July 30, 2013
Author: Joseph Bellinghieri & Jane M. Shields
Organization: MacElree Harvey
Conservation easements offer lasting protection to historic, scenic, and ecologically significant areas, as well as significant tax benefits to landowners.
Conservation easements offer benefits to landowners and the public, allowing historic, scenic and ecologically significant lands to be protected from development in perpetuity. If you are considering placing property under a conservation easement for personal or tax reasons, you should be aware of the stringent requirements governing these transfers of interests in land. Recently, the Internal Revenue Service has been closely scrutinizing these easements, and accompanying deductions, because of a few cases involving national land trust organizations and influential donors which have received widespread publicity.
What is a Conservation Easement?
A conservation easement is a recorded land use agreement in which the property owner conveys to a government unit or a charitable organization certain rights to be enforced for the public benefit. The conservation easement assures that the historic, scenic, natural or open space characteristics that make the property significant are fully identified and protected against intentional or inadvertent destruction. The easement is a voluntary, negotiated agreement between the original donor and the easement holder which must be in perpetuity in order to obtain the Federal tax advantages discussed below. Once the easement is imposed and recorded, it binds the current owner as well as any future owners to abide by its terms. For example, an easement may say that no more than one structure may be built on the plot. This type of easement would prohibit the current and any future owner from selling the land to a developer who would subdivide the land and place multiple structures on the property. Obviously, this type of agreement reduces the value of the property.
Tax Implications for Establishing Conservation Easements
The Internal Revenue Code (IRC) authorizes a charitable contribution deduction for the value of a conservation easement that is granted in perpetuity to a qualified organization exclusively for conservation purposes. A qualified organization is defined as a publicly supported charity or unit of government. Most historic preservation and conservation organizations meet the publicly supported charity requirement of the Code. The conservation purposes for which easements may be donated are defined in four categories:
The preservation of land areas for outdoor recreation by, or the education of, the general public,
- The protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem,
- The preservation of open space (including farmland and forest land) where such preservation is for the scenic enjoyment of the general public or pursuant to a clearly delineated Federal, state or local governmental conservation policy and will yield a significant public benefit, or
- The preservation of a historically important land area or a certified historic structure.
Deductions for Unappreciated Property
Generally, taxpayers may deduct their tax basis in unappreciated property held for one year or less as a charitable contribution against up to 50% of their adjusted gross income in the year of donation. Any excess value may be carried forward to a maximum of five years and deducted up to 50% of adjusted gross income in each of the carry-forward years until the amount of the gift is fully used.
Deductions for Appreciated Property
The Internal Revenue Code provides special rules for gifts of appreciated property held in excess of one year. For these gifts, the taxpayer may deduct the value of the donated property. However, the deduction is limited to 30% of the taxpayer's adjusted gross income, with a five-year carry-forward for any excess value. As an alternative, the taxpayer may elect to increase the deductibility to 50% of adjusted gross income if the taxpayer first decreases the value of the gift to what would have been long term capital gain had the donated property been sold rather than donated. In effect, the alternative election limits the deduction to the taxpayer's basis in the donated property.
Gift and Estate Tax Benefits
You may want to note that the Internal Revenue Code authorizes an unlimited charitable contribution deduction for estate and gift tax purposes. Therefore, any qualified conservation easement that is given will not subject the donor to any type of gift taxes or Federal estate taxes.
Furthermore, the Internal Revenue Service allows an executor to exclude from Federal estate tax some of the value of certain land encumbered by a qualified conservation easement. The law allows the exclusion from the taxable estate of up to 40% of the value of the land subject to a qualifying conservation easement that has reduced the value of the underlying land by at least 30%. The benefit is gradually reduced according to the extent by which the conservation easement's value falls below 30% of the land value.
The deduction that a donor can obtain is directly related to an appraisal of the property both before and after the conservation easement. Once an easement is placed on a property, its fair market value to the general public decreases. It is this decrease that can be deducted. Recently, the Internal Revenue Service has warned taxpayers and non-profit organizations against claiming or enabling improper deductions on the donation of conservation easement land.
In particular, the IRS has stated that there are three particular situations that it will consider inappropriate.
- Land donations to charitable groups that are deducted even though they are not significant conservation uses.
- Deductions that exceed the fair market value of the donated property.
- Organizations buying land, putting restrictions on its use and then selling it to individuals for a lesser price, plus a charitable contribution.
The appraisal which supports the claimed deduction must be prepared by a qualified professional who is able to document all of the necessary elements to support the deduction. The easement document must also be carefully crafted to meet the requirements of the donor and the IRS, especially given the higher scrutiny these donations are now receiving.
Penalties for Improper Deductions
You may want to note that there are Internal Revenue Service tax penalties that deal with certain of these improper deductions. In particular, IRC imposes a penalty on the amount of tax that is underpaid because of the valuation overstatement. It applies to individuals, closely held corporations and personal service organizations that have underpaid their income taxes by at least $1,000. The underpayment must be attributable to the overvaluation of property where the overvaluation exceeds by 150% the amount determined to be the correct valuation. The penalty is a flat 30% of the underpayment of taxes. There is also an overvaluation penalty set forth in IRC which applies to underpayments of estate gift taxes as a result of a valuation understatement.
Another tax penalty that is relevant to the overvaluation of easements is a penalty for the promoting of abusive tax shelters. The penalty assessed on a promoter is equal to the greater of $1,000 or 20% of the gross income derived or to be derived from the tax shelter activity. Although the penalty is directed at tax shelter promoters, it may be extended to appraisers, conservation easement holding organizations, attorneys and others who assist the organization or the sale of investments or other tax advantaged arrangements to make or furnish a statement that they know or have reason to know is false or fraudulent or who make a gross valuation overstatement. A gross valuation overstatement is defined as a misrepresentation of value that exceeds by 200% the amount determined to be the correct valuation in circumstances where the valuation of the property is directly related to the amount of any deduction or credit allowable.
As you can see, there are many pitfalls and mishaps that one can encounter when dealing with conservation easements. Expert advice and guidance are critical. An experienced land use attorney can help with any questions you have about establishing a conservation easement.