Conservation Easements Offer Tax Advantages and Increased Scrutiny
Conservation easements can be an effective way for wealthy taxpayers to achieve their philanthropic goals while scoring lucrative tax deductions. Recent developments from the IRS, Congress and the courts could make some taxpayers hesitant to use conservation easements. However, these vehicles remain viable tax planning tools if they’re used properly and in compliance with the latest rules.
Tax Advantages
A conservation easement restricts the use of real property and is granted by the property owner to a qualified organization in perpetuity and exclusively for conservation purposes. The organization must be committed to protecting the conservation purposes of the donation and have the resources to enforce the restrictions.
Generally, you can’t take a charitable contribution deduction for the donation of a partial interest in property (other than certain transfers involving trusts). However, starting in the 1970s, taxpayers have been allowed to claim charitable contribution deductions for the fair market value of donated conservation easements. The deduction was intended to encourage significant property owners to donate certain ownership rights to nonprofits to preserve buildings or land.
Increased Scrutiny
In recent years, the IRS has highlighted abuses of conservation easements, which are often prompted by promoters and based on questionable appraisals of the donation’s value. According to the IRS, some taxpayers have claimed deductions they’re not entitled to because they failed to comply with the applicable requirements. Others have used or developed the property in a manner inconsistent with charitable purposes, or been allowed to modify the easement or develop the land in a manner that conflicts with the easement’s restrictions.
The IRS has specifically targeted syndicated conservation easement (SCE) transactions that use inflated appraisals and partnership arrangements to reap “grossly inflated” deductions. These arrangements have been included on the agency’s “Dirty Dozen” list of tax schemes and scams for several years.
Government Response
SCEs face an ongoing crackdown on multiple fronts. For example, in December 2022, the IRS issued proposed regulations that identified SCE transactions as listed transactions, meaning tax avoidance transactions that must be reported to the IRS.
Then Congress passed the SECURE 2.0 Act in late December 2022. The law addresses conservation easement contributions by partnerships and other pass-through entities. It gives the IRS statutory authority to curb abusive conservation easement arrangements (as opposed to just regulatory authority, which is more vulnerable to court challenges).
SECURE 2.0 also includes a “disallowance rule” that prohibits charitable contribution deductions for easements if the deduction exceeds 2.5 times the sum of each partner’s relevant basis (generally, the amount of their investment) in the partnership that makes the contribution. Exceptions are permitted if any of these three conditions are met:
- The contribution satisfies a three-year holding period test,
- Substantially all the partnership is owned by family members, or
- The contribution relates to the preservation of a certified historic structure.
This provision applies to contributions made after December 29, 2022.
The IRS issued proposed regulations on the disallowance rule in November 2023. A public hearing on the proposed regulations that was scheduled for January 2024 was canceled because no one requested to testify, and the final regulations were published on June 28, 2024. The final regs provide guidance regarding the disallowance rule, including:
- Key definitions,
- Appropriate methods to calculate the relevant basis of a partner or an S corporation shareholder,
- The three exceptions (listed above), and
- Related reporting requirements.
The final regs also include reporting requirements for partners and S corporation shareholders that receive a distributive share or pro rata share of any noncash charitable contribution made by a partnership or S corporation. These requirements apply regardless of whether 1) the contribution is a qualified conservation contribution, and 2) the contribution is of real property or other noncash property.
Settlement Opportunity
In June 2024, the IRS announced that it was sending a time-limited settlement offer to some taxpayers who have participated in SCE transactions that are under audit. The offer requires substantial concession of the income tax benefits, as well as the payment of penalties. But those who decline the offer will face continued IRS enforcement actions, including potential full disallowance of charitable contributions related to the SCE and all applicable penalties.
The IRS has been serious about its enforcement activities in this area. For example, in January 2024, an IRS criminal investigation concluded with prison sentences for two promoters who made millions of dollars selling SCE arrangements to wealthy taxpayers. The sentences were for more than 20 years each. Additionally, the promoters were ordered to pay nearly $1 billion in restitution. So, a settlement offer may be worth exploring if you’re eligible.
Do It Right
The government has launched an aggressive enforcement initiative against conservation easement transactions. However, the IRS concedes the arrangements can be done in a legitimate manner that warrants a deduction. If you’re interested in making a charitable easement contribution, contact your tax advisor to ensure you comply with the applicable rules.
Copyright 2024
This article appeared in Walz Group’s October 7, 2024 issue of The Bottom Line e-newsletter, produced by TopLine Content Marketing. This content is for informational purposes only.
