Exchange Legal Viewpoint Easement Audits in Colorado: What Can We Learn from Them? by Bill Silberstein IRS Initiates Audits spected appraisers. Many of the ease- and to file an appeal with the IRS in Colorado I ments under audit involved public Office of Appeals. No payment is due n the eyes of many of us in the funding such as grants issued by the if a protest and appeal is filed in a land trust community in Colorado, Colorado funding agency, Great Out- timely manner. In some cases, the IRS the IRS appears to have declared doors Colorado, as well as federal fund- has taken the position that the conser- war on conservation easements. ing from the United States Department vation easement does not meet the According to briefings of the Colorado of Agriculture and county and munici- conservation purposes test of Internal congressional delegation by the IRS, pal open space programs. there are approximately 250 audits of Reportedly, DOR turned over 5,000 conservation easements that were con- state tax returns to the IRS and the IRS This is a time when veyed in Colorado in 2003 and 2004. eventually sifted these down to the 250 Because some of these easements are tax returns that are the subject of the the completeness on properties with multiple owners, pending audits. Despite the fact that of the there may be as few as 100 conservation many of these easements had been easements involved in these 250 audits. appraised and approved by state and land trust's file will The exact numbers are uncertain. federal agencies, the IRS has stated be scrutinized. The audits arose in response to that only three of the 250 conservation issues relating to the Colorado state easement audits were acceptable-and conservation easement income tax that all the rest had problems. Revenue Code (IRC) §170(h). In most credit that were brought to the attention The Colorado Coalition of Land cases the IRS is challenging the con- of the Colorado Department of Reve- Trusts has been active in obtaining this servation easement appraisal, often nue (DOR). The Colorado state income information, gathering additional infor- taking the position that the conserva- tax credit program began in 2000 and mation about the conservation ease- tion easement has zero value. in the following years was made more ments under audit, and providing edu- A common theme is emerging generous. A number of tax credits were cation to land trusts, landowners and in the few engineering reports that claimed based on exaggerated and pos- their advisers about the audit process. have been issued. The reports include sibly fraudulent appraisals. Some of a discussion of sales of easement- these cases were identified by DOR; Current Status encumbered property and conclusions some were identified by the land trust The first few audits are coming to about Property Reduction Value (PVR), community. a close and the landowners and their a term apparently invented by the IRS DOR, believing that it lacked the re- advisers are just beginning to see the engineers. Two hundred easement- sources and experience to enforce the revenue agent reports and engineering encumbered property sales are stated law, requested that the IRS investigate reports. "Engineering report" is IRS to have been identified in Colorado, the federal tax returns of easement terminology for what might be consid- and 35 analyzed. The reported results donors. The problem is that neither the ered a review appraisal, except the are that over 70 percent of the 35 state nor the IRS seems willing or able engineering reports are not appraisals analyzed transactions reflect a PVR to separate good easements from bad, (for example, they do not follow Uni- of between 0 percent and 20 percent; and a number of legitimate transac- form Standards of Professional Apprais- nearly 80 percent reflect a PVR of tions have been caught up in the IRS's al Practice) and they are not done by 30 percent or less; and fewer than 10 effort to disallow abusive transactions. appraisers, but rather by IRS engineers. percent reflect a PVR of greater than I feel quite confident in stating that The first few landowners are receiving 50 percent. Also, for conservation a large percentage of the conservation "30 day letters," which contain a state- easements that allow for at least one easements under audit involve ease- ment of the IRS position as a result of building envelope, the PVR was ments well within the mainstream of the audit and a calculation of the defi- "relatively small." One thing is clear- generally accepted practices of the land ciency and tax owed. The taxpayer has this 35-property sample bears little trust community, and that they were 30 days after the issuance of the 30 resemblance to the value reductions appraised by experienced and well-re- day letter (hence its name) to protest we in the land trust community 30 Summer 2007 Exchange expect to see in conservation ease- Notify the landowner, wait until the easement is the only issue in the audit, ments in Colorado. landowner period to object expires, lawyers that have experience with IRS and obtain a letter from the IRS that disputes will understand very quickly Lessons Learned to Date the landowner has not objected before that this is a valuation dispute and The IRS is a large bureaucracy, with providing information requested in the will likely know how to deal with it. many