On December 17, 2010, President Barack Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010 Tax Relief Act), 1 which provides, among other things, for the extension for two years of a host of tax provisions. Among these provisions is the retroactive two-year extension (for tax years beginning after December 31, 2009, and before January 1, 2012) of enhanced incentives for qualified conservation contributions, which include contributions to qualified organizations of easements restricting the use of real property for conservation purposes, otherwise known as “conservation easements.”
These enhanced incentives provide that a taxpayer’s qualified conservation contribution deduction is permitted up to the excess of 50% of the taxpayer’s contribution base (100% for qualified farmers and ranchers) over the amount of all other charitable contributions, with a 15-year carryover period of such contributions in excess of the applicable limitation. Without the extension, such contributions made in a tax year beginning after December 31, 2009, would have been subject to the otherwise applicable 30% limit for capital gain property (50% for qualified farmers and ranchers), with a five-year carryover period. 2
Conservation easements are some of the most effective tools available to ensure permanent conservation of privately held land in the United States. Through the use of a conservation easement, ownership of land is retained in private hands but use or development rights are voluntarily restricted. This allows taxpayers to benefit from substantial tax savings while generating significant public benefits. A number of other tax benefits can accrue from the creation of a conservation easement: (1) a reduction in federal estate taxes is possible, due to the diminution of the value of the real estate by the value of the donated conservation easement, (2) an estate tax exclusion is available under Sec. 2031(c), and (3) a postmortem election may be possible. Additionally, several states offer state income and property tax incentives to conservation easement donors. Discussion here is limited to federal income tax benefits from the creation of conservation easements.
A Tool for Effective Land Stewardship
Many tax practitioners will encounter conservation easements when clients seek advice after receiving a letter from a land trust promising hefty tax savings in exchange for a conservation easement. Significant tax benefits are indeed possible, but this is not the only motivation. Clients may be interested in protecting precious land and wildlife from commercial development or may wish to protect a cherished legacy from the imprudent decisions of indifferent heirs. For those who have held land for years or perhaps generations, stewardship of the land is of prime concern, and the tax benefits available with a conservation easement reward the landowner for that stewardship.
Increase in Conservation Easements
Use of conservation easements is on the increase, according to a recent study, although predictably such growth is not uniform from state to state.
Across the U.S. as a whole, the proportion of conservation investment allocated to easements is growing exponentially. Already 70% of the area of land protected in a given year, and half of all the financial investment in land conservation, is allocated to easements. The growth rate of conservation easements varies by a factor of two across states when measured in terms of the area protected and by a factor of three in terms of financial expenditure. 3
This study, undertaken by the British Ecological Society in conjunction with the Nature Conservancy, reports that not only is the upward trend of easements significant in terms of acreage, but the change “is more pronounced when viewed in financial terms than just in terms of area.” 4
The Role of the Tax Adviser
Certainly, the role of the tax adviser in implementing a conservation easement is to ensure that the donor receives the appropriate tax benefits and to safeguard the landowner from potential litigation. With heightened IRS scrutiny of all land trust practices, the additional goal must be to avoid audit, which can be expensive, time consuming, and painful. As a result, the strategy should be to strictly comply with the requirements, thereby denying the IRS the opportunity to attack the deduction.
Sec. 170(h) Basics
Although Sec. 170 denies a deduction for charitable contributions of partial interests in property in general, Sec. 170(h) excepts qualified conservation contributions from the partial interest rule. As a result, taxpayers may claim federal income tax deductions for qualified conservation contributions even though they are not giving their entire interest in the donated property.
“Qualified Conservation Contribution” Defined
The term “qualified conservation contribution” is defined in Sec. 170(h) as a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes. Conservation easements, which restrict in perpetuity the use of the property for conservation purposes, are a type of qualified real property interest. 5 Generally, qualified organizations include governmental units and publicly supported charitable organizations; however, such organizations must have a commitment to protect the conservation purpose of the donation and must have the resources to enforce the restrictions. For example, a conservation group organized or operated primarily or substantially for conservation purposes will be considered to have the requisite commitment. 6
To be permitted, contributions must contain, within the instrument of conveyance, a prohibition of the donee organization from subsequently transferring the easement (whether or not for consideration) unless, as a condition of subsequent transfer, it is required that the conservation purposes continue to be carried out as originally intended. Subsequent transfers must be restricted to organizations that qualify as eligible donees at the time of transfer. If, for some reason, it becomes impossible or impractical for the property to continue to be used for the conservation purpose that was originally intended, the property may be sold or exchanged with the proceeds used by the donee organization in a manner consistent with the original donative intent. 7
Organizations with a “conservation purpose” include those with any of the following objectives:
- Preservation of land areas for outdoor recreational or educational use by the general public;
- Protection of relatively natural fish, wildlife, or plant habitats or ecosystems;
- Preservation of open space (“open space easement”), 8 including farm and forest land, for the scenic enjoyment of the general public or under a governmental (i.e., federal, state, or local) conservation policy yielding significant public benefit; or
- Preservation of an historically important land area or an historic structure certified as being historically significant to the district. 9
Sec. 170(h)(5) provides that a contribution will not be considered to be exclusively for conservation purposes unless it is protected in perpetuity. Although technically only one valid conservation purpose is necessary, the easement has greater likelihood of surviving IRS scrutiny if the taxpayer can prove multiple purposes. For instance, in Kiva Dunes, 10 in which the taxpayer was overwhelmingly successful, three of the four conservation purposes mentioned above had been met. In addition, rights reserved by the landowner must be carefully limited to ensure that the conservation purpose remains protected. The Glass opinion, 11 in which the Tax Court upheld the easement, describes the sort of drafting in which the landowner retained specific rights while maintaining the conservation purpose, notwithstanding the fact that the property subject to the easement was modestly sized.
