Originally published on Forbes.com.
Somebody does not want the IRS poking too hard into abuses of President Trump’s favorite charitable tax dodge. A 94 page list of Trump charitable contributions leads with “Conservation Easements – $63,825,000”. And the House Appropriations Committee is letting the IRS know that it should not be spending any money on an initiative to look into abuses in that area. Whether there are dots that can be connected here remains to be seen, but it does strike me as a little odd.
Appropriation Committee Release
The House Appropriations Committee is proposing to cut the IRS budget again. To add some insult to the injury, they threw in some specific prohibitions on spending any of the money on certain things. Mostly it was stuff related to the interminable scandal, the existence of which is something of a required act of faith in some circles. Here is the list of prohibitions from the committee’s press release:
A prohibition on a proposed regulation related to political activities and the tax-exempt status of 501(c)(4) organizations. The proposed regulation could jeopardize the tax-exempt status of many nonprofit organizations and inhibit citizens from exercising their right to freedom of speech;
A prohibition on funds for bonuses or to rehire former employees unless employee conduct and tax compliance is given consideration;
A prohibition on funds for the IRS to target groups for regulatory scrutiny based on their ideological beliefs;
A prohibition on funds for the IRS to target individuals for exercising their First Amendment rights;
A prohibition on funds for the production of inappropriate videos and conferences;
A new prohibition on funds to implement new IRS guidance on conservation easements;
A new prohibition on funds to determine church exemptions unless the IRS Commissioner has consented and Congress has been notified;
Most of the prohibitions are a rehash of the interminable scandal. The one about videos goes back to Day 234 by Tax Prof reckoning.
But conservation easements? What is that about?
Deduction For Conservation Easements
If you have property that you want preserved in its current form, that is conventionally viewed as somehow beneficial either because it is good for the critters or makes the world prettier, giving an easement to a qualified organization is as close as you can get to a free lunch in tax planning. The way your deduction is arrived at is by subtracting the value of the property as limited by the easement from its highest and best use value (i.e. what gives you the best economic return). If your property is already at its highest and best use, the easement is not really worth anything. But remember, we are talking about giving up the right to do something that you don’t want to do anyway. So use your imagination.
Maybe there is gold buried under my townhouse. But digging it up would disturb the squirrels that my covivant is always yelling at for eating all the birdseed from the squirrel proof bird feeders. So I’m going to give the Save The Squirrels Foundation an easement that prevents me from digging for that gold. There could be $20 million worth of gold down there, but I’m going to be conservative and allow for risk and the like and only deduct $10 million.
But what about those fascists who run the homeowners association? They will shut down my mining operation. OK. I’ll buy them off. So my deduction is only $9.5 million.
OK so it is not that bad, but there have been some pretty outrageous valuations tried and stopped by the IRS. One of my favorites was a hypothetical vineyard that didn’t have a water supply. It takes water to grow grapes. I mean who knew?
On the other hand, you will find that conservation easements have worked well in many cases allowing responsible land trusts to preserve important habitat and scenery.
But what about syndicated conservation easements?
Have I Got A Deal For You?
A small group of promoters are offering packaged conservation easements. I have not seen any of their presentations, but someone who has tells me that they are very slick. They might promise tax deductions as much as 250% or more of the amount invested. Bradford Updike, an attorney, is the only person I have spoken with who thinks it is possible for these things to be legitimate. He wrote Conservation Easements: The Federal Tax Rules And Special Considerations Applicable To Syndicated Transactions.
While the vast majority of conservation easement transactions involve private landowners, a cottage sub-industry evolved within the financial services market over the past decade that involves companies that syndicate real estate investment opportunities to retail investors that utilize conservation as a possible program investment purpose. These securities offerings are premised on a real estate investment transaction that involves the acquisition by an investor group of an interest in environmental sensitive real estate that is also developable or marketable as commercial real estate. This transaction is further supported with, in many cases, significant federal income tax deductions that apply to conservation easements and that may be allocated to the investor partners if a conservation purpose is ultimately adopted by the partners.
Putting this together with other observations on the industry, I suspect that the people selling the deals emphasize a charitable deduction that is a multiple of the amount invested with a wink and a nod to legal documents that indicate that there will be a vote of the investors before the trigger is pulled on the easement donation.
Mr. Updike, due to client confidentiality, could not tell me who the players in the industry are. He estimated that there are four of five regulated broker dealers doing the the deals and maybe twenty or so others who are doing private placements. He seemed to think that the private placements tend to be sketchier and the purpose of his article was to help people separate the wheat from the chaff.
I did find one operator bragging about one of these deals – Sandlapper Securities LLC
The Companies acquired approximately 3,077 of raw, unimproved land in Polk County, FL, Roane County, TN and Benton County, TN. Geological testing of the Florida properties determined the highest economic use for the owners would be to quarry/mine limestone from the land. The Tennessee properties are optimally placed for residential development. Instead of developing these properties, the owners have all chosen to give up ALL development rights on each parcel of land, thus preserving the land for future generations placing the properties into a Conservation Easement.
What I Tend To Think
I need to go just a little tax geeky on you here. If a deal ends up with investors after a year or two getting a charitable deduction that is a multiple of the amount invested, there are only three ways that can possibly have happened. They bought the property from an idiot who had no idea of its potential. That can happen, but you probably can’t create a business model around it. Another possibility is that they kind of fibbed on the valuation. Like a ten Pinocchio type of fib. Like liar, liar, pants in a thermonuclear explosion type of fib. Like the gold mine under my townhouse.
