This has been a big month in the struggle against abusive syndicated conservation easements. There were three Tax Court decisions disallowing over $30 Million in deductions. And now we have the IRS updated report that comes largely from the filings required by its Notice 2017-10.

The major takeaway from the report is that the promoters are not being deterred. As my sixth grade teacher Sister Jane Aloysius would remark “They’re brazen as brass and as bold as gold”.

Some Background

When looked at in a certain way, the whole field of syndication of conservation easement deductions does not ever make good nonsense. The rather benign charitable deduction that supports the mini-industry contemplates someone like a farmer who would like to keep farming on inherited land but is besieged by developers who are offering extravagant sums to convert the green fields to housing subdivisions.

If the farmer gives an easement to a qualified land trust forsaking forever the right to dot the cornfields with McMansions, the fair market value of his or her property has been reduced. It might be a substantial reduction but the fair market value of the property before the easement grant is the upper bound of the deduction.

In the syndicated easement transactions the syndicators enter into a partnership with the farmer which gives them the advantage of the farmer’s holding period. At the end of the day, the farmer will get the full fair market value of the property, and the syndicators a substantial markup and the investors will get a tax deduction that is five or six times that.

Conceptually the syndicators argue that there is a highest and best use charitable deduction that is independent of what any buyers would actually offer for the property.

I once heard somebody describe ownership of land as a bundle of rights. Think of them as sticks. One of those sticks is the ability to develop the property to a more profitable state. The whole structure of the easement syndication model is that that single stick can be worth five or six times what the whole bundle is worth.

The Notice

Notice 2017-10 highlighted particularly egregious syndications as “listed transactions” . One of the key elements was a deduction to a partner of more than 2.5 times the partner’s investment. As best I can tell the reason for the 2.5 threshold is that is breakeven assuming a 40% tax rate. Multiples above that yield a significant return to the partner.

The Effect

Reilly’s Fourteenth Law of Tax Planning – If something is a listed transaction, just don’t do it – has not registered with people investing in conservation easement syndications. That was the takeaway from the IRS report.

“There was no notable decrease in the volume/dollars of syndicated conservation easement transactions from TY 2016 to TY 2017.”

Congressional Action Called For

Andrew Bowman of  Land Trust Alliance issued a statement on the IRS report.

“This new data undeniably shows the problem of abusive conservation easement tax shelters has gotten worse. We knew that tens of billions of dollars in tax deductions had been claimed since 2010. But the two most recent years for which robust data is available – 2016 and 2017 – now show almost $13 billion in claimed deductions. In 2016 alone, $6 billion was claimed; another $6.8 billion was claimed in 2017. And these $13 billion in claims came after the IRS told the bad actors to stop the abuse. 

While we applaud the IRS for taking both forceful and thoughtful actions to stop these abusive deals, those actions have not turned the tide. Congress clearly must take action to protect taxpayers. A solution is at their fingertips: the Charitable Conservation Easement Program Integrity Act.”

About The Act

The bill enacting the Conservation Easement Program Integrity Act S. 170 and H.R. 1992 is sponsored by Republican Senator Steve Daines of Montana and Democratic Representative Mike Thompson of California.

The bill would amend Code Section 170 to limit the deduction for a conservation easement of a partner in a partnership to 2.5 times the partner’s adjusted basis during the first three years of that partner’s membership. The amendment would be retroactive to 2016. Family partnerships are exempt.

Is This Good Legislation?

The Land Trust Alliance’s enthusiasm to the contrary notwithstanding, I don’t see much merit in this bill. Congress should not be passing a law to forbid things that the IRS has already defined as particularly egregious under existing law. These deals are bad under current law. What is required is vigorous enforcement, which arguably means better funding for the IRS.

There is also an implication that there is actually something OK about a 250% deduction, which in effect means that the partnership interest is being paid for by tax savings. A reasonable limit would be 80%.

Some Thoughts

I discussed this with Lori Faeth, LTA’s government relations director. Her comment was:

“Because 2.5 is roughly the break-even point, limiting transactions to that multiplier closes the door on profit opportunities. Enacting the Charitable Conservation Easement Program Integrity Act to codify the 2.5 multiplier from IRS Notice 2017-10 in federal law is the appropriate and proportional response to the situation we face, where tens of billions of dollars in tax deductions are being claimed.”

I had also mentioned the perception of one of my sources is that LTA is interested in hoarding the benefits of the deduction for the wealthy, while syndication has a democratizing effect. The response was:

“Our 1,000 member land trusts help thousands of landowners each year conserve the places we need and love. These landowners are often land-rich, cash-poor individuals, such as farmers or ranchers. As these working people fulfill their dreams and bring new benefits to their communities, they benefit from a conservation easement tax incentive we worked hard to enact. We believe that land conservation should be open to anyone with good intentions, regardless of means. By comparison, abusive syndicated conservation transactions are by their very nature exclusively available to elite, ultra-wealthy investors. The approach of excluding cash-poor individuals runs counter to our vision of bringing more people together to protect a variety of special places, from urban playgrounds to native prairies, from family farms to old-growth forests and from coastal wetlands to cactus-studded deserts.”

Actually I think the appeal of the syndications is to high-income people who are not very wealthy as I explained here.

I reached out to the offices of Senator Daines and Representative Thompson, but have not heard back.

Already A Work Around

Professor Nancy McLaughlin pointed me to an offering that works around the 2.5 multiple. Since the multiple is of the partner’s basis in the partnership, the partnership’s assets will consist of the property to be conserved and an equity portfolio for roughly 40% of the investment.

So you invest $100,000 and get a $240,000 deduction (effectively a multiple of 4 on the property portion of the investment) effectively giving you your interest in the $40,000 equity portfolio for free. And there would be nothing in the tax law to prevent you from pulling that back in the subsequent year.

The limit should be based on the attributed fair market value of any direct or indirect transfer within the last three years. And it should be less than 100%.

Update

I heard from one of my sources, who takes a dimmer view than most on syndicated easements. He goes by Factual Freddie and here is what he wrote me:

I agree the proposed bill is worthless or not appropriate. I suggest two actions:

1.      IRS/Treasury – Clarify the law/regulations that any valuation approach has a cap of the Value documented by comparable sales

2.      Get the Appraisal Foundation to issue a FAQ

a.      that reiterates this type of “CAP” on the Before “Value”,

b.      state that any “Before Value” is within the meaning of FMV, and

c.      Require disclosure of multiple related parcels and the original allocated purchase price.

d.      Any variance of this due to an interpretation of tax law must be disclosed as a departure from USPAP.