Perpetuation of the Original Conservation Purpose
The donor (and the donor’s successors in interest) must be subject to legally enforceable restrictions (e.g., through recording the legally enforceable restrictions on the recorded deed) that will prevent any use of the land by the donor that might be inconsistent with the conservation purposes of the donation. In the case of a contribution of a remainder interest, the contribution will not qualify if the tenants, whether they are tenants for life or a term of years, can use the property in a manner that diminishes the conservation values that are intended to be protected by the contribution. 12
Other special rules apply in the case of donations subject to a mortgage or the possibility of a remote future event and where the donor retains a qualified mineral interest or certain reserved rights. In the case of a reserved right, the donor must agree to notify the donee in writing before exercising the reserved right, such as the extraction of certain minerals, that may have an adverse impact on the conservation interests of the property. 13 Terms of the donation must include the donee’s right to enter and inspect the property at reasonable times in order to determine that use of the land continues to comply with the terms of the donation. In addition, the terms of the donation must give the donee the right to enforce the conservation restrictions through appropriate legal and equitable remedies, including (but not limited to) the right to require restoration of the property to its condition at the time of donation. 14
If it is possible that a subsequent unexpected change could make it impossible or impractical for the property to continue to be used for the conservation purpose that was originally intended, the conservation purpose can be treated as protected in perpetuity if in that case the restrictions on the use of the property are extinguished by judicial proceeding and the property is sold or exchanged with the proceeds used by the donee organization in a manner consistent with the original donative intent. 15
The Uniform Conservation Easement Act and Compliance with State Statute
Regs. Sec. 1.170A-14(b)(2) makes it clear that a qualified conservation contribution must conform to the requirements of the state in which the easement is located. In other words, the real property law that determines whether a property restriction may be enforceable in perpetuity will be state law rather than federal law. In recognition of certain problems with state common law as it pertains to easements of this type, referred to as easements “in gross” under common law (benefitting an individual or the public rather than any specific parcel of land and therefore usually ending with the death of the grantee), and also known as negative easements (restricting the owner from certain uses on his own land), in 1981 the National Conference of Commissioners on Uniform State Laws provided a Uniform Conservation Easement Act (UCEA) 16 as a suggestion for state legislatures to authorize statutes providing for conservation easements, making them enforceable if the statutory requirements are met.
The UCEA is designed to eliminate many of the common law impediments for conservation easements to run with the land. 17 To date, all states have passed laws specifically authorizing conservation easements; many have passed the UCEA or some amended version of it.
Practice tip: Since failure to do otherwise might result in denial of the federal tax deduction, strict compliance with these state statutes controlling the form and content of conservation easements is the first step in compliance with federal requirements and cannot be too strongly emphasized.
Documentation of the Present Condition of the Property
It is essential that the present condition of the easement is documented at the time it is donated. The responsibility for this documentation rests with the donor under the regulations, although the donee land trust may assume much of this responsibility, owing to its expertise in such matters and because the donee will normally require the documentation for its records. This requirement under the regulations is designed to protect the conservation interests associated with the property that, although protected in perpetuity by the easement, could be adversely affected by the exercise of the donor’s reserved rights. 18 Moreover, the gathering of this evidence can play a critical role in defending the donation’s conservation purpose if the IRS subsequently challenges it.
Maps and Photographs
Whenever possible, documentation should include survey maps from the U.S. Geological Survey showing the property lines and other contiguous or nearby protected areas; scale maps of the area showing all manmade improvements and incursions; photos (and videography, if available) of vegetation and identification of exceptional flora and fauna, land use history, and distinct natural features; aerial photographs of the property; and on-site photographs taken at appropriate locations on the property. 19 In short, the documentation should establish the condition of particular natural resources to be protected.
Signed Statement by Donor and Donee
The above documentation must be accompanied by a statement signed by the donor and the donee’s representative, clearly referring to the documentation and in substance stating that “[t]his natural resources inventory is an accurate representation of [the protected property] at the time of the transfer.” 20
Contemporaneous Letter from the Donee
The donee must provide a separate, contemporaneously written acknowledgment letter to the donor, notwithstanding the existence of other written records such as a Form 8283, Noncash Charitable Contributions (e.g., appraisal summary, discussed below). 21 Written acknowledgment is contemporaneous for these purposes if it is obtained by the taxpayer on or before the earlier of (1) the date on which the taxpayer files a return for the tax year in which the contribution is made or (2) the due date (including extensions) for filing the return. 22 The letter must indicate the amount and a description of any property other than cash contributed, must state whether the donee organization provided any goods or services in consideration for the contribution, and must set forth a good-faith estimate of the value of the donated property. 23
Under audit, adherence to these requirements is likely to be strictly enforced. For instance, in Gomez, 24 the Tax Court applied a strict compliance test to the contemporaneous substantiation letter requirement and denied the charitable deduction because the donee had issued the letter just prior to trial, rather than on or before the earlier of the two dates described above. In addition, in Bruzewicz 25 (discussed in the online appendix to this article), the donors presented a form letter from the donee indicating only that the type of donation was “easement” in substantiation of a facade easement executed on their home. The court determined that whereas the letter provided documentation of the cash donations listed in the same letter, it did not substantiate the facade preservation easement as spelled out in Secs. 170(f)(8)(A)–(C). It is fair to state, then, that deductions for conservation easement transfers may be disallowed if the content and timing of the acknowledgment letter fail to comply with the requirements of Sec. 170(f)(8).
