Proposed Regs Identify Syndicated Conservation Easements as Listed Transactions

(Parker Tax Publishing January 2023)

The IRS issued proposed regulations that identify certain syndicated conservation easement transactions, as well as substantially similar transactions, as listed transactions, a type of reportable transaction. Although syndicated conservation easement transactions were identified as listed transactions in Notice 2017-10, the IRS issued the proposed regulations after the Tax Court ruled in Valley Investors, LLC v. Comm'r, 159 T.C. No. 5 (2022), that Notice 2017-10 was improperly issued because the IRS did not follow the notice and comment procedures required by the Administrative Procedure Act. REG-106134-22.

Background

In Notice 2017-10, the IRS alerted taxpayers that certain syndicated conservation easement transactions, and substantially similar transactions, are tax avoidance transactions. The IRS identified such transactions as listed transactions for purposes of Reg. Sec. 1.6011-4(b)(2) and Code Sec. 6111 and Code Sec. 6112. A listed transaction is a type of transaction that must be disclosed to the IRS because it has the potential for tax avoidance or evasion. Material advisors and certain participants in listed transactions are required to file the disclosures with the IRS and are subject to penalties for failure to disclose.

Notice 2017-10 describes the following transaction as a listed transaction. An investor receives promotional materials that offer investors in a pass-through entity the possibility of a charitable contribution deduction that equals or exceeds an amount that is 2.5 times (that is, 250 percent of) the amount of the investor's investment. The investor purchases an interest, directly or indirectly, in the pass-through entity that holds real property. The pass-through entity that holds the real property contributes a conservation easement encumbering the property to a tax-exempt entity and allocates, directly or through one or more tiers of pass-through entities, a charitable contribution deduction to the investor. Following that contribution, the investor reports on his or her federal income tax return a charitable contribution deduction with respect to the conservation easement.

In Green Valley Investors, LLC, v. Comm'r, 159 T.C. No. 5 (2022), the Tax Court held that Notice 2017-10 was improperly issued because it was issued without following the notice and comment procedures required by Section 553 of the Administrative Procedure Act (APA). In reaching its decision, the Tax Court relied on an analysis similar to the analysis in Mann Construction, Inc. v. U.S., 2022 PTC 63 (6th Cir. 2022), in which the Sixth Circuit held that Notice 2007-83, which identified certain trust arrangements claiming to be welfare benefit funds and involving cash value life insurance policies as listed transactions, violated the APA because the notice was issued without following the APA's notice-and comment procedures.

Proposed Regulations

On December 6, the IRS issued proposed regulations which identify certain syndicated conservation easement transactions as listed transactions. The proposed regulations inform taxpayers that participate in syndicated conservation easement transactions, and substantially similar transactions, and persons who act as material advisors with respect to these transactions, and substantially similar transactions, that, once the proposed regulations are published in final form, the transactions must be disclosed in accordance with the final regulations and the regulations issued under Code Sec. 6011 and Code Sec. 6111. Material advisors must also maintain lists as required by Code Sec. 6112.

Observation: The IRS stated that it disagrees with the Sixth Circuit's decision in Mann Construction and the Tax Court's decision in Green Valley and will continue to defend the validity of Notice 2017-10 and other notices identifying transactions as listed transactions in circuits other than the Sixth Circuit. Prior to the date the regulations are published as final regulations, the IRS's position is that disclosure and list maintenance requirements for syndicated conservation easement transactions identified as listed transactions in Notice 2017-10 continue to be in effect, other than in the Sixth Circuit.

Prop. Reg. Sec. 1.6011-9(a) provides that a transaction that is the same as, or substantially similar to, a syndicated conservation easement transaction described in Prop. Reg. Sec. 1.6011-9(b) is a listed transaction for purposes of Reg. Sec. 1.6011-4(b)(2) and Code Sec. 6111 and Code Sec. 6112. Prop. Reg. Sec. 1.6011-9(b) defines a syndicated conservation easement transaction as a transaction in which the four elements described in Prop. Reg. Sec. 1.6011-9(b)(1) through (4) occur (regardless of the order in which they occur). These four elements are:

(1) a taxpayer receives promotional materials that offer investors in a pass-through entity the possibility of a charitable contribution deduction that equals or exceeds an amount that is 2.5 times the amount of the taxpayer's investment in the pass-through entity (i.e., the 2.5 times rule);

(2) the taxpayer acquires an interest, directly or indirectly through one or more tiers of pass-through entities, in the pass-through entity that owns real property;

(3) the pass-through entity contributes the conservation easement to a qualified organization and allocates a charitable contribution deduction to its partners; and

(4) the taxpayer reports on the taxpayer's federal income tax return a charitable contribution deduction with respect to the conservation easement.

