IRS targets syndicated conservation easements
Notice 2017-10 designates these investments as listed transactions
INSIGHT ARTICLE |
In an effort to address perceived abuses from the syndication of conservation easements marketed by promoters, the IRS issued Notice 2017-10 on Dec. 23, 2016, designating these tax strategies as “listed transactions”.
These types of transactions will receive intense IRS scrutiny and prudent investors would be wise to steer clear of these types of transactions due to the disclosure requirements, the strong likelihood of IRS examination and potential penalties. Those expecting the Trump administration to put the brakes on the IRS attacking these types of transactions, may be disappointed.
The IRS only issues these types of notices after vetting them with Congressional tax writing committees and the Joint Committee on Taxation, so the IRS position with respect to Notice 2017-10 has already received bi-partisan support.
What are syndicated conservation easements?
A taxpayer may make a contribution to a qualified charitable organization of an interest in real property that has its use restricted in perpetuity, which is known as a qualified real property interest. In this case, the taxpayer would be entitled to a charitable contribution deduction for the value of the property by virtue of section 170(f)(3)(B)(iii). Such qualified real property interests are commonly referred to as “conservation easements.” The intent of the deduction is to promote the conservation of land, such as wetlands, forests and farmland by encouraging people to donate property rights in the form of easements committing to retain the character of the property.
What has happened is that a number of promoters have developed pre-packaged conservation easements into investment vehicles that they market with the promise that the tax deduction will significantly exceed the amount invested. The way they do this is that they first identify a parcel of land that appears to be a good candidate for a conservation easement. Then they form an LLC or limited partnership, and market the investment in the pass-through entity through promotional materials to individuals looking for large tax deductions. The investors put money in the pass-through entity and the promoter uses those funds to purchase the land. The entity donates the conservation easement on the property to a charitable organization in order to create the deduction. In some cases the investment vehicle utilizes multiple tiers of pass-through entities. The way that the promoter creates a higher valuation for the land is that they will come up with plans to develop the property into something substantially more valuable, like a golf course, housing plan or retail complex. An appraiser will determine a valuation based on those plans that is several times the amount invested.
Notice 2017-10 and listed transactions
The IRS is challenging these types of transactions under various theories; including overvaluation of easements, partnership anti-abuse rules and economic substance. The IRS views syndicated conservation easement deals as tax shelters and on Dec. 23, 2016 issued Notice 2017-10 in response. The Notice applies to syndicated conservation easement transactions and substantially similar transactions entered into on or after Jan. 1, 2010 and identifies them as “listed transactions” effective Dec. 23, 2016.
A listed transaction is transaction that is the same or substantially similar to one of the types of transactions determined by the IRS to be a tax avoidance transaction and identified in some form of published guidance as a listed transaction. A listed transaction is one of the types of reportable transactions enumerated in regulations section 1.6011-4(b). Any taxpayer participating in a reportable transaction is required by regulations sections 1.6011-4(a), (d) and (e) to file a disclosure statement on Form 8886, Reportable Transaction Disclosure Statement, by attaching it to each original or amended tax return for each year in which the taxpayer participates in a reportable transaction. A copy of the disclosure statement must also be sent to the Office of Tax Shelter Analysis (OTSA) at the time of the first filing of a disclosure statement by a taxpayer with respect to a particular transaction. Also, under regulations section 1.6011-4(e)(1), if a taxpayer determines that he or she participated in a reportable transaction after receiving a timely filed Form K-1 from a pass-through entity less than 10 calendar days before the due date of the taxpayer’s return, the taxpayer is allowed 60 days from the due date of the return to file a disclosure statement with the OTSA. Notice 2017-10 provides that for the syndicated conservation easement listed transaction, disclosures required to be filed after Dec. 23, 2016 and before May 1, 2017 will be considered timely filed if the taxpayer files the disclosure with the OTSA by May 1, 2017.
Regulations section 1.6011-4(e)(2) provides a special rule that if a transaction becomes a listed transaction after the filing of an original or amended return reflecting participation by a taxpayer and before the end of the period of limitations for assessment of tax, then a disclosure statement must be filed with the OTSA within 90 calendar days after the date on which the transaction became a listed transaction. Notice 2017-10 extends the 90 day requirement to 180 days for syndicated conservation easements and substantially similar transactions. Therefore, since syndicated conservation easements became a listed transaction on Dec. 23, 2016, taxpayers participating in such transactions in prior open tax years must file disclosure statements with the OTSA by June 21, 2017.
Taxpayers participating in listed transactions must retain copies of all documents and other records related to a reportable transaction subject to disclosure that are material to an understanding of the tax treatment or tax structure of the transaction. These documents must be retained until the expiration of the statute of limitations for the final tax year for which disclosure of the transaction is required. Such transaction-related documents include marketing materials; written analysis used in decision making; correspondence and agreements between the taxpayer and any advisor, lender, or other party to the transaction; and documents discussing, referring to, or demonstrating the claimed tax benefits arising from the transaction and any documents referring to the business purpose of the transaction.
It is important to note that the Notice does not address one-off conservation easement donations made by individual land owners. Individual conservation easement transactions that are not a part of syndication deals marketed by promoters may still result in legitimate charitable contribution deductions if done properly. Such transactions should be evaluated on their own merits and discussed with one’s tax advisor before making the donation.
