A Tax Guide to Conservation Easements

C. Timothy Lindstrom

• Publisher: Island Press
• Year: 2012
• ISBN:
  9781610910545
• Topic: Architecture
• Subtopic: Architecture General

Voluntary land conservation, resulting from increasingly alluring tax benefits, has significantly changed the face of land use in the United States and promises to have an even more significant influence in the future. There are more than 1, 500 land trusts in the U.S. today, involving millions of acres of land that have been permanently protected by conservation easements. Most of these land trusts depend heavily upon the significant income or estate tax benefits offered by the federal tax code as an incentive for voluntary land conservation. However, only a very small percentage of land trust personnel, landowners or their advisors, or even government officials, fully understand the complexity of the requirements for these tax benefits.This is a comprehensive book on the tax benefits of the charitable contribution, or bargain sale, of a conservation easement. It provides a detailed explanation of the complex and extensive requirements of the federal tax code and related concepts, including the rules governing the operation of tax-exempt organizations such as land trusts. Clearly written, systematic in its coverage, it is intended to be of value for anyone who deals with land trust issues, including land trust staff and trustees, landowners, lawyers, accountants, government officials, and interested lay people. Structured for easy reference, A Tax Guide to Conservation Easements is designed to be used as a resource tool. Related topics are cross-referenced throughout. All principles in the book are illustrated with one or more useful examples.The tax benefits of contributing a conservation easement are unquestionably the heart of voluntary land conservation today. Knowledge of the tax law relating to land trusts and conservation easements is vital to properly establishing and managing land trusts and to insuring the tax deductibility of conservation easements. The future of voluntary land conservation is dependent on a clear understanding of tax policy. Complete, meticulous, and up to date, A Tax Guide to Conservation Easements is an essential handbook.

PART III

I ncome Tax Benefits

There are significant income tax benefits associated with the charitable contribution of conservation easements, provided that the easement document complies with all the requirements of Code section 170(h) and the accompanying Regulations, as discussed in part 2. Income tax benefits provided to conservation easement donors are a significant incentive for voluntary land conservation. However, like most tax incentives, they work best for those with high incomes.

The deduction for the contribution of a conservation easement is relatively simple in concept. However, the various statutory limitations, and the somewhat less than clear conceptual limitations (most prominently the requirement for “donative intent”), significantly complicate the deduction and limit the number of circumstances in which it may be available, even though the easement document meets all of the requirements described in part 2.

CHAPTER FOUR:

Tax Benefits

I. Calculation of the Tax Benefit

Calculation of potential income tax benefits from the contribution of a conservation easement is complex, although estimating the theoretical maximum benefit is not. Here again, the calculation of tax benefits should not be undertaken without the assistance of a tax expert knowledgeable about conservation easement deductions and familiar with a prospective donor’s tax circumstances.

Soliciting contributions based on projected tax savings can get a land trust into trouble very fast. This is because, in some cases, such solicitation may be considered the marketing of a tax shelter; the unauthorized practice of law; or, where projections and actual benefits are significantly different, fraud or misrepresentation. So, why read this section at all? Because understanding the tax mechanics for land trust personnel is essential to a realistic approach to the promotion of voluntary conservation. Furthermore, if you are a tax professional, you are in a position to provide projections and advice regarding potential tax benefits.

A. The Value of the Easement Is Deductible: Code Sections 170(a) and (h), Regulations Section 1.170A-14(h)(3)(ii)

The value of a conservation easement that complies with the requirements of Code section 170(h) may be deducted from the donor’s income for purposes of calculating the donor’s federal income tax. Remember that a deduction represents a reduction in the amount of income against which tax is imposed, not a direct dollar-for-dollar offset against income tax as is the case with an income tax credit. Therefore, the actual tax benefit is only a percentage of the amount of the deduction.

The value of a conservation easement for purposes of the deduction is typically the difference in the value of property before the easement contribution and after the easement contribution (see chapter 5 for a discussion of easement valuation).

