this settlement initiative, nor any settlement executed therefrom, will have any effect, limitation, or prohibition against the IRS asserting promoter, material advisor, appraiser, or return preparer penalties, discipline under Circular 230, or any other penalty, addition to tax, or additional amount. Execution of a Closing Agreement under this initiative does not preclude the IRS from investigating any associated criminal conduct or recommending prosecution for violation of any criminal statute.
In recent years, the IRS has prioritized tax enforcement efforts against syndicated conservation easements that it believes to be abusive. Freeman Law’s tax controversy practice regularly represents clients in conservation easement tax disputes. Schedule a consultation or call (214) 984-3000 to discuss your conservation easement concerns or questions.