EcoVest Wraps The Green Flag Around Tax Shelter

All in they have protected 20,824 acres, which is a larger area than Manhattan.  Why did they pick Manhattan as a comparison?  I get around in Manhattan mostly by walking.  It is just not really that big.  Granted going from the GW to the Battery would be quite a hike, but google maps says you can do it in four hours.  And going across is a piece of cake.

I would have liked to be a fly on the wall at the meeting where they came up with those comparisons.

For each property, they have a fully worked out development plan with the right zoning.  The appraisals are checked and double-checked.  Their methodology a before and after valuation of the easement with the before value based on the discounted cash flow of a hypothetical development has been blessed by the courts as the way you are supposed to do things.  And they do it.  Reilly’s Fourth Law of Tax Planning – Execution isn’t everything, but it’s a lot.

They put it this way in their release:

EcoVest takes numerous steps to ensure that its projects are fully compliant with the law. First, EcoVest underwrites the development potential of the property, including the commissioning of market studies, engineering and architectural reports, zoning, entitlements, and other necessary third-party reviews. Second, EcoVest undertakes rigorous processes to ensure that all independent appraisals associated with the real estate are valid. These appraisals are made by highly qualified independent appraisers and are then corroborated by additional reviews. Third, EcoVest programs are distributed through FINRA registered independent broker-dealers, which are each required to perform due diligence and verify the validity of the third-party appraisals and other underwriting work product. Fourth, after the due diligence process is completed, these FINRA-registered broker-dealers distribute offerings that give investors a choice to (i) fully develop the real estate in accordance with the underwritten development plan, (ii) hold the real estate for appreciation, or (iii) establish and then donate an easement on the real estate to a land trust in order to preserve the conservation values associated with the property in perpetuity and provide the potential for limited development. Finally, with respect to all of these steps, EcoVest ensures it is fully compliant with disclosure and reporting requirements of the IRS, the SEC and FINRA.

They Might Win

After that what is there to ask?  I clarified with Mr. McCullough what happens with the investors.  They make their contribution and if the vote goes to make an easement donation, they will typically get a deduction around four times the amount of their investment in the same year.

Is it conceivable that something like that could work even once, much less 96 times?  Actually, it could, in principle.  If the owner of the land contributes it to the partnership at the value they are willing to sell it for, there is a tack on the holding period.  Or hypothetically the purchase of the property could be leveraged.

What creates the additional value is all the soft costs.  So to legitimately give the investors a high multiple the increase in value from slapping the plan on does not have to be a multiple of the land cost.  It just has to be a multiple of the soft cost.

On The Other Hand

Achieving that sort of result reliably multiple times is what strains credulity. Mr. McCullough acknowledged that the investor vote has always been to make the easement donation rather than pull the trigger on the development plan.

This will lead me to one of my historical comparisons.  During World War II, the US Navy submarine effort was plagued by torpedo problems.  There was this marvelous magnetic exploder that was considered foolproof.  Skippers who reported premature explosions were considered incompetent, but they kept happening despite the assurances that the magnetic exploders were perfect.  Turns out that the magnetic field of the earth is different off the coast of Japan than it is around Groton, CT. I mean – Who knew?

All those hypothetical projects that support the large tax deductions never have to be “battle-tested”.

William Ellis, a CPA with extensive experience in real estate and various types of tax shelters explained the problem in an interview with Tax Analysts that he shared with me.

“ Demonstrating the value a willing buyer and seller would agree to has somehow fallen to the wayside, ” said Ellis, a former Big 4 tax partner whose practice primarily involved real estate and developer clients.

“These valuations simply represent a single point, projected discounted cash flow ‘foregone’ and not a price a purchaser would pay for the property in its present condition and location,” said Ellis. “That is the underlying difference in the valuations.”

“Any ‘before value’ under USPAP or any case should be required to demonstrate comparable raw land sales that are within the range of the ‘before value’ using the income approach to valuing land,” he said, adding that the “before valuations” for conservation easements should not be any different from any other appraisal for undeveloped land.

The fellow who explained to me how you might hit the high multiple home run explained to me that as you go from an original owner to an investor to a developer to a developer/builder, they each expect to experience a lift.  The discounted cash flow analysis has all the lift going to the early player and the subsequent hypothetical developer and developer-builder working for a predictable return while shouldering the downside risk.  Of course, since they are imaginary they don’t complain.

But The IRS Has Been Letting It Go

Ellis is actually criticizing the IRS for buying the hypothetical development approach and just arguing about the details rather than insisting on comparable land sales.  In other cases, the IRS will go for a zero deduction based on technical flaws in the easement.

If the IRS and the courts accept the hypothetical development approach, you can see why EcoVest can cast itself in a favorable light.

From The Do-Gooders

Syndicators like EcoVest catch a lot of flack from other players in the land trust/conservation easement world, who worry that they are being made to look bad.  From a policy viewpoint, four times investment as a deduction makes no sense.  The tax subsidy would more than pay for the property interest that is being donated.

Stephen Small, a lawyer who is an authority on the issues, wrote me:

EcoVest repeatedly asserts they are doing good things for conservation and that Congress, through tax incentives, has shown support for conservation. The DOJ action is not an attempt to interfere with meaningful conservation transactions.  It is an attempt to shut down the sale of interests in certain tax shelters. This is going to be a difficult task since the syndication easement tax shelter business seems to be thriving these days in spite of the DOJ action.

Need More Accountants Working For The IRS

An injunction is something of a blunt instrument.  If EcoVest’s deals are really that abusive, why aren’t deductions being disallowed across the board?  That would dry up their business pretty quickly.  In order to do that, though, you need revenue agents, who are accountants, to do the examinations.  And you need IRS lawyers to fight in Tax Court.  And the IRS headcount keeps going down.

I’m worrying that DOJ is becoming the go-to enforcement tool, but its actions by their nature are sensational.  Their part of the enforcement scheme is to make examples to intimidate people into getting on the right path.  But their reach is limited.  Only so many people read their press releases or the articles that are generated from them. It is audit action that creates the “word on the street” that will make people more cautious.

Other Coverage

Mark Meltzer has Atlanta real estate company fights charges of tax fraud in the Atlantic Business Chronicle.  It is pretty much based on press releases.

Chloe Johnson of The Post And Courier (Charleston SC) has $2 billion tax ‘scheme’ led by company that conserved 10,000 acres in SC, feds say.  She fleshes the story out very well from a somewhat local perspective.  Check it out.

Chole and I were the only people on the call with McCullough who asked any questions.  The moderator indicated that there were thirty other reporters on the call.  Go figure.

Vidya Kauri has something behind the Law360 paywall.