Conservation easements can be a used to reduce tax liability if a taxpayer owns land that is not intended for development, though the use of conservation easements has come under some scrutiny by the IRS.
What Is a Conservation Easement?
A conservation easement is a restriction on the owner’s use of the property. A popular form is the open space or scenic easement, wherein the owner of land agrees to set the land aside to preserve natural, scenic, historic, scientific and recreational areas, for public enjoyment.
The deductible value of the easement is generally determined using a “before and after” approach. That is, the value of the total property owned by the taxpayer (including adjacent property that is not encumbered by the easement) before granting the easement is determined. Then, the value of the property after granting the easement is subtracted to determine the value of the easement.
For purposes of determining the value of the property before granting of the easement, the Tax Courts have determined that the highest and best use of the property had to be taken into account. General guidelines for valuing property can be found in Revenue Procedure 66-49.
A charitable contribution of a qualified conservation easement is available to the extent the contribution does not exceed 50% of adjusted gross income (AGI). A qualified conservation easement contribution disallowed because it exceeds the percentage of AGI limitation can be carried over for up to 15 years.
The qualified easement contribution must be reduced if a rehabilitation credit was taken with respect to the property.
Estate Tax Exclusion
An estate tax exclusion is provided for qualified conservation easements. An irrevocable election must be made by the executor if the exclusion is to apply. The exclusion is available for the lesser of:
- the applicable percentage of the value of land subject to the qualified conservation easement, reduced by the amount of any charitable deduction for the easement under IRC Section 2055(f); or
- the exclusion limitation (currently $500,000).
The applicable percentage is equal to 40% reduced (but not below zero) by two percentage points for every percentage point (or fraction thereof) by which the value of the conservation easement is less than 30% of the value of the land (determined without regard to the easement and reduced by any development right).
The land subject to the conservation easement must be located in the United States or its possessions. The land must be owned by the decedent or members of decedent’s family at all times during the three year period ending at the decedent’s death.
The exclusion is not available to the extent that the land is subject to acquisition indebtedness or retained development rights (excludes certain farming uses). Nor is the exclusion available if the easement is granted after the death of the decedent and anyone receives an income tax deduction with regard to granting of the easement. A conservation easement is not available if it is not exclusively for conservation purposes.
Improper Deductions for Conservation Easements
The IRS has determined that some taxpayers have been claiming inappropriate contribution deductions for cash payments or easement transfers to charitable organizations in connection with purchases of real property.
In some of these questionable cases, the charity purchases the property and places a conservation easement on the property. Then, the charity sells the property subject to the easement to a buyer for a price that is substantially less than the price paid by the charity for the property.
As part of the sale, the buyer makes a second payment — designated as a “charitable contribution” — to the charity. The total of the payments from the buyer to the charity fully reimburses the charity for the cost of the property.
The IRS warned that in appropriate cases, it will treat these transactions in accordance with their substance rather than their form. Accordingly, the IRS may treat the total of the buyer’s payments to the charity as the purchase price paid by the buyer for the property.
Taxpayers are advised that the IRS intends to disallow all or part of any improper deductions and may impose penalties, and also intends to assess excise taxes (under IRC Section 4958) against any disqualified person who receives an excess benefit from a conservation transaction, and against any organization manager who knowingly participates in the transaction.
In appropriate cases, the IRS may challenge the tax-exempt status of the organization based on the organization’s operation for a substantial nonexempt purpose or impermissible private benefit. Taxpayers must maintain written records of the property’s fair market value before and after the donation, and the conservation purpose involved.