Q. Should I invest in conservation easements?  I go on hearing good things about them but don't really understand how they work or whether information technology is a good idea.

Conservation Easement Investments Have Loftier Abuse Potential

A. Conservation easements are a great idea, in theory.  Here's the fashion they work.  Basically, if y'all are willing to donate your holding for the public good, and that donation reduces the value of your holding, yous go to accept a tax deduction equal to the reduction in the value of your property.  You can use an amount of it up to l% of your adapted gross income as a deduction in any given yr.  Seems fair, right?  It encourages the wealthy to do things that promote the public good, particularly the surroundings.

Yet, the corporeality of deductions being taken for conservation easements accept been skyrocketing in recent years, and when yous look into information technology, the increase isn't what you might retrieve.  Yous see, there are at present people who are ownership the properties (often in syndications) primarily for the purpose of and then putting a conservation easement on it.  It'southward an investment.

"Simply wait," you say.  If the value of the property drops past the amount of the deduction, and you only get 37% (+ land) of the easement dorsum as a deduction, how is that a winning motion?  That's like donating money to charity for the revenue enhancement deduction and beingness surprised when you lot have less money afterwards.

Well, the mode they become investments is past, at a minimum, abusing the intent of the tax lawmaking provision, and in many cases, through outright fraud.  Imagine a situation where you put $100K into an investment and and so two years after pull out a $900K tax deduction.  Pretty fishy, huh?  That's why the IRS now has placed conservation easements on their "listed transactions" list, where they highly scrutinize them.

Appraisal Fraud

Where does the fraud come in?  Well, the fraud generally comes in with the appraisement.  For case, allow'south say you lot buy a hunting property for a million bucks.  It has a little tiny run-down shack on it and 60 acres of woods.  So you put a conservation easement on information technology proverb information technology can only be used for hunting.  But you get an appraiser to say if information technology were developed as a housing development it would be worth $10 Million.  But as a hunting property, it's only worth $1 1000000.  Yous've now somehow created $9 One thousand thousand in value that can exist taken as a revenue enhancement deduction.  If your marginal tax charge per unit, like mine, is 42%, you've now spent $1 Million in order to buy a $ix Million deduction (worth 42%*$9M =  $iii.78M off my taxes) + a $one Million property.

Well, that'southward such an awesome deal, let'due south get a bunch of other people together and do it every bit a syndication.  Permit'due south go 10 doctors together and each of them can put $100K into the bargain and get a $378K deduction for information technology.  Meanwhile, the syndicator takes the usual hefty syndication fees for putting it all together.  Then the doctors kickoff talking in the doctors' lounge and presently WCI gets an emailed question like the one at the beginning of this mail service.

Conservation Easement Taxation Avoidance

What if y'all just desire to purchase the tax deduction at a discount?  How does that piece of work?  Well, Timothy Lindstrom describes it like this:

Assume that instead of donating the conservation easement himself, John transfers his farm to a limited liability visitor ("John's LLC").  Initially John is the only fellow member.  John sells 4 memberships to wealthy neighbors for $50K each.  John and his neighbors agree (in an "operating agreement") that the income and losses of John's LLC will be allocated entirely to John and the revenue enhancement deductions will be allocated entirely to the four neighbors.  Upon liquidation, John will exist entitled to 94% of the assets of the LLC afterwards payment of all debts, and the neighbors will each be entitled to 1.5% of the avails.  John also has the right to buy out his neighbors after three years for $3.

Thus, John gets the $200K paid into the LLC by the neighbors, and the neighbors each get $250K of the easement donation deduction.  This saves each neighbor $99,000 in federal income taxes, a pretty expert upshot for a $50,000 investment.  John also gets to buy out his neighbors for a pittance and recover his ownership of the farm.

What has happened here?  Information technology is still elementary: John has just sold a tax deduction that he can't utilize to other taxpayers who tin can.  The fact that he used a limited liability company to make the transfer doesn't change what happened, or get in legitimate.  It does change the applicable tax rules, however, because we are no longer dealing with an individual transferring a deduction, merely the "allocation" of a deduction among members of a limited liability company….

