Resolution of IRS Challenge to Maine Conservation Easement Deduction

Back in 2022, I wrote about a troubling IRS challenge to the deduction of a conservation easement donated to a Maine land trust. I characterized the IRS’ actions as disturbing because they asserted several aggressive and unsubstantiated arguments to challenge the deduction. I can now report that the matter has been settled between the donor and the IRS, with a healthy result from a land conservation policy perspective.

First and foremost, during negotiations between the IRS and the donor’s attorney, the IRS dropped all challenges to the easement’s qualification under I.R.C.§ 170(h) and the accompanying regulations. Notably, this includes claims that the amendment provision and termination provision did not comply with the statute and regulations, as well as that the easement contained inconsistent reserved rights and lacked an adequate conservation purpose.

The amendment provision issue is particularly important, because our Maine statute includes unique language requiring court approval and Attorney General participation if an amendment were to “materially detract from the conservation values intended for protection.” The IRS, seemingly unaware of our statute, objected to this phrasing as unduly subjective. Fortunately, once the IRS was made aware of our statutory obligations, they dropped the challenge to the amendment provision, as well as all other non-valuation challenges.

While the IRS backing off its initial challenge is a welcome development, it does raise the question of how to draft our conservation easements going forward. As you may recall, in response to the IRS’ actions in 2022, the Maine Land Conservation Attorneys Network (MLCAN) revised the amendment provision in the Model Conservation Easement Boilerplate so as to eliminate the reference to the Maine statute. Now that the IRS has backed off its aggressive stance, MLCAN revisited the issue and decided to revise the Model once again. The February2024 version reverts to the pre-2022 language as a primary option, but also keeps the 2022 language as a secondary option for those who are especially risk averse about a potential deduction. You can see the new language in section 15.F of the new version.

From my perspective, whether I were representing the landowner or the holder, I would almost always go with Option 1, the pre-2022 language, because I think it provides much-needed clarity to both the landowner and the holder about the amendment process and standards. Although there are no guarantees in the future, because every IRS agent enjoys a certain degree of discretion, the fact that the IRS quickly backed down in challenging the amendment provision bodes well. Furthermore, recent case law in the Tax Court has not been kind to the IRS in its more aggressive arguments around amendment provisions and other matters.

Meanwhile, although the IRS essentially conceded its aggressive qualification arguments, the donors did settle on valuation due to problems with the appraisal. As a result of these shortcomings, the donors agreed to settle for 50% of the original claimed value, approximately $500,000 instead of$1,000,000, and with no penalties assessed (note: to preserve anonymity some of the details here have been changed).

The biggest flaw in the appraisal was a mismatch between the subject parcel for the before-and-after valuations. This particular easement entailed the protection of approximately 35 acres of a 100-acre larger parcel. The IRS regulations for conservation easement appraisal require that the before-and-after valuation must be of the larger parcel, not the conserved parcel. The appraiser got this half-right; the before value was of the entire100 acres but the after value was for only the 65 acres not subject to the conservation easement. And although the 35 acres subject to the CE might not have had a great deal of value, getting this wrong on the appraisal created an inroad for the IRS that they exploited to the fullest. The IRS also dinged the appraisal for other minor issues.

The moral of the story is to find an appraiser who understands the complexities of conservation easements and the regulations. This can be easier said than done, given the paucity of experienced appraisers in this field. It will also help to have an attorney who is paying attention to the appraisal requirements. Whenever I represent a landowner who is seeking a deduction for an easement or land donation, I run through a checklist to make sure the appraisal meets the technical elements spelled out in the regulations, but I don’t get into the details of the comparables and other substantive content. The Land Trust Alliance maintains just such a checklist, and land trusts might want to start sharing this document with prospective donors as well as their appraisers and attorneys.

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