Implications for material advisors
In addition to taxpayers participating in reportable transactions, material advisors in reportable transactions are also subject to disclosure rules under section 6111. A material advisor is defined as any person who provides any material aid, assistance or advice with respect to organizing, managing, promoting, selling, implementing, insuring or carrying out any reportable transaction and who derives gross income in excess of the threshold amount for such aid assistance or advice. The threshold amount for listed transactions is defined in regulations section 301.6111-3(b)(3)(i)(B) as $10,000 in the case of a reportable transaction where substantially all of the benefits are provided to individuals (looking through any S corporations, partnerships or trusts), or $25,000 for all other taxpayers. Material advisors must file Form 8918, Material Advisor Disclosure Statement each quarter in which they must identify and describe the transaction, provide information describing any potential tax benefits expected to result from the transaction and such other information required.
If a material advisor is required to file a disclosure statement with respect to a syndicated conservation easement or substantially similar transaction by January 31, 2017, Notice 2017-10 provides that such disclosure statement will be considered timely filed if the material advisor files the disclosure with the OTSA by May 1, 2017.
Material advisors are also required by section 6112 to maintain a list that identifies each person with respect to whom that advisor acted as a material advisor with respect to a particular reportable transaction. Regulations section 301.6112-1(b)(3)(i) requires each list to contain itemized statements including:
- The name of each reportable transaction, the citation to the published guidance number identifying the transaction if the transaction is a listed transaction or a transaction of interest and the reportable transactin number obtained under section 6111;
- The name, address and TIN of each person required to be included on the list;
- The date on which each listed person entered into each reportable transaction, if known by the material advisor;
- The amount invested in each reportable preansactin by each listed person, if known to the material advisor;
- A summary or schedule of the tax treatment that each person is intended or expected to derive from participation in each reportable transaction; and
- The name of each other material advisor to the transaction, if known to the material advisor.
In addition, the list must contain a detailed description of each reportable transaction that describes both the tax structure and the purported tax treatment of the transaction. The list must contain copies of any agreements, tax analyses or opinions, relating to each reportable transaction that are material to an understanding of the purported tax treatment or tax structure of the transaction that have been shown or provided to any person who acquired or may acquire an interest in the transactions, or to their representatives, tax advisors, or agents, by the material advisor or any related party or agent of the material advisor.
Upon receiving a written request from the IRS, a material advisor must provide the list to the IRS in a manner to enable to IRS to determine the information required without undue delay or difficulty. If any of the information is incomplete or missing, the material advisor will be deemed to not have complied with the request. The material advisor has 20 business days from the date of the request to comply.
Penalties for noncompliance
There are a plethora of penalties that the IRS has in its arsenal that can be assessed for not complying with the rules discussed above. These penalties are enumerated in Notice 2017-10 and include the following:
Section 6707A penalty on taxpayer for failure to include reportable transaction information required under section 6011 with return:
o Penalty equals 75 percent of the decrease in tax as a result of the transaction;
o $10,000 minimum and $100,000 maximum for listed transactions.
Section 6707 penalty on material advisors for failure to furnish information required under section 6111 regarding reportable transaction:
o Penalty for listed transaction equals the greater of $200,000 or 50 percent of gross income derived by advisor with respect to aid assistance or advice provided with respect to the listed transaction.
- Section 6708 penalty on material advisors for failure to maintain lists of advisees with respect to reportable transactions required under section 6112:
- Penalty equals $10,000 per day after 20th day list is not provided to IRS after receipt of written request;
- Reasonable cause exception.
- Section 6662 accuracy related penalty on underpayments:
- Penalty equals 20 percent of the portion of an underpayment attributable to (among other factors) negligence or disregard of rules or regulations, substantial understatement of income tax, valuation misstatement and/or disallowance of claimed benefit because transaction lacks exonomic substance.
- Penalty does not apply to any portion of underpayment which is attributable to a reportable transaction understatement on which a Section 6662A penalty is imposed.
- Section 6662A accuracy related penalty on understatements with respect to reportable transactions:
- Penalty equals 20 percent of the reportable transaction understatement; defined as the highest marginal tax rate applied to the increase in taxable income that would result from the different between the proper tax treatment of the transaction and the taxpayer’s treatment of the transaction on the return.
- Penalty is increased to 30 percent if the relevant facts affecting the tax treatment of the item are not adequately disclosed in accordance with the section 6011 regulations.
- Section 6694 understatement of taxpayer’s liability by tax return preparer:
- Penalty equals greater of $1,000 or 50 percent of the income derived by the tax return preparer with respect to the return or refund claim;
- Penalty assessed if the preparer knew or should have known of an understatement of tax due to unreasonable position;
- Unreasonable position is a position for which there is not substantial authority (or reasonable basis if the position is disclosed in the return). If it is a tax shelter or or reportable transaction, then the penalty applies unless it is reasonable to believe that the position would more likely than not be sustained on its merits;
- Reasonable cause exception.
- Penalty increased to greater of $5,000 or 75 percent of the income derived by the tax return preparer with respect to the return or refund claim if tax return preparer engages in conduct that is a willful attempt in any manner to understsate the liability for tax on the return or claim, or a reckless or intentional disregardof rules or regulations.
- Section 6695A penalty on appraisers for substantial and gross valuation misstatements attributable to incorrect appraisals:
- Penalty equals the greater of 10 percent of the amount of underpayment attributable to the valuation misstatement, $1,000, or 125 percent of the gross income received by the appaiser;
- There is a valuation misstatement if the value of the property claimed on the return is 150 percent or more of the amount determined to be the correct valuation, or the value of the property claimed ion te return is 200 percent or more (or 50 percent or less) of the correct section 482 transfer price, or the net section 482 transfer price adjustment exceeds the lesser of $5,000,000 or 10 percent of the taxpayer’s gross receipts.