The appraisal summary, as required by the regulations, 26 is satisfied by completing Form 8283, Section B, Parts I–IV, in full. Form 8283 requires detailed information about the donated property, to be completed by the taxpayer/donor or the appraiser, a signed declaration statement by the donor (Part II), a declaration to be signed by the appraiser, including an acknowledgment that the appraiser understands and assumes responsibility under Sec. 6695A for any substantial or gross valuation misstatement resulting from the appraisal (Part III), and a donee acknowledgment signed by an authorized agent of the donee charitable organization (Part IV).
For charitable contributions of property in excess of $5,000, the donor must obtain a qualified appraisal, to be retained in the donor’s records, and attach an appraisal summary (e.g., Form 8283, with Section B completed) to the tax return on which the deduction is first claimed, and must maintain records of the name and address of the donee, the date and location of the donation, a property description, and the terms of any agreement between the donor and the donee regarding restrictions on the use of the property. 27
Proposed regulations would change these requirements significantly. 28 For property contributions of more than $5,000, donors would be required to obtain a contemporaneous written acknowledgment, plus a qualified appraisal to be retained in the taxpayer’s records, and to complete Section B of Form 8283, which would be filed with the return on which the deduction is claimed. For property contributions of more than $500,000, the donor would be required to attach a copy of the entire qualified appraisal to the return and to submit copies of such substantiation with the return for any carryover year.
Valuation of the Easement
Valuation May Not Exceed FMV
Assuming that all requirements of Sec. 170 are satisfied and a deduction is allowed, the amount of the deduction may not exceed the fair market value (FMV) of the contributed property (i.e., the conservation easement) on the date of the contribution, reduced by the FMV of any consideration, if any, received by the donor. Fair market value is the price at which the contributed property would change hands between a willing buyer and a willing seller, neither party being under any compulsion to buy or sell and each having reasonable knowledge of relevant facts. 29
Valuation of Capital Gain Property
The value of a charitable contribution of a conservation easement is generally the FMV of the easement at the time of the contribution. If there is a substantial record of sales of easements that are comparable to the donated easement (e.g., purchases under a government program), the FMV of the donated easement is based on the sale price of those comparable easements. 30 However, as courts have pointed out, since conservation easements “are typically granted by deed or gift rather than sold, comparable sales are rarely available.” 31
In the likely event that no comparable sales are available, as a general rule the FMV of a perpetual conservation easement is equal to the difference between the FMV of the property it encumbers before the granting of the restriction and the FMV of the encumbered property after the granting of the restriction (the “before-and-after” approach). 32
When the before-and-after approach is used, the FMV of the property before contribution must take into account (1) the current use, (2) an objective assessment of how immediate or remote the likelihood is that the property, absent the restriction, would in fact be developed, and (3) any impact from local zoning, conservation, or historic preservation laws that may already restrict the property’s potential highest and best use. An appraisal of the property after contribution must take into account the effect of any development, however limited, allowed by the terms of the easement. For instance, if the donor retains the right to erect new buildings, this may increase the property’s FMV after the granting of the restriction, thereby decreasing the value of the easement. In addition, the appraisal may not take into account any reduction in value due to the existence of restrictions on transfer that are designed solely to ensure that the conservation restriction will be dedicated to conservation purposes. 33
Calculation Under Various Scenarios
If the easement covers a portion of contiguous property owned by the donor or a related person, then absent comparable sales data, the amount of the deduction is the difference between the FMV of the entire contiguous parcel of property before and after the granting of the restriction. (See Example 1 and Exhibit 1.) On the other hand, if granting a perpetual conservation easement has the effect of increasing the value of any other property owned by the donor or any related person, the amount of the deduction for the conservation easement will be reduced by the amount of the increase in the value of the other property, whether or not such property is contiguous. (See Example 2 and Exhibit 2.) Finally, if as a result of the donation of a perpetual conservation easement, the donor or any related person receives or may reasonably expect to receive financial or economic benefits that are greater than those that will inure to the general public from the transfer, no deduction at all is allowable under Sec. 170. 34
Considerations in Valuing Property Before and After Restriction
If before-and-after valuation is used, the property’s FMV before the contribution of the conservation easement must take into account not only the current use of the property but also an objective assessment of how immediate or remote the likelihood is that the property absent the restriction would in fact be developed and must consider the effect from zoning, conservation, or historic preservation laws that already restrict the property’s potential highest and best use. An appraisal of the property after contribution of the restriction must also take into account the effect of restrictions that will result in a reduction of the potential FMV represented by the highest and best use but will nonetheless permit uses of the property that will increase its FMV above that represented by the property’s current use. 35
In Symington, 36 an early and frequently cited case, the opinion provides an excellent explanation of the before-and-after valuation method, focusing on the realistic, objective potential uses that control valuation. It is also important to note that the restriction must prohibit some right that local zoning or land use laws do not already prohibit. In Turner, 37 the court determined that no deduction was available because the easement did not reflect a limitation on use of the property that was not already limited by local zoning ordinances, and the land had been developed to the extent permitted.
