Document Sample
					                            FEDERAL ESTATE AND INCOME TAX

                                        By: David J. Dietrich∗

Part One – Reprinted from Estate and Personal Financial Planning, 2001, with permission
                      of publisher Clark Boardman & Callaghan

       A land owner's decision to grant a conservation easement is often driven by multiple

considerations: (1) a genuine charitable motive in protecting environmentally unique land values

and (2) a desire to obtain a charitable income tax deduction. Since the Taxpayer Relief Act of

1997, a third motive now exists: an exclusion of up to $500,000 from the decedent's gross

taxable estate. This type of easement must, in any event, qualify as a traditional IRC § 170(h)

easement. Under IRC 170(h), there are no "brightline" tests as to the amount of the charitable

contribution or estate tax exclusion that may be enjoyed by the donor of a qualified conservation

easement. The amount of the deduction will be driven by fact specific considerations closely

related to the appraised value of the property that is the subject of the conservation easement.

       Part One of this article first reviews the background of the requirements for an income

tax deduction for a gift of a conservation easement, particularly focusing on the conditions of

transfers by the donee organizations, as well as the exclusivity requirement needed for the tax

deduction. Once these requirements are met, it is necessary to value the easement. Having

discussed the issues involved in determining the value, the article then examines the need for an

adjustment to basis and how like kind exchanges can be utilized. Part One then concludes with

an examination of the new Estate Tax exclusion. Part Two shifts the focus to state law and

drafting considerations. Thus, having the uniform application of the federal tax laws that were

discussed in Part One, those advising land owners about conservation easements will need to

turn to their specific state enabling statutes regarding the conservation easement being

considered. Part Two provides an overview of those statutes, as well as the chart regarding the

47 states that have adopted specific statutory approaches to these easements. It briefly examines

the impact easements will have on state ad valorem taxes and then shifts to drafting

considerations the advisor must take into account in meshing local law with the very specific

provisions of new Section 2031(c). Part Two then concludes with a specific example of a deed

of easement that might be used and the considerations involved in its drafting.


          The Tax Reform Act of 1969 contained a general rule prohibiting the deductibility of

charitable gifts of partial interests. See IRC § 170(f)(3) b. In response to adverse reaction to this

absolute bar to a deduction, the Tax Reform Act of 1976 provided an exception, setting forth a

clear statutory basis for the deductibility of charitable contributions for conservation easements.

It added new clause (3) to § 170(f)(3)(b), which allowed deductions for "easements with respect

to real property of not less than 30 years duration granted to a [qualified organization]

exclusively for conservation purposes." In 1980, the Tax Treatment Extension Act provided the

current status of conservation easement law on the federal level by allowing an express

deduction for "a qualified conservation contribution". IRC § 170(h)(1). That section provides

that the contribution must be of a "qualified real property interest," to a "qualified organization"

and "exclusively for conservation purposes." Each of these terms has been defined in the

legislation and is further defined in the implementing regulations. As stated in Reg. § 1.170A-

14 (a):

          A deduction under § 170 is generally not allowed for a charitable contribution of
          any interest in property that consists of less than the donor's entire interest in the
          property other than certain transfers and trust... However, a deduction may be

       allowed under § 170 (f) (3) (b) (iii) for the value of a qualified conservation
       contribution if the requirements of this section are met. A qualified conservation
       contribution is the contribution of a "qualified real property interest," to a
       "qualified organization" and "exclusively for conservation purposes." (These
       requirements are set out both in IRC § 170 (h) (1) and Reg. 1.170A-14(a), (b),
       and (c).) To be eligible for a deduction, the conservation purpose must be
       protected in perpetuity.


       As indicated by the Regulation, the statute contains specific statutory terms in

determining eligibility for the deduction of a gift of a conservation easement. Those

advising prospective donors must be familiar with these terms as they negotiate and then

draft the deed of easement, so that it will clearly entitle the donor to a charitable income

tax deduction.

1.     Qualified Real Property Interest

       The definition of a "qualified real property interest" is set out in IRC § 170(h)(2) and

Reg. § 1.170A-14(b). The Regulation amplifies the statutory language to the effect that the

entire interest of the donor in real property "other than a qualified mineral interest" is a qualified

real property interest. An entire interest in real property may consist of an undivided interest in

the property. A qualified mineral interest consists of the donor's interest in subsurface oil, gas

and other minerals and the right of access to such minerals. Reg. § 1.170A-14(b)(1)(i).

