More on Abusive Conservation Easements (12/28/19)

Peter Reilly has a good discussion on an abusive conservation easement.  IRS Grinch Ruining Christmas For Syndicated Conservation Easements (Forbes 12/24/19), here.  The fatal flaw in such easements is the valuations (dare I say bullshit valuations).  These are just variations of many shelters in the 1970s and early 1980s where the fatal flaw was the valuations.  They are therefore just a variation of bullshit tax shelters when the crux of the shelter is major overvaluations.

Peter points to the IRS News Release, IR-2019-213, here, Excerpts from the release:

On Dec. 13, 2019, the U.S. Tax Court entered its first decision on a syndicated conservation easement transaction. In TOT Property Holdings, LLC v. Commissioner, Docket No. 005600-17, the Tax Court sustained in its entirety the IRS's determination that all tax benefits from a syndicated conservation easement transaction should be denied and that the 40% gross valuation misstatement and negligence penalties applied. The Tax Court found that the transaction failed the legal requirements applicable to donations of land easements and, in imposing the gross valuation misstatement penalty, found that the actual value of the easement donation was less than 10 percent of what was originally reported on the tax return. 

"In denying the deductions and upholding the 40% gross valuation misstatement penalty, the Tax Court confirmed that aggressive syndicated easement transactions simply will not survive scrutiny," said IRS Commissioner Chuck Rettig. "We will not stop in our coordinated pursuit of these abusive transactions while seeking the imposition of all available civil penalties and, when appropriate, various criminal options for those involved." 

"If you engaged in any questionable syndicated conservation easement transaction, you should immediately consult an independent, competent tax advisor to consider your best available options," Rettig added.

Peter's posts are usually very good, and this is not exception.

Also, in a related development, in United States v. Zak (N.D. Ga. Dkt. 18-cv-05774-AT Order dated 12/10/19, here), the Court considered a government suit against allegedly abusive shelter promoters.  The Court rejects the defendants' motions, except for one count against Zak which is dismissed without prejudice.

Key excerpts from the Order are (emphases supplied by JAT):

"The Government alleges that defendants ran a “conservation easement syndication scheme.'"

* * * * 

The Government laid out eleven discrete steps that represent the “general pattern” the defendants took in enacting their conservation easement offerings. (Doc. 1 at 18–22.) In brief, according to the Government, the defendants first formed an LLC to take ownership of a piece of land, then hired an appraiser to provide an appraisal of the land, which would be used later in tax filings. (Id. at 18–19.) The defendants then marketed ownership interests in the LLC – whose value is derived only from the possible future tax benefit of converting the land to a conservation easement – to wealthy persons who may seek to maximize their tax benefits. (Id. at 19–20.) The marketing of the LLC clearly explains how the conservation easement might benefit a person in a particular tax bracket by reducing his or her tax burden substantially. (Id.) Once all stakes are sold, the LLC designates the land as a conservation easement, finalizes the appraisal of the land’s value, and prepares its own tax return. (Id. at 20–21.) The LLC is formed as a pass-through entity, so the sizable tax benefit it incurs for designation of the land is then passed through it to the investors themselves. (Id. at 16.) The investors list the conservation easement tax burden on their personal income tax returns, reducing their own tax liability. (Id. at 21–22.)

Good Article on the Abusive Syndication Easement -- Legislative and Judicial Initiatives (6/25/22)

I recommend to readers this article:  Peter Elkind, The Tax Scam That Won’t Die (Propublica 6/17/22), here.  Key excerpts related to tax crimes:

Criminal investigations of industry practices are reportedly underway in three states. The crackdown’s most sensational case became public in February, when a federal grand jury in Atlanta indicted North Carolina developer Jack Fisher, a major syndication deal promoter and owner of Inland Capital Management. The 135-count indictment charged Fisher and six associates with participating in a conspiracy to sell $1.3 billion worth of illegal tax shelters. The charges against Fisher include wire fraud, conspiracy to defraud the U.S., money laundering and aiding in the filing of false tax returns. He has pleaded not guilty.

The indictment was backed by a string of damning statements attributed to Fisher, including several secretly recorded by an undercover government agent posing as an easement promoter.