Allocation of Basis
In calculating the basis of property retained by the donor, the original basis amount must be reduced by the elimination of that part of the total basis that is allocable to the qualified real property interest granted. The amount of basis that is allocable to the qualified real property interest will bear the same ratio to the total original basis of the property that the FMV of the qualified real property interest bears to the FMV of the property before the granting of the qualified real property interest. 38 The following examples illustrate the allocation of basis.
Example 1: Taxpayer D owns Greenacre, a 200-acre estate containing a house built during the colonial period. At its highest and best use—for home development—the FMV of Greenacre is $300,000, and D’s basis is $150,000. D donates an easement (to maintain the house and Greenacre in their current state) to a qualifying organization for conservation purposes. The FMV of Greenacre after the donation is reduced to $125,000. Accordingly, the value of the easement and the amount eligible for a donation deduction under Sec. 170(f) is $175,000 ($300,000 – $125,000). 39
The amount of basis allocable to the easement is $87,500 ($175,000 ÷ $300,000 × $150,000), and basis in D’s remaining interest is reduced to $62,500 ($150,000 – $87,500). 40 See Exhibit 1.
Example 2: Taxpayer S owns 10 one-acre lots that are currently woods and parkland. The FMV of each of S’s lots is $15,000, and the basis of each lot is $3,000. S grants to the county a perpetual easement for conservation purposes to use and maintain eight of the acres as a public park and to restrict any future development on those eight acres. As a result of the restrictions, the value of the eight acres is reduced to $1,000 an acre. However, by perpetually restricting development on this portion of the land, S has ensured that the two remaining acres that she retains will always be bordered by parkland, thus increasing their FMV to $22,500 each. 41
Note that if the eight acres represented all of S’s land, the FMV of the easement would be $112,000, an amount equal to the FMV of the land before the granting of the easement (8 × $15,000 = $120,000) minus the FMV of the encumbered land after the granting of the easement (8 × $1,000 = $8,000). 42
However, because the easement covered only a portion of S’s contiguous land, the amount of the deduction under Sec. 170 is reduced to $97,000 ($150,000 – $53,000)—that is, the difference between the FMV of the entire tract of land before ($150,000) and after [(8 × $1,000) + (2 × $22,500) = $53,000] the granting of the easement. 43
In addition, since the easement covers a portion of S’s land, only the basis of that portion is adjusted. Therefore, the amount of basis allocable to the easement is $22,400 [(8 × $3,000) × ($112,000 ÷ $120,000)]. Accordingly, the basis of the eight acres encumbered by the easement is reduced to $1,600 ($24,000 – $22,400), or $200 for each acre. The basis of the two remaining acres is not affected by the donation. 44 See Exhibit 2.
Calculation of the value of the easement is highly facts-and-circumstances specific, and it is important to remember that the IRS may challenge the valuation when few other attacks can be made, as it did in Kiva Dunes, 45 discussed on p. 176. In fact, the IRS has frequently argued that an easement has no or little value, as it did in Hughes, 46 although some commentators have noted a growing resistance by the courts to zero valuations, in recognition that easements have a significant impact on FMV. 47 In any event, courts invariably review each party’s valuations and then make their own determination of the value.
Charitable Deduction Percentage Limitations and Carryover Periods
Prior to the Pension Protection Act of 2006 (PPA), 48 qualified conservation contributions were subject to the same percentage limitation and carryover rules as charitable contributions of capital gain property for all other purposes. In the case of individual taxpayers, charitable contributions were deductible up to 30% of the taxpayer’s contribution base (referring generally to the taxpayer’s adjusted gross income without regard to any Sec. 172 net operating loss carryback) if made to charitable organizations described in Sec. 170(b)(1)(A) (e.g., public charities, private foundations other than private nonoperating foundations, and some governmental units). However, if the taxpayer reduced the value of the contribution by the amount of capital gain accrued on the property (in other words, reducing the value of the contribution to the taxpayer’s adjusted basis in the property), up to 50% of the contribution base could be deducted. In addition, individuals making charitable contributions to charitable organizations described in Sec. 170(b)(1)(B) (e.g., private nonoperating foundations) were permitted to deduct up to 20% of the taxpayer’s contribution base. Contributions of capital gain property under these rules were permitted after considering all other charitable contributions, and amounts in excess of the percentage limitations were permitted to be carried forward to the five succeeding tax years. In the case of corporate taxpayers, charitable contributions could not exceed 10% of the taxpayer’s taxable income. 49
Special Percentage Limitation and Carryforward Rules—Individuals
The PPA liberalized the percentage limitation and carryforward rules previously imposed on qualified conservation contributions. These rules were extended by the 2008 Farm Bill 50 to tax years through December 31, 2009, and were recently extended by the 2010 Tax Relief Act for tax years beginning before December 31, 2011. 51 As a result, taxpayers may now deduct the FMV of a qualified conservation contribution up to the excess of 50% of the donor’s contribution base (100% for qualified farmers or ranchers) over the amount of all other allowable charitable contributions. Any excess contribution amount may be carried forward and deducted for the succeeding 15 years. 52 Example 3 provides a scenario applicable to an individual taxpayer.
