In addition to improving the environment, land designated with a conservation easement can offer tax advantages to a property owner.
A conservation easement is a legally binding permanent restriction on the use of property granted in perpetuity. There are four types of easements: preserving land for recreation, protecting natural habitat, preserving open space , and preserving a historically important area or structure.
A qualified appraiser must assign a value of the easement, which will determine the amount of the tax deduction. Because it is difficult to find a market comparison, the value is typically determined by calculating the difference between the fair market value (FMV) before the easement places restrictions on use of the property and the value after the easement. This is referred to as a “before and after” valuation process.
- The appraiser first determines a value based on the highest and best use of the property, which includes current use and the likelihood of development.
- The “after” valuation considers specific restrictions imposed by the easement.
- The difference between the two is the value of the easement. In essence, how much has the value of the property decreased as a result of the easement?
A deed of conservation easement must be executed and filed with the local registry of deeds.
- The deed details the conservation purpose, restrictions, and permissible use. The donor gives up certain rights specified in the deed but retains ownership of the underlying property.
- Restrictions are binding in perpetuity — not only to the land owner who grants the easement, but also to future owners.
Determining the tax deduction
A contribution of the easement is not technically a “transfer,” and no charitable deduction is allowed unless a conservation easement is executed and signed by the donor and a qualifying organization accepts the easement. A qualifying organization is usually a government entity or charitable organization.
Legislation was enacted in 2015 that expanded the amount of the deduction. Today, a property owner can deduct fair market value of the conservation easement up to 50% of AGI in a tax year (increased from 30%). Ranchers and farmers are allowed to deduct 100%. Any excess amount can be carried over to future tax years (up to 15 years, compared with five years for typical charitable deductions).
The taxpayer must substantiate the easement. Required documents include written acknowledgment from the receiving entity, IRS form 8283 Noncash Charitable Contributions, stamped conservation easement deed, qualified appraisal, and baseline study (includes information on the conservation values of the property completed by a trained specialist such as a biologist, botanist, etc.).
Example of how a conservation easement provides a tax benefit
Consider John who owns a tract of undeveloped forest land and pursues a conservation easement.
- John contacts a local land trust charitable organization about placing the land in a conservation easement to be utilized for public walking trails
- The current use valuation, incorporating potential for development, is $1 million
- The qualified appraisal, based on valuation “after” restrictions are imposed by the conservation easement, is $400,000
- The difference in value — $600,000 — represents the value of the conservation easement, which can be claimed as a charitable deduction against federal income tax
- John’s AGI is typically $200,000 annually, which means that he can claim an annual charitable deduction of 50% of AGI, or $100,000 leaving an excess deduction of $500,000, which must be carried forward to future tax years
- If his income is consistent, the charitable deduction for the conservation easement will be exhausted over six tax years (assuming no other charitable contributions)
Extinguishment. Conservation easements may be discontinued if an unexpected change in conditions makes it impossible or impractical for the continued use of the property for conservation. This action requires a judicial proceeding. The charitable recipient’s proceeds from sale/exchange of property must be used in a manner consistent with conservation purposes.
Enhancement rule. The property owner must consider enhancement to the value of other property owned by donor (or related person) resulting from easement. The amount of easement deduction is reduced by the increase in value of the other property.
Contiguous parcel rule. Special appraisal rules apply if a portion of the easement is contiguous to other property owned by the donor. For example, if Bob owns 1,000 acres of farmland and decides to put 500 acres of that in a conservation easement.
Potential tax or audit issues with conservation easements
- An easement granted in exchange for something else is not allowed
- Inadequate documentation or faulty process
- Lack of perpetuity in deed terms
- Reserved property rights inconsistent with conservation
- Improper appraisal method or overvaluation of the conservation easement
- Conservation easement syndicates created specifically as abusive tax shelters
Seek professional advice
Use of a conservation easement can impact an individual’s overall tax planning. In addition to seeking advice from a financial advisor, a property owner may also want to consult with a legal expert who specializes in real estate law.
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