The US Tax Court determined that the easements’ values were overstated in numerous recent cases involving syndicated conservation easements. The following article examines the recent results of five syndicated conservation easement (SCE) cases. Although the specifics of each case vary, the themes stay consistent.
Promoters put property in an LLC, sell shares of the LLC to investors, and then donate a conservation easement to a qualifying charity. They get an appraiser to value the land based on its highest and best use and then claim a charitable deduction based on the value of the donated land. The deductions are claimed on the LLC’s partnership return and then passed through to the investors.
Theoretically, that is all above board, but the Tax Court has repeatedly determined that SCE appraisals grossly overstate the value of the land. When taxpayers underreport their tax liability due to the mis-valuation of property by 200% or more, they face a gross negligence penalty of 40%. Because these appraisals are often hundreds of times higher than the actual fair market value of the property, the Tax Court has levied this penalty on billions of dollars of deductions.
In some cases, the Tax Court has completely disallowed the deduction. In those situations, the taxpayer incurred a 40% penalty on the tax understated due to the mis-valuation and a 20% penalty on the understated tax related to the fair market value of the disallowed deduction. In the majority of the cases, the Tax Court has not pursued fraud penalties, even over-ruling the IRS’s recommendations for fraud penalties in at least two cases.
The Tax Court heard expert testimony when evaluating the SCE appraisals, but the gross valuation misstatements were not the Court’s only concern. In nearly every case, the Court’s decision also noted that the LLCs were only formed to claim tax deductions for investors. The LLCs may have had promotional materials that listed multiple use options for the property and/or the partnerships may have had a vote on whether or not to conserve the land. However, these actions were arguably only employed to hide the true nature of the tax shelter.
Note that these Tax Court cases only relate to the legitimacy of the SCE deductions. They do not look at possible criminal actions of the promoters. The IRS Criminal Investigation (CI) is actively seeking to bring charges against promoters, with at least two so far facing decades in prison. If you are worried about criminal charges, contact an experienced tax attorney as soon as possible.
Here is an overview of five recent cases to give you an idea of how this situation tends to play out in Tax Court. To get help now, contact us at Wiggam Law today.
Excelsior Aggregates LLC v. Commissioner
In this case, the Tax Court issued a decision on three factually litigated cases in Escambia County, Alabama, that applied to 10 other partnerships that agreed to be bound to this decision. Across the 13 cases, the promoters bought the land for $9.5 million, collected $36 million from investors, and then claimed $187 million in charitable deductions.
For the three litigated cases, the Tax Court reduced the value of the deduction claimed by an average of 88%. Initially, the three partnerships claimed about $33.7 million in charitable deductions for their conservation easements and fee simple deductions in 2014.
Excelsior Aggregates, LLC (EAG) and Alabama S&G, LLC (ASG) claimed easement deductions of $12.5 and $11.2 million, respectively, as well as fee simple deductions of approximately $4.2 and $3.7 million, respectively. The IRS reduced EAG’s allowable deduction to $693,000 and ASG’s to $810,000. Barnes-Escambia Properties, LLC (BEP) claimed a fee simple deduction of $2.1 million, which the IRS reduced to $1.9 million, which was a significant win for this particular partnership..
The Tax Court applied a 40% negligence penalty on EAG and ASG’s tax understatement related to the gross valuation misstatement and a 20% penalty to any tax that was understated for any other reason. BEP incurred no penalties
Besides BEP, all of the other partnerships subject to this ruling claimed at least a $10 million conservation easement deduction. The LLCs donated the easements to the National Wild Turkey Federation Research Foundation. When calculating their deduction, they based the value on how much the land would be worth if turned into a sand and gravel pit. The promotional materials stated that investors who purchased shares in the LLC could opt for one of the following three options: 1) put the land in a conversation easement, 2) develop a sand and gravel business, or 3) hold the land for appreciation.
However, the materials didn’t go into detail about the first two options. They just explained the tax benefits of the conservation easement. Promoters of shares in the Big Escambia Tract promised investors that they would get a $4 tax deduction for every $1 invested in the land. Allegedly, the members voted, but there was no record of the vote. The Tax Court considered these elements when reviewing the legitimacy of the claim, and it appeared to be highly unlikely that the land would have ever been developed as a sand and gravel pit. Rather, the development options were just listed to hide the tax shelter.
