The IRS has introduced T.D. 9999, offering guidance on an amendment to the amendment to the Internal Revenue Code under the SECURE 2.0 Act of 2022 that limits partnerships and S corporations from claiming deductions for charitable conservation easements made after December 29, 2022.
Under these final regulations, a deduction for a qualified conservation contribution by a partnership or an S corp will be disallowed if the contribution amount surpasses 2.5 times the relevant basis of each partner or S corp shareholder, unless a statutory exception is satisfied.
How We Got Here
In 2023, for the second consecutive year, syndicated conservation easements landed on the IRS’ Dirty Dozen list of tax scams to avoid. These abusive schemes involve placing a piece of land in a pass-through entity at an inflated value and then selling membership interests in the entity to investors seeking excessive tax deductions that far surpass their actual investment. The focus of the recently issued regulations is on implementing anti-abuse measures and stringent reporting requirements to close potential loopholes. By explicitly aiming to halt the abuse of syndicated conservation easements, these regulations are poised to render syndicated transactions an obsolete tax strategy. Given the Disallowance Rule and the mandatory three-year holding period for statutory exceptions, it is expected that taxpayers who previously invested in such easements will opt out of future participation.
Although syndicated conservation easements have long been a focal point of abuse and are facing heightened scrutiny from the IRS, it is important to note that many conservation easement donations do not involve tiered partnerships and typically involve properties held for extended periods. While the introduction of Disallowance Rules and statutory exceptions represents a shift for many taxpayers engaged in traditional conservation easements, the additional reporting requirements mainly entail information that the partnership or S corp should already possess and is required to share with partners or shareholders.
Moreover, the Land Trust Alliance has long advocated for enhanced regulations governing conservation easements to bolster compliance. Upon unveiling the new guidelines, it provided assurance1 that adherents of the Land Trust Standards and Practices2 remain well positioned to navigate the updated regulations seamlessly.
Although these regulations may initially appear daunting to traditional conservation easement contributors, individuals who claim these deductions for legitimate purposes should approach them with confidence and diligence. It is important to be familiar with the requirements to help ensure accurate reporting of the contribution.
Overview
As noted, Section 170(h) states that a partnership’s charitable contribution will not qualify as a qualified conservation contribution if it exceeds 2.5 times the total relevant basis of each partner or S corp shareholder unless one or more of the following exceptions are met:
- Contributions by family partnerships and S corps (including two anti-abuse rules).
- Contributions made prior to a three-year holding period.
- Qualified conservation contributions for preserving certified historic structures.
The final regulations also impose new reporting obligations, requiring a separate form to be attached to any return where a partner or shareholder receives a noncash charitable contribution exceeding $500 from a partnership or S corp, not limited to conservation easements.
The implications of the new Disallowance Rule are outlined below, including definitions, methods for calculating relevant basis, the three statutory exceptions, and the associated reporting requirements.
What Changed
Definition of Amount of “Qualified Conservation Contribution.” The final regulations clarify the definition of qualified conservation contribution amounts concerning amended returns and administrative adjustment requests (AARs). For example, if an S corp makes a contribution within the 2.5 basis limit, but later files an amended return claiming a higher amount that exceeds this limit without qualifying for any exceptions, the entire contribution is denied. If a lower amount is reported through an amended return or AAR, the 2.5 basis limitation rules must be reapplied to the reduced amount, but only if the adjustment occurs before the S corp is notified of an IRS audit. A partnership or S corp is considered on notice when either it is first contacted by the IRS regarding an examination of the return related to the contribution or when someone is contacted about an examination regarding penalties for promoting abusive tax shelters related to these contributions. This change allows fixing errors made in good faith while still balancing potential circumvention of the Disallowance Rule.
Added Step in Determination of “Modified Basis” of the “Ultimate Member” for Partnerships. Any ultimate member who is a direct partner in a contributing or upper-tier partnership must compute the “modified basis” as of the first day of the partnership’s taxable year in which the qualified conservation contribution is made. This calculation involves five adjustments, executed in the specified sequence:
- Increase for any contributions made by the ultimate member to the partnership during the year.
- Adjust the ultimate member’s hypothetical distributive share of partnership items for the year.
- Reduce the total amount of distributions made by the partnership to the ultimate member during the year (but not below zero).
- Added Step in Final Regulations – Increase modified basis by the ultimate member’s initial basis in any additional interests acquired. Decrease modified basis by the ultimate member’s basis in any interests partially disposed of.
- Reduce the ultimate member’s share of §752 liabilities of any partnership, including lower-tier partnerships, meaning the modified basis is determined without regard to these liabilities.
The resulting figure represents the ultimate member’s modified basis for determining the limitation amount of qualified conservation contributions. For S corps, the modified basis calculation differs and begins at the end of the year. Any decrease in adjusted basis due to the qualified conservation contribution must be added to the modified basis, helping ensure it does not reflect a reduction for the member’s pro rata share of the S corp’s basis in the conservation easement.
Allocation of Modified Basis to Determine Relevant Basis in Partnerships. The final regulations clarify the allocation of a partnership’s basis in assets among partners concerning §704(c) property. To determine a partner’s share of the adjusted basis in all properties held by a contributing partnership, the partnership must distribute its adjusted basis in each property (excluding any real property subject to a qualified conservation easement). This allocation is based on the adjusted basis immediately before the contribution, helping ensure no duplication or omission of properties and setting the adjusted basis for each property at no less than zero. The regulations also provide two examples illustrating §704(c)’s impact on determining the relevant basis.
