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Real Estate Firm Challenges Conservation Easement Reporting Notice

MAR. 11, 2022

GBX Associates LLC v. United States

DATED MAR. 11, 2022
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GBX Associates LLC v. United States

[Editor's Note:

View exhibits in the PDF version of the document.

]

GBX ASSOCIATES LLC
2101 Superior Avenue
Cleveland, Ohio 44114
Plaintiff,
v.
UNITED STATES OF AMERICA,
950 Pennsylvania Avenue, N.W.
Washington, DC 20220

ALSO SERVE:
UNITED STATES OF AMERICA,
c/o Office of the United States Attorney
United States Court House
801 West Superior Avenue, Suite 400
Cleveland, Ohio 44113-1852
and
DEPARTMENT OF THE TREASURY,
150 Pennsylvania Avenue, N.W.
Washington, DC 20220
and
INTERNAL REVENUE SERVICE,
1111 Constitution Avenue, N.W.
Washington, DC 20004
Defendants.

IN THE UNITED STATES DISTRICT COURT
NORTHERN DISTRICT OF OHIO
EASTERN DIVISION

JUDGE: * * *

VERIFIED COMPLAINT FOR INJUNCTIVE AND DECLARATORY RELIEF

Plaintiff GBX Associates LLC brings this action for injunctive and declaratory relief and states as follows:

SUMMARY OF THE CASE

1. Internal Revenue Service Notice 2017-10, attached as Exhibit 1, requires taxpayers and material advisors to report information about certain transactions involving a charitable contribution of a conservation easement.

2. The consequences for noncompliance include both civil penalties and criminal prosecution.

3. Before an agency may promulgate a regulation that has the force of law, the Administrative Procedure Act, 5 U.S.C. §§ 551, 553-59, 701-06 ("APA") requires the agency to publish a notice about the proposed rule, allow the public to comment on the rule and, after considering the comments, make appropriate changes and include in the final rule a concise general statement of its contents (the "notice-and-comment procedures").

4. The Internal Revenue Service ("IRS") did not follow these notice-and-comment procedures when it issued Notice 2017-10.

5. Plaintiff seeks entry of a judgment declaring that Notice 2017-10 is unlawful and an injunction enjoining its enforcement.

6. In light of the recent decision of the United States Court of Appeals for the Sixth Circuit in Mann Construction, Inc. v. United States, No. 21-1500 (Mar. 3, 2022), Plaintiffs likelihood of success in challenging the lawfulness of Notice 2017-10 is high.

7. Plaintiff is suffering and will continue to suffer irreparable harm without an injunction because compliance with the obligations triggered by Notice 2017-10 involves significant time and expense, and the stigma of being involved in transactions described as tax avoidance transactions in Notice 2017-10 damages Plaintiffs business.

8. The public interest is best served by requiring agencies to obey Congressionally mandated procedures when promulgating rules that have the force of law and carry both civil and criminal sanctions.

PARTIES, JURISDICTION AND VENUE

9. Plaintiff GBX Associates LLC ("GBX") is a limited liability company with its headquarters located at 2101 Superior Avenue, Cleveland, Ohio.

10. Defendants are the United States of America; one of its administrative agencies, the Department of the Treasury ("Treasury"); and a bureau of Treasury, the IRS.

11. This Court has jurisdiction over this cause of action pursuant to 28 U.S.C. § 1331, 28 U.S.C. § 1346(a)(2), 28 U.S.C. § 2201 and the APA, 5 U.S.C. § 702.

12. Venue is proper in this judicial district pursuant to 28 U.S.C. § 1391(e)(1)(C).

BACKGROUND AND FACTS

13. GBX is a real estate investment and development firm that focuses on the acquisition, preservation and rehabilitation of historic buildings in urban centers.

14. To assemble the capital required to make these historic buildings contributing assets to the community, GBX utilizes a variety of federal, state and local tax incentives.

15. Congress created two tax incentives related to the rehabilitation and preservation of historic buildings: rehabilitation credits, known as Historic Tax Credits, in 26 U.S.C. § 47, and a tax deduction for the charitable contribution of an easement that preserves the historic character of a certified historic structure, known as an Historic Preservation Easement, in 26 U.S.C. § 170(h).

16. As the IRS has acknowledged, "Congress wanted to encourage both the rehabilitation of historic structures and the granting of facade easements and provided tax incentives to encourage both." Rev. Rul. 89-90, 1989-2 C.B.

17. An Historic Preservation Easement is a "qualified real property interest" described in 26 U.S.C. § 170(h).

18. The Internal Revenue Code allows a deduction for a qualified conservation contribution, which is a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. 26 U.S.C. §§ 170(f)(3)(B)(iii), 170(h)(1)-(5).

19. To utilize this incentive to generate the capital necessary to acquire, preserve and rehabilitate historic buildings, GBX establishes funds through which investors invest in real estate projects and receive, as part of their return on investment, allocations of deductions.

