Originally published on Forbes.com.
The Brookings Institution, which, according to Wikipedia is described as liberal, conservative or centrist, depending on whom you ask, has taken on the issue of charitable contribution of conservation easements with the publication of a paper by Adam Looney. Easement contributions can garner bipartisan support because they are tax breaks for the wealthy that purport to be of service to conservation and historic preservation. People get tax benefits for not doing things that they did not want to do anyway or, in the case of the scoundrels, could not have done.
Make Golf Great Again
Conservation easements seem to be in favor with President Trump. A 94-page list of Trump charitable contributions starts with Various Conservation Easements – $63,825,000, which represents well more than half of the lengthy list’s total. In an article in Golfweek, Bradley Klein and Martin Kaufmann discuss the implications of a Trump presidency for the sport, if you can call it that. The golf industry now has “an informed advocate at the highest rung of government”.
They quote Jay Karen, CEO of the National Golf Course Owners who among other things hopes for better treatment of golf course conservation easements. He commented, “We should not be disqualified just because we are golf”. In my view, they should, but that’s just me. And President Trump seems likely to lean Mr. Karen’s way. On the other hand, Trump did make a cryptic remark that implies that he might not think that highly of conservation easements as a matter of policy, More on that in the other coverage section at the end.
About Easements
Generally to get a charitable deduction for giving away property, you have to actually give it away. You can however get a deduction if you give a “qualified organization” a “qualified real property interest”, which includes “a restriction (granted in perpetuity) on the use which may be made of the real property”. The gift has to be “exclusively for conservation purposes”. The regulations flesh out the details. A “qualified organization” has to have a commitment to protect the conservation purposes of the donation and have the resources to enforce the restrictions. Conservation purposes include preservation of land areas for outdoor recreation by or education of the general public, protection of “relatively natural” habitat, preservation of open space and historically important land area or a certified historic structure.
So you get to take a charitable contribution not for giving up anything you are actually using, but rather for promising not to change the way you are using something and making that promise legally enforceable on you and future holders of the property. And the deduction is even better than a standard charitable deduction. Normally deductions of appreciated property are subject to a 30% adjusted gross income limit and unused deductions are carried forward five years. Conservation deductions are subject to the 50% limit, same as cash, and have a fifteen year carry-forward. In the right circumstance, farmers and ranchers can have a 100% limit.
The Problem
There are actually two big problems. The first, which we will pass by for now, is that some of the “qualified organizations” are a little on the sketchy side. More significant though is the valuation issue. Conservation easements are generally not bought and sold, so they have to be valued indirectly. The value of the easement is the value of the property at its highest and best use (i.e. what will bring the owner the maximum economic return) less the value as encumbered by the easement.
In the case of the facade easements on structures in historic districts, a position had been developed that the easement had to be worth something – say ten or maybe fifteen per cent of the property’s fair market value. Eventually the IRS and the Tax Court made it clear that a facade easement on a property that already had a lot of restrictions could be worthless. I compared those type of easements to me renouncing my super powers.
It is in the country with the larger tracts, that room for imagination can really take hold. I have written about hypothetical gravel mines and vineyards that formed the basis for high pre-easement valuations, but probably the most common form of fantasy is the subdivision development analysis. Anybody who has actually been involved in the development of real estate, even tangentially as I have been, will tell you that it is a series of one GD thing after another as problems with zoning, financing and construction will crop up along with market fluctuations. In a hypothetical development for conservation easement purposes it is much, much easier as various obstacle are assumed away on the road to great fortune. Professor Nancy McLaughlin wrote:
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
In other words, sometimes the highest and best use of a farm is, you know, farming.
The Brookings Paper
Adam Looney is now a Senior Fellow in Economics Study at Brookings. His most recent position was in the Treasury Department as Deputy Assistant Secretary for Tax Analysis. He told me part of his role there was similar to the role played by the Joint Committee in assessing the cost of various tax expenditures. In its most recent scoring of tax expenditures the Joint Committee lists the conservation easement deduction as one that cannot be scored. Mr. Looney’s report cited IRS estimates for a total of deductions for charitable contribution of conservation easements of $3.2 billion in 2014. When I spoke with him the thing that he thought was most remarkable was that the deduction was only claimed on about 2,000 returns.
Also remarkable is the concentration of the deductions. Between 2010 and 2012, 25 organizations received half the dollar value of conservation easement deductions. There are about 1,700 land trusts nationwide. He singled out Foothills Land Conservancy of Maryville, TN. Mr. Looney cites the Foothills Form 990 which shows four employees spending $19,000 to monitor 19,600 acres of easements it maintains in five states. (I don’t get the exact same details looking at the 990 myself, but it is close enough). The $236,689,500 in value of easements received by Foothills in 2013 was one fourth of the total value of deductible conservation easements. Mr. Looney noted that many exempt organizations do not report the value of easements as donations on Form 990, a practice that Foothills apparently switched to in subsequent years. The rationale, which I find pretty reasonable, is that the easements don’t provide resources with which the exempt organization can operate.
I spoke with Bill Clabough, the executive director of Foothills. He said that he did not think the way his organization is portrayed in the report is a real apples to apples comparison with a group like the Nature Conservancy. Because it is regional, it is able to run very lean. He regularly drives by one of their 4,000 acre sites on an exit off Route 40. He is very proud of the 90,000 acres that Foothills has protected. My own assessment is that although there are sketchy conservation groups, Foothills isn’t one of them. Rather they are blessed to be in an area rich in preservation opportunity and organized to run lean. Mr. Clabough was dismissive of the notion that there is much in the way of abuse in the whole field
One of the things discussed in the report is the syndication of easement donations, which is probably the biggest area of potential abuse. I have not been able to figure out how syndicating easements could conceivably work without inflated valuations.
