Two Updates on Syndicated Conversation Easements (10/26/20)

I report in brief two recent developments in syndicated easement cases that have been the focus of so much IRS audit and investigation activity and Tax Court cases.

First, In Pine Mountain Preserve, LLLP v. Commissioner, ___ F.3d ___ (11th Cir. 2020), here, the Eleventh Circuit reversed the Tax Court and held “(1) that the 2005 and 2006 easements satisfy § 170(h)(2)(C)’s granted-in-perpetuity requirement, (2) that the existence of an amendment clause in an easement does not violate § 170(h)(5)(A)’s protected-in-perpetuity requirement, and (3) that the Tax Court applied the wrong method for valuing the 2007 easement.”  I will not dive into the legal issues in those holdings since they do not involve tax procedure (independent of the underlying substantive tax law issues).  

The valuation issue is interesting, though, because the Eleventh Circuit said that the Tax Court appeared to just "split the baby" on valuation.  (See Slip Op. pp. 9 & 21-24.)  At least, the myth is that courts having to deal with tough valuation issues often just split the baby (choose a mid-point between the parties' valuation positions) or come close to the midpoint with a variance masking that, really, they did just split the baby.  In valuation lingo, that looks like the fact finder (courts here) are in equipoise on some range of values around that mid-point.  See John A. Townsend, Burden of Proof in Tax Cases: Valuation and Ranges—An Update, 73 Tax Lawyer 389 (2020), available here on SSRN.

The Eleventh Circuit required that, on remand, the Tax Court value the easement contribution based on the regulations in  § 1.170(A)-14(h)(3)(i) which, as I understand in the case will require that the contribution be valued as follows: (i) value the whole property on the date of the contribution; (ii) value the taxpayer’s remaining interest in the property (as burdened by the easement), and (iii) deduct the difference.  In many of the conservation easement cases and certainly the abusive ones, the devil is in the valuations.  Taxpayers often overstate the “before” value and understate the “after” value resulting in inappropriate charitable contributions.  (That is setting aside unique abuse in unique methodologies other than the methodology in the regulations.)

Second, in AM 2020-010 (10/5/20), here, the IRS attorney gave advice on the following subject:  Determining the Fraud Penalty in TEFRA Syndicated Conservation Easement Cases.  The TEFRA audit and litigating regime has been replaced for years beginning in 2018 by the centralized partnership audit regime enacted in the Bipartisan Budget Act of 2015, but there are still plenty of TEFRA cases in the audit and litigation pipeline that can be subject to the analysis in the memorandum.  The summary conclusion is:

The procedures for determining the applicability of the civil fraud penalty against a partnership subject to TEFRA that participated in a SCE transaction are the same as those for establishing civil fraud against a partnership subject to TEFRA generally; i.e. through all facts and circumstances that establish the willful intent to evade tax at the partnership level. Under TEFRA, the IRS determines the applicability of the civil fraud penalty at the partnership level and then the penalty is directly assessed on the partners of the partnership through a notice of computational adjustment. 

The general procedures for applying the fraud penalty at the partnership are described (cleaned up for readability to core propositions by stripping case and other  citations):

As with all penalties determined at the partnership level, fraud is determined by conduct that occurred at the partnership level. For purposes of penalties, the “partnership conduct,” including the partnership’s intent, is determined by looking to the conduct and intent of those managing the partnership. Likewise, any partnership-level defenses to any penalties must also be determined by the manager’s conduct on the partnership’s behalf. .

Accordingly, in order to determine the fraud penalty under section 6663(a) with respect to a TEFRA partnership, the IRS must prove, by clear and convincing evidence, the partnership-level elements of the fraud penalty based on the conduct and intent of the manager(s). If the IRS proves fraud, the fraud penalty is applicable to all the partners in the partnership on any underpayments of tax resulting from the adjustments to partnership items that are attributable to fraud, and any additional underpayments for the same year. Those partners may then raise any partner-level defenses in a refund action under section 6230(c).