As a result, due to the reliance of innocent people on the program as designed, Colorado acquired tens of thousands of open-space acres in permanent conservation easements for tax credits that never exceeded half the appraised value of the conservation easement itself.
The Colorado Conservation Easement Program Prior to the 2008 Changes in the Law, The Significant Changes and the Unfair Disallowance-of-Tax-Credit Process
By Stanley K. Mann
The Program Prior to 2008
Providing tax incentives to landowners for donating perpetual conservation easements is not new to Colorado. Since the 1980s the incentives were somewhat patterned after IRC § 170 (h).1 The incentives progressed from tax reduction to transferable tax credits with carry-forward provisions. The program was so successful that the legislature kept increasing the incentive in order to induce landowners to donate their exploitation rights in land to conservation trusts.
Thus, on January 1, 2003 the tax credit then available was increased from a maximum of $100,000 to $260,000.2 This maximum was based upon a two-tiered structure whereby the tax credit claimed could equal 100% of the first $100,000 of donated easement value, and 40% of the next $400,000 of donated easement value up to a maximum donated value of $500,000. The mathematical result was thus a maximum tax credit of $260,000.
Also, at that time the donating taxpayer could carry over the deductions for a period of five years after the year of donation.3 Alternatively, the donating taxpayer could even sell the state income tax credit to a third party.4 And, landowners found the sale of the credits to be relatively easy. For example: “A taxpayer could reasonably expect to broker his or her credits for about eighty cents on the dollar with 10 cents on the dollar (or a 10 percent reduction) offered to attract buyers; and 10 cents on the dollar (or a 10 percent commission) taken by a broker. Taxpayers who knew other taxpayers who might be interested in buying their credit could avoid a broker's surcharge by exchanging the credits themselves.”5
Because of the overwhelming success of the incentive legislation, other inducements were also added. Among those inducements was the elimination of the minimum threshold amount available for transfer to tax credit buyers, which theretofore had gone through a series of complex limitations.6
To qualify for a state tax credit, under the 2003 version of the law, the donating taxpayer, in support of the value of the easement, had only to submit to the Colorado Department of Revenue a summary of a qualified appraisal, as opposed to a complete appraisal.7 Further, the definition of “who is an eligible taxpayer” for a tax credit included a resident individual, or a domestic or foreign corporation, . . .a partnership, S corporation, or other similar pass-through entity, estate, or trust.8 And, the motive for making the donation was not restricted to some altruistic notion of conservation, but could clearly focus upon the economic gain from the sale of the tax credit.9 “Thus, the fact that a donor may be motivated solely by tax credits should not be understood to defeat the charitable intent of a donor making a conservation easement contribution.”10
The law necessarily “. . . created an incentive for people to become Colorado taxpayers. A significant, yet currently anecdotal, consequence of the credit law involves the creation of pass-through entities such as partnerships and LLCs under Colorado law for the sole purpose of qualifying partners and members for tax credits.”11
The law also led to the fragmentation of real property by dividing property formerly owned by one owner into multiple parcels and multiple ownerships, or by fragmentary phased donations over a period of years either by the one owner or the multiple owners.
Even back in 2003 some recognized the fact that the incentives resulted in fragmentation of real estate strictly for conservation easement donations; that the motive was to obtain saleable tax credits, and that, through the LLC structure, non-Colorado residents could receive the proceeds from those sales.12 While even back in 2003 these results were regarded by some as “abuses,” the legislature apparently continued to recognize the success of the program and condone the so-called “abuses.”
The legislature’s recognition of the success of the conservation easement incentives was again dramatically illustrated by the fact that on May 1, 2006, then Governor Owens signed into law House Bill 06-1354. House Bill 06-1354 replaced the former two-tiered structure described above with a single-rate structure that allowed 50% of the fair market value of the donated easement to be claimed as a tax credit. And by raising the maximum easement donation value to $750,000, the maximum tax credit that could be claimed was raised from $260,000 to $375,000. Even the federal government added to the incentives by increasing the allowable conservation credit donation deduction up to 50% of the total contributions and by extending the carry-over period for the donation deduction to 15 years.13
Even in 2003 legislators were being urged to understand and appreciate the success of the conservation easement program in Colorado, and not allow the so-called, and readily recognized “abuses” to harm the overwhelming success experienced to date.
