Readers of NTU know this story all too well: the Internal Revenue Service is encouraged to take comprehensive enforcement action against a few taxpayers deemed to be skirting the law, only to engage in behavior that sets dangerous precedents for the many. So it has been with the IRS’s heavy handed approach toward certain conservation easement deductions, as NTU has documented on numerous occasions. But the story bears re-telling, especially when it comes from a noted tax commentator who has actually supported such enforcement actions in the past.
Writing in his regular Forbes column this week, veteran CPA Peter J. Reilly decried the “band of scoundrels” who are facilitating partnership-based conservation easement tax deduction transactions he describes as a “raid on the Treasury.” Yet Reilly also expressed concerns over the IRS’s strategy of focusing on technical errors to invalidate these transactions, instead of challenging excessive valuations of land donations that can lead to large deductions. He noted that “gotchas” over details in easement agreements, such as how proceeds are divided from improvements to land if an easement is extinguished (say by government eminent domain) can affect all types of easement deductions. He wrote, “The problem with those ‘gotchas’ is that they are traps that people who are not trying to get away with anything can fall into.” He quoted David Wooldridge, an attorney representing taxpayers in a conservation easement case, Belair Woods, LLC, who contended:
Proceeds clauses similar to the one in Belair appear in most conservation easement deeds that were granted prior to IRS raising this issue in Rose Hill [a case in which NTU filed a friend of the court brief], and many granted afterwards. These include the so-called syndicated conservation easements, but they also include most easements that would be considered “traditional.” The Service’s position therefore would invalidate easement deductions for a majority of existing conservation easements, both traditional and “syndicated.”
Reilly is not the only critic of partnership conservation easements facing the cold reality about the direction the IRS has been taking. The Land Trust Alliance and its allies, who have often encouraged the Service and Congress to crack down on partnership conservation easement deductions, are now facing an unpleasant problem: the non-partnership arrangements they have long touted are now being threatened by an IRS run amok in this area of law.
Given NTU’s four-plus decades of work in the taxpayer rights space, our reply to these revelations is a humble, “we could have told you so.” The IRS’s tendency in both law enforcement and litigation has been to develop tactics that the agency employs far beyond their original target, sometimes with little discretion. Whether the Service’s stated intent is to “go after bad guys” claiming supposedly undeserved Earned Income Tax Credits, or small cash-intensive businesses accused of “structuring,” or “captive insurance transactions,” the results can hurt perfectly innocent taxpayers, and necessitate a legislative or judicial remedy. (NTU Foundation’s Taxpayer Defense Center recently filed a brief before the U.S. Supreme Court supporting such a remedy.) Overzealous actions such as these, and many more, are at base the reason for NTU’s campaigns on behalf of major IRS reforms enacted into law in 1988, 1996, 1998, 2015, and 2019.
When it comes to conservation easement deductions, the IRS could have prevented the widening war on taxpayers and environment by simply providing a “safe harbor” that clearly identified the sample language of an easement transaction that would pass the agency’s muster and not be subject to audit-driven tax hikes. Indeed, the IRS had provided some of that guidance in private letter rulings, but has since reversed itself, and now falls back on the bogus position that a safe harbor would be too difficult to design. Nonsense – just as it did with other complex tax questions involving the valuation of donations like artworks, the agency need only work constructively with members of the practitioner community to methodically review and publish findings on how an easement agreement must be structured going forward. Congress could also affirm its intent toward the Section 170 (h) deduction just as it did in 2015, and prohibit the IRS from retroactively raising taxes, reinterpreting the law, and misusing its “listed transaction” enforcement powers.
Reilly wrote that the IRS’s “collateral damage” in its pursuit of partnership conservation easements reminded him of the officer in the Vietnam conflict who said, “It became necessary to destroy the town to save it.” There may be equally appropriate analogies from the natural or even supernatural world – that sharks caught in a feeding frenzy are not too particular about who they eat, or that a vampire can only enter a place after being invited by a member of the household. Regardless, the object lesson is clear. Without strong oversight and protections against abuse, calling down tax enforcers on one group of taxpayers can lead to unintended consequences, and others getting hurt.