Letter to the Editor of Tax Notes on Partnerships and Proposed Conservation Easement Bill
December 13, 2020
by Monte A. Jackel
I published this on December 14, 2020 in Tax Notes https://www.taxnotes.com/tax-notes-federal/partnerships/conservation-easement-bill-does-not-jibe-partnerships/2020/12/14/2d99w on the proposed charitable easement bill limiting the section 170 deduction for partnerships. It is reproduced below.
“I write this letter in response to Kristen A. Parillo’s news story titled “House Easement Abuse Bill Contains Break for Historic Buildings” (Dec. 8, 2020). The story summarizes the recently proposed House bill titled the “Charitable Conservation Easement Program Integrity Act of 2020.”
This bill is the most recent version of the congressional attack on so-called abusive charitable conservation easements. It imposes a limit under section 170(h) for certain donations of appreciated long-term capital gain property of a conservation easement. The approach is to disallow any deduction for a charitable contribution made either by a partnership or by any other member partnership in a tier of partnerships of an easement when the fair market value of the donated property (assuming it is correct) exceeds 2.5 times the partner’s adjusted basis attributable to the donated property (determined under rules similar to section 755).
The bill does not attack the bona fides of the donating partnership. As has been pointed out in these pages, if the property was held by a state law partnership that was not recognized for federal tax purposes (either under the common law antiabuse cases, section 7701(o), or reg. section 1.701-2), then, as a tenancy in common, the donated property would most likely not have a long-term capital gain holding period and, thus, only the tax basis of the property would be deductible for federal tax purposes. (Prior analysis: Tax Notes Federal, Nov. 23, 2020, p. 1259.) In light of this, it would be prudent to list these other authorities under the “no inference” language of the bill.
The bill has an effective date that is tied to the date of Notice 2017-10, 2017-4 IRB 544, which lists charitable easements as a transaction of interest under the reportable transaction listing regulations. This is because the validity of a similar IRS notice on microcaptives, Notice 2016-66, 2016-47 IRB 745, that is currently before the Supreme Court is being challenged based on the IRS’s failure to provide advance notice and comment under the Administrative Procedure Act for the notice and also because the proceeding challenging the notice is potentially subject to the anti-injunction tax statute. (Prior coverage: Tax Notes Federal, Dec. 7, 2020, p. 1649.) In light of that status, the drafters should keep an eye out for the SCOTUS opinion on the issue.
There are defects in the bill that have been previously pointed out but that lawmakers have still yet to address. Thus, I recommend Congress focus on the following:
- The exception for family partnerships uses the term “substantially all” when referring to ownership by family members of interests in the partnership. To avoid disputes later, the meaning of this term should be specified.
- The bill does not amend the penalty provisions of the IRC, particularly sections 6662, 6664, and 6694, which relate to the substantial understatement and overvaluation penalties. For example, what if the FMV of the donated property exceeds 2.5 times tax basis, but the FMV can be established by the taxpayer to be what the taxpayer claims it is on his tax return? Shouldn’t there be an express exception for this situation, or will these penalties apply on a strict liability basis without regard to what the actual FMV is because the taxpayer is acting contrary to a statute?
- The area of law on in-kind contributions of appreciated property (where the contributor is not ever subject to federal income tax on the built-in gain on the property unless there are liabilities on the donated property) is itself somewhat distortive as applied to partnerships. This is because the partners’ basis in their partnership interests is reduced for tax purposes only by the tax basis attributable to the partner, but for section 704(b) book purposes the capital accounts are reduced by the FMV of the donated property. See section 704(d)(3)(B). This is done so that the built-in gain on the donated property is not retained by the partners under general income tax principles.
However, by these mismatched reductions, the contributing partner of the donated property (if there is one because otherwise the property would have been purchased by the partnership) retains some share of the built-in gain, and the other portion of that built-in gain is shifted to the other partners, creating an inside and outside tax and book disparity that is normally sought to be avoided in applying subchapter K.
Further, there is a question of whether the charitable donation of in-kind appreciated property within seven years of its contribution triggers section 704(c)(1)(B) as if the donated property was first distributed to the partners and then donated by them. If it were triggered, book and tax would be equalized. Is this or should this be the case? In addition, how is the excess of FMV over what is allowed as a tax deduction under section 170 treated for section 704(b) book purposes? As a nondeductible expense? Note that the so-called “n rule” may have to be modified here. See reg. section 1.704-1(b)(4)(iv)(n) (book accounting generally follows tax accounting).
Finally, if there are liabilities on the donated property that are shifted to the charity, that is if there is a partial or bargain sale under IRC sec. 1011(b) and reg. section 1.1011-2, it seems that limit in the proposed bill should apply only to that portion of the property attributable to the donated portion of the property but not to the sale portion. This should be clarified. Regardless, explicit regulatory authority should be granted to Treasury to deal with these partnership issues and, at a minimum, a statutory decision should be made regarding the application of section 704(c)(1)(B) to the easement donation.”