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The additional scrutiny and skepticism related to certain conservation easement transactions 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 should pay special attention to this Risk Alert. Conservation easements have been around for years. Why should we care now? The IRS has been increasing its focus on and criticism of certain syndicated conservation easement transactions in recent years. 2017: Identified syndicated conservation easement transactions as tax avoidance transactions and designated them as “listed transactions,” requiring taxpayers participating in these transactions to file Form 8886, Reportable Transaction Disclosure Statement, which highlights their participation in the transaction to the IRS. 2019: Included the syndicated conservation easement strategy in its annual “Dirty Dozen” list of tax scams. February 2020: IRS Commissioner Charles Rettig’s reported to Senator Charles Grassley and disclosed that the IRS is auditing investors in addition to pursuing investigations of promoters, appraisers, tax return preparers and others. This report noted that approximately 84% of the top tier partnerships that were involved in these transactions during tax years 2016 – 2018 are under IRS audit or have an audit planned. June 2020: Announced a settlement initiative for certain docketed Tax Court cases involving syndicated conservation easement transactions. Joe Kingma, attorney at Copeland, Stair, Kingma, & Lovell, LLP, 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, in 2020 two class action lawsuits were 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? The IRS has identified certain syndicated conservation easement transactions as abusive. In an abusive syndicated conservation easement transaction, a “promoter” syndicates ownership in real estate through a partnership. Promotional materials provided by the promoter suggest a prospective investor will share in a conservation easement contribution 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, individual investors in the partnership can claim a contribution deduction based upon the higher value. The IRS has challenged the common sense of these transactions and asserts that investors claim charitable contributions that grossly multiply their actual investment in the transaction. In other words, the promoter abuses the charitable contribution deduction for the benefit of the investors. Although current IRS guidance indicates that the conservation easement transaction is considered “abusive” if the contribution amount is at least two and a half times the investment amount, the IRS may change this threshold. What should I do if a client or prospect asks me to provide services that include or relate to syndicated conservation easement transactions? Strongly consider declining ANY service related to abusive syndicated conservation easement transactions If the firm is considering promoting syndicated conservation easement transactions, preparing tax returns for conservation easement syndicates, advising clients about the potential tax benefits, or preparing income tax returns which include an abusive syndicated conservation easement deduction, consider declining the engagement. The risks of preparing the returns that include 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 penalties up to forty percent (40%). Consider requiring that the taxpayer provide the firm with a copy of the promotor’s private placement memo and acknowledge the warnings therein in writing. Finally, consider noting that the firm is not an appraiser and cannot address the appraisal’s accuracy. Carefully evaluate real estate appraisals If audited, the IRS is likely to challenge the real estate appraisal that supports the value of the contribution deduction. Can the tax practitioner accept information provided by the client, such as an appraisal, without question or further procedures? Maybe. Circular 230 Section 10.34, Standards with respect to tax returns and documents, affidavits and other papers, 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. If the firm accepts the engagement and prepares a return that includes a syndicated conservation easement transaction, the firm should scrutinize the appraisal and ask “does this appear incorrect, inconsistent or incomplete?” For example, if the same 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. Circular 230 Section 10.22(b), diligence as to accuracy – reliance on others, permits 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. 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 litigate the claim or accept the settlement offer. Consider whether the firm should do likewise or advise the client to do so before preparing a return that includes an abusive conservation easement transaction. Carefully review documents for completeness and accuracy prior to filing A conservation easement contribution deduction may be disallowed because a form was completed improperly. 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 conservation easement contribution deduction may be disallowed if the contribution is not “protected in perpetuity.” The IRS disallowed the 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 The IRS has indicated it will assert preparer penalties and may refer practitioners who rely upon unrealistic appraisals when preparing returns that include a conservation easement deduction to the Office of Professional Responsibility. Practitioners should be prepared for that referral. 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 an abusive syndicated conservation easement deduction, 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. Conclusion 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. * * * * * This information is produced and presented by CNA, which is solely responsible for its content. Continental Casualty Company, a member of the CNA group of insurance companies, is the underwriter of the AICPA Professional Liability Insurance Program. The purpose of this article is to provide information, rather than advice or opinion. It is accurate to the best of the authors’ knowledge as of the date of the article. Accordingly, this article should not be viewed as a substitute for the guidance and recommendations of a retained professional. In addition, CNA does not endorse any coverages, systems, processes or protocols addressed herein unless they are produced or created by CNA. Any references to non-CNA websites are provided solely for convenience, and CNA disclaims any responsibility with respect to such websites. Examples are for illustrative purposes only and not intended to establish any standards of care, serve as legal advice, or acknowledge any given factual situation is covered under any CNA insurance policy. 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