§ 14.4 - Federal Tax Consequences

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§14.4 FEDERAL TAX CONSEQUENCES

Deductibility of gifts of qualified conservation easements for federal tax purposes has been provided by Congress and has been expressly recognized by the Internal Revenue Service (IRS).

(1) History

The IRS first recognized the deductibility of gifts of conservation easements with Revenue Ruling 64-205, 1964-2 C.B. 62 (IRS ruled that an easement in gross for certain conservation purposes was a sufficient real property interest to support a charitable deduction). The IRS later publicized the availability of an income tax deduction for gifts of "scenic easements" to qualified recipients. I.R.S. News Release No. 784 (Nov. 15, 1965). The Tax Reform Act of 1969, Pub. L. No. 91-172, 83 Stat. 487 (codified as amended in scattered sections of 26 U.S.C.), however, undermined the status of conservation easements by limiting the types of partial interests that would qualify as a charitable gift without expressly exempting conservation easements (the legislative history appeared, however, to indicate that Congress intended that conservation easements fit within the stated exceptions). Federal tax regulations and private letter rulings, however, continued to allow deductibility of conservation easements, relying on the legislative intent of the Tax Reform Act of 1969. I.R.S. Tech. Mem. 1970-26 (Dec. 10, 1970); see, e.g., I.R.S. Priv. Ltr. Rul. 74-0340A (Jul. 16, 1974).

The authority for the deductibility of conservation easements was restored expressly by the Tax Reform Act of 1976. Pub. L. No. 94-455, 90 Stat. 1520 (codified as amended in scattered sections of 26 U.S.C.) (the 1976 Act added I.R.C. § 170(f)(3)(B)(iii) and (iv), which allowed qualified conservation contributions). Subsequent amendments to the tax code in 1977, 1980, and 1984 further clarified the requirements for qualifying conservation easements. Tax Reduction and Simplification Act of 1977, 26 U.S.C. §§ 51-52, -280c; Pub. L. No. 96-541, 94 Stat. 3204 (1980); and Tax Reform Act of 1984, Pub. L. No. 98-369, 98 Stat. 494 (codified as amended in scattered sections of 26 U.S.C.).

(2) General principles of charitable gift law

To qualify as a tax-deductible gift, the donation of a conservation easement must meet certain requirements of the federal tax code. First, the donation must comply with general principles of charitable gift law. These principles are briefly discussed below. Second, the donation must satisfy specific requirements under I.R.C. § 170(h) pertaining to "qualified conservation contributions," one of three classes of partial interests recognized as tax-deductible under the federal tax code. These requirements are discussed in detail in §14.4(5).

There are two key general principles of charitable gift law that apply to conservation easements. First, the donation of the conservation easement must be a "true" gift for which no bargained-for benefit is anticipated. For there to be a charitable gift, the donor must have the requisite "donative intent" (i.e., "disinterested generosity"). Comm'r v. Duberstein, 363 U.S. 278, 80 S.Ct. 1190, 4 L.Ed.2d 1218 (1960). Generally, the donor does not have the requisite "donative intent" if the "gift" is made with an expectation of financial gain or measurable personal benefit. Smith v. Comm'r, 42 T.C.M. (CCH) 431 (1981). Thus, there is no deduction for quid pro quo gifts of conservation easements, such as when a developer deeds to a city a conservation easement as part of its subdivision approval. See Treas. Reg. § 1.170A-14(h)(3)(i); Hernandez v. Comm'r, 490 U.S. 680, 690, 109 S.Ct. 2136, 104 L.Ed.2d 766 (1989). However, if the expectation of personal benefit includes only "psychic satisfaction" or "incidental economic or personal benefit," the donor has the requisite "donative intent." Treas. Reg. § 1.170A-7(b)(1); Ackerman Buick, Inc. v. Comm'r, T.C. Memo. 1973-224, 32 T.C.M. (CCH) 1061 (1973); Rev. Rul. 75-66, 1975-1 C.B. 85 (landowner donates wetlands property but retains the right to use the property to train a hunting dog).

Second, the donation of the conservation easement generally must be complete and irrevocable, without strings or contingencies. For there to be a charitable gift, the possibility of the property reverting back to the donor must be "so remote as to be negligible." Treas. Reg. § 1.170A-7(a)(3). For example, there is no charitable gift if the donor agrees to donate property to a governmental entity or a land trust upon the condition that he or she receives a charitable deduction from the IRS. Similarly, there is no charitable gift if the transfer includes a reversionary interest (e.g., no gift if title would revert on the happening of an event that is not so remote as to be negligible).

