On November 4, 2016, the IRS updated its Conservation Easement Audit Techniques Guide (CE Audit Guide) for the first time since March 15, 2012.
According to the IRS’s introduction on its Audit Techniques Guide website, Audit Techniques Guides (ATGs) are developed to help IRS examiners during audits by explaining issues and accounting methods within specific industries. ATGs are also meant to provide guidance to small business owners and tax professionals for tax planning purposes within those industries. However, each ATG contains a disclaimer that it is not “an official pronouncement of the law or position of the Service and cannot be used, cited, or relied upon as such.” This article will not explain the CE Audit Guide in depth, but rather discuss the specific updates made in November.
The CE Audit Guide was originally published September 2011, with updates issued on January 3, 2012, March 15, 2012, and, most recently, November 4, 2016. The updated CE Audit Guide can be found here. A full redline showing the changes made to the last 2012 CE Audit Guide can be found here.
The revisions can be categorized into the following groups:
Hot Topics: Addition of more detail in certain hot topics, or where IRS legal challenge has succeeded.
Unsurprisingly, given recent case law developments, the CE Audit Guide now contains more detail regarding successful challenges to the deductibility of the easement contribution, emphasizing to the auditor which areas to review more closely for potential successful challenge.
- Perpetuity requirements. The CE Audit Guide now contains descriptions of Belk v. Commissioner, 140 T.C. 1 (2013), and Carpenter v. Commissioner, T.C. Memo 2012-1. In Belk, the easement permitted the landowner to move the boundary of the easement, which was held by the Tax Court to defeat the deductibility of the easement contribution. In Carpenter, the easement contained language permitting the parties to terminate the easement if they, by mutual agreement, determined that the easement purposes were impossible to accomplish; the Tax Court held that the easement may only permit termination upon judicial termination as to whether the easement purposes are impossible to accomplish.
The CE Audit Guide also contains a description of Carroll v. Commissioner, 146 T.C. 13 (April 27, 2016), discussed by Professor William T. Hutton here. In Carroll, the division of proceeds formula in the extinguishment clause did not track the precise language in Treasury Regulations § 1.170A-14(g)(6)(ii), which the Tax Court held defeated the deductibility of the easement contribution. It is unclear whether this decision will be appealed.Given these new case descriptions in the CE Audit Guide, an IRS auditor likely will closely examine both the landowner’s right to move any boundaries and the extinguishment clause of the easement closely to determine whether the taxpayer has tripped any of these wires.
- Conservation Purpose. The CE Audit Guide now includes a description of Atkinson v. Commissioner, T.C. Memo 2015-236, in which the Tax Court found that a conservation easement over golf courses did not protect a relatively natural habitat due to the courses’ use of pesticides and other chemicals that could injure the property’s ecosystem. The Audit Guide emphasizes the importance of the IRS’s having expert testimony to support this type of challenge, which indicates this may be an area of focus for the IRS going forward. For example, see PBBM-Rose Hill v. Commissioner, Bench Op. (October 7, 2016), discussed by Professor Nancy McLaughlin here.
- Required documentation, such as the appraisal, gift letter, and baseline report. The Audit Guide now includes a comprehensive list of required documentation to be submitted with the donor’s tax return: a contemporaneous written acknowledgment (gift letter), Form 8283, recorded conservation easement, qualified appraisal, and baseline report. This list will presumably make it easier for the auditor to check those items off during its review.The CE Audit Guide also provides more detail regarding the appraisal, gift letter, and the baseline report as follows:
- Appraisal: Appraisals have always been discussed in detail throughout the CE Audit Guide, but it now contains a more thorough description of the Treasury Regulation requirements for a qualified appraisal, such as the appraisal must be signed by the appraiser and must contain the resume of the appraiser evidencing that the appraiser is qualified to make appraisals of the type of property being appraised.
- Gift Letter: Although a specific form of gift letter is not required, the gift letter must describe the property received by the donee, contain a statement as to whether the donee provided any goods or services in whole or in part for the gift, and provide a description of and good faith estimate of the goods or services provided to the taxpayer. The Audit Guide references French v. Commissioner, T.C. Memo 2016-53, and several other Tax Court decisions holding that the easement deed itself can serve as a contemporaneous written acknowledgment, within certain parameters.
The CE Audit Guide also goes on to state that, while Congress provided for an exception to the gift letter requirement if the donee reports the donation pursuant to regulations to be adopted the Treasury Department and IRS, the Treasury Department and IRS have decided not to issue any regulations for that exception and thus the donee reporting option is not available.
- Baseline Report: The Baseline Report must be signed by both the donee and the donor.
- State tax credits. The Guide now contains a comprehensive list of states that offer tax credits for conservation easements (16 states and one territory), along with an explanation of how receipt and sale of state tax credits are treated for income tax purposes.
Cool Topics: Removal of requirements or removal of detail within topics that are no longer hot, or where IRS legal challenge has failed.
The CE Audit Guide revisions show some retraction in certain areas that seem to have been settled or rejected by the courts, and may no longer provide a red flag for an auditor:
- Exhibits. The prior iteration of the CE Audit Guide stated that all exhibits to the CE must be recorded; however, the Guide now states that this requirement is dependent on state law. Some states may not require all exhibits to be recorded, per Butler v. Commissioner, T.C. Memo 2012-72 (Georgia).
- Quid pro quo concerns with cash donations. The 2012 Audit Guide contained multiple examples of inappropriate benefits the taxpayer may have received in exchange for a cash donation to a donee, such as conducting baseline studies, completion of funding applications, preparing legal documents, soliciting subordination of lending agreements, and arranging for appraisals. Scheidelman Commissioner, T.C. Memo 2010-151, was previously cited in various sections of the Audit Guide as an example of this inappropriate quid pro quo. The updated 2016 Audit Guide no longer contains these examples, partially because the quid pro quo holding in Scheidelman was overturned by the Second Circuit (682 F.3d 189 (2d Cir. 2012)) and perhaps partially due to the common provision of these services by land trusts.
- Mortgage requirements. The 2012 Audit Guide admonished more than once that any subordination by a lender must comply with the division of proceeds requirements of Treasury Regulations § 1.170A-14(g)(6)(ii), citing Kaufman v. Commissioner, 134 T.C. No. 9 (2010). These references have been deleted due to the overturning of that decision in Kaufman v. Commissioner (Kaufman III), 687 F.3d 21 (1st Cir. 2012).
- Penalties. Before an auditor seeks a penalty against the taxpayer, the auditor is repeatedly advised in the updated CE Audit Guide to substantiate the reasons for such penalties and seek written approval from a supervisor. (The Audit Guide also details the threshold for the gross valuation misstatement penalty, and when and to what extent the reasonable cause exception or the substantial compliance doctrine can be used as a defense.)
Clean up, reorganization, and removal of inapplicable dates.
The CE Audit Guide now:
- Clarifies that cash donations are deductible for all 170(c) organizations, not just 170(h) qualified organizations;
- Removes subheadings from TOCs and rearranges certain sections so that most discussion of a specific topic can be found in a certain section (such as perpetuity or supporting documentation); and
- Removes date parameters for façade easement requirements and the Enhanced Conservation Tax Incentives, since they are permanently applicable at this point.
Finally, it is interesting to note that the working group at the IRS which focuses on conservation easements is now called the “Conservation Easement Cadre.”
For further information about the ATG or to discuss the content of this article, feel free to contact Misti at email@example.com or (415) 772-5753.