DEPARTMENT OF REGULATORY AGENCIES, DIVISION OF REAL ESTATE

CONSERVATION EASEMENT TAX CREDIT PROGRAM, AFTER CHANGES IN 2014

NOVEMBER 2016 PERFORMANCE AUDIT

THE MISSION OF THE OFFICE OF THE STATE AUDITOR IS TO IMPROVE GOVERNMENT

FOR THE PEOPLE OF COLORADO

Representative Dan Nordberg – Chair Representative Dianne Primavera – Vice-Chair Senator Rollie Heath Representative Tracy Kraft-Tharp Senator Chris Holbert Senator Tim Neville Senator Cheri Jahn Representative Lori Saine

Dianne E. Ray State Auditor Monica Bowers Deputy State Auditor Jenny Page Audit Manager Christopher Harless Team Leader Kevin Amirehsani Staff Auditors Amber Spencer Torry van Slyke

AN ELECTRONIC VERSION OF THIS REPORT IS AVAILABLE AT WWW.COLORADO.GOV/AUDITOR

A BOUND REPORT MAY BE OBTAINED BY CALLING THE OFFICE OF THE STATE AUDITOR

303.869.2800

PLEASE REFER TO REPORT NUMBER 1561P WHEN REQUESTING THIS REPORT

LEGISLATIVE AUDIT COMMITTEE

OFFICE OF THE STATE AUDITOR

DIANNE E. RAY, CPA ——

STATE AUDITOR

OFFICE OF THE STATE AUDITOR 1525 SHERMAN STREET

7TH FLOOR DENVER, COLORADO

80203

303.869.2800

OFFICE

November 16, 2016

Members of the Legislative Audit Committee:

This report contains the results of a performance audit of Colorado’s Conservation Easement Tax Credit Program within the Division of Real Estate at the Department of Regulatory Agencies. The audit was conducted pursuant to Section 2-3-103, C.R.S., which authorizes the State Auditor to conduct audits of all departments, institutions, and agencies of state government, and Section 2-7-204(5), C.R.S., which requires the State Auditor to annually conduct performance audits of one or more specific programs or services in at least two departments for purposes of the SMART Government Act. This report presents our findings, conclusions, and recommendations, and the responses of the Division of Real Estate.

OF THE STATE AUDITOR

CONTENTS Report Highlights 1 CHAPTER 1 OVERVIEW 3

Conservation Easement Tax Credits 4 Claiming and Using Tax Credits 7 Administration 13 Major Program Changes 15 Program Funding 16 Audit Purpose, Scope, and Methodology 17

CHAPTER 2 ADMINISTRATION OF CONSERVATION EASEMENT TAX CREDITS 21

Timeliness of Application Reviews 23 RECOMMENDATION 1 39 Placeholder Certificate Process 42 RECOMMENDATION 2 50 Fee Setting and Fund Management 52 RECOMMENDATION 3 61 Communicating Review Standards to Appraisers 64 RECOMMENDATION 4 71 Effectiveness of the Tax Credit for Land Conservation 74 RECOMMENDATION 5 83 Policy Considerations 86

APPENDIX A Characteristics of Seven Randomly Selected Conservation Easements Approved for the State Tax Credit A-1

APPENDIX B

Conservation Easements on Private Lands Encumbered Between 2011 and 2015 Compared to Areas Categorized by the Crucial Habitat Assessment Tool B-1

REPORT

FOR FURTHER INFORMATION ABOUT THIS REPORT, CONTACT THE OFFICE OF THE STATE AUDITOR 303.869.2800 - WWW.COLORADO.GOV/AUDITOR

HIGHLIGHTS

KEY FINDINGS

The Division spent an average of 133 days on its initial reviews of conservation easement tax credit applications from January 2015 to June 2016, which exceeded the statutory 120-day average timeframe. Lengthy reviews are an inefficient use of Division resources and increase costs for some landowners.

In an effort to increase cash flow in 2014, the Division created a placeholder process to encourage landowners and non-landowners to prepay fees for preliminary advisory opinions in exchange for discounted fees on future tax credit applications. The Division improperly recorded 63 such prepayments and spent the money before receiving applications for the preliminary advisory opinions, resulting in unfunded liabilities through 2016. As of September 2016, about $48,000 in liabilities remained.

The Division has not collected sufficient revenue from application fees to cover its expenses associated with reviewing applications, partly due to flaws in its fee-setting methodology. Consequently, the Division has had difficulty funding Program staff positions and has a backlog of applications waiting to be reviewed.

The Division identified problems with most conservation easement appraisals from January 2014 to June 2016, indicating the Division could improve its communication to help appraisers understand how to meet applicable standards.

Currently, no state agency reports on the types of lands, wildlife, or habitats being conserved by the Program, making it difficult for the public and policymakers to determine the benefits that the State has received from the Program in return for forgone tax revenue.

The Conservation Easement Oversight Commission may need authority from the General Assembly or legal guidance to set Program policies or direct outcomes, which would help ensure the Program addresses the State’s conservation needs effectively.

BACKGROUND

Colorado landowners are eligible for a state income tax credit when they donate a conservation easement on their land to a qualified organization, such as a land trust or local government.

In 2014, following the passage of Senate Bill 13-221, some Program administration shifted from the Department of Revenue to the Division. The Division instituted processes for reviewing applications for the conservation easement tax credit and for providing preliminary advisory opinions on whether proposed easement donations would qualify for the tax credit.

Since 2000 when the Program began, the State has issued almost $1 billion in tax credits for over 4,200 conservation easement donations on more than 1.7 million acres.

KEY RECOMMENDATIONS

The Division of Real Estate, within the Department of Regulatory Agencies, should: Implement timeliness goals and strategies to reduce the time it takes to review applications and issue decisions. Address the problems created by its placeholder process by either issuing refunds or continuing to track usage. Improve its fee-setting methods to ensure revenues are sufficient to cover the Program’s administrative costs. Better communicate review standards to appraisers and give landowners information on finding competent appraisers. Expand its public reporting on the specific conservation benefits the State receives from the Program. The Division of Real Estate agreed with these recommendations.

KEY CONCERNS The Division of Real Estate (Division) should improve its administration of the Conservation Easement Tax Credit Program (Program) by reviewing tax credit applications faster, improving its management of Program fees and resources,

and implementing strategies to help reduce the incidence of problems in conservation easement appraisals.

DEPARTMENT OF REGULATORY AGENCIES DIVISION OF REAL ESTATE

CONSERVATION EASEMENT TAX CREDIT PROGRAM, AFTER CHANGES IN 2014 PERFORMANCE AUDIT, NOVEMBER 2016

CHAPTER 1 OVERVIEW

A conservation easement is a legal agreement that restricts a landowner’s development and usage rights to preserve land for certain public benefits, such as open space, fish and wildlife habitats, outdoor recreation, or historical sites. Since 1976, Colorado statutes have allowed private landowners to donate a conservation easement on all or a portion of their land to a governmental entity or nonprofit organization, such as a land trust, to permanently limit how the land is used and protect its conservation value [Section 38-30.5-101 et seq., C.R.S.].

4

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

The governmental entity or nonprofit organization that receives a conservation easement donation is known as a conservation easement holder, and it has the right to restrict the landowner from using the land in ways that would be inconsistent with the intended protection, such as building structures, diverting or damming streams, harvesting timber, or conducting surface mining. The landowner retains the ability to occupy, sell, or pass on the land to heirs, and may be allowed to use the property for traditional land uses, such as livestock grazing or farming, depending on the specific terms of the conservation easement. Conservation easements are viewed as desirable mechanisms for land preservation, because conservation-oriented parties, including governments and land trusts, can protect land without having to acquire full ownership of it. The specific conservation purposes being protected and any restrictions on the easement’s land are contained in the deed of conservation easement, which is maintained as part of local property records and the property title.

CONSERVATION EASEMENT TAX CREDITS

Landowners who donate a conservation easement to a governmental entity or nonprofit organization may qualify for federal and state tax benefits. Federal law [26 USC 170(h)] allows landowners to claim a federal income tax deduction for all or part of a donated conservation easement, which the tax code refers to as a “qualified conservation contribution.” Since 2000, Colorado statute [Section 39-22-522, C.R.S.] has allowed landowners to claim a state income tax credit for the same purpose. The state conservation easement tax credit is available to Colorado residents, C corporations, trusts, estates, and members of pass-through entities, such as partnerships, S corporations, and limited liability companies [Section 39-22-522(1), C.R.S.]. Regardless of whether a landowner receives a federal or state tax credit for a conservation

5

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

easement, the property remains on the local tax rolls for property tax purposes. To claim a state conservation easement tax credit, a landowner’s donation of a conservation easement must meet general federal requirements for a charitable contribution, plus specific requirements for a qualified conservation contribution, as described below:

CONSERVATION PURPOSE. State statute [Section 39-22-522(2), C.R.S.]

requires the conservation easement to be donated exclusively for one or more of the following conservation purposes outlined in federal statute [26 USC 170(h)(4)]:

Outdoor recreation or education for the general public. Protection of a relatively natural habitat or ecosystem. Preservation of open space (including farmland and forests) where

there is significant public benefit, and preservation is either for the general public’s scenic enjoyment or pursuant to a federal, state, or local governmental conservation policy.

Preservation of a historically important area or structure.

According to federal regulations [26 C.F.R. 1.170A-14(e)], the deed of conservation easement must prohibit uses of the land that are inconsistent with the established conservation purpose. For example, in Colorado a donated conservation easement would not qualify for the state tax credit if the easement purpose were to protect habitat for a threatened bird species but the easement deed did not prevent the landowner from using insect pesticides that would eliminate the species’ natural food source.

PERPETUITY OF RESTRICTIONS. The deed of conservation easement must ensure that the restrictions remain on the property forever, thereby creating a perpetual legal and financial obligation for current and future landowners to maintain the property in accordance with the easement’s terms and conditions [26 USC 170(h)(5)(a)].

6

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

QUALIFIED EASEMENT HOLDER. The conservation easement must be donated to a qualified organization [26 USC 170(h)(3)]. State statute [Section 38-30.5-104(2), C.R.S.] requires the holder of a conservation easement to be a governmental entity or a nonprofit organization that is exempt under section 501(c)(3) of the federal Internal Revenue Code. Additionally, state statute [Section 12-61-724(8), C.R.S.] requires the receiver of the donation to be certified at the time of the donation by Colorado’s Department of Regulatory Agencies (Department), Division of Real Estate (Division). This certification is intended, in part, to ensure that the conservation easement holder has the resources and commitment to protect the conservation purposes of the donation. State statute [Section 12-61-724(1)(b), C.R.S.] requires the easement holder to assume stewardship responsibilities to ensure that the landowner abides by the easement’s terms and conditions.

QUALIFIED APPRAISAL AND APPRAISER. The amount of money that a landowner can claim as a tax credit for a conservation easement donation is based on the fair market value of the donation, as established by a qualified appraiser in a qualified appraisal [26 C.F.R. 1.170A-13(c)(3)(A) and Section 39-22-522(4)(a)(II.5), C.R.S.]. Federal regulations require the qualified appraisal for the conservation easement donation to be completed no more than 60 days prior to the donation and not later than the filing of the income tax return for the year of the donation [26 C.F.R. 1.170A-13(c)(3)(A)].

In Colorado, any individual who performs a conservation easement appraisal must be licensed as a certified general appraiser and comply with all state licensure and continuing education requirements established by the Board of Real Estate Appraisers (BOREA) [4 C.C.R., 725-4(4.1)(E)(1)]. The appraisal must be credible and performed in accordance with Uniform Standards of Professional Appraisal Practice (USPAP), which is a widely recognized industry standard [Section 12-61-727 (2)(a)(II), C.R.S.]. Further, conservation easement appraisers must complete a conservation easement update course every year [4 C.C.R., 725-2(6) and (7)].

7

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

CLAIMING AND USING TAX CREDITS

To claim a tax credit for a conservation easement donation, a landowner must first apply for a tax credit certificate from the Division. Once the application is approved, the Division issues a tax credit certificate that specifies a particular amount that the landowner can claim for a particular tax year. A “tax year” is the 12-month period covered by a particular tax return; for individuals, the tax year runs on a calendar year—January 1 to December 31. After receiving the tax credit certificate from the Division, the landowner must then submit the certificate to the Department of Revenue with a state income tax return for the year specified to claim the credit. If the landowner receives the tax credit certificate from the Division after the filing deadline for the tax year specified, the landowner may have to submit an amended return to claim the credit.

Unlike most other tax credits, a conservation easement tax credit does not have to be used by the taxpayer claiming the credit within the same tax year. Thus, it is important to distinguish between claiming the credit and using the credit. Landowners can claim a conservation easement tax credit for a donation made within that tax year and can claim only one donation per tax year [Section 39-22-522(6)(b), C.R.S.]. The landowner can use the credit to offset taxes owed during the year of the donation. If the value of the tax credit is greater than the landowner’s state income tax liability for the tax year in which the conservation easement is donated, the remaining value of the credit can be carried forward and used against income tax liabilities in each of the 20 succeeding tax years. The credit cannot be applied to tax years prior to the donation.

Colorado’s conservation easement tax credits are also transferable [Section 39-22-522(7), C.R.S.], meaning that after claiming a tax credit, landowners may sell the right to use the credit to another taxpayer, known as a transferee, for offsetting his or her income taxes. This option has generated an ancillary industry of “tax credit brokers” whom landowners hire to facilitate the sale of conservation easement tax credits to transferees for amounts that are less than their full value.

8

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

TAX CREDIT CERTIFICATES ISSUED

As shown in EXHIBIT 1.1, through the years, the General Assembly has adjusted the methods for calculating the amount of a conservation easement tax credit that a landowner can claim for a single easement donation [Section 39-22-522(4)(a)(II.5), C.R.S.], and the total amount in tax credits that is available for all claims in Colorado in a single tax year, which is also known as the aggregate cap. For the 2016 tax year, statute [Section 39-22-522(2.5), C.R.S.] makes available up to $45 million for conservation easement tax credits on a first-come-first-served basis.

EXHIBIT 1.1. STATE CONSERVATION EASEMENT TAX CREDIT CALCULATION METHODS, MAXIMUMS, AND

AGGREGATE CAPS

TAX YEARS CREDIT AMOUNT BASED ON

THE DONATION’S FAIR MARKET VALUE (FMV)

MAXIMUM CREDIT

ALLOWED PER DONATION

AGGREGATE CAP

2000 to 2002 100% of FMV $100,000 Unlimited

2003 to 2006 100% of the first $100,000 of

FMV plus 40% of any additional FMV

$260,000 Unlimited

2007 to 2010 50% of FMV $375,000 Unlimited

2011 to 2012 50% of FMV $375,000 $22 million

2013 50% of FMV $375,000 $34 million

2014 50% of FMV $375,000 $45 million

2015 to Present 75% of the first $100,000 of

FMV plus 50% of any additional FMV

$1.5 million $45 million

SOURCE: Office of the State Auditor’s analysis of Section 39-22-522, C.R.S.

EXHIBIT 1.2 shows the total amount of tax credit certificates the Division has issued to landowners for Tax Years 2012 through 2016, as of November 2016.

9

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

EXHIBIT 1.2. STATE CONSERVATION EASEMENT

TAX CREDIT CERTIFICATES ISSUED (IN MILLIONS) TAX YEARS 2012 THROUGH 20161

2012 2013 2014 2015 2016

Amount of Tax Credit Certificates Issued

$22.0 $28.2 $11.62 $5.32 $1.92

SOURCE: The Division of Real Estate’s website. 1 As of November 2016. 2 Additional credits may be issued for 2014, 2015, and 2016 because the Division was still reviewing applications for these tax years in September 2016.

Between January 2000, when the tax credit was created, and September 2016, landowners claimed or were approved to claim $965 million in state tax credits on over 4,200 conservation easement donations, covering more than 1.7 million acres. EXHIBIT 1.3 shows conservation easements on private lands in Colorado, including easements that garnered the tax credit and those that did not, as of June 2015, according to the most current data available from the Colorado Ownership, Management, and Protection (COMaP) service, which is a resource sponsored by Colorado State University that maps all protected lands in the state. The map in EXHIBIT 1.3 is segmented to show easements established before 2000 and those established after 2000, when the conservation easement tax credit was created.

11

LEGEND

ESTABLISHED PRE-2000

ESTABLISHED 2000-2015

ESTABLISHED DATE UNKNOWN

STATE CAPITAL

MUNICIPALITY

INTERSTATE HIGHWAYS

EXHIBIT 1.3. CONSERVATION EASEMENTS ON PRIVATE LANDS IN COLORADO

SOURCE: Office of the State Auditor’s analysis of data from Colorado Ownership, Management, and Protection (COMaP v. 10, released April 7, 2016).

