Eleventh Circuit Invalidates Notice Identifying Conservation Easements as Listed Transactions

(Parker Tax Publishing June 2024)

The Eleventh Circuit held that Notice 2017-10, which identified syndicated conservation easement transactions as listed transactions, was issued by the IRS unlawfully without public notice and comment. The court found that the notice was a legislative rule and that Congress did not did not expressly exempt the IRS from notice-and-comment rulemaking. Green Rock LLC v. IRS, 2024 PTC 185 (11th Cir. 2024).

Background

Green Rock LLC is a limited liability company based in Birmingham, Alabama. It raises money from investors and serves as a material advisor for syndicated conservation easement arrangements. In those arrangements, an investor buys into a pass-through entity that holds real property; the pass-through entity donates a conservation easement that agrees to restrict land uses associated with the property; and the investor claims a tax deduction under Code Sec. 170(h) for the value of the donation.

In Notice 2017-10, the IRS designated certain conservation easement transactions as presumptively tax-avoidant listed transactions. The notice covers transactions in which three criteria are present: first, where a taxpayer purchases a property interest through a "syndicate" or pass-through entity; second, where the taxpayer is solicited through "promotional materials" that tout an available charitable deduction; and third, where the taxpayer is promised a deduction that values the donated easement at or above "two and one-half times the amount" invested in the syndicate.

Green Rock served as a material advisor to transactions covered by Notice 2017-10. It never violated Notice 2017-10, and it complied with the reporting requirements for several years. In 2021, Green Rock filed suit in a district court under the Administrative Procedure Act (APA). It sought to set aside Notice 2017-10 as a legislative rule improperly issued without notice-and-comment procedures, and as arbitrary, capricious, and otherwise contrary to law. In December of 2022, while the lawsuit was pending, Congress amended Code Sec. 170(h) in the Consolidated Appropriations Act, 2023 (Pub. L. 117-328), to provide that syndicates would no longer be allowed to write off easement donations at inflated valuations. The legislation effectively eliminated the deductions that Notice 2017-10 subjected to disclosure, but the amendment is not retroactive and therefore did not apply in this case. After Congress eliminated conservation easement deductions at inflated valuations, Green Rock ceased syndicating conservation easements.

The district court granted summary judgment for Green Rock. It adopted the reasoning of Mann Construction, Inc. v. U.S., 2022 PTC 63 (6th Cir. 2022), where the Sixth Circuit held that Notice 2007-83, which identified certain trust arrangements as listed transactions, violated the APA because it was issued without following the APA's notice-and-comment requirements. The district court also found that Congress had not expressly exempted listed transactions from notice-and-comment rulemaking. The IRS appealed to the Eleventh Circuit.

Code Sec. 6707A was enacted by the American Jobs Creation Act of 2004 (2004 Act) to provide civil penalties for violators of the reportable transaction regime. Code Sec. 6707A(c)(1) defines a "reportable transaction" as "any transaction with respect to which information is required to be included with a return or statement because, as determined under regulations prescribed under section 6011, such transaction is of a type which the Secretary determines as having a potential for tax avoidance or evasion." Under Code Sec. 6707A(c)(2), a "listed transaction" means "a reportable transaction which is the same as, or substantially similar to, a transaction specifically identified by the Secretary as a tax avoidance transaction for purposes of section 6011."

The designation of a listed transaction triggers significant reporting and recordkeeping requirements. Under Code Sec. 6011(a) and Reg. Sec. 1.6011-4(d), a taxpayer must file a Form 8886, Reportable Transaction Disclosure Statement, for each listed transaction. Additionally, a material advisor must file a Form 8918, Material Advisor Disclosure Statement and keep detailed records for each listed transaction. Penalties may be imposed on taxpayers and material advisors who violate these reporting and recordkeeping requirements.