       The Regulation prohibits property from being characterized as a "qualified real property

interest" if the property in which the donor's interest exists was divided prior to the contribution

in order to enable the donor to retain control of more than a qualified mineral interest or reduce

the real property interest donated.      Id.   Minor interests that will not interfere with the

conservation purposes of the donation (such as rights of way), may be transferred prior to the

conservation contribution without affecting the treatment of a property interest as a "qualified

real property interest".

2.     Perpetual Conservation Easement

       To be eligible for a deduction, the conservation purpose must be protected "in

perpetuity."   A "perpetual conservation restriction" is defined under the Regulations as a

restriction granted in perpetuity on the use that may be made of real property.            Reg. §

1.170A-14(b)(2). The restriction may be in the form of an easement, restrictive covenant,

equitable servitude, or similar real property interest recognized under applicable state law. Id.

The terms easement, conservation restriction, and perpetual conservation easement have the

same meaning under the Regulations.

3.     Qualified Organization

       The third principal requirement for a qualified conservation contribution is that the

contribution must be made to a qualified organization. Reg. § 170A-14(c)(1). To be considered

an eligible donee under this section, the organization first must be a “qualified organization,”

which is defined in IRC § 170(h)(3) as including the following entities:

       a.      The United States;

       b.      A state;

       c.     A political subdivision of the United States or a state, but only if the contribution
       is made exclusively for public purposes;

       d.      A state or federally chartered corporation trust, community chest, fund, or
       foundation that is organized and operated for specified purposes including charitable,
       scientific or educational purposes and that normally receives a substantial part of it
       support either from certain governmental entities or from direct or indirect contributions
       from the general public; and

       e.      Certain IRC § 501(c)3 organizations.

In addition, the organization must have a commitment to protect the conservation purposes of the

donation, and have the resources to enforce the restrictions. Reg. § 1.170A-14(c)(1). The

organization need not, however, set aside funds to enforce the restrictions that are the subject of

the contribution.

4.     Conservation Purpose

       The fourth requirement for a conservation contribution to be deductible is that it must

serve a "conservation purpose." Conservation purposes are defined in IRC § 170(H)(4)(A), as


       a.     The preservation of land areas for outdoor recreation by, or the education of, the
       general public;

       b.     The protection of a relatively natural habitat of fish, wildlife or plants, or similar

       c.     The preservation of open space (including farmland and forest land, where such
       preservation is:

               (i)    For the scenic enjoyment of the general public; or

               (ii)   Pursuant to a clearly delineated federal, state, or local governmental and
               conservation policy, and will yield a significant public benefit; or

               (iii) The preservation of a historical land area or certified historic structure.
               IRC § 170 (h) (4) (A)

                       ENFORCEMENT REQUIREMENTS

       A transfer to a qualified organization is deductible only if the conveyancing document

prohibits the qualified organization from subsequently transferring the easement to any other

entity, unless the donee organization requires that the originally intended conservation purposes

continue to be carried out. Reg. § 1.170A-14(c)(2). Even then, subsequent transfers must be

restricted to organizations qualified as described above. If there is later an "unexpected change

in the condition surrounding the property" that make "impossible or impractical the continued

use of the property for conservation purposes," the requirement of the Regulation will be met "if

the property is sold and exchanged and any proceeds are used by the donee organization in a

manner consistent with the conservation purposes of the original contribution". Id.

        If the donor has reserved rights "the exercise of which may impair the conservation

interests associated with the property," the donor must agree in writing to notify the donee before

exercising any reserved right. Reg. § 1.170A-14(g)(5)(ii). The Regulation specifically addresses

the right to extract "certain minerals which may have an adverse impact on the conservation

easements associated with the qualified real property interest."

        The Regulation further states that the terms of the donation must provide "a right of the

donee to enter the property at reasonable times for the purpose of inspecting the property to

determine if there is compliance with the terms of the donation."              Id.   Additionally, the

Regulations require the conservation easement to expressly provide the donee with a right of

inspection on the property and an enforcement right" by appropriate legal proceedings, including

but not limited to, the right to require the restoration of the property to its condition at the time of

the donation".