(3) Income tax consequences

The donor of a conservation easement that qualifies as a charitable gift under I.R.C. § 170(h) may receive an income tax deduction for the donation. I.R.C. § 170. For income tax purposes, the value of the easement generally is the difference between the value of the land with the easement and its value without the easement, as determined by an appraisal. Treas. Reg. § 1.170A-14(h)(3). See §14.6.

The income tax benefit to the donor from a charitable gift of a conservation easement, typically measured as the amount of income the gift protects from being taxed, will depend upon the income tax rate that applies to the donor. Generally, the higher the income tax rate, the more attractive the income tax benefits from the donation. See Konrad J. Liegel, The Impact of the Tax Reform Act of 1986 on Lifetime Transfers of Appreciated Property for Conservation Purposes, 74 CORNELL L. REV. 742 (1989). A taxpayer, however, cannot eliminate all tax due with a large charitable donation.

Donations generally are deductible only up to 30 percent of adjusted gross income (AGI) for individuals and 10 percent of taxable income (TI) for corporations. I.R.C. § 170(b)(1)(C)(i); I.R.C. § 170(b)(2). Taxpayers generally may carry unused deductions forward for five years, subject to the annual limitations referenced in the previous sentence. I.R.C. § 170(b)(1)(B).

To address the needs of land-rich but cash-poor owners of land with significant conservation values, the Pension Protection Act of 2006, Pub. L. No. 109-280, 120 Stat. 780 (codified as amended in scattered sections of 29 U.S.C.), made changes to these general limitations for donations of qualified conservation easements in 2006 and 2007. These changes were extended through 2014, but expired on December 31, 2014. Under these temporary conservation tax incentives, donations of qualified conservation easements are deductible up to 50 percent of AGI for individuals with a 15-year carry forward (subject to the same 50 percent limitation each year). I.R.C. § 170(b)(1)(E). In addition, donations of qualified conservation easements by certain individuals and corporations, defined as a "qualified farmer or rancher" under I.R.C. § 2032A(e)(5), are deductible up to 100 percent of AGI or TI with a 15-year carry forward. I.R.C. § 170(b)(1)(E)(iv); I.R.C. § 170(b)(2)(B); see also I.R.S. Notice 2007-50, 2007-25 I.R.B. 1430 (guidance regarding deductions by individuals for qualified conservation contributions). Legislative efforts continue to make these temporary enhanced conservation tax incentives permanent.

Practice Tip: Practitioners should check current law to see if these changes have been extended, given ongoing efforts to extend or make these enhanced conservation tax incentives permanent.

When a donor imposes deed restrictions that restrict the government or land trust's uses of the property to certain uses (e.g., open space), the donor may be able to receive a charitable deduction only for the restricted value of the property. Rev. Rul. 85-99, 1985-2 C.B. 83. This problem can be avoided by conveying the intended restrictions in the form of a conservation easement to one qualified organization (e.g., a land trust), prior to or contemporaneously with the donation of the possessory interest to another qualified organization (e.g., a government agency).

(4) Gift/estate tax consequences

The donation of a conservation easement that qualifies as a charitable gift under I.R.C. § 170(h) and I.R.C. § 2055 may significantly reduce the federal and state estate taxes due on the donor's estate, and thereby help prevent the sale of the decedent's property by heirs to pay the estate tax. A lifetime charitable donation of a conservation easement to a qualified recipient (e.g., a public charity) entitles the donor to a gift tax deduction for the value of the conservation easement and removes the value of the conservation easement from the potentially taxable estate of the donor, thus lowering the value of the estate subject to estate taxes. I.R.C. § 2522. A charitable donation of a conservation easement at death similarly lowers the value of the estate subject to estate taxes. I.R.C. § 2055. Perpetual restrictions on the use of real property, such as conservation easements, that qualify for a charitable deduction under either I.R.C. § 2522(d) or § 2055(f) are exempt from the "estate freeze" provisions of I.R.C. § 2703. Treas. Reg. § 25.2703-1(a)(4). Unlike the income tax, there are no percentage limits to the amount of an estate that can be given to a charity.

The Taxpayer Relief Act of 1997, Pub. L. No. 105-34 §508, 111 Stat. 788, 860 (codified in scattered sections of 26 U.S.C.), as amended by the Internal Revenue Service Restructuring and Reform Act of 1998, Pub. L. No. 105-206 §6007(g), 112 Stat. 685, 810 (codified as 38 U.S.C. §1103 and in scattered sections of 26 U.S.C.) (creating a new code section, I.R.C. § 2031(c)), provides additional estate tax benefits for estates containing land subject to a qualified conservation easement.The benefits provided under I.R.C §2031(c) were made permanent by the American Taxpayer Relief Act of 2012, Pub. L. No. 112-240...

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