The indictment, for example, charged that Fisher’s conservation deals relied on “fraudulent” and “grossly inflated” land appraisals, often valuing the easement properties at more than 10 times what he had paid for them just months earlier. It asserted that Fisher routinely “pre-determined” these valuations before any appraisal was actually performed, telling his two “hand-picked” appraisers what valuation he needed to generate the generous deductions he’d promised investors. In one recorded conversation described in the indictment, Fisher said one of the appraisers simply “puts down whatever we say.” In another, he said he always made sure easement valuations were high enough to make sure investors “can still get a good return on their money,” even if a later IRS audit reduced their charitable deduction.

The government also charged that Fisher frequently orchestrated the illegal backdating of checks and tax documents, allowing him to keep offering unsold stakes in his deals to investors as much as nine months after the year-end tax deadline, after the easement was already donated. In one recording, Fisher acknowledged rewarding partners at an accounting firm with free shares in an easement deal because “they participated in basically backdating all the documents.” After learning he was under investigation, according to the indictment, Fisher told one associate he could claim that backdated checks weren’t deposited until after the close of the tax year because they had been “lost” on someone’s desk.

Both appraisers, now among Fisher’s fellow defendants, have pleaded not guilty. One says on his website that his firm decided in mid-2019 to stop doing conservation easement work “until there is greater clarity from the courts on conservation easements.”

Peter Reilly on Conservation Easement Donations as Bullshit Tax Shelters (7/24/17)

Peter Reilly has a great write up on the conservation easement tax scam -- aka bullshit tax shelter (my description, not his) -- that has featured prominently in many recent cases and is the subject of Notice 2017-10, here.  Peter's write up is New IRS Scandal - Syndication Of Conservation Easement Deductions (Forbes/Taxes 7/24/17), here.  And  I have previously written on Notice 2017-10 in IRS Designates Syndications Exploiting Improper Valuations for Conservation Easement Deductions (Federal Tax Crimes Blog 1/2/17), here.

Bullshit tax shelters are built on one or two foundations (sometimes both) -- fake law and fake facts.  The bullshit conservation easement shelters often get the law right, but fail on the facts -- particularly the valuations.  I encourage readers to review Peter's article and then read the extra materials I offer below.

I particularly like Peter's Accounting View -- balancing of the books analysis -- to show the problem with the bullshit conservation easement shelters.  

I extend Peter's analysis because many bullshit tax shelters suffer that basic problem.  The seminal balancing of the books case is Commissioner v. Tufts, 461 U.S. 300 (1983).  The taxpayer acquired basis in property via a nonrecourse loan, used the basis for depreciation tax benefit, then surrendered the property and walked away from the nonrecourse loan.  Had that been a recourse loan, the taxpayer would have had to recognize cancellation of indebtedness income, thereby balancing his books for the deductions funded by the recourse loan.  But, the taxpayer argued, because it was a nonrecourse loan, he received no benefit from the the "relief" from  the nonrecourse loan and thus had no offsetting income entry from COD or otherwise.  In effect, the taxpayer was arguing for free deductions with no balancing of his books.  The Supreme Court in Tufts rejected the argument, but took an intermediate position that the nonrecourse loan was includible as an amount realized on a deemed sale of the property securing the nonrecourse loan.  So, the taxpayer could get a combination of deferral from the nonrecourse loan (based on the interim depreciation deductions) and conversion to capital gains.  That is not a bad tax shelter.  But, at least the Supreme Court required a balancing of the books, albeit at capital gains rates.

I am not certain whether Tufts was an overvaluation case in its inception -- i.e., the property securing the nonrecourse loan was overvalued and thus the nonrecourse loan was underwater all along, serving only to generate deductions that the taxpayer in Tufts tried to shelter by not balancing his tax books at the end.  But, many taxpayers before and after Tufts tried that gambit of the overvaluation of the property secured by nonrecourse loans.  At least Tufts required a balancing of the books.