The third way is more complicated. They partnered up with somebody who had appreciated property who could not possibly use the deduction in his lifetime. The portion of the deduction that was attributable to built-in appreciation was allocated to the investors. I don’t think that can work applying 704(c) principles to the transaction. Since the donation is of something without basis, though, maybe it can seem to work. If the IRS adopts a hands-off attitude then it will work. If it is done that way, then maybe a one or two Pinocchio, liar, liar pants really hot type of fib on the valuation would make it work.
I Am Not Alone
I spoke with two other attorneys who work a lot with land trusts and have written some on the subject. They, along with many in the conservation field, believe that the syndications producing deductions that are a multiple of cash investment are bogus.
Steve Small who has been advising owners and land trusts for forty years told me that he has had clients sending him presentations to look at, because they seem to good to be true, offering to pay him to evaluate them. He told them that he would not have to charge them much. In a recent article in Tax Notes – A Modest Legislative Proposal to Shut Down Specific Tax Shelters, he wrote:
Those proposals are, of course, nothing more than old-fashioned tax shelters, dressed up in new clothes, that take advantage of tax code rules and appraisers who don’t just push the envelope, but make it disappear.
I spoke with Nancy McLaughlin of the University of Utah. She also does not think that deals that give investors a quick multiple can possibly be legitimate. She has another concern though that she fears people lose sight of. The abusive transaction on the front end may well be followed a few years down the road by abusive transactions that gut the easement allowing development to happen anyway making the whole exercise just a grab for tax benefits. She pointed to the story of billionaire Chis Cline and the Jackson Hole Land Trust in which the land trust claims a net gain for conservation, but having somebody endanger a species by building a cabin in the path of their migration route in violation of an existing easement is disturbing. (See Update)
And The IRS
The IRS finally responded to the growing problem by issuing Notice 2017-10 making some syndicated conservation transactions “listed transactions”. That is a really big deal. There were only 35 listed transactions before that going back to 1990. I’m not going to give you all the technicalities of something being a listed transaction. I’ll just give you the summary – Reilly’s 14th Law of Tax Planning – If something is a listed transaction, just don’t do it.
And Congress
Which brings us back to the beginning. The Appropriations Committee has effectively put the IRS attack on conservation easements in the same category as its mythical assault on free speech and grassroots conservative groups funded by billionaires. How did the cottage industry manage that kind of attention? Nancy McLaughlin and Steve Small think they did it the old fashioned way by paying huge dollars to lobbyists. One of my sources identified the Partnership for Conservation, which spent $60,000 in 2016 and $150,000 so far in 2017. Actually that doesn’t sound like that much, but so it goes.
I ran by Attorneys McLaughlin and Small the notion that the President might have had something to do with it given his fondness for conservation easements and his extensive use of them.
What About The President?
They were dismissive of that notion noting that President Trump was doing easements on his own properties – mainly golf courses, those great bastions of conservation values – and using the deductions himself. But of course, we don’t know that the President actually could use the charitable deductions himself, since he has not released his returns. That had me digging into the 2005 tax return that was so dramatically released by Rachel Maddow.
Of course, we only have the two pages. Round numbers there is adjusted gross income of $50 million and itemized deductions of $17 million. Because of the 3% carve-back, gross itemized deductions had to be about $18.5 million. On a return like Trump’s when it comes to itemized deductions, it likely boils down to two things – state income taxes and charity. The rest is likely noise. In 2005 charitable contributions of easements would still have been subject to a 30% AGI limit. If Trump had been subject to that limit that would have been $15 million which does not seem to leave enough left over for state income taxes, but we don’t know what the timing on the state income taxes was. The amount of the estimated tax payments as opposed to the amount paid with the extension indicates that 2005 was a much more expensive tax year than 2004 had been. So the amount actually deducted for state income taxes on the 2005 return would have been much lower than the ballpark of $5 million that you would have from the 2005 return.
It looks like the President may have lost some of the tax benefits of his easement deductions making the prospect of trying to syndicate them in the future attractive. So we can’t rule out administration pressure adding to the normal beltway banditry that is trying to give this set of promoters a free pass.
Bottom Line
Trafficking in conservation easements is a tax strategy that represents a bet on Congress continuing to dump on the IRS. If you are really interested in conservation, you might be well served to distance yourself from it as I can tell you anecdotally respectable conservation organizations are doing.
Other Coverage
David Herzig had something in The Surly Subgroup
If you did not know that Notice 2017-10 listed syndicated conservation easements, this provisions would seem pretty benign. But, this is rather a big deal. I can’t remember ever seeing a syndicated group who promoted a listed tax shelter getting a get out of jail free card from Congress. As I read the section, if enacted, this would stop the IRS from getting promoter penalties against the syndicators of listed conservation easement transactions. That seems like a rather big deal (I’m sure KPMG, Anderson and E&Y wish they would have thought of this about 10 years ago). I will keep looking into other implications.
Update
See the comment section for a more extensive discussion of the Jackson Hole story. Pete Lawton, Chair of Jackson Hole, wants to make it clear that the owner who built the cabin was not the original grantor of the easement and that he was willing to tear the cabin down if an agreement was not worked out. Regardless of the particulars of that case though, Professor McLaughlin’s issue about future easement enforcement is a valid one.
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