As somebody who believes that the syndicated conservation easements (SCE) constitute an industry based on nonsense, I want to be able to tell you that if you are offered the chance to participate in one, you absolutely should not. I can’t really do that though. There is a reason for this. The best prospect for an SCE investment is a HENRY – High Earnings Not Rich Yet – and not long ago I looked into what tax planners can do for Henry (or Henrietta of course – have to find a better acronym).
Not That Much To Do For Henry
There is an exercise I go through for myself not long after Thanksgiving every year. I really recommend it for most everybody. You sit down and add up what you have for income and deductions and project what your likely tax liability is. One reason is so that you have the cash ready when you need to pay it. The other is because you can do a lot more to change things before the year is over than you can do afterwards.
Good tax advisers will do this for their clients almost reflexively. The smart ones get clients to recognize the value and pay for it. And they are like to provide Henry with significant value. Only it is not really magical. I had a Henry who was thinking about SCE call me up and I was a little embarrassed that I could not come up with anything else for him to consider, that was not already covered. Of course I am no longer actively practicing and my writing with its focus on court opinions is necessarily behind the curve. So I reached out to more active tax practitioners with this question
#tax – If someone has a big W-2 (500k plus) but no influence over employer or net worth, what can they do beyond 401(k) to manage tax liability?
— Peter Reilly (@peterreillycpa) November 18, 2019
The only exciting answers I got assumed away my constraint that Henry had no influence to speak of over their employer. Some of the suggestions were way off, like setting up a donor advised fund. Somebody in their mid thirties to early forties making $500,000 per year who still has a few hundred thousand dollars in student debt is not ready to focus on philanthropy.
Nothing compared to a simple straightforward SCE investment like the one offered by WealthPrime came up. They offer a 4 to 1 charitable write-off on your investment. Keeping the math easy they use the example of somebody in California so a $50,000 investment buys you $100,000 in tax savings. I spoke with Wealth Prime Founder Dan Harding and he indicated they still have 2022 deals available but you have to act quickly. Ratio CPA recently posted an article Does Syndicated Conservation Easement Deserve to be on the IRS “Dirty Dozen” List?. I was unable to get through to them. Their advice about the valuation multiplier is that it should not be higher than 5. At a multiplier of 5 you could get $100,000 in savings for $50,000 even if you live in Florida. Ratio CPA seems to have other secret sauces that the rest of the profession is missing out on.
Should You Do It ?
If you or your tax adviser have run the numbers and made sure you have done all the boring stuff like maxing out your 401(k) and maybe bunching your itemized deductions so that you are sure that the SCE deduction will really save you, should you go ahead and do it? In stark terms, say you have the $100,000 and you can pay it in April or give Wealth Prime $50,000 now and have the other $50,000 to keep. Or maybe it is $300,000 versus $150,000. We will stick with the former for illustrative purposes.
If you are going to go ahead, the wise thing to do is make sure you use a substantial firm to prepare your return, because despite the recent taxpayer victory in Green Valley Investors LLC, the IRS is doing everything in its power to have these deals continue to be listed transactions. You may have a little difficulty there, because a lot of practitioners don’t want anything to do with these things.
The risk that you run is that sometime in the future you will get a bill from the IRS for as much as $140,000 plus interest. Then you get to compare that to whatever your $50,000 net saving turned into. Of course if things have gone very badly for you, you may be able to work the collections system. There are also law firms specializing in class action lawsuits against the various promoters and enablers of these transactions. So maybe you recover something there.
Are you the sort of person that can live with the tsoris, the agita, of that tax exposure hanging over your head like the sword of Damocles for more than a decade? Recently the Tax Court issued an opinion in the Champions Retreat case. The SCE industry celebrated the decision as a $7.8 million deduction was allowed while the IRS had only wanted to allow $20,000. The original deduction was $10.4 million on the 2010 return. I am not sure whether the investors are celebrating.
Assume for the sake of argument that a Champions investor, let’s call them Henry Champ (HC), was on a 4 to 1 deal with a 50% rate and saved $100,000 in exchange for a $50,000 investment. Thanks to this big win, they get 75% of the $100,000 or looking at it pessimistically, they now have a $25,000 deficiency. According to this calculator, you can tack almost $14,000 in nondeductible interest onto that. It is not clear at least to me whether there are penalties. Also to be optimistic let’s assume the investors did not have to kick in for the cost of the litigation.
Now if HC did something really smart with the $50,000 they are ahead and maybe they are celebrating, but that is not the way it works for a lot of people.
They Might Be Legit
The Senate Finance Committee report on syndication easements provided this framework.
This report finds syndicated conservation-easement transactions to be transactions designed to provide tax deductions to high-income taxpayers by way of (1) inflated appraisals of undeveloped land through (2) partnership entities that appear to serve no non-tax business purpose for existing other than the provision of tax deductions. Where the report describes appraisals as inflated, it does so because those appraisals value property at multiples of what transaction promoters or their investors paid to acquire ownership interests in that property, as is discussed in this report.
The value of an easement is the fair market value of property before the easement less the value of the property as encumbered by the easement. The industry argues that the procedure for determining the before FMV is different in the case of the easement. It is not. Given that the market for undeveloped land, imperfect as it may be, is not populated with idiots, promoters cannot routinely acquire properties and have them in relatively short order be worth a multiple of what they acquired them for.. That’s why I think the industry is based on nonsense.
I cannot however rule out that there may be some deals out there like Champions Retreat or Kiva Dunes, which more or less inspired the industry. There you have owners who have owned the property for a very long time and want to continue it in its existing state. The owners, however, are sort of land poor and can’t take advantage of the big built-in deduction so they are in effect inviting you to partner with them. In those cases maybe the appraisal is legit, which is not to say there are not other possible issues. And frankly you probably won’t be able to discern the potentially legit ones from the others.
Bottom Line
Putting aside any moral issue, investing in an SCE in the end is a sort of gamble. You are betting on the industry lawyers and lobbyists versus the IRS. Even if the IRS overall wins, there is some chance that your deal might slide by. There is an entirely new partnership audit regime in effect and nobody knows how it will actually work in practice. I’m going to still refer you to Reilly’s Second Law of Tax Planning – Sometimes it’s better to just pay the taxes. But if you go for it, I can’t tell you you are for sure wrong.
Originally published on Forbes.com.
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