divisions. The Land Trust Alli- summons. The summons is not self- The first contact from the IRS noti- ance has been working long and hard executing. If you choose not to or fail fying the landowner of commencement to have a dialogue with, and to edu- to reply to the summons, the IRS may of the audit will usually include a re- cate the regulatory side of the IRS. elect to enforce the summons in fed- quest for extension of the statute of I fully support those efforts. But the eral court. This is a very brief descrip- limitations. The general statute of limi- enforcement side of the IRS-the folks tion of a highly technical area. tations to challenge a tax deduction is who audit taxpayers-is very different. This is not a level playing field. three years from the filing of the tax re- I would strongly advise land trusts that The IRS will not tell you about the turn on which the deduction is claimed, cooperation with IRS auditors does not rules and most lawyers, CPAs and other including tax returns on which any help your donors. landowner advisers do not know them. carry-forward of the deduction is Exercising what seemed to be com- Lawyers that specialize in advising claimed. Landowners should consider mon sense, the Colorado Coalition of 501(c)(3) organizations, or about con- very carefully with knowledgeable and Land Trusts at first cooperated with servation easements, are unlikely DOR and the IRS and invited them to to know the rules. Only lawyers that participate in its statewide land trust specialize in tax disputes with the IRS The outcomes conference. The subjects of this con- know these rules. Find one of these will have ference were water rights and mineral lawyers and obtain his or her advice rights in land conservation transactions. before responding to the IRS regarding consequences for the The result of this cooperation and edu- an audit of one of your donors. entire land trust cation was that shortly after this con- The IRS is asking land trusts ference, landowners received a new and conservation easement donors community. round of questioning from the IRS ask- to demonstrate that the land trust ing the taxpayer to explain how the has the resources and commitments conservation easement transaction dealt to enforce the terms of the easement experienced advisers whether they with water rights and mineral rights. and is therefore a qualified recipient wish to grant the extension to the IRS. My advice to Colorado land trusts of the conservation easement, as Granting an extension to the is that they should not voluntarily pro- defined in the IRS regulations. Your IRS gives the IRS more time to build vide information to the IRS about land- land trust should be prepared to its case, and to build pressure on the owner transactions. The negative con- answer this question for your donors. donor. These cases drag on for many sequences include the possibility of This is a time when the complete- years. In the Glass case, the conserva- exposing the land trust to liability to ness of the land trust's file will be tion easements were donated in 1992 landowners by voluntarily providing scrutinized. Your file should be com- and 1993, the notice of deficiency confidential information. plete, including up to date annual was issued in 1999, the Tax Court trial A land trust (or a donor) involved property inspection reports and a copy was conducted in August 2004, and in an audit will need to learn about of the letter required by IRC §170(f)(8) the Tax Court decision was issued in the rules of the game, and you should to be sent to the conservation ease- December 2005. This is a much longer require the IRS to follow proper proce- ment donor acknowledging receipt time frame than average, but illustrates dures such as issuing formal "informa- of the conservation easement (the the point. In the end, interest on the tion document requests" (IDRs). Notify "goods and services" letter). tax deficiency asserted by the IRS and the landowner when you receive an Land trusts can and should help penalties can be as great as the tax IDR. Do not reply to the IDR until the landowners defend their conserva- deficiency itself. after the time has expired for the land- tion easements. Land trusts are prohib- The 250 Colorado audits are only owner to file an objection to the IDR ited from providing private inurement at the very early stages. The IRS war with the IRS and you request and re- or private benefit to their donors. How- on these conservation easements will ceive a letter from the IRS stating that ever, the land trust mission revolves drag on for many years and the out- the landowner has not objected to the around land conservation, and it falls comes will have consequences for IDR. The IDR is not self-executing. within that mission to defend legiti- the entire land trust community. P If you fail or choose not to respond to mate conservation transactions and to all or part of an IDR, the IRS has the educate landowners, the public, legisla- Bill Silberstein, a former Land Trust power to issue a summons. If a sum- tors, regulators and other policymakers Alliance board member, is a lawyer with mons is issued, follow the same proce- about land conservation transactions. the Denver, Colorado firm of Isaacson dure as for the IDR before complying. If the value of the conservation Rosenbaum P.C., bsilberstein@ir-law.com. Summer 2007 31