Throughout history, people have valued land for what they could do with it: Hunt on it; farm it; build a residence, office building or factory on it. But with careful planning and the right mindset, land today can be valued for what its owners cannot do with it.
In Aurora, Colo., for instance, CFP Alan Gappinger is working with a husband and wife who own 20 acres outside of Boulder. The clients love the land's natural beauty, so they are donating a conservation easement to a land trust in order to prevent further development on the site. The property is worth upwards of $30,000 an acre--but the easement will lower that market value. The transaction is in the process of being finalized, and the couple will start taking both a state credit and a federal tax deduction for their donation this year, says Gappinger. Their land will remain in its pristine state.
Basically, a conservation easement is a transfer of property usage rights which creates a legally enforceable land preservation agreement between a landowner and either a municipality or a "qualified land protection organization." The easement restricts real estate development, commercial and industrial uses, and other activities on the land to a mutually agreed upon level.
However, a conservation easement lowers a property's market value. The diminution in value is treated essentially as a donation which the landowner can take as a federal income tax deduction--within certain limits. Prior to the Pension Protection Act of 2006, (PPA), donors of conservation easements could only deduct the value of their gift at an annual rate of 30 percent of their "contribution base," with a five-year carry-forward. Under the PPA, if donations are made by the end of 2007, donors may deduct the value of the gift at the rate of 50 percent of their contribution base. Any amount of the donation remaining after the first year can be carried forward for 15 additional years--allowing a maximum of 16 years for the deduction to be utilized. Even more favorable treatment applies if the donor is a farmer or rancher.
For Gappinger's clients, the timing of the transaction was fortunate. The PPA makes 2007 a great year for conservation-minded clients by significantly expanding federal tax incentives for conservation easements. Clients must act quickly, however, if they want to take advantage of these rules. Unless they are re-authorized by congress, the new federal incentives will expire at the end of 2007. A bill to make the rules permanent, S. 469, has been proposed by Sen. Max Baucus (D-Mont.) and co-sponsored by Sen. Charles Grassley (R-Iowa).
These new rules open up a way for even land-owners of modest income to put conservation easements on their property and thus receive significant tax benefits, says Philip Tabas, vice president and general counsel at The Nature Conservancy in Arlington, Va. In particular, the new rules give land rich/cash poor landowners much more of an incentive to donate conservation easements. "The greatest philanthropists for conservation have always been wealthy landowners," says Rand Wentworth, president of the Land Trust Alliance in Washington, D.C. "What congress has done is to make it possible for large landowners to conserve land and receive significant tax breaks even if they're not wealthy. You don't have to have a seven-figure income to benefit from the tax breaks," he adds.
The main issue for landowners is whether or not these tax incentives are strong enough to encourage them to part with a significant portion of their holdings' value. While the previous tax breaks were attractive, says Wentworth, they often were not good enough to give up development rights.
The tax breaks, even if fully utilized, usually did not fully compensate land owners for giving up development rights on their property, explains Tabas. The problem was further compounded because the annual deduction limits and five-year carry-forward often did not allow landowners to fully utilize the tax breaks. "Property values are so high that the value of a donation can be in the millions. When you're looking at those kinds of numbers, it's hard for even the wealthiest to deduct," says Bob Dale, a partner in the fee-only investment and financial advisory firm of Yount, Hyde & Barbour P.C. in Middleburg, Va.
Therefore, the new, longer carry-over period will encourage more donations simply because there is a greater likelihood of being able to take full advantage of the deduction, says Bob Soonthornchai, also a partner at Yount, Hyde & Barbour, where conservation easements are a specialty.
Attorney Joan DiCola, a solo practitioner in Boston, gives this example: Suppose a conservation easement lowers the value of a property by $1 million, and the donor's contribution base is $100,000. Under the old rules, the donor could take only a $30,000 annual deduction for six years for a total of $180,000 in federal income tax deductions. Under the new rule, the donor can take deductions of $50,000 annually for 16 years for a total of $800,000 in deductions. If the donor is a working farmer or rancher, he would be able to take even greater tax deductions, DiCola adds.
The new 16-year deduction allowance period--the year of the donation plus 15 years--will afford most taxpayers the opportunity to take the full deduction--a definite benefit to land rich/cash poor individuals who, in the past, often did not have the income necessary to absorb the full deduction, Dale says.
The new tax incentives for farmers or ranchers are particularly good. "Qualified" farmers or ranchers can deduct a conservation easement donation at an annual rate of 100 percent of their contribution base with a 15-year carry-forward. Qualified farmers or ranchers are those whose gross income from farming/ranching is greater than 50 percent of their annual gross income. However, in order to qualify for the 100 percent annual contribution deduction, the conservation easement contract must provide that the property "remain available" for agriculture or livestock production. There is no requirement that the property continue to be so used--only that it "remain available" for such use.
Furthermore, a corporation that qualifies as a farmer or rancher can deduct up to 100 percent of the excess of the corporation's taxable income over the amount of all other allowable charitable contributions. Any excess may be carried forward for up to 15 years. To qualify for this tax break, the corporation's stock must not be readily tradable on an established securities market at any time during the year of the contribution.
