Syndicated Easement Promoter's Gain From Sales of LLC Interests Is Ordinary

Internal Revenue Service

In a legal memorandum, the IRS concluded that a syndicated conservation easement promoter’s gain from selling to investors interests in limited liability companies used in easement transactions is ordinary income under <a href="/research/federal/usc26/1221#cqcp-0000003" resolve="/lr/resolve/section-1221a1/cqcp#cqcp-0000003" title="section 1221(a)(1)">section 1221(a)(1)</a> because the promoter held the LLC interests primarily for sale in the ordinary course of business. The taxpayer was an individual who directly, and indirectly through entities owned and managed by the taxpayer, engaged in the promotion and sale of interests in LLCs whose only assets were land. Each LLC engaged in a syndicated easement transaction identified by the IRS as a listed transaction in <a href="/lr/resolve//1fxgg">Notice 2017-10</a> — that is, each LLC donated a conservation easement over the land in exchange for a charitable contribution deduction. To carry out the transactions, the taxpayer identified third-party owners of undeveloped land they had held for more than one year. After the landowner contributed the land to a newly formed LLC, the taxpayer (through a managed LLC) purchased a controlling interest in the landholding LLC in exchange for cash. The taxpayer then directed the managed LLC to divide the land into parcels and to contribute each parcel to separate LLCs, referred to as syndicated conservation easement (SCE) LLCs. The managed LLCs either continued to hold interests in the SCE LLCs or distributed the interests to the taxpayer and two other partners. The managed LLC or the taxpayer then sold the SCE LLC interests to newly formed LLCs (called investor LLCs) and solicited individual investors to purchase interests in them. Shortly after, the SCE LLCs donated a conservation easement to a <a href="/research/federal/usc26/501#cqfp-0000011" resolve="/lr/resolve/section-501c3/cqfp#cqfp-0000011" title="section 501(c)(3)">section 501(c)(3)</a> organization. The SCE LLCs reported the donation as a charitable contribution on their federal tax returns, and the taxpayer and the investors, through the investor LLC, claimed a deduction for their distributive shares of the charitable contribution deduction. The taxpayer reported gains from the sales of the SCE LLC interests to investor LLCs as long-term capital gains. The IRS advised that the gains should instead be treated as ordinary income because the SCE LLC interests sold by the taxpayer are excepted from the definition of capital asset under <a href="/research/federal/usc26/1221#cqcp-0000003" resolve="/lr/resolve/section-1221a1/cqcp#cqcp-0000003" title="section 1221(a)(1)">section 1221(a)(1)</a>. That provision states that the definition doesn’t cover “stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” According to the IRS, the taxpayer met the factors established by case law indicating that the SCE LLC interests were held primarily for sale to customers in the ordinary course of a trade or business. The IRS said its conclusion that <a href="/research/federal/usc26/1221#cqcp-0000003" resolve="/lr/resolve/section-1221a1/cqcp#cqcp-0000003" title="section 1221(a)(1)">section 1221(a)(1)</a> applies doesn’t conflict with <a href="/research/federal/usc26/741" resolve="/lr/resolve/section-741/cp04" title="section 741">section 741</a>, which provides a general rule that gain from the sale or exchange of a partnership interest is capital gain. The IRS said the legislative history of <a href="/research/federal/usc26/741" resolve="/lr/resolve/section-741/cp04" title="section 741">section 741</a> shows that Congress intended to codify a line of cases that had rejected the government’s position that the aggregate theory of partnership determined whether the sale of a partnership interest was a sale of the selling partner’s undivided interest in each specific partnership asset. The courts in those cases held that the entity approach should determine the consequences of the sale of a partnership interest. The IRS noted that none of those cases contained facts showing that the sale of a partnership interest was something other than the sale of a capital asset. Congress’s codification of that case law shows that it intended to give capital asset treatment only to the sale of partnership interests that are in fact held as capital assets, the agency said. Congress’s statement that <a href="/research/federal/usc26/741" resolve="/lr/resolve/section-741/cp04" title="section 741">section 741</a> merely retained the general rule that the sale of a partnership interest is treated as the sale of a capital asset leaves open the possibility for ordinary treatment on the sale of a partnership interest when the facts and circumstances are appropriate, according to the IRS.

