IRS Loses Battle In Battle On Conservation Easements

America Tax Courtroom held IRS Discover 2017-10 is invalid in a November 9, 2022 determination in Inexperienced Valley Traders, LLC, et al., Bobby Department, Tax Issues Associate v. Commissioner of Inside Income, 159 T.C. No. 5. In Inexperienced Valley Traders, the Tax Courtroom held that the IRS violated the Administrative Process Act’s necessities when issuing Discover 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 shall be no method to affect what occurs along with her land. However preservation is necessary to Jill. Sustaining open land is necessary to Jill. And offering public entry to seashores is necessary to Jill. How can Jill go away her land to her youngsters, however stop them from paving paradise to place up a 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 permit landowners to maintain title to their property, however limit 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 position 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 partially – 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 assets, sustaining or enhancing air high quality, professional preserving the historic, architectural, archeological, or cultural points of actual property.** In English: a conservation easement is a manner for a landowner to voluntarily pledge their land is not going to be developed for the remainder of time. By putting a conservation easement on the land, the landowner grants some third occasion – 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 best to sue to forestall Jill, her youngsters, her grandchildren, her nice grandchildren – you get the purpose – from growing the land. The Nature Conservancy doesn’t personal the land, nor does it have the best to own the land, however it has the best – and the duty – to make sure that the easement’s protections and prohibitions on improvement are noticed.

What Makes A Conservation Easement ‘Syndicated’?

Assume the easement Jill has positioned on her lakefront property is price hundreds of thousands of {dollars}, however she doesn’t earn hundreds of thousands of {dollars}. Jill can’t get the total good thing about her donation. Via 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 capable of create a mechanism whereby People can collectively be part of conservation efforts and be rewarded for doing so.

If Jill places her land in a partnership and stays a companion, and the partnership locations a conservation easement on the land, then all of the companions get the advantage of the donation deduction. Bear in mind: Jill has now given up the best to depart the land to her youngsters when she dies. The land is now owned by the partnership, topic to the easement. As a result of every companion owns a share of the land, every companion can take their proportional share of the tax profit.

What Is The Worth Of A Syndicated Conservation Easement?

Simply what is the right tax profit for every companion to take their proportional share? That’s the final supply of disagreement between taxpayers and the IRS. Keep in mind, Jill didn’t donate her land to charity, and she or he 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.

In response to Treasury Regulation 26 CFR 1.170A-14(h)(3)(i), “The worth of the contribution below part 170 within the case of a charitable contribution of a perpetual conservation restriction is the truthful market worth 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 seek out, the IRS permits landowners to make use of the “earlier than and after technique”. The earlier than and after technique 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 truthful market worth 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 speedy or distant the chances are the property, absent the restriction, would the truth is be developed, in addition to any impact from zoning, conservation, or historic preservation legal guidelines that already limit the property‘s potential highest and greatest use.”

What’s the worth of giving up the best to develop lakefront property, for the remainder of eternity? That query is strictly the supply of the continuing 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 “drastically inflate[] the worth of the conservation easement primarily based on unreasonable conclusions in regards to the improvement potential of the actual property.” However taxpayers, alternatively, say the values should not inflated, and have been profitable in lots of circumstances the place the query of what the precise worth of the easement is set 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 obtained promotional supplies that supplied potential buyers a charitable contribution deduction that equals or exceeds 2 1/2 instances the quantity of an investor’s funding by means of a pass-through entity, comparable 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 collaborating 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 Part 6662A of the Inside Income Code. Part 6662A imposed a penalty on taxpayers who “understate” their tax on account of collaborating 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 shall be an understatement of tax. By including Part 6662A to the Code, Congress imposed a further penalty – on prime of the myriad of different civil and probably prison 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 % of the quantity of the understatement of tax attributable to the listed transaction.
• Part 6700 of the Inside Income Code offers for promoter penalties to be assessed at a share of the transaction.
• Sections 6707 and 6707A penalize the failure to file sure studies or preserve 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 prison penalties, as nicely. And keep in mind, all of those penalties are inclusive of one another, and never mutually unique.

In gentle of the intense penalties related to itemizing a transaction, one would anticipate the IRS to be diligent in making certain that the itemizing discover is air-tight. However because the Tax Courtroom held in Inexperienced Valley, the Tax Courtroom didn’t observe 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 observe the Administrative Process Act (APA)’s necessities when it revealed Discover 2017-10, as a result of it didn’t observe formal rulemaking procedures the APA required. Particularly, the IRS didn’t challenge a discover of formal rulemaking, ask the general public to submit feedback, after which publish closing 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 latest Supreme Courtroom of the USA case CIC Companies, LLC v. Inside Income 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 observe 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 choices:

(1) abstract choices,

(2) memorandum choices, and

(3) division choices.

Abstract choices are issued in “small” circumstances, that means the quantity at challenge is lower than $50,000. They haven’t any precedential worth and so they can’t be appealed. Memorandum choices are “T.C. Memo” choices. They sometimes cope with authorized points which might be established. They’ve some precedential worth. They’re authored by one choose and reviewed by the presiding choose and the Chief Choose of the Tax Courtroom. Division opinions are essentially the most precedential sort of Tax Courtroom opinion. Division opinions contain new or uncommon authorized questions, and they’re determined by the whole 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 whole 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) attraction, however within the interim, Discover 2017-10 is invalid.

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

Sandra Brown, a tax litigation companion 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. However, the authorized discovering of a requirement of discover and remark below the APA is compelling, makes good sense and is prime to administrative due course of.”

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

“ If people ‘should flip sq. corners after they cope with 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 Discover 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.