Example 3: In tax year 2011, G, a calendar-year taxpayer who is not a qualified farmer or rancher in that year, has a contribution base of $100. During 2011, G makes $60 in cash contributions to an organization subject to the 50% limitation under Sec. 170(b)(1)(A) and also makes a qualified conservation contribution of capital gain property with an FMV of $80. Assuming all other requirements of Sec. 170 are met in 2011, G may deduct $50 of the cash contributions. The unused $10 of cash contributions is carried forward for up to five years. No current deduction is allowed for the qualified conservation contribution, but the entire $80 qualified conservation contribution deduction may be carried forward for up to 15 years. 53
This ordering rule permits the taxpayer to use the contributions with a five-year carryover period first, while saving the qualified conservation contributions, which have a 15-year carryover period, for use in later years. Under prior (pre-PPA) law, the charitable deduction would have been limited to 30% of adjusted gross income, and the general five-year carryforward period would have applied.
Special Percentage Limitation and Carryforward Rules—Farmers and Ranchers
Qualified farmers or ranchers, including qualifying corporations the stock of which is not readily tradable on an established securities market during that year, are permitted a qualified conservation contribution up to 100% (rather than the 50% limit for nonfarmers) of the taxpayer’s contribution base, after taking into account all other allowable charitable contributions. 54 The same carryforward period of 15 years applies.
Example 4: Using the illustration in Example 3, if G is a farmer or rancher eligible for the 100% limitation in Sec.170(b)(1)(E)(iv), he is allowed a deduction of $50 in the current year for the cash contributions (50% of the $100 contribution base) and is allowed to carry over the excess $10 for up to five years, and is also allowed a deduction of $50 in the current tax year for the qualified charitable contribution (the amount of the remaining contribution base). The excess of $30 from the qualified conservation contribution may be carried forward for up to 15 years as a contribution subject to the 100% limitation. 55
Note that as an additional condition of eligibility for the 100% limitation, with respect to contributions of property in agriculture or livestock production or property that is available for such production by a qualified farmer or rancher, the qualified real property interest must be subject to a restriction that the property will remain generally available for such production. 56
For purposes of the special percentage limitation, the term “qualified farmer or rancher” means a taxpayer whose gross income from the trade or business of farming is greater than 50% of the taxpayer’s gross income for the tax year. 57 Farming is defined under Sec. 2032A(e)(5). If a passthrough entity such as a partnership or an S corporation makes a qualified conservation contribution, determination is made at the partner or shareholder level as to whether an individual is a qualified farmer or rancher for the tax year of the contribution. 58
Requirements of a Qualified Appraisal and the Appraisal Summary
Any donor who claims a charitable contribution of property with a value of greater than $5,000 must comply with the following:
- Obtain a qualified appraisal for the contributed property;
- Attach a fully completed appraisal summary (Form 8283) to the tax return on which the deduction for the contribution is first claimed (or reported) by the donor; and
- Maintain records containing various additional items of information. 59
In addition to the above, for contributions of property for which the taxpayer claims a deduction of more than $500,000, the taxpayer must also attach a qualified appraisal to the return on which the deduction is claimed. 60
Specific requirements contained in Regs. Sec. 1.170A-13(c)(2) determine whether an appraisal will be considered qualified. A qualified appraisal means an appraisal document that:
- Relates to an appraisal made no earlier than 60 days prior to the date of contribution or no later than the due date (including extensions) of the return on which the deduction is first claimed, or, in the case of a deduction first claimed on an amended return, the date on which the return is filed; 61
- Is prepared, signed, and dated by a qualified appraiser; 62
- Includes all information necessary to prepare a qualified appraisal; 63 and
- Does not involve a prohibited appraisal fee. 64
Under Sec. 170(f)(11)(E)(i)(II), enacted by the PPA and applicable to appraisals performed for deductions of more than $5,000 claimed on returns filed after August 17, 2006, the term “qualified appraisal” means an appraisal document prepared by a qualified appraiser in accordance with generally accepted appraisal standards, such as the substance and principles of the Uniform Standards of Professional Appraisal Practice (USPAP), as developed by the Appraisal Standards Board of the Appraisal Foundation. 65 The USPAP are broadly written standards and are regarded as minimal standards for the profession, requiring, for example, that appraisals be set forth in a way that is not misleading and that contains sufficient information to enable the intended users of the appraisal to understand the report.
Proposed Regulations—Qualified Appraisal
If finalized, the proposed regulations would require that, in addition to the above substantiation requirements, donors claiming contributions of more than $500,000 would be required to attach the appraisal document to the return for any carryover year. 66 In addition, the proposed regulations provide that the valuation effective date, which is the date to which the valuation opinion applies, generally must be the date of the contribution. If the appraisal is prepared before the date of the contribution, the valuation effective date must be no earlier than 60 days before the date of the contribution and no later than the date of the contribution, although the appraiser may sign the appraisal report as late as the due date (including extensions) of the return on which the deduction is claimed or reported. 67 This requirement ensures that the preparation of the appraisal will be linked more closely in time to the date of contribution than under prior law, which had permitted the preparation of the appraisal as late as the due date (including extensions) of the return on which the deduction is first claimed. 68 As under current regulations, if the taxpayer claims the deduction for the first time on an amended return, the appraisal report date must be no later than the date the amended return is filed. 69
Complex regulations: Owing to legislative activity in this area in recent years, there is a rather complex structure of Code and regulations governing the definition of a qualified appraiser, the result of which is varying requirements, depending upon the date of the appraisal and whether the appraisal is of real or another type of property. For appraisals prepared with respect to returns filed on or before October 19, 2006, a qualified appraiser is defined in Regs. Sec. 1.170A-13(c)(5). However, with the enactment of Sec. 170(f)(11)(E)(ii) by the PPA, a qualified appraiser is an individual who:
- Has earned an appraisal designation from a recognized professional appraiser organization or has otherwise met minimum education and experience requirements set forth in the regulations; 70
- Regularly performs appraisals for which the individual receives compensation; and
- Meets other requirements as prescribed in the regulations or other guidance.
