Originally published on Forbes.com.
Abuse of the tax benefits of conservation easements has reached a fever pitch as easement donations are now syndicated at multiples of nine to one and above. Put $100,000 into the syndication black box and take out a charitable contribution of $900,000 a year or two later. And wrap yourself in a green flag to defend the travesty.
Other Abuses Can’t Hold A Candle
In the past, abuse of conservation easement deductions has been around the edges. Some sketchy land trusts, worthless facade easements for 10 to 15% of property value, properties with dubious conservation value, such as golf courses, and appraisals based on fantasy developments like the vineyard with no water supply. All this abuse was happening in a reasonable framework – people promising to not do things with a property they already owned.
Maybe they had their fingers crossed when they made the promise (the sketchy land trusts). Maybe the promise they were making was the equivalent of renouncing their super powers (facade easements in historic neighborhoods, and fantasy developments). And, more likely than not in the case of golf courses, the conservation value of the donation was altogether dubious. In the Art of the Deal, President Trump writes of “truthful hyperbole”. You have to wonder what the proportion between “truthful” and “hyperbole” is in the case of the more than sixty million in conservation easement contributions he claims to have made since 2010.
None of that holds a candle to syndicated easements. And it appears that there are people in Congress, who would prefer that the IRS not look under the hood of transactions, that are on their face, abusive.
A Listed Transaction
On January 23, 2017, the IRS issued Notice 2017-10 which added a new item to the list of listed transactions.
A transaction described in this section is a listed transaction. An investor receives promotional materials that offer prospective investors in a pass-through entity the possibility of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor’s investment.
250% was an interesting threshold. Assume you buy a ranch for a million dollars. You then give the descendants of the local cattle rustlers, who have moved into white collar work by forming a phony land trust, an easement promising not to turn the ranch into any type of theme park other than a dude ranch. For that, you get a deduction of $2.5 million. Assuming you live in a state like New York or California and can use the deduction, you have effectively gotten the property for free. So 250% is a very generous threshold. I would consider anything much over 80% to be kind of sketchy.
Listed transaction status means that taxpayers and promoters have to rat themselves out by filing Form 8886 or Form 8918. Failure to adequately disclose carries nasty penalties. I have not made a close study of those rules. When my regional firm was swallowed by a national not quite Big 4, along with the thirty-five-page engagement letter, we had to send our clients bulky questionnaires to make sure they had not been in listed transactions. I barely understood most of them and I ended up telling my clients that there wasn’t anything in there that somebody did by accident.
Here is what you need to know about listed transactions. Reilly’s 14th Law of Tax Planning – ]If something is a listed transaction, just don’t do it.
Koskinen Clues In The Senate
There are some pretty influential people who would just as soon the IRS did not look too closely at the syndication of conservation easements. The House appropriation bill included “A new prohibition on funds to implement new IRS guidance on conservation easements”. Over in the Senate, they were a little more curious. Senator Ron Wyden wrote IRS Commissioner John Koskinen to find out what had been uncovered about conservation easement syndications. Koskinen’s response was quite revealing. As of July 1, 2017, the IRS has received 200 Forms 8886 and 5,500 Forms 8918. It would appear that the material advisers are being more diligent about covering their own posteriors than looking out for their clients.
As of July 1 2017, 104 of the Forms 8886 had been processed. Only forty had complete disclosures, but they represent what must be the tip of a huge iceberg. Charitable deductions indicated by the forty forms totaled over $200 million. On average the amount of the deduction averaged nine times the amount invested. At that rate a million dollar investment would yield over three million in tax savings. Of course the potential here is almost limitless. All you need is some property and a lot of imagination about what conceivably could be there – like the gold mine under my townhouse. Mining operations would disturb the squirrels that my covivant is always yelling at because they eat from the squirrel proof bird feeder. I’m thinking of an easement to the Save the Squirrels Foundation.
The Accounting View
I think the attraction of conservation easements to tax bandits is based on a peculiarity of the charitable deduction for appreciated property. It has to do with double entry accounting. Generally in order for you to have a deduction you have to reduce the basis of an asset or somebody else has to recognize income. When it comes to reported earnings, which is what the stock market bandits fool with, there is a kind of mirror image. Reported earnings should produce an asset increase or liability decrease. The discipline of double entry is frustrating to scoundrels. Any lie is like the bubble you try to smooth out when you are hanging wall paper.
You can lie about a charitable deduction for appreciated property because that unrealized appreciation you are deducting is a debit that does not require a credit. And, of course, the entity on the other side of the transaction recognizing income is, by definition, exempt. Many of the turn of the millennium tax shelters worked by creating basis out of thin air with an unbalanced entry involving option contracts, that was based on a strained interpretation of partnership regulations. The unbalanced entry of a deduction for appreciated property is approved by the Code.
In the case of marketable securities, there is a reality test that limits the phantom deduction. Even the sky is not limit to the deduction for other forms of appreciated property as the imagination of appraisers boldly goes where no one has gone before.
Commentary
I heard from Nancy McLaughlin of the University of Utah. Professor McLaughlin has written extensively on conservation easements. Her comment is.
IRS Commissioner Koskinen’s letter to Senate Finance Committee leadership confirms what many have known for a long time—most syndicated easement donation transactions are patently abusive . It would be a great disservice to federal taxpayers if Congress were to curtail the IRS’s ability address these abuses, as the House has proposed.
It also is important that the IRS continue its enforcement efforts with regard to conservation easement donations generally. The case law reveals persistent overvaluation of easements and many failures to comply with the deduction requirements in non-syndicated transactions. Federal taxpayers should not be expected to invest billions of dollars in easements that are overvalued or that don’t actually protect land with important conservation values in perpetuity as promised.
Stephen Small who during his time at the IRS wrote regulations on easements and now consults with land trusts and similar organizations wrote me.
I think the numbers in the IRS letter are staggering, and this is only the beginning of this information-gathering. These transactions are nothing but tax shelters. Some of them may possibly have some conservation benefits, although many I have seen do not, but the real goal of these deals is getting big write-offs to investors.
I am very glad the IRS is finally pursuing this, and I hope they keep up the effort.
The Land Trust Alliance issued a statement, which includes:
This further validates the Land Trust Alliance’s longstanding concerns with these transactions and our advisory to our 1,000 members, first issued in 2015, warning them to steer clear of these deals. In the vast majority of cases, conservation easement donors are philanthropic heroes working with nonprofit land trusts that are above reproach, and we can’t let the actions of those focused on material greed undermine a program that benefits all Americans
Other Coverage
William Hoffman wrote Conservation Easements May Hide Tax Shelters, IRS Finds on taxanalysts and has several interviews. CharitablePlanning.com has something behind its paywall and my regular readers know what a big spender I am not.
I can’t help but remember a post that I did in my earliest days of blogging Conservation Easements A New Field For Villainy. The post was about denial of exempt status to a sketchy land trust.
Note
Steve Small suggested that I clarify a couple of things. One is that if somebody has owned a property for a long time, it is possible that a deduction that is a high multiple of basis might be legitimate. The other is that if somebody buys a property for a million and a year or two later takes an easement deduction, that might be a bad thing, but it is only a listed transaction if there is “promotional material”. So I won’t be sending out brochures on my townhouse gold mine easement.
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