Conservation easements have been a vehicle for landowners to preserve the environment and get a charitable deduction in one transaction, involving the transfer of certain rights of ownership to a land trust or government agency to preserve the land for future generations.
“Owners of undeveloped land who don’t know what to do with it can get a charitable deduction for putting a conservation easement on the property,” suggested Tom Wheelwright, a CPA and CEO of WealthAbility. “The IRS will always scrutinize it, but if it’s done correctly, it’s a great opportunity for wealthy clients that don’t know what to do with the land.”
However, abuses of the deduction have arisen, particularly in the area of syndicated arrangements, giving rise to increased scrutiny by the IRS.
An IRS news release issued in late December 2019, and a Tax Court decision filed Feb. 5, 2020, underscore this increased scrutiny.
In the release, the IRS urged taxpayers involved in designated syndicated conservation easement arrangements to consult with their tax advisors following a recent U.S. Tax Court decision and agency plans to continue enforcement efforts in this area.
“In late 2016, the Internal Revenue Service designated certain syndicated conservation easement arrangements as ‘listed transactions’ in Notice 2017-10,” it stated. “On Dec. 13, 2019, the Tax Court entered its first decision on a syndicated conservation easement transaction. In TOT Property Holdings LLC v. Commissione, Docket No. 005600-17, the Tax Court sustained in its entirety the IRS’s determination that all tax benefits from a syndicated conservation easement transaction should be denied and that the 40 percent gross valuation misstatement and negligence penalties applied.”
The Tax Court found that the transaction failed the misstatement penalty, since the actual value of the easement donation was less than 10 percent of what was originally reported on the tax return.
“In denying the deductions and upholding the 40 percent gross valuation misstatement penalty, the Tax Court confirmed that aggressive syndicated easement transactions simply will not survive scrutiny,” said IRS Commissioner Chuck Rettig in a statement. “We will not stop in our coordinated pursuit of these abusive transactions while seeking the imposition of all available civil penalties and, when appropriate, various criminal options for those involved.”
“If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options,” Rettig added.
Tax Court trials in four other syndicated easement cases were conducted earlier in 2019, and more than 50 cases are pending. In other recent cases,the Tax Court has rejected arguments that various regulations that taxpayers failed to comply with are invalid, essentially negating one of the main defenses.
Still worth a look
Given the continued IRS scrutiny and negative Tax Court opinions, does this mean that conservation easements are no longer a good option? Not at all, according to Wheelwright.
“Despite the commissioner’s intention to raise the level of scrutiny, conservation easements are still deductible as charitable contributions so long as the legal requirements are met,” he said. “What is important in the TOT case is to note that the valuation was highly speculative. Practitioners should help their clients carefully evaluate a conservation easement, both as to meeting the mechanics of a perpetual easement and to reflect a sustainable value. As the court in TOT explained, the deduction is for the highest and best use of the property absent the easement less the value with the easement. Speculative valuations based on hazy future land developments are questionable and should be avoided.”
Nevertheless, it is vital that all the requirements of the Tax Code be met. The extent to which conservation easements are scrutinized is illustrated by the most recent Tax Court decision, Railroad holdings, LLC v. Commissioner, issued Feb. 5, 2020. It denied a deduction due to the wording of the deed that, if the easement were ever extinguished and proceeds were to be allocated between the donor and the donee of the easement, the donee “shall be entitled to a portion of the proceeds at least equal to the fair market value of the Conservation Easement *** as of the date of this Conservation Easement,” rather than being entitled to a proportionate share of the proceeds.
The Tax Court said that the donor was not entitled to the deduction because, as a result of the extinguishment provision, the conservation purpose of the easement was not protected “in perpetuity” as required by Code Section 170(h)(5)(A).
The upshot is that whether a conservation easement is of the plain vanilla variety or is syndicated, it must comply precisely with the statutory requirements or it will fail the increased scrutiny.