1.      Recreation or Education

        A contribution to preserve land areas for the outdoor recreation of the general public or

for its education must provide for the "substantial and regular use" of the general public. Reg. §

1.170A-14(d)(2). Examples include actual physical access to a water area or a hiking trail.

2.      Protection of Environmental System

        A contribution for the protection of a "significant relatively natural habitat for a fish,

wildlife or plant community will meet the conservation purposes test even though the habitat or

environment has been altered to some extent by human activity so long as the fish, wildlife or

plants continue to exist there in a "relatively natural state." Reg. § 1.170A-14(d)(3). The

Regulation uses the specific example of a "salt pond formed by a manmade dike if it were a

"natural feeding area for a wildlife community that included rare, endangered or threatened

native species."

       Limitations on public access to property that is the subject of this kind of a contribution

does not per se render the donation nondeductible. Reg. § 1.170A-14(d)(3)(iii). The Regulations

set forth a "significant habitats and ecosystems" requirement that includes but is not limited to:

       a.      habitats for rare, endangered or threatened species of animal, fish or plants;

       b.     natural areas that represent high quality examples or a terrestrial community or
       aquatic community such as islands that are undeveloped or not intensely developed where
       the coastal ecosystem is relatively intact; and

       c.      natural areas that which are included in, or which contribute to, the ecological
       viability of a conservation area.

Reg. § 1.170A-14(d)(3)(ii).

3.     Open Space

       The third type of permitted conservation purpose involves the preservation of open space.

IRC § 170 (h) (4) (A) (iii) provides that an open space easement must be either:

       a.      Pursuant to a clearly delineated federal, state or local governmental conservation
       policy, which will yield a significant public benefit; or,

       b.     For the scenic enjoyment of the general public, which will yield a significant
       public benefit.

       The Regulations state that "scenic enjoyment" will be evaluated by considering all

pertinent facts and circumstances germane to the contribution and refers to the following criteria

to be considered:

               (i)     The compatibility of the land use with other land in the vicinity;

               (ii)    The degree of contrast and variety provided by the visual scene;

               (iii) The openness of the land (which would be a more significant factor in an
               urban or densely populated setting or in a heavily wooded area);

               (iv)    Relief from urban closeness;

               (v)     The harmonious variety of shapes and textures;

               (vi)   The degree to which the land use maintains the scale and character of the
               urban landscape to preserve open space, visual enjoyment, and sunlight for the
               surrounding area;

               (vii) The consistency of the proposed scenic view with a methodical state
               scenic identification program, such as a state landscape inventory; and

               (viii) The consistency of the proposed scenic view with a regional or local
               landscape inventory made pursuant to a sufficiently rigorous review process,
               especially if the donation is endorsed by an appropriate state or local
               governmental agency. Reg. § 1.170A-14(d)4(ii).

In any event, some form of access, either visual or physical, is required, although a contribution

with only a portion of visual access will reduce the contribution but not completely prevent it.

Reg. § 1.170A-14(d)4(ii).

       For a open space easement to be considered a governmental policy open space easement,

the Regulations indicate that general policy declarations are not sufficient, but neither is a tract

by tract certification program required. Reg. § 1.170A-14(d) 4(iii). Thus, the Regulations

require donations that further a "specific, identified conservation project," such as:

               (i)     The preservation of land within a state other local landmark district that is
               locally recognized as being significant to that district;

               (ii)    The preservation of a wild or scenic river;

               (iii) The preservation of farmland pursuant to a state program for flood
               prevention and control; or

               (iv)   The protection of the scenic, ecological or historic character of land that is
               contiguous to, or an integral part of, the surroundings of existing recreational or
               conservation sites. Reg. 1.170A-14(d)4(iii).

Some states have adopted an Open Space Land and Voluntary Conservation Easement Act that

contains express findings and policy statements sufficient to comply with the Regulation. See,

e.g. § 76-6-102, M.C.A (Montana 2001). Thus, the Service in an early Private Letter Ruling,

PLR 87-11-054 (Dec. 15, 1986), found that a state statute identifying preservation of farmland as

a conservation goal and township ordinance favoring open space was an express "delineated

governmental policy are demonstrative of significant public benefit").