“The fact that tax credits are incentives for the donation of easements on smaller parcels of land or land owned by multiple owners should not be used as a means to discourage such donations. In fact, motivation of potential donors by the tax credit incentive is a tribute to the success of the incentive itself. After all, the motivation is a tax credit incentive designed both to mimic and expand on federal tax deduction incentives and it is doing just that. If the tax credit incentive causes Colorado taxpayers to conserve Colorado properties that they would not otherwise have conserved and, at the same time, provides a new source of income for such taxpayers, the tax credit is accomplishing exactly what its sponsors intended. It brings Colorado taxpayers and more important, additional Colorado properties to the conservation arena.” (Emphasis added)14
The 2008 Changes
Unfortunately, the United States experienced a major economic downturn in 2007. While the downturn may not have been the cause for new legislation in the Colorado conservation easement program, it did appear to cause a strange kind of “witch-hunt” and media frenzy in the program. And, even though the so-called “abuses” recognized from 2003 had not heretofore been worthy of legislative action other than the addition of greater inducements to the program, now they seemed to be the basis of serious curtailment of some aspects of the program. House Bill 08-1353 became effective July 1, 2008, and will no doubt dramatically reduce the number of acres that will become part of the conservation easement program in Colorado.
Perhaps harkening back to what was already voiced in 2003 by some, House Bill 08-1353 declared in part that “Some promoters have abused the tax credit program to obtain a financial benefit for themselves and their clients by submitting easements that misrepresent a property’s conservation or financial values.” The Bill requires conservation easement appraisers to submit full appraisals to the division of real estate within thirty days accompanied by an affidavit to include: a statement as to value, and the method of determining value; whether or not sand, gravel, minerals, water and improvements were considered; whether subdivision analysis was considered; contiguity information; licensing qualifications; classroom education in conservation easement valuation; and the number of previous conservation easement appraisals. And, the real estate division has broad powers to investigate valuation and report to the Department of Revenue.
House Bill 08-1353 enacted CRS 12-61-720 to set up standards for holders of conservation easements; enacted CRS 12-61-721 to create an oversight commission to oversee the conservation easement program; revised CRS 39-22-522 to qualify the manner in which claimed tax credits could be investigated; and modified other Colorado statutes to conform with the changes.
These 2008 changes in the law related to conservation easements are not necessarily bad in and of themselves, but a series of events prior to their enactment together with that enactment has resulted in some highly unfair practices by the State of Colorado against its own innocent citizens.
The Unfair Disallowance-of-Tax-Credit Process
For reasons known only to the State agent in question, an agent for the State, empowered to investigate conservation easement appraisers, began a sort of witch hunt against selected real estate appraisers in Colorado. The method was to allege numerous allegations against the appraiser and supply the same allegations to the media. Obviously, a media feeding frenzy resulted and the entire Colorado easement program came under severe attack.
We are familiar with a case where the agent for the State referred to above reported to the Real Estate Board for Colorado a multitude of violations against an appraiser who had appraised quite a number of conservation easements in Colorado. Based upon that information, the Board summarily suspended the license of that appraiser, and further sought the revocation of the license and civil penalties. All of this information was given to the media and widely circulated in numerous publications.
Hearing before an Administrative Law Judge resulted in a finding different from what the agent and the Board anticipated, because the violations were not as numerous and egregious as alleged. Indeed, the ALJ ruled that although there were some errors, they were not sufficient to prove they were willful or that the valuation of the property was inflated or intentionally inflated. The ALJ imposed a short license suspension, with credit given for the time the license had been under summary suspension, and a $500 fine.
However, in spite of this ruling by the ALJ, according to broad media reports, the agent for the State referred to above reported to the Real Estate Board the initial allegations and sought revocation of the appraiser’s license and a fine in the range of $15,000.00.
Even before the 2008 revisions to the Colorado conservation laws, CRS 39-22-522 (3.5)(a) stated in part: “In resolving disputes regarding the validity or the amount of a credit allowed pursuant to subsection (2) of this section, including the value of the conservation easement for which the credit is granted, the executive director shall have the authority, for good cause shown to review and accept or reject, in whole or in part, the appraisal value of the easement, . . . .” (Emphasis added.) But, based upon the allegations against the appraiser referred to above, without any reference whatsoever to the actual outcome of the hearing before the ALJ, tax credits were disallowed on the property the subject of the appraisal.
If this were an isolated incident it might be possible to explain the disallowance, but there are literally hundreds of such cases now pending in the State and also before the IRS hearing officers and the U.S. Tax Court, and some of the tax credit disallowances date back as far as 2003. To add insult to injury the Executive Director of the Department of Revenue has stated publicly that she has insufficient funds to seek new appraisals by qualified appraisers or otherwise hire qualified investigators to properly investigate and process these hundreds of disallowance cases. In fact, the Executive Director maintains that her “hands are tied” and she must simply process the hundreds of cases in a slow case-by-case process with her present staff.