13

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

ADMINISTRATION

The Division is primarily responsible for administering Colorado’s Conservation Easement Tax Credit Program (Program), although other state agencies and entities have responsibilities related to conservation easement donations and tax credits, as described below.

DIVISION OF REAL ESTATE. The Division receives and reviews applications for conservation easement tax credits to determine whether (1) the conservation easement is a qualified conservation contribution with a conservation purpose that is recognized by state and federal law and (2) the appraisal is credible and complies with state and federal requirements [Sections 12-61-727(3)(a) and (b), C.R.S.]. After reviewing an application and determining that the easement is qualified under state and federal law and the appraisal is credible, the Division issues a tax credit certificate to the landowner, which entitles the landowner to claim the credit on a state income tax return. The Division also oversees the total aggregate cap for the tax credit. In addition, the Division, in consultation with the Conservation Easement Oversight Commission (Commission), issues conservation easement holder certifications to entities, such as land trusts, that want to receive conservation easement donations that will be used for the tax credit. The Division is also responsible for regulating real estate professionals doing business in Colorado, including real estate appraisers, real estate brokers, and mortgage loan originators. The Division works with BOREA, the Real Estate Commission, and the Board of Mortgage Loan Originators to administer licensing and continuing education requirements, investigate complaints, and take disciplinary action against licensees for noncompliance with applicable requirements.

CONSERVATION EASEMENT OVERSIGHT COMMISSION. The Commission

is a Type 2, nine-member commission that makes the final determination about whether a donated conservation easement is a qualified charitable contribution, as defined by the federal Internal

14

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

Revenue Code, and therefore qualifies for the state tax credit. The Commission also advises the Division about whether to certify conservation easement holders. The Commission members represent a number of different stakeholder interests. By statute [Section 12-61-725(1), C.R.S.], the Great Outdoors Colorado Trust Fund, Department of Agriculture, and Department of Natural Resources each have a permanent member on the Commission, and the Governor appoints the remaining six members for 3-year terms. The six gubernatorial appointments must represent (1) a land trust, (2) a local government agency concerned with open space or land conservation, (3) a land trust or a local government agency concerned with open space or land conservation, (4) an individual who is competent and qualified to analyze the conservation purpose of conservation easements, (5) a certified general appraiser with conservation easement appraisal experience, and (6) a landowner who has donated a conservation easement in Colorado. No more than three of the Governor’s appointees serving at the same time may be from the same political party.

BOARD OF REAL ESTATE APPRAISERS. BOREA is a Type 1, seven-member board that establishes rules regarding licensure, continuing education, and experience requirements for real estate appraisers in Colorado. BOREA also reviews complaints against certified general appraisers who accept a conservation easement appraisal assignment and has the power to take disciplinary action, including revocation of licensure and fines. BOREA’s membership comprises three licensed appraisers, one county assessor, one banker with experience in mortgage lending, one representative of an appraisal management company, and one member of the general public. All members are appointed by the Governor with confirmation by the State Senate for 3-year terms.

DEPARTMENT OF REVENUE. As the State’s tax authority, the Department of Revenue is responsible for administration, collection, audit, enforcement, and other activities pertaining to Colorado’s tax laws. The Department of Revenue’s Taxpayer Service Division is

15

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

responsible for processing tax filings, including all conservation easement tax credit claims. For credits claimed on or after January 1, 2014, the Department of Revenue’s responsibility includes such tax compliance matters as ensuring the individual or entity claiming a credit is a Colorado resident with income tax liabilities, that the full value of the credit has not already been used, and that the credit is not being claimed for multiple donations [Section 39-22-522(3.6)(b), C.R.S.]. The Department of Revenue is authorized to disallow a conservation easement tax credit that does not meet these requirements but is not authorized to disallow a claim based on the requirements under the jurisdiction of the Division and Commission. When the Department of Revenue disallows the use of a credit, statute [Sections 39-22-522.5(2) and (6), C.R.S.] provides taxpayers a process to protest the disallowance in an administrative hearing or bypass the hearing and protest in district court.

MAJOR PROGRAM CHANGES

The Program has undergone the following major changes:

2000: The conservation easement tax credit is created for

landowners donating conservation easements to qualified organizations. The Department of Revenue is solely responsible for determining whether tax credit claims meet the State’s statutory requirements. The General Assembly also makes the tax credit transferrable to other taxpayers through passage of House Bill 00-1348.

2008: Due to abuses of the Program, largely associated with

appraisals, the General Assembly passes House Bill 08-1353, which vests the Division with responsibility for reviewing appraisals of conservation easements for which tax credits will be claimed. The legislation also requires any entity wishing to receive conservation easement donations that will be used to claim a state tax credit to become certified by the Division. Finally, the legislation creates the Commission to advise the Division on whether to approve applications for holder certification and advise

16

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

the Department of Revenue on whether conservation easement donations meet federal and state requirements. The Department of Revenue retains final authority for allowing or disallowing claims for the conservation easement tax credit. The Commission’s advisory role vis-à-vis the Department of Revenue continued for tax credits claimed on conservation easement donations made through 2013 but was replaced by the application review process that was created by Senate Bill 13-221 for donations made on or after January 1, 2014.

2011: The total amount of money available for conservation

easements is capped for each calendar year, following passage of House Bill 10-1197. The Division is vested with responsibility for managing the cap.

2014: Following passage of Senate Bill 13-221, which addressed the audit recommendations from the Office of the State Auditor’s 2012 performance audit of the Program, the Program is restructured, making the Division and Commission responsible for reviewing and approving applications for tax credits and the Department of Revenue responsible for ensuring compliance with all other tax laws related to the claim or use of tax credits. As a result of this change, tax credit claims are certified by the Division and Commission before the taxpayer files a tax return. Senate Bill 13-221 also creates an option for landowners to request a preliminary advisory opinion from the Commission and the Division on an easement’s conservation purpose and the appraisal’s credibility prior to completing a donation transaction and recording the easement [Section 12-61-727(14), C.R.S.].

PROGRAM FUNDING

For Fiscal Years 2014 through 2017, the Division was appropriated 5.8 full-time equivalent (FTE) staff to administer the Program—3.5 FTEs were for reviews of applications for tax credit certificates and preliminary advisory opinions and 1.3 FTEs were for administering the holder certification process.

17

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

The Division’s and Commission’s administration of the Program is entirely cash funded by application fee revenues from landowners applying for conservation easement tax credits or preliminary advisory opinions, and from entities applying to become certified conservation easement holders. Our audit did not review the Division’s processes or funding for certifying easement holders. For the application review function, the Division has collected, on average, about $205,000 in fees each year and expended an average of about $201,000 each year. We discuss the Division’s fees and funding for this function in detail in CHAPTER 2.

AUDIT PURPOSE, SCOPE, AND METHODOLOGY

We conducted this audit pursuant to Section 2-3-103, C.R.S., which authorizes the State Auditor to conduct audits of all departments, institutions, and agencies of state government, and Section 2-7-204(5), C.R.S., the State Measurement for Accountable, Responsive, and Transparent Government (SMART) Act. This audit was conducted in response to a request from the former Executive Director of the Department of Regulatory Agencies. We appreciate the assistance provided by the management and staff of the Department of Regulatory Agencies and Division of Real Estate during this audit. The key objective of the audit was to evaluate Program operations and the effectiveness of Division and Commission processes since the structural changes included in Senate Bill 13-221 took effect in January 2014. The audit also reviewed the extent to which the Division’s processes and changes addressed the concerns in our 2012 performance audit of the Program. This audit did not review the Department of Revenue’s processes, conservation easement donations made prior to January 2014, or processes for certifying conservation easement holders. We performed our audit fieldwork from March to September 2016.

18

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

We conducted this performance audit in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

To accomplish the audit objective, we performed the following audit work:

Analyzed Division electronic data and documentation on

conservation easement tax credit certificate applications and preliminary advisory opinion applications.

Examined Program fee collection and revenue and expenditure

data from the Colorado Financial Reporting System (COFRS) and Colorado Operations Resource Engine (CORE).

Reviewed various sources of information related to land conservation in Colorado, including the Division’s most recent annual report for the Program; Colorado Ownership, Management, and Protection (COMaP); the Colorado Department of Natural Resources’ 2015 edition of the State Wildlife Action

Plan; the Trust for Public Land’s 2009 report, A Return on Investment: The Economic Value of Colorado’s Conservation

Easements; and the Colorado Natural Heritage Program’s 2011 report, The State of Colorado’s Biodiversity.

Interviewed management and staff of the Department of Regulatory Agencies and the nine members of the Commission, and communicated with members of the land conservation community regarding their experiences working with the Division and Commission.

We relied on sampling to support some of our audit work. Specifically, we selected a random sample of 10 of the 62 conservation

19

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

easements for which landowners had received a tax credit certificate, a deficiency letter, or an opinion between January 2014 and March 2016. We designed our sample to provide sufficient and appropriate evidence for the purpose of evaluating Division and Commission application review processes. We planned our audit work to assess the effectiveness of those internal controls that were significant to our audit objectives. Our conclusions on the effectiveness of those controls, as well as specific details about the audit work supporting our findings, conclusions, and recommendations, are described in CHAPTER 2 of this report.

CHAPTER 2 ADMINISTRATION OF

CONSERVATION EASEMENT TAX CREDITS

Since the State established the conservation easement tax credit in 2000, Colorado has witnessed a marked increase in the conservation of privately owned lands. To date, the State has assisted landowners in protecting over 4,200 parcels of land by allowing them to claim about $965 million in tax credits through the State’s Conservation Easement Tax Credit Program (Program).

22

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 Given the amount of tax revenue the State has forgone and will forgo through conservation easement tax credits, it is important that the Program operates effectively, efficiently, and according to statutory intent. For example, as outlined in Section 12-61-727, C.R.S., the Division of Real Estate (Division) must process each application for a conservation easement tax credit in a timely manner, ensure the appraisal supporting the landowner’s requested tax credit amount is credible, and ensure its overall administration of the Program is fiscally sound and transparent. In addition, the Division and the Conservation Easement Oversight Commission (Commission) must ensure each conservation easement donation has a conservation purpose in compliance with federal and state requirements. Overall, we found that the Division has procedures and internal controls in place to ensure that appraisals accompanying tax credit applications are credible, that the conservation easement donation has a qualifying conservation purpose, and that Commissioners and Program staff avoid conflicts of interest when making decisions regarding appraisal credibility and conservation purpose of easement donations. Specifically:

The Division has implemented processes intended to ensure that appraisals are reviewed in a consistent manner using relevant criteria and that appraisers are referred to the Board of Real Estate Appraisers (BOREA) for investigation when significant issues with appraisal credibility are identified. Our audit work indicated that these processes were working as intended.

The Division has implemented controls intended to ensure that Program staff possess appropriate qualifications, education, and experience to review conservation easement applications for compliance with federal and state requirements for the tax credit. Our audit work indicated that these controls were working as intended.

The Division has implemented controls intended to ensure Program staff and members of the Commission abide by

23

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

Department policies and state regulations to avoid possible conflicts of interest. Specifically, all Program staff and Commission members annually sign agreements to disclose conflicts of interest and recuse themselves from tax credit certificate application reviews, discussions, and votes when they have a real or perceived conflict of interest regarding specific applications. Our audit work indicated that these controls are working as intended.

We also identified areas where the Division should improve Program operations related to the timeliness of its application reviews, accounting and fiscal management of the placeholder certificate process, fee setting and cash fund management, communication of its appraisal review standards to appraisers, and public reporting of Program information. Further, we identified matters for policymakers to consider regarding the role and authority of the Commission. The remainder of CHAPTER 2 describes these findings and our recommendations.

TIMELINESS OF APPLICATION REVIEWS A landowner seeking a Colorado conservation easement tax credit certificate begins the process by submitting to the Division an application for either a tax credit certificate or a preliminary advisory opinion on whether a potential easement donation may qualify for a tax credit. The Division reviews submitted applications to determine whether the landowner’s conservation easement donation, or proposed donation, has a conservation purpose that qualifies for the tax credit and whether the conservation easement appraisal is credible. In order for the Division to consider a tax credit certificate application complete, statute [Section 12-61-727(5), C.R.S.] requires that the application include documentation supporting the conservation purpose of the easement and an appraisal of the easement’s value, among other information. The Division requires applications for preliminary advisory opinions to include similar documentation. If the

24

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 Division does not receive a complete application, it communicates with the landowner and appraiser, as appropriate, to obtain the information needed to make the application complete. Upon receipt of an application with all required supporting documentation, Division staff send the landowner a letter stating that the application is deemed complete. Division staff track each application in an electronic database and review completed applications in the order received using checklists to assess whether each potential easement donation meets applicable state and federal requirements for conservation purpose and appraisal credibility. Staff note on the checklists any problems they have identified with an application. Once staff complete their review of the application, they write two detailed reports summarizing their analyses—one on the conservation purpose of the easement and one on the appraisal. In each report, staff note any significant deficiencies or problems that they have identified. Staff also prepare 1-page summaries of each report in which they recommend: (1) full approval or a favorable opinion, (2) denial or a nonfavorable opinion, (3) approval or a favorable opinion if certain conditions are met, or (4) issuance of a deficiency letter to the landowner explaining the deficiencies identified. The Commission has final authority for deciding whether the conservation purpose of an easement donation meets the qualifications for a state tax credit, and it has delegated its approval authority to the Division whenever staff identify no problems related to a donation’s or proposed donation’s conservation purpose. Thus, if Division staff identify no problems with an application, the Division issues a tax credit certificate, or a favorable preliminary advisory opinion, which indicates that if the landowner applies for the tax credit, the Division has not identified a reason to deny it. When Division staff identify problems with an application, either the Commission or the Division Director reviews the problems and decides what action to take. For problems with the conservation purpose of a donation, such as undefined building envelopes (areas

25

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

where building can occur within an easement) that could undermine the conservation values present on the property, Division staff send the application and their conservation purpose checklist, report, summary, and recommendations to the Commission. The Commission reviews the materials provided by staff and votes on whether to approve the tax credit certificate, have the Division staff issue a deficiency letter to the landowner, or issue a favorable or nonfavorable preliminary advisory opinion. For problems with appraisals, the Division Director reviews the Division staff’s checklists, reports, summaries, and recommendations and makes the final decision regarding appraisal credibility. When staff identify significant problems with the appraisal, such as inadequate support for the conclusions in the appraisal, the Division Director may send the landowner a deficiency letter explaining the problems, ask the landowner to obtain a second appraisal (for tax credit certificate applications), or issue a nonfavorable opinion (for preliminary advisory opinion applications). If the landowner resolves all problems related to a tax credit certificate application to the satisfaction of the Commission and Division Director, the Division sends the landowner a tax credit certificate, and if not, the Division sends the landowner a letter of denial. During the period we reviewed, January 2014 through June 2016, the Division received a total of 71 complete conservation easement tax credit applications and 65 complete preliminary advisory opinion applications.

WHAT AUDIT WORK WAS PERFORMED, WHAT WAS THE PURPOSE, AND HOW WERE THE RESULTS OF THE WORK MEASURED?

We analyzed information on the time it took between the Division’s receipt of a complete application to its issuance of a tax credit certificate or an opinion, for the 71 complete tax credit certificate

26

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 applications and 65 complete preliminary advisory opinion applications the Division received from January 2014 through June 2016 (the audit period). We examined the Division’s application file documentation and electronic data for a random sample of 10 of the 62 conservation easements for which landowners had received a tax credit certificate, deficiency letter, or opinion as of March 2016. The sample included seven tax credit applications and seven preliminary advisory opinion applications that landowners submitted for these 10 easements. We also listened to recorded audio of Commission meetings and reviewed meeting minutes, interviewed the nine Commissioners, and obtained anecdotal information about the review process from members of the land conservation community. Additionally, we conducted a survey of 96 landowners who had applied for conservation easement tax credit certificates or preliminary advisory opinions during the audit period and received responses from 58 landowners (60 percent). The purpose of the audit work was to determine whether the Division reviews applications for tax credit certificates and preliminary advisory opinions, and issues decisions, in accordance with the time frames established in statute and rule. Although statute and rules do not establish a firm deadline for the Division’s overall review process, they do specify the average time in which reviews should be made, as well as deadlines for the applicant’s responses and the Division’s final decisions. These timeframes and deadlines are as follows:

120 DAYS, ON AVERAGE, FOR THE DIVISION’S INITIAL REVIEW. Statute states that the Division shall either approve an application and issue a tax credit certificate to the landowner, or mail a letter to the landowner documenting potential deficiencies in the application, within an average of 120 days from the date a completed application is received [Sections 12-61-727(7)(a) and (10), C.R.S.]. Division rules further require the Division to review applications for preliminary advisory opinions and issue either a favorable or nonfavorable opinion within an average of 120 days [4 C.C.R., 725-4(4.4)(G)]. According to the Division, statute establishes an average time frame, and not a firm deadline, because

27

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

some applications are complex and require extensive Division review.

