David Stewart 0:01

Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week, conservation easements, part 2. We're continuing our look at a divisive topic within the tax community. The first part of this series, which ran last week, features an interview with Robert Ramsay, the executive director of the Partnership for Conservation, which advocates for the use of investment vehicles and conservation easement deals. This episode, part two, features an interview with Steve Small, a conservation easement attorney in Boston and one of the authors of the federal income tax regulations on conservation easements. Listeners interested in a brief overview of the conservation easement issue and the controversy surrounding them should check out episode one before moving on. I'm joined again by Tax Notes Legal Reporter, Kristen Parillo. Kristen, welcome back to the podcast.

Kristen Parillo 0:53

Thanks Dave, for having me back

David Stewart 0:55

Before we get to your interview for this week, could you give listeners a brief overview of the interview you did last week with Robert Ramsay?

Kristen Parillo 1:01

I asked Robert about the Partnership for Conservation's opposition to the IRS's enforcement strategy against syndicated easements and legislation that would cap the size of the deductions for donating an easement through these syndicated partnership deals. We also talked about an article he wrote for Tax Notes about a dirty dozen myths on syndicated easements, which has reignited the debate around whether syndicated deals are abusive.

David Stewart 1:27

Now you've just talked with someone with a distinctly different perspective. What sort of issues did you get into with Steve Small?

Kristen Parillo 1:33

Steve takes a traditional view of conservation easement donations. So, I asked why he thinks that syndicated easement deals are abusive tax shelters and why he thinks legislation is needed to curb valuation abuse.

David Stewart 1:48

Alright, let's go to that interview.

Kristen Parillo 1:51

Welcome to the podcast, Steve. Thanks for joining us.

Steve Small 1:55

Happy to be here, Kristen.Thank you for having me.

Kristen Parillo 1:56

So as you all know, the tax treatment of conservation easements has been getting a lot of attention in the last few years. Let me start by asking if you agree that there should be tax incentives for donating a conservation easement?

Steve Small 2:10

Absolutely. This provision deduction for conservation easement was first added to the tax code in 1976. It was modified and extended in 1980. And the idea was very simple then and it's the same idea now where if someone has land that has an important conservation values, they might be tempted to sell out for development and just consider that payment. There should be a federal tax incentive for people who want to protect that land instead of develop it. And that's really what a conservation easement is. One of the things I found that's very unusual about this particular field, and you see, it cuts across social and economic and geographic and even political lines . I remember having dinner 20 plus years ago in southern Arizona with a rancher who thought that Barry Goldwater was a communist, but by God, he didn't want any condominium in his valley, and he didn't want any real estate developers in his valley. So this is a provision that really can work for anyone who has land they love.

Kristen Parillo 3:15

And the IRS and Congress have been focusing specifically on syndicated easements. You wrote an article for Tax Notes back in 2004, where you said you were seeing syndicated deals involving golf course easements. Can you walk us through how the syndicated partnerships became so pervasive in the conservation easement area?

Steve Small 3:37

It's a long steady story, a long steady flow. I did start to notice transactions in 2004 and leaving golf course easements aside for a moment, the thing that really concerned me was inflated appraisals, where a piece of rural land, an appraiser would say, "This could be zoned for a 3,500-unit PUD -- planned unit development -- commercial golf course hotel, and it's worth $40 million. And instead of doing that, we're going to put a conservation easement on it and take a $39 million deduction. And it may well have been that the land could have been zoned for a PUD, but no one would have built it, because the market simply did not exist. So the value for IRS purposes and for deduction purposes, and I know we're going to get into that, was grossly inflated. And I started to see these deals happening clearly in the beginning of the 2000s. You know , I mentioned that at the end of a long Tax Notes article I had published in Tax Notes 2004. And I think the key questions at the end of the article -- has the taxpayer owned the property for less than 24 months? And if the answer to question number one is yes, is the claim deduction greater than two and one half times the cost basis? And I thought that was a pretty good filter for realistic or unrealistic appraisals. And I think that this was not a busy time for syndications, and most of these were not true syndications in the sense we see today, but the IRS wasn't paying much attention to this field. And as a colleague of mine once said years ago, if there's a provision in the tax code long enough, people will find a way to abuse it. And that's what subsequently happened. People said, "My goodness, this is an easy way to make money because nobody's paying attention."

