Tax Planning

Non-profit upkeep easements: is tax planning needed?

Shortly after taking office, President Joe Biden issued an executive order that marked the beginning of a unified government agency plan for the conservation of land and water resources.

Executive Order 14008, issued January 27, 2021, provides the initial impetus for the government’s plan to protect U.S. land and water resources. Four US agencies, including the US Department of the Interior, Agriculture and Commerce, have submitted a report to the National Climate Task Force entitled “Conserving and Restoring America the Beautiful 2021”.

By 2030, every state should have received at least 30% of its land and water resources. This 30 by 30 goal is to be achieved through a combination of government and local initiatives, as well as voluntary actions by farmers, indigenous communities, local communities and local landowners, including the use of conservation easements.

Tax breaks are often used to incentivize human behavior. Incentives for taxpayers to fight climate change and to conserve land and water are contained in the tax code. One such incentive is Section 170 (h), which allows for a charitable deduction for maintenance easements donated to charitable land trusts or other organizations under Section 501 (c) (3). Section 170 (h) (4) and Treasury Regulation 1.170A-14 (d) set out detailed requirements that must be met before an easement is classified as a “qualified maintenance easement” that is eligible for Section 170 charitable deduction.

In recent years, however, perceived abuses related to conservation easements have developed, along with attempts by the IRS and the Tax Court to ban all charitable contributions related to conservation easements. These measures curb the incentives for such easements. With the increasing dangers of climate change and the loss of natural resources, conservation easements, charitable or not, are needed more than ever.

On September 29, 2020, the Senate introduced Senate Act 4751, which amends Section 170 (h) by adding a new subsection. On December 2, 2020, the House of Representatives introduced HR 8842 with a similar amendment to Section 170 (h). Both bills are entitled “Charitable Conservation Easement Program Integrity Act of 2020”.

Taxpayers interested in investing in a non-profit nature conservation easement should be aware of the proposed legislation and keep an eye on their tax planning. Even taxpayers who have previously applied for a nonprofit allowance for an easement should closely monitor these bills to see if the bills are reintroduced and brought back to life.

This is important in part because the legislation can be retroactive in nature. In both HR 8842 and p. 4751, the Charitable Conservation Easement Program Integrity Act adds Section 170 (h) (7) and prohibits a deduction if it is more than 2.5 times the adjusted base of the taxable partner in his or their partnership interests. The full deduction will not be granted instead of only prohibiting the portion of the deduction that is greater than 2.5 times the adjusted base.

This regulation applies to the first three taxable years after the establishment of the partnership and three years after the contribution by the partner. It also applies to S corporations and limited liability companies taxed as partnerships.

However, family partnerships are excluded. If a partnership, in which “substantially all” of the shares are held by persons who are related within the meaning of Section 152 (d), donates a maintenance easement, this partnership is exempt from these proposed new regulations. Individual landowners are also excluded from the legislation, and so deductions made for charitable conservation donations on land owned by an individual would not be affected by the proposed legislation.

In its current version, the law on gifts of nature conservation easements would apply for tax years ending after December 23, 2016. The proposed law seeks to address concerns about a partner’s ability to manipulate their adjusted base in the interests of their partnership, while requiring the partner to hold the stake direct and not use a complex structure that makes it difficult or difficult to accurately determine the adjusted base makes impossible.

In addition, a loophole has been proactively closed by adding the wording that the three-year rule applies to the later point in time at which the property is acquired by the partnership and the point in time when the partner has acquired his stake in the partnership. If the partnership is part of a tiered structure and the investment was made several levels above the taxpayer’s investment, both the House of Representatives and the Senate fall back on the yet-to-be-written regulations of the Treasury and the agencies.

Both bills stipulate that the exclusion provisions do not apply if contributions are paid outside the three-year holding period of the partner and the partnership (s). In the case of shareholders whose shares are not held directly but are held via another transit company, the refusal of the deduction (regardless of the amount) is only effective for contributions that are made after the effective date.