Example: Mr. Jones contributes an easement on land that is valued at $1 million before the contribution. After the contribution the land is valued at $300,000. The value of the easement is $700,000 ($1,000,000 – $300,000) : the difference in the value of the land before and after the easement is in place.

B. Calculating the Maximum Tax Benefit

The maximum possible federal income tax benefit (i.e., the tax savings resulting from an easement deduction) that may be enjoyed from the charitable contribution of a conservation easement is calculated by multiplying the appraised value of the easement by the top federal tax rate. Many states with an income tax provide a deduction for easement contributions as well. In such cases, adding the applicable top federal and state tax rates together, and multiplying the value of the easement by those combined rates, provides the maximum possible combined federal and state income tax benefit from any easement contribution. However, it is important to note that very few donors will enjoy the maximum benefit due to a number of restrictions imposed by tax law on how the deduction is used. These restrictions are described in the following sections.

As of January 2007, the top federal income tax rate for individuals was 35 percent (ranging from 10 percent). The top federal income tax rate for “C” corporations (corporations taxed as separate entities) was 39 percent (starting at15 percent but not increasing incrementally). “S” corporations, and other entities, such as limited liability companies and partnerships, pass income and deductions through to their owners, and they are then figured into the individual’s personal tax return (see the discussion of various entities in section V of this chapter).

Example: If Mr. Jones resides in a state with a 6 percent income tax that allows a deduction for the contribution of a conservation easement, he would enjoy an additional state income tax benefit of $42,000 (.06 × $700,000).

Another way to calculate the total maximum benefit for Mr. Jones would be simply to add the top federal and state rates together and multiply the value of the easement contribution by that combined rate (41 percent).

The federal tax system is a graduated system, in which lower income is taxed at lower rates. As a result, all taxpayers pay less than the top rate of tax on some portion of their income, so the overall rate of tax paid is always less than the “marginal rate” imposed on their income (i.e., the highest rate of tax imposed on their income). Some taxpayer’s income is insufficient for any of it to be taxed at the top rate. For example, the 2007 federal tax rates for married persons filing jointly are 10 percent on income up to $15,650; 15 percent on income from $15,651 to $63,700; 25 percent on income from $63,701 to $128,500; 28 percent on income from $128,501 to $195,850; 33 percent on income from $195,850 to $349,700; and 35 percent on all income over $349,700. Rates for single filers and married persons filing separately are different. If a married couple’s income is no higher than $200,000, their marginal rate will be only 33 percent, and the tax benefits they would receive from any charitable deduction will likely be less than the benefits enjoyed by a couple with a 35 percent marginal rate.

Because of the graduated tax system, an accurate computation of the tax benefits that will result from a conservation easement deduction for any given individual must take into account all of the different rates at which the income sheltered by the deduction would have been taxed.

Example: In 2007 Sharon and Sol Green contributed a conservation easement valued at $200,000; that is the amount they are entitled to deduct from their income for federal tax purposes. The Greens’ income in 2007 was $400,000. The conservation easement was their only charitable contribution in 2007. The effect of that contribution was to reduce the Greens’ taxable income to $200,000 (ignoring for a moment the 3 percent phase-out in certain itemized deductions, discussed in section I, I of this chapter).

According to the tax rate schedules for a married couple for the year 2007, the first $15,651 of the Greens’ income would be taxed at 10 percent (.10 × $15,651 = $1,565.10); the next $48,049 would be taxed at 15 percent (.15 × $48,049 = $7,209.35); the next $64,800 at 25 percent (.25 × $64,800 = $16,200); the next $67,350 at 28 percent (.28 × $67,350 = $18,858); the next $153,850 at 33 percent (.33 × $153,850 = $50,770.50); and the balance of $50,300 at 35 percent (.35 × $50,300 = $17,605).

