On November 12, the IRS sounded renewed alarms for those taxpayers that, in the IRS’s view, are abusing the tax benefits associated with conservation easements. Potential repercussions include civil penalties and even criminal investigations and prosecution, leading many taxpayers to wonder if the warnings apply to them.
A conservation easement is an agreement between a landowner and a land trust or government agency that permanently limits the use of the land in order protect the land’s conservation objectives (i.e., maintaining and improving water quality, wildlife habitat, etc.). Qualified organizations, including government organizations, have the right to restrict the landowner from developing the land. Landowners benefit from this transaction by preserving the intended use of the land and conservation goals while potentially realizing significant tax savings.
The Internal Revenue Code permits a deduction for perpetual conservation easements donated to a qualified organization exclusively for conservation purposes. The deduction allowed for the donated easement is the fair market value (FMV) of the easement at the time of donation based on the potential “highest and best use” of the property at the time of the donation. “Highest and best use” is essentially how much the land would be worth if it could be most profitably developed, given the constraints of reality and the law. The valuation based on “highest and best use” is a key issue relevant to the practices condemned by the IRS.
While deductions for donated conservation easements are legitimate, some conservation easement syndicates have promoted and delivered returns on investment through tax deductions that potentially lack economic substance. IRS Notice 2017-10 laid out the fact pattern that is now a “listed transaction” under § 6011:
A promoter seeks out high-tax bracket investors to invest in a pass-through entity that holds land, offering a potential charitable contribution deduction worth 2.5 times, or even greater, than the investment amount.
The pass-through entity donates a conservation easement on the land to a qualified organization and allocates the deduction to the investor.
The investor reports the conservation easement deduction on their federal income tax return.
The IRS has attacked this specific fact pattern and similar cases, arguing that the valuations are unreasonable, and that these transactions violate the economic substance doctrine by existing “solely as a conduit for selling tax deductions.” The IRS has also argued that in some cases the transactions fail the basic requirements to claim the deduction for the donated easement.
In the November news release, the IRS put all parties related to these transactions on notice. Participants in the syndicates, promoters, appraisers, tax return preparers and others could all be subject to penalties, including a potential 40% accuracy related penalty. The IRS is allowing for taxpayers to avoid penalties related to the deduction claimed by removing the deduction on a filed qualified amended return or administrative adjustment request.
If you receive any promotional materials involving proposals similar to the ones described above, please consult with your Schneider Downs tax advisor before participating in such a transaction. Additionally, if you have already participated in a transaction with respect to a conservation easement, Schneider Downs can assist with the related compliance and assessment of risk related to the transaction.
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