The IRS is increasing it enforcement actions for syndicated conservation easement transactions. This includes more coordinated examinations across IRS divisions, as well as more criminal investigations. The IRS believes that these audits and investigations may cover billions of dollars of potentially inflated charitable contribution deductions for qualified conservation easements made through partnerships and limited liability companies (LLCs).
Deductible Conservation Easements
The contribution of less than the donor’s entire interest in a property generally does not qualify as a deductible charitable contribution. However, a charitable deduction is allowed for the contribution of a real property interest to qualified charitable organization exclusively for conservation purposes. This is referred to as a qualified conservation contribution (QCC).
A real property interest includes a conservation easement – that is, a restriction, granted in perpetuity, on the use of real property. For instance, the goal of land conservation easements is to preserve land, natural habitats, open spaces, and historically important land areas. However, an easement that preserves the façade of a building in a registered historic district may also be a conservation easement.
What are Syndicated Conservation Easements?
The annual deduction for QCCs is limited to 50% of the taxpayer’s adjusted gross income (100% if the taxpayer is a qualified farmer or rancher). Any excess may be carried forward 15 years, but subject to the same limit in the carryover years.
Instead of losing any portion of the charitable deduction, however, a taxpayer may transfer the underlying real property to a syndicate such as a partnership or LLC. The conservation easement is then made by the entity, entitling it to the charitable deduction.
A typical syndication arrangement sells interests in the partnership or LLC to third parties. The operating agreement of the partnership or LLC generally allocates its income entirely to the taxpayer who owned the property. But it also allocates its deductions, including any QCC deduction, to the other partners or members. Thus, the syndication is used to “sell” the taxpayer’s QCC deduction.
Syndicated Easements as Abusive Transactions
The IRS is concerned about abuses of syndicated conservation easements. The abuse can take several forms, including:
- excessive charitable deductions based on inflated property valuations and appraisals;
- failing to preserve the property under the easement;
- the easement holder permitting modifications to and violations of the terms of the easement; and
- claiming a deduction for a façade preservation easement when the taxpayer was already prohibited under local zoning ordinances from altering the façade.
In fact, in Notice 2017-10, the IRS identified certain syndicated conservation easements and substantially similar transactions as “listed transactions” that must be disclosed on a taxpayer’s return, as well as by material advisors. The guidance specifically covers transactions where investors in passthrough entities are offered charitable contribution deductions worth at least two and a half times their investment.
The IRS also included syndicated conservation easements on its 2019 “Dirty Dozen” list of tax scams to avoid. In addition to grossly overstating the value of the easement donated to charity, these transactions often failed to comply with the basic requirements for claiming a charitable deduction for a donated conservation easement.
Increased IRS Enforcement Actions Against Syndicated Easements
In November 2019, the IRS announced that it is increasing enforcement actions against abusive syndicated conservation easements with more audits and investigations. In fact, the increase in enforcement in a priority compliance area for the IRS.
“We will not stop in our pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions based on these aggressive transactions. Every available enforcement option will be considered, including civil penalties and, where appropriate, criminal investigations that could lead to a criminal prosecution”, said IRS Commissioner Chuck Rettig.
The IRS currently has more than 80 docketed cases in the Tax Court. Moreover, there is sufficient precedent to move the Tax Court to invalidate the claimed deductions in all these cases, leaving only the final penalty to be determined. Those penalties could include:
- the 40% accuracy-related penalty for participants;
- appraiser penalties for substantial and gross valuation misstatements attributable to an incorrect appraisal;
- promoter, material advisor, and accommodating entity penalties for promoting abusive tax shelters and penalties for aiding and abetting understatement of tax liability; and
- return preparer penalties for understatement of tax liability.
Remedies for Taxpayers in Easement Syndications
Taxpayers involved in easement syndications may be able to avoid penalties if they quickly file amended returns or an administrative adjustment request to reverse improper charitable deductions. However, this remedy would appear to be limited to taxpayers who are not currently in litigation. The IRS encourages taxpayers to immediately consult an independent, competent tax advisor to consider their best available options.
By John Buchanan, J.D., LL.M.