Having been deeply involved in the BLIPS shelters (not as promoter or adviser or taxpayer but as litigator), I always thought that, even if one accepted the aggressive legal position taken about contingent debt when contributed to the partnership, there was a balancing of the books problem akin to what the Supreme Court required in Tufts.  Thus, having achieved the basis benefit fueled by the loan, albeit recourse, that ultimately went "poof," the taxpayer should have to balance his books with the offsetting taxable income.  The shelter opinions that I saw either ignored that or dissembled on it.  Of course, there was a problem at the inception of the analysis on contingent debt, but assuming that problem was cleared, then the back-end issue balancing issue was a problem.

At any rate, thanks to Peter Reilly for his analysis.

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.

Senate Finance Committee Begins Investigation of Abusive Conservation Easement Appraisals (4/2/19)

The Senate Finance Committee Chair and Ranking Member announced here that they have started

an investigation into the potential abuse of syndicated conservation easement transactions, which may have allowed some taxpayers to profit from gaming the tax code and deprived the federal government of billions of dollars in revenue. For several years now, the IRS has been investigating these transactions. They appear to involve promoters selling interests in tracts of land to taxpayers looking for large tax deductions. In such an arrangement, the taxpayers then get inflated appraisals of those tracts of land and grant conservation easements on that land. The resulting inflated charitable deductions are then split among the taxpayers.

The SFC sent letters to 14 "individuals who appear to be associated with these investor groups that might have unfairly profited from conservation easements."  The names are listed on the press release.

I have written on conservation easement bullshit tax shelters:

• Peter Reilly on Conservation Easement Donations as Bullshit Tax Shelters (Federal Tax Crimes Blog 7/24/17), here.
• IRS Designates Syndications Exploiting Improper Valuations for Conservation Easement Deductions (Federal Tax Crimes Blog 1/2/17), here.

Peter Reilly has a very good update on this development:  Peter J. Reilly, Grassley Wyden Take On Sketchy Conservation Tax Shelters (Forbes 3/28/19), here.

The type of investigation appears somewhat like the investigations by the Senate's Permanent Subcommittee on Investigations of the Committee on Governmental Affairs, see here.  Criminal investigations sometimes are in process when such investigations occur or, as I think occurred in the KPMG situation, arose from the commotion of the investigation.

DOJ Tax Publicizes Sentencings and Plea Agreements of Syndicated Conservation Easement Enablers; Where Are the Taxpayers (1/10/24)

DOJ Tax issued a press release about sentencing and guilty pleas of enablers in abusive, illegal (maybe redundant) syndication easement tax shelters. Two Tax Shelter Promoters Sentenced to 25 Years and 23 Years in Billion-Dollar Syndicated Conservation Easement Tax Scheme; Two More CPAs Plead Guilty (Press Release # 24-29 1/9/23), here.

The lengths of the sentences are noteworthy.

The two other individuals pled guilty to a single count each of the Klein/defraud conspiracy, thus capping their potential sentences each to 5 years. Of course, they were not the masterminds of the fraudulent tax shelter scheme, but their pleas indicate that they willfully participated.

Of course, it is late in the Syndicated Conservation Easement game, so enablers in the game should be on notice now that they can be caught and punished. How much effect this will have as a future deterrent is unknown because, I suspect, many who know the downside will attempt maneuvers to prevent the IRS or DOJ Tax from discovering their complicity in such conduct. Most economic crime violators (including enablers) do not think they will be caught or their skullduggery will be understood.

My only comment relates to what I call the elephant in the room—the taxpayers willfully participating in such schemes. My experience in these elaborate abusive shelters is that well-heeled taxpayers are also complicit. Those taxpayers who are complicit feel (or at least hope) that the blizzard of paper (including fake opinions and appraisals) and participation of facially expert promoters will protect them from penalties, civil and criminal, thus giving them cost-free access to the audit lottery. But those who consulted independent counsel (and many, probably most, did at least in the Son-of-Boss shelters and, I suspect, in the Syndicated Conservation Easement Shelters) would have known the shelters did not work.

If the IRS and DOJ Tax want to discourage abusive tax shelters, it should prosecute the taxpayers involved (or at least enough of them, the more egregious ones, to send the message to the abusive tax shelter taxpayer community that there is risk of a criminal reckoning). Even where the enablers of the abusive tax shelters put together a package that facially seems to support the tax benefits claimed, most well-heeled tax shelter investors have their own independent legal counsel. Good advice would certainly include enough warning that the gambit is illegal and that their participation is willful. Prosecuting and convicting taxpayers would send the message of risk to all participating in abusive shelters and could substantially reduce the number of players involved by reducing the market for abusive tax shelters.

