On September 13, 2021, the United States House Ways and Means Committee announced a proposal to limit charitable deductions for contributions to conservation easements made by partnerships and other flow-through entities. The proposal, which targets syndicated conservation easement transactions, would ban a taxpayer’s charitable contribution deduction when it exceeds 2.5 times the taxpayer’s modified base in the flow-through entity. The proposal also addresses the application of the accuracy penalty and limitation period to conservation easement transactions. If passed, the House’s proposal would make it considerably more difficult for taxpayers to prevail in cases involving conservation easement transactions.
Context of Syndicated Conservation Easements and IRS Enforcement Efforts
Under Section 170 of the Internal Revenue Code (IRC), a taxpayer is entitled to a charitable deduction for contributing a qualifying real estate interest to a qualifying organization exclusively for custody purposes. A taxpayer’s charitable deduction is generally limited to 50% of their adjusted gross income. Developers and advisers have established unionized conservation easements to circumvent deduction limitations for individual taxpayers. In the typical syndicated custodial easement transaction, a flow-through entity is established to acquire real estate, and investors acquire an interest in the flow-through entity in exchange for a commission. The flow-through entity then grants a conservation easement to a tax-exempt organization, such as a land trust. Under the tax provisions relating to partnerships, the deduction for the charitable contribution of the entity is transferred to the investor partners. In some cases, syndicated conservation easement transactions produce charitable deductions that far exceed the amounts invested in the flow-through entity.
The IRS has actively pursued abusive conservation easement transactions for over a decade. In Notice 2017-10, the IRS identified syndicated conservation easement transactions as listed transactions that expose taxpayers to increased reporting requirements and increased penalties. In November 2019, the IRS announced a coordinated campaign to target syndicated conservation easement transactions. In June 2020, the IRS made a time-limited settlement offer to taxpayers with matters pending in the Tax Court. The IRS has successfully argued conservation easement cases in Tax Court and continues to identify new cases for audit.
Summary of the house proposal
The House’s proposal would significantly limit the use of unionized conservation easements. If adopted, it would provide the following:
Disallowance rule. The deduction for a taxpayer’s charitable contribution would be disallowed when it exceeds 2.5 times the taxpayer’s modified base in interest in the flow-through entity.
Exception when the three-year holding period is satisfied. The disallowance rule would not apply to conservation contributions when the three-year holding period is met. The holding period is satisfied three years after the latest of the last date on which the intermediary entity acquired part of the property subject to the conservation easement or any partner / member acquired an interest in the intermediary entity. .
Exception for certain family partnerships. The House proposal provides for a limited exception to allow contributions made through family partnerships.
Application of the precision penalty. The House’s proposal confirms that the accuracy penalty would apply to any underpayment attributable to the rejection of a conservation easement transaction under the proposed rule. Such a refusal would be considered a gross valuation anomaly, and a penalty equal to 40% of the underestimation would apply. There would be no reasonable cause defense against the 40% accuracy penalty. Finally, the IRS would not be required to obtain surveillance approval under IRC Sec. 6751 (b) before assessing the accuracy penalty.
– For returns filed for partnership tax years beginning before January 1, 2018, the tax may be imposed on the partners within two years of the date on which a final administrative adjustment of the partnership cannot no longer be sought in the United States Tax Court.
– If a conservation easement deduction is denied under this proposal, it will be considered a listed transaction that must be disclosed to the IRS. Therefore, the limitation period for valuation does not expire until one year after the earliest of the following dates: (i) the date the transaction is disclosed to the IRS; or (ii) the date a significant adviser meets the disclosure requirements under IRC Sec. 6112.
Effective date– The House’s proposal would be made retroactive for all transactions made after December 23, 2016 (i.e. the date of Notice 2017-10).
It remains to be seen whether the House’s proposal will pass, but it appears to have bipartisan support. In the meantime, the IRS continues to identify, verify and aggressively advocate cases involving consortial conservation easements. Taxpayers who have invested in conservation easement transactions should consult their tax advisor to understand how current legislation and ongoing IRS enforcement efforts affect them.
Co-written by Jennifer A. Vincent
© 2021 Greenberg Traurig, LLP. All rights reserved. Revue nationale de droit, volume XI, number 263