In addition, Sec. 170(f)(11)(E)(iii), also enacted by the PPA, provides that with respect to any specific appraisal, an individual shall not be treated as a qualified appraiser unless the individual demonstrates verifiable education and experience in valuing the type of property subject to the appraisal, and the individual must not have been prohibited from practicing before the IRS under 31 U.S.C. Section 330(c) at any time during the three-year period ending on the date of the appraisal.
Lesson of Kiva Dunes: In Kiva Dunes, 71 the landowner was highly successful in defending an easement, due in large part to an extremely well-qualified appraiser who had extensive knowledge of the specific geographic and market areas of the property being appraised.
In that case the Tax Court, relying in large part upon the expertise of the landowner’s appraiser, valued the easement at approximately $28.7 million, less than the taxpayer’s $31.9 million claim, but well above the IRS’s $10 million valuation. 72 The Kiva Dunes appraiser used reasonable assumptions of the number of lots available for sale, average lot price, and market absorption rate, supported by credible evidence of comparable sales and absorption data from the local market. In other words, by investing in the most knowledgeable appraiser available for that particular property and market, the landowner greatly improved its success against the IRS challenge.
Prop. regs.—Qualified appraiser: Under the proposed regulations, a qualified appraiser is an individual with verifiable education and experience in valuing the relevant type of property for which the appraisal is performed. 73 The proposed regulations further state that an appraiser is considered to have such verifiable education and experience if the individual has successfully completed professional or college-level coursework in valuing the relevant type of property as is customary in the appraisal field and has two or more years experience in valuing that type of property. 74
Because significant education and experience are required to obtain a designation from a recognized professional appraiser organization, these designations are deemed to have demonstrated sufficient verifiable education and experience. Education includes coursework obtained in an employment context. 75 These proposed regulations, issued August 7, 2008, gave notice to appraisers of the increased qualifications necessary in order to produce such appraisals. Notwithstanding pushback from some in the industry, the heightened requirements should be beneficial for taxpayers.
Prop. regs.—Declaration by appraiser and valuation misstatement penalties: Further, the proposed regulations require a statement in the appraisal of the appraiser’s specified education and experience in valuing the relevant type of property, 76 in addition to a declaration by the appraiser that the appraiser understands and assumes responsibility under Sec. 6695A for any substantial or gross valuation misstatement of the value of the property that may result from the appraisal. 77 Note that penalties under Sec. 6695A may be imposed at 125% of the gross income the appraiser receives for preparing the appraisal, a predictable uptick in the penalty for misstatement of the valuation. 78
Subordination by the Mortgagee
If the donated property is subject to a mortgage, the donor may take a deduction only if the rights of the mortgagee are subordinated to those of the qualified donee to enforce the conservation purpose in perpetuity. 79 In other words, the donor must be able to prove that the easement is senior in priority to all existing security interests held by the mortgagee. In doing so, the donor must show that the deed of gift that conveys the easement has a priority over the mortgagee. In most states, the subordination agreement must be recorded in the public records and must be a true subordination; a mere acknowledgment is not sufficient. 80
Interestingly, in Satullo 81 (discussed in the online appendix), the Tax Court opened the door to a possible reprieve of this requirement. The court acknowledged that Regs. Sec. 1.170A-14(g)(3) provides that a deduction for an easement will not be disallowed if, on the date of the easement donation, it appears that the possibility that the easement might be defeated by the performance of some act or the happening of some future event is “so remote as to be negligible.” The court then slammed the door on Satullo, stating that in this case not only was the deed of gift recorded in the land records some two years after the easement was granted, but the possibility of defeat of the easement was far from remote as it applied to Satullo since the donee had already lost a high percentage of easements through foreclosure proceedings.
Practice tip: Certainly such hinted reprieves should not be left to chance; donors do not wish to be in the position of arguing that foreclosure by their mortgagee is “so remote as to be negligible.” Consequently, careful attention to the wording of the subordination agreement and recordation requirements seems prudent and warranted.
With Notice 2004-41, 82 the IRS put taxpayers on notice that in appropriate cases it will disallow deductions and may impose penalties and excise taxes under Sec. 4958 against any person who receives an excessive benefit from a conservation easement transaction and against any organization manager who knowingly participates in the transaction. The IRS will scrutinize transfers of easements on real property to charitable organizations, will apply the substance-over-form doctrine to transactions, and may also challenge the exempt status of organizations based on operation for substantial nonexempt purposes or for impermissible private benefit. 83 The IRS will also review promotions of transactions involving improper deductions for conservation easements. Promoters, appraisers, and other persons involved in these transactions may be subject to penalties under Secs. 6694, 6700, and 6701. 84
In addition, on February 28, 2005, the IRS announced its 2005 “Dirty Dozen” 85 list of common tax scams, listing among them “abuse of charitable organizations and deductions” and providing historic facade easements as an example. The IRS explained that it had observed an increase in the use of tax-exempt organizations to improperly shield income or assets from taxation, which can occur when a taxpayer moves assets or income to a tax-exempt supporting organization or donor-advised fund but maintains control over the assets or income, thereby obtaining a tax deduction without transferring a commensurate benefit to charity. The IRS provided the example of a “contribution” of an historic facade easement.
