Syndicated conservation easements (SCETs), which are a common type of charitable conservation contribution, top the 2021 “Dirty Dozen” list of tax scams published by the Internal Revenue Service (IRS) in July.
What Are SCETs?
SCETs are conservation donation transactions (CDTs), which are private placement offerings where investor returns are based on a share of tax savings from a charitable donation. In practice, CDTs involve unrelated investors acquiring interest in a passthrough entity (i.e., a partnership or limited liability company) that holds or acquires unimproved land. Before year-end, the passthrough entity either grants a conservation easement forever limiting future development or outright donates the land to a land trust in exchange for charitable donation tax deductions that benefit investors. These deductions serve as a return on investment and have values based solely on land appraisals that FINRA has often observed to be as much as four to more than 10 times the price paid to acquire the land. Common CDTs involve SCETs but may also include fee simple donations of land that are substantially similar to SCETs.
Investment programs involving SCETs or fee simple donations differ from other tax-advantaged investments—such as tax deductions associated with oil and gas direct participation programs (DPPs) or tax deferrals resulting from Delaware Statutory Trust (DST) 1031 Exchange replacement property investments—because investor tax benefits of such programs often far exceed their initial investment.
While some broker-dealers offer CDTs, the IRS continues to express concerns about their validity, and a federal grand jury returned the first federal indictment in a case involving syndicated conservation easements in June 2021. Beginning in 2019, the IRS identified SCETs and “substantially similar transactions” on its annual “Dirty Dozen” list of tax scams.
Before You Invest
Investors should seek independent legal and tax advice while considering the following potential risks of CDT investment programs:
- Risk of IRS Audit – Since 2017, the IRS has considered certain SCETs, including “same as or substantially similar” transactions like fee-simple donations of land, to be tax shelters and is treating them as “listed transactions,” meaning investors must report them to the IRS. Further, the IRS has publicly stated it is either auditing or plans to audit a majority of SCET and similar passthrough entities. IRS challenges can result in significant reductions in claimed deductions, recalculation of tax liabilities, plus interest and substantial penalties.
- Inflated Appraisals – In light of IRS scrutiny, investors should carefully evaluate investment programs whose returns are based on charitable contribution deductions that are equal to or exceed two-and-one-half times an investor’s investment based on appraised easement values that are far in excess of the land’s fair market value, as noted in IRS Notice 2017-10, Listing Notice – Syndicated Conservation Easement Transactions. Appraisal values that substantially diverge from local real estate values may bear a much higher burden of proof and are a potential warning sign.
- Conflicts of Interests – Sponsors, consultants, land developers, prior landowners, broker-dealers and registered representatives involved in CDTs may have close or affiliate relationships creating conflicts of interest arising from substantial compensation and fees. Investors should carefully consider disclosures regarding use of proceeds, process for pricing land acquisition, and conflicts of interest.
- Deals Marketed Based on Tax Benefits – To meet IRS requirements, CDT transactions must involve bona fide investments in a real estate investment partnership owning real estate with a variety of options for the land. Investors should be cautious of CDTs that are marketed or involve investor communications primarily touting the tax benefits. Such communications may cause the passthrough entity to be viewed by the IRS as a sham entity for tax purposes and invalidate the tax benefits.
Be sure to learn about and understand CDTs when evaluating these investment programs.
- FINRA, 2018 Report on Examination Findings – Reasonable Diligence for Private Placements (Dec. 7, 2018).
- United States Senate, Report on Syndicated Conservation-Easement Transactions.
- Land Trust Alliance, Important Advisory: Tax Shelter Abuse of Conservation Donations (Feb. 1, 2018).