By Kenneth H. Bridges, CPA, PFS March 2020
“Syndicated conservation easements” have been the tax shelter du jour (especially amongst Georgia residents) for more than a decade now (in fact, we were first approached about these at least 18 years ago). Their popularity really seemed to take off after a big taxpayer win at the Tax Court in 2009 (Kiva Dunes Conservation) in a case involving a developer who granted a perpetual conservation easement, keeping property as a public golf course which otherwise could have been developed as residential lots. In the Kiva Dunes case (for which the tax year was 2002), the taxpayer claimed a deduction of $30.6 million, the IRS sought to disallow the deduction entirely, and the Tax Court allowed a deduction of $28.7 million.
Since the Kiva Dunes decision in 2009, the conservation easement cases have largely gone against taxpayers, and we note that it takes quite some time for a case to make its way to the Tax Court (e.g. the four cases in which the Tax Court most recently issued rulings involve tax years 2010 – 2013, and there are cases docketed with the Tax Court for even earlier years than that).
The Tax Court has issued rulings in the past few months in four conservation easement cases. Below is a brief synopsis of each.
- TOT Property Holdings, LLC v Commissioner – In its December decision in TOT Property Holdings, the Tax Court disallowed the deduction entirely because it found that the “perpetuity requirement” was not met because of how proceeds from sale of the property would be shared if the easement were ever extinguished judicially. The Tax Court could have stopped there, without giving consideration to whether the highest and best use value claimed by the taxpayer was reasonable, but the court went on to consider value because if the value were found to have been significantly overstated then the 40% gross valuation misstatement penalty would apply, rather than the general 20% accuracy-related penalty. The Court found that the value of the conservation easement was $486k, not the $6.9M claimed, and, accordingly, asserted the 20% accuracy-related penalty on the $486k and the 40% valuation penalty on the next $6.4M. The taxpayer had claimed that the highest and best use of the property was as a residential development for mountain resort homes, and the taxpayer’s appraiser used as comparable sales properties which had mountain and lake views. However, the subject property was not in the mountains and had no lakes, and nearby residential developments had failed. The Court also noted that the property was at least 32 miles from any interstate highway, had no public access water, and no hospital in the county. Accordingly, the Court agreed with the IRS’ appraiser that the highest and best use was recreational and hunting. The Court noted that the conservation easement syndicate had paid only a little over $1M for a 99% interest in the property, and thought that was likely the best measure of the land’s value (rather than the $7M+ claimed). The Tax Court felt there was no reasonable cause exception to penalties applicable here, even though the taxpayer hired a qualified appraiser and accountant, because the taxpayer should have known that it was not reasonable to claim a value so much greater than the value just paid to acquire the partnership interests. Immediately following the Tax Court’s decision, the IRS issued a News Release (IR-2019-213) quoting IRS Commissioner Chuck Rettig as saying, in part, “If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options”.
- Carter v Commissioner – In its February 3 decision in Carter, the Tax Court disallowed the deduction because the LLC retained the right to build some single-family residences on the property, with the location of such to be determined later, subject to the approval of North American Land Trust. The one bright spot for the taxpayers in this case was that the Tax Court ruled the IRS could not assess the almost $2M in penalties it sought, because the IRS could not prove that the agent first properly obtained written supervisory approval for such.
- Railroad Holdings, LLC v Commissioner – Similar to its rulings in TOT Property Holdings and Carter, in its February 5 ruling in Railroad Holdings, the Tax Court disallowed the deduction based solely on failure to adhere to the perpetuity rule. The deed provided that if the conservation easement was set aside by judicial proceeding, then the charitable organization holding the easement would receive an amount equal to the value of the conservation easement deduction claimed. Off-hand, that certainly seems fair enough, and if the value being assigned to the conservation easement was in fact grossly overstated, then that would mean that the charitable organization would likely receive all of the sale proceeds. However, the Tax Court said that strict compliance with the regulations is required, and the regulations require that the amount going to the charitable organization be determined at the time of a subsequent sale based on a formula, the numerator of which is the value assigned to the conservation easement and the denominator of which is the total value (i.e. highest and best use value used), and failure to adhere strictly to this formula means no deduction.