        An Open Space Conservation Easement must yield a "significant public benefit." The

determination of a significant public benefit "shall be evaluated on all pertinent facts and

circumstances of the particular contribution" and "no single factor shall be determinative." The

Regulations does list a number of factors, however, that will be considered:

               (i)    The uniqueness of the property to the area;

               (ii)    The intensity of land development in the vicinity of the property (both
               existing development and foreseeable trends of development);

               (iii) The consistency of the proposed open space use with public programs
               (whether Federal, state or local) for conservation in the region, including
               programs for outdoor recreation, irrigation or water supply protection, water
               quality maintenance or enhancement, flood prevention and control, erosion
               control, shoreline protection, and protection of land areas included in, or related
               to, a government approved master plan or land management area;

               (iv)    The consistency of the proposed open space use with existing private
               conservation programs in the area, as evidenced by other land, protected by
               easement or fee ownership by organizations referred to in §1.170A-14(c)(1), in
               close proximity to the property;

               (v)    The likelihood that development of the property would lead to or
               contribute to degradation of the scenic, natural, or historic character of the area;

               (vi)    The opportunity for the general public to use the property or to appreciate
               its scenic values;

               (vii) The importance of the property in preserving a local or regional landscape
               or resource that attracts tourism or commerce to the area;

               (viii) The likelihood that the donee will acquire equally desirable and valuable
               substitute property or property rights;

               (ix)     The cost to the donee of enforcing the terms of the conservation

               (x)    The population density in the area of the property; and

               (xi)  The consistency of the proposed open space use with a legislatively
               mandated program identifying particular parcels of land for future protection.

Reg. § 1.170A-14(d) 4(iv).

The more specific the state or local governmental policy with respect to the specific site to be

protected, the more likely the governmental decision, by itself, will tend to establish the

significant public benefit associated with the donation. Otherwise, the significant public benefit

will need to be independently established. Reg. § 1.170A-14(d)4(vi)A. A scenic view easement

must establish a significant public benefit in all cases because of its subjective nature. Reg. §


                           D.      EXCLUSIVITY REQUIREMENT

       The final requirement imposed by the Regulations for a "qualified conservation

contribution" is that the contribution be given "exclusively for conservation purposes" Reg. §

1.170A-14(e). This requirement does not prohibit the use of the property for purposes unrelated

to the conservation purpose so long as that use does not impair the conservation purpose. Reg. §

1.170A-14(e)(2). The key test is whether the retained uses do not significantly impair the

conservation interests. Id. A use that is destructive of the conservation easements, however,

will be permitted only if that use is necessary for the protection of the conservation interests that

are the subject of the contribution. Nonetheless, a donor may continue a pre-existing use of the

property that does not conflict with the conservation purposes of the gift. Reg. § 1.170A-


       The Regulations contain five examples that illustrate the exclusivity requirement. See

Reg. § 1.170A-14 (f), examples 1 through 5. Example 2 sets out the use of an operating farm as

a compatible buffer to a more natural preserve as a qualified conservation easement, even though

the operating farm is not a pristine natural preserve.

       The conservation easement must be protected in perpetuity and the interest retained by

the donor must be subject to legally enforceable restrictions preventing the use of the retained

interest for purposes inconsistent with the conservation purposes of the contribution. Reg. §

1.170A-14(g)(1). A conservation easement encumbered with a mortgage is disqualified, unless

the mortgagee subordinates its rights in the property to the right of the qualified organization to

enforce the conservation purposes of the gift and perpetuity. Reg. § 1.170A-14(g)(2).            If a

contribution otherwise qualifies for deduction under § 170, the deduction will not be disallowed

because of the possibility that the contributed interest may be defeated by the performance of an

act or the occurrence of an event that, at the time that the contribution is made, appears to be so

remote as to be negligible.

       In the case of the contribution of any real estate interest where subsurface oil, gas or other

mineral or the right-to access such minerals are retained, the contribution will be disallowed if

there may be extraction or removal of minerals by any surface mining method at any time . See

IRC § 170(h)(5)(i).    If, however, there has been a separation of the ownership of the surface

estate and the mineral interests, the foregoing rule will be treated as met "if the probability of

surface mining occurring on such property is so remote as to being negligible". This is a

provision of the new Taxpayer Relief Act of 1997.

       Previously, the foregoing rule applied only where there had been a severance of the

surface estate and mineral estate prior to June 13, 1976. Now, whether the probability of

extraction or removal of minerals by surface mining is so remote as to be negligible is a question

of fact and is to be made on a case by case basis.

