Are syndicated conservation easements reportable transactions?

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In recent months, several federal courts have considered challenges to the validity of certain IRS rulings involving which syndicated conservation easements are considered reportable transactions and have adjudged these rulings to lack validity in whole or in part due to the ways those rulings were issued.

Administrative Procedures Act  

The Administrative Procedures Act (APA) is the legal authority for rulemaking and promulgation of procedures necessary to ensure fairness and equity in administration of the federal laws, including the income tax laws. The APA requirements directly affect the administration and enforcement of federal tax law by the IRS. In this context, the IRS issues numerous official positions, including final regulations, temporary regulations, proposed regulations, revenue rulings, revenue procedures, the Internal Revenue Manual, Commissioner delegation orders, Chief Counsel orders and notices, and other announcements and notices.

Administrative agencies of the federal government, including the IRS, must meet more detailed procedural requirements in issuing rules and procedures under their general authority as administrative agencies than is necessary if they have a legislative directive from Congress to issue such guidance in a specified area.

In recent years, when organizations wished to challenge the validity of administrative rulings, they have increasingly included challenging the way the rules were promulgated, arguing that the appropriate procedures were not followed in the creation of the challenged rules and therefore those rules were invalid.

Recent court decisions

Notice 2007-83 identified certain trust arrangements claiming to be welfare benefit funds that involved cash value life insurance policies as listed transactions (a type of reportable transaction). Then, about five years ago, the IRS issued Notice 2017-10, identifying all syndicated conservation easement transactions, beginning from January 1, 2010, and including all substantially similar transactions, as listed transactions for purposes of Reg. §1.6011-4(b)(2).

Recently, however, courts have challenged the validity of these Notices for failing to follow the notice-and-comment rulemaking procedure set forth in section 553 of the Administrative Procedures Act (APA), 5 U.S.C. 551 - 559. The Treasury and IRS dispute the applicability of this requirement to the issuance of these Notices. In November 2022, the Tax Court held Notice 2017-10 and its identification of certain syndicated conservation easements as listed transactions to be a legislative rule because it created new substantive reporting obligations for taxpayers and material advisors, the violation of which prompted exposure to financial penalties and sanctions (Green Valley Investors, LLC, 159 TC —, No. 5, Dec. 62,122). And it held that, since the Notice was a legislative rule, it should have gone through the notice-and-comment rulemaking under the APA. Since it did not, it was improperly issued and therefore set aside by the Tax Court.

Identifying abusive tax avoidance transactions within the meaning of Reg. §1.6011-4 is an enforcement priority for the IRS so, in addition to fighting such challenges to the authority of such Notices in court, the IRS has rather quickly issued these proposed amendments to the regulations identifying certain syndicated conservation easement transactions as listed transactions with the intent to finalize the regulations as soon as due consideration of public comments can be completed.

2.5-times rule

Under the amended regulations as proposed, a taxpayer could receive promotional materials that offer 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 taxpayer’s investment in the pass-through entity. These proposed regulations provide additional guidance on how to determine whether the 2.5 times rule is met. The pass-through entity would allocate directly or through one or more tiers of passthrough entities, a charitable contribution deduction to the taxpayer. The pass-through entity that owned the real property contributes an easement on such real property to a qualified organization and treated the easement as a conservation easement. Finally, to prevent taxpayers from investing excess amounts in the pass-through entity to avoid meeting the 2.5 times rule, the proposed regulations contain an "antistuffing" rule.

Prohibited tax shelter transactions

Under the proposed regulations, a qualified organization is not automatically treated as a party to the transaction under Code Sec. 4965. However, a qualified organization that facilitates an abusive syndicated conservation easement transaction under Code Sec. 4965 is a “party” to a prohibited tax shelter transaction. If the tax-exempt entity knew or had reason to know that the transaction was a prohibited tax shelter transaction at the time the tax-exempt entity became a party to the transaction, the Code Sec. 4965 tax increases to the greater of (1) 100 percent of the entity’s net income attributable to the prohibited tax shelter transaction, or (2) 75 percent of the entity’s proceeds attributable to the prohibited tax shelter transaction.