* Disclaimer: Ratio CPA, LLC is not a promoter of conservation easement partnerships, and the following article is for educational use only. Furthermore, the information herein reflects the state of affairs as of November of 2022, when the article was written. Legislative changes have since made the article inaccurate.
What is the IRS “Dirty Dozen”?
If the name sounds evil, it is because it was meant to be. The IRS Dirty Dozen list gets updated on an annual basis and is the IRS’s way to warn taxpayers about the 12 most “common scams that taxpayers may encounter.”
The list includes everything obvious: concealing assets in offshore accounts, not filing tax returns, improperly transferring appreciable assets into a charitable trust, avoiding U.S. tax by making contributions to foreign retirement arrangements… you get the gist. Whenever you are avoiding, concealing, or improperly transferring money, you are obviously breaking the law.
But do all strategies on the Dirty Dozen list break a law?
The answer is no – and this is where the controversy begins.
What is Syndicated Conservation Easement?
It is worth to begin by stating that syndicated conservation easement, or a conservation partnership, is not illegal and is included in Treasury Regulation § 1.170A-14.
Despite this, it figures on the IRS Dirty Dozen List.
Syndicated land conservation is the purchase of land in an area that could be developed and capitalized on by, i.e., by building a hotel, high rise, parking garage, or resort. The conservation part kicks in because the buyers pledge not to develop and profit from the land, not to impact the land in any way, in perpetuity. Forever.
At its core, syndicated conservation easement is an attempt to do a lot of good for the environment and the public.
Besides the positive environmental impact, there is also a tax benefit used to incentivize participants, who are losing out on potential income by conserving the land. This lost income becomes grounds for a charitable donation deduction, thus lowering the investors’ income that is subject to taxation.
Why is Syndicated Conservation Easement so Controversial?
The controversy starts with two appraisals.
- The first appraisal is how much the land being purchased is worth today.
- The second appraisal measures how much the land would be worth in the future if, e.g., a resort was built on it.
We thus have two very subjective numbers – today’s value, and potential value in the future if a variety of other factors come to fruition.
The former causes the most controversy.
Let’s say the land will be used to build a high-end resort with restaurants and spas. Who is to say that the resort would draw in guests and be profitable? On the other hand, what if the resort were to become extremely popular, with year-long waiting lists and exorbitant fees?
Is it even possible to truly appraise the value of a resort that has not been built, and will never be build?
This has led many conservation easement promotors to overvalue (in the eyes of the IRS) the price of conserved land. This, in turn, led to investors receiving a much higher deduction than the IRS felt was suitable (and possibly objectively suitable).
Conservation easement as a tax reduction strategy has been demonized by the IRS. Conservation partnerships have been audited, fined, called abusive, the strategy has been put on the Dirty Dozen list, all the while… remaining a legal part of the tax code.
Why?
Why hasn’t the IRS simply made the strategy illegal?
Who Can Particpate in Syndicated Conservation Easement?
If you have ever heard that only business owners can participate in tax reduction planning and lower their taxes, you have been misinformed.
In fact, syndicated conservation easement is one of few strategies available to those receiving a W-2, a K-1, or wishing to lower their individual tax burden.
There is a caveat. To participate in syndicated conservation easement, you must be an accredited investor, which means your income must be over $200,000 for the last two consecutive years if single, over $300,000 if married, or you must own property valued over $1,000,000, not including your primary residence.
This means that syndicated conservation easement is only available to high income earners and high net worth individuals.
What Tax Savings Does Conservation Easement Have to Offer?
For those looking for tax savings, syndicated conservation easement offers a substantial return of investment for relatively little effort.
The return on investment can, in some cases, exceed 200% (as a percentage of cash contribution), depending on adjusted gross income (AGI) and regulatory limitations.
This return, in the form of a charitable donation deduction, would be claimed in Year 1 on an individual income tax return, thus the wait for ROI is not very long, as little as 5+ months.
Additionally, because taxpayers are receiving a tax deduction, and not income, there are no capital gains, or any income taxes, involved – making this strategy exceptionally effective.
Why Hasn’t Syndicated Conservation Easement Been Stricken From Law?
The short answer is… the IRS has tried. It has audited many conservation partnerships, disallowed or lowered deductions, has run this strategy through the mud to scare taxpayers, and has included it on the “Dirty Dozen” list along with tax fraud.
Starting in 2016, the strategy has been considered a “listed transaction”, which means anyone participating in syndicated conservation easement must inform the IRS of that fact by filing Form 8886. This makes the taxpayer more visible to the IRS; more susceptible to an audit.
In June of 2021, a bill was proposed to set limitations on how much those participating in conservation easement partnerships can deduct from their taxes. That number was to be 2.5% times the sum of each partner’s relevant basis in the partnership. However, this bill did not pass.
Despite the IRS’s best efforts – the strategy has not been stricken from the tax code, or even limited.
Whether because of the positive environmental consequences (who wants a parking garage on every square inch of land?), or the tax benefits, the strategy is here to stay… for now.
How to Save on Taxes with Conservation Easement… Conservatively
The truth is high income individuals want to invest in conservation partnerships for both the positive environmental effects AND the tax savings.
There are other, not-so-controversial tax reduction strategies available to high income earners, but they may not have the same level of savings or may not be as simple to implement.
Some taxpayers feel like the benefits are worth it, despite the higher audit potential.
There are a few things to look out for when implementing conservation easement conservatively.
The first would be doing due diligence on the promoter. How long have they been promoting this strategy? How often have their partnerships been audited? What were the outcomes of those audits? Very importantly – how was legal defense for the audits funded?
Next, ask questions about the land valuation process. Who appraises the land? What type of documentation is compiled during the appraisal process? Is there one appraisal or several? Is there a peer review?
Finally, we want to look for the magic number: the valuation multiplier. This number indicates how much the land would increase in value, were it to be developed. The higher the number, the higher your deduction, and the more likely the IRS will take an interest in a taxpayer’s participation. You want this number to be reasonable – which is usually under the 5x mark (but higher than 2.5%, as congress intended).
Summary
Despite the IRS’s best efforts to demonize syndicated conservation easement, the strategy remains legal. It remains included in the tax code for taxpayers to benefit from and implement freely.
Conservation easement, when done correctly, does not comprise tax fraud, but high income earners wanting to utilize this strategy must exercise extreme caution.
* Disclaimer: Ratio CPA, LLC is not a promoter of conservation easement partnerships, and the following article is for educational use only.