Syndication Of Conservation Tax Deductions – Why We Can’t Have Nice Things

The Senate Finance Committee report- Syndicated Conservation-Easement Transactions – released on August 25 is very heartening. It exposes tax shenanigans that threaten an otherwise benign tax incentive. At least it is as benign as any tax incentive can be. The report is a great read. I will give you some of the high points.

A Bipartisan Effort

It appears that the effort by the Committee is actually bipartisan.

In the news release Senator Grassley remarks:

“The American tax system relies on fairness and good faith compliance. This isn’t a partisan issue. Serious, fair enforcement of our tax laws is the best way to preserve that system and uphold our understanding that the law applies equally to all of us.”

Ranking member Senator Wyden may have gotten just a tad partisan in his remarks:

“This is part of a larger pattern of wealthy tax cheats ripping off the American people because they know they can get away with it after years of cuts to the IRS budget. As with broader enforcement issues, cracking down on abusive syndicated conservation easements requires ensuring IRS has the resources and legal tools to do its job”

“Defunding the IRS” has been sort of a GOP strategy.

A Major Motion Picture

There is something a little cinematic about the report as it sets the scene of the case that would launch the industry in a conversation between two fellows on a fishing boat near the Virgin Islands. There is audio from William Sylvester of Baker Donelson at a 2017 seminar.

I’ve been involved with conservation easements since 2002. A now-deceased stock broker from Birmingham, Alabama met a fellow from Columbia – no Charleston, South Carolina when they were boat fishing in the Virgin Islands and they had a good conversation about: was there a way to transfer interest in a good conservation-minded property to someone with a higher tax bracket?

That’s where the movie begins – two guys on the fishing boat pondering the problem of the land poor owners of the Kiva Dunes golf course who are encouraged to preserve their vulnerable environmentally sensitive property. The scene shifts to migratory birds resting at a golf course on the Gulf Coast in Alabama. The golf course is even better for the birds than nearby nature preserves, because there are fewer predators.

There will be crusading attorneys, played by Tom Hanks and Julia Roberts, who expose what is going on. And a small sleepy city taken over by a virtual cult funded by the transactions. Since it is an imaginary movie I can have Walter Brimley as the wise old accountant who figures out the numbers that stump the lawyers. 

And the narrator can be a contributor to a prestigious platform. Robert Redford is who I am thinking for that role. I haven’t figured out the villains. Also have not decided on the genre. I would not rule out horror or comedy, but it will most likely be a thriller. Possibly something like The Firm, which actually got some obscure technical tax stuff correct.

Kiva Dunes

Kiva Dunes is in Gulf Shore, AL. There wasn’t enough golfing going, so the owners were thinking that they would have to sell the course for condos. The tax incentive of a large deduction from a conservation easement was not that meaningful, because they did not have anywhere near the income to use much of it.

Mr. Sylvester designed a structure that allowed investors to get some of that deduction, thereby providing capital to the golf course. In my mind, it should not be able to work given certain principles of partnership taxation, but it did. The IRS had initially tried to deny the deduction entirely but ended up conceding that there was a deduction.

They had a hard fight on valuation. Taxpayer’s appraiser put the before easement value of the golf course at around $30 million. The IRS appraiser pegged it at $10 million. They both agreed that the highest and best use was a residential subdivision. They also agreed that the highest and best use with the easement was as a golf course, but had a $7 million difference of opinion going in the opposite direction there.

The IRS appraiser flubbed on the after valuation and his number was dismissed by Judge Wells. Judge Wells did adjust the after value up by almost $2 million. All in the taxpayer mostly prevailed on valuation.

The Significance Of Kiva Dunes

Kiva Dunes was an important precedent for golf courses as possibly having conservation value, but the notion of bringing in investors who would be awarded an almost immediate deduction is what was exciting. As the report notes:

Since then, promoters of syndicated conservation-easement transactions have been relying on the Kiva Dunes opinion to aggressively market such transactions involving inflated appraisals for lands that often appear to have questionable commercial values, at least at the values claimed by the promoters.

The taxpayer appraiser would go on to do many more appraisals. Within the industry, a theory developed that the valuation of the before value of a property for conservation easement property was different than the determination of value for any other purpose. The report quotes from an email string where a promoter is allaying the skepticism of a prospect’s advisor.

“[A] conservation easement appraisal is very different from a normal real estate appraisal since it takes in to account all future economic benefit on the land and takes future value discounted to present day. _________Appraisal has the most experience of any conservation easement appraiser in the country with over 500 CE appraisals to his credit. _______ has been tested under fire with the tax courts particularly in the Kiva Dunes case in [sic] known to be a huge victory for conservation easements. (Names are included in the report)

Kiva Dunes Does Not Mean What They Say It Means

There is nothing in the Kiva Dunes case that indicates the valuation conclusion would have been different had the property been valued for estate tax purposes. The IRS and the taxpayer might have been on opposite sides, but that is neither here nor there. Credible sources have told me that a less desirable nearby property transferred at a higher per-acre value not long after. Kiva Dunes sits on the Gulf Coast and as you drive along your view of the water will often be blocked by condos.