       Reg. § 1.170A-14(g)(4)(ii) sets forth the relevant factors to be considered in determining

if the probability of extraction or removal of minerals by surface mining is "so remote as to be

negligible." These include "geological, geophysical or economic data showing the absence of

mineral reserves on the property, or the lack of commercial feasibility at the time of the

contribution of mining this mineral interest."        Although the Regulations retain an express

prohibition against any deduction where the ownership of the surface and mineral estate became

separated after June 12, 1976, new IRC § 170-(h)(5) conflicts with this Regulation and so this

portion of the Regulation is probably invalid.

       The next subsection of the Regulations requires that, for a deduction to be allowable, the

donor must make available to the donee, prior to the time the donation is made, documentation

sufficient to establish the condition of the property at the time of the gift. This Regulations set

out specific items of documentation, including survey maps from the U.S.G.S., maps of the area

showing all existing man-made improvements and incursions, vegetation land use history and

distinct natural features, aerial photographs, and on-site photographs on the property. The

documentation must be accompanied by a statement signed by the donor and a representative of

the donee clearly referencing the documentation and in substance stating "this natural resources

survey is an accurate representation of the [protected property] at the time of the transfer." Reg.

§ 1.170A-14(g)(5)(i)(d). Furthermore, the donor must agree to notify the donee in writing before

exercising any reserved right and the terms of the donation must provide the donee with the right

to enter the property at reasonable times to inspect the property and to enforce the conservation

easement restrictions by appropriate legal proceedings, "including but not limited to the right to

require the restoration of the property to its condition at the time of the donation." Reg. §



       The value of the contribution of a perpetual conservation restriction under IRC § 170 is

the fair market value of the perpetual conservation restriction at the time of the contribution.

Reg. § 1.170A-14(h)(3) and § 1.170A-7(c). If there is a substantial record of sales of easements

that are comparable to the donated easement, the fair market value of the donated easement is

based on the sales prices of those comparable easements. If comparable sales are not available,

the fair market value of a perpetual conservation restriction is equal to the difference between the

fair market value of the property it encumbers before the granting of the restriction and the fair

market value of the encumbered property after the granting of the restriction. Symington v.

Commissioner, 87 T.C. 892, 895 (1986). See also Akers v. Commissioner, 799 F.2d 243 (6th

Cir. 1987). The differential is based upon the highest and best use of the property before the

grant of the easement, not merely its actual use prior to the grant. Symington v. Commissioner,

87 T.C. 892, 897. Reg. 1.170A-14(h)(3)(I). See also, Strasburg v. Commissioner T.C. Memo.

2000-94. Importantly, in the event the donor (or his or her family) retains an unencumbered

portion of real estate, yet conveys a perpetual conservation restriction on another portion of that

property, the amount of the deduction is the difference between the fair market value of the

entire contiguous parcel of the property before and after the granting of the restriction.

        If the granting of the easement causes an increase in the value of other property owned by

the donor or a related person, the amount of the deduction for the conservation contribution is

reduced by the amount of the increase in value of the other property, whether or not such

property is contiguous. Id. See also PLR 199927014 (4/17/99). Additionally, if a donor or a

related person receives or can expect to receive financial or economic benefits that are greater

than those that will inure to the general public from the transfer, no deduction is allowable. See

Reg. § 1.170A-14(h)(3)(i).

        There may be instances where the grant of a conservation restriction may "have no

material effect on the value of the property, or may in fact serve to enhance, rather than reduce,

the value of property. In such cases, no deduction would be allowable. Reg. § 1.170A-14 (h) (3)


       Importantly, if the conservation easement grantor has not held the easement encumbered

property for more than one year after the grant, the deduction will be limited to the grantor’s cost

or basis of the land and improvements, regardless of the difference between the highest and best

use and the appraiser’s determination of the reduction in value due to the easement. Strasburg v.

Commission T.C. Memo. 2000-94.

                        F.      BASIS REDUCTION REQUIREMENT

       A donor who makes a qualified conservation easement contribution must reduce the

adjusted basis in the portion of the retained property by the amount of the total adjusted basis of

the properly allocable to the interest contributed. Reg. § 1.170A-14(h)(3)(iii). Examples are set

out in Reg. § 1.170A-14(h)(4). This portion of the adjusted basis allocable to the qualified real

property interest is determined by the ratio of the value of the qualified real property interest to

the value of the property before the granting of the restriction. Reg. § 1.170A-14 (h) (4).


