April 14, 2023
Proposed IRS Regulations Would Once Again Enhance Risks Related to Syndicated Conservation Easements
Conservation easements have long served as a tax mitigation tool for high-income taxpayers. They also have a long history of drawing scrutiny from the Internal Revenue Service (IRS). While conservation easements provide a legitimate way for high-income taxpayers to reduce their federal tax burden, they also present significant potential for abuse, and, as a result, the IRS pays close attention to taxpayers that claim significant easement-related deductions.
This is especially true with regard to syndicated conservation easements.
A syndicated conservation easement is a tax planning strategy that allows multiple investors to claim deductions related to a single property. Similar to “standard” conservation easements, there is nothing inherently unlawful about taxpayers using the syndicated conservation easement model. However, as the IRS noted in 2017, “some promoters were syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested,” in violation of the Internal Revenue Code.
In response to this concern, the IRS adopted Notice 2017-10. Notice 2017-10 was significant because it labeled most syndicated conservation easements as “listed transactions” under Section 1.6011-4(b)(2) of the Income Tax Regulations and Sections 6111 and 6112 of the Internal Revenue Code. As “listed transactions,” these syndicated conservation easements have been determined by the IRS to be abusive tax avoidance schemes.
U.S. Tax Court Invalidates IRS Notice 2017-10
Late last year, the U.S. Tax Court invalidated IRS Notice 2017-10. The Tax Court’s decision removed syndicated conservation easements from the IRS’s listed transactions—eliminating the presumption of abusive tax avoidance (though not eliminating the possibility of prosecution for tax evasion completely). Crucially, however, the Tax Court’s ruling was not based on any issue with the substance of the IRS’ decision but rather based on the court’s conclusion that the IRS adopted Notice 2017-10 without meeting the procedural requirements of the Administrative Procedures Act (APA).
This left the IRS free to try again; and about a month later, the IRS issued a Notice of Proposed Rulemaking seeking to reinstate its designation of syndicated conservation easements as listed transactions.
IRS Proposes New Rules for Syndicated Conservation Easements in 2023
If adopted, the IRS’s proposed syndicated conservation easement rules would label these conservation easements as listed transactions if they meet four criteria. As listed transactions, these syndicated conservation easements would be considered “the same as, or substantially similar to . . . a tax avoidance transaction” and potentially subject to disclosure, registration and/or other requirements. Under the IRS’s proposed rules, the four criteria for a syndicated conservation easement to be characterized as a listed transaction are:
- The syndicated conservation easement is promoted to investors as offering the possibility of a charitable contribution deduction that equals or exceeds 2.5 times the investors’ principal;
- Investors purchase an interest, either directly or indirectly, in a pass-through entity that owns the real property subject to the conservation easement;
- The investors’ pass-through entity contributes a conservation easement to a tax-exempt entity and allocates the resulting charitable contribution deduction among the investors; and,
- After the entity’s charitable contribution, investors report a charitable contribution deduction on their federal income tax returns related to the subject property.
Recognizing that the requirement for an offer of a deduction that equals or exceeds 2.5 times the investors’ principal itself presents the potential for abuse (i.e. if promoters are ambiguous about the size of the deduction that investors may be able to claim), the IRS’s proposed rules include provisions that seek to preempt potential workarounds. Specifically, the IRS’s proposal states that:
- “[T]o prevent promoters from circumventing the 2.5 times rule by having promotional materials contain language that is ambiguous as to the amount of the potential charitable deduction, the proposed regulations provide that the highest deduction amount stated or implied in the promotional materials, taken as a whole, applies;” and,
- “[A] rebuttable presumption deem[s] the 2.5 times rule to be met if (i) the pass-through entity donates a conservation easement within three years following taxpayer’s investment in the pass-through entity, (ii) the pass-through entity allocates a charitable contribution deduction to the taxpayer that equals or exceeds two and one-half times the amount of the taxpayer’s investment, and (iii) the taxpayer claims a deduction that equals or exceeds two and one-half times the amount of the taxpayer’s investment.”
Understanding the Risks of Syndicated Conservation Easements for Taxpayers
While the IRS is seeking to crack down on promoters who try to sell high-income taxpayers on abusive conservation easements, the IRS is also targeting taxpayers who claim abusive charitable contribution deductions. Even if a taxpayer is unaware that a syndicated conservation easement qualifies as an abusive tax scheme, the taxpayer can still face an IRS audit or investigation and liability for back taxes, interest and penalties.
As a result, regardless of whether the IRS adopts its proposed syndicated conservation easement rule—which it most likely will in some form—taxpayers who claim conservation easement deductions must be careful to ensure that they are fully complying with Section 1.6011-4(b)(2) of the Income Tax Regulations and Sections 6111 and 6112 of the Internal Revenue Code. While evidence of intent to evade tax is required for a criminal prosecution, all taxpayers have an obligation to pay what they owe, even if they have relied on bad or self-serving advice. With that said, taxpayers who have improperly claimed charitable deductions can mitigate their liability in many cases—provided that they take action to correct their mistakes before being contacted by the IRS or IRS Criminal Investigation (IRS CI).
Speak with a Federal Tax Lawyer at Brown Tax, P.C.
The federal tax lawyers at Brown Tax, P.C. represent high-income and high-net-worth individuals in all matters involving the IRS. If you have questions or concerns about claiming a charitable contribution deduction related to a syndicated conservation easement, we encourage you to contact us promptly for more information. To speak with one of our lawyers about your options in confidence, please call 888-870-0025 or request a confidential consultation online today.