I.R.S. Offers New Settlement For Easement Tax Shelters

In May, the I.R.S. announced a settlement offer for partnerships involved in disputes concerning "syndicated conservation easements." The key features of the offer include a 10% penalty for gross valuation misstatement, instead of a 40% penalty, and Easements no upfront payment required.

The dispute involves the value of charitable deductions claimed in regard to the Listed Transactions grant of an easement that prevents the owner from developing land. An easement is a legal right that allows one party to use a specific portion of someone else's property for a specific, limited purpose without actually owning the land.

The basic premise of the charitable deduction is that a landowner voluntarily surrenders development rights in a certain parcel of land to a governmental unit or a qualified charitable organization in order to permanently preserve the natural quality of the undeveloped land. In return, the landowner claims a Federal income tax deduction equal to the reduction in value of the property. It purportedly becomes a tax shelter when (i) multiple unrelated investors (ii) pool their money in a partnership or syndicate (iii) that is formed to acquire various parcels of undeveloped land (iv) for the principal purpose of contributing development rights to a land trust, (v) that allows the investors to claim charitable contribution deductions at purportedly inflated values far in excess of the investment in the land.

This article explains the history of this typically U.S. centric tax shelter to readers outside the U.S.

BACKGROUND

Within certain limits, charitable contributions made by U.S. taxpayers yield deductions for the donor. Gifts of partial interests in property are generally not deductible.¹ However, there are several exceptions, including the exception for "qualified conservation contributions."²

A qualified conservation contribution requires a contribution (i) of a "qualified property interest" (ii) to a "qualified organization" (iii) that is made "exclusively for conservation purposes."³

A qualified real property interest is any of the following:⁴

• The donor's interest in the real property, other than "qualified mineral interests" (interests in and mining rights to underground oil, gas, or other minerals)
• A remainder interest
• A restriction granted in perpetuity on the use of the property

A qualified organization includes governmental units, government-funded charitable organizations, and certain Code §501(c)(3) organizations (generally those that are publicly supported).⁵

A contribution is for conservation purposes if one or more of the following purposes apply to the easement:⁶

• The preservation of land for outdoor recreation by or the education of the general public
• The protection of a natural habitat of fish, wildlife, or plants
• The preservation of open space, including farmland and forests, for the scenic enjoyment of the general public or for a government conservation benefit
• The preservation of an historically important land area or certified historic structure (defined as either (i) being listed in the National Register or (ii) is a building located in and designated as being of historic significance to a registered historic district)

With respect to conservation purposes involving the exterior of a building in a registered historic district, additional requirements are imposed.⁷ The donor and, as applicable, the donee must generally agree to preserve the entire exterior and provide supporting documentation, including an appraisal and photographic evidence.

A contribution is made exclusively for conservation purposes only if that conservation purpose is protected in perpetuity.⁸ This requirement is generally not met if the donor retains a qualified mineral interest from which minerals may be extracted or removed.⁹

HISTORY OF SYNDICATED CONSERVATION EASEMENTS

General

A syndicated conservation easement ("S.C.E.") is a tax shelter that relies on aggressively high valuations of land. The I.R.S. became concerned about promoters offering investments purportedly yielding charitable deductions in excess of amounts invested, often 2.5 times the investment.¹⁰ In a report issued in2020, the Senate Finance Committee estimated the average investor receives $4 of tax deductions for every dollar paid to a promoter, which translates to $2 saved for each dollar invested.¹¹ The investment takes the form of a partnership that owned or acquired land rights, which it donates to generate charitable deductions under the rules outlined above. Since the donor is a flow-through entity, deductions flow up to the investors.

While the I.R.S. previously expressed general concerns about abuses of conservation donations,¹² the seminal case was Kiva Dunes Conservation, LLC v. Commr.¹³¹⁴ There, the taxpayer was the owner of a golf course. It claimed a $30 million deduction for placing a perpetual conservation easement on the golf course. The taxpayer prevailed, with the Tax Court allowing $29 million of the claimed deduction. The taxpayer's facts were more favorable than in many later cases. The taxpayer owned the property for more than a decade, supporting a valuation in excess of the original purchase price. The taxpayer based its valuation on the highest and best use of the property – beachfront residences – which the court found credible and with which the I.R.S. agreed. The main conflict was the valuation of the property, but the taxpayer used a local expert with deep knowledge of the area, while the I.R.S.'s appraiser appeared to be unfamiliar with the area and made several errors.

