Endangered Species Recovery Deductions ABA Tax Section Meeting January 21, 2011 Todd Reinstein, Pepper Hamilton LLP, D.C., Moderator Martin Osborne, I.R.S., D.C., Panelist Alan S. Lederman, Gunster, Ft. Lauderdale, Panelist 1

2 SOME ENDANGERED SPECIES

ESA On Private Land On private land, not involving federally funded projects, ESA generally prohibits, with respect to wildlife and fish, modifications to a private owner’s land that harm an endangered or threatened species. Harm includes significant habitant modification that injures wildlife by significantly impairing behavioral activities such as breeding, feeding or sheltering. 3

ESA On Private Land For example, in one reported District Court case, a private developer of a condominium was enjoined from continuing construction where the project would injure an endangered species of bird that perched on the project site. The result is that if an endangered species becomes present on the land, current and future development opportunities, and therefore resale value of the land, is seriously impaired. 4

ESA On Private Land Some commentators contend that ESA has promoted vast private sector expenditures to keep endangered species from land, uneconomical premature land development for commercial and housing uses, and, on a smaller scale, “shoot, shovel and shut up.” While some conservationists advocate strengthening ESA’s prohibitions, others advocate more positive incentives for species recovery. Section 175 is in line with the latter, incentive approach. 5

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Recovery Plans ESA requires that the Fish and Wildlife Service (FWS) prepare recovery plans, defined as plans for the conservation and survival of endangered and threatened species. The plans must be “site- specific.” Recovery plans are often criticized by commentators by reason of the plans’ legal unenforceability, large “site-specific” areas, single-species focus, and vagueness. 7

Summary of Section 175 Section 175 generally allows a taxpayer engaged in the trade or business of farming to deduct expenditures incurred for the purpose of achieving site-specific management actions in recovery plans issued under ESA. The annual deduction is limited to 25% of the gross income derived from farming that year. Expenditures that are otherwise depreciable or deductible are not deductible under section 175. ESA and Section 175 raise numerous income tax questions, as the following slides illustrate. 8

ESA-Related Tax Questions Is there any public policy doctrine or other disallowance applicable to: (a) expenditures designed to discourage endangered species recovery but which do not cause ESA-prohibited harm?; or (b) expenditures that cause an illegal harm to an endangered species; or (c) fines and penalties imposed for violating ESA? 9

ESA-Related Questions If, as is often the case, expenses to promote endangered species cannot be shown to increase the value of the land, will they be denied as a business expense for lack of a business purpose?; denied capitalization because not a betterment? and denied section 175 expensing, because not made “in furtherance of the business of farming” as required by pre-2009 Reg (a)(1)? Does the Blue Book stating recovery plans “[result] in a public benefit” eliminate any need for pretax private benefit? 10

ESA-Related Questions Can a charitable contribution be available for an expenditure to promote species recovery consistent with an ESA recovery plan, to the extent the taxpayer can demonstrate there is no increase in value of the land or other benefit? 11

Section “Farming” Limitation Section 175(a) limits the deduction to taxpayers engaged in the business of “farming.” Will Reg , which provides that “a taxpayer engaged in forestry or the growing of timber is not thereby engaged in the business of farming,” be applied to exclude forestry companies from Section 175(a), even though a significant fraction of endangered species are forest-based? 12

“Farming” Limitation Since Section 175(a) does not limit the endangered species deduction to land used in farming, while Section 175(b) limits the deduction to 25% of the gross income from farming: Can a taxpayer owning both non-farming and farming land claim a deduction for endangered species recovery with respect to non-farming land, to the extent of 25% of gross income from the farming land? 13

“Farming” Limitation Similarly, can a taxpayer owning farming land with a large gross income, and also owning a non-“farming” fishing business in the Gulf (Reg limits “farming” to areas where fish are artificially protected, not merely caught) claim a deduction for endangered fish species recovery following the BP oil spill? Since Section 175(c)(3) requires expenditures to be for an ESA recovery plan “for the area in which the land is located,” can only land-based recovery plans support a Section 175(a) deduction? 14

Applicability of Related Section 175 Rules Do Section 175(a) species recovery expenses qualify for the Section 263(a)(1)(C) exception to capitalization for soil and water conservation expenses? Are Section 175(a) species recovery expenses subject to the Section 1252(a) ordinary income recapture rule (phased out over 5-10 years) applicable to soil and water conservation expenses? 15

How “Site-Specific”? Is “site-specific” interpreted consistently with the ESA recovery plan definitions? Can recovery plans adopted before the 1988 ESA requirement of “site-specific” recovery plans be the basis of a Section 175 deduction? 16

How Is a Qualifying Purpose Determined? Is a subjective purpose of promoting species recovery required? In other words, if the only subjective purpose of the expenditure is to improve the land’s value (or perhaps improve the value of adjacent property or property owned by a related party) is the deduction denied? Is an objective benefit to endangered species required? Does consistency with the plan foreclose further IRS inquiry into subjective or objective species benefit? 17

What is “Consistent” with a Recovery Plan? In view of the vagueness of recovery plans for private land, how can consistency be determined? Is consistency with plans for federally-owned land sufficient? Will state plans shed light on federal recovery plans? Recovery plans are usually single-species. Suppose there is more than one species recovery plan for the taxpayer’s land, and these plans are inconsistent. Can the taxpayer use one recovery plan for some expenditures and another recovery plan for others? 18

What is “Consistent” with a Recovery Plan? What if a soil recovery plan is inconsistent with a species recovery plan? Can taxpayer claim soil recovery plan expenses that are inconsistent with the ESA recovery plan, and endangered species recovery expenses that are inconsistent with the soil conservation plan? 19

Threatened Species Can recovery plans for the approximately 300 “threatened” as well as the approximately 1,000 “endangered” species be the basis of a Section 175 deduction? Even though Section 175 only mentions “endangered” species, the Blue Book includes “threatened” species. 20

Guidance Forthcoming? In view of the absence of Section 175 on the Joint Treasury-IRS Priority Guidance Plan released in December 2010, can any guidance be expected soon? 21

Disclaimer This presentation has been prepared for information purposes only and does not constitute legal advice. Such presentation is not intended to create, and receipt thereof does not constitute, formation of an attorney-client relationship. The presentation should not be relied upon for any purpose without seeking legal advice from a licensed attorney. The author expressly disclaims all liability in respect to actions taken or not taken based the contents of this presentation or related materials and information. 22

Disclaimer Circular 230 disclosure: This presentation is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties that may be imposed under the Code. No portion of this presentation may be used in connection with the promotion, marketing or recommendation to another party of any transaction or matter addressed herein as it relates or may relate in any way to any U.S. federal tax advice. ©Alan S. Lederman