December 6, 2022

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Business is my step

Roots Of The 250% Solution To Charitable Easement Tax Abuse

7 min read

The Charitable Conservation Easement Program Integrity Act is back. We learn that from a press release issued by the Senate Finance Committee. Senator Grassley uses some pretty strong language.

The conservation easement program is an important tool for protecting and preserving our environment. But bad-faith scammers have taken advantage of the program through abusive schemes at the expense of American taxpayer. 

Senator Wyden also uses strong words and also probably overpromises on the effect of the bill.

Abuse of syndicated conservation easements by some bad actors is one of the most egregious tax shelters out there. Our bill would ensure IRS has the tools to crack down on these transactions.

It is hard to imagine a transaction that falls under this act that is not already abusive under current law. The “tools” the IRS needs to crack down on these transactions are more agents and lawyers.

A Particularly Egregious Abuse

The bill targets a transaction that the IRS identified as a listed transaction in Notice 2017-10. The penalties for not outing yourself as having engaged in a listed transaction are so severe that I have made listed transactions the subject of one of my laws of tax planning. –Reilly’s Fourteenth Law of Tax Planning –  If something is a listed transaction, just don’t do it. – The summary of the key provision of the bill in the press release is:

The Charitable Conservation Easement Program Integrity Act, which tracks an IRS Listing Notice published in December 2016, would generally disallow a charitable deduction if it exceeds 2.5 times (250 percent) of a partner’s original investment.

Here is the actual language being added to the Code:

In the case of any qualified conservation contribution of any partnership (whether directly or as a distributive share of such contribution of another partnership), no amount of such contribution may be taken into account under this section by any partner of such partnership as a distributive share of such contribution if the aggregate amount so taken into account by such partner for the taxable year would (but for this paragraph) exceed 2.5 times the portion of the adjusted basis of such partner’s interest in such partnership (determined immediately before such contribution and without regard to section 752) which is allocable (under rules similar to the rules of section 755) to the qualified real property interest with respect to which such contribution is made

This is followed by language that restricts this restriction to a three year window and makes it retroactive to 2016. There are also different rules for historic deals and an exemption for family partnerships.

I gave you the actual language because it illustrates Reilly’s Third Law of Tax PlanningAny clever idea that pops into your head probably has (or will have) a corresponding rule that makes it not work. My immediate thought on reading the summary was that it would be easy to beat by simply using leverage. That “without regard to section 752” kills that.

Why 250%?

You might be able to infer the reason for the multiple of 2.5. Very roughly if you can get an interest in a piece of property for $100,000 and then take a $250,000 deduction for giving up a conservation easement on it, you have essentially gotten the property as encumbered for free. That happens to be why I think that 2.5 is much too high.

I spoke with Steve Small who first came up with the 2.5 multiple in a Tax Notes article Proper — and Improper — Deductions for Conservation Easement Donations, Including Developer Donations. Mr. Small was on the ground floor of Section 170(h) as he described in the article:

Section 170(h) became law in 1980, and, as an attorney-adviser in the Office of Chief Counsel at that time, I participated in the drafting of the statute and then wrote the income tax regulations under section 170(h). In 1985, three years after I left the IRS, I wrote The Federal Tax Law of Conservation Easements, an annotated commentary on the statute and the regulations.

Mr. Small left the IRS in 1982 and started working as a tax attorney in a firm. There were only a few conservation easement deals, but as the field developed, his book became more important. Beginning in 1988 he was able to focus a practice on “private land protection“. As time went on, deals that he viewed as abusive began coming across his desk. He wrote the Tax Notes article in 2004.

The article includes a list of eleven questions to ask that would warn you that a deal is sketchy. Here are the first three:

1. Has the taxpayer owned the property for less than 24 months?

2. If the answer to question 1 is yes, is the claimed deduction greater than two and one-half times the cost basis?

3. Is the taxpayer a limited liability company or partnership?

Except for making it three years instead of two, that is really the essence of the current legislation. Given Mr. Small’s role in the original legislation and the resulting regulations, there is something fitting about that.

Is 250% Too Much?

The 2.5 limit knocks out the most egregious abuse, but it still strikes me as overly generous. If I was going to put in a limit it would probably be 90% on a three year hold and gradually rise. Remember the deduction is for an easement on the property. And unless you drink the Kool-Aid mixed by Partnership For Conservation (P4C), an easement can’t be worth more than the property itself.

When I asked Mr. Small whether 2.5 was too generous he indicated that it might be, but he offered a perspective from his time with the IRS.

As a colleague at Treasury said when I was in Chief Counsel, and we were trying to close all of the possible loopholes, and I said, what if someone just plain cheated? He said, that’s what we have tax fraud statutes for. Re the merits of the comment – I would guess that 95+% of the people who buy into syndications want a deduction immediately. So, again, if someone wants to cheat, the likelihood of stopping them is slim.

Another Perspective

I reached out to P4C and received the following comment from President and Chairman Robert Ramsay:

It is unfortunate the intransigence of certain stakeholders has, to this point, prevented constructive solutions from advancing for nearly two entire Congresses, left thousands of well-intentioned and law-abiding taxpayers in a state of onerous limbo and put a chilling effect on overall conservation efforts. 

When those stakeholders are ready to engage in a meaningful and collaborative dialogue to find compromise and pursue common sense solutions to protect and uphold the integrity of all conservation easements, Partnership for Conservation will be ready to participate. Until that time, continued insistence on the same misguided proposals targeting one class of landowner, including retroactive tax hikes, will only serve to further delay progress

To give them credit, the sort of model that P4C advocates, which involves a conservation easement being worth more than can be currently supported by the market for undeveloped land is the only way that high income low wealth individuals who don’t already own land can benefit from the deduction.

Back in the day there were legitimate tax shelters for people with high incomes and not much else. Nowadays not so much. On the other hand, marginal rates are much lower.

Land Trust Alliance

The Land Trust Alliance is probably one of the “intransigent stakeholders”, that Mr. Ramsay was referring to. Their view of the act is quite positive as you can see from this statement.

The stars are now aligned to pass this legislation this year and halt the abuse once and for all. We have bicameral, bipartisan legislation that will end the abuse. And Congress has a chance to address the problem now, thus preventing additional billions of dollars from wrongfully walking out the door of the U.S. Treasury. I look forward to thanking Congress for passing this legislation.

It is actually pretty unusual for an advocacy organization to ask for the Tax Code to limit their most cherished deduction.

Other Coverage

I have been covering this issue for over a decade. Here is a roundup of my coverage.

The American Society of Appraisers has something from when the bill was introduced in the Senate in September.

In an effort to address the potential exploits, S.4751, has multiple tweaks from the former. Many of the distinctions concern the two-and-one-half-times ratio. Specifically, the bill targets an exploit where taxpayers could try to satisfy the ratio by inflating the outside basis through debt or by contributing unrelated assets to the partnership. Further, if pass through entities exist, the bill addresses those that use the complex structure to circumvent the enforcement of the two-and-one-half-times ratio. Other changes include new limits set to prevent potential exploits to the holding period and clarification on when the rule denying a deduction due to pass through entities existing in the partnership would take effect.

Richard Tucker of Jefferson Land Trust urges support in The Leader.

Across the U.S., a few bad actors have been exploiting the incentive to make large profits at the expense of taxpayers. These transactions are abusive tax shelters and cannot be allowed to continue. That’s why I and other conservation leaders across the country are urging Congress to pass The Charitable Conservation Easement Program Integrity Act.

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