IRS Loses Battle In War On Conservation Easements

The US Tax Courtroom held IRS Discover 2017-10 is invalid in a November 9, 2022 determination in Inexperienced Valley Buyers, LLC, et al., Bobby Department, Tax Issues Associate v. Commissioner of Inside Income, 159 T.C. No. 5. In Inexperienced Valley Buyers, the Tax Courtroom held that the IRS violated the Administrative Process Act’s necessities when issuing Notice 2017-10, the IRS Discover that categorised syndicated conservation easements as listed transactions. Accordingly, the Tax Courtroom held, Discover 2017-10, which categorised syndicated conservation easements as a “listed transaction,” is invalid.

What Is a Conservation Easement?

Think about Jill owns 10 acres of lakefront property. Jill is getting on in years, and realizes after her loss of life, there can be no technique to affect what occurs together with her land. However preservation is vital to Jill. Sustaining open land is vital to Jill. And offering public entry to seashores is vital to Jill. How can Jill go away her land to her kids, however stop them from paving paradise to place up a car parking zone?*

The reply: a conservation easement. Conservation easements have been round for the reason that 1800’s. The federal authorities started utilizing them within the 1930’s to guard scenic corridors. Conservation easements enable landowners to maintain title to their property, however prohibit the power to the landowner – and each subsequent proprietor of the land for the remainder of time – from constructing on that property. Congress made Jill’s determination to put a conservation easement on her land tax deductible within the Tax Reform Act of 1969. Since then, the Uniform Conservation Easement Act has been enacted and adopted – both in complete or partly – by many states.

Technically, a conservation easement is a nonpossessory curiosity of a holder in actual property imposing limitations or affirmative obligations, the aim of which embrace retaining or defending pure, scenic, or open-space values of actual property, assuring its availability for agricultural, forest, leisure, or open-space use, defending pure sources, sustaining or enhancing air high quality, professional preserving the historic, architectural, archeological, or cultural elements of actual property.** In English: a conservation easement is a manner for a landowner to voluntarily pledge their land won’t be developed for the remainder of time. By inserting a conservation easement on the land, the landowner grants some third get together – a authorities company, a land belief, or one other non-profit, enforcement rights. If Jill positioned a conservation easement on her land and donated the easement to the Nature Conservancy, then the Nature Conservancy has the appropriate to sue to stop Jill, her kids, her grandchildren, her nice grandchildren – you get the purpose – from creating the land. The Nature Conservancy doesn’t personal the land, nor does it have the appropriate to own the land, but it surely has the appropriate – and the duty – to make sure that the easement’s protections and prohibitions on growth are noticed.

What Makes a Conservation Easement “Syndicated”?

Assume the easement Jill has positioned on her lakefront property is price tens of millions of {dollars}, however she doesn’t earn tens of millions of {dollars}. Jill can’t get the total good thing about her donation. By means of forming a partnership, and contributing her land to the partnership, many individuals can share in each donating the easement and the tax deduction that derives from that donation. By permitting taxpayers to deduct the worth of the donation of the conservation easement, Congress was in a position to create a mechanism whereby Individuals can collectively be part of conservation efforts and be rewarded for doing so.

If Jill places her land in a partnership and stays a accomplice, and the partnership locations a conservation easement on the land, then all of the companions get the good thing about the donation deduction. Consider: Jill has now given up the appropriate to depart the land to her kids when she dies. The land is now owned by the partnership, topic to the easement. As a result of every accomplice owns a share of the land, every accomplice can take their proportional share of the tax profit.

What’s the worth of a Syndicated Conservation Easement?

Simply what is the proper tax profit for every accomplice to take their proportional share? That’s the final supply of disagreement between taxpayers and the IRS. Bear in mind, Jill didn’t donate her land to charity, and he or she doesn’t deduct the worth of her land, per se. As a substitute, she will get to donate the worth of the conservation easement, or, extra exactly, the conservation easement donation. And if Jill positioned her land in a partnership, then the partnership (and its companions) will deduct the worth of the easement.

Based on Treasury Regulation 26 CFR 1.170A-14(h)(3)(i), “The value of the contribution beneath part 170 within the case of a charitable contribution of a perpetual conservation restriction is the fair market value of the perpetual conservation restriction on the time of the contribution.” As a result of data of gross sales of land that has been encumbered by a conservation easement are so troublesome to search out, the IRS permits landowners to make use of the “earlier than and after methodology”. The earlier than and after methodology is simply that – a comparability of the worth of the land earlier than the easement was positioned on it, in contrast with the worth of the land after. Treasury rules present, “ the fair market value of the property earlier than contribution of the conservation restriction should take into account not solely the present use of the property but in addition an goal evaluation of how quick or distant the chances are high that the property, absent the restriction, would in truth be developed, in addition to any impact from zoning, conservation, or historic preservation legal guidelines that already prohibit the property‘s potential highest and finest use.”

What’s the worth of giving up the appropriate to develop lakefront property, for the remainder of eternity? That query is precisely the supply of the continued litigation between the IRS and taxpayers who’ve participated in syndicated conservation easements. Because the IRS put it in Discover 2017-10, syndicated conservation easements “enormously inflate[] the worth of the conservation easement based mostly on unreasonable conclusions in regards to the growth potential of the true property.” However taxpayers, however, say the values aren’t inflated, and have been profitable in lots of circumstances the place the query of what the precise worth of the easement is determined by courts.***

Enter Discover 2017-10

The IRS, on the one hand, maintains that property contributed to partnerships and subsequently encumbered by conservation easements are overvalued. Discover 2017-10 “listed” a transaction whereby an investor acquired promotional supplies that provided potential traders a charitable contribution deduction that equals or exceeds 2 1/2 occasions the quantity of an investor’s funding via a pass-through entity, corresponding to a partnership. The investor then bought an curiosity within the entity that holds the property, and the entity contributes a conservation easement.

