In detail
Taxpayers recently scored an important victory in US Tax Court, particularly with respect to the IRS’s rule-making authority and the steps the IRS must take to properly issue certain items of sub-regulatory guidance under the Administrative Procedure Act (APA). Specifically, in Green Valley Investors, LLC, et al. v. Commissioner, 159 T.C. No. 5 (9 November 2022), the Tax Court ruled 15-2 that the IRS improperly issued Notice 2017-10, which designated syndicated conservation easements as “listed transactions.” Shortly thereafter, on 8 December 2022, Treasury and the IRS issued proposed regulations under section 6011 that identify syndicated conservation easement transactions with a charitable contribution deduction in excess of 2.5 times the initial investment as listed transactions required to be disclosed by taxpayers, similar to the disclosure requirement of Notice No, 2017-10. Likewise, Congress embraced a similar approach as part of the Consolidated Appropriations Act of 2023 (enacted 29 December 2022), disallowing charitable contribution deductions where the amount of the deduction is in excess of 2.5 times the sum of each partner’s basis in the partnership.
Green Valley Investors, LLC, et al. v. Commissioner, 159 T.C. No. 5.
Under Notice 2017-10, taxpayers participating in conservation easement transactions and claiming a non-cash charitable contribution deduction are required to file Form 8886, a Reportable Transaction Disclosure Statement, and attaching such statement to their federal income tax return. Critically, penalties are imposed for failure to file the disclosure statement. Section 6707A provides for a penalty of 75% of the “decrease in tax” shown on the return as a result of the reportable transaction, for a minimum of a USD 5,000 penalty all the way up to USD 100,000 for natural persons. The penalties are between USD 10,000 and USD 200,000 for corporate taxpayers engaged in conservation easement transactions that failed to disclose pursuant to Notice 2017-10. Further, disallowed listed and/or reportable transactions also incur an additional 20% accuracy-related penalty under section 6662A.
Green Valley was a consolidation of four separate cases arising from donated conservation easements encumbering over 600 acres of land in North Carolina. In 2011, the taxpayers purchased the land and contributed certain parcels to four partnerships. Thereafter, various investors purchased interests in the four partnerships in 2014 and 2015. The partnerships donated the conservation easements over the land, requiring that the land be maintained in its natural state for conservation purposes in perpetuity, and without the ability to build on and/or develop the land. Under section 170(h), the donation resulted in non-cash charitable deductions that flowed through to the partners based on the interest they purchased in one or more of the four partnerships. The IRS disallowed the deductions and imposed penalties, including for failure to comply with requirements under Notice 2017-10.
Bobby A. Branch, the organizer of the conservation easements and original purchaser of the 600 acres, challenged the assessment in Tax Court on behalf of the four partnerships. The Tax Court determined that the IRS failed to comply with the administrative requirements of the APA in issuing Notice 2017-10. Accordingly, the Notice was invalid and conservation easement transactions were not properly designated as “listed transactions.”
In general, the APA provides that the IRS, like any other federal agency, must: (i) issue a general notice of proposed rulemaking; (ii) allow interested parties an opportunity to participate and comment on a proposed rule; and (iii) include in the final version of the rule a “concise general statement of [its] basis and purpose.” See Perez v. Morg. Bankers Ass’n, 575 U.S. 92, 96 (2015). Only “legislative” rules are required to go through this process, while interpretive rules, general statements of policy, or other agency organization, procedure, or practice rules typically do not require such strict notice-and-comment procedures. In Green Valley, the Tax Court rejected the IRS’s contention that Notice No. 2017-10 was merely an “interpretive” rule and instead found the Notice to be a legislative rule. The Tax Court ruled that identifying the transaction as a listed transaction imposed new reporting and recordkeeping duties on taxpayers, which would need to file Form 8886 in response to the new rule or face additional penalties under sections 6707A and 6662A. Thus, the Notice imposed new duties on taxpayers and substantially changed their legal rights and obligations under federal income tax law. Because the Tax Court determined that the IRS failed to observe the APA’s notice-and-comment procedure when issuing the Notice, it was invalid.
In response to the Tax Court’s ruling, the IRS and Treasury formalized their position that the courts were wrong. See REG-106134-22; 87 FR 75185, 75190 (“The Treasury Department and the IRS disagree with the Sixth Circuit’s decision in Mann Construction and the Tax Court’s decision in Green Valley and are continuing to defend the validity of Notice 2017–10 and other notices identifying transactions as listed transactions in circuits other than the Sixth Circuit.”). Treasury and the IRS have indicated that they will continue to treat Notice 2017-10 as being in effect for taxpayers outside of the Sixth Circuit.
Proposed Treas. Reg. § 1.6011-9
On 8 December 2022, the IRS issued proposed regulations under section 6011 concerning syndicated conservation easement transactions (“Proposed Regulations” or “Prop. Reg.”). 87 FR 75185. Much like Notice 2017-10, the Proposed Regulations identify “Syndicated Conservation Easement Transactions,” and substantially similar transactions, as reportable transactions which require the participants and material advisors to file a disclosure statement with the IRS.
Unlike Notice 2017-10, Prop. Reg. § 1.6011-9(b) provides an expansive and detailed definition of “Syndicated Conservation Easement Transactions,” which consists of the following elements:
- A taxpayer receives promotional materials that offer investors in a passthrough entity the possibility of being allocated a charitable contribution deduction that equals or exceeds an amount that is two and one-half times [(or 250% of)] the amount of the taxpayer’s investment in the pass-through entity as determined under paragraph (d) of this section (2.5 times rule).