Determination of Relevant Basis for Partners in Upper-Tier Partnerships. In tiered partnerships or S corps, compliance with the Disallowance Rule is crucial at every level. The tracing of an ultimate member’s modified basis must flow through all upper-tier partnerships to the contributing partnerships where the relevant basis is established. This involves specific calculations and steps to maintain the Disallowance Rule’s integrity. The process starts with the upper-tier partnership, where the ultimate member has a direct interest, requiring each upper-tier partnership to perform calculations that the contributing partnership then uses to determine the ultimate member’s relevant basis. In addition, upper-tier partnerships must follow §704(b) principles. The final regulations state that to determine a partner’s share of the adjusted basis in properties held by an upper-tier partnership, the partnership must apportion its adjusted basis in each property (excluding interests in lower-tier partnerships) based on the adjusted basis before the qualified conservation contribution, helping ensure no redundancy or omission of property and treating the adjusted basis as no less than zero.
Determination of Relevant Basis for Shareholders in S Corps. The computations are similar for S corps except that, instead of determining the portion of modified basis that is allocable to the portion of real property in respect to which the qualified conservation contribution is made, S corps determine the portion of modified basis that is allocable to the upper-tier S corp’s interest in the next lower-tier partnership. To be consistent, the final regulations similarly adopted language for S corps on the effect of §704(c) on the allocation of modified basis.
Partnership Allocation of Qualified Conservation Contribution. Uncertainty surrounding the wording of §1.706-3(a) caused confusion among taxpayers regarding whether the allocation “in proportion to their interests in the upper-tier partnerships” implied a pro rata distribution of qualified conservation contributions without special allocation. In response to this, the final regulations were revised to clarify that upper-tier partnerships are required to allocate the qualified conservation contribution among their partners based on each partner’s share of the contribution at the time of day when the qualified conservation contribution was made.
Not Available to Individuals or C Corps. The final regulations include clarification that the Disallowance Rule does not apply to qualified conservation contributions made directly by landowners who are not pass-through entities, such as individuals or C corps.
More Substantial Reporting Requirements on Noncash Charitable Contributions. Noncash charitable contributions exceeding $500 require detailed entries on forms. The latest regulations prohibit vague phrases like “available upon request,” which could render the filing incomplete. Accurate numerical information must be provided in Sections A and B to help ensure submission integrity. Partnerships and S corps making noncash contributions of more than $500 must include a completed form for each partner or shareholder benefiting from the deduction. In addition, any pass-through entity tiers must provide partners or shareholders with a copy of the donor’s form for all charitable contribution allocations, not just those related to qualified conservation easements.
Reporting Requirements for Qualified Conservation Contributions. Upper-tier partnerships and S corps are required to submit additional forms to the IRS to apply the Disallowance Rule accurately across all tiers. Reporting requirements do not apply to contributions outside the three-year holding period or from family pass-through entities. Contributions for preserving certified historic structures that exceed 2.5 times the relevant bases are exempt from the Disallowance Rule but still need reporting. The final regulations require that detailed statements be retained and updated, and the relevant basis computed for all contributions under the certified historic structure exception, even if they qualify for other exceptions. No deductions under §170 or related provisions will be permitted without a statement confirming the contribution, including all necessary information per IRS guidelines.
A Look at the Exceptions to the Disallowance Rule
Anti-Abuse Rules & the Family Pass-Through Entity Exception. The Disallowance Rule does not apply to contributions from family partnerships and S corps where “substantially all” interests (defined as 70% to 95%) are held by an individual and their family. For those using a higher percentage, two anti-abuse rules are established: a one-year holding period and a 90% allocation rule.
- One-Year Holding Period: The family pass-through exception requires that at least 90% of interests in the property were owned by one individual and their family members for at least one year before the contribution.
- Tacked-Holding Periods Not Allowed: This rule prevents manipulation through tacked-holding-period transactions. The final regulations state that tacked-holding periods under §1223(1) and (2) do not count for the one-year ownership requirement. An example illustrates that a non-family partnership distributing to qualifying family entities, followed by a conservation contribution within a year, does not qualify due to the lack of the one-year holding period.
- Charitable Contribution of Qualified Conservation Contributions: The one-year requirement is waived if the contribution is limited by the 50% charitable contribution rules (§170(e)) relative to the partnership’s or S corp’s adjusted basis.
- Ninety Percent Allocation Rule: The family pass-through exception applies only if at least 90% of the qualified conservation contribution is allocated to the individual and their family members who own at least 90% of the interests in the contributing partnership or S corp.
Contributions Made Outside of a Three-Year Holding Period. The Disallowance Rule does not apply to contributions made at least three years after the latest of:
- The last date the contributing partnership acquired any portion of the real property.
- The last date any partner in the contributing partnership acquired an interest in that partnership.
- If the interest is held through one or more partnerships, the last date any such partnership acquired an interest in another partnership, and the last date any partner in those partnerships acquired an interest.
Known as the “three-year holding period exception,” this rule excludes tacked-holding periods under §1223 when determining the contribution date for the exception.
Certified Historic Structure Exception. The Disallowance Rule does not apply to qualified conservation contributions aimed at preserving certified historic structures. While no additional statements are needed for the family pass-through or three-year holding period exceptions, they are required for the certified historic structure exception, even if other exceptions that do not require statements are met.
Conclusion
Even with these final regulations, Forvis Mazars foresees further clarifying guidance on forms to come. Despite the complexities involved in navigating the formulas and calculations required to determine each member’s adjusted basis, modified basis, and relevant basis, Forvis Mazars is dedicated to assisting taxpayers with the application of these rules and offers further guidance on qualified conservation contributions. If you have questions or need assistance, please reach out to one of our professionals.