Still on the List in 2010
The IRS continues to list abuse of charitable organizations and deductions as one of the Dirty Dozen tax schemes, although by 2007 it no longer specifically mentioned conservation easements, 86 in response to pushback from various conservation groups that IRS tactics had a chilling effect on the donation of bona fide conservation easements, which represent the overwhelming majority of donations. However, wording on the IRS’s recently released listing for 2010 87 would indicate that the IRS continues to scrutinize arrangements that improperly shield income or assets from taxation while donors maintain control over donated assets or income from donated property, although it does not specifically mention conservation easements. In particular, the notice mentions donations that are highly overvalued or in which the organization receiving the donation promises that the donor can repurchase the items later at a price set by the donor. While the first of these potential attacks may be anticipated, the second would seem to run contrary to the basic rules of conservation easements.
Landowners recognize that conservation easements are an effective land stewardship tool, protecting in perpetuity the places that insure our natural environment, including productive farm and ranch land, wetlands, coastlines, and open spaces. Owing to the large potential tax benefits that accrue to donors of a conservation easement, it may be understandable that the IRS would closely scrutinize these transactions and issue proposed regulations to heighten the substantiation and reporting requirements for these deductions, and may be why conservation easements have attracted much attention from land use experts.
As always, vigilance and attention to detail remain the best strategies in ensuring that donors receive well-deserved tax benefits. To help practitioners understand the issues involved and how the IRS and the courts have dealt with them, a number of recent and landmark decisions affecting the law of conservation easements are discussed in depth in the appendix to this article.
1 Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, P.L. 111-312.
2 Sec. 170(b)(1)(E).
3 Fishburn, Kareiva, Gaston, and Armsworth, “The Growth of Easements as a Conservation Tool,” 4 PLoS One e4996 (March 2009).
4 Id. at 3.
5 Sec. 170(h)(2)(C).
6 Regs. Sec. 1.170A-14(c)(1).
7 Regs. Sec. 1.170A-14(c)(2).
8 However, if the public benefit of an open space easement is not significant, the charitable contribution deduction will be disallowed (Sec. 170(h)(4)(A)(iii), flush language).
9 Sec. 170(h)(4); Regs. Sec. 1.170A-14(d).
10 Kiva Dunes Conservation, LLC, T.C. Memo. 2009-145.
11 Glass, 124 T.C. 258 (2005), aff’d, 471 F.3d 698 (6th Cir. 2006).
12 Regs. Sec. 1.170A-14(g)(1). Some commentators suggest also including an acknowledgment clause in the conservation easement deed with the following sample language: “Except for such monetary consideration (if any) as is set forth in this Article, Holder acknowledges that no goods or services were received in consideration of the grant of this Conservation Easement.” Whereas this language is not a replacement for the required separate contemporaneous acknowledgment substantiation letter (discussed later), it provides backup confirmation that no quid pro quo existed as part of the transaction. See the Land Trust Alliance website.
13 Regs. Sec. 1.170A-14(g)(5)(ii).
15 Regs. Sec. 1.170A-14(c)(2).
16 The Uniform Conservation Easement Act is available online.
17 See Uniform Law Commissioners, Uniform Conservation Easement Act Summary.
18 Regs. Sec. 1.170A-14(g)(5)(i).
21 Sec. 170(f)(8)(A).
22 Sec. 170(f)(8)(C) and Regs. Sec. 1.170A-13(f)(3). See also Gomez, T.C. Summ. 2008-93.
23 Sec. 170(f)(8)(B). See also Gomez, T.C. Summ. 2008-93.
24 Gomez, T.C. Summ. 2008-93.
25 Bruzewicz, 604 F. Supp. 2d 1197 (N.D. Ill. 2009).
26 Regs. Secs. 1.170A-13(c)(2)(i)(B) and (c)(4).
27 Regs. Sec. 1.170A-13(c)(2)(ii).
28 Prop. Regs. Sec. 1.170A-16; Preamble to REG-140029-07.
29 Regs. Sec. 1.170A-1(c); Regs. Secs. 1.170A-14(h)(1)–(4).
30 Regs. Sec. 1.170A-14(h)(3).
31 Hughes, T.C. Memo. 2009-94, citing Symington, 87 T.C. 892 (1986).
32 Regs. Sec. 1.170A-14(h)(3)(i). Note that the general rule for determining the amount of a charitable contribution is modified when the contributed property would not give rise to long-term capital gain (Sec. 170(e)(1)(A)). The amount of a charitable contribution of property is reduced by the amount of gain that would not have been long-term capital gain had the taxpayer sold the property at its FMV at the time of contribution.
33 Regs. Sec. 1.170A-14(h)(3).
36 Symington, 87 T.C. 892 (1986).
37 Turner, 126 T.C. 299 (2006).
38 Regs. Sec. 1.170A-14(h)(3)(iii).
39 Regs. Sec. 1.170A-14(h)(4), Example (7).
40 Regs. Sec. 1.170A-14(h)(4), Example (9).
41 Regs. Sec. 1.170A-14(h)(4), Example (10).
45 Kiva Dunes Conservation, LLC, T.C. Memo. 2009-145.
46 Hughes, T.C. Memo. 2009-94.
47 For more on this topic, see McClure, Hollingworth, and Brown, “Courts to IRS: Ease Up on Conservation Easement Valuations,” 124 Tax Notes 551 (August 10, 2009).
