Introduction to Conservation Easements
Over the years, charitable contributions of conservation easements have allowed taxpayers to obtain a federal tax deduction for the purpose of conserving land for public use, public enjoyment, or to preserve historic building structures. For tax purposes, a conservation easement creates a discounted value for the property encumbered by the easement which generates a valuable charitable deduction.
To claim a deduction for a conservation easement, the donation of the easement has to be made to a qualified charitable organization. In addition, Treasury Regulation Section 1.170A-14(c)(1) states that the qualified organization must “have a commitment to protect the conversation purpose of the donation, and have the resources to enforce the restrictions.” Furthermore, the contribution must be exclusively for conservation purposes. Conservation purposes under Internal Revenue Code Section 170(h)(4)(A) are (1) preserving land for outdoor recreational use by, or education of, the general public; (2) protecting relatively natural habitats of fish, wildlife or plants; (3) preserving open space for scenic enjoyment of the general public or under a governmental conservation policy yielding significant public benefit; and (4) preserving a historically important land area or a certified historic structure.
Amount of Deduction that Can be Claimed by a Taxpayer
For individuals, the amount of the charitable contribution deduction from the donation of a conservation easement is limited to 50 percent of the individual’s contribution base (adjusted gross income, computed without regard to any net operating loss carryback), over the amount of all allowable charitable contributions for that year (100 percent for contributions of property by qualified farmers or ranchers), with a carryover period of 15 years. Partnerships and limited liability companies can also pass this deduction to their partners or members.
The Importance of Proper Valuation of the Conservation Easement and Form 8283
Donating a conservation easement requires an appraisal not more than 60 days before the contribution date and no later than the due date (including extensions) of the return on which the deduction is claimed. The quality of the appraisal is extremely important, as it must meet all of the requirements spelled out in the regulations. In particular, the appraisal must state it was prepared by a qualified appraiser. Internal Revenue Code Section 170(f)(11)(ii) defines a qualified appraiser as one “who has earned an appraisal designation from a recognized professional appraiser organization or has met minimum education and experience requirements.” The appraiser must also regularly perform appraisals for compensation and show proof of education and experience in valuing the type of property subject to the appraisal. The deduction must be disclosed on IRS Form 8283, Noncash Charitable Contributions. Taxpayers claiming the deduction must also attach a qualified appraisal, photographs of the entire exterior of the building and a list of all restrictions on the development of the building.
Syndicated Transactions to Promote Charitable Easement Deductions
More recently, developers and other promoters have begun using syndicated transactions to expand the tax breaks they receive from easement deductions. They typically offer promotional materials to would-be investors in real estate deals that involve taking advantage of charitable deductions for conservation easements. Investors are offered a substantial return in the form of a charitable deduction for investments into the real estate deal. On many occasions, investors in the deal are offered the opportunity to buy one of 99 lots (just under the limit for SEC registration of an investment fund) for $36,000 and promised a return charitable deduction of $158,000 from donations of the easement. In other words, the investor is offered a deal in which they buy the land for $36,000 but get a charitable deduction which may save them $60,000 in federal taxes. In total, the 99 lots would result in $15.6 million in deductions for property apparently sold to investors for $3.6 million and presumably acquired by the current land owner for much less. See Charitable Contributions of Conservation Easements, Adam Looney, the Brookings Institution, May 2017.
The IRS Classifies Abusive Charitable Easement Transactions as “Listed Transactions”
In January of 2017, the IRS identified certain charitable easement transactions as “listed transactions.” What this means is that the IRS has determined certain charitable easement donation transactions are characterized as illegal tax shelters. Although taxpayers are not prohibited from participating in a “listed transaction,” the failure to disclose a “listed transaction” on a tax return can result in severe civil and criminal penalties. Disclosing a “listed transaction” on a tax return all be guarantees an IRS audit. The notice issued by the IRS does not change the law regarding conservation easements. However, the January 2017 notice issued by the IRS requires reporting for charitable easement transactions with the following three characteristics: 1) the transaction was promoted; 2) involved investments through partnership structures; and 3) the promotion offered the possibility of a charitable donation of 2.5 times or more the investor’s initial investment.
Conclusion
If you are considering entering into a charitable easement transaction, make sure you do your due diligence. Carefully inspect the appraisal report to determine that it complies with the regulations. Finally, be wary of investing in syndicate transactions that promote charitable easement deductions. If it sounds too good to be true- it probably is.
Anthony Diosdi is one of the founding partners of Diosdi Ching & Liu, LLP, a law firm with offices located in San Francisco, California; Pleasanton, California; and Fort Lauderdale, Florida. Anthony Diosdi concentrates his practice on tax controversies and tax planning. Diosdi Ching & Liu, LLP represents clients in federal tax disputes and provides tax advice throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: Anthony Diosdi – adiosdi@sftaxcounsel.com
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.