Legally binding obligations that limit a property’s future use, conservation easements often protect biological, ecological, scenic, and historical resources. In addition they can serve as public parks. The way it works is a conservation easement limits commercial and industrial use, restricts or prohibits development and curbs other activities on the property.
At present the National Conservation Easement Database of the United States lists an estimated 40 million acres under conservation easements—nearly the size of Washington State. Last year Congress increased the conservation easements deduction benefit for landowners of private lands from 30% to 50%. A qualified farmer could deduct up to 100% of his or her income.
For those considering donating a conservation easement and claiming the federal tax deduction, special care must be taken to ensure compliance with the tax law and related regulations. For example, the donation must be made “to a qualified organization” “exclusively for conservation.” There are important rules which must be followed regarding how to appraise the fair market value of the conservation easement.
As in real estate, the name of the game is location, location, location. For an area with a high demand to develop the land, as a rule the easement’s value is likely to be substantially higher than on land with little or no demand to alter it. Sometimes placing an easement on the property gives the landowner a property tax savings. Each individual property needs to be evaluated thoroughly.
“Something could go wrong in an appraisal and the IRS could step in and determine the validity of your appraisal is off,” says attorney Bilal Malik, Managing Partner at the Malik Law Group in Atlanta, Georgia. “For instance, if your easement is based on a sprawling hotel complex never being built and the IRS determines a hotel can’t be built there, the easement could be invalidated. That’s why at least two (if not three) appraisals are strongly recommended. There’s got to be a true purpose behind the conservation.”
Additionally, conservation easement donations must comply with “conservation purposes” as defined by the IRS in IRC code section 170(h). The donated easement must be a true gift that protects significant historic, agricultural or natural resources public agencies or land trusts want to have conserved.
A donated easement’s function isn’t to simply prevent development on a property or be part of a “quid pro quo” agreement in exchange for a government action (i.e., zoning changes, building permits and the like). If this is the case in all likelihood the IRS will revoke the easement after a year or two.
Prior to 2015, if a landowner earned $50K per annum and donated a $1M conservation easement, s/he would be eligible for a $15K deduction. The new rule incents landowners to deduct 50% of their income—in this case $25K for the year. Over 15 years total deductions would add up to $400K. And, if the landowner uses the land for ranching or farming*, s/he is eligible for a $50K deduction—100% of income—for the first year as well as the following years. This maximum deduction totals $800K. Not a bad way to save on taxes. Note, no one’s deductions can exceed fair market value of the gift and the permanent incentive does create a means for landowners to have an ongoing deduction.
“Donated land must be a capital asset first (owned for at least 1 year) then it can be donated into an easement,” states Malik.
This guide recently published by the Land Trust Alliance outlines the practice in detail. Before you begin envisioning vegetables and livestock at your country home, remember, specific rules that apply—more on that below. There’s a set carry period—it was 5 years and now it’s 15.
As of the passing of the 2015 law, a “farmer or rancher” is defined as one who receives more than half of their gross income from “the trade or business of farming.” By law, activities included are described as:
- Planting, cultivating, caring for or cutting of trees;
- The preparation (other than milling) of trees for market;
- Handling, drying, packing, grading or storing on a farm any agricultural or horticultural commodity in its unmanufactured state, but ONLY if the owner, tenant or operator of the farm regularly produces more than one-half of the commodity so treated;
- Raising or harvesting any agricultural or horticultural commodity (including the raising, shearing, feeding, caring for, training and management of animals) on a farm; or
- Cultivating the soil.
For farmers or ranchers to qualify for the easement, it must contain a restriction requiring the land remain “available for agriculture.” This provision also applies to farmers who are organized as C corporations. Note, the expanded incentives are still relatively specific under IRC 170 (h)(2). If a conservation easement applies, you’ll be in the company of Louis Moore, Christie Brinkley and Paul Newman’s children.
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This article originally appeared on Forbes.com.