First Criminal Cases from Abusive Syndicated Conservation Easements (12/23/20; 12/29/20)

Abusive conservation easements have been a topic on this blog for some time now.  See here.  DOJ and the IRS have noised about criminal prosecutions, but until this past week none have surfaced.  Now, we have two criminal cases with a pre-wired plea on the filing of the criminal informations.  See DOJ Press Release: Atlanta Tax Professionals Plead Guilty to Promoting Syndicated Conservation Easement Tax Scheme Involving More Than $1.2 Billion in Fraudulent Charitable Deductions (12/21/20), here. 

Relevant excerpts from the press release are:

According to court documents, from at least 2013 through 2019, S. Agee and C. Agee, then partners at an Atlanta accounting firm, marketed, promoted, and sold together with co-conspirators,  investments in fraudulent syndicated conservation easement (SCE) tax shelters. The SCE tax shelters were designed to produce tax deductions for high-income taxpayers through partnerships that purported to make “real estate investments.” In truth, the partnerships were a sham, lacking economic substance and serving no legitimate business purpose. The placement of conservation easements over the real estate was a foregone conclusion, which fraudulently enabled the investors to shelter their income from the IRS with no economic risk and to claim substantial tax deductions to which they were not entitled. S. Agee, C. Agee, and their co-conspirators marketed the SCE tax shelters by promising investors that for every $1 invested in the partnership, the investor would receive more than $4 in charitable tax deductions. 

“The defendants’ and their co-conspirators' criminal conduct enabled their clients to claim more than $1.2 billion in fraudulent tax deductions and generated hundreds of millions of dollars of tax loss to the United States,” said Principal Deputy Assistant Attorney General Richard E. Zuckerman of the Justice Department's Tax Division.

* * * *

Conservation easements were created by Congress to be a key tool used for protecting environmentally and historically important land. The donated conservation easement typically restricts the use or development of land in order to protect its conservation value. When legitimately created and used in compliance with the Internal Revenue Code, the conservation easement can both protect the environment and provide tax incentives. By contrast, abusive SCEs are designed to game the system and generate inflated and unwarranted tax deductions, often by using inflated appraisals of undeveloped land and partnerships devoid of legitimate business purpose.

According to court documents, S. Agee and C. Agee additionally solicited investors after the end of the tax year and advised them to backdate payments and documents to make it appear that the “investments” were timely made before the end of the tax year. S. Agee and C. Agee also prepared and assisted in the preparation of false tax returns for clients who agreed to invest in the SCE shelters. In exchange for their promotion of the abusive SCE tax shelters, between 2013 and 2019, S. Agee and C. Agee each received more than $1.7 million in commissions.

S. Agee and C. Agee both pleaded guilty to one count of conspiracy to defraud the United States which carries a maximum penalty of five years in prison. They also face a period of supervised release, restitution, and monetary penalties.

The CourtListener dockets for these cases are:  Stein Agee, here, and Corey Agee, here.

Details are set forth in the Stein Agee Criminal Information and Factual Basis available at CourtListener here and here.  I have not attempted to determine if there are material differences in the fact patterns for Stein and Corey Agee, but have instead focused generally on Stein Agee.  As with conspiracy charges generally, the details are summarized in cascading fashion in the Manner and Means and Overt Acts paragraphs of the Criminal Information (pars. 103 and 104, pp. 21-30 (repeated in the Factual Basis, pars. 101 and 102, pp. 22-31)).  Those wanting to know at least the summary details should focus on those paragraphs.

JAT Comments:

Note:  I have substantially revised the Comments portion to present the materials in a way that I think will be helpful to Tax Crimes students, focusing on the potential sentencing considerations indicated by the Agee pleas.

