Farm Bill Improves Tax Benefits for Donors of Conservation Easements

R. Lee Stephens, Jr.

Robert J. Allen

Introduction

A conservation easement is an enforceable land preservation agreement between a landowner and an easement holder, which may be a governmental body or a qualified charity. The primary purpose of a conservation easement is to protect agricultural land, timber resources, historical sites, and other valuable natural resources such as wildlife habitat, clean water, clean air, or scenic open space by restricting real estate development, commercial and industrial uses, and certain other activities. The decision to place a conservation easement on property is strictly voluntary and the restrictions are forever binding on both the present and future landowners.

Ownership of real estate comes with certain property rights that may be compared to a "bundle of sticks". A landowner may have the right to build a house on their property, run a business or conduct industrial operations, if allowed by state and federal law and the local zoning ordinance. When a landowner donates a conservation easement on their land, they are in effect giving up certain "sticks" or development rights that they would otherwise possess. For example, a landowner may give up the right to conduct commercial and industrial activities and build a residential subdivision on the property, but keep the right to farm, harvest timber and hunt, among other things. In certain circumstances, a landowner and easement holder may agree in the deed granting the easement that the landowner may retain one subdivision right or the ability to build additional residential structures on the property.

A conservation easement confers benefits but also imposes responsibilities on the parties. The landowner who gives up development rights on their property continues to privately own and manage the land and may be eligible to receive significant state and/or federal tax advantages for having donated the conservation easement. In accepting the conservation easement, the easement holder assumes a responsibility like a trustee to monitor future uses of the land, to ensure compliance with the terms of the easement, and to enforce the terms if a violation occurs.

If you love your land enough to place a perpetual conservation easement on it, there are many benefits you can receive. You may not realize the same financial gain as if you sold the land to a developer, but the tax benefits can be significant. A conservation easement is one of the few ways that a landowner can ensure that future generations will have the ability to enjoy the property as open space for farming, forestry, hunting, and other outdoor activities. The tax benefits can come in the form of relief from property tax, income tax, and estate tax.

Property Tax and State Income Tax Credits

Many states offer property tax incentives to conservation easement donors, a land-use value assessment of the Property. Annual property tax payments are lowered forever with a conservation easement. Virginia is among about a dozen states that offer a state income tax incentive. Only Virginia, Colorado and South Carolina allow taxpayers to sell income tax credits that they can't or don't want to use themselves, which enables landowners to get cash in hand after putting the easement to record. Virginia's Land Preservation Tax Credit ("LPTC") is the most generous in the United States. Credits amount to 40% of the value of the conservation easement, after approval by the Department of Taxation. LPTC's are capped at $100 million per year. Virginia permits its taxpayers to use up to $100,000.00 per year of tax credits for the year recorded and 10 years carried forward.

Income Tax Deductions

Landowners who donate a qualifying conservation easement to a qualified land protection organization under the regulations set forth in § 170(h) of the Internal Revenue Code may be eligible for a federal income tax deduction equal to the value of their donation. The value of the easement donation, as determined by a qualified appraiser, equals the difference between the fair market value of the property before and after the easement takes effect. This is often referred to as the "diminution in value" of the land.

To qualify for this income tax deduction, the easement must be: a) perpetual, meaning continuing forever; b) held by a qualified governmental or non-profit organization; and, c) serving a valid "conservation purpose," meaning the property must have a significant natural, scenic, historic, scientific, recreational, or open space value. The "conservation purpose" is the most important and most difficult qualification. When a landowner donates an easement meeting these IRS rules, they may deduct the value of the gift at the rate of up to 30% of their adjusted gross income per year. Any amount of the donation remaining after the first year can be carried forward for five additional years or until the amount of the deduction has been used up, whichever comes first, allowing a maximum of six years within which the deduction may be utilized. (Landowners who donated easements in 2006 and 2007 were allowed to deduct up to 50% of their AGI with a 15-year carry-forward period and qualified farmers were further able to deduct up to 100% of their AGI.) The tax code is subject to frequent revision so tax professionals should be consulted to gain an understanding of the current rules.

Estate Tax Reductions and Exclusions

For landowners who will leave sizable land holdings in their estates upon their death, the most important financial impact of a conservation easement may be a significant reduction in estate taxes. Estate taxes often make it difficult for heirs to keep land intact and in the family because of high estate tax rates and the high development value of land. It may be necessary to subdivide or sell land for development in order to pay these taxes, which is often not the desire of the landowner or their heirs. A conservation easement can often provide significant help with this problem in three important ways:

Reduction in Value of Estate. The deceased's estate will be reduced by the value of the donated conservation easement. As a result, estate taxes will be lower because heirs will not be required to pay taxes on the extinguished development rights. In other words, heirs will only have to pay estate taxes on the preserved farmland value, and not the full development value.

Estate Exclusion. § 2031(c) of the federal tax code provides further estate tax incentives for properties subject to a donated conservation easement. When property has a qualified conservation easement placed upon it, up to an additional 40% of the value of land (subject to a $500,000 cap) may be excluded from the estate when the landowner dies. This exclusion is in addition to the reduction in land value attributable to the easement itself as described above.

After Death Easement. Heirs may also receive these estate tax benefits (but not the income tax deduction) by electing to donate a conservation easement after the landowner's death and prior to filing the estate return (called a "post mortem" election).