- The taxpayer acquires an interest directly, or indirectly through one or more tiers of pass-through entities, in the pass-through entity that owns real property (that is, becomes an investor in the entity).
- The pass-through entity that owns the real property contributes an easement on such real property, which it treats as a conservation easement within the meaning of [Prop. Peg. § 1.6011–9 (c)(2) (i.e., a deduction under section 170)], to a qualified organization and allocates, directly or through one or more tiers of passthrough entities, a charitable contribution deduction to the taxpayer.
- The taxpayer claims a charitable contribution deduction with respect to the conservation easement on the taxpayer’s Federal income tax return.
Prop. Reg. § 1.6011(b). With respect to the 2.5 times rule, if promotional materials provide investors with a range of possible charitable contribution deductions, the IRS will use the highest number in that range to determine whether the 2.5 times rule is satisfied. Prop. Reg. § 1.6011(d)(1).
The Proposed Regulations also establish a rebuttable presumption concerning the 2.5 times rule. The 2.5 times rule is deemed met if (1) the passthrough entity donates a conservation easement within three years of an investor’s investment, (2) the passthrough allocates a charitable contribution deduction to the investor that is equal to or exceeds 2.5 times the investment, and (3) the taxpayer claims a charitable contribution deduction that equals or exceeds 2.5 times the investment. Prop. Reg. § 1.6011-9(d)(2). The taxpayer may rebut this presumption by showing that none of the promotional materials contained a suggestion or implication that investors could receive a charitable contribution deduction that is equal to or exceeding 2.5 times the investment. The Proposed Regulations also provide an anti-stuffing rule, so as to not capture a taxpayer’s investment in other items of property outside of the real property over which a conservation easement was donated providing the charitable contribution deduction. Prop. Reg. § 1.6011-9(d)(3).
Finally, the Proposed Regulations state that qualified conservation organizations to which the conservation easements are donated will not be treated as a participant in a Syndicated Conservation Easement Transaction.
Consolidated Appropriations Act of 2023
As part of the Consolidated Appropriations Act of 2023 (enacted 29 December 2022), Congress amended section 170(h) to provide that “a contribution of a partnership . . . shall not be treated as a qualified conservation contribution . . . if the amount of such contribution exceeds 2.5 times the sum of each partner’s relevant basis in such partnership” (i.e., the partner’s investment). See H.R. 2617 at 2372-73; Section 170(h)(7). Thus, Congress statutorily embraced a variation of the 2.5 times rule. Accordingly, under the statutory variation of the 2.5 times rule, a charitable contribution deduction is disallowed altogether if the deduction is in excess of 2.5 times the initial investment. Similar to the Proposed Regulations, Congress stated that for purposes of this rule the relevant basis is limited to the portion of the basis (i.e., the portion of the original investment) that is allocable to the real property interest in which the purported charitable contribution was made.
There are exceptions to this general rule. First, the statutory version of the 2.5 times rule will not apply to any contribution which is made at least three years after the latest of: (1) the last date on which the partnership that made the contribution acquired any portion of the relevant real property interest; (2) the last date on which any partner acquired any interest in the partnership that made the contribution; and (3) if the interest in the partnership that made the contribution is held through one or more partnerships (e.g., a tiered partnership structure), the last date on which any partnership acquired an interest in any other partnership and the last date on which any partner in any partnership acquired an interest in the partnership. Further, family partnerships are exempted from the statutory 2.5 times rule, and the rule will not apply to any qualified conservation contribution made with the purpose of preserving any building which is a certified historic structure.
Congress authorized the promulgation of regulations to carry out the statute. Any disallowance of a charitable contribution deduction by virtue of this statutory language will be subject to an accuracy related penalty under section 6662(b) and an increased penalty in the event of a gross valuation misstatement. Moreover, taxpayers in violation of the statutory 2.5 rule will not be permitted to claim a reasonable cause defense under section 6664. Congress provides that any deduction that is disallowed by virtue of the statutory 2.5 times rule shall be treated as a listed transaction for purposes of the statute of limitations. See section 6501(c)(1), 6235(c)(6). Finally, Congress imposed a reporting requirement under section 170(f) for qualified conservation contributions made by a partnership with a purpose of preserving any building that is a certified historic structure, and the amount of which exceeds 2.5 times the sum of each partner’s relevant basis. Thus, an historic preservation easement which provides a charitable contribution deduction in excess of 2.5 times the sum of each partner’s basis, may be eligible for the deduction provided that this reporting requirement is met. Subject to certain exceptions, the rules set forth in the Consolidated Appropriations Act of 2023 shall apply to contributions made after 29 December 2022.
Congress and the IRS have acted swiftly in response to the Tax Court’s decision in Green Valley. While taxpayers may be relieved of liability for penalties for failure to disclose involvement in conservation easement transactions under the invalidated Notice No. 2017-10, the Proposed Regulations formalize a new reporting requirement for Syndicated Conservation Easement Transactions yielding a charitable contribution deduction equal to, or in excess of, 2.5 times a taxpayer’s initial investment in the investment fund which contributed the property. Likewise, the Consolidated Appropriations Act of 2023, generally denies a charitable contribution deduction in its entirety if the deduction exceeds 2.5 times the sum of each partner’s basis in the investment fund. Finally, although Congress has addressed syndicated conservation easements prospectively through the Consolidated Appropriations Act of 2023, the Tax Court’s decision in Green Valley still places at risk other non-conservation easement notices that did not go through the proper notice and comment procedures.
