Syndicated Conservation Easements
In an IRS news release of January 17, 2022, the IRS’s Office of Chief Counsel announced that plans to hire up to 200 additional attorneys “to help the agency combat syndicated conservation easements, abusive micro-captive insurance arrangements, and other tax schemes.”
Since 2020, syndicated conservation easements have been a focus for the IRS-Criminal Investigations unit. In December 2020, the Department of Justice announced a guilty plea entered in the first-ever criminal case by IRS-Criminal Investigations that involved conservation easements to the tune of near $1.2 billion in fraudulent tax deductions. This latest attorney-hire announcement by the IRS’s Office of Chief Counsel indicates that the focus on tax challenges relating to conservation easements will continue, apparently in earnest.
Under I.R.C. section 170(f)(3), and as a general rule, no charitable contribution deduction is allowed for a transfer of property of less than the taxpayer’s entire interest in the property. See also 26 C.F.R. § 1.170A-14(a). However, section 170(f)(3)(B)(iii) of the Code provides an exception to the partial interest rule for contributions of qualified conservation easements.
A “qualified conservation contribution” means a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes, each term having a technical definition in the Treasury Regulations. See 26 U.S.C. § 170(h)(1)-(h)(1)(C); 26 C.F.R. § 1.170A-14(e)(1) (defining “exclusively” in this context). The “qualified” nature of the contribution means a “perpetual conservation restriction” as to the use which may be made of the property. See 26 C.F.R. § 1.170A-14(b)(2). The donee of the easement contribution must (1) have a commitment to protect the conservation purposes of the donation, (2) the resources to enforce the restrictions, and (3) meet one of the organizational requirements contained in Treas. Reg. sec. 1.170A-14(c)(1)-(c)(1)(iv). “Conservation purposes” means, in short, preservation of land areas for outdoor recreation, protection of natural habitat of an ecosystem, preservation of open space, or the preservation of a historically important land area or structure. See id. at § 1.170A-14(d)-(d)(1)(iv). Each of those conservation purposes has a more detailed definition in the Treasury Regulations.
A “syndicated conservation easement” is essentially an investment vehicle where pre-packaged conservation easements are marketed to investors with the representation that a charitable deduction will accompany the investment in excess of the amount invested. The investment vehicle is usually in the form of pass-through entity, such as a limited liability company or a partnership. Individual investors invest money into the pass-through entity, and the promoter uses those funds to purchase the land. The entity donates a conservation easement on the property to a qualified organization in order to create the deduction for the investors, with the intent that the deduction exceeds the contribution. See IRS Notice 2017-10 at 2-3. In Notice 2017-10, the IRS describes the nefarious mechanics as follows:
The promoters obtain an appraisal that purports to be a qualified appraisal as defined in § 170(f)(11)(E)(i) but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property. After an investor invests in the pass-through entity . . . the pass-through entity donates a conservation easement encumbering the property to a tax-exempt entity. Investors who held their direct or indirect interests in the pass-through entity for one year or less may rely on the pass-through entity’s holding period in the underlying real property to treat the donated conservation easement as long-term capital gain property under § 170(e)(1). The promoter receives a fee or other consideration with respect to the promotion, which may be in the form of an interest in the pass-through entity. The IRS intends to challenge the purported tax benefits from this transaction based on the overvaluation of the conservation easement. The IRS may also challenge the purported tax benefits from this transaction based on the partnership anti-abuse rule, economic substance, or other rules or doctrines.
Id. at 2-3 (emphasis added).
The IRS may challenge any one or more requirements of a charitable conservation easement tax deduction, including the purported perpetuity of the transferred interest, the nature of the restrictions, the public benefit to be achieved, and whether or not the donee organization has resources to enforce the restriction as defined in the Treasury Regulations.
Perhaps a “low-hanging fruit” challenge is the valuation of the charitable conservation easement for the applicable tax deduction.
Recently, in the case of Long Branch Land, LLC v. Commissioner, No. 7288-19, T.C. Memo. 2022-2 (U.S. Tax Ct. Jan. 13, 2022) (mem. op.), the court addressed a taxpayer’s procedural challenge to try to overturn valuation misstatement penalties issued pursuant to section 6662 and section 6662A of the Internal Revenue Code and with respect to conservation easements granted to a qualified organization. See 26 U.S.C. § 6662(h) (gross valuation misstatement); id. at § 6662(e) (substantial valuation misstatement); id. at § 6662A (accuracy-related penalties). In that case, the taxpayer claimed a $10,425,000 charitable contribution deduction for a conservation easement it granted to a charitable organization as well as a $3,475,000 charitable contribution deduction for a donation of a fee simple interest in real property associated with that easement. The IRS selected LBL’s return for examination and valuation misstatement penalties were assessed.
In sum, any investor or promoter involved in a syndicated conservation easement should take caution and evaluate whether the deductions represented, taken or pursued are appropriate and defendable under I.R.C. section 170 and corresponding Treasury Regulations because the IRS is seeking to engage hundreds of attorneys to review these transactions to show otherwise.
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.