In the case of John'south LLC, the allocation of income and loss to John and the allotment of all tax benefits to the neighbors lack a concern purpose and are, instead, designed to help the neighbors avert taxes.  The members' economic interest in the LLC is conspicuously at variance with the allotment of tax benefits.  In the effect of an inspect, John'south LLC can expect the IRS to reallocate most of the tax benefits to John in accordance with economic interests of the LLC in which John, considering all of the relevant factors, has at least a 94% interest.  Each fellow member'due south $250,000 taxation deduction volition exist reduced to $fifteen,000, and his or her tax liability volition be recalculated.  The members volition owe the additional tax, plus interest and a substantial penalty….

Disguised Sales and State Tax Credits

Lindstrom goes on about bearded sales and state revenue enhancement credits:

Syndications are sometimes used to attempt to "sell" otherwise unusable charitable deductions.  Syndications are too used to attempt to avert tax on the sale of revenue enhancement credits generated past conservation easement donations.

Donations made to a partnership by partners are not treated as taxable events.  In other words, when John transferred his $3 million farm to John'due south LLC, no revenue enhancement was due on the transfer.  By the same token, when assets are distributed past a partnership to its partners, the distribution (so long as it is not partnership income) is not taxable.

Some states, such equally Virginia and Colorado, grant taxation credits (which are much more beneficial than deductions because they offer a dollar-for-dollar commencement of revenue enhancement liability) to easement donors.  These credits may, depending on state law, be sold by the donor to other taxpayers (unlike deductions, which cannot exist transferred).  The Revenue enhancement Courtroom has ruled that such sales are taxable.

Easement donors sometimes attempt to use the favorable partnership revenue enhancement rules described above to sell tax credits without paying taxation on the sale.  In these schemes, the easement donor "contributes" his revenue enhancement credits to a partnership or other pass-through entity.  Taxpayers who wish to learn the credits pay cash into the partnership in amounts that represent the purchase cost of the credits.  So the partnership allocates the credits to the purchasers and the greenbacks to the donor.  The partners argue that the transaction is non taxable.  (Once again, this is a dramatic oversimplification.)

However, in several very recent Revenue enhancement Court decisions these schemes have been recharacterized equally "disguised sales" and taxed appropriately.  In some schemes I accept seen, landowners have sought to use pass-through entities to non only transfer deductions they cannot use to other taxpayers who tin, but to sell tax credits without paying tax.  The variations are infinite.  The facilitators who sometimes create these schemes ofttimes claim six-figure fees for doing so.

No taxpayer contemplating involvement in the syndication of a conservation easement tax deduction should practice and so without the communication of a partnership taxation expert and without the benefit of a formal tax opinion alphabetic character from that expert.

Is This Actually Happening? conservation easements

This can't really be happening, can it?  I mean, ix:1?  Well, from the time the IRS made conservation easements listed transactions at the offset of 2017 until July when Senator Wyden asked IRS Commissioner John Koskinen what the IRS had uncovered, there were 200 required forms filed and the IRS analyzed 40 of them before Koskinen replied.  I quote Koskinen:

The average contribution deduction from this preliminary analysis was 9 times the corporeality of the investment in the transaction.

And then what does the IRS intend to do virtually this?  I quote again from Koskinen:

As disclosures are filed, we are compiling the information and volition use it as role of our enforcement program.  Once we compile and analyze all data from the disclosures, we intend to identify the syndication transactions that pose the most compliance risk and refer them for examination.

What does "enforcement program" and "examination" mean?  At best it ways an audit, and possibly not merely of this transaction.  At worst, it means jail time for tax evasion.

What Practice Experts Say About Syndicated Conservation Easements?

