Originally published on Forbes.com.
The Justice Department is taking on abusive conservation easement syndications. A complaint was filed on December 18 in the Northern District of Georgia seeking an order stopping Nancy Zak of Forever Forests LLC, appraiser Claud Clark III, EcoVest Capital Inc and EcoVest officers Alan Solon, Robert McCullough and Ralph R Teal Jr. from “organizing, promoting, or selling an allegedly abusive conservation easement syndication tax scheme”. The complaint also seeks disgorgement of their “ill-gotten gains”.
Peter Elkind in an article in Fortune titled The Billion-Dollar Loophole identified EcoVest as the single most prolific syndicator of conservation easements. Elkind also reported that EcoVest has invested $1.13 million in lobbyists.
Easement Deductions – The Basics
The notion of a charitable deduction for conservation easements is pretty benign. The idea is that you have this nice cow pasture or woodlot or whatever, that is good for the environment or the critters or the scenery. Rather than develop the property you give up your right to alter it – the easement. You get a tax deduction for the value that you gave up, the difference between the “highest and best use” valuation of the property and its value as encumbered by the easement. The easement is given to a qualified not-for-profit, often a land trust, that is capable of enforcing it.
There is a lot of case law about conservation easements. There are two broad issues. One is technical flaws in the easements and how the transactions are executed. Reilly Fourth Law of Tax Planning – “Execution isn’t everything, but it’s a lot.” The other and more entertaining issue is valuation. Developing real estate, for example, building and marketing 300 units of housing on a 500-acre tract, is a risky complicated enterprise – one GD thing after another. The hypothetical developments posited by appraisers of conservation easements run much more smoothly.
Why Syndication Of Easement Deductions Makes No Sense
In principle, you should not be able to make a business out of buying property with the tax savings from granting conservation easements for it. In order for it to work, you would have to be buying the property from very silly people who had no idea what it was really worth or you would have to be fibbing on the valuation. Let’s go with a 40% combined federal and state tax rate to make the math easy. Buy a parcel for $1 million dollars. Hold onto it for a year or so. Because you bought it right and this and that it is now worth $2 million as the site of a drugstore. As woodlot, it is worth a $100,000.
So you give a conservation easement to the Sylvan Eternal Land Trust agreeing to leave the land as a woodlot. Your tax deduction is $1.9 million which saves you $760,000. It’s great if you are interested in conservation, but if you are trying to make money, it is not so good. You, in effect, paid $240,000 for a $100,000 woodlot.
Say instead that the property went from $1 million to $4.5 million. Now you are talking. That creates tax savings of $1.76 million. You get your woodlot for free and a few hundred thousand dollars after the promoters rake in their ill-gotten gains.
That type of rapid appreciation can be just a little implausible, so what they will do is find somebody who has held the property for a long time. Rather than buy the property, a partnership is formed. The investors are then taking a tax deduction for somebody else’s appreciation. As a partnership tax geek, I have some concerns about whether that really works. As it happens, the complaint is taking more of a blunt force approach.
The Complaint
According to the complaint, the defendants’ abusive tax schemes have resulted in over $2 billion in deductions in 96 deals:
Defendants’ “conservation easement syndication scheme” – as described herein – encourages Defendants’ customers to “invest” in a conservation easement syndicate under the assumption that the syndicate will donate a conservation easement, claim a tax deduction for that conservation easement, and allocate a portion of that tax deduction to each customer who “invests” based on their “investment” in the syndicate. In reality, Defendants’ conservation easement syndication scheme amounts to nothing more than a thinly veiled sale of grossly overvalued federal tax deductions under the guise of investing in a partnership
There is a lot of detail in the eighty-page complaint, but it really boils down to two issues. The first is the obvious one of valuation. An example of that is “Partnerhsip Z”
The appraiser’s valuation of Partnership Z’s conservation easement was based on his determination of “market value” using a pre-determined highest and best use of a residential development. The appraiser ignored relevant comparable sales, used the incorrect standard for valuation, and otherwise used flawed assumptions and unsuitable data in reaching his opinion of value. As a result of these flaws, the appraiser’s valuation of the conservation easement exceeds by 200 percent or more, the correct value of the conservation easement.
Investors got $4.76 in deduction for every dollar invested.
There is a more subtle, less obvious issue that I have not seen in any conservation litigation yet. As noted above the deals involve the investors becoming partners in a partnership. A fundamental requirement for the existence of a partnership for tax purposes is that the entity will carry on business and divide profits. And that is just not happening in these deals.
The complaint explains the eleven-step process involved in delivering deductions to investors. Crucial is the formation of a partnership that can allocate a deduction to the investors. That’s where things break down.
Among other things, Defendants Zak, EcoVest, Solon, McCullough, and Teal knew or had reason to know that the customers were not entitled to the
charitable contribution deductions claimed because:
a. The conservation easement syndicates exist solely as a conduit for selling tax deductions;
b. The conservation easement syndicates are shams;
c. The conservation easement syndicates lack economic substance;
d. The conservation easement syndicates are not organized for the purpose of carrying on of a business or joint venture;
If these things ever get litigated it would make me and probably Tony Nitti feel good, if they dove into Section 704(c), but that is probably too much to hope for.
Comments
In the news release , there was some tough talk from Justice and IRS
“The Department of Justice is working with our partners in the Internal Revenue Service to shut down fraudulent conservation easement shelters, which in this case were based on willfully false valuations,” said Richard E. Zuckerman, the Tax Division’s Principal Deputy Assistant Attorney General. “Individuals investing in these schemes with benefits that seem too good to be true should ensure they are paying their proper federal income tax liability.”
“When it comes to aggressive transactions marketed by unscrupulous advisors, we will take every enforcement option available, including civil and criminal penalties,” said Internal Revenue Service Commissioner Charles P. Rettig. “Cheating on your taxes will not be tolerated.”
I got an off the record comment from a businessman who had recently been looking into investing in one of these deals (from a different promoter) and decided to pass. He told me “There was not a single person who I spoke to who understood what they were who thought they should exist …” I have to say that before this announcement I would have told somebody who asked me about investing in one of those things, that I didn’t think they should work, but there is a good chance that they would. At least for the moment, more seems to be right with the world.
Stephen Small, an attorney who consults for legitimate land trusts wrote me:
The sale of abusive and fraudulent conservation easement tax shelters needs to stop. These schemes are based on grossly overvalued appraisals. This abuse has been going on far too long and has cost the taxpayers far too much. I hope the Justice Department and the IRS can work together and put a hard stop to these abusive transactions.
Other Coverage
Richard Rubin reported Justice Department Sues Over Conservation Easements for the Wall Street Journal.
The move is the government’s most public and aggressive action against the sponsors of the transactions known as syndicated conservation easements.
Trackbacks/Pingbacks