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real estate easement


  • pg 1
									            Using Conservation
                         Easements for
                                 Real Estate

                         By Gary A. Zwick and James John Jurinski

                   Family members may want to impress the responsibility for
               stewardship of the land onto the next generation as a family value.
           At the same time, the rise in real estate values puts significant pressures on
             families to sell land with development potential. What’s the solution?

OWNERSHIP OF REAL ESTATE can create                          creased the wealth of many real-estate owning
problems for a family owning a business. Of                  families. If the real estate is solely owned by
course some family businesses consist primari-               older family members, estate planning is in
ly of commercial real estate holdings. In other              order to minimize estate taxes at death.
cases the real estate may be used in the busi-
                                                             Techniques include giving and selling fractional
ness—for example a farm, ranch, or resort. In
other cases real estate may be owned by the                  interests in the real estate to a spouse or to
family but has no functional use in the main                 younger family members with the aim of re-
business. The rapid appreciation of real estate              moving the asset—and subsequent apprecia-
values in many parts of the country has in-                  tion—from the taxable estate.

Gary A. Zwick is Of Counsel to the law firm of Walter & Haverfield, P.L.., in Cleveland, Ohio and is Chair of the
Tax Department and in charge of the firm’s Family Business Group. Professor James John Jurinski teaches a
course in family business planning as well as several tax courses at the University of Portland. This article is de-
rived from the 2000 supplement to the authors’ Tax and Financial Planning for the Closely Held Family Business, pub-
lished by ALI-ABA. For more information on this book, call 1-800-CLE-NEWS, or visit our Web site at www.ali-

44     The Practical Tax Lawyer                                                           Summer 2000

   Of course, lifetime transfers to minimize            One reason frequently cited by family mem-
transfer taxes come at the price of losing the        bers for having a family business is that it draws
step-up of basis at death for income tax pur-         the family together and promotes group values.
poses. Accordingly, the best candidates for life-     This is especially the case with land. Land cre-
time transfer are parcels that are likely to be       ates a sense of place, and a sense of belonging.
held for some time by the younger generation.         Being present at the family seat, even for a visit,
Parcels that will be immediately sold will be ex-     can trigger family memories and linkages with
posed to substantial capital gains tax on the         past generations. Accordingly, real estate de-
holding period appreciation. In any event, ad-        serves special planning attention.
visers need to quantify the likely tax costs of ei-      Additionally, in the case of farms or land with
ther strategy. Other strategies include making        historic or scenic values, some family members
the special use valuation election of Internal        may have a strong feeling of stewardship for the
Revenue Code (“Code”) section 2032A, which            land, aside from its family attachment. Family
reduces the value of real estate used in a farm       members may feel they are responsible for car-
or family business for estate tax purposes. (All      ing for and maintaining the land in its present
section references are to the Code unless other-      state. They may want to impress the responsi-
wise indicated.)                                      bility for stewardship on to the next generation
   When real estate is owned in one parcel, this      as a family value. In this sense the land becomes
creates a number of potential tax and nontax is-      a device that is far more powerful than other as-
sues for the family. If everyone agrees that the      sets of equal value.
parcel should be sold, the sole problem will be
how to minimize tax costs and fairly apportion        Pressure To Sell
tax costs between the generations and among              At the same time, the rise in real estate values
family members. If opinions differ about              puts significant pressures on families to sell
whether the parcel should be sold at all, then the    land with development potential. Because of
family may face a serious dilemma with family         the attraction of remote areas for second homes,
members split over the wisdom of the sale.            nearly every area of the country is feeling de-
                                                      velopment pressures. Although family mem-
THE POWER OF REAL ESTATE • Real estate                bers may have strong desires to continue their
has emotive power unlike most other assets. If        stewardship of the land, these must always be
the land is a farm or ranch or has special scenic     balanced against financial realities and the de-
or historical values it may hold special signifi-     sire to turn underproductive assets into cash re-
cance for the family. The prospect of selling the     turns. Undeveloped land that produces no in-
land may create a serious rift in the family.         come but generates significant local real estate
Consider a home that has been owned by fami-          taxes will obviously pose hard choices. Ad-
ly members for four generations. Although             ditionally, if the land is held by older family
market conditions may point toward selling the        members the fair market value of the land will
property, there will also be an enormous emo-         be included in the owner’s taxable estate and
tional cost in selling the property.                  exposed to federal estate taxes at rates from 37
                                                      Using Conservation Easements for Real Estate     45

to 55 percent. Without planning, the property           local governmental units and most “public”
may have to be sold just to pay the estate tax.         charitable organizations, but it specifically ex-
                                                        cludes private foundations.
CONSERVATION EASEMENT AS A SOLU-                          Not all land is eligible. Conservation ease-
TION • Families who want to maintain their              ments are also permissible if the land is within a
ownership of real estate with scenic, conserva-
                                                        25-mile radius of a Metropolitan Statistical area,
tion, or historic value need to consider the use of
                                                        or a national park or wilderness area, or within
a “conservation easement” which can provide
                                                        10 miles of an Urban National Forest. Ad-
the family with a significant tax subsidy for
                                                        ditionally, the land must have been owned by
keeping the property in a less intensively devel-
                                                        the decedent’s family for at least three years im-
oped state. A scenic easement is essentially a
                                                        mediately before death.
“negative easement” that legally limits the de-
velopment of the land. To encourage private                A deductible conservation easement must be
stewardship of land, Congress has provided for          “exclusively for conservation purposes.” This
significant tax benefits for the donation of de-        does not mean that “incidental benefits” are pro-
velopment rights to a qualified organization.           hibited. The easement must prohibit all but min-
Creation of a conservation easement provides            imal commercial activities on the land. How-
three distinct tax advantages: an income tax de-        ever, the family can reserve rights to continue
duction, reduction of potential estate tax, and         agricultural, farming, ranching, or forestry activ-
local property tax reduction. However, the price        ities on the land. Any retained development
of these benefits is the loss of the step-up in         rights are subject to estate tax unless the execu-
basis for income tax purposes.                          tor and heirs extinguish those rights. The ease-
                                                        ment may not be subject to a mortgage on the
Requirements for a Conservation Easement                property unless the mortgagee subordinates the
   For years after 1997, donation of a conserva-        mortgage to the right of the easement holder to
tion easement to a qualified organization pro-          enforce the conservation purposes of the gift.
vides the landowner with an income tax deduc-           Additionally, the estate tax exclusion is reduced
tion. Code section 170(f)(3)(b)(iii) permits an in-     by the amount of the outstanding mortgage.
come tax charitable deduction for gifts of “qual-
                                                           Although the conservation easement restricts
ified conservation contributions” and IRC sec-
                                                        use of the land “in perpetuity” and therefore
tions 2055(f) and 2522(d) permit deductions for
                                                        binds later owners, changes in the area may
estate and gift tax purposes. This discussion
                                                        allow later development. Permissible “conser-
presents only an overview of the major require-
                                                        vation purposes” under IRC section 170 include
ments found in the tax code and accompanying
regulations which should be consulted before            only the following five “resource categories”:
giving specific advice in this area.                    • The preservation of land areas for outdoor
   An income tax deduction is only allowed if           recreation by, or the education of, the general
the easement is granted to a “qualified organi-         public;
zation” that will enforce the development re-           • The protection of a relatively natural habitat
strictions. This includes most federal, state, and      of fish, wildlife or plants, or similar ecosystem;

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