By: Donald M. Deans, CPA, PFS
Time is certainly of the essence with regard to implementing the top tax strategy for 2016 for both individuals and Subchapter C corporations, investment in syndicated conservation easements, as transactions must be completed by December 30, 2016.
Here is what they are and how investors and the public benefit from their use, and how you can still bring well vetted offerings to your accredited investor clients and corporations.
What is a Conservation Easement?
A conservation easement is a voluntary encumbrance on land that creates a permanent and legally enforceable land preservation agreement between a landowner and a qualified conservation organization.
The value of the conservation easement donation is based on an independent appraisal and most often is measured by the difference between the appraised value of the property at its highest and best use before and after it is encumbered. For individuals, the value of the conservation easement is treated as a non-cash charitable contribution limited to 50 percent of adjusted gross income, with a 15-year carry forward. For Subchapter C corporations, the limit is 10 percent of taxable income.
Conservation easements were added to the Internal Revenue Code in 1980. The rationale was to provide a mechanism for charitable contributions to be used as an economical way of promoting conservation. As of September 2015 there are more than 114,000 conservation easements protecting more than 23 million acres.
Landowners benefit from preserving land by restricting development, industry or mining, while continuing to own the underlying land. They have gifted a property right. Because the restrictions reduce the value of the land, the IRS allows landowners to claim a tax deduction for donating the conservation easement to a qualified organization. Depending on the value of the easement, the tax benefits of the donation can be substantial.
The public benefits from the conservation purpose of the donation. According to Code Section 170(h), a conservation easement must comply with at least one of four conservation purposes:
• Preservation of land for outdoor recreation or education
• Protection of natural habitat of fish, wildlife, plant or ecosystem
• Preservation of open space
• Protection of historically important land or historical structures
Comedian Jeff Foxworthy contributed a conservation easement on more than 1,000 acres to the Chattahoochee Valley Land Trust. The nation’s two largest private landowners, Ted Turner and John Malone, make significant use of conservation easements to conserve land, each receiving the same substantial tax benefits as do investors in syndicated offerings.
Syndicated Partnerships and Conservation Easements
About 15 years ago, entities began developing partnerships that enabled property owners to monetize their property while ensuring the land is never developed. Early partnerships had problems because of the lack of informed advisors and many ended on the losing side of the IRS.
As these structures evolved, sponsors developed real estate syndications that incorporate the benefits of Code Section 170(h) for all involved. Though investors need to be aware of the risks, distribution through the IBD channel ensures additional due diligence. Experienced sponsors pre-assess 10 potential projects brought to them before selecting 1 that is pre-approved by a qualified land trust or agency for accepting a potential donation. The most often cited reason for a sponsor not pursuing a property is there isn’t enough money in it for the landowner.
Once the decision is made to put some money on the table, the sponsor engages a qualified appraiser to value the conservation easement at its highest and best use before and after the encumbrance. An important point that is missed by many who question the appraisal valuations in syndicated conservation easement offerings is that the Appraiser must follow the same IRS audit guidelines that any other landowner must follow, whether it is Ted Turner, John Malone, Jeff Foxworthy or syndicated conservation easement offering that significantly expands the range of people who can participate to fund the conservation of land.
If the property owner is willing to accept a percent of the conservation easement value, the sponsor forms two LLCs, an investment company and a property company. The property owner contributes the land to the property company. An offering is prepared that ranges from 20 percent to 25 percent of the conservation easement value. This includes payment to the property owner and all expenses. When the funds are raised, the investment company acquires the shares of the property company.
The investment company is now the landowner and the members have the opportunity to elect to develop the property for its highest and best use, hold the property, or make a donation of a conservation easement to a qualified organization. If the donation option is chosen, the members share in the non-cash charitable contribution at its full value. The PPMs we are seeing from sponsors in 2016 show a ratio of conservation easement value to offering are for four-to-five times the investment.
• Individuals with high income
• Individuals interested in preserving natural resources
• Individuals interested in significantly lowering their income tax obligations
• Individuals aware of higher potential for audit
If the IRS audits the Property Company, investors should expect the IRS to challenge the valuation of the Federal Deduction arising out of the Conservation Donation. While in reality, the risk of audit for the individual investor is the same percentage as someone should expect if they have a seven figure income. Performing an audit is how the IRS obtains the material they need to determine if the offering did indeed follow the rules and regulations of 170(h). Fortunately, the sponsors I recommend do follow the guidelines and should it ever come to audit, they are the ones that have substantial reserves to pay the cost of helping the IRS figure that out.
There are a number of qualified sponsors who have offerings available hopefully through until December 30th, 2016 (yes, the 31st is a Saturday). These well vetted offerings come with:
• Offering Summary
• Draft Appraisal (final appraisal made within 60 days)
• Tax Opinion
• 3rd Party Due Diligence Report
Hypothetical Example – Syndicated Conservation Easement Offering – Double D Ranch
The highest and best use appraisal of the property is $50,000,000.
• With a conservation easement in place, the value is diminished to $5,000,000.
• The value of the easement is $50,000,000 less $5,000,000, or $45,000,000
• The easement will qualify for a charitable deduction if all rules are followed
The landowner decides to monetize his ranch and work with a Conservation Easement Sponsor. The sponsor creates the Double D Ranch Investors, LLC and offers to accredited investors. Using a ratio of 4.5:1 results in a $10,000,000 offering for our example.
Assume a $100,000 investment in the Double D Ranch Investors, LLC offering and that the members choose to donate a conservation easement, making sure the land is never developed.
|Effective Tax Rate||50%|
The result is a charitable deduction for the investor of $450,000. At a combined effective federal and state tax rate of 50%, resulting in $225,000 in tax savings, the investor nets $125,000 on top of the $100,000 investment.
*This hypothetical example is for educational purposes only. As with any illustration, actual numbers are subject to change.