A local police force professor here in Utah has made herself an expert on these transactions.  Hither are her thoughts on syndicated conservation easements as an investment:

IRS Commissioner Koskinen'south letter to Senate Finance Committee leadership confirms what many take known for a long fourth dimension — most syndicated easement donation transactions are patently abusive.  It would be a great disservice to federal taxpayers if Congress were to curtail the IRS'southward ability address these abuses….It also is important that the IRS continue its enforcement efforts with regard to conservation easement donations generally.  The case police reveals persistent overvaluation of easements and many failures to comply with the deduction requirements in non-syndicated transactions.  Federal taxpayers should not exist expected to invest billions of dollars in easements that are overvalued or that don't actually protect country with important conservation values in perpetuity as promised.

Near syndicated easement donation transactions are manifestly abusive.  So if this is something you want to get into, you'd improve brand certain yours is one of the minority that is non abusive.

Forbes writer CPA Peter Reilly saw this coming in a 2014 blog postal service he entitled Conservation Easements a New Field for Villainy.

Quondam IRS conservation easement regulation author and author of The Federal Tax Law of Conservation Easements [currently out of print], Stephen Small said the post-obit:

I think the numbers in the IRS letter are staggering, and this is merely the first of this information-gathering.  These transactions are nothing but tax shelters.  Some of them may peradventure have some conservation benefits, although many I accept seen practice non, but the real goal of these deals is getting big write-offs to investors.  I am very glad the IRS is finally pursuing this, and I hope they proceed up the endeavor.

Ike Devji, who writes a lot for physicians about asset protection, calls conservation easements that "tax scam that doctors sell each other".

Again, the outcome here is not that easements are inherently illegal or abusive, at least non yet (call back, what's legal today may not exist in the future).  Rather, it's that they can be abused by bad planners, bad clients, and bad facts when they don't comply with the police.

What Does the IRS Say?

Believe the IRS when they say this:

In recognition of our need to preserve our heritage, Congress allowed an income tax deduction for owners of significant holding who surrender certain rights of ownership to preserve their land or buildings for future generations.

The IRS has seen abuses of this tax provision that compromise the policy Congress intended to promote.  Nosotros have seen taxpayers, often encouraged by promoters and armed with questionable appraisals, take inappropriately large deductions for easements.  In some cases, taxpayers claim deductions when they are not entitled to any deduction at all (for example, when taxpayers neglect to comply with the law and regulations governing deductions for contributions of conservation easements).  Also, taxpayers take sometimes used or developed these properties in a mode inconsistent with department 501(c)(3).  In other cases, the charity has allowed property owners to alter the easement or develop the state in a way inconsistent with the easement'south restrictions.

Another problem arises in connection with historic easements, particularly façade easements.  Here again, some taxpayers are taking improperly big deductions.  They concur not to modify the façade of their historic house and they give an easement to this outcome to a charity.  However, if the façade was already discipline to restrictions under local zoning ordinances, the taxpayers may, in fact, be giving up nothing, or very little.  A taxpayer cannot give upwardly a right that he or she does non have.

and when they say this:

The Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) are aware that some promoters are syndicating conservation easement transactions that purport to give investors the opportunity to obtain charitable contribution deductions in amounts that significantly exceed the amount invested.  This notice alerts taxpayers and their representatives that the transaction described in section 2 of this notice is a taxation avoidance transaction and identifies this transaction, and substantially similar transactions, as listed transactions for purposes of § 1.6011-four(b)(2) of the Income Revenue enhancement Regulations (Regulations) and §§ 6111 and 6112 of the Internal Revenue Code (Lawmaking).  This notice also alerts persons involved with these transactions that certain responsibilities may ascend from their interest….

The Treasury Department and the IRS recognize that some taxpayers may have filed tax returns taking the position that they were entitled to the purported taxation benefits of the type of transaction described in this notice.  These taxpayers should take appropriate corrective action and ensure that their transactions are disclosed properly.

Every bit for me and my house, we'll exist staying away from investing in syndicated conservation easements.  We simply don't need complicated shenanigans like that to meet our financial goals.  If you make up one's mind to go down this path, don't say I didn't warn you and please, please, please make certain the appraisal is truly authentic and at a minimum no more than 250% of what you invested.

What exercise you lot retrieve?  Have y'all participated in a syndication of a property bought in society to donate a conservation easement?  What was the outcome?  What was the ratio of your investment to your deduction?  Comment below!