$21M Deduction Denied (Conservation Easements)

February 2024

After already being named on the infamous “Listed Transactions” by the IRS, a recent tax court case is showing how serious the IRS is about disallowing them.

What started out with good intentions by the government went awry - as these things tend to do. Conservation easements were developed as a way to incentivize people to protect the land they own against development.

They would do this by allowing taxpayers to take a charitable deduction for the FMV of the land they were conserving. The trees, birds, and fish rejoiced.

Then came tax strategy promoters. What if there were a way to profit off this? What if, we could have people people buy the land, have the FMV assessed at 4, 5 or 6x the value, get them a massive charitable donation, and make a little money on the side?

In Oconee Landing Property LLC et al v. Commissioner, this is exactly what happened. Basically they pulled together some investors and offered them the promise of a tax deduction of $4 for every $1 invested. If something sounds too good to be true in tax, it usually is.

First - the deduction was denied because there wasn’t a qualified appraisal attached to the return. Imagine trying to write off $21M and not attaching an appraisal. Second, the property was “ordinary income property” so charitable contributions are limited to the property’s basis (what you purchased it for).

“Ordinary income property” means that if the property was sold at the FMV the date it was donated, the sale would result in ordinary income/ST capital gain (because it was held less than a year). So the “donation” basis is what you purchased it at, not what you can sell it at when dealing with property held for a short period.

The courts determined that the FMV of the properties was less than $5M, and a $21M deduction was claimed, it exceeded the FMV by more than 400%, and thus they were liable for a 40% gross misstatement as well as a 20% penalty on the portion of underpayment of liabilities.

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