If you have been longing for a clear explanation of how syndicated conservation easements work and why it is that they don’t really work it is now available in the form of an opinion by Judge Albert Lauber of the Tax Court – Oconee Landing Property, LLC, Oconee Landing Investors, LLC – TC Memo 2024-25. Syndicated conservation easements represent an industry based on nonsense. The nonsense is the idea that an easement on property can be worth more than the property itself.
The Industry Perspective
Robert Ramsay President of Partnership (P4C) laid out the view that the value of a conservation easement could be greater than the value of the property itself. He wrote an article published in TaxNotes on April 27, 2020 – A Dirty Dozen Myths About Conservation Easements and One Sad Truth. On valuation he wrote:
“Myth 7: A conservation easement’s value cannot exceed the current value of the land.
Reality: A conservation easement’s value is the value of the development rights that are forfeited in perpetuity when an easement is placed. Treasury’s own regulations require that these rights be valued based on the land’s highest and best use. When the existing state of land is different from its highest and best use, giving up the opportunity to develop the land forgoes substantial value. It is that value that the law permits as a deduction.”
I always thought that was just not so and I do have some support for that view. In Boltar LLC the Tax Court ruled:
“The concept of “highest and best use” is an element in the determination of fair market value, but it does not eliminate the requirement that a hypothetical willing buyer would purchase the subject property for the indicated value.”
Regardless the view expressed by Ramsay is still somewhat pervasive. I was speaking to an Atlanta lawyer recently about a totally unrelated story, but he indicated that he had invested in one of the easement deals and was sweating it out. He did mention however that his buddy had emphasized that the courts have not yet ruled on the issue of whether an easement can be worth more than the value of the land that it encumbers. Well it looks like Judge Lauber may have filled that hole.
The Property
The case is about the allowable charitable contribution deduction for the 2015 donation of an easement on 355 acres of raw land in Greene County Georgia to the Georgia-Alabama Land Trust. The land was part of of 1,130 acres that was referred to as the “Carey Station Tract” that was acquired by James M. Reynolds III and Reynolds Partner LP which is controlled by his cousin Mercer Reynolds. The Reynolds family has been prominent in Greene County for generations. Mercer played a prominent role in the 2000 and 2004 Presidential campaigns of George W Bush and served as American Ambassador to Switzerland and Liechtenstein.
Reynolds family interests owned a lot of land in Greene County and around 2007 they were doing exciting things with it under Mercer’s leadership. Family tracts on Lake Oconee became Reynolds Plantation, a nationally renowned golf community. Mercer was then considering a massive development on Jekyll Island. Things were different in 2011 as J. Scott Trubey and Bill Torpy related in At Reynolds Plantation, a vision comes together, then falls apart in the Atlanta Journal-Constitution.
“Like many others with bold dreams, Reynolds was a casualty in the real estate collapse. While there may have been more spectacular financial stumbles, few have been more surprising, given the Reynolds family’s large holdings, solid reputation and deep political and business connections.”
Reynolds Plantation went into receivership and ended up being owned by MetLife along with other land. What remained in their hands was the “Carey Station Tract”, which Judge Lauber refers to as the “Parent Tract”. It was the most significant remaining piece of Reynolds real estate in Greene County and the focus of their development efforts after 2011. Due to various sales over the years the tract was down to 1,038 acres in February 2013 when Mike Kelly president of Reynolds Development Management Group did an analysis of what might be done with the tract. His conclusion that the net present value from disposing of various pieces at prices ranging from $12,500 to $100.000 per acre over ten years was between $1.78 million and $4.27 million.
They began trying to sell the entire tract asking $7.9 million and by September of 2013 $6,7 million. An appraisal in June 2014 connected with seeking a release from the lender to sell a portion of the Parent Tract, now 1,025 acres, came in at $8,075,000. In early 2015 they authorized real estate broker Ted Baker the right to offer the entire Parent Tract, now 960 acres for $7.7 million ($8,000 per acre). Nothing came of that.
So they began to investigate the possibility of “wringing cash” from the Parent Tract by granting a conservation easement.
Wringing Cash
I remember one time coming up with an idea that was sort of outrageous and somebody mentioning that it did not pass “The Sixty Minutes Test”. Let’s try this one on. The Reynolds want at least $7 million for the parent tract. They can’t find anybody who wants to pay them that. So instead they will find appraisers who will say that the property is worth $60 million and they will get their $7 million from investors who will get roughly twice what they pay in reduced taxes thanks to a charitable deduction of an easement based on that valuation.
