In which we enjoy a rare taxpayer success against quid pro quo in Emanouil, encounter a temporary reprieve from the proceeds clause in Oconee Landing, and learn of further enforcement efforts against abusive syndications
Oh, for those bygone days of sleepy conservation donations. The first half of this year generated a flurry of activity by the Tax Court and IRS in the conservation easement realm, and, unfortunately, there has been no pause in the flurry for the second half of the year. Much of the activity relates to abusive syndications, which I’ll briefly summarize at the end of this article. But first, let’s talk about Emanouil, which includes an interesting quid pro quo discussion, and Oconee Landing, which (despite being a syndication) involves a novel argument regarding the proceeds clause.
For convenience, you can skip to a specific section below:
Emanouil: Developer’s Donation is Just a Donation and Not a Quid Pro Quo
I have an Excel spreadsheet just for quid pro quo cases, since this an issue that pops up frequently in land preservation. I’ve tracked—give or take—around 30 cases and a few IRS letter rulings from the past fifty-ish years that discuss the quid pro quo doctrine in the land or conservation easement donation context. By my count, five have gone in favor of the taxpayer. So, color me surprised to read a Tax Court case that found in favor of the developer taxpayer in the face of a quid pro quo argument by the IRS.
What is a quid pro quo, you ask, and why does it matter to us?
In the charitable giving context, a quid pro quo—or “this for that”—arises when the taxpayer makes a donation with the expectation of receiving something of value that is above and beyond the tax deduction. To claim a charitable tax deduction, the donor (1) must have donative intent, (2) may not condition the donation on some desired result, and (3) may not receive a substantial benefit in return for the donation that outweighs the general benefit to the public. If the donor does receive a benefit in return, then that benefit must be worth less than the donated property and the benefit must be properly appraised and deducted from the value of the donation (otherwise known as a “bargain-sale”).
For example, a quid pro quo may arise if a developer gives land to a local city with the expectation that the city will provide development approvals on another parcel owned by the developer. Similarly, a quid pro quo could taint a deduction if a donor conditions her own donation of land on the donation of some other property by a neighbor. Or, where a seller of land requires, as a condition of the sale, that the buyer donate a conservation easement to a local land trust. In that case, the buyer will face difficulty claiming a deduction because his donation was a condition of the sale imposed by the seller.
This is where the facts and the creditability of the witnesses really make a case.
The Case: The charitable developer
In Emanouil, the donor was a developer who donated land at the end of a years-long entitlement process to develop adjacent property. As part of the development entitlement hearings, the permitting authority suggested the donor contribute some of his property to the local town in mitigation for the approvals. The potential mitigation property included several tracts and, as negotiations proceeded, the mitigation property was narrowed down to a few tracts that the developer contributed to the town. Then, since the developer still had some leftover land nearby that wasn’t mitigation land and also was not part of the permitted development, the developer decided to donate the leftover land as well. Interestingly, the leftover land was part of the potential mitigation property initially suggested by the permitting authority but had been left out of the final mitigation area.
This is where the facts and the creditability of the witnesses really make a case. On its face, Emanouil looks very similar to Pollard, TCM 2013-38, which found for the IRS and against the developer taxpayer. But, here in Emanouil, Judge Gustafson notes that there was no written agreement or requirement to donate the additional properties. While one “can imagine a circumstance in which two parties with mutual interests and a high level of trust could conduct some business with each other … that depended on a side agreement … that was never reduced to writing and could never be enforced,” here there was no evidence of that since the town and the donor “seem to have had civil and cooperate business dealings, but they were hardly allies.”
Oddly, the IRS and the court did not discuss whether the donation would increase the value of the developable property, nor whether the donor was a dealer, additional issues that frequently arise when a developer donates property and seeks a charitable tax deduction. The parties and the judge apparently had enough on their plates, given the 60-page opinion.
The quid pro quo doctrine is highly fact-intensive and the taxpayer here was able to convince the judge that he really did have charitable intent in this one. Perhaps the judge was feeling the chill in the charitable giving atmosphere given all the recent tax court cases and decided to provide a little warmth for all the potential donors out there. Now to another (very) mild source of warmth:
Oconee Landing: Excluding Proceeds Allocable to Improvements May Not Matter if There Aren’t Any Improvements
A few years ago, the term “proceeds clause” would have drawn a blank face from most folks practicing in this area. It’s that boring provision in the back of the easement that talks about what happens if the easement is terminated because of condemnation or court order—an event that has only a very slight chance of happening since the point is that they are supposed to last forever. Now, sadly we get to read about the proceeds clause in a new tax court case or three every month or so.
What’s all this about the Proceeds Clause?
Basically, the Treasury Regulations for deductible conservation easements require that the financial proceeds that the landowner receives upon termination of the easement must be split between the easement holder and the landowner in the same proportion that the easement’s value bears to the underlying property at the time of the easement grant. Folks have tried different ways of wording that formula and created fertile ground for IRS challenge based on word choice. Someone back in the day reasonably thought, well, if the landowner builds a house by exercising a reserved right, that reserved right wasn’t part of the appraised value of the conservation easement, so the full value of that house is the landowner’s and should not be split with the land trust. Not so!, the IRS says, and the Tax Court agrees. So, if your easement excludes after-built improvements from the proceeds formula, it does not comply with the Treasury Regulations (which are actually silent on this issue) and is not deductible.
