In 1976, Congress created a charitable deduction under section 170(h) of the tax code to encourage taxpayers to conserve their property for future generations. Congress has consistently reaffirmed this provision, known as the conservation easement deduction, in legislation over the past several decades.
In recent years, the IRS has targeted taxpayers that claim the deduction. In a clear violation of Congressional intent, the agency has sought to make it more difficult for taxpayers to claim the deduction and has taken taxpayers to court over their use of this deduction.
While the IRS has a responsibility to go after bad actors, it is unacceptable for the agency to harass law-abiding taxpayers for claiming a deduction provided by Congress. Unfortunately, that is exactly what appears to be occurring.
Moving forward, policymakers should ensure that the deduction is being properly administered by the IRS and is being used to expand private conservation as intended by Congress. Congress should debate and consider reforms through regular order to ensure that the IRS is not subjecting taxpayers that are properly taking the deduction to undue scrutiny.
What is the Conservation Easement Deduction?
The conservation easement deduction has existed for decades and incentivizes property owners to conserve land and historic sites by offering a charitable deduction.
In order to claim the deduction, the taxpayer must agree to restrict their right to develop or alter the property. Organizations known as land trusts agree to monitor the restrictions placed on the property.
Essentially, the taxpayer agrees to have the land conserved for the benefit of future generations. The amount of the tax deduction is based on the value of what was donated – a value determined by an independent appraiser.
The taxpayer typically can deduct up to 50 percent of adjusted gross income (AGI) in any given year and carry forward any unused deductions for up to 15 years.
Congress Has Consistently Reaffirmed Its Commitment to Easement Deductions
It is important to note that the conservation easement deduction has bipartisan Congressional support.
Congress initially codified the provision in 1976 and extended the provision in 1977. It was then made permanent in the Tax Treatment and Extension Act of 1980.
More recently, in 2006, Congress narrowed the definition of conservation easements. At the same time, Congress temporarily expanded the easement deduction to 50 percent of AGI. This expansion was routinely extended by Congress and made permanent in 2015.
The IRS is Targeting Taxpayers Over the Conservation Easement Deduction
Despite the long history of the conservation easement deduction, the IRS has recently taken aim at taxpayers subjecting them to burdensome new filing requirements and onerous costs.
On December 23, 2016, the IRS published Notice 2017-10, making partnership donations of conservation easements “listed transactions,” which means the IRS suspects tax avoidance. This notice was implemented in the final days of the Obama administration without any opportunity for public comment.
The Notice ignores the fact that partnerships syndicated to multiple individuals are an extremely common form of financing real estate investments. As a result of the Notice, partnership conservation easement donations are being more heavily scrutinized, and taxpayers are exposed to a flurry of complex paperwork and compliance requirements. For instance, taxpayers wishing to claim an easement deduction covered by the Notice must now fill out Form 8886, a “Reportable Transaction Disclosure Statement.” This form takes approximately 20 hours to complete and has a top penalty of $100,000 for failing to properly complete it.
Adding insult to injury, Notice 2017-10 was applied retroactively all the way back to tax year 2010, so the complexity and potential liability is significant. In fact, if an individual fails to comply with the new listed transaction disclosure requirements, they could be hit with penalties up to $100,000 with no reasonable cause exception.
Notice 2017-10 does nothing to address the problem it identifies — overvaluation of the conservation easement. Instead of addressing potential overvaluation, the Notice just makes it harder for taxpayers to claim an easement deduction by burdening them with excessive paperwork and threat of audit.
The IRS has also used Section 6695A of the code to constrain the use of easement deductions. Section 6695A attempts to ensure that appraisals are accurate and applies a penalty of 125% of the appraiser’s fee if the appraised value is 150 percent above the IRS’s determined value.
There are several issues with this penalty as it relates to easement deductions. The IRS now routinely asserts on audit that conservation easements have little or no value – no matter how carefully prepared. The unreasonable threat of the penalty has the unfortunate effect of deterring competent appraisers that would otherwise appraise conservation easements. In Colorado, for example, there are now only five appraisers who are willing to work on valuing conservation easements. The recent Department of Justice action seeking an injunction and disgorgement of all past income from one conservation easement appraiser (whose appraisals have been upheld in court) only adds to difficulties of taxpayers in finding a competent and willing appraiser.
In addition, the penalty inherently assumes a bad faith motive on the behalf of the appraiser. Two competent appraisers can have different opinions on the highest-use value of a donation while still acting in good faith.
The IRS is Hauling Taxpayers to Tax Court
The IRS is also taking taxpayers to court to deny conservation easement deductions by asserting that longstanding and common easement grant deed provisions violate the rules. The IRS is also routinely alleging (without the benefit of qualified appraisals) that conservation easement donations have little or no value and that taxpayer easement appraisals are inflated. While there is nothing inherently wrong with the IRS challenging taxpayers that may be abusing the law, the IRS should not be routinely challenging tax benefits that Congress has specifically provided, particularly when there is no evidence of abuse.
Under these cases, the burden of proof typically falls on the accused, not the accuser, flipping the entire notion of American justice on its head.
Reforms Are Needed, But Law-abiding Taxpayers Must Be Protected
To be clear, it is important that the conservation easement deduction is not abused by taxpayers. There are several simple fixes that would strengthen and protect the easement deduction from potential abuse.
One possible solution is adding additional requirements specific to conservation easements to ensure the accuracy of appraisals by both taxpayers and the IRS.
Congress could also introduce more transparency into the process by requiring public disclosure of easement donations and the resulting benefits to the public.
These reforms would uphold the integrity of the conservation easement deduction while it remains in law for all taxpayers.