Syndicated conservation easements offer taxpayers significant tax deductions for donating property into charitable easements, but according to the IRS, fraudulent transactions have led to losses of $36 billion in tax revenue since 2010. In 2019, the IRS put syndicated conservation easements on its Dirty Dozen tax scams list, and it continues to top the list in 2024.
Carolyn Schenck, National Fraud Counsel of the Internal Revenue Service (IRS) reports that the IRS is auditing 100% of these cases and finding significant abuses. Taxpayers are appealing at high rates, but the U.S. Tax Court tends to favor the government in most of these cases.
If you’re deciding whether to accept a settlement offer or litigate a current SCE case, you may want to consider how the Tax Court has ruled in these cases in the past. As you will see below, an early victory for SCE cases helped to establish the growth of this investment strategy, but since that time, even the cases that have favored investors have still led to partial losses of deductions and significant interest.
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Kiva Dunes – A Victory for SCE Investors
In 2009, the Tax Court heard one of the earliest cases about syndicated conservation easements (SCE), and arguably, the results of this case inspired the widespread growth of these investments over the next 10+ years.
In Kiva Dunes Conservation, LLC v. Commissioner, the Tax Court overruled the IRS’s denial of Kiva Dune’s charitable deduction and also upheld the majority of the taxpayer’s valuation for the deduction. From the taxpayer’s perspective, this was a successful ruling, especially when compared to the more recent cases in front of the court.
Here’s the back story. Kiva Dunes was an upscale golf course in Alabama. The owners donated its land to a conservation trust based on the idea that the golf course was helpful to migratory birds. However, the golf course couldn’t financially benefit from the tax deduction so it created a partnership unit that allowed the deduction to be allocated to its partners.
Originally, the IRS wanted to deny the deduction based on the idea that a golf course does not conserve land. However, the Tax Court quickly denied that premise. Although golf courses may not feature all-natural land, they can still play an important role in preserving habitats for many different species.
Once the courts upheld the legitimacy of the deduction, the argument focused on the value of the easement. The courts prohibited the taxpayer from using post-valuation-date information to argue their case. While showing the land’s value if developed, the taxpayer relied on reports showing golf course closures and losses at local courses. The courts said this information was invalid as it wasn’t available at the date of the valuation. The IRS, however, has routinely used comp sale prices gathered after the valuation date to substantiate its valuation estimates.
In the Kiva Dunes case, the courts mandated that neither the IRS nor the taxpayer could use post-valuation-date information, except to measure the reasonableness of the appraiser’s assumption. This ruling upheld the valuation of Kiva’s deduction, but more significantly, it created consistency for valuation that helped to inspire the next decade of SCE transactions.
Why did investors win the Kiva Dunes SCE case?
One significant distinction between Kiva Dunes and a lot of the more recent SCE cases is the amount of time the land was owned. In the case of Kiva Dunes, the owners had the land for decades before donating the easement. In many cases that have gone to Tax Court, the land was held for months or even just days before it was donated.
Champions Retreat – Upholding 75% of the Deduction
In late 2022, the Tax Court allowed $7.8 million of a $10.4 million deduction claimed by Champions Retreat Gold Founders LLC on its 2010 tax return. Before Champions appealed, the IRS originally only wanted to allow a $20,000 deduction.
The case was very similar to the Kiva Dunes case, in that, a golf course donated an easement and claimed a deduction based on the value of developing the property. In this case, the golf course also had no use for the deduction so they created Kiowa Partners to claim the deduction and allocate it to the organization’s partners. Unfortunately, however, even preserving over 75% of the deduction didn’t necessarily protect investors that much.
In aggregate, the 15 partners contributed $2.7 million, and they got back $3.6 million in savings. When you subtract the tax savings from the partnership contribution, you see a financial benefit of about $900,000. However, when the deduction was reduced by about a quarter, that $2.59 million was added back to the partners’ income.
At the highest marginal tax rate, that leads to a tax liability of just over $900,000, and with interest, that increases the liability to around $1.3 million. Depending on how the investors spent their savings in 2010, they may have broken even or lost money through this deal.
How does the investment multiplier affect SCE court cases?
Like the Kiva Dunes case, the land in Champions was also owned for a relatively significant period of time. Additionally, the investors only received a tax benefit of 1.35 times their investment. This multiplier is significant because the higher it gets, the more likely the transaction is to be abusive, and the more likely investors are to see their deductions disallowed.
As of 2024, the IRS considers any SCE deduction worth over 2.5 times the original deduction to be a listed transaction that carries special reporting requirements.