Notice 2017-10

The taxpayer's success triggered the marketing of conservation easement schemes, most of them based on more aggressive valuations than the Kiva Dunes easement. In response, the I.R.S. upped the stakes in 2017 when it identified an investment in an S.C.E. as a "listed transaction" where the investment opportunity offers deductions that are at least 2.5 times the amount of the initial investment. Listed transactions are specific transactions that the I.R.S. determines to be tax-avoidance schemes. Participation in a listed transaction must be disclosed on Form 8886 (Reportable Transaction Disclosure Statement). Significant penalties are imposed for the failure to file Form 8886. Under Section 6707A, a penalty equal to 75% of the improper reduction in tax can be imposed.

However, Notice 2017-10 encountered procedural problems and was found to be invalid under the Administrative Procedure Act ("A.P.A."). In Green Valley Invs., LLC v. Commr.,¹⁴ four partnerships were involved. Each granted a conservation easement to Triangle Land Conservancy and each partnership claimed a deduction of between $22 million and $23 million. The I.R.S. disallowed the deductions and imposed 75% penalties on the improper reduction in tax triggered by the failure to file Form 8886. The taxpayers successfully argued that Notice 2017-10 was invalid because the I.R.S. failed to follow all three steps required for issuing what is known as a "legislative rule." A rule is a legislative rule when it is issued under a statute delegating broad authority to the administrative agency – here, the I.R.S. – to issue rules addressing a specific matter. For legislative rules to be valid, the A.P.A. requires that a three-step administrative process must be followed by an administrative agency such as the I.R.S.:

• The public must be notified.
• The public must be allowed to comment and participate in hearings.
• The final rule must include a general statement of its basis and purpose.

The Tax Court found that Notice 2017-10 was a legislative rule. Consequently, the Notice was invalidly issued because the public was neither notified of the rule nor allowed to submit comments and participate in hearings prior to its issuance.

The I.R.S. unsuccessfully argued that the notice was an interpretive rule. In support of that position, it argued that Congress effective set the policy when adding Code §6707A, which provides for a specific penalty imposed when Form 8886 is not timely filed. Because Congress did not expressly disagree with the I.R.S. approach under Code §6707A, the I.R.S. argued that inaction was the equivalent of approval. Second, the I.R.S. argued that the 2020 Senate Finance Committee report previously mentioned criticized the rise of S.C.E.'s. According to the I.R.S., such criticism justified bypassing the notice-and-comment requirements of the A.P.A. Neither argument was found to be credible and the Tax Court invalidated Notice 2017-10.^1516[17] The I.R.S. suffered similar setbacks in Mann Construction Services, Inc. v. United States¹⁶ and Green Rock LLC v. I.R.S.¹⁷

CURRENT LAW

Statute and Regulations

Although the I.R.S. initially indicated it would continue to enforce Notice 2017-10, it later backtracked and announced it would follow the Tax Court's decision.¹⁸ Instead, Congress amended Code §170 and the I.R.S. issued regulations to replace Notice 2017-10, effective beginning in 2023.

Under new Code §170(h)(7), a charitable contribution by partnerships and other flow-through entities is automatically disqualified from being a qualified conservation contribution if the amount of the contribution is more than 2.5 times all the partners' outside bases allocable to the real estate from which the contribution is derived.

