It is not just retailers that depend on the month of December to make their year. The peddlers of tax shelters, however dubious, also focus on year end business. Is a $500,000 charitable deduction for a $100,000 cash outlay on your Christmas shopping list? If so you might want to look into conservation easements.

Search Hard And Avoid The Negativity

In your search for information, you may be put off by warnings about a major IRS crackdown on syndications and cautionary articles from several people who have issues with these offerings including me.

But if you search hard enough you will find a consulting group that can put you in touch with the opportunities. The deals will have appraisals, legal opinions, reserves for audit defense and some degree of insurance protection.

The design addresses many of the technical foot faults that the IRS has used to disallow conservation easement deductions on less ambitious enterprises where there was usually only one taxpayer taking a deduction for an easement on property that they had owned for some time. I sense that the promoters have taken the essence of Reilly’s Fourth Law of Tax Planning – Execution isn’t everything, but it’s a lot – to heart.

The promoters have to make sure that the enterprise will be recognized as a partnership for income tax purposes or it all falls apart. So some of your investment will be set aside for other business that may be done with your partners. And you will be presented with an opportunity to vote.

An Easy To Predict Vote Outcome

You have been admitted to a partnership that owns a piece of property. It might have been acquired sometime in the last eighteen months for say $10M. Your contribution will have that value marked up to maybe $15M and for the whole thing to work the property has to now be worth $75M (plus a bit) so that you can get a charitable contribution five times your investment.

Your vote will be for one of three options. Sit on the property and see what happens. Execute the plan that will bring all that money with a present value of $75M. Make a charitable contribution of an easement on the property to a land trust forsaking forever the opportunity to build McMansions or mine something – clay, limestone, dilithium crystals (whatever) – and realize that great return. Spoiler alert. The vote always seems to go for the contribution.

My Inside Info

In addition to my own research I have two informants. I’ll call them Doubting Thomas (DT) and James The Just (JJ). DT has been promising me the material to do an expose on the conservation easement syndications which might be comparable to Janet Novack’s Hustling of X-Rated Tax Shelters that exposed the shenanigans of the then (i.e. 1998) Big Five accounting firms.

JJ, on the other hand, has been scolding me for being too hard on the deals. One thing that I have to give JJ is that if I talked you out of your five to one write-off deal, I don’t really have anything else that great to suggest beyond Reilly’s Second Law of Tax Planning – Sometimes it’s better to just pay the taxes.

So JJ is making the argument that this technique that has been available to the wealthy is now accessible to people who despite high salaries might not be that wealthy. JJ has also been providing me with a lot reading material. Ironically, it is something that JJ provided me that has buried in it what I think is the fatal flaw of these deals.

The Valuation Problem

What troubles me about these deals is that they seem to support the principle that it is possible for part of something to be worth a lot more than the entire thing. You are coming into a property based on a value of $15M and then giving away the development rights to the property which are purportedly worth $75M.

Since there is not usually much of a market for conservation easements, they are usually valued indirectly. Here is what the regulation says:

 If no substantial record of market-place sales is available to use as a meaningful or valid comparison, as a general rule (but not necessarily in all cases) the fair market value of a perpetual conservation restriction is equal to the difference between the fair market value of the property it encumbers before the granting of the restriction and the fair market value of the encumbered property after the granting of the restriction. 

26 CFR 1.170A-14(h)(3)

Now that “before” value according to the promoters is the discounted present value of the highest and best use they have documented . There is something not quite right about that, but I was having trouble finding something that clarified what was bothering me.

Finally I found it in one of the articles JJ sent me – Conservation Easements: The Federal Tax Rules And Special Considerations Applicable To Syndicated Transactions by Bradford Updike and Bryan Mick.

That article referred me to a Tax Court decision – Whitehouse Hotel Limited Partnership. Updike and Mick sum it up this way.

While the appraiser must consider the property’s highest and best use (“HBU”), an appraiser must also consider whether or not the property’s HBU would be considered by unrelated parties in determining the purchase price in an arm’s length transaction. Thus, FMV incorporates the HBU for property if the demand for such use will affect the purchase price

Bradford Updike and Brian Mick in Creighton Law Review

The classic example of a conservation easement is that of the farmer in the dell who is being hounded by developers to sell his beautiful pastures. The before value for that farm in the dell is what the farmer could have sold it to the developers for. If he put the property on the market and the only interest was from other farmers – not developers and miners – then its highest and best use is as a pasture – voices in his head telling him that if he builds it they will come to the contrary notwithstanding.

DT tells me that the advisers have moved to the notion that the hypothetical highest and best use value is the correct value for tax purposes independent of there being actual support for it in the market for raw land. He also tells me that the good advice given by Updike and Mick as to how these deals might be done legitimately is never followed in full (or even close) by any of the sponsors.

On the other hand, Bradford Updike updated the 2016 paper with one that takes into account the attack by DOJ against Ecovest and other actors in the field.

You can get a little of JJ’s power to the people attitude in there as Updike ponders the threats to the programs including:

Land Trust Alliance and possibly federal government actors working in concert to preserve the use of the conservation easement tax strategy as a tool for ultra-wealthy individuals while throwing all conservation-oriented real estate programs “under the bus” regardless of their character and substance

Conservation Oriented Real Estate 2019 Outlook – Bradford Updike Mick Law PC

Regardless the article is open to the notion that there are legitimate offerings out there. DT thinks otherwise.

Moral

I think that investments that offer a conservation charitable contribution that is a multiple of your investment, are probably inherently flawed. Real estate just does not work that way.

Given the IRS and DOJ activity in the area, prudent tax professionals will distance themselves from these deals and send clients elsewhere to have their returns prepared.

On the other hand, particularly given the new centralized partnership audit regime, investors in this years crop will probably for the most part get away clean.

Really though, this is probably one of those times when it is better to just pay the taxes. There is still litigation from the turn of the millennium tax shelters kicking around and it is safe to predict that a similar thing will happen with these deals and you might just be the “lucky one”.