60 DAYS FOR THE APPLICANT’S RESPONSE PERIOD. In cases where the Division or the Commission has identified potential deficiencies in an application for a tax credit certificate, statute specifies that the landowner applicant has 60 days after the mailing date of the Division’s letter to address the potential deficiencies identified and provide the Division with additional information or documentation that the Division deems necessary to make a final determination regarding the application [Section 12-61-727(7)(b), C.R.S.].

90 DAYS FOR THE DIVISION’S SECONDARY REVIEW. Statute specifies that, once the landowner submits additional information to address the deficiencies noted in the Division’s letter, the Division has 90 days to review it and make a final determination regarding the application [Section 12-61-727(7)(c), C.R.S.].

Statute states that the prescribed deadlines “may be extended upon mutual agreement between the [Division] Director and the Commission and the landowner” [Section 12-61-727(7)(d), C.R.S.].

WHAT PROBLEM DID THE AUDIT WORK IDENTIFY?

We found that the Division’s reviews of completed applications for tax credit certificates and preliminary advisory opinions were often not timely.

UNTIMELY INITIAL REVIEWS

TAX CREDIT CERTIFICATE APPLICATIONS. We found that the Division exceeded the 120-day statutory limit for the average time spent on initial reviews of tax credit certificate applications that the Division received since January 2015, spending an average of 133 days for

28

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 applications received between January 2015 and June 2016. The Division received influxes of tax credit certificate applications at the end of December in both 2014 and 2015. For this reason, we analyzed these batches of applications separately from those the Division received during the rest of Calendar Years 2014 and 2015. EXHIBIT 2.1 shows a breakdown of the number of tax credit applications that exceeded the 120-day average time frame and the Division’s average review times for applications received during these periods.

EXHIBIT 2.1. DIVISION’S INITIAL REVIEW TIMES FOR TAX CREDIT CERTIFICATE APPLICATIONS

JANUARY 1, 2014, THROUGH JUNE 27, 2016

PERIOD WHEN THE DIVISION RECEIVED COMPLETED

APPLICATIONS

NUMBER OF APPLICATIONS

RECEIVED

COUNT OF APPLICATIONS EXCEEDING 120 DAYS

AVERAGE LENGTH

OF INITIAL REVIEWS

ANNUAL AVERAGE REVIEW LENGTH

Jan. 1, 2014 – Dec. 27, 2014 23 1 (4%) 61 days 91 days

Dec. 28, 2014 – Dec. 31, 2014 12 8 (67%) 147 days Jan. 1, 2015 – Dec. 27, 2015 22 16 (73%) 159 days

159 days1 Dec. 28, 2015 – Dec. 31, 2015 6 5 (83%)1 162 days1

Jan. 1, 2016 – June 27, 2016 8 02 40 days2 Pending2

TOTALS FOR JANUARY 2014 – JUNE 2016

71 30 (42%) 112 DAYS3

SOURCE: Office of the State Auditor’s analysis of data provided by the Division of Real Estate. 1 Includes four applications that were still being reviewed or waiting in the queue as of June 27, 2016 but which had already exceeded 120 days for their initial reviews at that time. 2 The averages for Calendar Year 2016 are incomplete. As of June 27, 2016, most applications received from January to June 2016 (five of eight applications) were still being reviewed or waiting in the queue and had not yet exceeded 120 days for their initial reviews. The remaining three applications had been reviewed within 120 days. 3 The average review length for January 2014 to June 2016 is incomplete because it includes nine applications that were still being reviewed at the time of the audit.

As shown in EXHIBIT 2.1, the average length of time for initial reviews of tax credit certificate applications was within the 120-day maximum during most of 2014 but exceeded 120 days for applications received between December 28, 2014 and December 31, 2015. As of June 27, 2016, the Division took more than 120 days to review 30 of the 71 complete tax credit certificate applications (42 percent) it had received since January 2014. The Division’s initial review times for the 12 applications that it received at the end of December 2014 more than doubled compared to its review times for the 23 applications it received between January and December 27 of the same year. The

29

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

Division’s longest initial review took 274 days, from February to November 2015. As of June 2016, the Division had not completed its initial review for five of the eight applications that it had received since January 2016, and therefore, it was too early to determine whether the Division’s average review times for these applications would follow past trends.

PRELIMINARY ADVISORY OPINIONS. We found that the Division spent an average of 124 days on initial reviews of applications for preliminary advisory opinions received between January 1, 2014 and June 27, 2016, which exceeds the 120-day average time frame set in rule. EXHIBIT 2.2 shows the number of preliminary advisory opinion applications for which the Division initial review times exceeded 120 days and the average length of initial reviews for applications received during three time periods. As of the end of our fieldwork in June 2016, the Division had not completed its initial review of the 17 applications that it had received since November 1, 2015, and therefore, EXHIBIT 2.2 breaks out these applications separately.

EXHIBIT 2.2. DIVISION’S INITIAL REVIEW TIMES FOR PRELIMINARY ADVISORY OPINION APPLICATIONS

JANUARY 1, 2014, THROUGH JUNE 27, 2016

PERIOD WHEN THE DIVISION RECEIVED COMPLETED

APPLICATIONS

NUMBER OF APPLICATIONS

RECEIVED

COUNT OF APPLICATIONS EXCEEDING 120 DAYS

AVERAGE LENGTH OF

INITIAL REVIEWS

Jan. 1, 2014 – Dec. 31, 2014 26 0 (0%) 51 days

Jan. 1, 2015 – Oct. 31, 2015 22 18 (82%) 168 days

Nov. 1, 2015 – June 27, 2016 17 13 (76%)1 145 days1

TOTALS FOR JANUARY 2014 – JUNE 2016 65 31 124 DAYS

SOURCE: Office of the State Auditor’s analysis of data provided by the Division of Real Estate. 1 As of June 27, 2016, all 17 preliminary advisory opinion applications received since November 2015 were still being reviewed or waiting in the queue, and 13 of these applications had already exceeded 120 days for their initial reviews. The remaining four applications had not yet exceeded 120 days.

As shown in EXHIBIT 2.2, the average length of time for initial reviews of preliminary advisory opinion applications was within 120 days during 2014 but exceeded 120 days for applications received after

30

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 January 1, 2015. The Division took more than 120 days to issue preliminary advisory opinions on 18 of the 22 preliminary advisory opinion applications (82 percent) that it received between January and October 2015; the Division’s longest review was 282 days during this period. As of June 2016, a total of 13 of the 17 applications that have been pending since November 2015 had already been in the Division’s queue for more than the 120-day maximum set by Division rule.

WAIT TIMES FOR INITIAL REVIEWS OF APPRAISALS. When reviewing

application files for a sample of 10 conservation easements we found that the applications often waited in a queue for the Division to begin its initial review of the appraisal. As shown in EXHIBIT 2.3, for the applications in our sample, an average of 94 days elapsed from the date the applications were complete until the date the Division began reviewing the appraisals. Further, five of the 10 sampled applications waited 119 days or longer for the Division’s review to begin, which caused the applications’ review times to exceed 120 days and, therefore, contribute to the average being above the 120-day maximum set in statute and rule.

EXHIBIT 2.3. QUEUE TIMES FOR THE DIVISION’S INITIAL REVIEWS OF APPRAISALS

FOR A RANDOM SAMPLE OF 10 APPLICATIONS

SAMPLED EASEMENTS

MONTH DEEMED

COMPLETE

DAYS APPLICATION WAITED IN QUEUE FOR

REVIEW

TOTAL DAYS FOR THE INITIAL REVIEW1

QUEUE TIME AS A PERCENTAGE OF THE INITIAL

REVIEW

Easement A 2/2014 2 26 8% Easement B 2/2014 31 89 35% Easement C 12/2014 23 106 22% Easement D 12/2014 58 106 55% Easement E 4/2015 175 248 71% Easement F 4/2015 77 112 69% Easement G 5/2015 173 217 80% Easement H 6/2015 142 171 83% Easement I 7/2015 137 215 64% Easement J 8/2015 119 123 97% AVERAGE

94 141 67%

SOURCE: Office of the State Auditor’s analysis of application files provided by the Division of Real Estate. 1 The number of days from the date the application was deemed complete to the completion of the initial review. Includes days the application waited in queue for review.

31

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

Based on our sample review, the initial review period for appraisals would be shorter if applications did not sit in a queue. Once the Division began reviewing these sampled applications, it took from 4 to 83 days, or 48 days on average, to complete the initial reviews.

SECONDARY REVIEWS

We found that the Division exceeded the 90-day time limit for nine of the 19 applications (47 percent) for which it conducted secondary reviews as of September 2016. For all nine that exceeded the 90-day limit, the Division received consent from the landowners to extend the deadlines and so was not out of compliance with statute. Secondary reviews ranged from 29 days to 320 days, with an average of 119 days.

WHY DID THE PROBLEM OCCUR?

Overall, we identified six main reasons for the Division’s untimely application processing for the Conservation Easement Tax Credit Certificate Program, as described below.

LACK OF ANALYSIS TO ENSURE STAFFING ADDRESSES APPLICATION

SURGES. First, we found that the Division has not analyzed staff workload capacity, which is the number of applications staff can process in a given period. Had the Division conducted such analysis, the resulting information could have helped the Division determine whether it needed to adjust staffing levels in response to the surges in tax credit certificate applications it received in December 2014 and December 2015. Although the Division was appropriated 3.5 FTE staff positions for reviewing applications through Senate Bill 13-221, the Division was using only 2.25 FTE staff in January 2015 to review applications, which it does not believe was sufficient to manage the workload. The Division reported to us that it did not hire staff to fill the additional FTE position because revenue from application fees was not sufficient to fund the position. We discuss the Division’s difficulty in setting fees to fully cover costs in the section titled “Fee Setting and Fund Management.”

32

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 As shown in EXHIBIT 2.4, in December 2014, the Division received 21 new applications for tax credit certificates or preliminary advisory opinions, and the average number of applications in review or waiting in a queue increased significantly for the next 11 months. In December 2015, the Division received another relatively large influx of 13 applications for tax credit certificates or preliminary advisory opinions, increasing the average number of applications in review or waiting in a queue.

EXHIBIT 2.4. DIVISION’S AVERAGE MONTHLY WORKLOAD FOR TAX CREDIT CERTIFICATE AND PRELIMINARY

ADVISORY OPINION APPLICATIONS JANUARY 2014 THROUGH JUNE 2016

PERIOD WHEN THE DIVISION RECEIVED COMPLETED

APPLICATIONS

AVERAGE NUMBER OF NEW APPLICATIONS

PER MONTH

AVERAGE NUMBER OF APPLICATIONS IN REVIEW OR QUEUE PER MONTH

Jan. to Nov. 2014 4 8 Dec. 2014 21 33 Jan. to Nov. 2015 4 27 Dec. 2015 13 37 Jan. to June 2016 3 31 SOURCE: Office of the State Auditor's analysis of application data provided by the Division of Real Estate.

Despite the influx of tax credit certificate applications in December 2014, the Division did not prepare for future surges in applications, such as by determining the maximum number of applications that it can process in a month with current staffing levels and following current processes, which is information it needs to determine when staffing changes may be necessary. Our analysis found that the Division has historically kept the backlog of applications waiting in the queue from growing during periods when it received an average of four or fewer tax credit certificate and preliminary advisory opinion applications per month. Thus, given current review processes and Program staffing (two full-time application reviewers and a Program manager who assists part-time with application reviews), we estimate the Division can handle a workload of about 48 tax credit certificate and preliminary advisory opinion applications per year, although this workload capacity estimate would change should the Division change

33

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

its staffing and/or processes. The Division received more than 48 applications in both 2014 and 2015; hence the backlog. Second, although the Division hired part-time external contractors to review applications and manage the backlog for about $21,000 in October 2015, the backlog persisted. We estimate that the addition of one full-time equivalent (FTE) staff for reviewing applications, at the cost of about $77,000 annually, would increase the Division’s capacity for reviewing applications by about 40 percent and eliminate the backlog within about 21 months, assuming the Division makes no other changes to the review process and receives the same rate of new applications going forward. As of August 2016, the Division still had one open FTE staff position that it has never filled due to insufficient revenue from application fees. Our RECOMMENDATION 3 includes improvements that should help the Division address its difficulties with funding its costs, thereby allowing the Division to hire another staff to review applications.

LACK OF PERFORMANCE GOALS AND MONITORING OF REVIEW

TIMELINESS. The Division has not established achievable performance goals for how long applications can wait in a queue or for how long staff should spend reviewing applications. In its strategic plans for Fiscal Years 2014 and 2015, the Division included a goal of 60 days for the total processing time from when an application is deemed complete until it sends a final decision to the landowner. However, the 60-day goal did not distinguish queue wait times from review times and was unachievable given that the average time for initial reviews was at least double that between December 2014 and June 2016. The Division did not establish a timeliness goal for Fiscal Year 2016 and has not set goals for reducing the backlog of applications waiting in queue. Further, the Division does not track sufficient information in a central location to monitor the timeliness of reviews. Although the Division tracks the dates when applications are deemed complete and when it sends deficiency letters to landowners in its database, the Division does not track when reviewers actually begin reviewing applications in

34

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 its database. Thus, the Division is unable to readily calculate the length of wait times and review times and is unable to analyze trends in processing times, which is necessary information for planning staffing levels and gauging the efficiency of its review processes.

APPRAISALS THAT DO NOT MEET DIVISION STANDARDS. The Division reported to us that it takes staff longer to review appraisals that have significant deficiencies that call into question the appraisals’ credibility. Indeed, through our file review of a sample of 10 conservation easements, we found that staff often request more than one revision and engage in multiple back-and-forth exchanges with the appraisers to address deficiencies, which adds time to the review process. Our recommendations in the section titled “Communicating Review Standards to Appraisers” are aimed at reducing the incidence of conservation easement appraisals that fail to meet the Division’s standards.

INEFFICIENT APPLICATION REVIEW PROCEDURES. In June 2016, the Division conducted a Lean review and found that it could streamline two application review procedures that add considerable time to the processing of applications, which we also identified as being inefficient. First, Division staff reported that they often spend a considerable amount of time reviewing title commitment exceptions, which are legal restrictions on the property rights of the landowner and include items such as liens, public utility easements, and rights to drainage ditches. Title commitment exceptions can be numerous for any given property; for example, one conservation easement donation had 135 exceptions, each of which was reviewed by Division staff, per Division policy. This review by Division staff is often unnecessary because it duplicates work that certified conservation easement holders are required to do under state regulations to ensure that any liens or encumbrances are addressed and the conservation purposes will be ensured in perpetuity [4 C.C.R., 725-4(2.1)(B)(2)]. In October 2016, the Division reported to us that it changed its procedures to rely more on the title reviews conducted by easement holders so that staff only review title exceptions that could have an impact on the value or conservation purpose of an easement donation. The Division found

35

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

that it could save at least 15 hours of staff review time per application (a savings of about 75 percent of the review time) by changing its procedures in this way. Second, both the Division’s Lean review and our audit found that the reports staff compose for their application reviews are lengthy and time-consuming to prepare. According to Division staff, the reports, particularly for appraisal reviews, are often repetitive and sometimes take weeks to write and revise. In October 2016, the Division reported to us that it has developed a template for more concise reports. The Division estimated that it can save about 20 hours of staff time on about one-half of the appraisals it reviews by using this more concise report format.

INFREQUENT USE OF SETTLEMENTS. Statute [Section 12-61-727(12)(d),

C.R.S.] gives the Division the option to compromise with a landowner regarding deficiencies in an application “including the amount of the tax credit certificate to be issued.” Applying this compromise option could be an efficient mechanism when deficiencies are not severe enough to change the valuation of the easement to such an extent that the tax credit amount would be affected. However, the Division has offered to compromise with only two of the 19 landowners to whom it sent deficiency letters between January 2014 and June 2016. Further, of the 12 appraisals during this period for which the Division sent deficiency letters and later approved a revised appraisal, six changed the valuation of the easement upon revision and only three changed the valuation sufficiently to affect the amount of tax credit the landowner could claim. The Division may be able to reduce the review time on more applications if it exercises its option to settle when it has sufficient information to support a negotiated settlement or when the appraisal has deficiencies that do not significantly affect the valuation of the easement. For example, if the appraisal valued the easement at $3.5 million and the landowner was claiming the maximum $1.5 million tax credit, a revision in the appraisal would have to reduce the valuation by $550,000 (16 percent) to affect the amount the landowner could claim for a tax credit. In such a scenario, if a revision is not likely to change the value that much, or at all, and

36

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 the deficiencies identified are not fundamental to the credibility of the appraisal, the Division could eliminate its request for a revised appraisal and secondary review by offering to settle with the landowner for the tax credit amount claimed. The Division could send a deficiency letter that explains the landowner’s options to either address the deficiencies identified in the appraisal or accept a denial and subsequent settlement. We estimate that eliminating secondary reviews for some applications could save an average of 130 days per application.

