I’ve heard that easements are starting to come under greater scrutiny by the IRS . . . should I be concerned?

Prospective donors and preservation organizations alike should be aware that preservation easements-and particularly façade easements-appear to be coming under increased scrutiny by the IRS. In fact, easements have been coming under a higher level of scrutiny generally, with increased attention by the news media and by Congress as well. We believe that individuals and organizations that carefully comply with the various legal and appraisal requirements that relate to preservation easements should have no reason to be concerned, but this increased scrutiny reinforces the need to ensure that all such requirements are fully met.

In June 2004, the IRS issued a public notice indicating that it plans to start looking closely at charitable deductions taken for conservation easement donations. While the notice did not specifically identify preservation easements as a concern, an accompanying statement by IRS Commissioner Mark Everson noted that the Service had uncovered "numerous instances" where the tax benefits of preserving historic buildings had been "twisted for inappropriate individual benefit." Mr. Everson stated that the IRS would consider imposing penalties on promoters, appraisers, and other persons involved in improper transactions.

In late October 2004, the IRS Commissioner for Tax Exempt and Government Entities, Steven Miller, reiterated that the IRS is concerned about abuses in this area - both with respect to the promotion and the valuation of façade easements - and he stated that the IRS plans to take action to address its concerns. Mr. Miller specifically warned about substantial deductions being claimed by taxpayers for façade easement donations on properties already restricted by local preservation laws, in which the obligations imposed by the easement are essentially the same as already imposed by the local preservation law. (The original IRS notice from June 2004 and Mr. Miller's comments, set out in an October 2004 speech, are available here.)

Subsequent to these developments, the Washington Post published a multi-part series in mid-December 2004 that raised serious questions about the activities of several easement-holding organizations that have been aggressively marketing tax deductions for the donation of easements, particularly for façade easements in tightly regulated historic districts. The series prompted calls from key congressional leaders for stronger-and retroactive-penalties for those donors who claim exaggerated deductions for façade easements, as well as penalties for the organizations and promoters who encourage abuses. The National Trust has expressed support for efforts by the IRS to investigate problems when they have occurred, and for policy changes that would strengthen accountability requirements for easement donations and for easement-holding organizations.

On August 17, 2006 significant legislative changes to address abuses in the area of façade easement donations were passed by Congress as part of an omnibus pension reform bill, H.R. 4, and signed into law by the President as Public Law 109-280. A summary of those changes can be found here.

With the increased attention on facade easements from both the media and congress, it is important for preservation organizations to make clear - and for easement donors, appraisers, and consultants to understand - the complexities and factors involved in valuing preservation easements. Organizations working in this area should avoid over-simplifying the subject of easement valuation. Donors should be cognizant of the need to obtain good tax and legal advice, and to take seriously the Service's concerns about valuation problems.

From the National Trust for Historic Preservation's perspective, preservation easements on properties already subject to local preservation laws may still provide important substantive preservation benefits. At the same time, the donation value of easements must be based on a case-by-case analysis of each property-and IRS regulations specifically require this analysis to take into account "any effect from . . . historic preservation laws that already restrict the property's potential highest and best use." Obviously, the value of a preservation easement depends on a number of factors, and preservation organizations should be clear that there is no "one size fits all" approach.