When hearing the case, the Tax Court looked closely at the valuation of the land based on similar properties, demand for sand and gravel, the local economy, and several other factors. Based on expert testimony from multiple sources, the court concluded that the valuation of the land for the deduction was grossly overstated, and they applied penalties as noted above.
Savannah Shoals, LLC v. Commissioner
In this case, Savannah Shoals LLC claimed a $23 million charitable tax deduction for donating a conservation easement to Southeast Regional Land Conservancy, Inc. The IRS attempted to deny the deduction, claiming that the LLC didn’t meet the substantive or reporting requirements. The Tax Court disagreed with the IRS and allowed the deduction but lowered the value of the deduction to $480,000. Then, the Court applied a 40% gross valuation penalty to the tax understated due to the gross valuation misstatement
Savannah Shoals, LLC owned 103 acres of heavily wooded, rolling to steep vacant land near Lake Hartwell in Georgia. When talking with prospective investors, Shoals said that they could operate a quarry, put the land in a conservation easement, or hold it indefinitely. The majority of the investments were received on December 28, 2017, and the vote to put the land in a conservation easement happened the same day.
Note that one Shoals LLC was terminated before donating the easement, and another was started. The Tax Court opinion refers to these two entities as New Shoals and Old Shoals, but that level of detail is outside this article’s scope.
Shoals claimed a deduction of $23 million and a basis of $37,776 for the donated land. Due to an e-filing error and the involvement of multiple tax preparers, there were two different Forms 8283, Noncash Charitable Contributions, prepared with slightly different numbers. Originally, the IRS attempted to disallow the deduction due to this discrepancy, but the Tax Court said that this part of the issue was immaterial and not gross negligence.
Instead, the Court focused on the value of the deduction, which was based on the “highest and best use” for the land as an aggregate mine. The appraiser lacked significant information about the property, including the fact that Shoals had just acquired it the day before the appraisal. His report even stated that there were no known sales of the land in the last four years. He based his valuation on the property’s value as if it were producing income as an aggregate mine.
The Tax Court heard testimony from several experts determined that the proposed mining operation was not feasible due, in part, to an abundance of aggregate in that area. In its decision, the court stated that the income method, a type of discounted cash flow appraisal method, was not an effective evaluation method for vacant land with no income-producing history. Rather, the court looked at comparable sales of vacant land instead. Based on the testimony they heard, the Court lowered the deduction to about 2% of the amount originally claimed.
Oconee Landing Property, LLC et al. Vs. Commissioner
Oconee Landing Property LLC claimed a $20.67 million charitable deduction for donating 355 acres in Greene County, Georgia to the Georgia-Alabama Land Trust (GALT). The Tax Court disallowed the entire deduction, claiming that the land was worth less than $5 million and that the LLC failed to provide a qualified appraisal.
The LLC incurred a 40% gross valuation statement for the tax that was understated due to the gross valuation misstatement and a 20% accuracy-related deduction for the rest of the understated tax. In other words, the tax that was understated due to the $15 million overvaluation was exposed to a 40% penalty, but the tax that was understated due to the $5 million disallowed deduction only received a 20% penalty.
The donated land’s appraised value was based on its alleged value if it were developed into mixed-use residential properties. The appraisal included comps of similar land in Florida and North Carolina but not Alabama. The Tax Court took into account expert testimony about the demand for these types of properties and the likelihood of development. The Court also considered the fact that the property’s owners had been trying to sell for years with no offers even remotely close to the appraised value.
As with the other cases, the Court also considered that the LLC did not seriously entertain the idea of developing the land. Although development was mentioned in the promotional materials, the materials also stated that Carey Station Manager, LLC would decide between conservation and development. The LLC would let the members know about its decision, and then the members would have one day to respond if they disagreed. This is not how an LLC functions if it allows its members to decide between multiple options. This is the way an abusive tax shelter functions.
In addition to reducing the valuation, the Court disallowed the deduction for two reasons. One, the Court determined that the “qualified appraiser” requirement was not met when the original landowner knew or should have known that the appraisal was falsely overstated. Two, the property was “ordinary income property” to Oconee, and thus, they were only able to claim a charitable deduction limited to their basis in the property. Here, the court determined that no basis had been proven, so the value was zero.