If you want all the hairy details and evolution of the proceeds clause argument, you can find a full explanation in my article on PBBM-Rose Hill and an excellent history of the clause and the regulations from the Tax Court in Oakbrook Land Holdings.
The Case: No improvements, no problem (maybe)
This brings us to Oconee Landing, clearly an overvalued syndicated easement case, in which the taxpayer essentially acquired (through a multi-tier partnership arrangement) a 356-acre property in Georgia on December 21, 2015 for $2.4 million, and then eight days later contributed a conservation easement for which the taxpayer claimed a $20 million deduction. Same old, same old.
The interesting part here is that Judge Lauber dismissed the IRS’s motion for summary judgment based on the proceeds clause, rather than providing an automatic win to the IRS, as is the case lately when the IRS makes that argument. Here, the judge noted that the property has no existing structures or man-made features and that the easement does not permit any improvements except for (1) small recreational structures, such as deer stands, hunting blinds, emergency shelters, and play structures for children, not to exceed 150 square feet and (2) a nature trail for use by hikers and bicyclists in a small area of the property. The easement also prohibits installing any utilities to service the recreational structures.
The Tax Court found that there was an issue of material fact as to whether the limited improvements permitted would cause the land trust to receive less than its full proportionate share of any future sales proceeds, which nicely injects some reason into the bizarre world of the proceeds clause.
The Tax Court found that there was an issue of material fact as to whether the limited improvements permitted would cause the land trust to receive less than its full proportionate share of any future sales proceeds, which nicely injects some reason into the bizarre world of the proceeds clause. Now the ball is in the litigants’ court to prove whether there could be value associated with those limited improvements. Even if the taxpayer does succeed on that argument in the end, it probably is going to encounter more resistance on the valuation side, given the $20 million deduction claimed eight days after the $2.4 million purchase.
And speaking of those chilling syndications…
Update on Enforcement Efforts against Abusive Syndications
Rather than delving into what an abusive conservation easement syndication is, I’ll refer you to my syndication overview here. Here’s the latest:
- Senate Finance Committee Report. The Senate Finance Committee finally issued its Bipartisan Investigative Report on Syndicated Easement Transactions in August, finding that, surprise!, overvalued syndicated easement transactions are bad.
- Senate Finance Committee Members Reintroduce Charitable Conservation Easement Program Integrity Act (S. 4751) with More Teeth. Senators Grassley, Daines, and Roberts introduced S.4751 in late September, which revises the original S.170/H.R. 1992. The original Integrity Act, as introduced in 2017, is explained in more detail here, and has evolved over the past few years. Briefly, the Integrity Act as originally drafted would prohibit a deduction claimed by a partner for a donation by a partnership that is not a family partnership, the amount of the contribution exceeds 2.5 times the partner’s basis, and the donation occurred within the first five years following the partner’s initial investment in the partnership. The new Daines bill updates the Integrity Act to (a) prevent taxpayers from using debt and unrelated assets to game the 250% value threshold, (b) reduce the holding lookback period from five years to three years, but have the three-year period expire on the later of the date the taxpayer acquired the partnership interest and the date the partnership acquired the property (not solely the date the partnership acquired the property), and (c) prevent further gaming with complex ownership structures by prohibiting a deduction if the partner’s interest in the partnership isn’t held directly by the partner. The text of the new bill can be found here.
- IRS Settlement FAQ. IRS Office of the Chief Counsel issued a Notice (CC-2021-001) on October 1, 2020, providing guidance regarding the IRS’s syndication settlement program announced in June.
- IRS Signals that 75% Fraud Penalties Are Next. IRS Office of the Chief Counsel issued a Memorandum (AM 2020-010) on October 9, 2020 providing guidance from IRS National Fraud Counsel and Assistance Division counsel regarding how and when a civil fraud penalty can be assessed for a syndicated conservation easement transaction, signaling that the IRS may finally start seeking the 75% civil fraud penalty instead of the 40% gross valuation misstatement penalty in these cases. This likely will put some pressure on syndication participants to accept the IRS’s settlement program, which will only impose a 10-20% penalty on rank-and-file partners.
- More Tax Court Cases and Deduction Denials Based on the Proceeds Clause. The Tax Court is swimming in partnership petitions contesting IRS denials of deductions and the court has issued several additional rulings based on the extinguishment proceeds clause in Belair Woods, TCM 2020-112 (July 22, 2020), Smith Lake, TCM 2020-107 (July 13, 2020), Maple Landing, TCM 2020-104 (July 9, 2020), and Riverside Place, TCM 2020-103 (July 9, 2020). Judge Lauber’s opinion Belair Woods interestingly finds that, even though the easement only permits future improvements of roads and irrigation (not buildings), those types of improvements are valuable enough that excluding them from the extinguishment proceeds formula in the easement improperly deprived the easement holder of its full share of the proceeds. The final ruling in Oconee Landing will shed some light on whether there are any types of minor improvements that may be permissibly excluded.
I’m tired and bored of abusive syndicated easements. How about you? If only Congress would pass the Conservation Easement Integrity Act so we could see the backside of this ugly tax shelter scheme.