For many years, conservation easements have been a powerful estate planning tool that enable taxpayers to receive income and estate tax benefits while continuing to own and enjoy the properties. So it’s no surprise that the IRS has been scrutinizing easements to ensure they meet tax code requirements. The tax agency has even issued a warning that some of the transactions are “bogus tax avoidance strategies.”
Curbing abusive arrangements
A conservation easement is a restriction on the use of real property. It involves an arrangement to permanently restrict some or all of the development rights associated with a property. The easement is granted to a conservation organization — usually a government agency or qualified charity — by executing a deed and recording it in the appropriate public records office. The organization is responsible for monitoring the property’s use and enforcing the easement.
In a legitimate transaction, a taxpayer can claim a charitable contribution deduction for the fair market value of a conservation easement transferred to a charity if the transfer meets tax code requirements. The IRS explains that “in abusive arrangements, promoters are syndicating conservation easement transactions that purport to give an investor the opportunity to claim charitable contribution deductions and corresponding tax savings that significantly exceed the amount the investor invested.” The tax agency added “these abusive arrangements, which generate high fees for promoters, attempt to game the tax system with grossly inflated tax deductions.”
As part of recent legislation, an easement-related provision changed the tax code to curb certain abusive conservation easement transactions. The IRS announced it “is committed to ensuring compliance with the conservation easement deduction law as amended and will continue to keep an eye on transactions that are ‘too good to be true.’”
A guide for auditors
To assist auditors examining tax returns, the IRS has a Conservation Easement Audit Technique Guide (ATG). The fact that the ATG is more than 100 pages demonstrates how complex the transactions are and how serious the IRS is about uncovering abusive arrangements.
The ATG explains that to qualify for tax benefits, an easement must be granted exclusively for one of the following purposes:
- To preserve land for public recreation or education,
- To protect a relatively natural habitat of fish, wildlife or plants,
- To preserve open spaces, either for the public’s “scenic enjoyment” or according to a governmental conservation policy that yields a “significant public benefit,” or
- To preserve a historically important land area or a certified historic structure.
It’s critical for an easement to be carefully drafted so there’s no confusion about which land uses are given up and which are retained.
Tax benefits
For estate tax purposes, a percentage of the land’s value (up to certain limits) can be excluded from a gross estate (in addition to any reduction in value resulting from the easement). Certain other limitations apply.
For income tax purposes, a qualified transaction entitles a taxpayer to deduct the easement’s value (defined as the difference between the property’s fair market value before and after the easement is granted) as a charitable gift. The deduction is subject to the same limitations that apply to other charitable donations. Conservation easements valued over $5,000 must be supported by a qualified appraisal.
Common errors
The ATG identifies common mistakes when making donations. They include:
- Use of improper appraisal methodologies and overvalued easements,
- Failure to comply with substantiation requirements, and
- Failure to restrict development of the land in perpetuity, allowing the easement to be abandoned or terminated.
If you’re contemplating a conservation easement, know that the IRS is scrutinizing them. Work with tax, legal and valuation professionals to stay out of IRS trouble and avoid losing valuable tax benefits.