A lawyer, present at that same public meeting where the Executive Director made her comments, stated at the meeting publicly that he was part of the current Governor’s study team to find a solution, and that the solution endorsed by the Governor—a mediation process—is no solution at all in that at the current rate it will take over 100 years to process the currently pending cases.
Apparently, some in the State government recognized that the Department of Revenue needed some guidance as to what constitutes “for good cause shown,” because HB 08-1353 revised CRS 39-22-522 (3.5)(a) to require the executive director of revenue to also consult with the Division of Real Estate and the Oversight Commission to review and accept or reject a tax credit. No such consultation is required with respect to the currently pending cases. According to the Executive Director’s statements at the above-described public meeting, her staff examines the returns and if the appraisal seems too high the tax credit is disallowed. No expert input is sought, no qualified appraisers consulted, no investigation by qualified people conducted, but just the staff of the department because, “there are simply insufficient funds.”
It appears to be patently obvious that in all these pending cases the process, as it is being conducted by the Department of Revenue and the mediation process, is seeking an easement value of zero or nearly zero as an effort to “recover unpaid state income taxes.” Media reports and some legislators seem to erroneously believe something near $200 Million will be recovered by the State. In adopting such a non-supportable position and belief, these acting agents of Colorado are ignoring these important things:
- As the law is structured the State acquired each conservation easement in the first place pursuant to its own standards and requirements.
- Those standards and requirements had recognized pitfalls and what some stated as potential “abuses” dating from 2003. However, the legislature patently endorsed those pitfalls and abuses by its added incentives in subsequent years.
- As the law was structured, the State acquired the conservation easements for a tax credit valued at half the actual appraised value of the donation.
- The current State process goal seems to be to keep the conservation easement donations on the one hand, but to fully recover the taxes previously credited for those easements. To accomplish this and recover almost $200 Million for the State would require a zero value for every disallowed tax credit—even after full hearings or trials—which is an outcome that is virtually not possible.
- The current process totally ignores due process of law for those accused of submitting claims for tax credits.
- Conservation easements are to be valued by taking into consideration the highest and best use of the land involved.
- Donors would never have made the donations in the first place if they had known there was a chance they would lose both their land exploitation rights and their tax credits.
- The land of each donor is now tainted with a far lower value due to the conservation easement, and the remaining land may now be undevelopeable because of the loss of economies of scale.
- In most cases the donors sold the tax credits to third persons, paid ordinary income tax on the proceeds, spent the tax credit proceeds and are now in no position to pay back the tax credit purchasers let alone pay the State.
- The statute of limitations for amending tax returns will actually run out well before most cases will be processed by the State unless the donor/taxpayer actually preliminarily files some sort of petition for refund in advance of a final resolution. Likely, few will know of this process because they will not have any idea what to ask for as a refund, and will assume that in a worst-case scenario they would not actually lose their entire tax credit. But, even if they lost part of it they would be entitled to some refund of taxes paid upon the sale of a full tax credit, but lose it because the statute of limitations will have run. This is unfair to the donor because if the donor/taxpayer’s position is different from that reported in an earlier return, there is no opportunity to recover potential refunds of taxes paid.
- In an attempt to comply with the law, hundreds of donors expended significant sums in legal, accounting and appraisal fees to participate in the Colorado conservation easement program, and are now expending huge sums defending themselves against the IRS and the Colorado Department of Revenue—all with absolutely no hope of recovering any of those expenditures, even when they prevail.
- It is totally unrealistic to anticipate the State will prevail in enough cases now pending to actually offset the expenses required to process the pending cases in a manner that will afford due process of law and avoid the other potential claims Colorado will face if the current process continues at its current pace.
- Donors, in an effort to survive this costly and unfair assault, will have to exploit any land they retain to the greatest possible limit, thus defeating the very goal the conservation easement program sought in the first place.
- Donors will litigate these disallowance for years to come, at great cost to the State, and there are many legal options that may be available to donors whose tax credits have been disallowed if the current process is allowed to continue:
- Estoppel to deny the tax credits because the State designed the program; knew or should have known of its pitfalls and potential “abuses;” passed additional legislation adding new incentives to participate in the program; knew donors relied upon the structure of the program, then sought to disallow the credits.
- Laches for failing to process the disallowances in a manner involving due process, mitigation of losses to the donors and irretrievable harm to the donors.
- Interference with contract prohibited by the State and Federal Constitutions.
