Updated Risk Alert: IRS Scrutiny of Conservation Easements Increases a CPA Firm’s Professional Liability Risk

On December 8, 2022, the Internal Revenue Service (IRS) issued a Proposed Rule to designate certain syndicated conservation easement transactions as “listed transactions” in response to the Tax Court finding that Notice 2017-10, which previously addressed syndicated conservation easements, was improperly issued. On November 20, 2023, the IRS issued Proposed Regulations for IRC §170(h) (disallowance of deductions for certain qualified conservation contributions made by partnerships and S corporations). Although many tax practitioners are cognizant of the IRS’ enforcement activity related to syndicated conservation easement transactions, this Risk Alert is being updated to reflect more recent IRS developments and its impact on a CPA firm’s professional liability.

The additional scrutiny and skepticism related to transactions identified as “syndicated conservation easements” increases a CPA firm’s professional liability risk. Notably, CPA firms in the AICPA Professional Liability Insurance Program have faced significant claims related to advice regarding syndicated conservation easements. As a result, CPA firms previously involved in these transactions or considering providing service to individuals or businesses involved in these transactions under existing guidance and/or Prop. Reg. §1.170A-14 should pay special attention to this Risk Alert.
 

Conservation easements have been around for years. Why should we care now?

Charitable contributions in the form of a “qualified conservation contribution” have long been permissible under IRC §170(h). While the IRS has historically taken a dim view of contributions of real estate under IRC §170(h), the IRS has increased its focus on and criticism of abusive syndicated conservation easement transactions in recent years.

• December 2016: Issued Notice 2017-10 identifying syndicated conservation easements as tax avoidance transactions and designating them as “listed transactions,” requiring taxpayers participating in these transactions to file Form 8886, Reportable Transaction Disclosure Statement, which discloses their participation in the transaction to the IRS.
   

• March 2019: For the first time, included the syndicated conservation easement strategy in its annual “Dirty Dozen” list of tax scams. The strategy would appear on the IRS Dirty Dozen again in 2021, 2022 and 2023.
   

• February 2020: Then-IRS Commissioner Charles Rettig reported to the Senate Finance Committee that the IRS was auditing investors in addition to pursuing investigations of promoters, appraisers, tax return preparers and others alleged to be involved in the marketing of syndicated conservation easements. This report noted that approximately 84% of the top-tier partnerships that were involved in these transactions during tax years 2016 – 2018 were under IRS audit or had an audit planned.
   

• June 2020: Announced time-limited settlement terms for certain docketed Tax Court cases involving syndicated conservation easement transactions.
   

• January 2022: Announced plans to hire up to 200 additional attorneys to help combat syndicated conservation easements and other tax schemes.
   

• May 2023: Secured multiple guilty pleas which led to jail sentences in excess of 20 years in criminal actions involving fraudulent charitable contribution deductions as part of a syndicated conservation easement scheme.

 
Joe Kingma, attorney at Sites & Harbison, PLLC, Atlanta, with experience defending CPA firms in professional liability claims, notes “accounting firms earning $10,000 or more a year from conservation easement work may well be Material Advisors who must disclose their involvement on Form 8918, Material Advisor Disclosure Statement, and maintain a list of transactions. Given the current toxic atmosphere surrounding conservation easements, accountants may want to avoid Material Advisor status.”
 
In addition to the above, class action lawsuits have been filed against attorneys, accountants and appraisers who, allegedly, conspired to defraud investors by pitching these alleged schemes which they knew would expose them to IRS scrutiny. “The harsh terms of the IRS proposed settlement seems almost intended to pit taxpayers against their accountants and is likely to spawn malpractice suits,” Kingma observed.
 

What kind of conservation easement transactions are concerning?

In an abusive syndicated conservation easement transaction, a “promoter” syndicates ownership in real estate, typically through an entity taxed as a partnership. Promotional materials provided by the promoter suggest a prospective investor will share in a charitable contribution deduction of at least two and a half times the amount of their investment. The promoter secures an appraisal of the real estate based on its highest and best use which is typically significantly higher than if appraised for its intended use.
 