Kristen Parillo 5:25

And those who support these syndicated deals argue that the IRS is unfairly targeting partnerships. They say that syndication is a good thing because it lets people who may not be able to buy land on their own, to invest in a partnership, and still participate in conservation efforts. Why do you disagree with that view?

Steve Small 5:45

First of all, that's all a red herring, or put another way, it's all smoke and mirrors. There's really nothing wrong with a syndicated transaction. As such, happens all the time in the commercial world. The issue here isn't whether it's syndicated, the issue isn't in whether there's offering material, whether the conservation easement really accomplishes some conservation purpose. The sole issue here is that these deals rely on grossly inflated appraisals to come up with a grossly inflated income tax deduction. And all of the other smoke and mirrors out there is really nothing but that. It's a distraction. I know that there was an article by Robert Ramsay in the Tax Notes stuff last month. And one of the things he said, one of his myths as he put it about conservation easements was, and I'm quoting from his article, "Sponsors of conservation easement transactions should be fearful of the IRS." That's a quote. And I look at that and I say, sponsors of conservation easement transactions? Sponsors of charitable contribution transactions? To me, that's a giveaway right there. In a true charitable contribution, one gives away value. It's philanthropy. There's a tax incentive that provides a benefit and encourages people who want to do that sort of thing. Whether it's writing a check to your alma mater, or donating a painting to a museum, or donating a conservation easement. And once again, the people who are fighting the attempts to clamp down on these abusive transactions throw smoke out there. This has nothing to do with land conservation. In fact, a c olleague said to me, "You know, you could clarify this for a lot o f people and instead of saying syndicated conservation easements, you said, and I'm g oing t o say it now, abusive syndicated conservation easement tax shelter transactions." That's all we're talking about. We're not talking about partnerships. We're not talking about LLCs. We're not talking about conservation. We're talking about inflated appraisals.

Kristen Parillo 7:52

So how can the IRS curb this valuation abuse? Do you think their stepped-up enforcement efforts in the last, like six months, can get at the root of the problem?

Steve Small 8:01

I think that's a great question. I've been concerned about these transactions for years, and I know the Land Trust Alliance, which is the umbrella organization for the land conservation groups around the country, has also been very concerned. And I know they've made attempts and I've made attempts over the years to convince the IRS, "Listen, we know you have to audit transactions. OK? Nobody ever says, 'Oh good. Come audit me.' People complain about that, but there are some really bad transactions out there that you need to start auditing." And I know for a fact that the IRS was provided names, appraisers, promoters, syndicators, and so forth, and apparently nothing happened. Whether that was a lack of sufficient personnel, whether it was a lack of willpower, isn't really the issue. The IRS simply wasn't paying attention. And I don't mean that as a critical observation. The tax code is massive, and there are only so many things the IRS can pay attention to. But there's a part two to that also. And that is enforcement. Let's say the IRS really stepped up enforcement and oversight of syndicated conservation easement tax deduction tax shelters. There was a case that interestingly enough just came down yesterday: Brannen Sand & Gravel. It's not a conservation easement case, but I'm going to get to my point here. The partnership return Tax Court opinion notes the partnership return was filed on September 19, 2011, for U.S. return of partnership income for 2010. OK? That was a 2010 transaction that was at some point subsequent to that audited. A Tax Court decision that finally closed this case and rendered a verdict against the taxpayer, forgetting appeals. OK? About which I know nothing in this. It was reported on June 4, 2020. So even in an enforcement case, even when the IRS is paying attention, even when the IRS wins, and then I say Brannen was not a conservation easement case, it takes so long for lack of a better expression, justice to be done that IRS enforcement efforts alone simply aren't going to do it. And one of the things that we've noticed with significant interest in these syndicated abusive conservation easement tax shelter transactions is that so many of them today also have in the offering materials, a request for funds to set up a legal defense fund. And it can be $200,000. It can be $300,000. I think I've seen one for $750,000. And what that means to me is that if one of these transactions gets audited, it may not be resolved for a decade. And if 20 of them get audited, they may not be resolved for a decade. And there are hundreds and hundreds of these transactions going on right now. So, that tells me that enforcement, even the best possible enforcement, isn't going to stop it. It's a situation where I think we need a change in the law to stop it. And we can talk about that. But I've said for a long time that if the IRS went after eight to 10 of the appraisers who are the key participants in many of these transactions, they would really shut down a lot of these abusive transactions. And someone said to me a year ago, "No, that's not true. There's so much money to be made here that if the IRS shuts down eight to 10 people, there are at least 25 people in line right behind them ready to step up and do the work and get paid for it." So, enforcement again, intending no disrespect or criticism of the IRS, that's just not the way to stop this.