Effective legislation that changes the rules for years for which declarations have already been filed are likely to be challenged in court. An ex-post defense is thought of, although that defense is primarily criminal, according to the early interpretation of US Constitutional Article 1 Section 9 by the Supreme Court at Calder v. Bull. Other arguments could also challenge this legislation and bring the matter to justice. However, it takes many years to resolve a dispute and taxpayers should plan to look into retrospective application should this legislation enter into force in its current form.

The first and foremost tax planning strategy is to ensure that taxpayers, including partnerships, file their tax returns in a timely manner. At this point in time, the three-year limitation period for a tax return submitted on time for the 2016 calendar year in accordance with Section 6501 (a) has expired. The IRS would not be able to prohibit charitable deduction unless the numbers are large enough to allow the six-year limitation period under Section 6501 (e) to apply.

If the bill is passed, investors affected by it, that is, those whose valuations are higher than 2.5 times the adjusted base, should seriously consider changing the previous year’s still-statute-barred returns to meet the new laws with a deduction claim, which is limited to 2.5 times the adjusted base. Playing the tax audit lottery is rarely a good idea, especially since all of these consortium partnership maintenance easements are now reported to the IRS and are generally not allowed as requested in IRS Notice 2017-10.

For future investments and tax planning strategies, partnerships would have to organize and invest in real estate and then wait three years. After a three-year waiting period for both the company and the shareholders, the company could donate the maintenance easement and the investors could claim the deduction based on a qualified expert opinion without taking into account the 2.5-fold adjusted basic limit.

After the three-year retention period has expired, the limit on the amount of the charitable deduction only applies if this has to be substantiated by a qualified expert opinion. Another option is to invest in a syndicated partnership with the expectation that the donation withdrawal will not be more than 2.5 times the investment made. While other factors can affect a partner’s adjusted base in the partnership, a general expectation that it will be the amount of money invested is a good place to start. The proposed legislation restricts the use of debt in the calculation of the adjusted basis.

Other options for tax planning are the direct acquisition of real estate by investors, whereby the maintenance easement is brought in without the use of a partnership or an S-company structure. If a person acquires property on his or her behalf or through an individual member LLC, this legislation does not prevent that person from donating a maintenance easement and a deduction for charitable contributions under Section 170 (h) based on qualified judgment without consideration to assert the 2.5 times adjusted base figures.

The same applies if a person already owns real estate and decides to donate an easement to a charity. Another option is to gather your relatives together and form a family partnership, which is also exempt from these restrictive rules. The new legislation only applies to capping charity deductions attributable to investments structured through flow-through companies such as third party partnerships, including syndicated partnerships.

There is no magic 8-ball to determine whether this bill will either be passed separately or as part of a larger bill. Since the proposal would, at least in theory, increase revenue, it could be used as a source of funding for one of the larger bills Congress is considering. This provision could easily be included in a draft vote as part of the annual budgetary procedure.

If a draft budget is added that is subject to reconciliation, it limits the Senate’s ability to filibuss the legislation and it could be passed by majority vote of the Senate along with a more usual House vote. It is noteworthy that the budget proposed by President Joe Biden on May 28, 2021 contains no reference to maintenance easements. However, budgets are rarely (if ever) passed in the form proposed by the White House, and so there are no guarantees that this bill will die in committee. Watch this room!

This column does not necessarily represent the opinion of the Bureau of National Affairs, Inc. or its owners.

Information about the author

Nancy Ortmeyer Kuhn is a Director at Jackson & Campbell, PC in Washington, DC and Chair of the Tax Group. Nancy’s legal practice focuses on litigation and federal tax matters. She was a US Tax Court attorney for two years and then litigated with the Chief Counsel of the Internal Revenue Service for approximately nine years. Nancy then switched sides, representing taxpayers before the Internal Revenue Service, the tax court and the district courts. In addition, she oversees general legal disputes before various regional and federal courts. She is an active member of the District of Columbia’s Women’s Bar Association and a founding member of 131 & Counting, a nonprofit that celebrates women in electoral office.

Bloomberg Tax Insights articles are written by seasoned practitioners, academics and policy experts who discuss developments and current issues in the tax field. To make a contribution, please contact us at TaxInsights@bloombergindustry.com.

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