When the real estate is donated to a land trust or other qualified organization, the partnership reports a non-cash charitable contribution deduction based upon the higher value, which is then passed through to the partners based on their percentage investment in the venture.
 
The IRS has challenged the common sense of these transactions and asserts that investors improperly claimed charitable contributions that grossly multiplied their actual investment in the transaction. In other words, the promoters have abused the qualified conservation charitable contribution deduction generally allowed under IRC §170(h) for the benefit of investors. IRS guidance under Notice 2017-10 indicates that a syndicated conservation easement or substantially similar transaction is considered “abusive” if the contribution amount is at least two and a half times the investment amount. Recently, the IRS announced Proposed Regulations to IRC §170(h) which would disallow charitable contributions deductions for certain charitable conservation contributions by pass-through entities where the amount of the contribution exceeds two and a half times the sum of the partner’s basis in the entity.
 

What should I do if a client or prospect asks me to provide services that include or relate to syndicated conservation easement transactions?

Know the rules and understand whether the transaction is a “qualified conservation contribution” or one that falls under either the Proposed Rule or the “Disallowance Rule” of the Proposed Regulations
Examine the economics of any conservation contribution transaction – syndicated or other – particularly the appraisal. IRS sensitivity to disproportionate valuations in conservation easement transactions is already high. Transactions that are technically not disallowed under Prop. Reg. §1.170A-14, may still be subject to audit and/or disallowance. The Proposed Regulations pointedly state that the Disallowance Rule is not a safe harbor, and that any transaction not disallowed by the Disallowance Rule must still comply with other requirements under IRC §170(h).
 
Strongly consider declining ANY service related to abusive syndicated conservation easement transactions
If the firm is approached to promote syndicated conservation easement transactions, prepare tax returns for conservation easement syndicates, advise clients about the potential tax benefits, or prepare income tax returns which include a charitable contribution deduction from an abusive syndicated conservation easement, consider declining the engagement. The risks of promoting, advising clients to invest or preparing tax returns that report abusive syndicated conservation easement transactions include an almost-certain IRS audit and, if the charitable contribution is disallowed, a malpractice claim.
 
Strengthen your engagement letter template
At a minimum, engagement letters should note the risk of total disallowance, as well as accuracy-related penalties. Consider requiring that the taxpayer provide the firm with a copy of the promoter’s private placement memo and acknowledge the warnings therein in writing. Finally, consider noting that the firm is not an appraiser and may or may not be able to rely on the appraisal.
 
Evaluate the tax return signing implications caused by the real estate appraisal and appraiser
If audited, the IRS is likely to challenge the real estate appraisal that supports the value of the charitable contribution deduction. Can the tax practitioner accept information provided by the client, such as an appraisal, without question or further inquiry?
 
Circular 230 section 10.34(d) permits the practitioner to rely in good faith without verification upon information provided by the client provided it does not appear to be incorrect, inconsistent with an important fact or other factual assumption, or incomplete. However, section 10.34(d) also states a practitioner may not ignore the implications of information received. In addition, Circular 230 section 10.34(a) states that a practitioner may not willfully sign a tax return or advise a client to take a position on a tax return which contains a tax position that is “unreasonable” as defined by IRC §6694(a)(2). Included in the definition of unreasonable under IRC §6694(a)(2) is a position with respect to a “tax shelter” (significant purpose of entity is the avoidance of tax) or a reportable transaction to which IRC §6662A applies.
 
If the firm accepts the engagement and prepares a return that reports a syndicated conservation easement transaction or attempts to claim a charitable contribution deduction resulting from such a transaction, the firm should scrutinize the underlying appraisal and ask “does this appear incorrect, inconsistent or incomplete?” For example, if a piece of real estate was purchased for $1 million and donated six months later for $5 million, something would appear to be incorrect. Additional questions should be asked by the practitioner until an acceptable explanation is received and documented.
 
Although Circular 230 section 10.22(b) does permit the practitioner to rely on the work product of another person if the practitioner uses reasonable care in engaging, supervising, and evaluating the person, taking into account the nature of the relationship between the practitioner and the other person, this reliance is still subject to section 10.34. Consider the relationship between the appraiser and promoter. Some appraisers work exclusively for promoters. Would that appear reasonable?
 