Classifying these transactions as “listed” was designed to discourage taxpayers from taking part in these transactions, simply determine these taxpayers who did take part in them, and penalize accordingly.

Penalties for Violations

A “listed transaction” is the IRS’s model of the Scarlet Letter. Civil penalties abound:

• In 2004, Congress enacted Section 6662A of the Inside Income Code. Part 6662A imposed a penalty on taxpayers who “understate” their tax on account of taking part in a “reportable transaction.” United States taxpayers are obligated to self-report our tax to the IRS. If a taxpayer makes a mistake within the IRS’s favor, it ends in an overstatement of tax. If a taxpayer makes a mistake (or makes an error or omission) within the taxpayer’s favor, then the outcome can be an understatement of tax. By including Part 6662A to the Code, Congress imposed a further penalty – on high of the myriad of different civil and probably legal penalties relevant to United States taxpayers whose tax returns are incorrect – on taxpayers who take part in “listed” or “reportable” transactions and whose returns understate tax on account of that reportable transaction. The penalty is both 20 or 30 p.c of the quantity of the understatement of tax attributable to the listed transaction.
• Section 6700 of the Inside Income Code offers for promoter penalties to be assessed at a proportion of the transaction.
• Sections 6707 and 6707A penalize the failure to file sure experiences or maintain observe of sure info required to be stored in reference to a listed transaction.
• Accuracy penalties and civil fraud penalties usually tend to be imposed in reference to a listed transaction.

These are simply the civil penalties – there are potential legal penalties, as properly. And keep in mind, all of those penalties are inclusive of one another, and never mutually unique.

In mild of the intense penalties related to itemizing a transaction, one would anticipate the IRS to be diligent inf making certain that the itemizing discover is air-tight. However because the Tax Courtroom held in Inexperienced Valley, the Tax Courtroom didn’t comply with the Administrative Process Act’s necessities when issuing the discover, and it’s due to this fact invalid.

Enter the Inexperienced Valley

In Inexperienced Valley, the taxpayer argued that the IRS didn’t comply with the Administrative Process Act (APA)’s necessities when it revealed Discover 2017-10, as a result of it didn’t comply with formal rulemaking procedures the APA required. Particularly, the IRS didn’t subject a discover of formal rulemaking, ask the general public to submit feedback, after which publish ultimate steering that addresses the feedback from the general public.

IRS argued that it was not required to undergo formal discover and remark, however the Tax Courtroom disagreed.

Relying closely on current Supreme Courtroom of the US case CIC Services, LLC v. Internal Revenue Service and Sixth Circuit Case Mann Development, Inc. v. United States, 27 F. 4th 1138 (2022), the Tax Courtroom held that “the act of figuring out a listed transaction by the IRS, by its very nature, is the creation of a substantive (i.e., legislative) rule and never merely an interpretative rule.” Accordingly, Discover and Remark rulemaking was required and the IRS’s failure to comply with that process renders the discover invalid.

What Does This Imply for the Battle on Conservation Easements and IRS Enforcement?

There are three sorts of Tax Courtroom selections:

(1) abstract selections,

(2) memorandum selections, and

(3) division selections.

Abstract selections are issued in “small” circumstances, that means the quantity at subject is lower than $50,000. They don’t have any precedential worth and so they can’t be appealed. Memorandum decisions are “T.C. Memo” selections. They sometimes take care of authorized points which can be established. They’ve some precedential worth. They’re authored by one choose and reviewed by the presiding choose and the Chief Decide of the Tax Courtroom. Division opinions are probably the most precedential kind of Tax Courtroom opinion. Division opinions contain new or uncommon authorized questions, and they’re determined by your complete physique of Tax Courtroom judges. (Not together with senior or particular trial judges).

The Inexperienced Valley opinion is a division opinion, with 15 of the 17 complete Tax Courtroom judges agreeing within the outcome to invalidate Discover 2017-10 (albeit for various causes), with two dissenters. The IRS can (and certain will) enchantment, however within the interim, Discover 2017-10 is invalid.

Tax litigator Michelle Levin, a accomplice with Dentons, mentioned, “ Because the Mayo determination in 2011, tax practitioners have been slowly creating an experience in APA legislation and figuring out potential APA challenges to IRS actions. Yesterday’s determination makes clear that the Tax Courtroom can also be honing its APA experience with an intensive evaluation of the APA’s necessities and the way to steadiness these obligations with each the Inside Income Code and IRS guidelines and rules.”

Sandra Brown, a tax litigation accomplice with Hochman Salkin Toscher Perez, P.C. believes that, “the Tax Courtroom’s determination displays the continued affect of the Administrative Process Act in tax administration. Nobody can doubt each the significance and burdensome nature of the listed transaction regime. Given the restricted listings during the last years, IRS and Treasury has acknowledged this and has exercised restraint. Nonetheless, the authorized discovering of a requirement of discover and remark beneath the APA is compelling, makes good sense and is key to administrative due course of.”

The Courtroom of Appeals for the Sixth Circuit put it finest in Mann Development:

“ If people ‘should flip sq. corners once they take care of the federal government,’ … ‘it can’t be an excessive amount of to anticipate the federal government to show sq. corners when it offers with them.” Two years after I revealed an article in Tax Notes arguing that Notice 2017-10 is invalid for these very causes two years in the past, I’m relieved to see the Courts making use of the identical rule of legislation to the federal government.

Petitioners had been represented by Vivian Hoard, Kip Nelson, Richard Coughlin, Brian Bernhardt, and Elizabeth Blickley of Fox Rothschild LLP.