20. On December 23, 2016, without first providing any notice to the public or soliciting comments from the public, Treasury and the IRS released Notice 2017-10, entitled "Listing Notice — Syndicated Conservation Easement Transactions."

21. Notice 2017-10 identifies syndicated conservation easement transactions and any substantially similar transactions as "listed transactions" for purposes of 26 U.S.C. §§ 6111 and 6112 and 26 C.F.R. § 1.6011-4(b)(2).

22. This designation as a "listed transaction" imposes reporting and recordkeeping requirements on taxpayers who participate in the transaction and on material advisors. 26 U.S.C. §§ 6111, 6112.

23. Notice 2017-10 specifies that participants in the transaction "include, but are not limited to, investors, the pass-through entity (any tier, if multiple tiers are involved in the transaction), or any other person whose tax return reflects tax consequences or a tax strategy described" in the Notice.

24. The required reporting for participants is done on IRS Form 8886, Reportable Transaction Disclosure Statement, which must be included with the taxpayer's income tax return and separately submitted to the IRS Office of Tax Shelter Analysis.

25. The instructions to Form 8886 estimate that the burden of completing it is, on average, 21 hours and 31 minutes.

26. Each taxpayer required by Notice 2017-10 to file Form 8886 who fails to do so faces a civil penalty of up to $100,000 or $200,000, depending on whether they are natural persons. 26 U.S.C. § 6707A(b)(2)(A).

27. Any person required by Notice 2017-10 to file Form 8886 who "willfully" fails to do so also faces criminal sanctions of fines and up to one year in prison for each unfiled form. 26 U.S.C. § 7203.

28. Material advisors have both reporting and list maintenance obligations that arise from Notice 2017-10.

29. The required reporting for material advisors is done on IRS Form 8918, Material Advisor Disclosure Statement, which must be filed with the IRS Office of Tax Shelter Analysis by the last day of the month that follows the end of the calendar quarter in which the advisor became a material advisor.

30. Material advisors who file a Form 8918 receive a reportable transaction number from the IRS and must provide that reportable transaction number to all taxpayers and other material advisors for whom the material advisor acts as a material advisor.

31. The instructions to Form 8918 estimate that the burden of completing it is, on average, 14 hours and 31 minutes.

32. Each material advisor required by Notice 2017-10 to file Form 8918 who fails to do so faces a civil penalty of the greater of$200,000 or 50 percent of the gross income derived by such person with respect to aid, assistance or advice which is provided with respect to the listed transaction, increased to 75 percent in the case of an intentional failure. 26 U.S.C. § 6707(b).

33. Any person required by Notice 2017-10 to file Form 8918 who "willfully" fails to do so faces criminal sanctions of fines and up to one year in prison for each unfiled form. 26 U.S.C. § 7203.

34. A material advisor is also required to maintain a list identifying each person with respect to whom the advisor acted as a material advisor. The list must include: (1) an itemized statement containing: (a) the name of each reportable transaction, the citation to the published guidance number for the transaction, and the reportable transaction number, (b) the name, address and TIN of each person required to be included, (c) the date on which each person entered into each reportable transaction, if known, (d) the amount invested in each reportable transaction by each person, if known, (e) a summary or schedule of the tax treatment that each person is intended or expected to derive from participation in each reportable transaction, and (f) the name of each other material advisor to the transaction, if known; (2) a detailed description of the transaction that describes both the tax structure of the transaction and the purported tax treatment of the transaction; and (3) documents, including: (a) a copy of any designation agreement, and (b) copies of additional written materials, including tax analyses or opinions, related to each reportable transaction. 26 C.F.R. § 301.6112-1.

35. Each material advisor must maintain that list in readily accessible form for seven years and make it available to the IRS upon request. 26 C.F.R. § 301.6112-1.

36. Each material advisor required by Notice 2017-10 to maintain a list who fails to make such list available within 20 days of a written request from the IRS faces a civil penalty of $10,000 for each day of such failure. 26 U.S.C. § 6708(a).

37. Any person required by Notice 2017-10 to maintain a list and make it available upon request who "willfully" fails to do so also faces criminal sanctions of fines and up to one year in prison. 26 U.S.C. § 7203.

38. In addition to the federal reporting obligations, several states have laws that impose reporting obligations that are triggered by the IRS's "listed transaction" designation. As a result, both participants and advisors must file disclosures with state revenue departments or face penalties for their failure to do so.

39. GBX is a material advisor with respect to Historic Preservation Easement transactions that the IRS considers substantially similar to the listed transaction described in Notice 2017-10.

40. While GBX believes that the investment funds it forms and manages are distinguishable from the listed transaction described in Notice 2017-10 and are not tax avoidance transactions, the penalties for non-compliance with Notice 2017-10 are so extreme that GBX works diligently to comply on a protective basis with all of the reporting and list maintenance requirements arising from the Notice.

41. GBX spends significant time and money complying with the onerous requirements Notice 2017-10 imposes on GBX as a material advisor and on the funds and project partnerships it manages.