In a legal memorandum, the IRS concluded that a syndicated conservation easement promoter’s gain from selling to investors interests in limited liability companies used in easement transactions is ordinary income under section 1221(a)(1) because the promoter held the LLC interests primarily for sale in the ordinary course of business.

In a legal memorandum, the IRS concluded that a syndicated conservation easement promoter’s gain from selling to investors interests in limited liability companies used in easement transactions is ordinary income under section 1221(a)(1) because the promoter held the LLC interests primarily for sale in the ordinary course of business. The taxpayer was an individual who directly, and indirectly through entities owned and managed by the taxpayer, engaged in the promotion and sale of interests in LLCs whose only assets were land. Each LLC engaged in a syndicated easement transaction identified by the IRS as a listed transaction in Notice 2017-10 — that is, each LLC donated a conservation easement over the land in exchange for a charitable contribution deduction. To carry out the transactions, the taxpayer identified third-party owners of undeveloped land they had held for more than one year. After the landowner contributed the land to a newly formed LLC, the taxpayer (through a managed LLC) purchased a controlling interest in the landholding LLC in exchange for cash. The taxpayer then directed the managed LLC to divide the land into parcels and to contribute each parcel to separate LLCs, referred to as syndicated conservation easement (SCE) LLCs. The managed LLCs either continued to hold interests in the SCE LLCs or distributed the interests to the taxpayer and two other partners. The managed LLC or the taxpayer then sold the SCE LLC interests to newly formed LLCs (called investor LLCs) and solicited individual investors to purchase interests in them. Shortly after, the SCE LLCs donated a conservation easement to a section 501(c)(3) organization. The SCE LLCs reported the donation as a charitable contribution on their federal tax returns, and the taxpayer and the investors, through the investor LLC, claimed a deduction for their distributive shares of the charitable contribution deduction. The taxpayer reported gains from the sales of the SCE LLC interests to investor LLCs as long-term capital gains. The IRS advised that the gains should instead be treated as ordinary income because the SCE LLC interests sold by the taxpayer are excepted from the definition of capital asset under section 1221(a)(1). That provision states that the definition doesn’t cover “stock in trade of the taxpayer or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the taxable year, or property held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business.” According to the IRS, the taxpayer met the factors established by case law indicating that the SCE LLC interests were held primarily for sale to customers in the ordinary course of a trade or business. The IRS said its conclusion that section 1221(a)(1) applies doesn’t conflict with section 741, which provides a general rule that gain from the sale or exchange of a partnership interest is capital gain. The IRS said the legislative history of section 741 shows that Congress intended to codify a line of cases that had rejected the government’s position that the aggregate theory of partnership determined whether the sale of a partnership interest was a sale of the selling partner’s undivided interest in each specific partnership asset. The courts in those cases held that the entity approach should determine the consequences of the sale of a partnership interest. The IRS noted that none of those cases contained facts showing that the sale of a partnership interest was something other than the sale of a capital asset. Congress’s codification of that case law shows that it intended to give capital asset treatment only to the sale of partnership interests that are in fact held as capital assets, the agency said. Congress’s statement that section 741 merely retained the general rule that the sale of a partnership interest is treated as the sale of a capital asset leaves open the possibility for ordinary treatment on the sale of a partnership interest when the facts and circumstances are appropriate, according to the IRS.

Sec. 741 Recognition and character of gain or loss on sale or exchange

Sec. 751 Unrealized receivables and inventory items

Sec. 1221 Capital asset defined

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Syndicated Easement Promoter's Gain From Sales of LLC Interests Is Ordinary