IRS Issues Final Regulations on Disallowance of Conservation Easement Deductions

(Parker Tax Publishing July 2024)

The IRS issued final regulations concerning the statutory disallowance rule enacted by the SECURE 2.0 Act of 2022 to disallow a deduction for a qualified conservation contribution made by a partnership or an S corporation after December 29, 2022, if the amount of the contribution exceeds 2.5 times the sum of each partner's or S corporation shareholder's relevant basis. The final regulations provide guidance regarding this statutory disallowance rule, including definitions, appropriate methods to calculate the relevant basis of a partner or an S corporation shareholder, the three statutory exceptions to the statutory disallowance rule, and related reporting requirements. T.D. 9999.

Background

Under Code Sec. 170(f)(3)(A), a deduction is generally not allowed for a charitable contribution of an interest in property that consists of less than the taxpayer's entire interest in such property. However, Code Sec. 170(f)(3)(B)(iii) provides that Code Sec. 170(f)(3)(A) does not apply to a qualified conservation contribution. The term "qualified conservation contribution" is defined in Code Sec. 170(h)(1) as a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. In general, a qualified conservation contribution may include a contribution of a conservation easement.

The existing regulations under Reg. Sec. 1.170A-14 provide rules for qualified conservation contributions described in Code Sec. 170(h). Consistent with Code Sec. 170(f)(3), Reg. Sec. 1.170A-14(a) provides that a deduction generally is not allowed for a charitable contribution of any interest in property that consists of less than the donor's entire interest in the property other than certain transfers in trust. However, by reason of Code Sec. 170(f)(3)(B)(iii), a deduction may be allowed for the value of a qualified conservation contribution if the requirements of Reg. Sec. 1.170A-14 are met. To be eligible for a deduction under Reg. Sec. 1.170A-14, the conservation purpose of the contribution must be protected in perpetuity.

Code Sec. 170(f)(19) and Code Sec. 170(h)(7) were added to the Code by the SECURE 2.0 Act of 2022 (Pub. L. 117-328). Code Sec. 170(h)(7)(A) states that a contribution by a partnership (whether directly or as a distributive share of a contribution of another partnership) is not treated as a qualified conservation contribution for purposes of Code Sec. 170 if the amount of such contribution exceeds 2.5 times the sum of each partner's relevant basis in such partnership (Disallowance Rule). Thus, a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes is not a qualified conservation contribution if the Disallowance Rule applies. Code Sec. 170(h)(7)(F) generally provides that the rules of Code Sec. 170(h)(7) "apply to S corporations and other pass-through entities in the same manner as such rules apply to partnerships."

Code Sec. 170(f)(19) provides that, in the case of a partnership or S corporation claiming a qualified conservation contribution for the preservation of a building that is a certified historic structure in an amount that exceeds 2.5 times the sum of each partner's or S corporation shareholder's relevant basis, no deduction under Code Sec. 170 is allowed unless the partnership or S corporation includes on its return for the tax year a statement that such contribution was made and any other information as the IRS may require. A contribution to preserve a certified historic structure is one of the three exceptions to the Disallowance Rule.

In November 2023, the IRS issued proposed regulations (REG-112916-23) that provided guidance under Code Sec. 170(f)(19) and (h)(7). The proposed regulations under Prop. Reg. Sec. 1.170A-14(j) through (n), Prop. Reg. Sec. 1.706-3, and Prop. Reg. Sec. 1.706-4 were proposed to apply to contributions made after December 29, 2022. To align the reporting requirements under Prop. Reg. Sec. 1.170A-16 with the publication of the revised Form 8283, Noncash Charitable Contributions, and its instructions, the proposed regulations under Prop. Reg. Sec. 1.170A-16 were proposed to apply to contributions made in tax years ending on or after November 20, 2023 (the date the proposed regulations were published in the Federal Register).

T.D. 9999

On June 28, the IRS published final regulations in T.D. 9999 that adopt the proposed regulations with modifications in response to practitioners' comments.

Amount of Qualified Conservation Contribution

Prop. Reg. Sec. 1.170A-14(j)(3)(ii) defined "amount of qualified conservation contribution" as the amount claimed as a qualified conservation contribution on the return of the contributing partnership or contributing S corporation for the tax year in which the contribution is made.

The proposed regulation further provided, "if the contributing partnership or contributing S corporation files an amended return or administrative adjustment request under section 6227 of the Code claiming a different amount with respect to the qualified conservation contribution, the rules of [Reg. Sec. 1.170A-14] must be re-applied with respect to such different amount to determine the application of section 170(h)(7) and [Reg. Sec. 1.170A-14.]" One practitioner commented that this sentence seemed to inappropriately allow partnerships or S corporations to file administrative adjustment requests (AARs) or amended returns after they had been notified of an IRS examination.

In the preamble to T.D. 9999, the IRS responded that the proposed regulation was not intended to allow for the filing of an amended return or AAR in situations in which the partnership or S corporation would not otherwise be allowed to do so. Moreover, the IRS agrees that the re-application provision in Reg. Sec. 1.170A-14(j)(3)(ii) should not be understood to allow a partnership or S corporation to avoid the Disallowance Rule by filing an amended return or AAR claiming a lower amount with respect to a qualified conservation contribution after being contacted by the IRS concerning an examination regarding the return.

