Monday, March 27, 2023
Congress and DOJ Shut Down Ecovest Conservation Easement Syndicate and Others Like it
Way down in the bowels of the Consolidated Appropriations Act of 2023, which President Biden signed into law on December 29, 2022 - in Section 5, Division T, Title VI, Section 605 -- there is a provision intended to shut down syndicated conservation easements by limiting 170(h) deductions to 2.5 times a partner's recalculated outside basis. Recalculated primarily by subtracting out upward basis adjustments attributable to borrowed money, it looks like. The law does not apply retroactively, so DOJ continues to prosecute cases arising before the act. In fact, the shut down applies only to contributions made after December 29 2022. And late last week, DOJ finally settled what's described as a $3 billion conservation easement syndicate. The complaint in United States v. Ecovest Capital, Inc. reads almost like a committee report, describing conservation easements generally, than by specific description of the steps involved, including a one and two tiered model where the promoters use one or two LLCs essentially, then a series of examples derived from Ecovest transactions, and then conclusions. I love taking my students through the guts of how things work in the real world. I think the students like it. So here is a snippet from the government's complaint describing conservation easement syndication:
Step One: A “sponsor” creates a conservation easement syndicate (LLC) or identifies an existing LLC that can be turned into a conservation easement syndicate. The LLC is taxed as a partnership. If the LLC does not own the real property at issue, the real property is contributed by its owners in exchange for the LLC interests in a transaction that is considered a “nonrecognition” transaction for federal income tax purposes. This means that the parties to the transaction do not have to recognize the gain or loss on the transaction for federal tax purposes.
Step Two: The LLC acts through a manager. The manager is generally the sponsor or an employee, agent, or subsidiary of the sponsor. The LLC engages the services of a conservation manager who assists in the planning, organization, and execution of a conservation As part of these services, the conservation manager contacts a land trust and works in conjunction with the land trust to draft the deed of conservation easement and the baseline documentation. Baseline documentation that describes and depicts the property at the time of the donation is required. Generally, the initial services provided by the conservation manager include hiring an appraiser and assisting with the determination of the highest and best use of the property to be used in the appraisal.
Step Three: The appraiser, prepares an “initial valuation” of the proposed conservation easement. Here, in creating their initial valuation, the appraisers utilize unrealistic assumptions, violate the standards governing appraisal practice and otherwise prepare valuations that grossly overvalue the conservation easement. This initial valuation is used to market and sell the LLC interests. The appraisers know that their valuation will be used in this manner.
Step Four: The LLC or conservation manager engages a law firm to provide a tax opinion letter, confidential offering summary or private placement memorandum, and other transactional documents (subscription agreements for purchasing LLC units, operating agreement(s) of the LLC, redemption agreements, etc.) to be used in marketing and selling the LLC interests. The marketing materials include the initial valuation and typically state that the land trust has preliminarily accepted the draft deed of conservation easement.
Step Five: The LLC interests are marketed and sold as securities that are exempt from registration under Regulation D of the Securities Act. The LLC interests are generally sold in an “all or nothing” or “minimum/maximum” offering, meaning that a specific number of units must be subscribed or the closing will not take place. The LLC interests are sold either privately (through accountants, return preparers, financial advisors, and/or Defendants) or through broker-dealers. The LLC interests are generally marketed to taxpayers who, without the deductions stemming from the LLC interests, would be in one of the highest federal income tax brackets.
Step Six: Prospective customers are given an offering package with the marketing materials and transactional documents, including the confidential offering summary or private placement memorandum, tax opinion, operating agreement(s), subscription agreement, and redemption agreement. The offering package includes the anticipated value of the conservation easement, the anticipated value of the corresponding tax deduction (as determined by the preliminary appraisal,) and states that a draft deed of conservation easement has been approved by a land trust. Copies of the preliminary appraisal and draft deed are not provided, but are available for review by prospective customers. The offering package includes an example of the tax benefit or a “tax savings analysis” of a customer’s investment.
Step Seven: Each customer who wants to purchase LLC interests must fill out certain transactional documents, including a subscription agreement, indicating the number of units to be purchased. The customer must also certify that the customer is an “Accredited Investor” as defined by securities Broker-dealers or the syndicate’s sponsor may require prospective customers to complete additional forms.
Step Eight: After all LLC interests are subscribed and accepted by the LLC, the closing transaction is executed. Customers wire money to the LLC through a bank designated by the LLC or the sponsor and proceeds are distributed as described in the offering documents. The LLC uses the proceeds to pay fees and expenses, redeem the membership interests of the original LLC members, and to set up an operating account and an audit reserve fund.
Step Nine: Shortly after closing, the LLC’s manager makes a recommendation to the members regarding the use of the property – to place a conservation easement over the property. The LLC then executes a conservation easement over the property.
Step Ten: An appraiser, generally the same person who provided the initial valuation, finalizes the value of the conservation easement by preparing a “final appraisal” that purports to be a qualified appraisal (as defined in 26 U.S.C. § 170 and the regulations thereunder). The appraiser generally uses the same flawed assumptions and methodology as used in the initial valuation to arrive at approximately the same grossly overstated value. On occasion, the LLC hires a second appraiser (the review appraiser) to provide a “review” of the appraiser’s initial or final valuation and support the value provided by the original
Step Ten:[sic] A return preparer prepares the LLC’s tax return, Form 1065 and accompanying schedules reporting the conservation easement as a charitable contribution. As part of this process, the return preparer also prepares the Schedules K-1 for each customer/LLC member on which the customer’s share of the conservation easement deduction is reported. As part of the Form 1065, the LLC files a Form 8283 (appraisal summary), which must be signed by the appraiser and the land trust (or other organization to which the conservation easement was donated). The appraiser also prepares a supplemental statement to accompany the Form 8283 and submits a copy of the final appraisal to the LLC with the knowledge that it will be used to support a charitable contribution deduction reported on the Form 1065 and ultimately claimed by the individual customers.
The government's complaint sought an injunction and disgorgement of all profits made from the syndication. The final order states that defendants agree to never ever market conservation easements again and that defendants paid an undisclosed amount in settlement. If its true they generated $3 billion in illegitimate charitable contribution deductions, they must have been paid a sizeable sum. -- a 10% fee would have netted a cool $300,000,000. If the settlement payment was anything less than that amount, I'd say its been a pretty good couple five or six years for the syndicate.