Buckelew Farm LLC et al. v. Commissioner
Buckelew Farm, LLC, formerly known as Big K Farms, LLC claimed a $47.57 million deduction for donating 1,545 acres of land in a conservation easement to Southeast Regional Land Conservancy, Inc. (SERLC). Originally, the IRS disallowed the deduction and proposed a civil fraud penalty. When the Tax Court heard the case, they allowed the deduction but reduced the value of the donation to $4.6 million. The Tax Court also decided to levy a 40% penalty rather than the civil fraud penalty.
When selling shares to investors, Big K Farms offered a return of 1 to 4.39. In other words, a $200,000 investment would lead to about $878,000 in tax deductions. The appraiser based the valuation on what the land would be worth if it were converted into 307 residential lots oriented around hunting and conservation.
During the hearing, The IRS’ experts said that the highest and best use of the land would be continued timber production, some hunting and fishing, possibly agriculture, and very low-density residential. When re-assessing the valuation, the experts also looked at the values of comparable properties in the area. When discussing land use options, they looked at what was legally permissible, physically possible, financially feasible, and most productive. The proposed development used in the original appraisal was not legally allowed with the zoning rules in the area.
This deduction was reduced to about 10% of the original amount claimed, and a 40% penalty was upheld. To understand the financial extent of this ruling, consider the theoretical investor above, who put in $200,000 for a $878,000 deduction. Their deduction gets reduced to $87,000. Assuming that the top marginal tax bracket applies, the investor would have originally claimed a $324,000 tax savings, which drops to $32,000 in light of the lower deduction. In other words, the investor is now facing a tax liability of approximately $292,000 plus a 40% penalty of $116,800.
Note these are just sample numbers, and the specifics depend on the other factors in the investor’s tax situation. Additionally, in many cases, the IRS is applying the tax at the partnership level at a rate of 21%. However, to take advantage of that type of savings, you may need to work with an attorney to contact the IRS about a settlement.
Corning Place Ohio, LLC v. Comm’r
This case is an urban version of the above cases. Corning Place Ohio LLC bought a historic building in downtown Cleveland and renovated it into luxury apartments. The renovation was approved by the National Park Service and the State of Ohio, and they both gave the LLC preservation credits to fund the project.
Then, the partnership also donated a conversion easement to Historic Gateway Neighborhood Corp. and claimed a subsequent tax deduction worth $22.6 million. The easement stated that the building’s facade would be maintained forever in its rehabilitated condition for preservation purposes. The value of the deduction was based on the idea that the LLC had placed the building’s facade in an easement and given up the right to build a 24-story addition on top of the building.
This addition was structurally impossible, but moreover, it would have prevented the partnership from receiving the state and federal tax credits they used to rehabilitate the building, as the rehabilitation plan stated that rooftop improvements could not be visible from the street.
The Tax Court determined that the easement was worth just $900,000, not over $22 million. The Court also ruled that the LLC was not entitled to a charitable contribution deduction because it was claimed on the wrong entity tax return. For the tax understatement related to the gross valuation misstatement, the Court applied a 40% penalty, and for the $900,000 deduction that was not claimed, the Court applied a 20% penalty. A 20% penalty was also applied to a disallowed real estate loss deduction of $665,500.
Legal Guidance for SCE Investors
The IRS is taking this issue very seriously. In addition to the above cases, other recent Tax Court cases include Plateau Holdings, LLC v. Commissioner, TOT Property Holdings, LLC v. Commissioner, and Mill Road 36 Henry, LLC v. Commissioner. Additionally, there have been several guilty pleas from promoters, and two promoters were sentenced to 25 and 23 years in prison.
In July 2024, the IRS began sending settlement letters to some investors. If you have received a letter and don’t have a pending case in Tax Court, you may be eligible for a settlement. The settlement eliminates the deductions except to the extent that partners contributed cash, and it applies a 21% tax on the partnership level along with a 5% penalty.
For TEFRA partnerships, only the authorized signer needs to make the election, but with non-TEFRA partnerships, all of the partners must sign and agree to accept the deal. This is not legal advice and may not be the best or even a relevant option in your situation. To get guidance now, contact us at Wiggam Law today. Call us at (404) 609-1300 or fill out our online consultation form to schedule a meeting with one of our tax attorneys today to find out more about your options.