NO MECHANISMS FOR ENCOURAGING LANDOWNERS TO SUBMIT

APPLICATIONS EARLIER IN THE YEAR. The Division has not established submission deadlines or other mechanisms to encourage landowners to submit their applications at times of the year other than December. Currently, two factors tend to encourage taxpayers to submit applications late in the year. First, tax filing deadlines likely play a role in the surges of applications the Division has received in December of each year. To be eligible to receive a tax credit for a given tax year, a landowner must first record the deed of conservation easement with the appropriate county office by December 31 of that year, obtain a tax credit certificate, and file his or her tax return by April 15 of the following year (or October 15 if a filing extension is granted). The process of donating a conservation easement to a certified land trust is lengthy, and landowners often submit their tax credit certificate applications to the Division after recording conservation easements late in the year to meet tax deadlines. Given the average length of review times for tax credit certificate applications, a landowner who submits an application on December 31 is unlikely to receive a decision from the Division by the April 15 tax-filing deadline. Second, the Division revises its application fee amounts annually, publicly informing the Commission of the upcoming changes in December and making the changes effective January 1. The Division increased application fees in 2015 and 2016, so in those years landowners had an incentive to submit applications before January 1 to avoid paying the increased fee amount. If the Division set application submission deadlines earlier in the year, it could

37

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

incentivize submissions at different times and help spread the application review workload more evenly across the year. For example, after improving its processes and reducing the backlog of applications, the Division could set an application deadline of September 15 for landowners who wish to receive a tax credit certificate prior to the April 15 tax-filing deadline. This would give the Division about 210 days to process the application from start to finish, including resolving any noted deficiencies. To ensure that such a deadline is workable and appropriately balances the Division’s priorities with the needs of landowners, the Division may need to obtain input from industry stakeholders, including those who serve on the Commission.

WHY DOES THIS PROBLEM MATTER?

ADDED TIME AND COSTS FOR LANDOWNERS. Statute includes review process time frames to help ensure the application process is timely for landowners. Each step in the review process adds time that landowners must wait to receive a tax credit certificate for filing a tax return. During the audit review period, the Division’s total processing time, from the date it deemed an application complete until it mailed the tax credit certificate to the landowner ranged from 4 days to 328 days, with an average of 131 days. We identified three landowners (of the 58 who applied for preliminary advisory opinions) who submitted applications for tax credit certificates before the Division finished reviewing their preliminary advisory opinion applications, because the Division’s review process was taking longer than they expected. All three landowners had applied for preliminary advisory opinions to determine whether their conservation easement transactions would qualify for the state tax credit but abandoned their applications and did not receive opinions. When applicants abandon their preliminary advisory opinion applications, the application process can be wasted time for the applicant and the Division. Because the Division does not track the time staff spend reviewing preliminary advisory opinion applications, we could not determine the staff resources spent on these reviews prior to the applicants abandoning them. Recognizing the cost to landowners that can be caused by prolonged processing times, the

38

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 Division agreed to reduce the fee for tax credit certificate applications for six landowners who had applied for preliminary advisory opinions from August to October 2015, including two of the three who abandoned their applications before applying for a tax credit certificate. The third landowner was already promised a discount due to the placeholder certificate process we discuss in the next section. In addition, landowners may incur additional costs when the Division is not timely in processing an application. For example, some landowners must file extensions for their tax filings, which causes an additional burden and may increase their costs for professional tax services.

INEFFICIENT USE OF STAFF RESOURCES. When Division staff spend time working with appraisers to correct deficiencies in appraisals that do not affect the valuation of the easement, it is an inefficient use of staff resources. For example, such time could be spent completing substantive reviews of more applications or developing appraisal course materials or guidance on the Division’s review standards, as we recommend in RECOMMENDATION 4.

DISCONTENT IN THE LAND CONSERVATION COMMUNITY. Members of the conservation easement community, including landowners, land trust representatives, and appraisers expressed their concerns to us during the audit regarding the length of the process. In addition, 73 percent (36 out of 49) of participants in our survey who responded to a question on the Division’s timeliness disagreed or strongly disagreed with the statement that “the Division processed their applications in a reasonable amount of time.” During our audit we found that this discontent strained relations between the conservation community and the Division, and between the Commission and the Division, which at times led to miscommunication and breakdowns in collaboration.

39

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

RECOMMENDATION 1

The Division of Real Estate (Division) should implement strategies to reduce the length of time it takes to review applications for conservation easement tax credits and preliminary advisory opinions and to issue its decisions by: A Implementing an ongoing process for analyzing the number of

applications that have been processed and are in a queue, and using this information to evaluate the sufficiency of available staffing resources. The Division should then use the results of this evaluation to seek additional staff resources, if needed.

B Setting goals for the timeliness of application reviews and for

reducing the backlog of applications waiting in queue, and monitoring performance toward such goals and statutory timelines.

C Continuing to identify and implement strategies for improving the

efficiency of application reviews. D Increasing the use of the settlement option for deficiencies in

appraisals when the Division has sufficient information to support a negotiated settlement or when such deficiencies are unlikely to affect the value of the tax credit claimed or the credibility of the appraisal.

E Implementing mechanisms to encourage landowners to submit

applications throughout the year, such as setting deadlines for landowners who want to receive decisions on their applications by a certain date.

40

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

RESPONSE

DIVISION OF REAL ESTATE

A AGREE. IMPLEMENTATION DATE: JULY 2017 AND ONGOING.

The Division understands the importance of analyzing and tracking the resources necessary to process the tax credit certificate applications received. In late Spring 2016, the Division initiated a LEAN project specific to the tax credit certificate application portion of the Conservation Easement Program. One of the recommendations that resulted from the LEAN project was to establish a procedure for tracking the time spent performing specific assignments and workloads. As a result, the Division is now using a Google-based software solution for tracking, and will use such information to seek additional staff resources, if needed. The Division is tracking when applications have been deemed complete, when the 120-day deadline occurs, and internal target deadlines for completion of the appraisal and conservation purpose reviews. The Division is also tracking information that is specific to each application to ensure that staff is consistently informed of each application's progress.

B AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees, and notes that another recommendation from the Division’s LEAN project was to establish a single system for monitoring the different stages of the tax credit certificate application review process and establish internal deadlines for Division staff. The Division is now using a Google-based software solution to monitor the process and deadlines, including timeline goals. As mentioned in the Division's response to 1A, the Division is tracking when applications are deemed complete, the 120-day deadline for each application and internal target deadlines for staff to complete appraisal and conservation purpose reviews. The Division has also streamlined the reporting process as a result of the LEAN project to further reduce the amount of time spent processing applications. In addition to utilizing the foregoing strategies, the Division will evaluate whether there are

41

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

sufficient funds available to enable the Division to hire contractors to assist in eliminating the backlog of applications.

C AGREE. IMPLEMENTATION DATE: JULY 2017.

As noted in the audit report, the Division identified multiple strategies for improving the efficiency of application reviews as part of a LEAN project conducted earlier this year and has implemented the same. For example, the Division is now using checklists for the conservation purpose and appraisal reviews solely when there are no concerns identified with the application and has created efficiencies in how title exception review is documented. The Division agrees to evaluate the progress resulting from the LEAN changes on at least a quarterly basis to determine whether efficiencies are being recognized and whether additional enhancements may be necessary.

D AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division believes that, pursuant to state law, there must be enough accurate data support to allow the Division to extract a value from an appraisal report on which to base a settlement offer. However, the Division agrees with this recommendation in terms of increasing the use of the settlement option when the Director is provided with sufficient information from the appraisal submitted to the Division enabling it to be in a position to negotiate a settlement with the landowner (and the Division has negotiated settlements for three such applications within the past four months). The Division will also evaluate increasing the use of negotiated settlements for applications that have been denied, but prior to the conclusion of the administrative court process.

E AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees to evaluate and implement mechanisms to encourage landowners to submit their applications earlier in the calendar year, and will also endeavor to enhance its communications to the land conservation community to create application submission deadlines that are associated with guaranteed dates of a decision being made on an application.

42

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

PLACEHOLDER CERTIFICATE PROCESS The Division’s operations in administering the Program are cash-funded, meaning that the Division’s administrative costs for reviewing applications for tax credit certificates and preliminary advisory opinions are funded by fees collected from applicants. The Division does not receive appropriations from the State’s General Fund for the Program. Program expenses include the salaries and benefits for three staff and some allocated departmental expenses, such as information technology maintenance costs. When landowners submit an application, they can pay their fee either by check or electronically. Program staff forward all checks to Division accounting staff who validate that all checks and electronic payments are recorded in the State’s accounting system. The fees are deposited into the Conservation Easement Tax Credit Certificate Review Fund (Fund). In January 2014, the Division realized that the amount it was collecting in fees was unlikely to cover costs for the remainder of the fiscal year. To help manage its cash flow, the Division developed a process to collect fees from landowners for preliminary advisory opinion applications before the landowners applied. From February to June 2014, the Division asked representatives of land trusts and other conservation professionals to encourage landowners who were planning to apply for a preliminary advisory opinion to apply earlier or to pre-pay the $2,300 application fee before submitting an application. In return, the Division would grant the landowner a discount of $2,300 on a future application for a tax credit certificate or $4,600 if the landowner pre-paid for preliminary advisory opinions on both the appraisal and conservation purpose of the easement. To represent the transaction in the absence of an actual application, the Division issued what it called “placeholder certificates” to those who paid the fee in advance. The placeholder certificates do not expire and can be used in subsequent years to obtain both a preliminary advisory

43

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

opinion and a discounted tax credit certificate application fee. The Division also promised to grant discounts on future tax credit certificate applications to landowners who applied for preliminary advisory opinions between January and June 2014. The Division uses a spreadsheet to track the purchasers of the placeholder certificates and those entitled to discounts and uses a database and separate spreadsheet to track applications received. From February to June 2014, the Division sold 63 placeholder certificates, collecting a total of $144,900 in advance for preliminary advisory opinion application fees. The Division also promised future discounts to 11 landowners who submitted complete or partial applications for 21 preliminary advisory opinions between January and June 2014. In addition to implementing the placeholder process, from March to May 2014 the Division temporarily halted its application reviews and reassigned Program staff to other projects that had staffing shortages and are funded separately. Although Senate Bill 13-221 authorized the Department of Regulatory Agencies (Department) to obtain a loan from the General Fund during Fiscal Year 2014, it did not obtain the loan because it would not have helped the Division avoid a negative year-end fund balance and over-expenditure, since the loan would not have offset expenditures.

WHAT WAS THE PURPOSE OF THE AUDIT WORK AND WHAT WORK WAS PERFORMED?

The purpose of the audit work was to determine whether the Division’s placeholder certificate process complied with statute and generally accepted accounting principles. As part of the audit work, we analyzed the Division’s data tracking for the 63 placeholder certificates and the 21 promised discounts issued between January and June 2014, and its data tracking for the 65 preliminary advisory opinion applications received from January 2014 through June 2016. We also analyzed Program revenue and expenditure data from the Colorado Financial Reporting System (COFRS) and Colorado

44

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 Operations Resource Engine (CORE). We interviewed staff at the Colorado Department of the Treasury and Office of the State Controller, as well as Department budgeting staff and Division management and staff.

WHAT PROBLEMS DID THE AUDIT WORK IDENTIFY AND HOW WERE THE RESULTS OF THE AUDIT WORK MEASURED?

We found three main problems with the Division’s placeholder certificate process, as described below.

THE DIVISION ACCEPTED FEES FROM NON-LANDOWNERS. Statute [Section 12-61-727(6), C.R.S.], authorizes the Division to collect a fee from “landowners” applying for a tax credit certificate or a preliminary advisory opinion. Section 12-61.727(1)(f), C.R.S., defines a landowner as “the record owner of the surface of the land and, if applicable, owner of the water or water rights beneficially used thereon who creates a conservation easement.” Nevertheless, the Division promoted the idea that land trusts and other conservation professionals purchase placeholders to use at a later date when they had a landowner client ready to submit an application. Division staff discussed this idea at the Commission’s April 2014 meeting, at which time the Commission selected four commissioners who represented the land conservation industry to promote the idea within the broader land conservation community. The Division sent an email to land trusts and landowner representatives in April 2014, which stated that the email recipients could secure a discount on a future tax credit certificate application “without having to identify a specific property to be conserved.” Division staff also communicated that placeholders were transferrable, meaning purchasers could pass or sell them to other landowners or stakeholder entities to use with other donations. The Division thus sold 45 of the 63 placeholder certificates to non-landowners, including three tax credit brokers, a land trust, a law

45

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

firm, and a non-profit organization that helps facilitate conservation easement donations. It is unclear that the Division is authorized to collect fees from these purchasers because they are not landowners and did not pay on behalf of any particular landowner when they purchased the certificates.

THE DIVISION IMPROPERLY RECORDED THE FEES FOR PLACEHOLDER

CERTIFICATES AS REVENUE RATHER THAN LIABILITIES. When the Division received the fees for the 63 placeholder certificates in Fiscal Year 2014, it recorded each $2,300 fee as revenue, rather than a liability as required by generally accepted accounting principles (revenue recognition principle). According to generally accepted accounting principles, revenue is earned when services are provided, and expenses should be reported during the same period in which the associated revenue is earned. The placeholder certificate obligated the Division to review an application for a preliminary advisory opinion at a future, undetermined date. The Division did not provide a service at the time it received the pre-paid fees. Therefore, each of these fees should have been considered unearned revenue and recorded as a liability in the State’s accounting system until the placeholder certificates were redeemed.

THE DIVISION DID NOT KEEP ADEQUATE RECORDS OF PLACEHOLDER

CERTIFICATES. As of March 2016, when landowners redeemed placeholder certificates to obtain preliminary advisory opinions, Division staff had not recorded that the certificates had been redeemed or which applications they were used for. Similarly, for the 11 landowners who were promised discounts on future tax credit applications because they had applied for preliminary advisory opinions before June 2014, the Division did not record which applications were associated with the promised discounts. By inquiring with Division staff about particular applications, we identified two landowners who had multiple application numbers associated with each of their promised discounts. Both landowners had submitted partial applications before the deadline in June 2014 so that they would be eligible for the discounted fees. When the landowners completed their applications in 2015, the Division did not document

46

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 the application numbers associated with each promised discount in its tracking spreadsheets. Further, we found that the Division did not track whether a landowner actually used a certificate to pay for a preliminary advisory opinion application or decided to skip the preliminary advisory opinion and applied directly for a tax credit certificate. By inquiring with Division staff about specific applications, we found that 11 landowners who together possessed 18 placeholder certificates skipped the preliminary advisory opinion and applied directly for a tax credit certificate. The Division allowed all 11 landowners to pay discounted fees for their tax credit certificate applications; however, as of March 2016, the Division had not documented in its tracking spreadsheet or application database that the landowners had abandoned the option to obtain preliminary advisory opinions from the Division.

WHY DID THESE PROBLEMS OCCUR?

THE DEPARTMENT DID NOT HAVE A FUNDING MECHANISM TO AVOID AN

OVER-EXPENDITURE IN THE FIRST YEAR OF THE NEW APPLICATION

REVIEW PROCESS. In Senate Bill 13-221, the General Assembly

authorized the Department to borrow from the State’s General Fund without interest during Fiscal Year 2014 to provide financing needed to implement the new review process “prior to sufficient moneys becoming available in the [Fund].” However, this loan provision did not help the Department as the General Assembly had intended. According to the State Controller, had the Department obtained the loan authorized by Senate Bill 13-221, any portion of the loan used to fund expenditures that the Department did not pay back by the end of Fiscal Year 2014 with offsetting revenue would have caused the Fund’s balance to be negative and constituted an over-expenditure that violates statute [Section 24-75-109(2)(b), C.R.S.]. Since the authorized loan would not have avoided an over-expenditure, the Department did not obtain it, and instead the Division implemented the placeholder certificate process to generate revenue for the Fund.

