Troubling IRS Audit of Maine Conservation Easement Donor

A recent Internal Revenue Service challenge to a charitable deduction for a Maine conservation easement carries troubling implications. We’ve known for many years that the IRS has struggled to find the right balance as a regulator; ideally, the Service would target the patently abusive projects, mostly organized by fraudulent syndication promotors, while not casting its arguments so broadly so as to disqualify the vastly more numerous well-conceived projects. Alas, that appears to be wishful thinking, as the storms created by the IRS’ overly aggressive arguments have now come crashing down on at leas tone Maine donor.  

Although the details are confidential, I am authorized to share the fundamentals of the project. The donor is an individual who granted a conservation easement to a reputable, accredited land trust. The protected property is of a fairly typical size (somewhere in the 25-to-50 acre range),and has modest frontage on a large lake and modest frontage on a public road. It is mostly forested, with a few acres of agricultural land along the road, over half a mile away from the lakeshore. The protected property is also across a road from another conserved parcel, which abuts yet a third conserved parcel, creating a habitat corridor of approximately 100 acres. For the most part, the easement follows the Maine Land Conservation Attorneys Network (MLCAN) Model Conservation Easement Boilerplate, which is in widespread use throughout the state.

My commentary here pertains only to the IRS’ technical and conservation-related arguments against the conservation easement, which has implications for Maine’s conservation community at large. The Service also challenged the appraisal’s valuation of the easement, a topic that I may cover in a future E-Bulletin. It’s highly unlikely that any of the issues raised by the IRS will be formally resolved in court, as the case will probably settle well before then. Thus, we are left to read the tea leaves and do our best in the face of uncertainty.

Now, on to the specifics. Here are the arguments employed by the IRS in claiming that the easement does not qualify for a deduction under Section170(h) and the Regulations:

· Amendment Provision – This is perhaps the most alarming of the IRS’ positions. The easement’s amendment provision follows the 2018 MLCAN Model, which hasn’t changed since then. The MLCAN amendment provision seeks to meet the dual requirements of § 170(h) and Maine’s unique enabling statute. In a nutshell, the provision leaves a great deal of discretion to the land trust, but requires that an amendment must obtain court approval and Attorney General participation if it “materially detracts” from the conservation values, which tracks the statutory standard in 33 M.R.S. § 477-A(2)(B). The IRS lost on this very issue in the Tax Court and the 11^th Circuit in Pine Mountain Preserve, as well as subsequent Tax Court cases. Nevertheless, the IRS continues to challenge easements based on perfectly robust amendment provisions that contain a conservation purposes or conservation values standard to ensure against deleterious amendments that weaken the easement’s protections. Moreover, the IRS does not seem to understand the statutory basis for the “materially detract” standard, as its Explanation of Items characterized the word “materially” as “too subjective. ”The IRS did issue a model amendment provision a couple years ago in IRS Chief Counsel Memorandum 2020-001, but it has generally been viewed as unworkable in the conservation community because it prohibits any amendment that would “permit development, improvements, or uses prohibited by this Easement on its effective date.” That standard is so rigid as to preclude the possibility of many useful amendments that allow for one type of unforeseen use, often of negligible conservation impact, in exchange for tightening restrictions on other, often more important, uses. The IRS standard also doesn’t account for Maine’s statutory “materially detract” standard and court approval process. Finally, the IRS’ model amendment provision was issued before it lost on this issue in Pine Mountain Preserve! The IRS can’t seem to take the hint, and keeps trotting out a strained legal theory that has been soundly rejected by the courts.  

· Termination Provision – The IRS also challenged the Maine easement’s termination provision for varying slightly from the language of Regulation § 1.170A-14(g)(6)(ii). However, it appears that the landowner inadvertently gave the IRS an earlier draft of the easement that contained a termination provision that was different from what appeared in the final version. The final version of the easement included an updated termination provision that had been approved by MLCAN earlier that year, and this updated version, which remains in the most recent MLCAN Model, more closely hews to the Regulation. The IRS has been made aware of the discrepancy between the earlier draft and the final draft, and so hopefully this becomes a non-issue in the present dispute. But the lesson remains for all of us: Make sure your termination and proceeds provision follows the text of Regulation § 1.170A-14(g)(6)(ii) as closely as possible for any donated easement in which a deduction will be sought. And don’t forget to make sure there is no so-called improvements clause, which has been found to be a fatal flaw by the courts. To reiterate, every version of the MLCAN Model since2018 appears to pass muster by adopting the language of the Regulations virtually verbatim.

· Constructive Approval Provision – Another area the IRS has consistently scrutinized in recent years is the so-called “constructive approval” provision. This is a clause stating that if the land trust does not respond to a request for approval within a certain time frame, the requested activity will be deemed approved. The IRS won a court case on this issue in Hoffman Properties II, L.P. v. Commissioner, 956 F.3d 832 (6^th Cir. April 14, 2020). And for programmatic and legal reasons, constructive approval provisions have never been a good idea. For instance, a simple happenstance such as a land trust employee or volunteer coming down with an illness or misplacing a request for approval could lead to dire consequences in which a patently prohibited action is inadvertently allowed. For this reason, the MLCAN Model has always used the opposite of constructive approval, which is a constructive denial provision. See Section 11.C of the MLCAN Model. The complication in the Maine easement under audit is that the landowner objected to the straightforward constructive denial language in the MLCAN Model, and negotiated for a more nuanced constructive approval provision that added some safeguards to prevent abuse. Even though the negotiated provision would probably pass muster with the Tax Court, the IRS is taking a maximalist approach on this issue. The lesson for the Maine land trust community is to stick with the language in the MLCAN Model, which continues to follow a constructive denial approach, albeit with a new addition in 2021 that acknowledges that a constructive denial is not a decision on the merits and allows the landowner to resubmit the request.

· Inconsistent Reserved Rights – The IRS has been challenging easements left and right on the matter of inconsistent reserved rights for a number of years. The Regulations do include a provision stating that any reserved rights must be consistent with the conservation purposes of the easement, § 1.170A-14(e)(2),but the IRS has interpreted that provision quite expansively, as appears to be the case in the Maine easement under audit. Essentially, the IRS is arguing that the agricultural uses of the handful of acres over a half-mile from the lakeshore is inconsistent with the easement’s purpose of protecting the water quality of the lake. The IRS emphasizes that fertilizers and other chemicals allowed in this agricultural area could harm the lake’s water quality.  

· Lack of Adequate Conservation Purposes – Separate from the inconsistent reserved rights issue, the IRS also sets forth a number of tendentious arguments that the easement lacks adequate conservation purposes. For example, even though the easement’s recitals extensively refer to the habitat, water quality, and scenic purposes, the IRS faults the document for not using the verbatim conservation purposes language of 170(h) and the Regulations. The IRS also claims that the habitat protection is not significant because it protects only common animal and plant species. And they argue that the scenic views are not unique and therefore do not qualify under the Regulations. Each of these arguments comes across as a gross overreach by the IRS.

So what does the Maine land conservation community do in the face of this IRS aggression? The Maine Land Conservation Attorneys Network will be meeting in the fall to discuss possible next steps on these issues, especially the amendment provision in the MLCAN Model. For the time being, Maine land trusts and conservation easement donors and their attorneys should be aware that, in the very unlikely event of an audit, the IRS may take a zealous posture on a number of technical and substantive issues.