The other great difference between Kiva Dunes and the current deals is that the owners who partnered with investors had owned the course for nearly a decade. The Kiva Dunes partnership model would have limited applicability since it requires someone who owns valuable property that they want to conserve who cannot use the deduction.

The notion that there are different rules for valuing property for conservation purposes dies hard. I will be discussing that in a follow-up article on reactions to the report. The report tries to drive the stake through the heart of that particular vampire.

However, the transactions reviewed in this report illustrate a consistent pattern of land (or interest in a partnership holding land) sold in an arm’s length transaction, followed shortly thereafter by an appraisal asserting land values multiple times higher than the value established in that prior arm’s length transaction. This pattern clearly calls into question the accuracy of these appraisals that consistently value property many times higher than was established in prior arm’s length transactions.

They Are Pure Shelters

Much of the report is about establishing that the industry is about selling tax deductions.

… essentially what promoters of syndicated-conservation easement transactions promised their taxpayer-investors every year: for every dollar you give us, you will get back two dollars, sometimes a little more and sometimes a little less. But it was not the promoters who gave back the two dollars; it was the Federal government by way of foregone tax revenue, and the only risk involved was whether or not the transaction would lead to an audit.

Email chains and slide decks from seminars in the appendix make the case. I found much of it amusing.

Valuation Shenanigans

One of the matters that the report touches on is the financial engineering that the promoters have engaged in. Rather than taking a parcel and valuing based on a single fantasy development, they divide it up and have five fantasy developments. In considering matters like how many housing units can be absorbed in that market or how many starships will stop at the dilithium crystal mine, they don’t consider the other four developments.

And if there happens to be a sewage treatment plant nearby, who cares? It is not as if they are actually going to build.

The Moral

The conclusion of the report about the larger implications of these deals is pretty compelling.

In order for this self-reporting system to work and not devolve into a culture of duplicity as the norm, it is critical for taxpayers to generally believe the system is fair – even if a taxpayer does not like paying over his or her hard-earned money to the government, he or she knows his or her neighbors must do so as well. If this understanding breaks down, so too could a culture of compliance in our self-reporting system. If syndicated conservation-easement transactions continue to exist in the form they have over the past decade, they risk not only depriving the government of billions of dollars of revenue but also degrading the general understanding that our Nation’s tax laws apply equally to us all.

I would suggest that if Congress stopped using the Internal Revenue Code as the Swiss Army knife of policy there might be less opportunity for these sorts of shenanigans. Tax incentives seem like a free lunch, but we can see from the havoc wrought by this one incentive, it might be better to spend money on the purposes and use the tax system to raise the needed money.

Unless there are extremely tight controls as we have with the Low Income Housing Tax Credit, scoundrels will abuse the program. And that is why we can’t have nice things.

Other Coverage

This was breaking news last week, but another syndication easement development intervened slowed me down. I am going to do a separate piece on responses to the report, so I will not include some releases here. Here is some other coverage of the report.

Renu Zaretsky has The Road To Abusive Tax Shelters Is Paved with Good Intentions on Tax Vox.

Many conservation easement transactions do follow the law’s intention: They preserve undeveloped land for use by current and future generations of taxpayers. The tax subsidy has so far conserved 27,745,552 acres of American lands, including 73 acres just a few miles from the trail we hiked in Ithaca last month. Maybe new legislation will reform the deduction and make it harder for people to cheat. It’d be pretty cool if it did. 

I would argue that no new legislation is required. Enforcement alone should solve this particular problem. Funding the IRS is more of what is needed.

On Your Tax Matters Partner I have Conservation Easement Tax Deduction Coverage Round Up, which gives links to nearly a decade of coverage on the issue.

Tamar Hallerman of the Atlanta Journal-Constitution has Congressional panel targets ‘abusive’ tax shelters popular in Ga.

The transaction, flagged in last week’s U.S. Senate Finance Committee report, is an example of syndicated conservation easements that the panel said “appear to be highly abusive tax shelters.” Syndicated easements have become increasingly popular in Georgia over the last decade, where a cottage industry of promoters has emerged in Rome and metro Atlanta.

John Bailey of the Rome News Tribune has Senate report calls for changes to syndicated conservation easement practices.

…..at least one locally-run businesses, Webb Creek Management, characterized the lengthy report as “disappointing” and “a wholesale refusal to acknowledge or even inquire into the benefits provided by the preservation of thousands upon thousands of acres of important real estate across the country.

A massive DOJ investigation and a major class action lawsuit might be the worst thing to happen to the Rome GA economy since Sherman, as I noted here. Rome’s prominence in the industry was even an issue in a Congressional race.

Jay Adkisson has Syndicated Conservation Easement Tax Shelters Slammed By U.S. Senate Finance Report on Forbes.com

The Senate Report is extremely well documented, and reads like an interesting financial book. The report exposes the practices of the promoters, the actuaries, and the clients, all of whom knew what was going on in reality and were culpable of being involved in a tax shelter. 

I am not including coverage behind paywalls.

Note

A lot of names are named in the report, which makes it interesting reading. I despaired of trying to reach them all, so you can read them for yourself. William Sylvester did not respond to my inquiry.