Changes are potentially coming to the popular tax deduction for conservation easements with the introduction of The Charitable Conservation Easement Program Integrity Act (“Act”) by Congress by Rep. Mike Thompson (D-CA) and Sens. Steve Daines (R-MT) and Debbie Stabenow (D-MI). If passed, the Act would eliminate loopholes that the IRS has said are used by syndicated investor groups to abuse the system and generate huge tax-free returns. However, the changes could also impact those who are using the deduction in good faith, with the Act disallowing deductions that exceed 250% of the original investment of any partner, subject to some exceptions.
WHAT IS A CONSERVATION EASEMENT?
Congress initially created the deduction to offset the potential lost revenue and incentivize landowners to participate in conservation efforts. The program has resulted in the preservation of millions of acres of open land and wildlife in the United States along with hundreds of thousands of square feet of historic buildings. Landowners relinquish development and usage rights to conserve the land or buildings on which the easement is placed. In exchange for giving up those rights, developers can take a tax deduction for the value of those rights, which can generate hundreds of millions of dollars in tax savings depending on the value of the land or building in question.
The IRS began reporting information on conservation easements in 2003. Over the course of 15 years, the numbers of returns that include the deduction jumped from 2,000 to 10,000 per year, with the IRS believing some $21 billion worth of conservation easement deductions were improper or fraudulent. Indeed, an investigation by the Senate Finance Committee found that syndicated investment schemes were more likely to be abusing the program. These syndicated easements bring in investors to purchase land at a low price, then have the land appraised at a massively higher value based on the “highest and best” use when fully developed, generating significant tax-free revenue for the syndicates and their investors. The bipartisan committee report stated that the transactions at issue had “land valuations that appear so inflated above their original purchase prices that they cannot reasonably be characterized as anything other than abusive tax shelters.”
The IRS has attempted to crack down on the tax shelter scheme: dozens of appraisers have had their licenses revoked for inflating valuations and the Justice Department obtained its first guilty pleas for fraud related to the program last year. However, the IRS has said that abuses of the system are continuing and legislation is needed to address the problem.
HOW THE ACT WILL CHANGE THE PROGRAM
The Act would limit the deductions claimed by syndicated easement groups by amending the tax code to prohibit large gains. The proposed changes would disallow a charitable deduction if the deduction payout exceeds 250% of the original investment of any partner. Syndicates are currently believed to be generating anywhere from 400% to 900% of the original investment amount.
However, the Act does include provisions to limit the impact of this major change and protect the deduction for non-syndicated deals. One exception creates immunity for family partnerships, allowing partnerships held directly or indirectly by individuals and their families to gain the full advantages of the deduction. Congress also seeks to add a three-year holding period exception, which will exempt contributions made by partnerships if the partnership has been established for at least three years and has owned the contributed property for at least the same period.
This is the third time the Act has been introduced to Congress, first in 2019 and again in 2020. Historically, the Act has received bipartisan support, with prior sponsors including Chuck Grassley (R-IA) and Ron Wyden (D-OR). It may be more likely that the Act passes this term because it will generate significant federal revenues at a time when deficits have exploded as a result of COVID stimulus.
KJK will continue to monitor developments on the Act and the easement program. If you have any questions, please contact Jennifer Hart at jmh@kjk.com or 216-310-4917 or Jon Pinney at jjp@kjk.com or 216-538-8695.