The Internal Revenue Code’s §170
Charitable Contribution Deductions (Part II of II)
The Tax Cuts and Jobs Act of 2017 and subsequent tax acts, such as the CARES Act, have complicated charitable giving and estate planning. This second part of this two-part article provides an overview of the limits placed on conservation easements. (Read Part I here.)
In this second of a two-part article, the limits on the value and legality of conservation easements, charitable remainder, and lead trusts are discussed.
Conservation Easements. Taxpayers who donate to a conservation group or a state or local government an easement to restrict development of their property, are entitled to a charitable contribution deduction for the resulting decline in the fair market value (FMV) of the property. A charitable contribution deduction in 2020 of up to the 60% of AGI limitation is allowable; amounts in excess of the limitation are carried forward for 15 years.
IRS Notice 2004-41, 2004-2 CB 31, addresses charitable contributions and conservation easements. In this Notice, the IRS notes that some taxpayers claim inappropriate charitable contribution deductions for cash payments or easement transfers to charitable organizations in connection with the taxpayers’ purchases of real property.
In some of those questionable cases, the charitable organization purchased the property and placed a conservation easement on the property. The charitable organization then sold the property, subject to the easement, to a “third party” buyer for a price substantially less than the price it had paid for the property. As part of the sale, the “third party” buyer would make a second payment characterized as a “charitable contribution” in order to fully compensate the charitable organization for its cost of the property. The IRS warned that it would look to the substance of the transaction, not its form, and treat the total of the “third party” buyer’s payments to the charitable organization as the purchase price paid by the “third party” buyer for the property.
In the Tax Court case, Graev v. Commissioner, 140 T.C. No. 17, June 24, 2013, the taxpayers contributed cash and a conservation easement to a qualified charitable organization, and claimed a charitable contribution deduction for the cash and conservation easement they had donated to an Architectural Trust. Prior to the “contribution” and at the taxpayers’ request, the Architectural Trust issued a side letter to the donor promising that, in the event the Internal Revenue Service (IRS) disallowed their charitable contribution deduction, the Architectural Trust would refund the entire cash contribution and assist in removing the façade conservation easement from the property’s title.
The Tax Court held for the IRS and opined that the Architectural Trust’s side letter made the “contributions” conditional gifts and therefore not deductible. For a review of this case and others on point, see http://architecturaltrust.org/easements/tax-law-irs-matters/court-cases/.
IRC § 170(h) authorizes a deduction for the donation of conservation easements and façade easements provided that, among other things, the easements are “granted in perpetuity” and their conservation purposes are “protected in perpetuity.” IRC § 170(h)(4) provides that the conservation purposes for which tax-deductible easements may be donated are: (1) the protection of habitat; (2) the preservation of open space for the scenic enjoyment of the general public or pursuant to a clearly delineated federal, state, or local governmental conservation policy; (3) historic preservation; and (4) the preservation of land for outdoor recreation by or education of the general public.
Generally, in order to qualify as a deductible charitable contribution for a conservation easement, the easement must contain a “perpetual-use restriction” on the real property so that the property will always be used for one of the above listed intended charitable uses and therein lies the rub: satisfying the protected-in-perpetuity requirement requires satisfying each and every one of the following requirements: (1) eligible donee; (2) restriction on transfer; (3) no inconsistent uses; (4) enforceable in perpetuity; (5) mortgage subordination; (6) mineral extraction restrictions; (7) baseline documentation; (8) donee notice, access, and enforcement; and (9) judicial extinguishment, impossibility or impracticality, and division and use of proceeds. If the donee charity “is not absolutely entitled to a proportionate share of extinguishment proceeds, then the conservation purpose of the contribution is not protected in perpetuity.”
The Tax Courts have heard 80 plus cases involving conservation easement and taxpayer claimed charitable income tax deductions over the past 10 years or so and have issued a like number of opinions involving the IRS challenges to taxpayer claimed deductions under IRC § 170(h).
2019 Tax Court case of Coal Property Holdings, LLC v. Commissioner, T.C., No. 27778-16. In September 2013, Coal Property Holdings, LLC (Coal Holdings), acquired 3,713 acres of land in Tennessee that had been subject to surface mining during the last century. Three weeks later, an entity owned by an investor acquired a 99% interest in Coal Holdings for $32.5 million. Three days after that, Coal Holdings donated a conservation easement over the property to a Tennessee land trust. A $155.5 million charitable contribution deduction was claimed on the 2013 U.S. Return of Partnership Income filed by the LLC with the charitable contribution deduction allocated to the partners in proportion to their capital and profits interests, and reported to the respective LLC members on their individual Form K-1.