47

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

DIVISION MANAGEMENT BELIEVED IT COULD ACCEPT A FEE PAYMENT

FROM A NON-LANDOWNER IF THE ULTIMATE BENEFICIARY IS A

LANDOWNER. The Division expected the conservation professionals

who purchased placeholder certificates to eventually transfer the certificates to landowner clients who would redeem them for application review services. However, since the landowners redeeming these placeholder certificates were not involved in the initial transaction, they cannot be considered the buyers of the placeholder certificates. Toward the end of our audit, in October 2016, the Division reported to us that it was seeking advice from the Attorney General on the legality of these transactions, but it had not yet received an opinion.

DIVISION PROGRAM STAFF DID NOT FULLY COMMUNICATE THE

PLACEHOLDER PROCESS TO DEPARTMENT BUDGETING STAFF AND

DIVISION ADMINISTRATIVE STAFF. Department budgeting staff reported being unaware that the purchasers of the placeholder certificates had not submitted applications for preliminary advisory opinions at the time they paid the fee, or that the Division still had outstanding obligations 2 years later to provide preliminary advisory opinions to some purchasers. Thus, Department budgeting staff were unable to properly evaluate whether the placeholder process would fix the problems with the fund balance. Further, the Division reported that its administrative staff person who recorded placeholder payments was not familiar with the placeholder process. As a result of these misunderstandings, the Division improperly recorded the placeholder fees received in the Fund as revenue instead of as liabilities. In late September 2016, after we had discussed these problems with the Division, it made accounting adjustments totaling $48,300 in the State’s accounting system to reclassify the payments for unredeemed placeholder certificates as liabilities.

THE DIVISION DID NOT DEVELOP A METHOD TO TRACK THE

REDEMPTION OF PLACEHOLDER CERTIFICATES FOR PRELIMINARY

ADVISORY OPINIONS. Although Division staff created a spreadsheet for recording the amounts landowners paid for tax credit certificate applications, the Division did not develop a similar method for

48

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 preliminary advisory opinions capable of tracking the complexities that developed when it began allowing landowners and others to pre-pay for applications and transfer placeholder certificates to others. Toward the end of our audit, in September 2016, staff reported to us that they had improved their tracking spreadsheets to record such information.

WHY DO THESE PROBLEMS MATTER?

SELLING PLACEHOLDERS TO NON-LANDOWNERS CREATED LIABILITIES TO

ENTITIES THAT ARE NOT ELIGIBLE APPLICANTS. As of August 2016, the Division was obligated to provide nine preliminary advisory opinions to no one in particular, as the future clients of the tax credit brokers and attorneys who still possessed placeholder certificates had not yet been identified. Further, it is not clear that the Division was authorized to collect fees from non-landowners, so the Division may have been in violation of statute. Thus, the Division may have to refund all fees collected from non-landowners for any placeholder certificates that have not yet been redeemed.

IMPROPER RECORDING OF FEES CREATED AN UNFUNDED LIABILITY. When the Division did not properly record the placeholder certificate fees as liabilities, the fees appeared as revenue available for spending in the State’s accounting system. By the end of Fiscal Year 2014, the holders of 71 placeholder certificates and promised discounts had not yet submitted complete applications for preliminary advisory opinions, but the Division was obligated to provide application reviews for these holders. However, during Fiscal Years 2015 and 2016, the Division spent the money that it had received for these placeholder certificates and partial applications on current-year expenses, and did not reserve revenue to cover the costs of conducting the promised reviews. Although the Division has made accounting adjustments to accurately reflect these obligations in the State’s accounting system, the Division did not maintain a positive fund balance because the money was spent in prior fiscal years. Shortly after making the accounting adjustments, as of September 30, 2016, the fund balance was about -$17,500.

49

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

PROVIDING DISCOUNTS LED TO INCREASED APPLICATION FEES. When the

Division gave a $2,300 tax credit certificate discount to those who purchased a placeholder certificate or submitted an application for a preliminary advisory opinion in Fiscal Year 2014, a portion of the Division’s application review work was unfunded, which caused the Division to raise its application fees in 2015 and 2016, as discussed in the section titled “Fee Setting and Fund Management.”

LACK OF ADEQUATE RECORDS MAKES IT DIFFICULT TO RECONCILE FEE

PAYMENTS WITH APPLICATIONS RECEIVED. Due to the Division’s inadequate record-keeping for placeholder certificates, Division staff must rely on personal knowledge or information kept in separate application files to determine whether the Division has received the correct amount of fee payments from all landowners who have applied for tax credit certificates and preliminary advisory opinions.

50

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

RECOMMENDATION 2 The Division of Real Estate (Division) should address the problems created by the placeholder certificate processes within the Conservation Easement Tax Credit Program (Program) by: A Ensuring that Division administrative staff and Department of

Regulatory Agencies budgeting staff understand the purpose of the Program’s fees, and the services provided in exchange for the fees.

B Either issuing refunds, as appropriate, to all current holders of

placeholder certificates who are not landowners or continuing to track the usage of placeholder certificates for particular applications, depending on the opinion the Division receives from the Attorney General regarding the legality of the placeholder certificates.

RESPONSE

DIVISION OF REAL ESTATE

A AGREE. IMPLEMENTATION DATE: SEPTEMBER 2016.

As a result of the audit, appropriate Division administrative staff and Department budgeting staff understand the purpose of the Conservation Easement Program's fees and services provided in exchange thereof. Further, the Department has made the necessary adjustments to account for the outstanding liabilities, and will ensure that a separate accounting review occurs for newly created fee types in the future (such as the placeholder certificate fees charged three years ago during 2014), with supporting authoritative guidance from the State Controller’s Office where appropriate.

B AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees, and will continue to track the placeholder

51

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

certificates until the last one is utilized and processed. The Division will also issue refunds, as appropriate, to holders of placeholder certificates who are not landowners, depending on the opinion the Division receives from the Office of the Attorney General regarding the legality of the placeholder certificates and whether the Division can retain such fee payments.

52

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

FEE SETTING AND FUND MANAGEMENT When a landowner submits an application for a tax credit certificate or a preliminary advisory opinion, he or she pays a fee to cover the Division’s and Commission’s costs of administering the application review process. This fee revenue is deposited into the Fund and used for expenses, including salaries and benefits for the staff who review the applications and Departmental administrative expenses that are allocated to the Program. Each November, Division staff project the number of applications it will receive for the remainder of the fiscal year by reviewing the number of applications already received and asking representatives of the land trust community about the conservation easement projects they have in progress for which landowners will apply for a tax credit certificate. The Division provides the projections to Department budgeting staff, who calculate what the application fees should be to cover expected costs through the end of the fiscal year. The Department then sets fees for the next calendar year based on these fiscal year calculations, with changes taking effect on January 1. EXHIBIT 2.5 shows the history of the set fees since the Program was restructured by Senate Bill 13-221.

EXHIBIT 2.5. APPLICATION FEES CALENDAR YEARS 2014 THROUGH 2016

APPLICATION FEES 2014 2015 2016

Tax Credit Certificate $4,600 $8,300 $10,375 Preliminary Advisory Opinion on an Appraisal or Conservation Purpose1

$2,300 $2,300 $2,300

SOURCE: Office of the State Auditor’s analysis of Division of Real Estate documentation. 1 Landowners applying for preliminary advisory opinions on both the appraisal and the conservation purpose of an easement pay two application fees, or $4,600.

53

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

WHAT AUDIT WORK WAS PERFORMED, WHAT WAS THE PURPOSE, AND HOW WERE THE RESULTS OF THE WORK MEASURED?

We examined the revenue, expenditures, and Fund activity recorded in the State’s accounting system from the time the Division began using the Fund in November 2013 through June 2016. We also reviewed fee-setting documentation, and interviewed Department and Division staff. The purpose of our work was to determine whether the Division collects sufficient revenue from application fees to cover the costs of reviewing applications. According to statute [Section 12-61-727(6), C.R.S.], “the fees must cover the costs of the Division and the Commission in administering” the aspects of the Program that pertain to the application review process. Therefore, we would expect total revenue in the Fund to be roughly equal to the total expenses incurred for each fiscal year, because all revenue in the Fund is from application fees, and those fees should be set to cover all expenses incurred by the Division and the Commission in reviewing applications.

WHAT PROBLEMS DID THE AUDIT WORK IDENTIFY?

Overall, we found that the Division has not collected sufficient revenue from fees to cover the costs of administering the application review process. EXHIBIT 2.6 shows total expenses from the Fund exceeded revenue in Fiscal Years 2015 and 2016. In addition, had the Division correctly recorded as liabilities the fees it collected for pre-paid preliminary advisory opinions and placeholder certificates, as discussed in the section titled “Placeholder Certificate Process,” the Division’s expenses would have exceeded revenue in Fiscal Year 2014 as well.

54

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 EXHIBIT 2.6. CONSERVATION EASEMENT TAX CREDIT REVIEW FUND REVENUE AND EXPENSES

FISCAL YEARS 2014 THROUGH 2016

SOURCE: Office of the State Auditor’s analysis of data recorded in the State’s accounting systems COFRS and CORE.

WHY DID THESE PROBLEMS OCCUR?

We identified the following deficiencies in the fee-setting process that resulted in the fees being too low to generate sufficient revenue to cover costs.

FLAWS IN THE FEE-SETTING METHODOLOGY. We found three problems

in the Department’s fee-setting methodology, which caused the fees to be set inaccurately for 2015 and 2016. First, Department budgeting staff did not incorporate revenue for the first half of the fiscal year (i.e., July 1 to December 31) into the fee-setting methodology for both years. Since the new fees take effect on January 1, the fees should be set to cover the fiscal year’s estimated expenses minus the amount of revenue received or expected to be received through December 31. However, Department budgeting staff did not subtract the $29,900 in

$(150,000)

$(100,000)

$(50,000)

$-

$50,000

$100,000

$150,000

$200,000

$250,000

$300,000

2014 2015 2016

REVENUE

EXPENSES

CHANGE IN FUND NET POSITION

55

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

revenue that was received between July and December 2014 when setting fees for 2015 or the $117,111 received between July and December 2015 when setting fees for 2016. This flaw in the fee-setting methodology would have caused fees to be higher than they needed to be to cover costs, were it not offset by the second problem described below. Second, due to a breakdown in communication, Department budgeting staff misinterpreted the time frames that Program staff used to project the number of applications that would be received. For the 2015 and 2016 fees, Program staff provided Department budgeting staff with projections of the number of applications they expected to receive during the upcoming calendar year. However, the budgeting staff believed that the projections applied only to the remainder of the fiscal year. For instance, when setting the 2016 fee in December 2015, Department budgeting staff assumed that the projected number of applications applied to the period January 1 to June 30, 2016, rather than January 1 to December 31, 2016. This misunderstanding would have caused the resulting fees to be lower than they needed to be to cover costs, were it not mostly offset by the Department’s failure to incorporate 6 months of revenue in the fee calculations, as described above. Third, for the 2016 fee, the Department miscalculated the discounts that apply to tax credit certificate applications when landowners previously purchased a placeholder certificate (see the section titled “Placeholder Certificate Process”). Specifically, the Department set fees based on the assumption that such discounts would reduce a tax credit certificate application fee by $1,722, rather than $2,300.

INACCURATE PROJECTIONS. The Division incorrectly estimated the number of applications the Program would receive in Calendar Years 2015 and 2016, as shown in EXHIBIT 2.7.

56

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 EXHIBIT 2.7. DIVISION’S APPLICATION AND REVENUE PROJECTIONS COMPARED TO

ACTUAL APPLICATIONS AND REVENUE RECEIVED CALENDAR YEARS 2015 AND 2016 (PARTIAL)

2015 2016 (PARTIAL)

PROJECTION ACTUAL PROJECTION ACTUAL

THROUGH SEPT. 30

Preliminary Advisory Opinion Applications ($2,300 Fee)1

2 14 14 16

Tax Credit Certificate Applications (Full Fee)

8 26 18 9

Tax Credit Certificate Applications with One Discount (Full Fee Minus $2,300)

0 5 9 10

Tax Credit Certificate Applications with Two Discounts (Full Fee Minus $4,600)

21 4 4 0

TOTAL TAX CREDIT CERTIFICATE APPLICATIONS

29 35 31 19

REVENUE FROM APPLICATIONS $148,7002 $252,1003 $314,7252 $208,8503

SOURCE: Office of the State Auditor’s analysis of the Department's fee-setting documentation and revenue data recorded in CORE. 1 Does not include preliminary advisory opinion applications for which landowners previously paid in 2014 through the placeholder certificate process. 2 Projected revenues are based on the number of applications projected for a calendar year and do not reflect the fiscal-year revenue projections the Department used in its fee-setting methodology. 3 Actual revenues reflect total fees deposited into the Fund during the calendar year, including those that were deposited in January but that were paid based on the previous year’s fee amount. We identified two reasons for the Division’s inaccurate projections. First, the Division has not obtained consistent information from the land trust community about the number of conservation easement transactions being worked on. Conservation easement transactions often involve lengthy periods of negotiation between landowners and the land trusts that will eventually become the holders of the easements. Thus, the land trusts are able to anticipate about how many of their conservation easements will likely be used to claim a tax credit in a given year. The land trust trade organization that the Division asked for estimates reported to us that it did not provide the Division estimates for 2016 because some landowners who were

57

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

working with the land trusts were hesitant to move forward with the application process due to delays in the Division’s application processing, making the count of conservation easement transactions more uncertain. As a result, the Division created estimates based on trends from the prior 2 years. Our RECOMMENDATION 1 in the section titled “Timeliness of Application Reviews” should help alleviate concerns with delays in application processing. In addition, the Division could expand its efforts to obtain information on planned conservation easements, for example by contacting the certified land trusts directly, rather than working through the trade organization to obtain the information. A second reason for the Division’s inaccurate projections is its timing. Historically, the Division receives a large influx of tax credit certificate applications in December, as the fees are being set, but the Division does not update its projections at fee-setting time to account for the influx. The Division could improve its projections if it were to take into account the actual number of applications received in December and set submission deadlines to encourage landowners to apply throughout the year, as we discuss in RECOMMENDATION 1. This may require changing the effective date for fee changes. Department staff reported setting fees to take effect on January 1 because Section 12-61-727(6), C.R.S., requires the Division to “certify to the General Assembly the amount of any fees prescribed” on or before each January 1. However, it is not clear that this statute requires the fees to take effect on January 1. For budgetary purposes, the start of the next fiscal year on July 1 may be a good effective date for new fees.

LOW YEAR-END FUND BALANCE TARGETS. Department staff set the fees for 2015 and 2016 with an aim toward ending Fiscal Years 2015 and 2016 with low fund balances ($6,519 and $17,254, respectively). These targets allowed virtually no margin for error; if the Division had received only one fewer application in Fiscal Year 2015 or two fewer applications in 2016 than it expected, it would have ended the respective fiscal year with a negative fund balance. The Department set the targets to avoid the possibility of ending the fiscal year with a fund balance above the 16.5 percent limit on cash fund uncommitted

58

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 reserves imposed by Section 24-75-402, C.R.S. However, having a 16.5 percent year-end fund balance would have been roughly $40,000 each year, more than six times the target the Department set for Fiscal Year 2015 and double the 2016 target. Further, this limit did not apply to the Program during Fiscal Years 2015 and 2016, because it only applies to programs in existence for more than 2 fiscal years. Finally, with the passage of House Bill 15-1261, beginning in Fiscal Year 2015, statute [Section 24-75-402(5)(g), C.R.S.] grants cash funds an exemption on this limit if they have uncommitted reserves of less than $200,000, which is the case for the Fund used for application reviews. Thus, the Department has authority to set fees toward a targeted year-end fund balance much higher than it has historically targeted, which could provide the Program more flexibility to cover expenses during cyclical fluctuations in applications.

INADEQUATE RECORDING AND MONITORING OF FEE REVENUE. The Division is not able to fully analyze why the number of applications and amount of fees received throughout the year differ from the projections that were used for fee setting, because the Division does not have an adequate method for associating fee payments with particular applications. For example, as of March 2016, staff did not record in a centralized database or spreadsheet whether a landowner who applied for a preliminary advisory opinion paid the full application fee or redeemed a placeholder certificate (i.e., a document that entitles a landowner to a preliminary advisory opinion and a discounted fee for a tax credit certificate application). Further, if a landowner had purchased a placeholder certificate, staff did not record sufficient detail, such as the placeholder certificate reference number, to indicate which placeholder the landowner was redeeming when he or she applied for a preliminary advisory opinion or tax credit certificate. Staff maintained a separate list of landowners who had purchased placeholder certificates and relied on memory to determine which placeholder certificate was associated with which application. Toward the end of our audit, in September 2016, staff had begun tracking the redemption of placeholder certificates.

