The Internal Revenue Service is aware that some promoters are involved in a scheme1 of syndicating conservation easement transactions that purport to give investors charitable contribution deductions significantly exceeding the amount invested.
These transactions are designated “listed transactions,” which are the same or substantially similar to those the IRS has determined to be tax avoidance transactions.
The promoter offers prospective investors the possibility of a greatly enhanced charitable deduction for a conservation easement donation in a pass-through entity (such as a partnership).
The purported tax benefit exceeds the wildest dreams of avarice.
IRS Notice 2017-10, issued on Jan. 23, 2017, takes aim at these schemes.
Six Steps to Scheme
Here’s how the scheme works:
(1) The promoters identify a pass-through entity that owns real property or forms a pass-through entity to acquire real property. Additional tiers of pass-through entities may be formed;
(2) The promoters then syndicate ownership interests in the pass-through entity that owns the real property (or in one or more of the tiers of pass-through entities) using promotional materials suggesting to prospective investors that they may be entitled to a share of a charitable contribution deduction equal to or exceeding an amount that’s two and a half times the amount of the investor’s investment;
(3) The promoters get an appraisal that purports to be a qualified appraisal (as defined in Internal Revenue Code Section 170(f)(11)(E)(i)), but greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property;
(4) After an investor invests in the pass-through entity, either directly or through one or more tiers of pass-through entities, the pass-through entity donates a conservation easement encumbering the property to a tax-exempt entity;
(5) Investors who held their direct or indirect interests in the pass-through entity for one year or less may rely on the pass-through entity’s holding period in the underlying real property to treat the donated conservation easement as long-term capital gains property under IRC Section 170(e)(1);
(6) The promoters receive a fee or an interest in the pass-through entity.
IRS Challenge
The IRS intends to challenge the purported tax benefits from this transaction based on the overvaluation of the conservation easement. It may also challenge the purported tax benefits based on the partnership anti-abuse rule, economic substance, or other rules or doctrines.
Listed Transactions
Transactions entered into on or after Jan. 1, 2010, that are the same as, or substantially similar to, the transactions just described are identified as “listed transactions” for purposes of Treasury Regulations Section 1.6011-4(b)(2) and IRC Sections 6111 and 6112, effective Dec. 23, 2016. Persons entering into these transactions on or after Jan. 1, 2010 must disclose the transactions as described in Treas. Regs. Section 1.6011-4 for each taxable year in which the taxpayer participated in the transactions, provided that the period of limitations for assessment of tax hasn’t ended on or before Dec. 23, 2016. Material advisors, including appraisers, who make a tax statement on or after Jan. 1, 2010, with respect to transactions entered into on or after Jan. 1, 2010, have disclosure and list maintenance obligations under IRC Sections 6111 and 6112.2
For rules regarding the time for providing disclosure of a transaction described in this IRS notice, see Treas. Regs. Section 1.6011-4(e) and Treas. Regs. Section 301.6111-3(e). However, if under Treas. Regs. Section 1.6011-4(e)(1), a taxpayer is required to file a disclosure statement regarding a transaction described in this notice after Dec. 23, 2016 and before May 1, 2017, that disclosure statement will be considered to be timely filed if the taxpayer alternatively files the disclosure with the Office of Tax Shelter Analysis by May 1, 2017. In addition, for purposes of disclosure of transactions described in this notice, the 90-day period provided in Treas. Regs. Section 1.6011-4(e)(2)(i) is extended to 180 days. Further, if under Treas. Regs. Section 301.6111-3(e), a material advisor is required to file a disclosure statement regarding the listed transaction described in this notice by Jan. 31, 2017, that disclosure statement will be considered to be timely filed if the taxpayer files the disclosure with the Office of Tax Shelter Analysis by May 1, 2017.
Independent of their classification as listed transactions, those that are the same as, or substantially similar to, the syndicated conservation easement transaction in this IRS notice may already be subject to the requirements of IRC.3 Whether a taxpayer has participated in the listed transaction described in this IRS notice will be determined under Treas. Regs. Section 1.6011-4(c)(3)(i)(A). Participants include, but aren’t limited to, investors, the pass-through entity (any tier, if multiple tiers are involved in the transaction) or any other person whose tax return reflects tax consequences or a tax strategy described in this notice.
Charities Off the Hook
A donee described in IRC Section 170(c) won’t be treated as a party to the transaction under IRC Section 4965, or a participant under Treas. Regs. Section 1.6011-4.
However, if a charity has been involved in setting up these transactions, it should speak to its advisors about whether it should report its involvement, according to Elinor Ramey, an attorney-advisor at Treasury, who spoke at a February 24 IRS Tax Exempt/ Government Entities (TE/GE) meeting in Baltimore.
Penalties
Participants required to disclose these transactions under Treas. Regs. Section 1.6011-4 who fail to do so will be subject to penalties under IRC Section 6707A. And participants required to disclose these transactions under Treas. Regs. Section 1.6011-4 who fail to do so may also be subject to an extended period of limitations period of limitations under Section 6501(c)(10).
Material advisors required to disclose these transactions under IRC Section 6111 who fail to do so may be subject to the penalty under IRC Section 6707. Material advisors required to maintain lists of investors under IRC Section 6112 who fail to do so (or who fail to provide these lists when requested by the IRS) may be subject to the penalty under IRC Section 6708(a). In addition, the IRS may impose other penalties on persons involved in these transactions or substantially similar transactions, including the accuracy-related penalty under IRC Section 6662 or Section 6662A, the IRC Section 6694 penalty for understatements of a taxpayer’s liability by a tax return preparer, and the IRC Section 6695A penalty for certain valuation misstatements attributable to incorrect appraisals.
Taxpayers who’ve already filed returns claiming the purported benefits described in IRS’ Notice should take appropriate corrective action and ensure that their transactions are disclosed properly.
Query: Should the shelter for participants in these transactions be a federal gated community?
Endnotes
- “Scheme” is the word that I’ve chosen to describe the transaction outlined in this IRS Notice. “Scheme” in our country is a pejorative. But in England, it’s synonymous with plan, and is pronounced “sheme.” Which reminds me of Dorothy Parker’s retort to an American actor (a fellow member of the Algonquin Roundtable) who, after a two-week tour with an English acting company, complained bitterly to Dorothy Parker about his “veddy, veddy, tough and exhausting shedule.” Dorothy Parker responded: “You, my friend, are full of skit.”
- See Treasury Regulations Sections 301.6111-3, 301.6112-1.
- Internal Revenue Code Sections 6011, 6111, and 6112.
© Conrad Teitell 2017. This is not intended as legal, tax, financial or other advice. So, check with your adviser on how the rules apply to you.