Going Green to Save Some Green
Tax Planning with Charitable Conservation Easements
Are you passionate about the environment and preserving our natural resources? Do you like paying less tax? Charitable conservation easements can help you do both. Taxpayers are allowed a charitable deduction for donation of a qualified easement to a qualified charity, to the extent the easement decreases the fair market value of the encumbered property.
What does that mean? Let’s say Jane Brown owns an undeveloped 15 acre parcel of land in Oxford County, Maine. She does not intend to develop the land and, more importantly, she wants to keep it from being developed by anyone else in the future, to preserve the land in its natural state forever. To achieve this goal, she could place an easement on the property restricting the use of the land for a conservation purpose, such as the protection of open space, timberland, farm land, scenic views, wetland, or other significant natural resource values. The easement would not need to restrict the sale of the property, but it is likely to decrease the fair market value since a potential new owner would not be allowed to develop it.
If Ms. Brown then donates the easement to a qualified charity, she can deduct for tax purposes, the fair market value of the conservation easement. As you might imagine, the valuation aspect of this transaction is often the trickiest part. Comparable sales, which the IRS deems the best evidence of fair market value, are not usually available to aid in the determination. Instead, the fair market value is determined using the “before and after” valuation method, which the IRS has endorsed in this context. Using this approach, an appraiser assesses the value of the property before the easement (considering its highest and best use) and the value of the property after the easement. Assuming the value of the property is decreased by the restriction, the difference is considered the value of the easement and allowed as a charitable deduction. In some instances, where the property’s highest and best use is subdivision development and the restriction is to prohibit any type of building and development in perpetuity, the projected decrease in value, and consequently the charitable tax deduction, may be significant.
Other types of charitable conservation easements, like those preserving the historic façade of a building, might not yield such a significant tax incentive. Indeed, the IRS has attempted to crack down on taxpayers (and appraisers) who reported large charitable deductions for façade easements. After several court cases where the Tax Court sided with the taxpayers’ contentions that easements diminished the value of their properties, the IRS published a Topical Tax Brief stating that the proper range for façade easements, in the IRS view, is between 10-15%, thus establishing an informal safe harbor on which many taxpayers (incorrectly) relied. Furthermore, the IRS added façade easements to its list of “Dirty Dozen” Tax Scams in 2005 (and 2006), stating “(I)n many cases, local historic preservation laws already prohibit alteration of the home’s façade, making the contributed easement superfluous. Even if the façade could be altered, the deduction claimed for the easement contribution may far exceed the easement’s impact on the value of the property.”
While it is theoretically possible for a façade easement’s value to be zero, the Tax Court has generally sided with the taxpayer in these cases and the Internal Revenue Service Advisory Council (IRSAC) stated in a 2009 General Report that there was a perception the IRS was overreaching on this issue. The IRS removed façade easements from the Dirty Dozen list in 2007.
Even so, it is important to follow the many rules, including the technical substantiation requirements for qualified appraisals (see previous article, How Much is that Doggie in the Window? When to Seek an Appraisal), in order to successfully undertake a charitable conservation easement. For example, the donation must be to a “qualified organization,” a charity or governmental agency that has a commitment to protect the easement (usually substantiated in its charitable mission and by-laws) and that has the resources to enforce the restrictions. Moreover, the restriction must have a conservation purpose, as introduced generally above, that falls within one of the following categories outlined by the IRS.
- Preserving land areas for outdoor recreation, or for the education of, the general public.
- Protecting a relatively natural habitat of fish, wildlife, or plants, or a similar ecosystem.
- Preserving open space, including farmland and forest land, if it yields a significant public benefit. The open space must be preserved either for the scenic enjoyment of the general public or under a clearly defined federal, state, or local government conservation policy.
- Preserving a historically important land area or a certified historic structure.
Although beyond the scope of this article, additional limitations generally applicable to charitable contributions may apply to conservation easement donations. One limit varies depending on the type of donee and type of property, and it often caps a deduction to 30% of the donor’s adjusted gross income (with the excess eligible as a carry-over to future years). Also, for some taxpayers, the so-called “Pease limitation” will cap overall itemized deductions for most deduction categories, including charitable contributions.
When the rules are followed, conservation easements can provide wonderful societal benefits and generous tax benefits for the donor. With proper planning, everyone wins.
If you are interested in learning more about conservation easements, please contact your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.