Originally published on Forbes.com.

With Notice 2017-10 IRS is cracking down on easement donation abuse.  Winston Churchill once remarked that the Balkans produced more history than they could consume.  There are certain tax benefits that have the potential for being like that and easement donation deductions finally worked their way into that category.

In the right situation, easement donations are about as close as you can get to a free lunch in tax planning. If you have property that you want preserved in its current use, either to preserve scenic views and help the critters out in the country or to keep a historic city neighborhood looking historic, an easement donation will assure that happens and give you a tax deduction for not doing something that you did not want to do anyway.

The Problem

What creates the potential for abuse with easement donations is the manner in which the deduction needs to be computed since there is not a lot of buying and selling of easements.  Appraisers subtract the value of the property in its restricted form from its “highest and best use”.  The highest and best use is the use that will bring the owner the most money.  Of course if the property is already at its highest and best use the easement is not worth anything, and the Tax Court has ruled that way in a number of cases involving facade easements on buildings.  What makes the easement so interesting is thinking about what the property might be.

So You Want To Be A Developer

If you have ever been even marginally involved in property development, you know that the venture is one GD thing after another.  Zoning, financing , permits, construction, rent-up. And as you get from here to there a shift in the market is more likely than not. When everything works out it can be quite lucrative.  Which can incite envy. One of the ways you can tell a real estate market has peaked is when lawyers, accountants and small time contractors, consumed by envy, become developers.

The hypothetical developments conceived for the highest and best use in easement donations can end up being a lot easier.  In some Tax Court decisions they have included things like a development that did not actually fit on the parcel, a gravel mine with no way to transport the gravel and a vineyard in a desert (that’s just a bit of an exaggeration).  Fairly mundane subdivisions are probably the greatest hypothetical use.  Professor Nancy McLaughlin commented

If all of the land that has been appraised by the development approach were actually subdivided, there would be enough subdivision lots on the market to last hundreds of years and little, if any, farmland left in the United States

The appraisers really shouldn’t have to think about the value of the developments being compromised by food riots, but there are more realistic constraints like zoning that they are too quick to assume away.

Syndication

Given the high value of the castles in the air that some appraisers can conjure, you can see that ultimately the owners of property have much more in the way of potential tax benefit than they can use themselves even with the generous 50% adjusted gross income limitation and 15 year carryover.  That’s where syndication comes in.

A year or so ago, thanks to all I have written about conservation easements, I received a call from someone who was promoting the syndication of conservation easements.  In order for it to work I figured that one of three things had to be going on.  There was fast and loose playing with Code Section 704, which concerns how you allocate income and losses among partners, property was being acquired from very dumb people or they were, you know, fibbing about the valuation.  I think the proportions may vary, but that the third element, the valuations, tends to predominate.  At least that is what the IRS is implying.

The promoters obtain an appraisal that purports to be a qualified appraisal as defined in § 170(f)(11)(E)(i) but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property.

Just Say No

The effect of the notice is to make transactions in which an investor receives promotional materials to invest in a pass-through entity that will provide the possibility of a charitable contribution deduction two and half times (or more) the amount of the investment a listed transaction.  Back in the day, when I was doing low-income housing tax shelters two for one on the investment was enough, but, of course, rates were higher back then.  The listed transaction status applies to transactions that are the same or substantially similar to the one described entered into after January 1, 2010.

Listed transactions require the filing of Form 8886 by the participant and Form 8918 by the promoter.  The penalties for not filing them are really nasty.  Although I am not afraid of getting technical, when it is necessary, I’m not going to give you a lot on the ins and outs of those forms.  Rather I will give you the practical advice. ]If something is a listed transaction, just don’t do it.[  If you already have done one of these things, get somebody other than the advisers who blessed the deal to help you with the required disclosure.

Other Coverage

Jay Adkisson beat me to it on forbes.com.  That might have been enough to make me pass on other developments, but conservation easements are something I try to be thorough about.

Novogradac & Company has a brief summary.  I have to tip my hat to them as a major player in the low income housing space that occupied so much of my early career.

Timothy Lindstrom wrote an article picked up by Land Trust Alliance in 2015 on how land trusts should respond to syndicated deals indicating that there was sketchiness there.  Notice 2017-10 might prompt land trusts to examine whether they might be consider to be promoters. As noted the penalties for failing to file Form 8918 are extremely nasty.

Ed Zollars of Current Federal Tax Developments has a good technical summary with an important cautionary note.

Advisers must remember that the disclosure is required regardless of whether or not the transaction is eventually found to achieve its claimed tax benefits and that the penalties would apply even if the taxpayer is found not to have understated his/her income.