Thus, under the new PPA regulations, farmers and ranchers can potentially pay no federal income taxes for 16 years, provided they place their land under conservation easement by the end of this year. Many farmers and ranchers are sympathetic to conservation easements, but their income is typically low and to give up so much value for such a limited income tax savings did not make the donation worth it to them, says Stephen Small of the Law Firm of Stephen J. Small in Boston. The PPA rules change the situation dramatically. "If you're a cranberry farmer sitting on valuable land, and you put an agricultural restriction on the land, you can take the difference in value as a deduction up to 100 percent of your AGI for up to 15 years," says DiCola.
She points out, however, that the 50 percent deduction may be more valuable than the 100 percent of contribution base deduction. When the numbers are run, the 50 percent deduction may work out as a better option because it's then limited to the top half of income, which has the highest tax rates. And, she adds, there's no issue as to whether or not the land is "available" for farming or ranching.
Clients who are attracted to conservation easements generally are those who have significant land holdings, but are not interested in speculation, says Small. A conservation easement would also be a good move for someone who wants to keep a family property in its natural state for future generations--an island off the Maine coast, for example, or a family ranch.
If all the client wants is a tax break, then do not do it, says Wentworth of the Land Trust Alliance, because the value given up will never equal the tax breaks. In fact, the Land Trust actively discourages people who are only looking for a tax dodge, he adds.
Dale agrees that the tactic is a huge financial decision. Landowners give up a considerable amount of value--something that needs to be taken very seriously. Typically, these owners have mulled over for several years the decision of whether or not to grant an easement. Clients have to understand that by donating the easement, they relinquish the ability to sell the property and maximize returns, Gappinger says.
Financial advisors should also pay attention to the overall tax benefits and implications in relation to the client's entire portfolio. Tax planning is key, particularly the evolution over multiple years, says Gappinger. When evaluating the benefits of an easement donation, he says, an advisor should analyze how the deductions and credits will impact future income tax returns. Gappinger notes that his clients who donated the easement outside of Boulder timed their donation to correspond to their transition into retirement. The couple has quite a bit of money in a qualified plan, he says, and the donation gave them the ability to do some strategic tax planning over the years.
Advisors also need to understand the state rules, since state credits and deductions may be worth more than the federal deductions. "What has really been the biggest motivator in Virginia is the Virginia Land Preservation Credits," says Dale. Virginia issues donors tax credits equal to 50 percent of the value of the easement, and Virginia taxpayers can sell the credits, allowing them to convert them into cash, he adds.
If clients are interested, however, they need to act quickly. Conservation easements are complex transactions that can take anywhere from six months to two years to put together. "There's a lot of paperwork to do. You have to meet with the organization. You have to get an appraiser. It doesn't happen overnight," says Dale. Furthermore, adds DiCola, if you have to get municipal approval to accept the gift it can take quite some time. Even though the conservation easement is a donation, there may still be people who oppose the town's acceptance.
Furthermore, it's not always easy to find an organization willing to accept an easement. The Nature Conservancy, for example, does not always accept land offered to it, notes Tabas. However, he points out there are many local land trusts interested in preserving local land, and those are good places to start when considering a conservation easement.
And while it does take time to set up the transaction, says Tabas, it can be done by the end of this year if donors start the process within the next few months.
The Land Trust Alliance and other conservation groups are pressing to make the PPA tax incentives permanent, says Wentworth. Both Senators Grassley and Baucus of the Senate Finance Committee have expressed support, he says. But the future is an unknown, and he recommends taking advantage of the tax breaks now--in case there is no extension. But sunset aside, the other issue is getting word of the tax break out. "Not many people know about it," says Small.
In the meantime, the PPA rules have had a definite impact on donations of conservation easements. Even though the new rules were just passed last August, Wentworth says his organization has seen an up-tick in conservation easements, and he expects even more in 2007. Small says he has one client, a major landowner in the west, who probably would have put his land under a conservation easement eventually. But now, with the new tax rules in effect and the sunset on the horizon, this client is planning to complete the transaction before the end of 2007.
Oftentimes, says Dale, landowners wanted to create the easements, but were merely waiting for the right time to do so. The new federal rules--particularly the extended carry-over provisions--should convince many landowners that now is the right time, he adds.
Conservation Easement Estate Tax and Property Tax Benefits
In addition to income tax benefits, a conservation easement donation reduces estate taxes in two ways:
1. The deceased's estate is reduced by the value of the donated conservation easement, i.e.; the land is valued taking into account the conservation easement, not the full development value of the land.
2. Under IRC section 2031(c), when property is under a qualified conservation easement, an additional 40 percent of the value of land up to $500,000 may be excluded from the estate. This is in addition to the reduction in land value attributable to the easement.
After a landowner's death and prior to filing the estate return, heirs can make "post mortem" elections and receive estate tax benefits by electing to donate a conservation easement. Heirs will not, however, receive the income tax deduction.
Under the laws of most states, assessors must reduce property tax assessments to reflect conservation easements. Lower assessments result in lower property taxes.--ERB
Elayne Robertson Demby, JD, has covered executive compensation, employee benefits, and financial issues for more than 10 years.