Conservation Easements: the Federal Tax Rules and Special Considerations Applicable to Syndicated Transactions

• Publication year: 2022

49 Creighton L. Rev. 293. CONSERVATION EASEMENTS: THE FEDERAL TAX RULES AND SPECIAL CONSIDERATIONS APPLICABLE TO SYNDICATED TRANSACTIONS

CONSERVATION EASEMENTS: THE FEDERAL TAX RULES AND SPECIAL CONSIDERATIONS APPLICABLE TO SYNDICATED TRANSACTIONS

Bradford Updike, JD, LLM and Bryan Mick, JD, MBA

Conservation easements are a fairly recent approach to land conservation. As government acquisitions and regulatory restrictions on land use have become prohibitively invasive, costly, and ineffective, governments, such as the United States, have looked to conservation easements as a potentially effective and less expensive conservation method than government ownership and regulation. The "use of conservation easements began to gain steam by the 1980s, and by the 1990s, exploded on the scene."(fn1) Today, several million acres of conservation-sensitive land have been protected with such easements.(fn2) Co-incidentally, the income tax benefits associated with these easements have included several billion dollars in federal income tax deductions.(fn3)

While the vast majority of conservation easement transactions involve private landowners, a cottage sub-industry evolved within the financial services market over the past decade that involves companies that syndicate real estate investment opportunities to retail investors that utilize conservation as a possible program investment purpose.(fn4) These securities offerings are premised on a real estate investment transaction that involves the acquisition by an investor group of an interest in environmental sensitive real estate that is also developable or marketable as commercial real estate. This transaction is further supported with, in many cases, significant federal income tax deductions that apply to conservation easements and that may be allocated to the investor partners if a conservation purpose is ultimately adopted by the partners.

This Article is presented in an effort to provide readers with an overview of the basic federal tax rules that apply to conservation easements, and to alert readers of special tax considerations that apply in cases where a conservation easement is contemplated within the context of syndicated partnerships or limited liability companies (sometimes referred to as "programs" or "investment programs"). While we believe conservation easements established as a component of a real estate and investment program can conceptually work for investors if structured with due care, the phrase caveat emptor is especially meaningful in regard to these investment programs given that certain of these programs have fallen short of meaningful economic substance or have presented issues relating to valuation or conservation purpose. The consequences of having too many transactions that fall within such parameters include (i) a potential audit nightmare for the investors that placed their capital in the programs, and more importantly (ii) the de-legitimization of a well-intended code provision aimed at protecting valuable natural resources through well-intended income tax benefits.

While we have written this Article to provide some foundational federal income tax-related information for individuals who may want to use conservation easements for income tax planning reasons, we would alert your attention, in particular, to our discussion of the following: the partnership "anti-abuse" regulations of the Internal Revenue Code ("Code"); supporting case law doctrines that discuss economic substance; and how these tax law authorities can affect the suitability and viability of investment programs where a conservation easement is contemplated as a part of the program's purposes.(fn5) As a note to those that are evaluating these transactions on behalf of securities firms, Regulatory Notice 10-22 promulgated by Financial Industry Regulatory Authority, Inc. ("FINRA") requires its member broker-dealers to conduct reasonable investigations that relate to the viability of an issuer's business and assets in general.(fn6) This requirement is a part of the reasonable-basis due diligence that must be conducted by a financial service firm to determine whether an investment product is suitable for any investor.(fn7) Given that the viability of substantially all private placements would, in the eyes of investors, hinge upon the presence of a reasonable opportunity for the investment in question to achieve an economic benefit that exceeds the amount of the invested capital (which, in the context of an easement-related offering, may possibly hinge upon the ability for the investor to claim significant charitable tax deductions), we would urge certain readers to cautiously review Section VI of this Article in particular, which addresses the implications of the economic substance and anti-abuse provisions of partnership income tax law.(fn8)

I. WHAT IS A CONSERVATION EASEMENT?

An easement refers to a legal interest that one person has in the land of another, with the land subject to the rights of the interest holder referred to as the servient tenement, and with the easement itself being the dominant tenement.(fn9) As applied to the preservation of lands, a conservation easement, which is a legal tool for conserving private land, is a written legal agreement between a landowner and a land trust or government agency that permanently limits uses of certain selected land in an effort to protect the land's conservation val-ues.(fn10) As is the case with other real estate instruments that convey ownership rights, conservation easements will (i) be drafted to legally identify the real estate whose use is so restricted, (ii) follow the acknowledgement requirements of the state where the property is located, and (iii) be filed within the real estate records of the county where the real estate is located to provide sufficient notice of the property use restrictions to the public.(fn11) Although these legal agreements significantly restrict the permitted uses of the subject property, these agreements can allow landowners to continue to own and use their land and to also sell or pass such land to heirs.(fn12) If properly drafted, these agreements can, in many cases, also provide the property owners with limited development rights within very carefully defined boundaries.(fn13)

The United States Congress determined years ago that it was in the country's best interest to preserve land of ecological or historic importance in a manner that protects conservation values identified by Congress as being important. To accomplish this, the Code provides significant federal income tax benefits to those who voluntarily restrict their property in a manner that preserves significant conservation values on their property in perpetuity. The federal income tax benefits provided by the Code for these restrictions are found in sections 170(a) and (h). The federal estate tax rules that apply to such easements are also found in sections 2031(c) and 2055(f) (as explained in Section VIII of this Article).(fn14)

As ninety-five percent of all endangered species of plants and wildlife are reported as living on privately-owned lands, the public policy that encourages private land owners to grant conservation easements to land trusts organized as federal tax exempt organizations and governmental agencies is well established.(fn15) Historically, these easements have protected millions of acres of wildlife habitat and open space.(fn16) The National Conservation Easement Database reports that 114,216 conservation easements cover 23.349 million acres of land in the U.S. (July 2015 data). According to the Land Trust Alliance, a nationwide association of land trusts in the 48 contiguous U.S. states, there are twice as many acres subject to conservation easements on private lands as compared with lands situated within National Parks.(fn17) The vastness of land covered by such protective easements has also translated to several billion dollars in income tax savings to donors.(fn18)

II. CONSERVATION EASEMENT'S PURPOSES AND DRAFTING REQUIREMENTS

Conservation easements are restrictions placed on real property to protect its natural resource values or those of ecologically related properties. Easements are either voluntarily sold or donated by the landowner and constitute legally binding agreements that limit certain types of uses or development on the subject property in perpetuity.(fn19) A central attribute of these easements is that their restrictions and terms can sometimes be designed to fit the needs of the underlying fee owner and the easement holder so long as they retain a public purpose or intent.(fn20)

Permitted Purposes. To be deductible, donated conservation easements must be legally binding and permanent restrictions on the use, modification, and development of conservation valued property such as parks, wetlands, farmland, forest land, scenic areas, historic land, or historic structures. Section 170(h) of the Code states that a qualified conservation contribution is "a contribution (i) of a qualified real property interest" (i.e., a restriction granted in perpetuity on the use which may be made of the real property), "(ii) to a qualified organization, (iii) exclusively for conservation purposes."(fn21) Qualified organizations that accept conservation easements (i.e., charitable organizations that are organized for conservation purposes and governmental units) must have a commitment to...