The APA requires that when federal agencies promulgate "legislative rules" - those that are binding or have the force of law - they must abide by the notice-and-comment procedures prescribed by 5 U.S.C. Sec. 553(b). Specifically, the agency must publish a notice of proposed regulation, offer the public an opportunity to voice comments and concerns, consider and respond to feedback, and include in the final regulation a concise general statement of the basis and purpose of the regulation. Under 5 U.S.C. Sec. 559, Congress may choose to exempt an agency from notice and comment if "it does so expressly." In Marcello v. Bonds, 349 U.S. 302 (1955), the Supreme Court explained that exemptions from the terms of the APA are "not lightly to be presumed," but Congress need not "employ magical passwords in order to effectuate an exemption."

Observation: In Green Valley Investors, LLC, et al, v. Comm'r, 159 T.C. 80 (2022), the Tax Court held that Notice 2017-10 was improperly issued in violation of the APA's notice-and-comment requirements. In 2022, the IRS issued proposed regulations in REG-106134-22 that identify syndicated conservation easements as listed transactions. The IRS stated in the preamble to the proposed regulations that it disagreed with the Tax Court's decision in Green Valley as well as the Sixth Circuit's decision in Mann Construction and would continue to defend Notice 2017-10 and other notices identifying listed transactions in circuits other than the Sixth Circuit.

Before the Eleventh Circuit, the IRS argued that when Congress enacted Code Sec. 6707A, it ratified the existing final regulations under Code Sec. 6011, including Reg. Sec. 1.6011-4(b)(2) which states that the IRS may identify listed transactions "by notice, regulation, or other form of published guidance." According to the IRS, because Congress was aware of the regulation and adopted parts of its language in the statute, Congress must have also intended to endorse the notice-listing process. The IRS hung its hat on the statutory phrase "as determined under regulations prescribed under section 6011" embedded in the definition of "reportable transaction" in Code Sec. 6707A(c)(1). The IRS contended that the preposition "under" is best understood in context to mean "in accordance with." So, according to the IRS, Code Sec. 6707A(c)(1) means that Congress intended for the process for defining reportable and listed transactions to be provided by - to be "determined in accordance with" - Reg. Sec. 1.6011-4(b)(2). The IRS further argued that holding that Congress did not authorize notice-based listing would eliminate every listed transaction to date. According to the IRS, it would be absurd for Congress to "invalidate sub silentio each and every one of the listed transactions already identified" in the 2004 Act, which provided penalties to strengthen the listing regime.

Analysis

The Eleventh Circuit affirmed the district court's order setting aside Notice 2017-10 with respect to Green Rock.

The Eleventh Circuit agreed with the Sixth Circuit that Code Sec. 6707A describes the "types" of transactions that are subject to penalties for non-reporting. In the court's view, the phrase highlighted by the IRS defines which transactions are reportable: transactions that are "determined under" the regulations issued under Code Sec. 6011. The court noted that Code Sec. 6707A is a definitional provision and reasoned that the phrase "determined under" can be fairly read to allow the IRS to define the substance of a reportable transaction through regulations issued under the IRS's Code Sec. 6011 authority. But the court said that an indirect series of cross-references hardly suffices as the "express" indication necessary to supplant the baseline procedures of the APA.

In the court's view, holding that Congress did not authorize notice-based identification of listed transactions would not eliminate every listed transaction as the IRS argued. The court noted that other listed transactions were issued in a different regulatory context. The court explained that the pre-2004 listed transactions - that is, 28 of the 34 existing listed transactions - were not backed by statutory penalties at the time of their issuance. And "penalties and criminal sanctions," the court observed, are what render a listing notice a legislative rule subject to notice and comment to begin with.

The court clarified that it did not purport to rule on the validity of any listed transaction not before the court. The court said that its decision is specific to Notice 2017-10. The court concluded that, because the notice was a legislative rule and Congress did not expressly exempt the IRS from notice-and-comment rulemaking, Notice 2017-10 is not binding on Green Rock.

For a discussion of the rules for return 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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