Proposed Regs Address SECURE 2.0 Act Conservation Contribution Disallowance Rule

(Parker Tax Publishing December 2023)

The IRS issued proposed regulations concerning the statutory disallowance rule enacted by the SECURE 2.0 Act of 2022 to disallow a deduction for a qualified conservation contribution made by a partnership or an S corporation after December 29, 2022, if the amount of the contribution exceeds 2.5 times the sum of each partner's or S corporation shareholder's relevant basis. The proposed regulations provide guidance regarding this statutory disallowance rule, including definitions, appropriate methods to calculate the relevant basis of a partner or an S corporation shareholder, the three statutory exceptions to the statutory disallowance rule, and related reporting requirements. REG-112916-23.

Background

Under Code Sec. 170(f)(3)(A), a deduction is generally not allowed for a charitable contribution of an interest in property that consists of less than the taxpayer's entire interest in such property. However, Code Sec. 170(f)(3)(B)(iii) provides that Code Sec. 170(f)(3)(A) does not apply to a qualified conservation contribution. The term "qualified conservation contribution" is defined in Code Sec. 170(h)(1) as a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. In general, a qualified conservation contribution may include a contribution of a conservation easement.

The existing regulations under Reg. Sec. 1.170A-14 provide rules for qualified conservation contributions described in Code Sec. 170(h). Consistent with Code Sec. 170(f)(3), Reg. Sec. 1.170A-14(a) provides that a deduction generally is not allowed for a charitable contribution of any interest in property that consists of less than the donor's entire interest in the property other than certain transfers in trust. However, by reason of Code Sec. 170(f)(3)(B)(iii), a deduction may be allowed for the value of a qualified conservation contribution if the requirements of Reg. Sec. 1.170A-14 are met. To be eligible for a deduction under Reg. Sec. 1.170A-14, the conservation purpose of the contribution must be protected in perpetuity.

Code Sec. 170(h)(7) was added to the Code by the SECURE 2.0 Act of 2022 (Pub. L. 117-328). Code Sec. 170(h)(7)(A) states that a contribution by a partnership (whether directly or as a distributive share of a contribution of another partnership) is not treated as a qualified conservation contribution for purposes of Code Sec. 170 if the amount of such contribution exceeds 2.5 times the sum of each partner's relevant basis in such partnership (Disallowance Rule). Thus, a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes is not a qualified conservation contribution if the Disallowance Rule applies. Code Sec. 170(h)(7)(F) generally provides that the rules of Code Sec. 170(h)(7) "apply to S corporations and other pass-through entities in the same manner as such rules apply to partnerships."

Code Sec. 170(h)(7)(G) authorizes the IRS to prescribe such regulations or other guidance as may be necessary or appropriate to carry out the purposes of Code Sec. 170(h)(7), including regulations or other guidance (1) to require reporting, including reporting related to tiered partnerships and the modified basis of partners, and (2) to prevent the avoidance of the purposes of Code Sec. 170(h)(7).

On November 17, the IRS issued proposed regulations (REG-112916-23) that provide guidance regarding the Disallowance Rule, including definitions, appropriate methods to calculate the relevant basis of a partner or an S corporation shareholder, the three statutory exceptions to the statutory disallowance rule, and related reporting requirements. In addition, the proposed regulations provide reporting requirements for partners and S corporation shareholders that receive a distributive share or pro rata share of any noncash charitable contribution made by a partnership or S corporation, regardless of whether the contribution is a qualified conservation contribution (and regardless of whether the contribution is of real property or other noncash property).

Proposed Regulations

Prop. Reg. Sec. 1.170A-14(j) provides guidance on the general applicability of the Disallowance Rule to partnerships and S corporations. Prop. Reg. Sec. 1.170A-14(j)(3) provides definitions. Consistent with Code Sec. 170(h)(7)(B), Prop. Reg. Sec. 1.170A- 14(k) provides that the term "relevant basis" means, with respect to any ultimate member (as defined in Prop. Reg. Sec. 1.170A-14(j)(3)(x)), the portion of such ultimate member's modified basis (as determined under Prop. Reg. Sec. 1.170A-14(l)) that is allocable (under the rules of Prop. Reg. Sec. 1.170A-14(m)) to the portion of the real property with respect to which the qualified conservation contribution is made. Prop. Reg. Sec. 1.170A-14(l) provides guidance on the determination of modified basis.

Prop. Reg. Sec. 1.170A-14(m) provides guidance on the allocation of modified basis to the portion of the real property with respect to which the qualified conservation contribution was made. Prop. Reg. Sec. 1.170A-14(m)(6) imposes recordkeeping requirements for substantiating the computation of each ultimate member's adjusted basis, modified basis, and relevant basis by the due date, including extensions, of the partnership's or S corporation's federal income tax return. Prop. Reg. Sec. 1.170A-14(n) provides guidance on the three statutory exceptions to the Disallowance Rule in Code Sec. 170(h)(7)(C), (D), and (E).

Under Prop. Reg. Sec. 1.170A-14(j)(2)(ii), an allocated portion of a contribution received by an upper-tier partnership or upper-tier S corporation is generally a "disallowed qualified conservation contribution" (i.e., a contribution for which a deduction is disallowed by Reg. Sec. 1.170A-14(j)) if either the contribution is a disallowed qualified conservation contribution with respect to the partnership that allocated the allocated portion to the upper-tier partnership or upper-tier S corporation, or such allocated portion exceeds 2.5 times the sum of each of that upper-tier partnership's or upper-tier S corporation's ultimate member's relevant basis as determined under Prop. Reg. Sec. 1.170A-14(j) through (m).