How could sophisticated real estate developers think that that actually worked? Well they brought in a company with strategic capital in its name, of which there seem to be many. Judge Lauber calls them SCP for short. The principals were Ricky Novak and James Freeman. Mr. Novak had been the chair of the Atlanta Bar’s Real Estate Section. Mr. Freeman had been Chair of the Board for the Georgia Society of CPAs. They went to work on the deal in early 2015.
The numbers evolved as things moved along. Some parcels were pulled out of the deal which lowered the target a bit.. And a decision was made to divide what was left into three separate parcels. That is why this opinion is ultimately talking about 355 acres valued at just over $20 million. In December 9, 2015 private placement memoranda (PPM) were issued for the three separate deals. The one for Oconee Landing called for 95 units at $49,000 per unit. Judge Lauber does the math to show that the investors were, in effect, paying less than $12,500 per acre.
The three entities together raised $11,856,000. The Reynonlds interests received $5,137,500. $3.75 million went into the companies as capital contributions and operational reserves. My inference is that is where the fees for this litigation are coming from. $2,723,500 went to the promoters, appraisers and others who made this all happen.
The Opinion
There were four issues for Judge Lauber to decide. IRS argued that the charitable contribution should be disallowed because there was no donative intent. Had Judge Lauber been from Georgia he might have said “Well that dog won’t hunt” instead he wrote:
“Oconee executed a valid deed of easement that conveyed property to GALT, a charitable organization recognized by the IRS as tax exempt under section 501(c)(3). The property thus conveyed had value: Respondent agrees that the easement accomplished valid conservation purposes, and his expert placed upon the easement a value close to $5 million.”
That was the end of the good news for the taxpayers. Judge Lauber agreed with the IRS that there was no deduction because there was not a qualified appraisal attached to the return. This was not some nit-picking clerical thing. Rather it was that there was an understanding that the appraiser had a target value they were shooting for. And the donor knew that that value was an overstatement.
“…..we conclude that the Reynoldses knew that the Parent Tract in 2015 was worth considerably less than $10 million. They may have believed that the property had considerable intrinsic value and might ultimately be developed into the Reynoldsboro of their dreams. But they were shrewd, experienced, and highly sophisticated real estate developers. Whatever the property’s future potential, they knew that, as of late 2015, the current market value of the Parent Tract was considerably less than $10 million.”
The next problem was technical. The entity that transferred the property to the investment entities was a developer. When developers sell land it is generally not a capital gain. And the deduction for appreciated property is limited to basis for ordinary gain property. Then to really rub salt in the wound Judge Lauber rules that the taxpayers have not offered any proof of what their basis was making for a deduction of zero.
Judge Lauber still has to review the competing appraisals to determine whether there is an overstatement large enough to qualify for the 40% penalty – a gross overstatement. He did in fact find the overstatement to be gross. It is worth noting that the taxpayers did not raise the argument that valuation of property for purposes of determining the value of an easement is somehow different. The taxpayer appraisers argued that the highest and best use was “immediate development as a mixed-use residential committee”. The IRS appraiser claimed that the highest and best use was “a speculative hold for future mixed-use development”. Judge Lauber agreed with the IRS appraiser.
“In short, at year-end 2015 the Subject Property (comprising 355 acres) was surrounded on three sides by more than 2,000 acres of undeveloped land. Much of this acreage already had CPUD zoning and had desirable features the Subject Property lacked. Most of this acreage was owned by sophisticated, well-capitalized investors who had established reputations as developers of existing communities in the area. Yet all of these developers were taking a decidedly “go slow” approach to development. Given that Greene County had issued only 203 new residential housing permits in 2014 and only 224 in 2015, that “go slow” approach was surely rational in economic terms.”
The difference in HBU dictated the difference in comparable sales. In the end the easement was worth less than $5 million making the $20 plus million taxpayer valuation a gross overstatement.
Reactions
Steven Small is an authority of private land protection. He has been a critic of syndicated easements. He wrote me:
“I applaud Judge Lauber’s ability to see this transaction for what it was – an abusive tax shelter. As Judge Lauber noted in his opinion, ‘ reached an advance agreement with that the Subject Property would be significantly overvalued.’”
Lew Taishoff covered the opinion in a piece titled Four-To-One.
He quotes a passage about the alternate investment strategy that the investors could, in principle, have selected, including:
“The Court finds as a fact that the purported ‘investment strategy’ was not a viable business proposition, that it was never intended to be implemented, and that it was included as ‘window dressing’ in an effort to obscure the character of the transaction as a tax shelter”
Mr. Taishoff’s parrting shot is:
“There’s a lot more, but it comes down to the anatomy of a tax dodge.
Maybe it’s time for IRS to bar some practitioners, as they did when the façade easement dodge collapsed.”
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Originally published on Forbes.com.
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