Potential tax schemes involving conservation easements have been under scrutiny by the IRS for years, and the agency’s latest regulations require taxpayers and advisors to report these types of transactions.
Advisors say clients in partnerships and pass-through entities can sometimes get entangled in these tax dodges.
In a syndicated conservation easement (SCE), investors typically acquire an interest in a partnership that owns land subject to a conservation easement and then claim an inflated charitable contribution deduction based on a grossly overvalued appraisal. SCEs often involve inflated property valuations from professionals tied to the promoter, creating conflicts of interest as well as bogus tax deductions, said Mark Heroux, a principal with Baker Tilly’s tax advocacy and controversy team in Chicago.
“Abusive syndicated conservation easement transactions are operating too often as nothing more than retail tax shelters that let taxpayers buy deductions at the end of any given year,” IRS Commissioner Danny Werfel said in a statement announcing the guidance.
Under the latest IRS regulations, participants in easements or their advisors must report participation in SCEs on IRS Forms 8886 and 8918—including transactions completed in taxable years still open. “This includes the 2021, 2022 and potentially the 2023 tax years if returns were filed before October 8 without the necessary disclosures,” Heroux said, adding that the reporting deadline is Jan. 6.
“If 2023 returns were filed after October 8 without the required disclosures, penalties may apply. We strongly advise amending these returns as soon as possible. Ideally, the IRS will be lenient with those who act promptly,” Heroux said.
Clients shouldn’t depend on that leniency, advisors say. This new regulation is part of IRS enforcement against SCEs that the agency says has seen “significant success in the courts” at trimming grossly inflated easement valuations for tax purposes. In the most recent sentencings, two accountants each got 20 months’ prison for their roles in the promotion and sale of abusive SCEs, according to the IRS.
The regulations help the IRS track down SCEs and cheating taxpayers, said Lawrence Pon, a CPA in Redwood City, Calif. Before these regs, Pon said, the IRS would allow up to 250% of basis for the deduction, still far below the deduction many SCE takers would claim.
Pon said that among the warning signs advisors should look for is when an SCE promoter insists on a nondisclosure agreement or tells a client that they don’t need to involve a tax advisor.
“One red flag is when a tax professional pitches a transaction that appears too good to be true and claims that the IRS has reviewed and issued no-change letters after an audit,” Heroux said. “These claims are rarely substantiated, and when pressed for proof the promoter may offer vague excuses. If the promoter had access to the audited taxpayer, they should be able to provide documentation, but it’s unlikely an audited taxpayer would willingly cooperate with such claims.”
Advisors should also assess the nature of the real estate involved.
“The real estate is supposed to be ripe for conservation: untouched forest in the northwest United States, hardly used wetlands in the South Carolina low country, as opposed to badly polluted former industrial property,” Heroux said. “And watch out for retained rights. The more retained rights to use the land, such as the ability to drill for minerals, the more likely the IRS will challenge the deduction.”