- Having sold their tax credits most donors will not be willing to mediate the value of their easement donations below the threshold required for what they claimed as a tax credit. For those there is no gain to the State, and litigation is certain.
- The costs of litigation for both the State and the donors will go on for years to come.
- Many innocent, well-meaning Colorado citizens will simply go bankrupt as a result of this unfortunate process.
- The reputation of Colorado and Colorado government will be seriously harmed.
Colorado lawmakers designed an excellent conservation easement program with built-in incentives to attract donors who would otherwise not consider such a donation but rather, would exploit their land in some fashion. The program was so successful that the lawmakers adopted new incentives to increase the conservation easement donations. Lawmakers knew that the structure of the law allowed what some viewed as possible “abuses,” but adopted new incentives nonetheless because the program was accomplishing exactly what it was designed to accomplish. As a result, due to the reliance of innocent people on the program as designed, Colorado acquired tens of thousands of open-space acres in permanent conservation easements for tax credits that never exceeded half the appraised value of the conservation easement itself.
Perhaps because of the 2007 economic downturn, or perhaps due to one or more overzealous State agents, or some combination of both, the conservation easement program became an item of focus and attack. Fueled by the media, an aggressive pattern of tax credit disallowances ensued, apparently upon the basis of the so-called “abuses” that lawmakers had heretofore obviously chosen to condone. The result has been that literally hundreds of disallowance cases are now pending in Colorado; no funds are available to process these cases in a due-process manner; no proper process has been put in place; and, the State, the donors, and the tax credit purchasers will all be facing irretrievable losses with no real expectation of favorable results.
The only logical solution to this terribly unfair situation is a total amnesty bill validating all tax credits prior to the 2008 changes in the law, and carefully designed to restore the integrity of the conservation easement program; exonerate the hundreds of innocent landowner donors; and restore the confidence of the past and future purchasers of tax credits. Article by Stanley K. Mann; blog (c)Sharon Cairns Mann.
1 See, Jay, Jessica E. CHANGES TO COLORADO’S CONSERVATION INCOME TAX CREDIT LAW, The Colorado Lawyer, February 2003, Vol. 32, No. 2.
2 House Bill (H.B.) 01-1090.
3 CRS Sections 38-30.5-100 et seq.; IRC Section 170(b); Treas. Reg. Section 1.170A-14 (1986); Treas. Reg. Section 1.170A-8 (1986).
4 CRS Section 39-22-522. See, H.B. 00-1348.
5 Id. Jay, fn 1. Conservation Tax Credit Exchange Brochure (2002), available at Conservation Resource Center, LEAP111@aol.com; 2334 N. Broadway, Ste. A, Boulder, CO 80304, (303) 544-1044.
6 H.B. 01-1090, codified in amended CRS Section 39-22-522 (signed into law June 1, 2001; effective Jan. 1, 2003).
7 Treas. Reg. Section 1.170A-13(c)(4) (1986).
8 H.B. 01-1090, supra, note 6.
9 McLennan v. U.S., 24 Cl.Ct. 102, 106, n.8 (1991) ("Donation of property for the exclusive purpose of receiving a tax deduction does not vitiate the charitable nature of the contribution.").
10 Jay, supra, fn. 1.
13 H.R. 4-289, Section 1206 (a)(1).
14 Jay, supra, fn. 1.
HB 08-1353, Section 1 (b).
 HB 08-1353, amending CRS 12-61-719.
 The public meeting was a Special Review Committee meeting regarding HB 10-1169, hosted by State Representative, Wes McKinley at the State Capitol Building on August 4, 2010.
 Fiscal Analyst, Harry Zeid, in The Colorado Legislative Council Staff Fiscal Note: State Fiscal Impact, HB10-1169 finds that the State Revenue impact will be $169.5 Million from the Bill and that the General Fund Expenditure will be $26,983. He assumes, of course, that the Department of Revenue estimate of $169.5 Million in disallowed credits will be lost if HB10-1169 were passed. This, however, has been interpreted to mean that if the disallowances are processed, all will be fully disallowed and the State will actually recover the full $169.5 Million in previously unpaid taxes.
 See fns. 2 and 13, supra.
 Fn. 20. supra.
 See, e.g., Colorado State Board of Dental Examiners v. Michell, 928 P.2d 839, 842 (Colo. App. 1996).
 Hughes v. Comm’r of Internal Revenue, U.S. Tax Court, 26, 42,43 (2009); Kiva Dunes Conservation, LLC, E.D. Drummond, Tax Matters Partner v. Comm’r of Internal Revenue, U.S. Tax Court, (2009-145).