Evaluate the appraiser’s qualifications and certifications. If the appraiser is deemed acceptable, document the rationale in the workpapers. Otherwise, consider alternatives. In its settlement offer announced in June 2020, the IRS encouraged taxpayers to consider consulting a qualified, independent appraiser when deciding whether to continue to litigate in Tax Court or accept the settlement offer. Consider whether the firm should advise the client to provide an independent appraisal before preparing a return that includes a syndicated conservation easement transaction.
 
Carefully review documents for completeness and accuracy prior to filing
If the tax forms are completed improperly, a charitable contribution deduction involving conservation easements may be disallowed without ever getting to the question of if the deduction results from a tax shelter or tax scam. For example, if the basis of the investment is not included on Form 8283, Noncash Charitable Contributions the IRS may disallow the contribution due to the technical error and may not need to challenge the real estate appraisal.
 
Double and triple check Forms 8283 and 8886 for completeness. Consider having the client and the promoter provide written approval of the forms prior to filing.
 
Similarly, a charitable contribution deduction from a conservation easement may be disallowed if the contribution is not “protected in perpetuity.” The IRS disallowed the charitable contribution deduction in several cases because the deed failed to protect the property in perpetuity. Consider obtaining a written representation from the attorney and client acknowledging that the deed does “protect in perpetuity” both the land and any improvements.
 
Understand the potential for preparer penalties and professional censure
The IRS has indicated it will assert preparer penalties and may refer practitioners who rely upon unrealistic appraisals when preparing returns that include a charitable contribution deduction from a conservation easement to the Office of Professional Responsibility. Practitioners who assist taxpayers with abusive syndicated conservation easement transactions should be prepared for that referral.
 
Don’t forget to evaluate the Material Advisor requirements under IRC §§ 6111 and 6112, including Form 8918, Material Advisor Disclosure Statement, for any transaction involving syndicated conservation easements, as the penalties for non-compliance are severe.
 
Consider disclosure for any transaction that attempts to meet the requirements of the Disallowance Rule of Prop. Reg. §1.170A-14
In light of the potential for accuracy-related and preparer penalties, discuss with your client how and to what extent the taxpayer may need to disclose any tax position claiming a charitable contribution deduction from a conservation easement under the new Proposed Regulations on their tax return. Document these discussions accordingly, including any discussion around the appraisal of the property contributed or other documents provided in support of the charitable contribution deduction in your workpapers.
 

What should I do if the firm has already provided services related to conservation easement transactions?

Identify those clients who may have engaged in an abusive syndicated conservation easement transaction, and advise them of the IRS heightened scrutiny and the significant likelihood that they will be audited.
 
Suggest that the client hire a qualified, independent appraiser to evaluate their filing position. If the appraisal amount is questionable or potentially unsubstantiated, ask the client if they wish to amend previously-filed returns to update the charitable contribution given the increased IRS scrutiny. Importantly, maintain documentation of these communications and the client’s response.
 
If the firm has promoted syndicated conservation easement transactions, prepared tax returns for conservation easement syndicates, advised clients about the potential tax benefits, or prepared income tax returns which include a charitable contribution deduction from an abusive syndicated conservation easement, discuss whether or not to report the matter to the firm’s professional liability insurance carrier as a potential claim with your insurance agent or broker. Many carriers require notification when the CPA firm becomes aware of an act or omission that may reasonably be expected to be the basis of a claim against the policyholder.
 

Anything else?

If the firm accepts a new client that was previously involved in a syndicated conservation easement transaction, advise the client to discuss the matter with a tax attorney who will be able to advise them under the attorney-client privilege. If the client requests the firm to prepare amended returns, consider whether this service should be engaged under a Kovel arrangement, which will extend attorney-client privilege to the CPA. For more information about Kovel arrangements, read Kovel agreement basics for you and your client.
 
Generally speaking, if a tax savings strategy appears too good to be true, it typically is. Syndicators are actively targeting CPA firms for new investors. Be wary of syndicators, and steer clear of clients who invest in abusive syndicated conservation easement transactions. Otherwise, risk being blamed when clients face the wrath of the IRS.