CONSERVATION EASEMENT PROPERTY
CONSERVATION EASEMENT PROPERTY
– THE GOOD, BAD, AND BEAUTIFUL –
Land is commonly a good investment, and when purchasing it at a discount because it is encumbered by a conservation easement (for second homes or otherwise), it can prove to be a very beneficial investment or family compound or retreat. Alternatively, land already owned can be restricted from future development, depressing its value. States often have programs encouraging conservation, where they will pay for development restriction. Conservation easements are often done to reduce estate tax exposures, where the property is intended to be family owned for generations. Alternatively, the valuation reduction created through a conservation easement can entitle the landowner to a charitable income tax deduction that reduces income taxes, while the landowner continues to use the property as a residence, farm, or ranch. These measures and transactions, however, have been under scrutiny in recent years by the IRS because taxpayers have sought unrealistic valuation reduction and corresponding charitable contributions. Pig’s get fat, and hogs get slaughtered!
The IRS has long granted the ability for taxpayers to deduct the present value of the granted easement as charitable deduction from the taxpayer’s income. However, the availability of the deduction is subject to certain restrictions on the transaction. Internal Revenue Code (“IRC”) §170(a)(1) allows for a deduction for any charitable contribution made during the taxable year. The recipient must be a “Qualified Organization” defined under IRC §170 (h)(3) and for purposes of a conservation easement, the easement must protect the conservation easement in perpetuity pursuant to Treas. Reg. § 1.170A-14(g). A “Qualified Conservation Contribution” is defined in IRC §170(h) as a contribution of a Qualified Real Property interest to a Qualified Organization exclusively for Conservation Purposes. A “Qualified Real Property Interest” is defined under §170(h)(2) as: (A) the entire interest of the donor other than a qualified mineral interest; (B) a remainder interest; or (C) a restriction (granted in perpetuity) on the use which may be made of the real property. The latter includes a conservation easement. A “Conservation Purpose” is defined under IRC §170(h)(4) to include the preservation of land areas for outdoor recreation by, of the education of, the general public and the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem among other purposes.
When determining the amount of the charitable deduction resulting from the sale or contribution of a conservation easement, Treasury Regulation §1.170A- 14(h)(3)(i) provides that you utilize the Before and After Approach in the absence of comparable sales data. This requires appraisal of the property before and after the easement exists. The difference between the value prior to and after the easement encumbers the property, is deemed the easements fair market value (“FMV”). This amount, in the context of a conservation easement contribution, is the amount of the charitable deduction. However, if the conservation easement is sold to a Qualified Organization, the calculation differs. Many state programs exist throughout the United States to encourage conservation of open and agricultural lands, where funds are available to purchase easements (the landowner gets paid to encumber their property with an easement.
In the context of a conservation easement sale to a Qualified Organization, the charitable deduction is still calculated through use of the Before and After Approach absent any comparable sales data. However, since proceeds are being received from the sale, these proceeds need to be recognized for tax purposes. If the Qualified Organization pays less than the FMV, it is considered a bargain sale. As a result, a charitable deduction is also available, calculated by taking the difference between the before and after approach values less any consideration received from the sale to the Qualified Organization (See §1.170A- 14(h)(3)(i) and Browning v. Commissioner 109 T.C. 303, 1997). For example, if a taxpayer sells a parcel of land to a “Qualified Organization” defined under Internal Revenue Code (“IRC”) §170(h)(3), the taxpayer may be eligible for a charitable deduction pursuant to IRC §170 for the difference between the Fair Market Value (“FMV”) of the property before and after the easement is granted pursuant to Treasury Regulation §1.170A- 14(h)(3)(i). If a qualified appraiser determined the FMV of a property at $1,000,000 before the easement, and a value of $300,000 following the sale of the easement to a Qualified Organization, the easement would have a FMV of $700,000. If you received $350,000 from the Qualified Organization as consideration for the sale, the difference between the FMV of the easement, $700,000, and the consideration received, $350,000, is considered the available charitable deduction. Therefore, a charitable deduction of $350,000 is available subject to Adjusted Gross Income (“AGI”) limitations. This deduction can be utilized to offset any gain incurred by the sale to the Qualified Organization. Any remaining deduction limited by AGI thresholds can be carried forward to be utilized in future years.
The most important factor in these cases is the valuation of the property both before and after the easement encumbers the property. Most charitable deductions claimed that are overturned and reduced by courts are because of inflated valuations that do not accurately depict the loss in value of the property from the encumbering easement. Qualified appraisals from qualified appraisers are essential for these purposes, and there exists procedures for advance agreement with the IRS on the valuations. The IRS advance procedure for agreeing on the valuation of conservation easement charitable deductions is a valuable resource for taxpayers seeking to navigate the complexities of tax deductions related to conservation efforts. Engaging in this process can mitigate future disputes and ensure a smoother tax experience.
Those seeking second homes with acreage should also consider properties encumbered by conservation easements. These properties can often be acquired for fractions of the cost of properties that are unencumbered, from future subdivision and development. Often there exists portions of the property that can be developed for one’s personal use. For example, if a farm, ranch, or mountain property is desired for a second home, often that home can be constructed without limitation on portions of the whole property that are excluded from development restriction. A recent example is a 200-acre ranch in Colorado, which has a 5-acre exclusion zone that can be developed for up to three residences for a single family. Restricting further development is often consistent with the families multigenerational desires, with the loss of multifamily development rights inconsequential.
If you would like to discuss your specific circumstances, please contact our office at your convenience.
We are pleased to be of service.
Colby J. Kempe, Esq., LL.M.
Mr. Kempe serves the Florida Bar Association as a member of the Real Property, Probate & Trust Law (RPPTL), the Palm Beach County Bar Association as the Co-Chair of the Estate & Probate Continuing Legal Education Committee, and the American Bar Association as a member of the Tax Section Investment Management and Estate and Gift Tax Committees.
