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An eight-year-old IRS notice casting syndicated conservation easements as listed transactions and disallowing nearly every conservation easement donation has created a logjam of Tax Court cases.
For every conservation easement client involved in a disputed matter, there are two viable options: Take advantage of existing settlement programs or press forward to litigation. Taxpayers should consult advisers to assess risks and potential rewards of each option.
In early 2024, taxpayers with conservation easements pending in the Tax Court began receiving letters from IRS attorneys offering to settle the case. The settlement letters prohibited the deduction under Section 170 of the tax code; allowed an “other deduction” equal to the cash contributed by the investors for syndicated conservation easements (or cost basis for non-syndicated conservation easements); and reduced the 40% gross valuation misstatement penalty down to 10%.
Over the summer, the IRS began sending letters offering a variation of the standard settlement terms for non-docketed cases still under examination. This version kept the prohibition on Section 170 deductions and cash-basis “other deduction,” but it reduced the gross valuation misstatement penalty to 5% and creates a fictitious partnership-level tax of 21% (as opposed to the potential 37% rate).
The IRS has shown neither a desire to negotiate its settlement programs nor any willingness to marry the two separate programs to treat taxpayers the same.
What Now?
Taxpayers should consider whether it makes sense to make deposits against potential deficiencies to stop the accrual of interest (presently running at 8%) on the proposed deficiencies against them. There are ways they can do this without destroying the jurisdiction of the Tax Court to hear their cases (which generally can’t hear full payment cases).
Next, taxpayers and their advisers should carefully and honestly analyze their cases. The recent string of valuation opinions from the Tax Court are all memorandum opinions—meaning that they turn on the facts particular to those cases as opposed to Tax Court opinions, which involve decisions that turn on an important legal issue or principle.
Because memorandum opinions turn on the facts particular to that case, taxpayers and their representatives have the ability to argue for a different result based on the facts particular to the taxpayer’s case.
At the very least, reviewing this stream of opinions provides insight into what the Tax Court relies on in reaching its decisions. Advisers can determine how a taxpayer’s case differs and how they can improve their valuation argument.
Taxpayers and their advisers then must analyze the cost of proceeding to trial. Expert witness fees and a cadre of IRS lawyers creating paperwork means a trial on the merits can be a costly endeavor that dwarfs the potential benefits.
Lastly, taxpayers and advisers must take a hard look at the practical realities of the conservation easement landscape. The IRS isn’t budging, and the Tax Court has been highly skeptical of income-based valuation approaches, despite their long-standing recognition as a valid valuation approach.
Easement Case Status
The sheer volume of conservation easement cases has created an administrative nightmare for the Tax Court, strained the IRS’s resources, and increased costs for taxpayers as they face years of delays and uncertainty over the eventual outcome.
Earlier this year, the Tax Court reported an estimated 750 docketed cases involving conservation easements. Speaking at the UCLA Tax Controversy Conference recently, Chief Judge Kathleen Kerrigan placed that number at over 1,000.
Conservation easement disputes aren’t new, although the proliferation of cases stemming from high-profile IRS attacks has brought them to the forefront of tax controversy matters. In cases such as RERI Holdings I, LLC v. Commissioner, the IRS prevailed on technical foot faults, resulting in full disallowance of the taxpayer’s deductions.
Since then, the Tax Court predominantly has found in favor of the taxpayer on those same technical arguments, including conservation purpose, retained rights, and qualified appraisal or appraiser issues.
Before October 2023, in cases decided on valuation, the Tax Court sustained an average of 78% of the original valuation claimed. It became increasingly skeptical of long-standing valuation principles as they apply to conservation easements, starting with Mill Road 36 Henry, LLC v. Commissioner, allowing an average of just 7% of the original valuation across the last six land conservation cases. The last historic facade conservation valuation opinion returned just 4%.
With each case taking months to prepare and weeks to try, the backlog keeps growing. But getting to trial is far from the end of the story. On average, it takes between 12 and 18 months after trial for the judge to issue a written opinion.
When considering how to proceed, taxpayers and their advisers should decide whether it’s strong enough to overcome any obstacles against it. All litigation has inherent risks, but it’s important to discern each case’s specific risks to determine potential outcomes.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Jasen Hanson is a shareholder in Chamberlain Hrdlicka’s tax controversy and litigation group in Atlanta.
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