       IRC § 1031(a)(1) provides generally that no gain or loss will be recognized on the

exchange of property held for productive use in a trade or business, or for investment, if that

property is exchanged solely for property of like kind that is to be held either for productive use

in a trade or business, or for investment. Reg. § 1.1031(a)-1(b) provides generally that, as used

in § 1031 (a) of the Code, the words "like kind" have reference to the nature or character of the

property and not to its grade or quality.

       One kind or class of property may not be exchanged for property of a different kind or

class. The fact that one of the parcels of real estate is improved is not material, for that fact

relates only to the grade or quality of the property and not to its kind or class. Unproductive real

estate held by one other than a dealer for future use or future realization of the increment in value

is held for investment and not primarily for sale. Reg. § 1.1031(a)-1(c) provides, as an example,

that no gain or loss is recognized if a taxpayer who is not a dealer in real estate exchanges city

real estate for a ranch or farm, or exchanges a leasehold of a fee with 30 years or more to run for

real estate, or exchanges improved real estate for unimproved real estate. Similarly, Rev. Rul.

55-749, 1955-2 C.B.       295 holds that where, under applicable state law, water rights are

considered real property rights, the exchange of perpetual water rights for a fee interest in land

constitutes a nontaxable exchange of property of like kind within the meaning of § 1031(a).

          In Rev. Rul. 72-549, 1972-2 C.B. 472, an easement and right-of-way granted to an

electric power company were held to be properties of like kind with improved real property

received by the taxpayer. And Rev. Rul. 78-163, 1978-1 C.B. 257 holds that the exchange of

timberland for bare land constitutes an exchange of like kind property within the meaning of

§ 1031(a).

          In several recent Private Letter Rulings, the IRS has concluded that the exchange of a

perpetual conservation easement encumbering one property for a fee interest in another property

constitutes a like kind exchange for purposes of § 1031. See PLR 98-51039, PLR 96-21012,

PLR 96-01046, PLR-92-32030 and PLR 92-15049. As a result, such a transaction should not be

viewed as triggering capital gain.


          The federal gift and estate transfer tax scheme provides charitable deductions for

conservation easement donations.

1.        Estate Tax Deduction

          IRC § 2055 (a), the estate tax deduction statute, allows a deduction for bequests to

various entities and includes:

          (a)    Bequests to the United States, state or any local subdivision if the bequest is
          exclusively for public purposes; and

        (b)      Bequests non-profit organizations operated for charitable, scientific or educational


Additionally, IRC § 2055(f) provides that a deduction will be allowed for the value of a

"qualified real property interest" as defined in IRC § 170(h)(2)(c). Indeed, § 2055(f) literally

allows a deduction for a bequest of a perpetual use restriction for a purpose unrelated to

conservation, because the express language of the statute does not require that the "qualified real

property interest" be for a conservation purpose. The Regulations adopted to implement § 2055

incorporate Reg. § 1.170A-14 and seem to incorporate the requirement that the contribution be

used exclusively for conservation purposes and that the conservation purpose be protected in

perpetuity, but do not expressly disallow an otherwise qualifying contribution merely because

the conservation purpose might ultimately be defeated as a result of events that appear highly

unlikely at the time of the contribution. The value of a deduction for a bequest of a qualified

conservation easement is the fair market value of the contributed property interest as of the

applicable date, generally the date of the decedent's death. Reg. 20.2055-2.

   2.         Gift Tax Deduction

        IRC § 2522(d) provides a deduction for federal gift tax purposes for charitable donations

and qualified conservation interests. The provision is identical to IRC § 2055(f), and is set out in

Reg. § 25.2522 (c)-3(c)(2)(iv), which allows a deduction for a charitable gift of a qualified

conservation contribution. The qualifications are the same as for estate tax purposes.

                    I.      NEW ESTATE TAX EXCLUSION IN TRA 1997

        The Taxpayer Relief Act of 1997 provided a significant estate tax benefit by removing

from the definition of the gross estate certain land subject to a qualified conservation easement.

