The changing landscape of conservation easements.

• Author: Durant, Monique O.

On December 17, 2010, President Barack Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (the 2010Tax 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."

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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.

Background

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)

Conservation Purpose

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 genera] 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...