59

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

Similarly, when the Division allowed six landowners to pay discounted fees for tax credit certificate applications because the Division had been delayed in issuing them preliminary advisory opinions, as discussed in the section titled “Timeliness of Application Reviews,” staff did not record which preliminary advisory opinion applications the landowners had previously paid for that entitled them to the discount, nor did staff record any transaction details from the State’s accounting system for the original fee payments. Although two of the six landowners who paid discounted fees under this arrangement completely withdrew their preliminary advisory opinion applications, the Division did not issue refunds or record in the State’s accounting system sufficient information, such as transaction numbers or dates, to indicate which previous fee payments were associated with applications that had been withdrawn and were therefore being used to justify the payment of reduced fee amounts. In the absence of such records, it is difficult for the Division to accurately determine exactly how many applications it received and how much landowners paid in fees for each one. Indeed, Division staff reported to us that they do not reconcile application data with transactions recorded in the State’s accounting system.

WHY DO THESE PROBLEMS MATTER?

Accurate fees and good fiscal management of the Fund are important for the success of the Program. When fee revenue is insufficient to cover costs, the Program may sacrifice the quality of program services to cut expenses. For example, when the Division had a budget deficit due to lack of fee revenue in March 2014, Division management directed staff to stop reviewing conservation easement tax credit applications and work on other Division projects so that their salaries would not be charged to the Fund. The Division did not have a backlog of applications waiting to be reviewed at the time of the 2014 shutdown; however, if such a shutdown were to occur when a backlog exists, such as any time in 2015, the Division would have greater difficulty providing services to landowners in a timely manner. Further, when fees are not set to cover costs, the Division has difficulty funding its staffing expenses. For example, Division

60

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 management reported to us that since January 2014, it has not filled one full-time equivalent (FTE) staff position that the General Assembly appropriated for the Program due to insufficient revenue from application fees to fund the position. The Division’s inability to fund the open staff position contributed to the backlog of applications in the Division’s queue. The Division’s timing for fee setting may also have contributed to the backlog of applications. By increasing fees on January 1 each year, the Division may be incentivizing more applications in late December from landowners wishing to avoid the increased fee. Finally, we estimate that, had the Division properly accounted for the placeholder fees, the Fund’s balance would have been negative in Fiscal Years 2014 to 2016. According to the State Controller’s Office, a negative fund balance would violate Section 24-75-109(2)(b), C.R.S., which prohibits a state agency from overspending resources.

61

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

RECOMMENDATION 3

The Division of Real Estate (Division) should work with the Department of Regulatory Agencies (Department) to improve the fee-setting process to ensure revenue is sufficient to cover the costs of administering the application review process for conservation easement tax credit certificates by: A Ensuring its fee-setting methodology correctly incorporates the

revenue, expenses, and application volume that the Division expects for a single time period and properly accounts for discounted fees.

B Improving the accuracy of the projections used to set fees by

expanding efforts to work with certified land trusts to obtain accurate information on upcoming conservation easement donations.

C Evaluating the most appropriate date to make new fees effective,

such as July 1 to correspond with the fiscal year. If the Department and Division determine that a date other than January 1 is more appropriate, they should take steps to change the date, including seeking legislative change if needed.

D Setting fees to cover the costs of administering the application

review process based on a targeted year-end cash fund balance that is high enough to provide a buffer in the event fee revenue fails to meet expectations, as allowed by statute.

E Implementing a process for reconciling its records of fee payments

received for each application with the State’s accounting system.

62

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

RESPONSE

DIVISION OF REAL ESTATE

A AGREE. IMPLEMENTATION DATE: JANUARY 2017.

The Department has immediately acted to modify its fee documentation for this particular program so that calendar year fee and revenue assumptions and projections are clearly projected on the schedule at the time fees are actually set. The Department and Division will also collaborate in the future to validate all assumptions on credits for previously paid fees.

B AGREE. IMPLEMENTATION DATE: JULY 2017.

Notwithstanding that it is not knowable how many applications will be received for a non-captive program (with a very small individual fee-paying population), the Division will expand upon its prior efforts to encourage submission of accurate information from certified land trusts on upcoming conservation easement donations. Such efforts will include contacting certified land trusts directly, via both electronic mail and telephone communications. If the Division identifies additional stakeholders who may have information germane to the number of applications the Division may receive, the Division will also include those individuals or entities in its outreach.

C AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees to evaluate the best date on which to implement new fees for the program in the future and, to the extent necessary, recommend such a change during the program’s sunset review in 2017.

D AGREE. IMPLEMENTATION DATE: JANUARY 2017.

The Division and Department will consistently adjust fees as appropriate within statutory parameters such that sufficient reserve

63

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

exists to absorb unexpected application volume shortfalls (including targeting a sufficient high enough year-end cash fund balance).

E AGREE. IMPLEMENTATION DATE: OCTOBER 2016 AND ONGOING.

The Division agrees, and Division staff are now tracking such fee payments on an electronic spreadsheet to ensure they reconcile with CORE. Moreover, the spreadsheet is updated in real time as applications are received, and is also shared directly with Division management, the Department's Budget Office and the Department's Controller.

64

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

COMMUNICATING REVIEW STANDARDS TO APPRAISERS House Bill 08-1353 was passed in 2008 to help prevent the over-valuation in conservation easement appraisals that had been identified by the Department of Revenue in prior years. Specifically, due to problematic appraisals, the Department of Revenue disallowed, in part or in whole, 591 of the 4,295 tax credits (14 percent) that were claimed by landowners for Tax Years 2000 through 2014, after either settling with the landowners or prevailing in court challenges. The Department of Revenue found that in many of these cases, the landowners had submitted appraisals that appeared to over-value the easements, enabling the landowners to claim larger tax credits than they were entitled to. Additionally, in 2016 one person was convicted of forging appraisals between 2005 and 2008 that inflated the value of conservation easements to obtain larger tax credits. House Bill 08-1353 established additional oversight over conservation easement appraisers, including giving the Division an oversight role in reviewing conservation easement appraisals and giving the Board of Real Estate Appraisers (BOREA) authority to set additional educational requirements for conservation easement appraisers. From 2011 through 2014, appraisers were required by BOREA to take specialized update courses before appraising conservation easements that will be used for the tax credit, and BOREA reinstated this requirement for conservation easements with an effective date on or after January 1, 2017. As of June 2016, there were 21 appraisers who had appraised conservation easements funded by the state tax credit since January 2014. Statute requires appraisals to be credible, meet federal standards for a federal tax deduction, and conform to Uniform Standards of

65

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

Professional Appraisal Practice (USPAP) [Section 12-61-727(3)(b) et seq., C.R.S.]. The Division has undertaken the following efforts to communicate with appraisers to improve the quality and credibility of appraisals:

The Division provides landowners with letters and staff reports explaining appraisal deficiencies and nonfavorable opinions that landowners can share with their appraisers.

In July 2015, the Division announced that it would not refer appraisers to BOREA for disciplinary action if the Division identified problems with unsigned, draft appraisals—other than fraud or egregious violations of USPAP—when they are submitted for preliminary advisory opinions. When the Division identifies deficiencies in a signed appraisal submitted with a tax credit certificate application, it can result in the Division referring the appraiser to BOREA.

From 2011 through 2014, the Division provided annual BOREA-required courses on conservation easement appraisal standards. The Division wrote materials for the course in 2011 in consultation with six conservation easement appraisers and other professionals engaged in conservation projects, and the course book includes extensive discussions of proper methodologies for valuing easements and methodological red flags to avoid. The 2015 update course had 22 attendees, including 12 of the 21 appraisers who are currently actively appraising conservation easements.

In July 2015, the Division convened a task force of select conservation easement appraisers and representatives from other state agencies to identify ways to improve the course materials and the Division’s appraisal review checklist, and to reduce the number of deficiencies in appraisals.

In January 2016, the Division held an open forum with about 20 conservation easement appraisers to discuss the Division’s

66

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 expectations for written appraisals and improve lines of communication.

WHAT AUDIT WORK WAS PERFORMED, WHAT WAS THE PURPOSE, AND HOW WERE THE RESULTS OF THE WORK MEASURED?

We analyzed information on the Division’s appraisal reviews for the 71 complete tax credit certificate applications and 65 complete preliminary advisory opinion applications it received from January 2014 through June 2016 (the audit period). We examined the Division’s application file documentation and electronic data for a random sample of 10 of the 62 conservation easements for which landowners had received a tax credit certificate, deficiency letter, or opinion as of March 2016. We also reviewed Commission meeting minutes and recorded audio, interviewed the nine Commissioners, and obtained anecdotal information about the review process from members of the land conservation community and landowners who had applied for conservation easement tax credit certificates or preliminary advisory opinions during the audit period. The purpose of the audit work was to evaluate whether the quality and credibility of conservation easement appraisals appear to have improved since 2008. Overall, we expected the conservation easement appraisals to have fewer deficiencies over time as the small group of appraisers who conduct these appraisals become familiar with applicable standards and their expertise grows.

WHAT PROBLEM DID THE AUDIT WORK IDENTIFY?

Overall, we found the Division continues to identify problems with most conservation easement appraisals, which indicates that the Division could improve its communication with the appraiser

67

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

community to help appraisers understand how to meet the Division’s review standards. Division staff identified problems in 100 percent of the 10 sampled appraisals we reviewed that they deemed significant enough to require the appraiser to revise the appraisals—in some cases multiple times. The Division sent the landowner a deficiency letter or nonfavorable opinions for seven of the 10 appraisals. The problems cited in the deficiency letters included serious deviations from USPAP, such as an appraiser’s failure to meet the requirement to include contiguous parcels owned by a family in the appraisal methodology. Further, of the 90 appraisals the Division reviewed from January 2014 to June 2016, the Division rejected 29 (32 percent) that had problems the Division deemed significant in its initial review by sending deficiency letters or nonfavorable opinions to the landowners and appraisers. Five appraisers had the majority of the total deficiency letters and nonfavorable opinions issued (22 of the 29, or 76 percent), with one appraiser having eight of the initial-review rejections. As shown in EXHIBIT 2.8, the rate of appraisal rejections from initial reviews increased from about 5 percent in 2014 to about 43 percent in the first half of 2016. Further, seven of the 12 appraisers (58 percent) whose work products the Division reviewed during 2016 had at least one appraisal rejected by the Division in its initial review.

EXHIBIT 2.8. APPRAISALS REJECTED BY THE DIVISION DURING INITIAL REVIEW

CALENDAR YEARS 2014 THROUGH 2016 CALENDAR YEAR

APPRAISAL REVIEW COMPLETED

APPRAISALS WITH DEFICIENCY LETTERS OR

NONFAVORABLE OPINIONS

APPRAISERS WHO SUBMITTED APPRAISALS WITH

SIGNIFICANT DEFICIENCIES 2014 1 out of 20 (5%) 1 out of 12 (8%) 2015 18 out of 47 (38%) 12 out of 14 (86%) 2016 partial1 10 out of 23 (43%) 7 out of 12 (58%) SOURCE: Office of the State Auditor’s analysis of data and documentation provided by the Division. 1 Includes applications for which the Division completed an initial review between January 1 and June 27, 2016.

68

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 WHY DID THIS PROBLEM OCCUR?

Although the Division has implemented a variety of mechanisms to inform and educate appraisers about its expectations, including reviewing draft appraisals and providing training, we identified additional methods the Division could use to communicate appraisal review standards to appraisers: First, the Division has not provided appraisers a guidebook, course materials, or review checklists that included detailed descriptions of its expectations for conforming to USPAP. According to Division staff and appraisers we interviewed, determining whether an appraisal conforms to USPAP requires a certain amount of interpretation and judgment, because USPAP does not always explicitly state the level of detail appraisers must provide to meet a particular standard. For example, USPAP requires the appraiser to “analyze the relevant legal, physical, and economic factors to the extent necessary to support the appraiser's highest and best use conclusion(s).” Such standards essentially call on appraisers to exercise professional judgment, so offering appraisers more specific guidance may be an efficient way for the Division to encourage the preparation of appraisals that meet its expectations. Second, the Division’s courses for conservation easement appraisers do not provide examples that could help appraisers better meet the expectations of Division reviewers. Specifically, the 2011 course book provides no examples drawn from actual appraisals to show appraisers how to adequately document their methodologies and market assumptions. Similarly, the course the Division presented in 2015 discussed the most common categories of problems that staff encounter when reviewing appraisals, but the course didn’t provide the participants examples of appraisals that met and did not meet the Division’s expectations to help explain how appraisers can avoid common problems. Third, although most of the 21 appraisers attended the Division’s open forum in January 2016 and the 2015 course, seven of the

69

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

appraisers received deficiency letters or nonfavorable opinions on appraisals during Calendar Year 2016, indicating more could be done to ensure appraisals meet the Division’s standards. By providing regular opportunities for discussion, for example, webinars or call-in conferences on topics such as common problems identified with appraisals, the Division could better educate the appraisers on ways to avoid drafting appraisals with deficiencies. Offering more open forums would also give the Division an opportunity to hear from other experienced appraisal professionals and receive input on how USPAP applies to conservation easement appraisals and on emerging best practices in the industry. As previously discussed, a subset of appraisers is responsible for most deficiencies with appraisals. However, the Division could do more to provide more information to landowners to help them assess the competency and expertise of conservation easement appraisers. One example might include the Division providing instructions on the Program’s webpage regarding how to research appraisers and providing a link to the appropriate BOREA webpage to allow landowners to determine whether disciplinary actions have been levied against specific appraisers.

WHY DOES THIS PROBLEM MATTER?

RELATIONS ARE STRAINED BETWEEN THE DIVISION AND THE

CONSERVATION COMMUNITY. The lack of understanding among appraisers regarding the Division’s appraisal standards has strained relations between the Division and program stakeholders, including appraisers, Commissioners, landowners, land trusts, and tax credit brokers. Appraisers reported to us that these strained relations could lead to a shortage of qualified appraisers, both because some may stop conducting conservation easement appraisals due to confusion and frustration and because some could face disciplinary action due to problems in appraisals. Problems that the Division identifies in appraisals can result in the Division referring appraisers to BOREA for formal complaint investigations and possible disciplinary action. Since 2014, the Division Director has referred five of the 21 conservation

70

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 easement appraisers to BOREA for investigation and asked BOREA to determine whether to open an investigation on a sixth appraiser. Such investigations could result in disciplinary sanctions, such as fines and license censure or revocation. As of September 2016, BOREA had ruled on four of the five cases the Director referred, imposing sanctions on all four, and declined to open an investigation on the sixth. The remaining appraiser continued appraising while the case was being investigated.

TIME AND COST TO THE LANDOWNER AND THE DIVISION. On average, applications with appraisal deficiency letters took 39 days longer to approve and issue a tax credit certificate than those that did not have these letters during the audit period. The Division has the authority to require a landowner to purchase a second appraisal from a different appraiser for a conservation easement donation due to failure of the first one to meet the Division’s standards. Although requiring second appraisals is uncommon, landowners responding to our survey indicated that the cost would be between $10,000 and $30,000. In addition, the lack of clarity about what is needed for an appraisal to meet the Division’s expectations may result in some landowners incurring costs for preliminary advisory opinions unnecessarily. Beginning in 2015, the Division started receiving applications for preliminary advisory opinions on appraisals for easements that had already been recorded with the county. The landowners may have submitted these applications due to some land trusts beginning to require their landholder clients to apply for preliminary advisory opinions with draft appraisals to protect the appraisers from referral to BOREA. Although the Division’s approach to issuing opinions on appraisals of easements with recorded deeds may have allowed some appraisers to address deficiencies in their draft appraisals without fearing professional sanctions from BOREA, we were not able to identify ways that it benefitted landowners. When landowners apply for preliminary advisory opinions on easement transactions that are already completed and recorded, the landowners incur the unnecessary expense of paying the $2,300 fee for the opinion, rather than simply applying for a tax credit certificate.

71

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

RECOMMENDATION 4

The Division of Real Estate (Division) should work to reduce the incidence of rejected conservation easement appraisals submitted with tax credit applications by: A Developing materials, or improving existing materials, to

communicate the Division’s expectations and appraisal review standards to appraisers. Such materials could include, but need not be limited to, a guidebook on how the Division interprets appraisal standards for documenting analyses.

B Improving modes of communicating appraisal review standards to

conservation easement appraisers. Improvements could include, but need not be limited to, providing examples of good appraisals in course materials and developing a regular forum for appraisers and Division staff to discuss interpretations of appraisal standards and how to meet the Division’s requirements.

C Pursuing means of providing more information to landowners to

help them assess the competency and expertise of conservation easement appraisers.

RESPONSE

DIVISION OF REAL ESTATE

A AGREE. IMPLEMENTATION DATE: JULY 2017.