Taxpayer Right to Be Present at Interview of Federally Authorized Practitioner (4/10/15)

In United States v. McEligot, 2015 U.S. Dist. LEXIS 45519 (N.D. Cal. Apr. 6, 2015), here, the third-party witness, the taxpayer's accountant and return preparer, had asserted the Federally Authorized Practitioner Privilege under Section 7525, here, and refused to be interviewed without taxpayer's counsel.  The IRS moved to enforce the summons.  The Court held (1) "a taxpayer does not have an absolute right to be present at a third party IRS summons proceeding concerning the taxpayer's liabilities" and (2) the summons should be enforced.

Taxpayer's Right to Have His Counsel at the Interview

The Court starts off by saying that any implication in Reisman v. Caplin, 375 U.S. 440 (1964) that the taxpayer might be present at the interview was not the "last word on the subject."  In Donaldson v. United States, 400 U.S. 517 (1971), the Court rejected guaranteed right for the taxpayer's counsel to be present and said such presence was permissible only where the taxpayer could show the potential for a significantly protectable interest.  For example, if the taxpayer's attorney were summonsed where the taxpayer might have attorney-client privilege and work-product protection.

The Court noted that subsequent changes to Section 7609, here, which require notice to the taxpayer and a right to move to quash the summons or intervene in a summons enforcement proceeding do not affect the issue of presence at the summons interview.  The Court then reasons and concludes:

The Government additionally notes that "[t]he Fourth Circuit, Tenth Circuit, Fifth Circuit, and a District Court within the Ninth Circuit have held that a taxpayer has no right to be present at the interview of the party being summoned." ECF No. 21 at 4. In United States v. Newman, 441 F.2d 165 (5th Cir. 1971) the Fifth Circuit held that a taxpayer could not intervene or be present at the IRS hearing, noting that United States v. Powell, 379 U.S. 48, 85 S. Ct. 248, 13 L. Ed. 2d 112 (1964) had compared such proceedings to grand jury proceedings. The Newman court noted that the investigatory, non-adversarial nature of the proceedings "would be frustrated by requiring those persons not parties who might be later affected to be allowed to take an active part through private counsel in such proceedings." n1 Newman, 441 F.2d at 174. In United States v. Traynor, 611 F.2d 809, 811 (10th Cir. 1979), the Tenth Circuit rejected a taxpayer's argument that she and "her counsel have the right to be present when the respondents produce the requested records, and to actively participate in such proceedings," noting that "[n]o persuasive authority ha[d] been cited in support of this rather novel suggestion." Similarly, in United States v. Daffin, 653 F.2d 121, 124 (4th Cir. 1981), the Fourth Circuit rejected a taxpayer's argument that he was "entitled to be present and to cross-examine witnesses when questioned by" the IRS agent, noting the Newman and Traynor opinions, as well as what it characterized as the Supreme Court's rejection of similar claims "in the context of other administrative investigatory proceedings" in In re Groban, 352 U.S. 330, 77 S. Ct. 510, 1 L. Ed. 2d 376, 76 Ohio Law Abs. 368 (1957). United States v. Daffin, 653 F.2d 121, 124 (4th Cir. 1981). In United States v. Kershaw, 436 F. Supp. 552 (D. Or. 1977), the District Court for the District of Oregon similarly denied taxpayers' motion to intervene at the interrogation of the accountant who had prepared their tax returns in order to object to questions. Because the accountant's "able counsel announced that he will not permit his client to testify to any matters covering the attorney-client relationship," the court concluded that the taxpayers' privilege was adequately protected at the hearing. Id. at 553.
   n1 Newman was decided in 1971, less than three months after the Supreme Court's Donaldson decision and before the 1976 Congressional reforms spurred by Donaldson.' 

Though not insubstantial in number, all of these decisions are thinly reasoned on the question of taxpayer's rights to intervene before at the IRS hearing. In several of the cases, the taxpayer neither cited any basis for the right to be present nor described the interest to be protected by her presence. None of the cases perform the "balancing of the equities" required by Reisman (as interpreted by Donaldson), or discuss the revisions to Section 7609 that occurred in the wake of Donaldson. Thus, these cases do not fully acknowledge Congress's demonstrated interest in ensuring that taxpayers be provided with "safeguards against improper disclosure of records held by third parties" in summons proceedings. Ip, 205 F.3d at 1172.