There are three exceptions to the above rule:

• Three-Year Exception.¹⁹ A contribution is not an S.C.E. and can qualify as a conservation contribution if the contribution is made at least three years after the latest of
  • the last date on which the partnership acquired any portion of the real estate,
  • the last date on which any partner acquired an interest in the partnership, and
  • if a partnership interest is held through other flow-through entities, then either (i) the last date in which the upper-tier partnership acquired any interest in the contributing partnership or any other upper-tier partnership and (ii) the last date any partner acquired an interest in the upper-tier partnership.
• Family-Partnership Exception.²⁰ A contribution is not an S.C.E. if 90% of the contributing partnership's interests are held by an individual and members of the individual's family. Family members include the spouse, children and other descendants, siblings, parents and ancestors, nieces and nephews, aunts and uncles, in-laws, and others who are members of the individual's household. Family members also include estates of such individuals and trusts where all the beneficiaries are such individuals.²¹
• Exception For Certified Historic Structures.²² A contribution is not an S.C.E. if its conservation purpose is the preservation of a certified historic structure.

The I.R.S. also issued Treas. Reg. §1.6011-9, which replaces Notice 2017-10 as the vehicle by which S.C.E.'s are identified as listed transactions and must therefore be disclosed. As with Notice 2017-10 and the amendments to Code §170, the main trigger is the offer of a deduction amounting to 2.5 or more times the value of the investment. The regulation also contains anti-abuse rules aimed at partnerships that use a series of transactions to avoid the 2.5 rule.²³

Settlement Offers

The latest settlement is the fourth general settlement that the I.R.S. has offered in this area. Each partnership that is issued an offer letter by the I.R.S. has 90 days to accept. The offer involves the following:

• The charitable contribution deduction will be disallowed.
• In place of the charitable contribution deduction, the I.R.S. will allow an "other deduction," generally equal to the partnership's costs of participating in the S.C.E. scheme.
• A gross valuation misstatement penalty will apply at 10% of the amount of the misstatement. If a partnership agrees to the settlement within 45 days after the close of the 90-day period, this rate increases to 20%.

Interest will accrue.

• The partnership will not be required to make an upfront payment.

Partnerships that are in the advanced stages of litigation are not eligible for this offer. This includes partnerships where

• the case has been tried and is awaiting the issuance of a decision;
• the case is on appeal to a circuit court;
• the case has been settled;
• the parties have agreed to be bound to another case and that test case has been tried and is awaiting a final decision;
• the case has a trial that will begin by June 12, 2026; and
• the case has been designated a test case, unless all cases bound to the test case will settle under this offer.

If the settlement offer is not accepted after the expiration of the 45-day period (i.e., 135 days after the offer is made), the taxpayer is exposed to the hazards of litigation. The I.R.S. believes that taxpayers' chances in court are weak. It has estimated that on average, the Tax Court has allowed only 6% of the claimed deduction and imposed a 40% gross valuation misstatement penalty.²⁴

This offer is more taxpayer-friendly than previous offers. The I.R.S. noted that the previous offers required upfront payments as part of the deal. This likely deterred taxpayers from accepting the deal, despite the limited prospects for success in the court proceedings.

• In 2020, the I.R.S. made its first settlement offer, available to partnerships with cases already docketed in the Tax Court.²⁵ Under the offer, the deduction was disallowed, and the partnership had to pay the full amount of tax, penalties, and interest before settling. Partners were permitted to deduct the cost of acquiring partnership interests and could pay a reduced 10-20% penalty. The exact rate was determined by the size of the partner's deduction compared to its investment.
• In June 2024, the I.R.S. announced a new offer.²⁶ Notably, this new offer reduced the penalty to a flat 10% for settling partners but still required upfront payment.
• Later in 2024, the I.R.S. began sending partnerships with cases not yet docketed in the Tax Court settlement offers.²⁷

Some cases that are frequently highlighted by the I.R.S. as warnings to taxpayers include the following:

Capitol Places II Owner LLC v. Commr.²⁸ A partnership claimed a $24 million deduction for a façade easement on a building in an historic district in Columbia, South Carolina. The partnership claimed that the contribution was a qualified conservation contribution because the building was a certified historic structure. However, the Tax Court found that the building was not recorded in the National Register and not certified as being of historic significance to the district.²⁹ The court also rejected the alternative argument that it protected an historically important land area, as a single building did not constitute a land area.