- Oakhill Woods, LLC v Commissioner – In Oakhill Woods, both the IRS and the taxpayer sought summary judgment on the issue as to whether failure to disclose cost basis on Form 8283 means automatic loss of the deduction. The taxpayer wanted the Tax Court to either rule that it substantially complied with the disclosure requirements or that the regulation requiring such was invalid. The IRS wanted the Tax Court to rule that the regulation is valid and that taxpayer automatically loses (regardless of whether or not the valuation was correct) due to failure to comply. The Tax Court denied taxpayer’s motion for partial summary judgment, and granted the IRS motion in part, ruling that the regulation is valid (i.e. you can lose deduction for failure to disclose basis) and that taxpayer did not substantially comply with the requirements. However, the Tax Court acknowledged that it was conceivable the taxpayer might have a reasonable cause defense for not complying, if the taxpayer can demonstrate that it received advice from a competent tax professional (who was independent of the transaction) that it did not need to provide the basis information, and that it relied in good faith on the advice so received. We note, however, that the Tax Court appears to be skeptical that the taxpayer can demonstrate this, and the Court also expressed skepticism as to the value placed on the easement, stating “Oakhill thus took the position that the 379 acres had appreciated by more than 800% during the previous 3 ½ years amid the worst real estate crisis since the Great Depression.” We note further that the taxpayer here did not just inadvertently forget to disclose the cost basis, but instead attached a statement saying “a declaration of taxpayer’s basis in the property is not included in the attached Form 8283 because of the fact that the basis of the property is not taken into consideration when computing the amount of the deduction”. The IRS and the judge were not impressed with this statement.
There is an old adage that “bad facts make bad law”.
In the 2009 Kiva Dunes case, the taxpayer had good facts, and the IRS, perhaps overly confident that they would win based solely on the amount of the deduction relative to the taxpayer’s cost basis in the property, appeared to put on a poor case. More than 10 years had lapsed between the time of purchase of the property and the granting of the conservation easement. This helped to avoid any issue with the fact the conservation easement deduction being claimed was many multiples of (52 times) the original purchase price paid. The taxpayer had already sold most of the property he owned around the golf course (limiting any value enhancement he was gaining by virtue of granting the conservation easement). Both parties agreed that the highest and best use of the golf course property was as residential lots, the property was zoned for such, and the market demand for such at the time was sufficient to absorb the hypothetical number of lots over a reasonable period of time. And, perhaps most importantly, the taxpayer had used an appraiser who was very familiar with the local market and who appeared to have done a very thorough appraisal, whereas the IRS used an appraiser who was not familiar with the local market and who appeared to have made a number of mistakes.
Since its big loss in the Kiva Dunes case, the IRS appears to have been a bit more careful with the cases it takes to Tax Court, and the Tax Court judges, perhaps perceiving that conservation easements have become an area of taxpayer abuse, appear to be quick to give the IRS a win based on what many might perceive as technical foot faults, rather than dealing with the more difficult and subjective issue of valuation.
Most people have seen nature documentaries of the African wildebeests gathering on the banks of the Mara River in Kenya, preparing to attempt a crossing, while the river teems with crocodiles preparing for a feast. An estimated over 1,000,000 wildebeests attempt the crossing each year, with all but about 6,000 making it safely across (although surely it must be a terrifying experience; even for those who do make it across safely). Syndicated conservation easements may prove to be similar, with the number of taxpayers who have participated in them exceeding the IRS’ capacity to pursue all of the cases (even though the IRS almost certainly knows who has participated due to the disclosures on Forms 8283 and 8886). This may particularly be the case once the IRS gets beyond the relative lay-ups it has been getting from technical foot faults, like failure to disclose cost basis and failure to adhere to the perpetuity clause, and has to pursue cases on the more substantive, time-consuming, and subjective issue of valuation. With this in mind, it will be interesting to see whether the IRS offers a broad-based settlement program.
Kenneth H. Bridges, CPA, PFS is a partner with Bridges & Dunn-Rankin, LLP, an Atlanta-based CPA firm.
This article is presented for educational and informational purposes only, and is not intended to constitute legal, tax or accounting advice. The article provides only a very general summary of complex rules. For advice on how these rules may apply to your specific situation, contact a professional tax advisor.