The proposed regulations include three rules to address potential avoidance of the 2.5 times rule. First, to prevent promoters from circumventing the rule by having promotional materials contain language that is ambiguous as to the amount of the potential charitable deduction, the proposed regulations provide that the highest deduction amount stated or implied in the promotional materials, taken as a whole, applies. Second, the proposed regulations include a rebuttable presumption deeming the 2.5 times rule to be met if (1) the pass-through entity donates a conservation easement within three years following taxpayer's investment in the pass-through entity, (2) the pass-through entity allocates a charitable contribution deduction to the taxpayer that equals or exceeds 2.5 times the amount of the taxpayer's investment, and (3) the taxpayer claims a deduction that equals or exceeds 2.5 times the amount of the taxpayer's investment. Third, to prevent taxpayers from investing excess amounts in the pass-through entity to avoid meeting the 2.5 times rule, the proposed regulations contain an "anti-stuffing" rule. The anti-stuffing rule provides that the amount of a taxpayer's investment in the pass-through entity for purposes of determining application of the 2.5 times rule is limited to the portion of the taxpayer's investment that is attributable to the portion of the real property on which a conservation easement is placed and that produces the charitable contribution deduction.

Example: Alex purchased an interest in a Land Holdings Partnership, (LHP), a partnership that owns real property with a fair market value of $500,000 and marketable securities with a fair market value of $500,000. Alex is one of four equal investors in LHP, each of whom purchased an interest in LHP for $250,000 of cash. With respect to an investor's $250,000 payment for its interest in LHP, the promotional materials stated that LHP expected to allocate a $500,000 charitable contribution deduction to the investor (that is, a charitable deduction that is two times the amount an investor paid for its interest in LHP). After all four investors have purchased their interests in LHP, LHP donates a conservation easement to a qualified organization and reports a $2 million charitable contribution deduction on its Form 1065. The Schedule K-1 (Form 1065) that LHP furnishes to Alex indicates that LHP allocated a $500,000 charitable contribution deduction to Alex for the tax year. Under the proposed regulations, the amount of Alex's investment in LHP that is attributable to the real property on which a conservation easement is placed is $125,000 (that is, only the portion of the investment that is attributable to the real property on which a conservation easement is placed and that produces the charitable contribution deduction). Because Alex's investment for purposes of the 2.5 times rule is $125,000 and his expected charitable contribution deduction, based on the promotional materials, is $500,000 (that is, an expected deduction that is four times the investor's investment), the requirements of the 2.5 times rule are satisfied.

Taxpayers who have filed a tax return (including an amended return (or Administrative Adjustment Request (AAR) for certain partnerships)) reflecting their participation in syndicated conservation easement transactions before the date of publication of final regulations, and who have not previously disclosed their participation in the transactions pursuant to Notice 2017-10, must disclose the transactions as provided in Reg. Sec. 1.6011-4(d) and (e) provided that the period of limitations for assessment of tax, including any applicable extensions, for any tax year in which the taxpayer participated in the transaction has not ended on or before the date the final regulations are published. Taxpayers that disclosed their participation in a transaction pursuant to Notice 2017-10 before final regulations are published will be treated as having made the disclosure pursuant to the final regulations for the years covered by that disclosure. In addition, material advisors have disclosure requirements with regard to transactions occurring in prior years. However, notwithstanding Reg. Sec. 301.6111-3(b)(4)(i) and (iii), material advisors are required to disclose only if they have made a tax statement on or after the date which is six years before the date of publication of the final regulations.

For a discussion of disclosures of reportable transactions, see Parker Tax ¶250,140.

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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