8108 / What is a conservation easement? Is a gift of a conservation easement deductible?

Editor’s Note: As required under the SECURE Act 2.0, the IRS released Notice 2023-30 containing safe harbor deed language for extinguishment and boundary line adjustment clauses in conservation easement deeds.  The new law provides donors the opportunity to amend certain conservation easement deeds to substitute the IRS’ safe harbor language for the language that was contained in the original deed. Taxpayers had until only July 24, 2023, to record their safe harbor deed amendments. These amendments must be effective as of the date when the original easement deed was recorded.  As long as the safe harbor language is substituted and the amended deed was signed by July 24, 2023, the amendment is treated as effective on the original date regardless of whether state law would render the amendment retroactively effective.

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.¹

The Tax Court held that taxpayers’ contributions of conservation easements (encumbered shoreline) were qualified conservation contributions because: (1) they protected a relatively natural habitat of wildlife and plants (in accordance with Treasury Regulation Section 1.170A-14(d)(3)); and (2) were exclusively for conservation purposes.²

The Tax Court held that a taxpayer did not make a contribution of a qualified conservation easement because the attempted grant did not satisfy the conservation purposes required under IRC Section 170(h)(4)(A). Specifically, the deed did not preserve open space, an historically important land area, or a certified historical structure.³

The IRS approved a contribution of a conservation easement in which the taxpayer retained limited water rights; the conditions of the use of those rights were sufficiently restricted that the Service determined their exercise would not adversely affect the purposes for which the easement was established.⁴ The IRS also determined that the proposed inconsistent use of some of a farm (i.e., construction of eight single-family homes) to be burdened by a conservation easement was not significant enough to cancel the conservation purpose of the easement because the conservation easement would still maintain over 80 percent of the entire tract in its presently undeveloped state, thereby preserving the habitat.⁵

Open space easements have been approved by the Service in several instances.⁶ (Although some of these rulings were made under prior law, they remain valid under the current IRC Section.)

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.⁷ For purposes of determining the value of the property before granting of the easement, the Tax Court determined that the highest and best use of the property had to be taken into account.⁸

General guidelines for valuing property can be found in Revenue Procedure 66-49.⁹ If there is a substantial record of sales of easements comparable to the one donated, the fair market value of the donation can be based on the sale prices of the comparable easements. However, where previous sellers of easements to the county had generally intended to make gifts to the county by way of bargain sales, the Tax Court determined that the comparable sales approach was inappropriate in a bargain sale of a conservation easement.¹⁰ Increases in the value of any property owned by the donor or a related person that result from the donation, whether or not the other property is contiguous to the donated property, reduce the amount of the deduction by the amount of the increase in the value of the other property.¹¹

The Service privately ruled that an estate could properly claim an estate tax deduction for the value of a conservation easement attributable to a 68.8 percent tenancy in common interest includible in the decedent’s gross estate notwithstanding the fact that the co-tenants would claim an income tax deduction for the conservation easement granted with respect to the interests in the property they owned.¹²

The Service determined that a taxpayer’s exchange of a conservation easement in real property under IRC Section 1031(a) would qualify as a tax-deferred exchange of like-kind property, provided that the properties would be held for productive use in a trade or business, or for investment.¹³

In a legal memorandum, the Service analyzed the issues regarding the Colorado conservation easement credit, including: (1) to the extent a taxpayer is effectively reimbursed for the transfer of the easement through the use, refund, or transfer of the credit, whether that benefit is a quid pro quo that either reduces or eliminates a charitable contribution deduction under IRC Section 170; and (2) whether the benefit of the state conservation easement credit is, in substance, an amount realized from the transfer of the easement under IRS Section 1001, generally resulting in capital gain.¹⁴

Improper deductions for conservation easements. The Service 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 Service warned that in appropriate cases, it will treat these transactions in accordance with their substance rather than their form. Accordingly, the Service 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 Service 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 Service may challenge the tax-exempt status of the organization based on the organization’s operation for a substantial nonexempt purpose or impermissible private benefit.¹⁵ Taxpayers must maintain written records of the property’s fair market value before and after the donation, and the conservation purpose involved.¹⁶

Guidance on qualified conservation contributions made in 2006 and thereafter. A charitable contribution of a qualified conservation easement is available to the extent the contribution does not exceed 50 percent of adjusted gross income (AGI). (The limit was 100 percent of AGI for certain farmers or ranchers.) A qualified conservation easement contribution disallowed because it exceeds the percentage of AGI limitation can be carried over for up to 15 years.¹⁷ The Service has released question-and-answer guidance relating to the increased percentage limitation and increased carryover period for qualified conservation contributions made in taxable years beginning after 2005. According to the Service, if a taxpayer has made a qualified conservation contribution, which is subject to the special 50 percent limitation (under IRC Section 170(b)(1)(E)), and one or more contributions subject to the other percentage limitations (i.e., the 60 percent (50 percent prior to 2018), 30 percent, or 20 percent limitations under IRC Sections 170(b)(1)(a), 170((b)(1)(B), 170(b)(1)(C), and 170(b)(1)(D)), the qualified conservation contribution may be taken into account only after taking into account the contributions subject to the other percentage limitations. The Service also states that the 50 percent limit applies to qualified conservation contributions only, not to all contributions of real property interests. The guidance also includes several questions and answers relating to the rules for qualified farmers and ranchers.¹⁸

The qualified easement contribution must be reduced if a rehabilitation credit was taken with respect to the property.¹⁹