On May 5, 2016, the Board of Real Estate Appraisers adopted a permanent rule to require those appraisers who prepare and sign an appraisal for a conservation easement in which a state tax credit may be claimed to complete the “Conservation Easement Update Course.” The course, which should be available by mid-November 2016, must be completed before an appraiser can complete an appraisal

72

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 assignment of a conservation easement for which a tax credit may be claimed. Once completed, the course is valid from the date the certificate of completion is issued through December 31st of the following calendar year. The new course content provides examples of both credible appraisals, as well as appraisals with deficiencies. The course will also cover the Uniform Standards for Professional Appraisal Practice and the U.S. Treasury Regulations. Instructional materials will be provided to the course participants, and the Division will explore developing additional guidance materials as well.

B AGREE. IMPLEMENTATION DATE: DECEMBER 2017.

Since the inception of the tax credit certificate application portion of the program, the Division’s appraisal examiners have been providing one-on-one feedback to the appraisers during the course of the application reviews about their work product. However, the Conservation Easement Update Course described previously (which should be available by mid-November 2016) will provide a forum for the appraisers to ask questions and discuss appraisal methodology. The Division will also expand its outreach efforts by conducting additional stakeholder meetings on an ongoing basis with the appraisers who prepare and complete conservation easement appraisals to discuss, and when possible, address industry concerns.

C AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees it is important to provide information to encourage the public to hire competent appraisers, and currently does so. For example, the Division currently provides the public with a list of the appraisers that have completed the Conservation Easement Update Course. In addition, appraiser disciplinary actions are viewable by the public as “public discipline” (some of which is available on the Division’s website). However, the Division agrees with the strategy suggested in the audit report, and will provide landowners with instructions regarding how to search an appraiser in the Division's eLicense system. The Division currently provides online resources and Frequently Asked Questions (FAQs) for consumers regarding eight different regulatory programs, including "Donating a

73

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

Conservation Easement." However, the Division will also develop and publish additional FAQs that a landowner may use when interviewing an appraiser to assist in determining whether the professional has the knowledge and expertise necessary to perform a particular appraisal assignment.

74

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

EFFECTIVENESS OF THE TAX CREDIT FOR LAND CONSERVATION Since 2000, the State has invested nearly $1 billion in the form of forgone tax revenue to conserve about 1.7 million acres of private land through the Program. In the 2.5 years following the Program’s restructuring by Senate Bill 13-221, which created the Division-managed application review process in 2014, the State has invested about $15.7 million to conserve about 39,000 acres of private land.

WHAT WAS THE PURPOSE OF THE AUDIT WORK, WHAT WORK WAS PERFORMED, AND HOW WERE THE RESULTS MEASURED?

The purpose of the audit work was to determine whether the benefits that the State receives from the Program in return for its investment in forgone tax revenue adequately address statewide conservation needs. In the legislative declaration for Senate Bill 13-221, the General Assembly stated that “the ability of landowners to claim a state income tax credit for the donation of a conservation easement is an important tool to help preserve the scenic beauty, natural resources, agricultural lands, and wildlife of Colorado.” In light of this legislative intent, we sought to determine the extent to which the Program protects open space landscapes, including agricultural lands; big game and critically threatened and endangered species; and high-priority habitats in need of conservation. To determine the benefits the Program provides Colorado in return for its monetary investment, we analyzed Division data on tax credit certificate applications approved between January 2014 and June

75

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

2016 (the audit period) and reviewed the Program’s 2014 Annual Report (Program Report), which was published in November 2015. The Program Report is the only such report the Division has published as of September 2016 and covers applications received during Calendar Year 2014. We also reviewed application documentation for a random sample of seven of the 55 conservation easements approved for tax credits between January 2014 and March 2016 to evaluate the extent to which they align with State conservation priorities by comparing them to the following:

The list of Tier 1 Species of Greatest Conservation Need identified in the 2015 State Wildlife Action Plan. The State Wildlife Action

Plan was developed by the Colorado Division of Parks and Wildlife in coordination with other state agencies and nonprofits. The State Wildlife Action Plan is intended to be used for statewide conservation planning, articulating conservation priorities on a wide range of wildlife (e.g., greater and Gunnison sage-grouse and the Preble’s meadow jumping mouse), big game (e.g., elk and pronghorn), plants (e.g., Colorado hookless cactus and Pagosa skyrocket), and habitats (e.g., ponderosa pine and shortgrass prairie).

The high-priority habitats identified by the Colorado Natural Heritage Program in its 2011 report, The State of Colorado’s

Biodiversity, which is referenced in the State Wildlife Action Plan. The Colorado Natural Heritage Program is a nonprofit organization affiliated with Colorado State University that tracks rare and threatened species [e.g., the Pawnee montane skipper (butterfly) and the boreal toad] and ranks Colorado’s habitats (e.g., greasewood and aspen) based on levels of biodiversity, threats, and protection.

In addition, we used geographic-information-system (GIS) software to compare the locations of conservation easements on privately owned lands to boundaries of high-priority conservation areas, as defined by the Crucial Habitat Assessment Tool, which is a mapping tool referenced in the State Wildlife Action Plan. Sponsored by the Western

76

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 Association of Fish and Wildlife Agencies, the Crucial Habitat Assessment Tool is a 16-state project intended to provide “a high-level, coarse-scale overview of crucial habitat” for decision-making on land uses. A crucial habitat is defined by the Crucial Habitat Assessment Tool as “a place likely to provide the natural resources important to aquatic and terrestrial wildlife, including species of concern, as well as hunting and fishing species.” For this analysis, we also used GIS data from the Colorado Ownership, Management, and Protection (COMaP) service, which is the most comprehensive map of protected lands in the state and is sponsored by Colorado State University. Using data from COMaP, we determined the locations of 114 conservation easements on privately owned lands that were established between January 2011 and June 2015, many of which—though not all—garnered tax credits for the landowners. Due to limitations in the available COMaP and Division data, we were not able to determine the precise locations of the seven sampled easements or restrict our GIS analysis to conservation easements that garnered the state tax credit.

WHAT PROBLEM DID THE AUDIT WORK IDENTIFY?

Overall, we found it difficult to determine the benefits that the State receives from the Program because currently no state agency reports on the types of lands being preserved through the Program, how they are used, or the specific wildlife and habitats they support that are valuable for conservation. In the absence of such reports, we conducted analyses, described below, to identify wildlife and habitats being protected by some conservation easements, which could be performed and reported by the Division for all conservation easements funded by the state tax credit.

WILDLIFE PROTECTED. The applications for three of the seven

conservation easements we sampled indicated there was physical evidence or a confirmed sighting of a Tier 1 Species of Greatest Conservation Need on the land, which are the species of highest

77

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

conservation priority identified in the State Wildlife Action Plan. Tier 1 includes 55 species, including the northern leopard frog, green-back cutthroat trout, lesser prairie-chicken, lynx, and white-tailed prairie dog. Two other sampled applications indicated Tier 1 species were possibly present based on the lands’ vegetation and location in relation to areas where the species are known to live. Applications for each of the seven sampled easements stated that the lands were home to big game animals, such as elk and mule deer. APPENDIX A shows the wildlife protected by the seven sampled conservation easements.

HIGH-PRIORITY AREAS AND HABITATS CONSERVED. EXHIBIT 2.9 shows

the acres in each crucial habitat category identified by the Crucial Habitat Assessment Tool that were preserved by 114 conservation easements from January 2011 to June 2015. We found that 28 conservation easements preserved about 80,000 acres in the highest priority Category 1 and Category 2 areas during this period. In addition, 102 conservation easements preserved about 192,000 acres in Category 3, 4, and 5 areas and another 11,000 acres in areas with no category ranking. Some conservation easements preserved acres in multiple crucial habitat categories. The Crucial Habitat Assessment Tool ranks each geographic area of the state that contains crucial habitats on a scale of one to five, with Category 1 representing rare or fragile areas considered essential to maintaining the viability or diversity of wildlife species, and Category 5 representing areas likely to have significant wildlife values but unknown levels of importance in meeting conservation objectives. Areas with no ranking do not contain habitats for any Tier 1 Species of Greatest Conservation Need. APPENDIX B shows the map of 114 conservation easements created from January 2011 to June 2015 in relation to the crucial habitat category areas.

78

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 EXHIBIT 2.9. ACRES PRESERVED BY 1141 CONSERVATION EASEMENTS ON PRIVATE LAND2 BY

CRUCIAL HABITAT CATEGORY JANUARY 2011 TO JUNE 2015

SOURCE: Office of the State Auditor’s analysis of data from Colorado Ownership, Management, and Protection (COMaP v. 10) and the Crucial Habitat Assessment Tool. 1 Some conservation easements protect land in multiple crucial habitat categories. 2 Includes both conservation easements for which landowners claimed a tax credit and those for which landowners did not.

In addition, we found that one of the seven sampled easements protected an under-conserved habitat type—greasewood—as shown in APPENDIX A. The Colorado Natural Heritage Program classifies the overall conservation status for 18 habitat types across the state using four categories: under conserved, weakly conserved, moderately conserved, and effectively conserved. The most frequently occurring habitat type among the seven sampled easements was sagebrush, which is classified as weakly conserved.

0

20,000

40,000

60,000

80,000

100,000

120,000

CATEGORY 1 CATEGORY 2 CATEGORY 3 CATEGORY 4 CATEGORY 5 NO CATEGORY

AC

RE

S

CRUCIAL HABITAT CATEGORIES

10 EASEMENTS

25 EASEMENTS

45 EASEMENTS

78 EASEMENTS

16 EASEMENTS

8 EASEMENTS

79

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

WHY DID THE PROBLEM OCCUR?

Currently, no single state agency is charged with tracking and reporting on the specific benefits the State receives from the Program in return for its investment in forgone tax revenue. Under statute [Section 12-61-727(13)(a), C.R.S.], the Division is required to prepare an annual Program Report that includes information on the appraised values and general conservation purposes of approved easement donations. For example, the Program Report states that virtually all the acres conserved in 2014 protected both open space and relatively natural habitats. However, the Program Report does not provide detail on the types of land conserved or the benefits the State is receiving from its investment. For example, it does not:

Indicate whether the Program helps achieve any statewide conservation priorities, such as those articulated in the State

Wildlife Action Plan and the Crucial Habitat Assessment Tool;

Identify the types of landscape such as ranches, croplands, forests, or mountain views that were preserved for open space;

List the wildlife, plant, and fish species protected or whether the lands are home to any of the 55 wildlife species designated as “species of greatest conservation need” in the State Wildlife Action

Plan;

List the types or acreages of habitat that have been protected, for example by summarizing conservation easement acreages by the 18 terrestrial habitats identified by the Colorado Natural Heritage Program;

Map the conservation easements that received tax credits. In fact, currently, no map exists of the conservation easements that have been funded by the state tax credit, so it is not possible to conduct comprehensive geographic analyses on the benefits the Program is providing.

80

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 Since Senate Bill 13-221 vested the Division with responsibility for receiving and reviewing tax credit certificate applications and responsibility for reporting on the outcomes of the Program, the Division is well-positioned to be able to report more broadly on the conservation results of the Program. Division management reported to us that it does not compile and report the type of information we describe above for two main reasons. First, management does not believe the Division has clear authority or responsibility for such reporting; it believes statutory change would be needed to allow it to expand its current reporting. Second, the Division does not have a process to collect and review some of the data it would need to expand its reporting. For example, it does not know the specific open space landscapes, fish, plant, and wildlife species, or habitat types that have been protected by the Program. Although landowners typically describe the conservation values of their land in their conservation easement tax credit applications, the Division does not collect this information in a way that permits aggregate analysis and reporting. Further, the Division does not have a process to consistently collect the GIS mapping coordinates for conservation easements. Although land trusts often determine the coordinates when accepting conservation easement donations from landowners, the Division does not require landowners to include this information in their applications. If the Division collected such information, it may be able to share it with the maintainers of the COMaP service at Colorado State University for the purpose of mapping conservation easements that the State has helped fund through the tax credit. The COMaP service maintains GIS data on conservation easements that comes from a variety of voluntary providers. However, the COMaP data set does not include every easement that was funded by the state tax credit or distinguish between those that were funded by the tax credit and those that were not.

81

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

According to the Division, statute may not allow it to publish maps of conservation easements for which it issued tax credit certificates or to share information on such easements with the maintainers of COMaP. Specifically, statute states that the Division and the Commission “shall deny the right of public inspection of any documentation or other record related to information obtained as part of an individual landowner’s application for a tax credit certificate or an optional preliminary advisory opinion” [Section 12-61-727(16), C.R.S.]. However, it is not clear whether the information that is protected by this statute includes the geographic locations of conservation easements. As the Division seeks to improve and expand its public reporting to include specific conservation values, it should also release its annual reports in a timelier manner. In reviewing the Division’s reporting, we found that, as of October 2016, the Division had not published the Program’s 2015 Annual Report because it was waiting until most of the applications received during that year had been approved or denied. Statute requires the Division to report for each calendar year “the total number of tax credit certificate applications received, approved, and denied” [Section 12-61-727(13)(a)(I), C.R.S.], meaning that the Division should report on applications received even if it has not yet completed its reviews of some applications. Each year’s report should be an annual snapshot showing both the number of new applications received during the year that just ended and the outcomes of applications that were received during the prior year but processed during the year that just ended.

WHY DOES THIS PROBLEM MATTER?

When information on the outcomes and benefits of the Program is not compiled and reported, the public and policymakers have a difficult time assessing the Program’s performance in light of its costs. In 2009, the Trust for Public Land, which is a national organization that conducts research and helps communities protect land, estimated that Colorado had earned a 6-to-1 return on state funds that had been invested in conservation easements since 1994, taking into account

82

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 conservation easements that received state funds through the state tax credit and Great Outdoors Colorado, and the economic effects of various benefits the easements provide, such as water supply protection, flood control, protection of fish and wildlife habitat, recreation, and aesthetics. However, such a return is not guaranteed for future investments in conservation easements, because the return depends on the quality of the lands being preserved. Over time, as more private land with high conservation value is either conserved or developed and real estate prices continue to rise, the benefits the State receives in return for its investments in conservation easements could decrease. Each year, the Program offers up to $45 million that can be claimed by landowners placing conservation easements on their properties [Section 39-22-522(2.5), C.R.S.]. To ascertain whether this potentially $45-million-per-year Program continues to be a cost-effective method of contributing to achievement of the State’s conservation priorities and whether it provides a high return on the State’s investments, policymakers need access to good information on what the Program is achieving.

83

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

RECOMMENDATION 5

The Division of Real Estate (Division) should improve and expand its public reporting on the benefits the State receives from the Conservation Easement Tax Credit Program (Program) by: A Collecting and reporting on the extent to which the Program helps

achieve statewide conservation priorities, such as those articulated in the State Wildlife Action Plan and the Crucial Habitat Assessment Tool, and on the species and habitats being protected by conservation easements that have been issued state tax credit certificates. If needed, the Division should seek legal guidance and/or statutory change to clarify its authority and responsibility for such reporting.

B Seeking a legal opinion from the Office of the Attorney General on

whether statute allows the Division to share specific geographic information on conservation easements for which state tax credit certificates have been issued with the maintainers of the Colorado Ownership, Management, and Protection (COMaP) service for the purpose of mapping such easements. If the Attorney General determines that statute does not allow the Division to share such information, the Division should work with the General Assembly to seek legislative change, as appropriate, to allow it to share the information needed by COMaP for mapping the locations of conservation easements for which state tax credit certificates have been issued.

C Issuing statutorily required annual reports earlier, such as by

March for the prior calendar year, to include information on the applications received during the previous calendar year regardless of whether a decision has been issued on them.

84

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

RESPONSE

DIVISION OF REAL ESTATE

A AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees that information about Colorado’s Gross Conservation Easement Program should be transparent and should demonstrate the utility of the program in achieving statewide conservation priorities. Pursuant to Section 12-61-727(13), C.R.S., the Division is required to create a report that provides five specific categories of information, including aggregate data on the "total number of tax credit certificate applications received, approved, and denied," along with average processing times; "the total acreage under easement summarized by the allowable conservation purposes;" "the total appraised value of the easements;" "the total donated value of the easements;" and "the total dollar amount of the tax credit certificates issued." The statute also allows the Division to include additional "easement-specific information" in the report if the information is otherwise publicly available. Given the foregoing, the Division does not believe it has existing statutory authority or resources to implement this recommendation, and thus, believes the statute would need to be modified to do so. That being said, the Division agrees to evaluate the matter further, and if a statutory modification and/or financial appropriation is necessary, the Division will recommend this change during the program’s Sunset Review in 2017.

B AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division will seek a formal opinion from the Office of the Attorney General as to whether the Division may share specific geographic information on conservation easements for which state tax credit certificates have been issued. If the Attorney General determines that a legislative change is necessary, the Division will make a recommendation to change the law during the Sunset Review of the

85

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

program in 2017. Additionally, the Division will evaluate if there are other sources of information that may serve COMaP’s needs.