Therefore, the final regulations limit the re-application provision by providing that, if the contributing partnership or contributing S corporation files an amended return or timely AAR claiming a lower amount with respect to the qualified conservation contribution, the rules of Reg. Sec. 1.170A-14 will be re-applied with respect to such lower amount to determine the application of Code Sec. 170(h)(7) and Reg. Sec. 1.170A-14 if and only if the amended return or timely AAR is filed before the contributing partnership or contributing S corporation is put "on notice" of an IRS examination relating to the qualified conservation contribution. A contributing partnership or contributing S corporation is considered to be on notice after the earlier of: (1) the date the contributing partnership or contributing S corporation is first contacted by the IRS in connection with any examination of a return that relates to the qualified conservation contribution, or (2) the date any person is first contacted by the IRS concerning an examination of that person under Code Sec. 6700 (relating to the penalty for promoting abusive tax shelters) for an activity that relates to the qualified conservation contribution.

Effect of Section 704(c) Property on the Allocation of Modified Basis

The proposed regulations allocated modified basis by reference, in part, to the partners' interests in the partnership, which is a concept under Code Sec. 704(b). Specifically, under Prop. Reg. Sec. 1.170A-14(m)(2)(iii)(B), to determine a partner's portion of the adjusted basis in all the contributing partnership's properties, the contributing partnership would apportion among its partners in accordance with their interests in the partnership under Code Sec. 704(b) its adjusted basis in each of its properties (except the portion of the real property with respect to which the qualified conservation contribution is made), using the adjusted bases immediately before the qualified conservation contribution, without duplication or omission of any property, and by treating the adjusted basis in each property as not less than zero.

The proposed regulations did not explicitly address the impact of Code Sec. 704(c) amounts. Generally, Code Sec. 704(c) provides rules for partnership allocations with respect to property that has built-in gain. One practitioner commented that the final regulations should discuss what impact, if any, Code Sec. 704(c) may have with respect to conservation easement transactions in the context of Code Sec. 170(h)(7).

The IRS agreed that it may be unclear how the presence of Code Sec. 704(c) property affects the partnership's apportionment of its basis in its properties among its partners for purposes of the computation of relevant basis. Thus, Reg. Sec. 1.170A-14(m)(2)(iii)(B), as finalized, provides that to determine a partner's portion of the adjusted basis in all of a contributing partnership's properties, the contributing partnership must apportion among its partners its adjusted basis in each of its properties (except the portion of the real property with respect to which the qualified conservation contribution is made), using the adjusted basis immediately before the qualified conservation contribution, without duplication or omission of any property, and by treating the adjusted basis in each property as not less than zero. Consistent with the proposed regulations, the final regulations provide that this apportionment must be done under principles similar to the determination of the partners' interests in the partnership under Code Sec. 704(b), but add a cross reference to Reg. Sec. 1.704-1(b)(3)(ii), which provides factors to consider in determining a partner's interest in a partnership. These factors include: the partners' relative contributions to the partnership, the interests of the partners in economic profits and losses (if different than that in taxable income or loss), the interests of the partners in cash flow and other non-liquidating distributions, and the rights of the partners to distributions of capital upon liquidation. In addition, Reg. Sec. 1.170A-14(m)(2)(iii)(B), as finalized, provides that the apportionment must reflect Code Sec. 704(c) principles.

Observation: For example, if a partnership property has built-in loss (i.e., the adjusted basis of the property exceeds its fair market value), and Code Sec. 704(c) would require that built-in loss to be allocated to a certain partner if that property were sold, then under the final regulations, all of the basis in the property that exceeds the property's fair market value must be apportioned to the partner to whom the loss would be allocated if the property was sold.

Qualified Conservation Contributions Made by Joint Tenancies

One practitioner commented that the proposed regulations lacked clarity as to which provisions apply to every contributing partnership or contributing S corporation and requested that the final regulations include a preliminary explanation of scope. The practitioner recommended that the final regulations explicitly state that Reg. Sec. 1.170A-14(j) through (n) does not apply to qualified conservation contributions made by individuals, joint tenancies, tenancies in common, or C corporations.

The IRS agreed in part with this request. The IRS noted that Code Sec. 170(h)(7)(A) and (F) provide that the Disallowance Rule applies only to certain qualified conservation contributions made by partnerships, S corporations, and other pass-through entities; thus, it does not apply to qualified conservation contributions made by individuals or C corporations. However, the IRS observed that in certain cases an arrangement that is a joint tenancy or tenancy in common under state law may be considered a partnership for federal tax purposes under Reg. Sec. 301.7701-1(a)(2). If so, a qualified conservation contribution by such an arrangement would be subject to the Disallowance Rule. Accordingly, Reg. Sec. 1.170A-14(j)(1) includes a statement that the Disallowance Rule does not apply to qualified conservation contributions made directly by landowners that are not pass-through entities, such as individuals or C corporations.

For a discussion of the limitation on deductions for qualified conservation contributions made by pass-through entities, see Parker Tax ¶84,155.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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