The LLC submitted an appraisal with the tax return that valued the easement based on the value of the land before and after the donation. The appraisal determined that the “highest and best use of the property” (the same ploy used by the IRS to destroy the family owned and operated farm businesses on the death of the owning farmer), absent the easement, would be an owner-operated in the ground-subsurface coal mine carrying a pre-donation value of $160.5 million. To determine the after-donation value of the property, the appraisers assumed that the restrictions imposed by the easement would not allow any subsequent development or coal mining on the property, making the highest and best use of the property agricultural or recreational, and estimated the after-donation value of the property at $5 million. The difference between the before-donation value and the after-donation value placed the easement value at $155.5 million, according to the appraiser.
The Tax Court held that the IRS properly disallowed, in its entirety, the charitable contribution deduction claimed by Coal Property Holdings, LLC because the conservation purpose of the easement was not “protected in perpetuity” as required by IRC § 170(h)(5)(A).
In May of 2020, the IRS won more Tax Court victories in Oakbrook Land Holdings LLC v. Commissioner, T.C. Memo. 2020-54 and the related Oakbrook Land Holdings LLC v. Commissioner, 154 T.C. No. 10 (May 12, 2020). Here, the conservation easement value of the subject property, which was purchased for $1,700,000 in 2007, was placed a year later in 2008, at a value of $9,545,000.
These Tax Court opinions held that the claimed conservation easement did not comply with the regulatory requirement established by Treasury Regulation §1.170A-14(g)(6), which the Tax Court held to be valid under the standards set forth in the Administrative Procedures Act and Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837.
(Note here that in 1984, the United States Supreme Court in Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., established the legal test for determining whether to grant deference to a government agency’s [in the instant case, the IRS’s Income Tax Regulation § 1.170A-14(g)(6)(ii)] interpretation of a statute which it administers.)
It should be noted that an En Banc review by the Tax Court justices upheld the regulatory requirements in Income Tax Regulation §1.170A-14(g)(6)(ii).
On September 27, 2020, The New York Times reported that business tax records for the various Donald Trump business entities show that some $119.3 million in charitable contributions have been claimed for conservation easement charitable deductions claimed on personal, partnership, limited liability company (LLC), and corporate tax filings submitted to the IRS: ($5.75 million for Mar-a-Lago in Palm Beach, FL [1985 purchase price about $10 million]; $39.1 million for the Bedminster, NJ golf course [2002 purchase price about $30 million]; $25 million for the Trump National Golf Club Los Angeles, CA [2002 purchase price about $27 million]; and, $21.1 million for the 230 acre Seven Springs estate in Bedford, NY. [1996 purchase price about $7.5 million]).
It is reported that President Donald Trump created a preservation easement in 1993 on his Palm Beach, Florida Mar-a-Lago property that prevented the selling of the antiques inside the historic building and/or adding more structures thereto. Without the preservation easement, the property was reportedly appraised at $25 million; after the placement of the preservation easement, the reported appraised value was $19.25 million and an income tax contribution deduction of $5.75 million was reportedly claimed.
Donald Trump bought his 520-acre Bedminster, NJ, golf course property in 2002 for less than $35 million. The property, previously known as Lamington Farm and inclusive of the estate of automaker John Z. De Lorean, had been the site of a foundering 36-hole golf course construction project designed by golf course architects Tom Fazio and Tom Fazio II. It has been reported that Trump used a conservation easement strategy to generate a $39 million income tax charitable contribution deduction.
In 2014 Donald Trump placed a conservation easement on his Trump National Golf Club Los Angeles, CA, which overlooks the Pacific Ocean. Trump claimed a $25 million charitable tax deduction for the conservation easement.
In 2015 Donald Trump placed a conservation easement on his 230-acre Seven Springs estate in Bedford, NY. The New York Times has just reported that Trump claimed a $21.1 million charitable tax deduction for the conservation easement.
IRS Tax Court victories over the last ten years in May of 2020 seem to jeopardize the conservation easement charitable deductions tax breaks President Trump’s businesses were able to claim on their filed federal and state income tax returns. See Oakbrook Land Holdings LLC v. Commissioner, T.C.Memo. 2020-54 and the related Oakbrook Land Holdings LLC v. Commissioner, 154 T.C. No. 10 (May 12, 2020). These Tax Court decisions held that the conservation easement did not comply with the regulatory requirement established by Treasury Regulation §1.170A-14(g)(6) which was held to be valid under the standards set forth in the Administrative Procedures Act and Chevron U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837.
Tax Court judges have invalidated more than $275 million of similar deductions because property owners, in legal documents, used clauses virtually identical to one used when the Trump golf course donated an easement to a land conservancy in 2014.
It is important to address here the use of investment vehicles commonly referred to as “syndicated conservation easements” for creating an income tax charitable contribution deduction. According to a 2017 Brookings Institution report, $3.2 billion of income tax charitable contribution deductions were claimed by donor/taxpayers in 2014. The explosive growth in preservation easement charitable contribution deductions may be traced to the number of “syndicated conservation easements” investment opportunities that are being marketed to and used by sophisticated taxpayers; abusive, to boot.