C AGREE. IMPLEMENTATION DATE: JULY 2017.

The Division agrees with this recommendation, and will evaluate its resources to identify a period earlier in the year when the annual report may be issued, without compromising the Division’s ability to complete tax credit certificate application reviews prior to the April 15th tax deadline. The Division also believes an appropriate disclaimer should be included in any such report, as issuing the report earlier in the calendar year will result in publication of incomplete data.

86

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6

POLICY CONSIDERATIONS During our audit, we identified areas in which the Conservation Easement Oversight Commission (Commission) lacks explicit authority for setting policies for the Conservation Easement Tax Credit Program (Program) and directing Program outcomes. This is a matter for policymakers to consider, and therefore, we issue no recommendations in this section.

THE COMMISSION’S SCOPE OF AUTHORITY

When reviewing applications for tax credit certificates, the Commission’s authority is narrowly restricted in statute [Section 12-61-727(3)(d), C.R.S.] to determining whether conservation easement donations are “qualified conservation contributions” as defined in the federal Internal Revenue Code and associated regulations. According to the federal Internal Revenue Code, such contributions must be given to a qualified organization exclusively for one or more of the following four conservation purposes, which the easement must protect in perpetuity:

Outdoor recreation or education for the general public. Protection of a relatively natural habitat of fish, wildlife, or plants,

or similar ecosystem. Open space for scenic enjoyment of the general public or as part of

a federal, state, or local governmental policy, yielding a significant public benefit.

Preservation of a historically important land area or certified historic structure.

If the Commission does not identify any deficiencies in an application based on these federal criteria for a qualified conservation contribution that cannot be resolved—and if the Division finds no

87

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

deficiencies related to the credibility of the appraisal that cannot be resolved—then statute says “the [Division] Director and the Commission shall approve the application, and the Division shall issue a tax credit certificate to the landowner” [Sections 12-61-727(10) and (11), C.R.S.]. Statute [Section 12-61-727(12)(d), C.R.S.] grants the Commission and Division authority to compromise with a landowner when they identify deficiencies in an application. However, the Commission lacks clear authority to define what constitutes a deficiency.

THE COMMISSION LACKS CLEAR AUTHORITY TO SET GOALS, PRIORITIES, AND STANDARDS FOR APPROVING TAX CREDIT CERTIFICATES

The General Assembly has not charged any entity with setting specific goals or priorities for the Program, such as the amount of private land that the Program aims to preserve for specific conservation purposes. Consequently, the Commission does not have a measure for ensuring that the Program is effective at addressing the State’s highest conservation needs. For example, as discussed in the previous section titled “Effectiveness of the Tax Credit for Land Conservation,” the Program appears to protect some wildlife species in need of conservation; however, no priorities have been established for determining whether the Program protects a sufficient amount of land for Tier 1 Species of Greatest Conservation Need, such as the Gunnison sage-grouse or burrowing owl, in relation to the amount of land it protects for big game. Similarly, no criterion has been set for determining whether the Program protects a sufficient amount of critical habitats deemed “under conserved” by the Colorado Natural Heritage Program or geographic areas of the state deemed Category 1 by the Crucial Habitat Assessment Tool. As discussed in the previous section, this is a mapping tool that ranks areas of the state containing crucial wildlife habitats on a scale of one to five, with Category 1 representing rare or fragile areas considered essential to maintaining

88

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 the viability or diversity of wildlife species, and Category 5 representing areas likely to have significant wildlife values but unknown levels of importance in meeting conservation objectives. We found that only three of seven conservation easements in the random sample we reviewed for the previous section had confirmed evidence of Tier 1 species, and only one of the seven protected an under-conserved habitat (see APPENDIX A). We also found that, between 2011 and 2015, Colorado landowners conserved about one-thirteenth the acreage of land in Category 1 areas compared to the acreage conserved in Category 4 areas. In the absence of specific Program goals and priorities, we were unable to determine whether the wildlife species, habitats, and geographic areas we identified that have been protected by the Program represent the right balance for addressing the State’s conservation needs. If the General Assembly were to decide that the Program needs direction to ensure that the State’s highest conservation needs are met, the Commission may be the entity best suited for developing Program goals and priorities, given its composition. Specifically, the Commission includes representatives from non-profit land trusts, the Department of Natural Resources, the Department of Agriculture, Great Outdoors Colorado, and other conservationists who are familiar with the state’s overall needs for land preservation and who have connections with the greater land trust community. Implementation of any Program goals or priorities would have to be coordinated with the land trusts that have been certified by the Division to hold conservation easements qualifying for the tax credit, because the land trusts typically fill the front-line role of soliciting landowners to donate conservation easements through the Program. For example, if the Commission were to establish specific goals and priorities for the Program, the Division could require certified land trusts to demonstrate how their selection criteria and acquisition strategies align with the Commission’s goals and priorities. If the Commission were to set goals and priorities for the Program, it could also use them as a basis for ensuring that each conservation easement tax credit issued secures benefits that are in the best interest

89

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

of taxpayers. For example, the Commission could use its goals to establish additional standards that conservation easements must meet to be approved for a tax credit. The Commission could also compromise with landowners on the dollar amount of a tax credit when a conservation easement fails to align fully with the Commission’s goals or priorities, or when the overall benefits provided to the State do not seem to be commensurate with the easement’s appraised value. This is an important distinction, because the value of the tax credit for a conservation easement is based on the real estate market, which may not always reflect how the land’s attributes are valued from a conservation standpoint. We identified the following four issues that raise the question of whether the benefits provided by certain types of conservation easements are worth the amount of money the State is investing in the easements in the form of forgone tax revenue. The Division has brought conservation easements exhibiting each of these issues to the Commission for review on multiple occasions and has indicated to us that it believes the Commission has authority to formulate policy for these issues. However, on each occasion, the Commission has concluded that it lacks authority to address the issues by setting Program goals and priorities, issuing formal guidance, or developing standards for approving applications for tax credit certificates. Thus, the General Assembly may choose to clarify the Commission’s scope of authority in these areas.

SMALL-ACREAGE EASEMENTS. The Commission lacks clear authority to create minimum acreage requirements for conservation easements qualifying for the tax credit. Our audit found that the smallest conservation easements that were approved for tax credits between January 2014 and June 2016 (the audit period) had the highest dollar amounts of tax credits per acre conserved. The high ratio of state dollars invested to acres conserved for several of these easements caused Commissioners to ask whether the State is receiving values commensurate with its investment. For example, in the March 2015 Commission meeting, Commissioners discussed whether to approve a $90,000 tax credit for a 4.8-acre conservation easement covering two

90

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 contiguous lots in a subdivision near Estes Park, one of which had a 3,200 square-foot home on it. For this easement, which prevents the landowner from selling the second lot to a developer, the State’s investment was about $18,000 in tax credits per acre, which is significantly more than the median of $650 per acre for tax credits approved during our audit period. Commissioners questioned whether the State was gaining sufficient benefits in the form of wildlife protection, given the small size of the easement. One Commissioner remarked, “It just looks to me like it’s a great opportunity for a landowner to prevent having a house built close to them, and also it pays for their land. What a benefit to that landowner, but is it a benefit to the State of Colorado? – I don’t think so.” On the other hand, another Commissioner said, “The question of ‘Is there conservation value?’ really doesn’t have anything to do with how much they are getting for the tax credit, because that’s going to vary depending on where you are in the state anyway.” A third Commissioner remarked, “It clearly has some conservation value,” and later added, “I think that [the federal law that defines a ‘qualified conservation contribution’] is sufficiently vague that it would be very hard for this Commission to defend saying ‘there are no conservation values on this property’ or ‘the easement doesn’t protect them.’” Commissioners made similar points in the August 2015 Commission meeting when they discussed whether to approve a $375,000 tax credit for a conservation easement on a one-acre yard adjacent to a city park in Aspen. In both cases, the Commission decided it lacked authority to deny the tax credits based on the size of the easements and, so, approved the tax credits after determining that the properties’ conservation values met the federal requirements.

EASEMENTS WITH NATURAL RESOURCE EXTRACTION. The Commission

lacks clear authority to require landowners seeking the tax credit to restrict subsurface mining activity on the land, such as by obtaining surface use agreements from the owners of the mineral rights. Although surface mining is prohibited by conservation easements that qualify for the tax credit, federal regulations allow some methods of subsurface mining that have “limited, localized impact on the real property but that are not irremediably destructive of significant

91

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

conservation interests” [26 C.F.R., 1.170 A-14(g)(4)(i)]. However, it is not always clear whether the impact of subsurface mining meets this criterion. For example, during the December 2014 Commission meeting, Commissioners discussed a preliminary advisory opinion application for a $306,000 tax credit for a conservation easement on a 720-acre property that had 12 coalbed methane wells on nine separate well pads. One Commissioner stated that the mining activity was problematic due to the often-significant noise and dust from oil-company truck traffic that was mentioned in the application materials. During the meeting, Division staff asked whether Commissioners wanted to develop a formal position statement to explain how it evaluates the effects of oil and gas development on conservation values when reviewing tax credit certificate applications. Most Commissioners were uncomfortable to do so for fear that the resulting standard might have been viewed as arbitrary, and so the Commission decided not to provide guidance on the topic. Ultimately, the Commission issued a favorable opinion, and the landowner received a tax credit for the full amount requested.

EASEMENTS WITH FLOATING BUILDING ENVELOPES. The Commission lacks clear authority to set limitations on the use of building envelopes in conservation easement deeds. Conservation easement deeds are frequently written with provisions allowing the landowner to erect limited structures, such as a house or barn, on a defined section of the property. However, sometimes the deeds are written to include “floating building envelopes,” which define large sections of the property within which the landowner may select an area to build a structure at a future date. By allowing the landowner potentially to build on multiple areas of the property, such provisions increase the risk that future building could harm or compromise the conservation values that the easement intends to protect. In the November and December 2015 Commission meetings, Commissioners expressed difficulty in assessing the potential negative impact of a 40-acre floating building envelope on a 560-acre conservation easement that allowed the landowner to develop on two acres anywhere within the envelope. After receiving additional information from the landowner, the Commission issued a favorable opinion on the conservation

92

CO

NSE

RV

AT

ION

EA

SEM

EN

T T

AX

CR

ED

IT P

RO

GR

AM

, AFT

ER

CH

AN

GE

S IN

201

4, P

ER

FOR

MA

NC

E A

UD

IT –

NO

VE

MB

ER

201

6 purpose of the easement, indicating that it would likely be approved when the landowner applied for a tax credit certificate. However, in discussing this easement, the Commission discussed whether it had legal authority to provide general guidance or establish standards for approval regarding the use of floating building envelopes in conservation easements qualifying for the state tax credit. To date, the Commission has not created such guidance or standards.

EASEMENTS ON LAND THAT IS ALREADY CONSERVED. The Commission

lacks clear authority to deny or reduce the amount of tax credits for conservation easements created on land that is already protected by a conservation easement. Landowners may put more than one conservation easement on their property, or amend existing easements, to further protect conservation values that may not have been fully protected in the initial easement deed. In the September 2014 meeting, Commissioners discussed whether to issue a favorable preliminary advisory opinion on a conservation easement donation that was placed on 35 acres of land that was already included in a conservation easement that the landowner used to claim a $100,000 tax credit in 2002. The primary change between the existing easement and the new easement was removal of a building envelope, which augmented the protection of the land’s conservation values somewhat but did not increase the number of acres that had been conserved. Ultimately, the Commission issued a favorable opinion, and the landowner received a $242,500 tax credit for the second easement. If the General Assembly were to empower the Commission to limit or adjust the amount of tax credits approved in such cases where landowners previously received a tax credit for the same land parcels, it may also need to give the Department of Revenue authorization to coordinate with the Commission to help detect when such cases arise so that the Commission will be able to decide whether to deny or reduce the amount of the second tax credit. The Commission has not addressed these four issues because it lacks clear authority to establish requirements for the tax credit and define what constitutes a deficiency in a tax credit certificate application. Were such authority granted, the Commission would be able to either

93

RE

POR

T O

F TH

E C

OL

OR

AD

O ST

AT

E A

UD

ITO

R

deny applications that do not meet the Commission’s standards or compromise with landowners on the amount of tax credits granted to ensure they do not exceed the value of the conservation benefits the State receives in return for forgone tax revenue.

APPENDIX A

A-1

CHARACTERISTICS OF SEVEN RANDOMLY SELECTED CONSERVATION EASEMENTS APPROVED FOR THE STATE TAX CREDIT

JANUARY 2014 TO JUNE 2016

SAMPLED EASEMENT

1 2 3 4 5 6 7

GENERAL CHARACTERISTICS

Acres 834 320 5 548 9,796 788 60 Includes a Primary Residence Acres with Structures or Available for Future Building1

15 4 0.1 7.4 to 152

18 5 3

Used for Agriculture Used for Grazing Allows Limited Public Hunting Access

HABITATS PROTECTED3

Greasewood Sand Sage Shortgrass Prairie Foothill Shrubland Grasslands Juniper Oak & Mixed Mountain Shrub Pinyon Juniper (Colorado Plateau) Ponderosa Pine Sagebrush Salt Shrub Aspen Lodgepole Pine Mixed Conifer Pinyon Juniper (Southern Rocky Mountain) Shrub-Steppe Spruce Fir Alpine Tundra

TIER 1 SPECIES OF GREATEST CONSERVATION NEED PROTECTED4

Boreal Toad Northern Leopard Frog C C Burrowing Owl Lynx Golden Eagle Greater Sage-Grouse C Gunnison Sage-Grouse Greater Sandhill Crane Bluehead Sucker Flannelmouth Sucker Roundtail Chub Fringed Myotis White-Tailed Prairie Dog Townsend’s Big-Eared Bat

A-2

CHARACTERISTICS OF SEVEN RANDOMLY SELECTED CONSERVATION EASEMENTS APPROVED FOR THE STATE TAX CREDIT

JANUARY 2014 TO JUNE 2016

SAMPLED EASEMENT

1 2 3 4 5 6 7

BIG GAME AND OTHER SELECTED SPECIES PROTECTED

Black Bear C Moose C Elk C C C Mule Deer C C C C C White-Tailed Deer Pronghorn C Bighorn Sheep Mountain Lion Bobcat Coyote C Bald Eagle SOURCE: Office of the State Auditor’s analysis of tax credit application materials and data from the Division of Real Estate. 1 Includes areas containing current structures, such as residences or barns, as well as areas where future structures are allowed to be built. 2 The total area available for structures on this property varies depending on which sites the landowner chooses to build on in the future, as permitted by the easement. 3 Habitat types as identified by the Colorado Natural Heritage Program’s 2011 report, The State of Colorado’s Biodiversity. 4 Tier 1 Species of Greatest Conservation Need as identified by Colorado Parks and Wildlife’s 2015 State Wildlife Action Plan. LEGEND Colored rows show the conservation status of state habitats as determined by the Colorado Natural Heritage Program: UNDER CONSERVED HABITAT

WEAKLY CONSERVED HABITAT MODERATELY CONSERVED HABITAT EFFECTIVELY CONSERVED HABITAT refers to wildlife that are possibly present on the property based on habitat maps. C refers to wildlife that application documents indicate were confirmed on the property based on physical sightings, dung, or footprints.

APPENDIX B

LEGEND CONSERVATION EASEMENT ESTABLISHED 2011-2015

CRUCIAL HABITAT CATEGORIES:

CATEGORY 1

CATEGORY 2

CATEGORY 3

CATEGORY 4

CATEGORY 5

NO CATEGORY

CONSERVATION EASEMENTS ON PRIVATE LANDS ENCUMBERED BETWEEN 2011 AND 2015 COMPARED TO AREAS CATEGORIZED BY THE CRUCIAL HABITAT ASSESSMENT TOOL

SOURCE: Office of the State Auditor’s analysis of data from Colorado Ownership, Management, and Protection (COMaP v. 10, released April 7, 2016) and the Crucial Habitat Assessment Tool.

This map compares the locations of 114 conservation easements created from January 2011 to June 2015 to the areas defined by the Crucial Habitat Assessment Tool. Not all conservation easements created during this time period are shown on the map due to limitations in the source data. Please refer to the section of the report titled “Effectiveness of the Tax Credit for Land Conservation” on page 74 for our related finding.

Sponsored by the Western Association of Fish and Wildlife Agencies, the Crucial Habitat Assessment Tool ranks each geographic area containing crucial habitats for wildlife on a scale of one to five, with Category 1 representing rare or fragile areas essential to maintaining the viability or diversity of wildlife species, and Category 5 representing areas likely to have significant wildlife values but unknown levels of importance in meeting conservation objectives.