42. GBX also spends significant time and money providing information regarding the reporting and list maintenance requirements to other material advisors, to the investors who participate in the funds GBX offers and to the tax professionals who work with those material advisors and investors.

43. GBX estimates that its employees spend 150-200 hours each year on compliance with Notice 2017-10.

44. GBX also pays outside advisors for guidance on compliance with Notice 2017-10 and review of the Forms 8886 and 8918 that must be filed with the IRS.

45. There is no mechanism for GBX to recover the economic costs associated with complying with Notice 2017-10 and GBX cannot stop incurring these costs without risking criminal prosecution unless and until the Court declares Notice 2017-10 unlawful and sets it aside.

46. In addition, GBX has suffered and continues to suffer reputational harm because Notice 2017-10 improperly declares the investment opportunities it offers and the real estate development projects it undertakes to be tax avoidance transactions.

CAUSE OF ACTION
Violation of the APA's Notice-and-Comment Rulemaking Requirement (5 U.S.C. § 553)

47. Plaintiff repeats and realleges paragraphs 1-46 of this complaint.

48. The APA provides that "[a] person suffering legal wrong because of agency action, or adversely affected or aggrieved by agency action within the meaning of a relevant statute, is entitled to judicial review thereof." 5 U.S.C. § 702.

49. The AP A also authorizes this Court to "hold unlawful and set aside agency action, findings, and conclusions found to be . . . without observance of procedure required by law." 5 U.S.C. § 706(2)(D).

50. "Agency action" includes the whole or part of an agency rule, order, license, sanction, relief, or the equivalent or denial thereof, or failure to act. 5 U.S.C. § 551(13).

51. The IRS and Treasury are each an "agency" within the definition of the APA. 5 U.S.C. § 551(1).

52. Pursuant to the AP A, certain "rules" promulgated by an agency must be published in accordance with notice-and-comment procedures. 5 U.S.C. § 553.

53. "Rule" is defined as, "the whole or a part of an agency statement of general or particular applicability and future effect designed to implement, interpret, or prescribe law or policy." 5 U.S.C. § 551(4).

54. Notice 2017-10 is a "rule" within the definition of the APA. 5 U.S.C. § 551(4).

55. Because Notice 2017-10 is a "rule" under the APA, the IRS was required to issue a notice of proposed rulemaking in advance of its effective date, to allow interested persons an opportunity to make written submissions and comments, to consider those submissions and comments in the final rule, and to include in the final rule a "concise general statement of [its] basis and purpose." 5 U.S.C. § 553.

56. The IRS did not comply with the notice-and-comment procedures when it issued Notice 2017-10.

57. Notice 2017-10 constitutes a "substantive" or "legislative-type" rule subject to the AP A's notice-and-comment procedures as a matter of law. See 5 U.S.C. § 553.

58. Notice 2017-10 has the force and effect of law.

59. Notice 2017-10 creates new substantive duties, the violations of which prompt exposure to financial penalties and criminal sanctions.

60. Notice 2017-10 is not an "interpretive rule" under 5 U.S.C. § 553(b)(3)(A).

61. Notice 2017-10 omits any finding of good cause "that notice and public procedure thereon are impracticable, unnecessary, or contrary to the public interest" or "brief statement of the reasons therefor." 5 U.S.C. § 553(b)(3)(B).

62. Congress did not expressly exempt the IRS from notice-and-comment procedures required by the APA.

63. Notice 2017-10 is unlawful because the IRS and Treasury failed to comply with the notice-and-comment procedures and there is no applicable exception to those requirements.

64. Compliance with Notice 2017-10 has and will continue to injure Plaintiff, subjecting it to onerous reporting and recordkeeping requirements as well as reputational harm.

PRAYER FOR RELIEF

WHEREFORE, Plaintiff respectfully requests that the Court provide the following relief:

i. Declare Notice 2017-10 unlawful and set it aside;

ii. Permanently enjoin enforcement of Notice 2017-10; and

iii. Order all other relief to which Plaintiff may be entitled, including an award of attorneys' fees and costs.

Respectfully submitted,

CRITCHFIELD, CRITCHFIELD & JOHNSTON, LTD.

By: Eric T. Michener (S.Ct. #0074559)
225 North Market Street; P.O. Box 599
Wooster, Ohio 44691
Phone: (330) 264-4444
Fax: (330) 263-9278
E-mail: michener@ccj.com

MCDERMOTT WILL & EMERY LLP

By: Jenny L. Johnson Ware
(pending Motion to be Admitted pro hac vice)
444 West Lake Street
Chicago, IL 60606
Phone: (312) 984-2130
Email: jjohnsonware@mwe.com

Andrew R. Roberson
(pending Motion to be Admitted pro hac vice)
444 West Lake Street
Chicago, IL 60606
Phone: (312) 984-2732
Email: aroberson@mwe.com

Sarah M. Raben
(pending Motion to be Admitted pro hac vice)
444 West Lake Street
Chicago, IL 60606
Phone: (312) 899-8476
Email: sraben@mwe.com

Attorneys for Plaintiff/GBX Associates LLC

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