The IRS has declared war on conservation easements. In response, legislators in Washington are lining up behind the tax agency. Both parties claim that a tax policy intended to increase charitable gifts of land for preservation has led to overvaluations and excessive tax deductions.
The IRS sees syndicated conservation easements, or investment partnerships that acquire land to donate and claim deductions, as the worst offenders. However, they’re also questioning the charitable intent and deductions of any individual who makes a gift of land for preservation in perpetuity.
Conservation easements have taken over IRS resources
Recent years have seen a steady increase in enforcement pressure. In December 2016, the IRS designated syndicated conservation easement transactions as “listed transactions.” This obligated partnership promoters and participants to report their involvement to the IRS. In 2019, syndicated conservation easements made the IRS “dirty dozen” list of tax scams and the IRS strongly encouraged those who engaged in any questionable syndicated conservation easement transactions to immediately consult an independent, competent tax advisor to consider their best available options. Last year, the IRS’ position in conservation easement disputes prevailed repeatedly in Tax Court. In April 2021, the IRS established the Office of Promoter Investigations increasing the focus on promoters of abusive tax avoidance transactions to address syndicated conservation easements.
The agency has the political support and statutory authority to collect underpaid taxes and is confident about its enforcement process. A 2020 Senate Finance Committee report described syndicated conservation easements as “highly abusive tax shelters.” The report noted that over 80 percent of these partnerships are under audit or will be.
Time to assess your conservation easement audit risk
If you’ve donated land for preservation or invested in a syndicated conservation easement, you should prepare to be audited. You should also know that the IRS has a winning record in these proceedings.
The IRS has won in court on technical issues, but it also wins on valuations, demanding payment of taxes, penalties and interest. Some taxpayers are watching and waiting, to see how these cases play out at the appellate level. If you’ve been notified of an audit, you should be ready to defend your donative intent and valuation.
The importance of the tax matters partner
Syndicated conservation easements must have a tax matters partner (TMP). This person represents the partners and can bring suit in the tax court on their behalf. This is a key technical point and the IRS treats failure to comply with technical issues as low-hanging fruit. The tax court can dismiss your case for lack of jurisdiction and disallow your challenge to the IRS position.
The tax matters partner or partnership representative is responsible for keeping the other partners informed about proceedings and rulings. The IRS exam team will always ask for documentation on investments, donations, deductions and paid allocations. Expect them to back these document requests with summons and enforcement proceedings.
IRS agents use a conservation easement audit playbook
The IRS revised its Conservation Easement Audit Techniques Guide in 2018. The guide breaks down the examination of charitable contributions of conservation easements for agents and taxpayers. It tells you what the IRS exam team will demand.
According to the guide, “a charitable contribution is not deductible unless it is properly substantiated in accordance with the Internal Revenue Code and the regulations.” The reporting requirements are extensive. A conservation easement will need complete and accurate documentation, including:
- Contemporaneous written acknowledgment from the charity receiving the gift, including a description of the property;
- A statement affirming that the donor did not make the gift in consideration for any direct or indirect benefit;
- The deed to the property, stamped with the recording date;
- A qualified appraisal; and
- A baseline documentation report, documenting the condition of the land when donated and stating the public benefit, purpose, use limitations and reserved rights.
Nothing is unimportant in these audits, but appraisals receive particular scrutiny. Given that the IRS sees these valuations as the basis for abusive deductions, one or more additional appraisals may be a good idea. These appraisals should also include their valuation methods. This documentation matters because the default stance of the IRS is that easement valuations are inherently self-serving.
Settlement offers demonstrate IRS confidence
In June 2020, the IRS introduced a settlement initiative to resolve claims against similarly structured conservation easement partnerships. Mike Desmond, IRS Chief Counsel, sent settlement letters to dozens of partnerships suspected of abusive transactions. In a public statement, Mr. Desmond observed that “Abusive transactions, like settlement offers, don’t get better with time. And this is a good opportunity to get out.”
The settlement offers were essentially a demand for unconditional surrender. The IRS made these offers to selected partnerships, to clear cases on the docket in tax court. Key settlement terms were not encouraging:
- Partners in conservation easements had to accept a complete disallowance for their deductions.
- Every partner had to sign off on the settlement, paying all tax, penalties and interest.
- Investors could deduct the cost of their acquisition and pay a reduced penalty, depending on their claimed deduction.
- Partners providing associated services had to agree to maximum allowable penalties, with no deduction for costs.
Enforcement pressure continues to increase. The IRS has also informed partners in syndicated conservation easement audits that they may incur penalties. These include an accuracy-related penalty up to 40 percent and civil fraud penalties as high as 75 percent.
The need for experienced legal counsel and tax advisors
The conflicting interests of taxpayers and the IRS in conservation easement audits almost guarantee litigation. Given the financial risk, taxpayers need both experienced legal counsel and CPAs who know the terrain.
The IRS has advised that it may entertain settlement offers from syndicated conservation easement partnerships under certain conditions. These include:
- Partners willing to settle must represent a significant percentage of the partnership interests.
- All partners, including those who elect not to participate in the settlement, must waive the right to consistent agreements.
- The settlement increases and the taxpayer’s offer to settle must be made within 30 days of notice by the IRS Chief Counsel.
- The settlement amount is a lump sum payment, covering each partner’s tax, penalties and interest.
If you receive a letter from the IRS about your gift of a conservation easement and the resulting deductions, we can help. Windham Brannon has provided tax advisory services to hundreds of clients at every level of tax controversy. We know the IRS, its policies and procedures and how best to coordinate our work with legal counsel.
Our experience and insights make us well-equipped to advocate for your best interests for the most favorable outcome possible. To discuss the way forward, contact Tomika Bullet.
