The long efforts to put in place the enforcement mechanisms to attack syndicated conservation easements appear to at last be finalized. In October 2024, the Internal Revenue Service issued final regulations targeting syndicated conservation easements. The agency first started identifying claims for substantial conservation easement deductions by investors in syndicated partnerships back in 2016, and issued Notice 2017-10 identifying syndicated conservation easements as abusive and requiring reporting by participants. It also sought help from Congress to specifically disallow the abusive aspects of the transactions.
The syndicated conservation easement industry fought back. The industry won a court case on the basis that the notice issued by the IRS failed to meet Administrative Procedure Act requirements for notice and opportunity for comments. Lobbying efforts stymied the progress of congressional action and included efforts to strip the IRS of enforcement funds. Initial efforts to get taxpayers to accept settlement offers were frustrated by funds available for the defense of the transactions built into the deal structures.
The IRS has challenged $21 billion in deductions claimed by 28,000 syndicated conservation easement investors. Even the Land Trust Alliance, which administers traditional conservation easements, became concerned that the syndicated conservation easement activity would result in the complete loss of the conservation easement deduction. The IRS estimated that the number of syndicated conservation easement deductions grew from 249 deals in 2016, generating $6 billion in charitable deductions, to 296 deals in 2018 producing $9.2 billion in deductions. Traditional conservation easement deductions have resulted in around $1 billion in annual deductions.
Statutory action
After several years of frustration in getting Congress to address syndicated conservation easements, success was achieved with the enactment of Code Sec. 170(h)(7) in 2022. Code Sec 170(h)(7) provides that a contribution by a partnership is not treated as a qualified conservation contribution if the amount of such contribution exceeds 2.5 times the sum of each partner's interest in the partnership. Exceptions are provided for three-year holding periods, contributions made by family pass-through entities, and contributions made to preserve a certified historic building. Reporting requirements apply to partnerships, S corporations, and other pass-through entities. The statute does not apply retroactively, but only to contributions made after Dec. 29, 2022.
Final regulations
In order to overcome the APA challenges to the syndicated conservation easement notice, the IRS began a process of issuing proposed regulations to meet APA requirements. In November 2022 the IRS issued proposed regulations that disallowed deduction for syndicated conservation easement transactions made by a partnership or an S corporation after Dec. 29, 2022, if the amount of the contribution exceeds 2.5 times the sum of each partner's or S corporation shareholder's relevant basis. The regulations also imposed new reporting requirements for the members of the entity who are seeking a deduction based on the transaction — IRS Form 8886, "Reportable Transaction Disclosure Statement."
The final regulations were issued on Oct. 7, 2024, and are effective Oct. 8, 2024. They address three specified classes of abusive syndicated conservation easement transactions and substantially similar transactions:
1. Transactions involving contributions occurring before Dec. 30, 2022;
2. Transactions for which a charitable contribution deduction is not automatically disallowed by Code Sec. 170(h)(7); and,
3. Transactions that substitute the contribution of a fee simple interest in real property for the contribution of a conservation easement.
The final regulations generally adopt the 2022 proposed regulations with clarifications of the meanings of the terms "substantially similar transactions," the 2.5 times rule, "conservation easement," and "participant." The final regulations also clarify that participants and material advisors must report syndicated conservation easement transactions to the IRS that were completed in tax years that are still open. It is possible that taxpayers could be subject to both the requirements of Code Sec. 170(h)(7) and the final regulations.
Settlement offers
The IRS initiated its third settlement offer to try to dispose of many of the audits before it in June 2024. The earlier settlement offers had only limited success. However, the final regulations and growing success in the courts may push more syndicated deals into settlement. Only taxpayers who receive a settlement offer letter from the IRS are eligible for the settlement offer. The settlement offers have typically involved agreeing that the deduction for the contribution be disallowed in full; all partners must agree to settle; the partnership must pay the full amount of tax penalties and interest before settlement; partners can deduct the cost of acquiring partnership interests; and penalties can range from 10% to 20% for investor partners and up to 40% for partners active in the transaction. The settlement offers require the cooperation of partners during the resolution of the issue.
It may be difficult for some partnerships to get the consent of all partners in a deal to participate in the settlement and to be willing to cooperate in the resolution.
Criminal and civil enforcement
With Code Sec. 170(h)(7) in place, as well as now the final regulations, the Tax Court has set aside APA concerns and started to deny overvaluation of conservation easements. For example, in Mill Road 36 Henry LLC v. Commissioner, U.S.T.C. Oct. 26, 2023, the court limited the LLC's deduction to its tax basis and added an accuracy-related penalty. A circuit court case has also rejected the claimed deductions.
Some of the key promoters of syndicated conservation easements, as well as one of the appraisers utilized by the promoters, have been convicted of fraud and falsification of documents and some have already received substantial prison sentences.
Summary
The tools now seem to be in place to curtail the syndicated conservation easement industry. There remains a lot of work for the IRS to resolve all of the transactions still under audit. It remains to be seen how helpful settlement offers will be in disposing of some of these audits.