• Corning Place Ohio, LLC v. Commr.³⁰ After redeveloping a building it purchased for $6 million into an apartment complex, a partnership contributed a façade easement and claimed a $23 million deduction. The easement restricted the partnership's right to increase the building's height, and the valuation was derived from the lost opportunity to add 34 floors to the 11-story building. Both the Tax Court and Sixth Circuit found this development to be highly improbable, and for that reason the valuation was unsupported. The partnership's feasibility study used soil samples from a different site and was labelled as not for use for "actual construction." Conversations indicated that the partnership never seriously entertained initiating such a development. In addition, the partnership received other tax credits for historic preservation, which would have been violated by the development. The partnership's deduction was reduced to $900,000, and the 40% gross valuation misstatement penalty was imposed.

Penalties

The I.R.S. has indicated that it will pursue numerous penalties against partnerships and partners who do not accept or are ineligible for the settlement offer. These include the following:

• Gross valuation misstatement penalty. Imposed where a valuation is overstated by at least 200%; the penalty is 40% of the underpayment.³¹ Subsection (b)(10) was added to Code §6662, which imposes the penalty, to specifically include S.C.E. penalties.
• Penalties on promoters of abusive tax shelters, applicable to promoters of S.C.E.'s. The penalty is $1,000 for each offense but increases to 50% of the promoter's income if the activity involves a false or fraudulent statement.³²
• Penalties for aiding and abetting understatement of tax liability, applicable in relevant part to appraisers, lawyers, and accountants. $1,000 in cases involving individual taxpayers and $10,000 for corporate taxpayers.³³ Penalties for understatement of taxpayer's liability by tax return preparer. Imposed on a tax return preparer who understates tax liability due to an unreasonable position or due to wilful and reckless conduct.³⁴ For unreasonable positions, the penalty is the greater of $1,000 or 50% of the return preparer's income. For wilful or reckless positions, the penalty is the great of $5,000 or 75% of income.
• Fraud penalty. 75% of the underpayment.³⁵
• Criminal penalties.

CONCLUSION

Taxpayers have not had much success validating deductions for S.C.E. contributions in court, but the lack of uptake for the I.R.S.'s previous offers indicates that not all taxpayers are willing to throw in the towel. The payment of a 40% penalty several years down the road may be viewed as more attractive than a payment at the time of settlement. However, a reduction in the penalty to 10% which can be paid over a period of time may attract the attention of investors and promoters in S.C.E. schemes.

Footnotes

1. Code §170(f)(3).

2. Code §170(f)(3)(B)(iii).

3. Code §170(h)(1).

4. Code §170(h)(2).

5. Code §170(h)(3).

6. Code §170(h)(4).

7. Code §170(h)(4)(B).

8. Code §170(h)(5)(A).

9. Code §170(h)(5)(B).

10. Notice 2017-10.

11. S. Rep. 116-44.

12. Notice 2004-41.

13. .C. Memo. 2009-145.

14. 9 T.C. 80 (2022).

15. Although this invalidated the imposition of the penalty for listed transactions, the Tax Court in a follow-up opinion agreed that the deductions had been overvalued by $20 million and upheld other penalties related to the contributions (T.C. Memo. 2025-15).

16. 7 F.4th 1138 (2022).

17. 4 F.4th 220 (2024).

18. A.O.D. 2024-01.

19. Code §170(h)(7)(C).

20. Code §170(h)(7)(D).

21. Treas. Reg. §170A-14(n)(3)(iii)(D).

22. Code §170(h)(7)(E).

23. Treas. Reg. §1.6011-9(d).

24. "Conservation Easements." Internal Revenue Service, May 6, 2026.

25. IR-2020-130.

26. IR-2024-174.

27. AP-08-0924-0018.

28. Docket No. 16536-23 (2025).

29. These are the two alternative definitions of a "certified historic structure," as outlined earlier.

30. Docket No. 12428-20 (Tax Court 2024); Docket No. 25-1093 (6th Cir. 2025).

31. Code §6662(h)(1). If the underpayment does not relate to a gross valuation,

i.e., does not breach the 200% threshold, the penalty is 20%.

32. Code §6700.

33. Code §6701.