Brookings Recommendations
Mr. Looney recommends that promoted syndications be considered a listed transaction, which will give the IRS a chance to get a better picture of what is going on. He also calls for greater transparency in Form 990 reporting of easement transactions. He also calls for tighter definition of what is a valid conservation purpose.
A more radical recommendation is to convert the tax benefit of the easement deduction to an allocated credit, which would place a limit on the revenue loss and perhaps make recipient organization pickier in the projects that they accept.
That’s How they Got Al Capone
In my discussion with Mr. Looney, I asked him about a tendency I have seen in the case law. There are quite a few “gotcha” cases. Recently decided, for example, was Ten Twenty Six Investors, one of the many facade easement cases involving the National Architectural Trust. The taxpayers were denied a 2004 deduction because NAT had not gotten around to recording the easement until 2005. This is a great illustration of Reilly’s Fourth Law of Tax Planning – Execution isn’t everything but it’s a lot.
In Mr. Looney’s view it is a matter of the IRS making efficient use of scant resources. It is very expensive to fight the appraisal battle, so if a sketchy easement deduction can be disallowed because of a technical error, so much the better. It does, however make for excessive process. Gordon and Lorna Kaufman had their deduction denied because of problems with language. They took it up to the First Circuit which reversed the Tax Court. Back down in the Tax Court the easement was found to have zero value.
Mr. Looney compared the IRS approach to convicting Al Capone of income tax evasion instead of more serious crimes. I have to say that it bothers me a bit.
A Few Bad Apples Or A Broken System
Mr. Looney’s view, which I tend to share is that there is a serious fundamental problem with conservation easement charitable deductions:
My sense is that many people in the conservation community want to believe that there are only a couple bad actors that are threatening to ruin it for everyone. It’s true there are bad actors, but I think the problem is much more pervasive, and intrinsic to the incentives of the deduction. So most of the back and forth starts with one side saying “just catch the bad guys and leave us alone.”
Richard Rubin did a piece on the Brookings report in the Wall Street Journal (Sorry that may be behind a pay wall. I finally broke down and started paying for WSJ). That elicited a response from the Land Trust Alliance which issued a statement in the form of a letter from President Andrew Bowman. It expresses the “bad apples view”:
While we believe this analysis misses the mark, we acknowledge there exists a small group of bad actors seeking to profit off charitable donations. That’s why the Land Trust Alliance has long stood against these bad actors — and why the IRS recently took actions to weed out abuse.
The Alliance will continue to advocate for this widely beneficial and extremely cost-effective tax deduction that’s proven to save the places people need and love. We are emboldened by all we’ve accomplished together to date, and the entire land trust community must remain vigilant against profit-seeking promoters who may not be deterred by media attention, think-tank reports, IRS audits or penalties.
A small point on that might be that you really can’t call a deduction cost-effective if the Joint Committee isn’t even scoring it. The fundamental problem with the deduction is that it is something of a free lunch and that there will be a natural tendency for a race to the bottom when it comes to appraisal quality.
On the other hand, I love what the land trusts are doing and as long as the IRS is underfunded, the scoundrels will be able to find a weak point in the system somewhere.
Other Coverage
Wealth Strategies Journal noted the issuance of the Brookings report without much in the way of comment. Kavya Vaghul of the Washington Center for Equitable Growth did a piece on the Brookings report which opened with a quote from President Trump that seemed to express skepticism about conservation easements – “they have a deduction for birds flying across America”. This appeared to be a reference to the Kiva Dunes decision. Ms. Vaghul concluded:
Conservation easements are just another example of the inequities inherent in the federal tax deduction for charitable contributions. Finding ways to limit the abuse of conservation easements can not only preserve the progressive federal tax system but also more honestly create safe habitats for those migrating birds across America.
Mr. Looney mentioned Kiva Dunes to me as particularly egregious, because it was a case of someone developing pristine property increasing its economic value and then getting a large conservation easement deduction for not developing it further.
Julie Havlak had something in the Independent Journal Review that in my view sensationalizes the Brooking report:
The abuse of conservation tax breaks is cheating taxpayers of billions of dollars. Instead of protecting the environment, conservation tax deductions are often protecting golf courses, resorts, and backyards, according to a new study.
She has a number for lost tax revenue, which I think she got from a deduction number, although that is not really clear.
Wealth Strategies Journal had a brief mention of the Ten Twenty Six Investors decision. Lew Taishoff, who covers the Tax Court more thoroughly than anyone, had The Race To the Courthouse Door, which covered the technical aspects of the Ten Twenty Six decision:
An architectural easement is what we dirt lawyers call an “easement in gross.” That is, one not connected to adjoining property. For example, my right to drive over your driveway if we live next door to each other is an “easement appurtenant,” that is, part of my right in my land, which I can pass on to anyone else who gets title to my land. An easement in favor of a 501(c)(3), which doesn’t own any land anywhere, over your building is an easement in gross, and not enforceable at common law in Our Fair State.
Of course there are exceptions, and the recording statute, among others, bails out the grossers. Our Environmental Conservation Law does, but Ten Twenty Six is loudly protesting their easement wasn’t created under that law, because then their easement would require recording to be effective.
………………………….
We wouldn’t have gone behind NAT’s back, says Ten Twenty Six. OK, says Judge Iron Mike, you could have disremembered to tell either NAT or your buyer about the easement, and that’s not so remote as to be negligible.
I shall not, in a blogpost meant for family reading, repeat the old joke about the translation of the words “trust me, trust me.”
No recording in the right year, no perpetuity, no deduction, 40% chop. Gross.
Mr. Taishoff is even older than I am, so he will sometimes have pop culture references that I don’t get. The “trust me, trust me” one falls in that category.
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