Disregarding the reductions in income allowed the Greens (personal exemptions, standard or itemized deductions, etc.), the total tax due on the Greens’ income would be $112,207.95, just over 28 percent of their income. The income tax on the $200,000 sheltered by the conservation easement deduction would have been $67,006 ([.35 × $50,300 = $17,605] + [.33 × $149,700 = $49,401] = $67,006). This tax is 33.5 percent of the $200,000 sheltered by the easement deduction. Thus, the actual tax benefit received by the Greens was not 35 percent but 33.5 percent of the $200,000 easement ($67,006 / $200,000).

As the preceding example demonstrates, calculating the actual, not theoretical, tax benefit from an easement contribution is not simple. Other deductions, filing status, and the number of personal exemptions will affect the donor’s income, thereby affecting applicable tax rates, just as the total amount and kind of income will affect applicable rates. Without factoring all of these variables together, which can best be done by actually filling out a tax return for the donor that includes all of these variables, an accurate estimate of the tax benefits of an easement contribution for any given individual or couple cannot be made.

Some states, in addition to allowing a charitable deduction for the contribution of a conservation easement, allow a credit against state tax due for easement contributions. Discussion of state tax credits, and other state tax benefits, is beyond the scope of this text (there is a short discussion of the federal tax treatment of state tax credits in section VI of this chapter). However, tax credits are powerful incentives because they directly offset tax due on a dollar-for-dollar basis, rather than merely reducing the amount of income subject to tax, as is the case with an income tax deduction. Of course, state tax rates are considerably lower than federal tax rates. In addition, some states allow easement donors to sell their credits to other taxpayers in the state. The ability to sell a credit makes the credit valuable to easement donors whether or not they have significant tax liability.

C. The Amount of the Federal Deduction Is Subject to an Annual Limitation: Code Section 170(b), Regulations Section 1.170A-8(a)

The Code does not allow taxpayers to deduct more than a fixed percentage of their annual income for charitable contributions, no matter how large that contribution may have been. More than any other feature of federal tax law, this limitation disadvantages low-income donors. This is particularly significant when it comes to conservation easement deductions, because while some of the nation’s most valuable land, from a natural resource standpoint, is farm and ranch land, few family farmers and ranchers have substantial incomes. Therefore, the tax incentive for them to protect their land is significantly reduced compared to the incentive for wealthier individuals.

In 2006 Congress, as part of the Pension Protection Act, amended the provisions of the Code that limit the percentage of income against which a person making a qualified conservation contribution may claim a deduction. By increasing the percentage of income against which a conservation easement deduction may be taken, Congress made the tax incentives for easement contribution much more meaningful for landowners with smaller incomes, and particularly for landowners whose income comes mostly from the business of farming or ranching.

Unfortunately, the 2006 law expired at the end of 2007; however, Congress continues to consider making it permanent. Note that the following discussion of annual limitations is divided into “2006 law” and “current law” to reflect this 2006 revision. However, because the 2006 law will apply only to easements donated in 2006 and 2007, readers need to know both laws, recognizing that the current law applies to all conservation easements contributed before 2006 and after 2007, unless Congress renews the 2006 provisions.

1. The Current Law: Code Section 170(b)(1)(C)(i), Regulations Section 1.170A-8(d)(1)

Again, the current law is the law applicable to all conservation easements except those contributed in 2006 and 2007.

a. Individuals

Under the current law, when an individual mak...

Table of contents

• About Island Press
• Title Page
• Copyright Page
• Table of Contents
• Preface
• PARTI - Basic Principles
• PART II - Regulatory Requirements for Deductible Conservation Easements
• PART III - I ncome Tax Benefits
• PARTIV - Estate and Gift Tax Benefits
• APPENDIX A - Internal Revenue Code Provisions Governing Conservation Easements
• APPENDIX B - Income Tax Regulations for Conservation Easements
• APPENDIX C - Uniform Conservation Easement Act
• APPENDIX D - IRS Notice 2004-41: Charitable Contributions and Conservation Easements
• APPENDIX E - IRS Ruling Relating to S Corporations
• Glossary
• Resources
• Index
• Island Press Board of Directors