A charitable deduction for a conservation easement has been in the tax law for some time. Congress put in place the ability of a taxpayer to claim a charitable deduction for a contribution of an interest in real property (i.e., land) to a qualified organization exclusively for conservation purposes. Conceptually, a landowner agrees not to do something with its property in perpetuity. The reasons to enter into one of these arrangements are diverse. Perhaps it’s to protect open space by forgoing development, to preserve the land as farmland, or to set aside historically important structures. The eligible deduction is based on the difference in the fair market value of the property before and after the easement. Valuation issues are ripe for abuse and as you might guess, that’s where the trouble exists. It is important to note that the strategy is viable and there are a number of charitable organizations that can and do facilitate these transactions legitimately.
Promotors grabbed hold of this idea and began forming partnerships to “share” the deduction amongst investors in a venture whose goal was to provide outsized deductions versus the economic realities of the transaction. The arrangement has a number of variations but typically follows the following pattern. Promoters obtain an interest in real property via a partnership or other pass-through type entity. They then sell interests (syndicate) to investors who acquire a percentage of the partnership. The partnership then makes a contribution of the easement. The magic is in the valuation of the easement which is grossly overstated. The deduction generated for the investors is well in excess of their purchase price paid for their interest in the partnership, often by a factor of 2 to 9x.
These transactions have risen to the top of the IRS’s radar. They are considered listed transactions (i.e., abusive tax shelters) if entered into after January 1, 2010, which means that special disclosure is required on your tax return if you are claiming a benefit from one of these transactions. That disclosure is required every year in which you are a participant in the venture. The IRS also has included these transactions on its list of “Dirty Dozen Tax Scams.”
The IRS has used its data mining capabilities to identify investors and promotors of these transactions and is taking them to court, and winning. In a recent press release (6/25/20) the IRS outlined its approach:
The IRS has developed a comprehensive, coordinated enforcement strategy to address abusive syndicated conservation easement transactions and has also been working closely with the U.S. Department of Justice to shut down the promotion of them. The IRS will continue to disallow the claimed tax benefits, asserting civil penalties to the fullest extent, considering criminal sanctions in appropriate cases, and continuing to pursue litigation of the cases that are not otherwise resolved administratively. This syndicated conservation easement resolution should not be deemed to have any impact on the potential criminal exposure, investigation and/or prosecution of any individual or entity that participated in or assisted or advised others in participating in a syndicated conservation easement transaction in any manner whatsoever.
In addition, part of the IRS’ strategy is the creation of two new offices that are actively investigating these transactions: the Promoter Investigation Coordinator and the Office of Fraud Enforcement.
The IRS recently notified taxpayers with pending tax court cases of a potential settlement offer that included the following terms:
Taxpayers who have been a party to one of these transactions or have received a settlement offer letter from the IRS need to quickly take some proactive steps to avoid further issues. First and foremost obtain legal and financial counsel. These professionals should not be individuals who were a party to the original transaction because they may also be targets of the IRS’s enforcement efforts.
Withum’s tax controversy group can assist you in evaluating your exposure to potential IRS assertions of taxes and penalties associated with these transactions.