I hope you have all had a fun, safe, and fulfilling Labor Day. After the long weekend and, if you are from Cincinnati, some entertaining fireworks and music courtesy of WEBN, Western and Southern, and Rozzi’s, it is time that most of us step back into our offices and catch up on the deluge of e-mails that have accumulated over the past few days. For a brief moment, however, let’s forget work and talk about saving money, a topic in which most are interested.
Today’s topic seems to have become increasingly popular in the past few years. Charitable conservation easements are an excellent example of a device used by Congress to pursue a societal goal. Just as mortgage interest deductions promote home ownership and lower tax rates on long term capital gains promote long term investment, charitable conservation easements promote land conservation by providing a charitable deduction for granting an irrevocable restriction on developing one's property.
Because this topic can easily spiral into a tangled mess of legalese, let's break it down into plain English steps:
1. Landowner identifies a piece of property with conservation value.
2. Landowner's attorney or conservation organization's attorney drafts a legal document formally restricting any development on the piece of property forever.
3. Landowner commissions a valuation of the property wherein a valuation expert identifies the value of the land before and after the easement is placed upon it.
4. Landowner donates the restrictions contained within the legal document, called an easement, to a conservation organization, who monitors the landowner's compliance with the document's constraints.
5. At the end of the tax year, the landowner claims a non-cash charitable contribution deduction for the decrease in land value resulting from the restriction of development rights.
It all sounds pretty easy and popular, right? After all, the president has donated millions in conservation easements - so why doesn't every homeowner with a quarter of an acre of land do it? Let's take a look:
1. Conservation easements are expensive to implement. - If you'd like to place a conservation easement on a piece of land, you'll need to involve your attorney, accountant, and valuation expert. After drafting the easement and performing a valuation of the land before and after the conservation easement's restrictions, you'll have to pay the charitable conservation organization to manage the easement and ensure your compliance. This can be structured as an annual fee, a percentage of the future sales price (if the plot of land is ever sold), or a lump-sum up front fee. In any structure, the fees paid to a conservation organization, though necessary for continued compliance audits, can be substantial. These fees can make small conservation easements unattractive, even though they can increase the charitable deduction.
2. Conservation easements are an audit magnet. - For years, unscrupulous conservation easement promoters have hawked questionable deals promising up to 250% return on investment; i.e. $2.50 in charitable deduction for every $1 invested. I've heard stories of developers in Colorado granting easements on land in a valley while building a housing development higher up the mountain. Armed with the promise that the future homeowners' views would remain unspoiled by development in perpetuity, the developers profited handsomely while attempting to take a charitable deduction for the purported "decrease" in value of the land in the valley attributable to the conservation easement. Golf course owners have also tried to get in on the action by donating their development rights. On a developed golf course!
These abuses have caused intense scrutiny of charitable conservation easement transactions; it's completely understandable to see why. It's also understandable to see why we frequently hear of the IRS successfully disallowing part or all of the deduction resulting from these abusive transactions. Unfortunately, there is no guarantee that your conservation easement donation will not be audited by virtue of being above board. After all, the IRS must investigate the transaction to verify just that.
3. Conservation easements take time. - Large conservation easements, or donations of multiple, small easements cause a great deal of strain on valuation analysts and the charitable organizations to whom you are donating. Though there are large conservation organizations in most markets, their resources are never unlimited. For one large transaction, we were told the process could take nine months or more. On top of frustration, the wait time could cause additional tax planning considerations, especially if the donation spans multiple years or your income fluctuates significantly each year.
4. Conservation easements are limited. - Not in size, but in the deduction realizable. For most individuals, conservation easement deductions are limited to 50% of Adjusted Gross Income. Farmers and ranchers can wipe out their income entirely, but that concept is greater than the scope of this narrative. Fortunately, the deduction can be carried forward 15 years. But, for example, if your income is $250,000 and you inherited a piece of land that could possibly provide $5,000,000 in charitable deductions by placing a charitable conservation easement upon it, it might not make sense from a tax prospective because you will never fully realize the charitable deduction at your current income level.
After reading this list of negatives, it may seem as though charitable conservation easements are the last tax reduction strategy you'd want to utilize. But you shouldn't let the fear of an audit discourage an otherwise reasonable, beneficial transaction. A cost-benefit analysis is necessary; i.e. is this transaction large enough to be worth fighting if it was ever challenged by the IRS, but for most large landowners, the answer will be a resounding yes. If you have to spend some money to preserve a $1,000,000 charitable contribution deduction throughout which you have followed the letter and intent of the law, and in the process you help keep land conserved, I'd consider the process worth it.
Just make sure you don't try to take a deduction for 90% of the value of a piece of property in the middle of nowhere with no reasonable chance of being developed; if you do, you could end up on the news like the rest of them.
Ready to talk about charitable conservation easements? How about other novel tax reduction strategies? Drop me a line - firstname.lastname@example.org. I'll be glad to help!