The IRS attempt to curb syndicated conservation easements was dealt a significant blow by the Tax Court in its November 9 decision in Green Valley Investors, LLC, et al., Bobby Branch, Tax Matters Partner v. Commissioner of Internal Revenue, 159 T.C. No. 5. IRS Notice 2017-10 designates certain syndicated conservation easements as listed transactions and reportable on Form 8886. The Tax Court held that Notice 2017-10 classification of syndicated conservations easements as listed transactions is not valid, and that the IRS violated the Administrative Procedure Act’s (APA) requirements when it was issued.
A conservation easement is a legal agreement in which a landowner gives a charitable organization or government the right to prevent future land development. The donation of a conservation easement qualifies as a charitable donation if certain requirements are met. Congress established the tax break to encourage preservation of land. With standard conservation easements, landowners give up development rights for their land, most commonly by, donating those rights to a nonprofit land trust.
Unlike the standard conservation easement, syndicated conservation easements will involve an intermediary, or a promoter, to sell ownership interests in land to investors through partnerships. The promoters purchase vacant land then hire an appraiser with the idea of a receiving a large value on that land. A common scenario may involve a remote piece of land with little previous value now being appraised for a large amount due to unrecognized development value for luxury homes. The investors claim large charitable donations based on the appraisal value. The promoters receive fees in return.
The Department of Justice has called syndicated conservation easements abusive and included them on the IRS’ annual “Dirty Dozen” list of tax scams for multiple years. It has targeted top promoters with criminal charges and civil lawsuits resulting in several guilty pleas and a civil settlement. The IRS designated syndicated conservation easements as potential tax avoidance schemes. The use of these easements has rapidly increased over the last decade as promoters have promised large returns. The IRS wrote in their 2022 Dirt Dozen list that it had examined several hundred syndicated conservation easement deals where tens of billions of dollars of deductions were improperly claimed.
In December 2016, when the IRS issued Notice 2017-10, it specifically listed transactions where investors in pass-through entities receive promotional material offering the possibility of a charitable contribution deduction worth at least two and half times their investment. In many transactions, the deduction taken is significantly higher than 250 percent of the investment. The Notice retroactively applies to all syndicated conservation easement transactions beginning January 1, 2010. Classifying these transactions as listed was meant to easily identify participating taxpayers.
A bipartisan group of lawmakers has tried to curb this activity. Democrat Wyden and Iowa Sen. Charles Grassley, the finance committee’s ranking Republican, jointly released a 151-page investigative report in 2020 that referred to syndicated conservation easements as a “dollar machine” for wealthy taxpayers. “You simply insert the dollar bill and then watch the Dollar Machine return two dollar bills to you,” the report explained. “But it was not the promoters who gave back the two dollars; it was the Federal government by way of foregone tax revenue, and the only risk involved was whether or not the transaction would lead to an audit.” Both sides in Congress are looking to change the law. However, lobby efforts remain strong. The Partnership for Conservation was formed by proponents of syndicated conservation easements. Spending millions on lobbying Congress and public relations, it argues that syndicated deals offer both conservation and profit.
In Green Valley, the Tax Court maintained that the IRS violated the APA’s formal rulemaking procedures when issuing Notice 2017-10. The IRS did not issue a formal rulemaking notice, ask the public to submit comments, and then publish final guidance addressing public comments. The IRS argued that it was not required to go through formal notice and comment. The Tax Court disagreed and rejected the IRS’ attempt to impose penalties on the four partnerships in question that took a combined $90 million in deductions in 2014 and 2015.
The Tax Court in Green Valley relied heavily on recent Supreme Court case CIC Services, LLC v. Internal Revenue Service and Sixth Circuit Case Mann Construction, Inc. v. United States, 27 F. 4th 1138 (2022), and maintained that “the act of identifying a listed transaction by the IRS, by its very nature, is the creation of a substantive (i.e., legislative) rule and not merely an interpretative rule.” Accordingly, Notice and Comment rulemaking was required and the IRS’ failure to follow that procedure renders Notice 2017-10 invalid. The IRS is expected to appeal.