48 Pension Protection Act of 2006, P.L. 109-280.
49 Sec. 170(b), prior to amendment by the Pension Protection Act of 2006.
50 The Food, Conservation, and Energy Act of 2008, P.L. 110-246 (the Farm Bill), §15302.
51 The 2010 Tax Relief Act §723.
52 Sec. 170(b)(1)(E).
53 Notice 2007-50, 2007-25 I.R.B. 1430, Q&A-1.
54 Secs. 170(b)(1)(E)(iv) and 170(b)(2)(B). For contribution of property in agriculture or livestock production after August 17, 2006, by a farmer or rancher, the qualified real property interest must be subject to a restriction that the property remains available for such production.
55 Notice 2007-50, 2007-25 I.R.B. 1430, Q&A-2.
56 Sec. 170(b)(1)(E)(iv)(II). There is no requirement as to specific use in agriculture or farming or that the property be used for such purposes, only that the property remain available for such use. Joint Committee on Taxation, Technical Explanation of the Pension Protection Act of 2006 (JCX-38-06), p. 277 (August 3, 2006).
57 Sec. 170(b)(1)(E)(v); Notice 2007-50.
58 Notice 2007-50, Q&A-5.
59 Regs. Sec. 1.170A-13(c)(2)(i), referring to required information listed in Regs. Sec. 1.170A-13(b)(2)(ii). The list of additional items of information to be maintained includes (1) the name and address of the donee organization to which the contribution was made, (2) the date and location of the contribution, (3) a description of the property in reasonable detail, (4) the property’s FMV at the time the contribution was made, the method utilized in determining the FMV, and, if the valuation was determined by appraisal, a copy of the appraiser’s signed report, and (5) in the case of ordinary income or capital gain property, the cost or other (adjusted) basis, with reduction (if any) for short-term capital gains if the property was not held for a year or more prior to donation.
60 Sec. 170(f)(11)(D).
61 Regs. Sec. 1.170A-13(c)(3)(i)(A).
62 Regs. Sec. 1.170A-13(c)(3)(i)(B).
63 Regs. Sec. 1.170A-13(c)(3)(i)(C), referring to Regs. Sec. 1.170A-13(c)(3)(ii), which provides a comprehensive listing, including (1) a description of the property in enough detail so a person not generally familiar with the type of property can tell that the property appraised is the property contributed, (2) the physical condition of any tangible property, (3) the contribution date, (4) the terms of any understanding between the donor and the donee relating to the use, sale, or other disposition of the contributed property, (5) the qualified appraiser’s name, address, and taxpayer identification number, (6) the qualified appraiser’s qualifications, including background, experience, education, and membership in professional associations, (7) a statement that the appraisal was prepared for income tax purposes, (8) the date the property was appraised, (9) the appraised FMV of the property on the contribution date, (10) the valuation method used, and (11) the specific basis for the valuation.
64 Regs. Secs. 1.170A-13(c)(3)(i) and (c)(3)(i)(D). In short, a prohibited appraisal fee as provided by Regs. Sec. 1.170A-13(c)(6) is a fee arrangement based in whole or in part on a percentage of the property’s appraised value.
65 Notice 2006-96, 2006-2 C.B. 902, §3.02.
67 Prop. Regs. Sec. 1.170A-17(a)(5).
70 Notice 2006-96 §3.03(3)(a) provides that for real property, on returns filed after October 19, 2006, the appraiser is qualified if licensed or certified for the type of property being appraised in the state in which the real property is located.
71 Kiva Dunes Conservation, LLC, T.C. Memo. 2009-145.
72 The Tax Court made adjustments for the costs of improving the real estate into a golf course like the one at issue, and factored in depreciation of the improvements, which were not included in the Kiva Dunes appraisal.
73 Prop. Regs. Sec. 1.170A-17(b)(1).
74 Prop. Regs. Sec. 1.170A-17(b)(2).
75 Prop. Regs. Sec. 1.170A-17(b)(2)(ii).
76 Prop. Regs. Sec. 1.170A-17(a)(3)(iv)(B).
77 Prop. Regs. Sec. 1.170A-17(a)(3)(vi). This is in contrast to the statement required under the current regulations, which require a declaration that (among other things) the appraiser understands that an intentionally false or fraudulent overstatement of the value of the property described in the qualified appraisal or appraisal summary may subject the appraiser to a civil penalty under Sec. 6701 (Regs. Sec. 1.170A-13(c)(5)(i)(D)).
78 Sec. 6695A(b).
79 Regs. Sec. 1.170A-14(g)(2).
80 Chief Counsel Advice 201002038 (1/15/10), pertaining to the donation of facade easements, provides an example of a subordination agreement: “ABC Mortgage Group hereby acknowledges and agrees that it is the Mortgagee (Lender) under the Mortgage dated January 15, 2001, and recorded on February 1, 2001, Document # 10101010 in James County, California, and the holder of the Note secured thereby, and that it hereby subordinates its rights in the mortgaged property to the rights of the DEF Land Trust (Grantee) as set forth in the Deed of Conservation Easement, dated March 15, 2009, to enforce the conservation purposes in perpetuity.” [Signed by Joan Smith, President, ABC Mortgage Group]
81 Satullo, T.C. Memo. 1993-614.
82 Notice 2004-41, 2004-2 C.B. 31.
85 IR-2005-19 (2/28/05).
86 IR-2007-37 (2/20/07).
87 IR-2010-32 (3/15/10).
Monique Durant is an associate professor at Central Connecticut State University in New Britain, CT. For further information about this article, please contact Prof. Durant at Durantmon@ccsu.edu.