An IRS notice issued eight years ago has complicated the landscape for conservation easements by labeling them as listed transactions. This stance has effectively blocked almost all conservation easement donations and created a significant backlog of cases in the Tax Court. Taxpayers embroiled in these disputes generally face two main routes: engaging in current settlement programs with the IRS or opting for litigation. Each path bears distinct risks and rewards, which taxpayers should carefully assess in consultation with their advisors.
In early 2024, IRS attorneys began offering settlement letters to taxpayers with pending cases in Tax Court. These letters propose a disallowance of deductions under Section 170 of the tax code, but allow an “other deduction” equivalent to the investor’s cash input for syndicated easements. They also suggest lowering the gross valuation misstatement penalty from 40% to 10%. For non-docketed cases still in review, the IRS has extended similar offers with further penalties reduced to 5%, substituting a partnership-level tax of 21% instead of potentially higher rates.
Despite these settlement offers, the IRS has so far shown little flexibility in its negotiation terms, nor an inclination to harmonize its existing settlement programs, creating a challenging landscape for taxpayers. Taxpayers must consider whether to make deposits against potential deficiencies, which could halt the accrual of interest—currently at 8%—without compromising the jurisdiction of the Tax Court.
The current volume of cases has imposed a significant administrative burden on the Tax Court, stretching IRS resources and increasing costs for taxpayers. Chief Judge Kathleen Kerrigan reported that in 2023, there were over 1,000 docketed cases involving conservation easements, a number that has been growing since the IRS intensified its scrutiny on such transactions.
The path to trial involves weighing various factors, including the Tax Court’s recent tendency to render memorandum opinions based on case-specific facts, rather than setting broad legal precedents. Reviewing past opinions could provide insight into the court’s decision-making process, helping taxpayers and their advisors to refine their argumentation strategies.
Finally, taxpayers must weigh the significant costs of litigation, including expert witness fees and extensive paperwork from IRS legal teams. With mounting delays, uncertainties, and minimal recent successes in court on income-based valuation approaches, taxpayers must decide prudently if moving forward with litigation is a path worth pursuing.
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