The IRS wants us to know that it is getting really serious about abuse in the area of the syndication of conservation easements. IR-2019-182 issued on November 12 tells us:
“The Internal Revenue Service announced today a significant increase in enforcement actions for syndicated conservation easement transactions, a priority compliance area for the agency.
Coordinated examinations are being conducted across the IRS in the Small Business and Self-Employed Division, Large Business and International Division and Tax Exempt and Government Entities Division. Separately, investigations have been initiated by the IRS’ Criminal Investigation division.
These audits and investigations cover billions of dollars of potentially inflated deductions as well as hundreds of partnerships and thousands of investors.
About Syndicated Conservation Easements
Conservation easement charitable deductions are a relatively benign tax expenditure. The idea is that somebody who owns property with a highest and best use different from its current use should be able to give up the right to develop in the interest of conservation and receive a charitable deduction (Note I am simplifying here).
When you give something to charity your deduction is generally the fair market value of what you gave. The best way to arrive at fair market value is through comparable sales. But people don’t buy and sell conservation easements very much, if at all.
So you value the easement by figuring out the value of the property without the easement and subtract the value of the property with the easement. It is the before value that is a problem, because we have to think about what you might do with the property.
And the hypothetical developments that people come up with can be extremely lucrative and practical concerns that would confound the actual execution can be glossed over. So there was a case with a vineyard that had no water supply, a gravel mine with no means to transport the gravel and a housing development that did not actually fit on the parcel.
The syndicated easements take this to a new level. In the recently decided Coal Property Holdings decision, a property interest was purchased for $32M and shortly afterwards a conservation easement on it was valued at $160M. The valuation issue was not touched by the Tax Court, because the deduction was disallowed on technical grounds.
At the investor level, this translates into people essentially buying charitable deduction for twenty cents on the dollar more or less.
The IRS indicated that transactions of this sort would be considered listed transactions in Notice 2017-10. I’m not going to try to explain the implications of something being a listed transaction. I will just refer you to Reilly’s Fourteenth Law of Tax Planning – If something is a listed transaction, just don’t do it.
What Should You Do?
Well clearly you should not buy one of these things. And if you have bought one for a 2019 deduction send a copy of the notice to whoever sold it to you and tell them you want your money back. Let me know how that works out, I’m not sure how practical it is.
The hard question is what to do if you invested one of these and claimed the deduction in a year that is still open. The IRS is offering you an out.
Taxpayers may avoid the imposition of penalties relating to improper contribution deductions if they fully remove the improper contribution and related tax benefits from their returns by timely filing a qualified amended return or timely administrative adjustment request.
That would be Form 1040X or Form 8082. You should probably get a tax professional other than the one who indicated that this sort of thing was a good idea to prepare it for you. But should you really amend and pay back the tax that you avoid by, you thought, helping the environment?
Is The IRS Bluffing?
There are a couple of things that you might get by amending your return. You might get the satisfaction of a being a good citizen. When I write a big tax check, I think about the National Park Service. My covivant and are on a tour of the country right now and they are marvelous places staffed by wonderful people.
You also might get some peace of mine. Some people worry all the time about the IRS coming after them. It is possible that sending in the amended returns might get you some equanimity, but, frankly, I suspect that you will just start worrying about something else.
Let’s go with a hard-nosed financial analysis. What you get out of doing the amended return routine is that, if you do it properly, you avoid the penalty of either 20% or possibly 40%. As noted you should get help if the dollars are substantial.
If you go to a tax practitioner who follows AICPA ethical guidelines, they can’t give you audit lottery advice. That is what I’m for. Since you don’t know whether you will end up with a 20% or 40% penalty, call it 30%.
So if your tax savings was $100, your expected tax plus penalty is $130 times the probability that you will get caught in this dragnet the IRS just announced. Breakeven on that is about 77%. Purely as a wagering matter I think the better bet is to not amend, because the IRS with this notice is mostly bluffing.
There will be quite a few deficiency notices and a couple of the most egregious promoters will end up doing some time. A number of professionals will have to take up another trade, but I really doubt that the resource strapped IRS will be able to capture as many as half of the people who purchased four or five to one charitable deductions.
Frankly, I wish it was otherwise and I could honestly tell you that you should race to your nearest tax pro and get that amended return in right away. That is the way the system should work, but it doesn’t.
Is It Over?
I recently heard from someone who is seriously contemplating buying one of these deals. He found it on a website and was puzzled how it could possibly work. You know put in a hundred dollars of cash and out comes a five hundred dollar charitable deduction. I’ve been playing phone tag with the representative, so these guys are still in business. From what I understand, they do a lot of Holiday Season business.
The Land Trust Alliance has issued a press release generally celebrating the IRS crackdown.
Land Trust Alliance President and CEO Andrew Bowman said the following:
“We’re encouraged to see the IRS increase enforcement activity on abusive conservation easements. At the same time, we hope the agency is careful not to sweep up well-meaning philanthropists in actions that target wrongdoers. One way to help avoid such an outcome is for Congress to pass the Charitable Conservation Easement Program Integrity Act. This bipartisan legislation would stop the get-rich-quick schemes and protect American taxpayers.”
Richard Rubin has a story in the Wall Street Journal emphasizing that the criminal enforcement is in the picture.
Dylan Moroses has something behind the Law360 paywall.
Allison Versprille has something in Bloomberg Tax.
I have to say that I am generally sympathetic to the perspective of being pro-IRS on this particular issue. However, I do feel some real sympathy with the people who were convinced that this was a reasonable investment.
I want to thank Nancy McLaughlin for alerting me this notice.