Mill Road 36 Henry – Reduced Valuations for SCE Deductions
The Champions case was not necessarily an outlier. Prior to 2023, the Tax Court allowed over 75% of the value of SCE deductions to stand when hearing cases. However, after about a decade, the courts took a sharp turn in Mill Road 36 Henry, LLC V. Commissioner.
Mill Road 36 Henry originally claimed a charitable deduction of $8.9 million based on the highest and best value of the donated land as an assisted living facility. By the time the case went to court, the taxpayer was arguing for a $6.7 million evaluation, but the court disallowed the deduction stating that no developer would spend that much on the land when nearby parcels were available for much lower prices.
The court disallowed all but $900,000 of the deduction. Because it was inventory in the hands of the original owner and it was transferred to a partnership, the IRS also argued that the deduction was limited to the owner’s basis in the property. That further reduced the allowed deduction to $426,563.
Which portion of SCE deductions does the Tax Court usually allow?
Over the next six land conservation cases, the court allowed less than 10% of the original valuation for the SCE deduction claimed and in some cases, much less. That trend is continuing. Now, most of the SCE cases in Tax Court tend to focus on valuation.
However, the IRS continues to bring forward ancillary claims to justify disallowing these deductions.
Beyond Valuation Misstatements – Other Taxpayer Missteps
In many recent SCE cases, the Tax Court has reduced the charitable deduction on the grounds that the property’s value was overstated. You see this trend in cases related to Excelsior Aggregates, Savannah Shoals, Oconee Landing Property, Buckelew Farm, and Corning Place Ohio which are covered in more detail in this post on the Tax Court’s reduction of deductions in SCE cases.
However, mis-valuation was not the only element the courts looked at. The courts also looked at other elements of these transactions including their economic substance, the independence of the appraiser, the validity of the partnership, step transactions, and other elements. Even if you are very confident about the legitimacy of the appraisal, you must ensure that the technical elements are correctly in place when dealing with SCE transactions as you can see in the following rulings.
In two cases, the Court disallowed the deduction in its entirety. The Court said that Oconee Landing failed to provide a qualified appraisal. Furthermore, the courts ruled that because the property was ordinary income property, the deduction was limited to Ocenee’s basis, which was not established, thereby eliminating that deduction as well.
Finally, in Corning Place Ohio, LLC, the Court reduced the value of the charitable deduction, but then, the court also disallowed the entire deduction based on the fact that it was claimed on the wrong entity’s tax return. While the deduction was claimed by Corning Place, it should have been claimed by CP Investments. At the time when the deduction was claimed, CP Investments was the sole member of Corning Place, LLC, making it a disregarded entity.
Wins for SCE Investors – Focus on APA Rules
Although the Tax Court has disallowed or reduced many SCE deductions, others have been upheld, but sometimes, only on a technicality. In two recent cases, investor victories are due to the IRS’s failure to stay compliant with the rules of the Administrative Procedure Act (APA).
In Valley Park Ranch, LLC v. Commissioner, the case focused on whether or not the easement was protected in perpetuity and by extension whether it met the requirements of Treasury Regulation 170(h)(2)(C) and (h)(5). The Tax Court ruled that this regulation is procedurally invalid under the Administrative Procedure Act.
About a year later, taxpayers also prevailed on a technicality in the case of Green Valley Investors, LLC v. Commissioner of Internal Revenue by also relying on the IRS’s violation of the APA. In this case, the plaintiff argued that the IRS failed to have a notice and comment period when issuing Notice 2017-10 which classified SCEs as listed transactions. The Court sided with the plaintiff, classifying the notice as invalid. However, since that time, the IRS has successfully classified some SCE deductions as listed transactions.
Why do you need an experienced attorney for SCE cases?
These cases emphasize the importance of working with legal counsel who understands how to approach a case from every angle including procedural missteps.
Should You Invest in an SCE?
If you are thinking about investing in an SCE or have already claimed an SCE deduction, you should consult with a tax attorney. The IRS is auditing nearly all of these deductions, and despite a few small taxpayer victories, the Tax Court has upheld the government’s interest in most of these cases.
Promoters may tell clients that their investment opportunities aren’t the same as the ones that have undergone challenges in Tax Court, but before putting your money into this type of investment, you should learn more about the long-term implications of SCE transactions.
Guidance for SCE Investments and Legal Challenges
As of 2024, the IRS has sent settlement letters to many taxpayers. This is not the first round of SCE settlements offered by the agency, but it’s certainly one of the most attractive. If you’re considering accepting a settlement or pursuing litigation, you should talk with a tax attorney. While the pros and cons of settlements are relatively clear, the potential advantages of litigation are elusive and inherently risky.
To get help now, contact Wiggam Law for guidance. Feel free to call us at (404) 233-9800 or use the online contact form to request a consultation.