Kristen Parillo 11:46

Now there's legislation pending in the House and Senate that would cap the size of the deduction that can be claimed by these syndicated transactions. Groups like the Partnership for Conservation don't like this bill. They say it would hinder conservation and retroactively increase taxes on taxpayers since the effective date is tied to December 2016, when the IRS issued the notice flagging these deals as a listed transaction. Do you think limiting the size of the deductions that can be claimed in these syndicated deals is fair?

Steve Small 12:20

Years ago, a fellow from the IRS said to me about the related matter, he said, "You know, we said, 'We don't need any new rules. We need people to follow the existing rules.'" The fact of the matter is , is the regulations already limit the size of the income tax deductions for any charitable contribution. And they limit it to the fair market value of the asset that's being contributed to charity. And the whole key here with the syndicated transactions is appraisers either don't understand that that's the rule, or they think there's a different way to deal with it. Let me just give you one example. I've used this example before, and I'm changing a couple of the details, but this is all available in the public records, so I'm not giving away any secrets. Promoters purchased, let's say 3,500 acres of relatively rural land for $13.5 million. And that works out rounding to about $4,000 an acre. The IRS rules state that you get a charitable deduction for the fair market value of the asset that you contribute to charity. And fair market value is defined, and this is the key, this is the whole key right here, fair market value isn't whatever you think it might be. Fair market value is defined as the price at which the property would change hands between a willing buyer and a willing seller. There's more to it than that. But what that means is fair market value is what you would get if you put the property on the market and sold it. And in this case, getting back to my example, promoters bought 3,500 acres for $13 million, works out to $4,000 an acre. The promoters then sliced and diced that 3,500 acres into a number of smaller parcels, syndicated out in a more than a dozen separate LLCs, more than a dozen separate deals. All of these parcels in, and in the end total deductions generated for the investors who bought into these abusive tax shelter transactions, was $1.4 billion. That means that an appraiser, or more than one appraiser, has said either with a straight face or not, this property may have changed hands for $13.5 million, but it's really worth $1.4 billion. And going back to the definition of fair market value, I say to clients a lot that people love their land and often tend to think it's worth more than it really is worth. And I'll say, "Tell me, if you didn't own this piece of property, what would you pay for it? If it was on the open market?" And that's really the issue here. And there is no way that these appraisals that come up with these numbers resemble what a willing buyer would pay a willing seller. Nobody in any of these transactions would pay $400,000 an acre for land that would reasonably change hands for $4,000 an acre. So, that's really the issue. That's really cutting to the chase. If people followed the rules and paid attention to the definition of fair market value, knowing that it means, "What would you pay for the property? What would a buyer pay for the property?" We wouldn't need any new rules. But those rules have been abused, so I think people aren't going to stop voluntarily. I think we need legislation to fix it. And the Land Trust Alliance, with a number of sponsors on Capitol Hill, has introduced the Conservation Easement Program Integrity Act. And that provides the math limits, number limits, to the size of the deduction that can be taken in certain of these abusive transactions. This legislation is not designed to shut down conservation. It's not designed to make landowners aggravated. It's designed to stop these syndicated transactions. What we're talking about, these abusive syndications, this is not about land conservation. It's not about, you know , LLCs or partnership. That's a tax-friendly vehicle of choice for all sorts of transactions, supposedly all the time. This is not about investors. And it is not about people who want to participate in land conservation in this great country of ours, but land is too expensive, but they can buy into a conservation deal here. This is not about the IRS, and it's not about the Department of Justice. This is all about grossly-inflated appraisals that don't follow the rules that we already have. The rules that we already have limit deductions to fair market value, and those rules are not being followed. So I think until we see legislation, we're going to see a continuation of these abusive tax shelter transactions.