Curiously, however, 2017’s TCJA did not address or limit preservation easement charitable contribution deductions.
In December 2016, IRS Notice 2017-10, 2017-4 IRB 544, characterized syndicated conservation easements as “listed transactions”—potential tax avoidance strategies.
A transaction described in this section is a listed transaction. An investor receives promotional materials that offer prospective investors in a pass-through entity the possibility of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor’s investment.
Donor/Taxpayers claiming such deductions in 2020 (and for all prospective years) are required to attach Form 8886 Reportable Transaction Disclosure Statement (Rev. December 2019) to their timely filed income tax returns and to file Form 8886 with the Office of Tax Shelter Analysis (OTSA) at that same time.
Taxpayers who claimed deductions in years 2010 through 2015 were required to file Form 8886 by October 2, 2017. Failure to file Form 8886 (Rev. December 2019) prevents the tolling of the statute of limitations for assessments and penalties.
As part of a continuing effort to combat abusive transactions, the IRS Office of Chief Counsel announced on June 25, 2020, the completion of the first settlement under its initiative to resolve certain docketed cases involving syndicated conservation easement transactions. The IRS Office of Chief Counsel has now sent letters to dozens of partnerships involved in these transactions whose cases are pending before the U.S. Tax Court. IRS Chief Counsel, Mike Desmond, said that “the IRS will continue to actively identify, audit, and litigate these abusive transactions as part of its vigorous effort to combat abuse in this area. These transactions undermine the public’s trust in tax incentives for private land conservation and in tax compliance in general.”
The IRS Office of Chief Counsel settlement offers require a concession of the tax benefits claimed by the taxpayers and imposes penalties: all partners in an electing partnership must agree to settle to receive these terms, and the partnership must make a lump-sum payment representing the aggregate tax, penalties and interest for all of the partners before settlement is accepted by the IRS; Chief Counsel will allow investors to deduct the cost of acquiring their partnership interests but it will require a penalty of at least 10%; partners who are promoters of conservation easement schemes are not allowed any deductions and must pay the maximum penalty asserted by IRS (typically 40%); and if less than all the partners agree to settle, the IRS may settle with those partners but will normally impose less favorable terms on the settling partners.
Charitable Lead Trusts. These trusts pay an annuity or other fixed amount to a charitable organization for a set term of years; any balance remaining at the end of that period is paid to the donor or another beneficiary. A charitable contribution deduction is allowed to the donor taxpayer in the year the charitable lead trust is established and funded; the exact amount is computed using IRS annuity tables used to value certain charitable interests in trusts. The IRC § 7520 interest rate for a particular month is the rate that is 120% of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls. The October 2020 IRC § 7520 rate is 0.4%. It appears that a donor who contributes cash to a charitable lead trust may be able to claim and elect to claim a charitable income tax deduction using the 100% AGI limit for “cash charitable contributions” paid to charitable organizations in calendar year 2020.
Charitable Remainder Trusts. These trusts pay an annuity or other fixed amount to the charitable organization for a set term of years; any balance remaining at the end of that period is paid to the donor or beneficiary. A charitable contribution deduction is allowed to the donor taxpayer in the year the charitable remainder trust is established and funded; The IRC § 7520 interest rate for a particular month is the rate that is 120% of the applicable federal midterm rate (compounded annually) for the month in which the valuation date falls. The October 2020 IRC § 7520 rate is 0.4%. It appears that a donor who contributes cash to a charitable remainder trust will not be able to claim and elect to claim a charitable income tax deduction using the 100% AGI limit for “cash charitable contributions” paid to charitable organizations in calendar year 2020.
Remainder Interests in Homes and Farms. A charitable contribution deduction is allowed to the donor taxpayer in the year of the deed transfer; the amount of the deduction for a donation of a remainder interest in real property is the FMV of the remainder interest at the time of the contribution. The remainder interest value is determined by multiplying the FMV of the property on the date of the contribution by the appropriate factor found in IRS Publications 1457 and 1458. If the contributed remainder interest includes both depreciable and non-depreciable property, e.g., a house and land, the FMV must be allocated between each kind of property at the time of the contribution and an adjustment for depreciation or depletion using the factors shown in IRS Publication 1459.
Generally, no deduction is allowed for a charitable contribution, not made in trust, of less than the entire interest in property. However, this does not apply to such a transfer if it is a transfer of either a remainder interest in a personal residence or farm, an undivided part of an entire interest in property. or a qualified conservation contribution.
James P. Crumlish is a Certified Public Accountant and Chartered Global Management Accountant with offices in Westhampton Beach, NY. He is a business consultant and provides tax and auditing services.
Mr. Crumlish can be contacted at (212) 996-3788 or by e-mail to jamespcrumlish@gmail.com.
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