(A longer version of this article originally appeared in the June issue of Trusts & Estates magazine. As a Wealth Management Letter reader, you can subscribe to Trusts & Estates for just $99. That’s a savings of 64% off the regular Trusts & Estates rate of $275. To take advantage of this special introductory offer, email[email protected].)
Now may be the perfect time for clients to donate land for public preservation. So you may as well understand how this works—and its tax benefits
Recent legal changes have enhanced conservation easements’ effectiveness in estate planning. But increased scrutiny by the Internal Revenue Service heightens the need for careful documentation of agreements and for thoughtful valuations of donated land.
Still, now may be a good time to consider this option, especially for clients who need tax relief, want to continue using the property even if it’s shared in part or completely with the public, and believe in preserving natural environments. These days, banks and other landholders are finding that conservation groups are eager buyers for select parcels. Despite the recent financial meltdown, conservancy groups and land trusts have strong balance sheets and ready cash. So, they’ve been purchasing and placing easements on significant parcels of real estate. The Tejon Ranch in Los Angeles and Plum Creek Timber property in Montana are just two striking examples.
For clients and their advisors, using conservation easements in estate and generational transfers is complex. So, let’s look at some of the issues involved to ensure the process is clear, timely and meets the needs of all parties involved.
The Setting
Easements were first created in the 1880s by Frederick Law Olmstead, the father of U.S. landscape architecture who designed exquisite, natural looking parks in urban spaces. Among Olmstead’s most famous works, of course, are New York’s Central Park and Prospect Park. In 1891, landscape architect Charles Eliot founded The Trustees of the Reservations in Massachusetts to select natural or cultural landscapes that had inherent beauty and interest, then to improve, preserve and open these places to the public. Today, this organization holds 96 properties and 25,000 acres in Massachusetts.
It wasn’t until 1964 that the IRS first recognized a “noncash charitable contribution” and the need for donated land contracts to remain in perpetuity. Land donations were made tax-deductible in 1969 and by the 1970s, several states developed easement programs. In 1981, community land trusts and the state attorneys general drafted the Uniform Conservation Easement Act to offer common legal language for the states to adopt, thus setting the standard for all conservation easements.
The 1980s saw strong growth of the land trust movement so that today the Land Trust Alliance, a grassroots organization that unites and champions organizations in local communities working to save natural areas, now represents 1,600 land trusts nationwide. The Nature Conservancy and other preservation organizations are major forces in land conservation today.
Tax Breaks
Government oversight has grown along with tax breaks encouraging land donations and preservation. The Pension Protection Act of 2006 (PPA) enhanced the IRS’ ability to scrutinize and influence valuations of conservation easements by establishing definitions for “qualified appraisal” and “qualified appraiser.” The PPA also created penalties and sanctions on an appraiser for valuation differences between the IRS’ donation valuation and the appraiser’s value, if the IRS’ valuation is upheld by the courts.
On the other side of the ledger, The Food, Conservation and Energy Act of 2008 (the Farm Bill) extended tax donation provisions that provide 100 percent deductibility of the donation with a 15-year carry forward if the donor is a full-time farmer. A landowner who’s not a farmer can claim 50 percent of the value of the contribution with a 15-year carry forward. The rule was extended until Dec. 31, 2009—so your farm clients should make their donations now. There are, however, bills before Congress to make this incentive permanent—and its prospects look quite good.
This is quite an incentive: Under the Farm Bill, the donation amount is applied directly to the donor’s adjusted gross income and can have a significant impact.
In addition to this tax break, the Farm Bill funds hundreds of different programs that in turn fund conservation purchases and easements.
Meanwhile, a total of $733 million of federal funds in the 2009 budget is earmarked for farm preservation and agricultural conservation efforts.
At the same time, state tax credits also seek to entice property owners to use conservation easements. The state tax credit does not affect the value of a client’s federal conservation easement deduction.
Twelve states currently provide tax credits based on a percentage of the dollar amount of a person’s donation. Some states, such as Colorado, make their credits transferable to other people as a tax incentive. The Colorado tax credit is up to a maximum of $350,000—among the highest credits available in the nation. Iowa has just instituted a state tax credit with a maximum of $100,000 based on 50 percent of the fair market value of a conservation easement donation. Note, though, that states also impose caps and limitations—so please check carefully.
The Easement Document
When taking advantage of a conservation easement, be careful to ensure that the “easement document” is in order. This is the legal agreement between a landowner and a qualified organization that restricts future activities on the land to protect its conservation values. A non-possessory interest of a holder in real property imposes limitations or affirmative obligations, the purposes of which include retaining or protecting natural, scenic, or open-space values of real property, assuring its availability for agricultural, forest, recreational, or open-space use, protecting natural resources, maintaining or enhancing air or water quality, or preserving the historical, architectural, archaeological, or cultural aspects of real property.
The “conservation easement” creates a restriction on the bundle of rights related to the real estate. Typical easements convey use but conservation easements restrict use. The language of the easement can be infinitely variable as the owner and the land trust negotiate its terms and location. The use and perception of easements has grown and changed significantly since their initial inception.
Indeed, as the popularity of, and familiarity with the use of easements has grown, a market has developed specifically for land subject to a conservation easement and its restrictions. Sophisticated buyers recognize there are significant tax benefits in purchasing real estate subject to an easement. These days, this is proving to be an excellent opportunity for wealthy clients who still have money. Recreational properties and agricultural lands are routinely bought and sold subject to varying conservation easements.
Conservation easements have become a vehicle for land trusts and conservancy groups to leverage their equity into protection of more acreage. Many communities and organizations are making open space protection a goal.
Process
If a client is interested in donating land for conservation easements, be sure to take these key steps to identify the inherent issues, problems and possible solutions:
• Meet with the family, the family attorney and the family’s accountant to discuss the family’s goals and to address the impact of the potential restrictions on the property.
• Review the real estate holdings and determine which parcels are eligible for an easement.
• Determine the various ownerships and business structures involved.
• Address the client’s tax-planning horizon, including potential for generational transfer.
Points specific to the easement that need to be discussed include:
• Access—Decide “who” will have access to the property and at what times.
• Development Restrictions—How onerous should they be?
• Improvements—Will any buildings be in the easement? Can the owner renovate, remodel or remove?
• Recreational Uses—Should it be passive-only or are there other options?
• Owners’ Obligations—What will their responsibilities entail and does everyone in the family agree with the plan? Will there be building envelopes, that is to say, separations between the inside and outside environment of a structure, that will remain unrestricted?
• Qualified Appraisal—Ensure the appraiser will pass IRS scrutiny. It’s helpful if the “qualified appraiser” has adequate experience and educational credentials to perform the work. The appraiser should review the impact of the easement or donation on the values both before and after the easement has been put into effect. The donation’s amount is determined by this before and after appraisal. The appraiser also is best equipped to review the easement location. Be aware that the property under easement can enhance or detract from other property the client owns.
• Local Land Trust or Conservancy Group—Determine these organizations’ interest in the property as well as their funding requirements and needs. It’s important to research additional conservation or preservation groups for potential interest in the parcel or parcels. It’s also important to conduct a thorough review of currently available government funding and privately sponsored programs for funding.