Our next tax strategy to be addressed is the donation of a Conservation Easement, or the investment in an entity that may make a donation of a Conservation Easement. Simplistically, a conservation easement is a donation of a qualified property interest to a qualified conservation organization for conservation purposes. Now, let’s get into the details.
First, we will discuss the characteristics of a Conservation Easement. A Conservation Easement is characterized by each of these requirements and qualities:
• It is voluntarily granted by the owner of real property.
• It is permanent. All future property owners are bound to comply with the terms of the easement.
• It is held and enforced by a qualifying conservation organization.
• The owner of the real property maintains ownership of the underlying property and all uses of the property, other than that which has been donated.
It is important to note that the underlying property does not become publicly owned.
Our next part addresses how the donation is made, and more importantly, how it is valued. Conservation Easements were added to the Internal Revenue Code in 1980, with the addition of code section 107(h). This code section, along with Treasury Regulation 1.70A-14, governs charitable contributions of Conservation Easements.
The valuation of the Conservation Easement is dependent upon an independent appraisal of the property and is governed by Treasury Regulation 1.70A-13.
The valuation of the Conservation Easement is measured by the difference between the appraised value of the property, before it is encumbered with an easement, and the appraised value of the property after it is encumbered. This appraisal methodology is referred to as “the before and after” method.
The appraisal should incorporate the highest and best use of the property, which includes evaluating the potential for existing uses, as well as considering alternative uses for the property. There are certain nuances relating to the appraisal process. Though not meant to be all inclusive, key ones are:
• The final appraisal must be completed within sixty days of the date of the donation.
• The property needs to owned for at least one year in order to perfect the fair market value of the easement, as determined by the before and after appraisal methodology.
The donation is in the form of a non-cash contribution using IRS Form 8283. When the deduction is taken, it is limited to a percentage of adjusted gross income. Presently, that percentage is 30%. However, when the extenders are raised by Congress and signed by the President, that percentage will increase to 50%. Finally, the non-cash contribution is not a preference item and is not subject to alternative minimum tax.
We have discussed the characteristics of a Conservation Easement and how it is donated. Now we will discuss what a “real property” interest is.
All real property has numerous property rights, or interests. Based upon where the property is located, these rights have different values, as to what are the highest and best uses. Let’s think of certain property interests of real property: development rights, water rights, air rights, and mineral rights, to name a few.
Each of these has different highest and best uses, based upon where the property is located. Think of the value of development rights in suburban Atlanta or Philadelphia! Think of mineral rights in West Virginia or Texas! You all get the picture….
Next, we will address the qualified conservation organization. To qualify for a deduction, the real property interest has to be donated to a qualified conservation organization. This organization must be either a 501(c)(3), or a governmental entity. The organization must have a commitment to protect the conservation purpose of this donation. It also has to have the resources to enforce the terms of this easement in perpetuity.
The last item that we will address is the “conservation purpose” of the donation. The regulations require that the Conservation Easement comply with at least one of the following conservation purposes:
• Preservation of land areas for outdoor recreation or education of the public
• Protection of natural habitat of fish, wildlife, plants, or ecosystem
• Preservation of open space
• Protection of historically important land or historical structures
It would help if the donation met more than one purpose.
Securitized Tax Benefits
Since 1980, when Conservation Easements were codified, there have been over 100,000 easements donated and over 20,000,000 acres encumbered.
You may wonder…why is this important to me? “I live in an apartment in Manhattan and have no real property…” Well, folks, there are owners of real property who personally cannot use all of the tax benefits of their Conservation Easement. Accordingly, these property owners have securitized these tax benefits and have sold them to investors as private placements.
From what I have seen in these offerings, the non-cash charitable deduction varies from 3 to 5 times the investment. The corresponding tax effect ranges from 1.5 to 2.5 times your investment. Obviously, this is based upon the investor’s effective tax rate, though as an example, a $100,000 investment would generate a reduction in taxes of $150,000 to $250,000. Yes, you read that correctly.
If someone is considering granting a conservation easement or making an investment in one of these offerings, they must understand that this is a complex transaction. The sponsor of this offering must have experience in many facets of the Internal Revenue Code, as well as security laws. When Conservation Easements are sold, they are a security. The SEC recently brought an administrative proceeding against a CPA for not selling Conservation Easements as a security. Please consider that the IRS has a 68 page audit guide for Conservation Easements, so make sure to dot all the i’s and cross all the t’s.
I have reviewed a large number of these offerings and have several that I would recommend. Certainly contact me as well if you have questions about donating a Conservation Easement.
I hope everyone has a wonderful Holiday Season. See you all next year!