Thus, if a contribution is a disallowed qualified conservation contribution with respect to a partnership, then the contribution is a disallowed qualified conservation contribution with respect to any upper-tier partnership or upper-tier S corporation owning a direct or indirect interest in that partnership. On the other hand, if a contribution is not a disallowed qualified conservation contribution with respect to a partnership, then the rules of Prop. Reg. Sec. 1.170A-14(j) through (m) must be applied to the next tier of upper-tier partnerships and upper-tier S corporations (which own a direct interest in the partnership) to determine if the Disallowance Rule applies to those upper-tier partnerships and upper-tier S corporations. In other words, the test of Reg. Sec. 1.170A-14(j) through (m) must be applied at each tier unless and until the test is failed at one tier, in which case that portion of the contribution will be a disallowed qualified conservation contribution to that tier and any subsequent tiers.

Ultimate Member

Prop. Reg. Sec. 1.170A-14(j)(3)(x) defines the term "ultimate member" as any partner (that is not itself a partnership or S corporation) or S corporation shareholder that receives a distributive share or pro rata share, directly or indirectly, of a qualified conservation contribution. Thus, ultimate members would either be partners holding a direct interest in a partnership, which may be the contributing partnership or an upper-tier partnership, or shareholders holding a direct interest in an S corporation, which may be the contributing S corporation or an upper-tier S corporation. Prop. Reg. Sec. 1.170A-14(j)(3)(x) provides that upper-tier S corporations and upper-tier partnerships themselves are not considered ultimate members.

The IRS explained that the Disallowance Rule is meant to compare the amount of a claimed qualified conservation contribution with the equity investment made by those persons expected to claim a deduction with respect to such contribution. Because it is the ultimate members, such as individuals, estates, and C corporations (that is, non-pass-through entities), who ultimately claim a deduction for a qualified conservation contribution, the proposed regulations require that the determination of relevant basis be made with respect to those ultimate partners and S corporation shareholders.

For example, assume a contributing partnership has two partners: (1) an upper-tier S corporation, which has two individual shareholders, and (2) an upper-tier partnership, which has three partners: a C corporation, an estate, and an individual. Under the proposed regulations, relevant basis would be computed with respect to the three individuals, C corporation, and estate, and not with respect to the upper-tier S corporation or upper-tier partnership.

Effect of Disallowance Rule

Code Sec. 170(h)(7) does not explicitly address what effect the application of the Disallowance Rule to one partnership or S corporation in a tiered structure has on the other partnerships or S corporations in the tiered structure. The proposed regulations provide that if the Disallowance Rule applies to a partnership or S corporation, then the qualified conservation contribution is a disallowed qualified conservation contribution to that entity as well as to any person receiving a distributive share or pro rata share, directly or indirectly, of that entity's disallowed qualified conservation contribution; however, the disallowance would not affect the qualified conservation contribution with respect to any lower-tier entities. In other words, if the application of the Disallowance Rule with respect to an upper-tier partnership or upper-tier S corporation results in a disallowed qualified conservation contribution, that would affect federal income tax consequences up the chain of tiers, but not down the chain of tiers, so, for example, the contributing partnership would not be affected.

Reporting Requirements

Existing Reg. Sec. 1.170A-16 generally requires a donor to file Form 8283, Noncash Charitable Contributions, in the case of a noncash charitable contribution exceeding $500. To further clarify reporting requirements for donated property, Prop. Reg. Sec. 1.170A-16(c)(3)(v) and (d)(3)(ix) add a requirement that, if a box in Section A or Section B of the Form 8283 (respectively) requests insertion of a number, the taxpayer must include the number in the box or attach a statement explaining why the taxpayer cannot include the number in the box. Taxpayers that do not include numbers where required or engage in a practice to obfuscate or otherwise defeat the requirement to include a number in the box, could be subject to heightened scrutiny and a denial of the deduction for failure to provide the requested information on the Form 8283.

According to the IRS, the rule regarding specific reporting of numerical amounts is necessary because the IRS has observed a pronounced increase in taxpayers filing a Form 8283 that does not contain any numbers and instead refers to an attachment. Often, the attachment contains nonresponsive information or includes multiple numbers for different boxes, leaving the IRS to guess which of the included numbers is appropriate for a particular box. Thus, under the proposed regulations, Sections A and B of Form 8283, including any attachments thereto, may not include nonresponsive information, such as "available upon request," "provided upon request," or any other nonresponsive information other than the information requested. Including any nonresponsive language may result in a presumption that Form 8283 is incomplete.

Existing Reg. Sec. 1.170A-16(d)(3) defines a completed Form 8283 (Section B) required to substantiate charitable contributions of more than $5,000. To ensure that taxpayers claiming qualified conservation contributions properly comply with Code Sec. 170(f)(19) and (h)(7), which require a partnership or S corporation to calculate the sum of the relevant basis of the partnership's or S corporation's partners or shareholders, the IRS stated that it must have relevant basis reporting from both the contributing partnership or contributing S corporation and each partner or shareholder receiving an allocation of the contribution (which will be ultimate members, upper-tier partnerships, or upper-tier S corporations). Accordingly, the proposed regulations insert a new paragraph, Prop. Reg. Sec. 1.170A-16(d)(3)(viii). The new paragraph provides that the sum of each ultimate member's relevant bases, computed in accordance with Prop. Reg. Sec. 1.170A-14(j) through (m), must be reported on the Form 8283 (Section B) in order for the Form 8283 (Section B) to be considered complete.

The proposed regulations are proposed to apply to contributions made after December 29, 2022, the date of enactment of the SECURE 2.0 Act.

For a discussion of the disallowance rule in Code Sec. 170(h)(7), see Parker Tax ¶84,155.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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