IRS Designates Syndications Exploiting Improper Valuations for Conservation Easement Deductions (1/2/17)

I note at a couple of places in the Federal Tax Procedure Book that some of the most abusive tax shelters do not fail because the legal positions are faulty.  Rather, they fail because the legal positions are all based false facts, often a false valuation of property.  For example, in discussing the substantial and gross valuation misstatement penalties in §§ 6662(e) and (h), here, I state:

Section 6662(e)’s substantial valuation misstatement penalty and § 6662(h)’s gross valuation misstatement penalty are directed to return reporting positions where the law is correctly applied but a critical valuation is grossly erroneous, resulting in the substantial understatement of the tax liability.  In many of the abusive tax shelters over the years, the Achilles heel has been and continues to be inflated valuations.  The legal superstructure had some facial merit, but it was built on a factual house of cards because of gross overvaluation.  A facet of this problem was that, since tax professionals were not valuation experts, they could render their opinions without taking responsibility for the key valuation facts that supported the whole purported tax shelter superstructure.  For example, as to property otherwise qualifying for the old investment tax credit (10 percent of qualifying investment in property), tax shelter promoters would sometimes inflate the value of property to 10 or 20 times its true value and sell it to investment partnerships (where the partners were tax shelter investors) for the inflated value.  Of course, only crazy people would pay the inflated value, so the tax shelter investors paid only a small amount down and “paid” the balance by nonrecourse indebtedness (before the rules related to nonrecourse indebtedness and passive losses).  Assuming that the value was correct, the taxpayers would be entitled to the credit; the problem was in the valuation.  Many, many tax issues, not just tax shelter issues, rely upon valuations.  Thus, for example, estate and gift tax returns rely upon reasonably correct valuations.  The purpose of this penalty is to put some sting in overly aggressive valuations.

I have posted on variations of this theme.  Court Sustains Use of Regular Summons to Appraiser Investigated Even Though Third Party Taxpayers May be Identified (Federal Tax Crimes Blog 1/14/16), here.  See also Prominent and Very Rich Investor Indicted in SDNY (Federal Tax Crimes Blog 5/24/16), here.

Such overvaluations carry risk of criminal prosecution and significant civil penalties.

The IRS strikes again at a valuation shelter in a different package, this one syndications -- promoted "investments" -- offering conservation easement deductions.  Notice 2017-10, 2017-04 IRB, here.  The Notice describes the problem:

The promoters (i) identify a pass-through entity that owns real property, or (ii) form a pass-through entity to acquire real property. Additional tiers of pass-through entities may be formed. The promoters then syndicate ownership interests in the passthrough entity that owns the real property, or in one or more of the tiers of pass-through entities, using promotional materials suggesting to prospective investors that an investor may be entitled to a share of a charitable contribution deduction that equals or exceeds an amount that is two and one-half times the amount of the investor’s investment. The promoters obtain an appraisal that purports to be a qualified appraisal as defined in § 170(f)(11)(E)(i) but that greatly inflates the value of the conservation easement based on unreasonable conclusions about the development potential of the real property. After an investor invests in the pass-through entity, either directly or through one or more tiers of pass-through entities,  the pass-through entity donates a conservation easement encumbering the property to a tax-exempt  entity. Investors who held their direct or indirect interests in the pass-through entity for one year or less may rely on the pass-through entity’s holding period in the underlying real property to treat the donated conservation easement as long-term capital gain property under § 170(e)(1). The promoter receives a fee or other consideration with respect to the promotion, which may be in the form of an interest in the pass-through entity. The IRS intends to challenge the purported tax benefits from this transaction based on the overvaluation of the conservation easement. The IRS may also challenge the purported tax benefits from this transaction based on the partnership anti-abuse rule, economic substance, or other rules or doctrines.

The Notice also describes the consequences of designating the transactions as listed transactions:

Transactions entered into on or after January 1, 2010, that are the same as, or substantially similar to, the transaction described in section 2 of this notice are identified as “listed transactions” for purposes of § 1.6011-4(b)(2) and §§ 6111 and 6112 effective December 23, 2016. Persons entering into these transactions on or after January 1, 2010, must disclose the transactions as described in § 1.6011-4 for each taxable year in which the taxpayer participated in the transactions, provided that the period of limitations for assessment of tax has not ended on or before December 23, 2016. Material advisors, including appraisers, who make a tax statement on or after January 1, 2010, with respect to transactions entered into on or after January 1, 2010, have disclosure and list maintenance obligations under §§ 6111 and 6112. See §§ 301.6111-3, 301.6112-1. 

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Participants required to disclose these transactions under § 1.6011-4 who fail to do so will be subject to penalties under § 6707A. Participants required to disclose these transactions under § 1.6011-4 who fail to do so may also be subject to an extended period of limitations under § 6501(c)(10). Material advisors required to disclose these transactions under § 6111 who fail to do so may be subject to the penalty under § 6707. Material advisors required to maintain lists of investors under § 6112 who fail to do so (or who fail to provide such lists when requested by the IRS) may be subject to the penalty under § 6708(a). In addition, the IRS may impose other penalties on persons involved in these transactions or substantially similar transactions, including the accuracy-related penalty under § 6662 or § 6662A, the § 6694 penalty for understatements of a taxpayer’s liability by a tax return preparer, and the § 6695A penalty for certain valuation misstatements attributable to incorrect appraisals. 

I posted earlier today a dramatic example of the onerous potential penalty in § 6707.  See SD NY District Court Rejects Partial Payment § 6707 Penalty Refund Suit (Federal Tax Crimes Blog 1/2/17), here.