Kristen Parillo 17:03

Well, my last question for you is where do we go from here?

Steve Small 17:07

Well, I think it has become, unfortunately, a legislative issue. Intending no offense to this session of Congress or any other, the chances of getting legislation, any bill passed, are always slim . And I think there's a flip side to that. I wrote an article on syndicated transactions that was published in Tax Notes in 2016. And in that article, I suggested legislation that would limit the deduction, if the claimed deduction was greater than 250 percent of the investment. But I concluded that article with a very interesting and sad , thought, and I want to repeat it here. Two of my colleagues in Washington, who know their way around the Hill, said, 'You know, you have to watch out. Whenever you introduce legislation, that's not a secret anymore. It's not in your pocket anymore. The interest groups will form that want to oppose it, and they'll be out there spending money opposing it. So you could introduce legislation, but there's never a guarantee that it will become law." And they were absolutely right. This legislation has been introduced to curb abuse. It's costing taxpayers hundreds of millions of dollars a year. It's making people rich. And there are a lot of lobbyists out there saying, "Oh no , no. This is going to shut down a land conservation." Well, in fact, if this isn't shut down, land conservation may be threatened. So I hope that common sense prevails, and that we can get a legislative solution to this problem. I'm sorry that we need one, but that's where I come out.

Kristen Parillo 18:43

Well, thanks so much for talking with us, Steve. I'm sure this is not the last word on this issue.

Steve Small 18:49

No, Kristen . And thank you for having me. And again, I appreciate your all interest in this subject, because I think it's a very narrow niche as far as the tax code is concerned, but it's causing a lot of problems. And if these problems can be stopped, if these transactions can be stopped, and we can return to whatever normal is, then would be a good time.

Coming Attractions with Faye McCray

David Stewart 19:12

And now, coming attractions. Each week, we highlight new and interesting commentary in our magazines. Joining me now from her home is Content and Acquisitions Manager Faye McCray. Faye, what will you have for us.

Faye McCray 19:22

Thanks, Dave. In Tax Notes Federal, Itai Grinberg proposes a method to limit which multinational enterprises the OECD’s pillar 1 reallocation would apply to. Three professors at the University of Houston-Victoria examine the requirements for individuals to receive economic impact payments. In Tax Notes International, Andrew Hughes develops several practical arguments and strategies that transfer pricing and international tax practitioners can use in today’s economic environment. Tatiana Falcão discusses the EU’s proposed carbon border adjustment mechanism. Tax Notes Federal, Tax Notes State, and Tax Notes International are launching Global Roundtable, a regular series that brings together experts from each discipline to help advance the discussion of tax issues. In the first installment, the authors discuss whether the OECD should release its recommendations for taxing the digital economy this year in light of the disruption caused by the COVD-19 pandemic.

David Stewart 20:21

You can read all that and a lot more in the pages of Tax Notes Federal, State, and International. That's it for this week, you can follow me online @TaxStew, that's S T E W, and be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts .org . And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.