See IRC § 2031(c). In general, this new section provides, as to certain properties and at the

election of the estate, an exclusion of value equal to as much as forty (40%) percent of the value

of the property. In 1998, the exclusion was capped at $100,000 and rises in annual increments

of $100,000 to a cap of $500,000 in 2002. Electing the exclusion effectively reduces the gross

estate and, as a result, the federal estate tax owed. The trade-off is that--to the extent of the

exclusion--the land takes a carry-over basis rather than a stepped-up basis for federal income tax

purposes. IRC § 1014 (a) (4).

        In order to qualify for the benefit the statute requires: *

1.     The Economic Growth Tax Relief Reconciliation Act of 2001 (Section 551(a)) defines
“land subject to a qualified conservation easement” as any land located within the U.S. or a U.S.
possession. IRC §2031(c)(8)(A)(i).

2.      The property must have been owned by the decedent or a member of the decedent's
property at all times during the three year period ending on the date of the decedent's death. For
this purpose, "family" is defined with reference to § 2032A(e)(2), namely ancestors, spouse,

* Author’s Note: In order to qualify for the benefit the statute previously required:

   The subject property must be located:

   a.        In or within 25 miles of a metropolitan area (as defined by the Office of Management and Budget);

   b.        In or within 25 miles of a National Park or Wilderness Area designated as part of the National
             Wilderness Preservation System (unless the IRS should determine that no significant development
             pressure exists).

   c.        In or within 10 miles of an area which is an Urban National Forest (as designated by the Forest

lineal descendants of the decedent, or the decedent's spouse, and the spouse of any lineal

3.      A "qualified conservation easement" must have been conveyed by the decedent, a
member of the decedent's family (as defined above), the executor of the decedent's estate, or the
trustee of the trust, the corpus of which includes the land subject to the conservation easement.
The exclusion also applies to an interest in a "partnership, corporation, or trust if at least Thirty
(30%) percent of the entity is owned directly or indirectly by the decedent. IRC 2031(c)(2).

        The exclusion available is based upon an "applicable percentage" of the value of the

easement protected property. The amount is forty (40%) percent of the easement protected

property's value, reduced by two percentage points for each percentage point (or fraction there

of) by which the value of the qualified conservation easement is less than thirty (30%) percent of

the value of the land determined without regard to the easement. This rule is intended to

discourage "marginal" easements that reduce the value of land only marginally. The Senate

Committee Report indicates that the exclusion amount is calculated based on the value of the

property after the conservation easement has been placed on the property. 143 Cong. Rec.

H6409-01, H6511

       a.     Example One: If land is valued at $1,000,000 and an easement is donated which
       reduces the value to $700,000, the donor is entitled to a $300,000 income tax deduction
       under IRC 170(h). In addition, his estate can reduce the reportable value of the land on
       the Federal Estate Tax return subject to estate tax from $1,000,000 to $700,000. Finally,
       the executor can elect to exclude an additional $280,000 of the remaining value under
       §2031c, calculated as follows:

                       (i)    40 minus [2 times (.30 minus THE VALUE OF THE EASEMENT
                       (300,000 here) / (THE VALUE OF THE LAND WITHOUT THE
                       EASEMENT (1,000,000 here) less any "retained development rights.
                       (none here)")]

                       (ii)    If the election occurs after year 2000, the full 280,000 exclusion
                       can be taken on the estate tax return

       b.      Example Two: If land worth $1,000,000 before an easement is worth $900,000
       after the easement (a ten percent reduction), the exclusion available would be zero
       because the easement was zero percentage points lower than the thirty percent threshold.

                       (i)    40 minus [2 times (.30 minus THE VALUE OF THE EASEMENT
                       (100,000 here) / (THE VALUE OF THE LAND WITHOUT THE
                       EASEMENT (1,000,000 here) less any "retained development rights"
                       (none here))]

       Any "retained development rights" retained in the easement agreement will be subject to

estate tax. IRC § 2031 (c) (5) (A). The law, however, gives the heirs nine months after the

decedent's death to agree to terminate some or such retained rights and thereby avoid the tax on

those rights. The heirs have two years after the decedent's death to put this agreement into effect.

IRC § 2031 (c) (5) (C). "Retained Development rights" are defined as any right "to use the land

for a commercial purpose not directly related to and supportive of the use of the land as a farm

for farming purposes." IRC § 2031 (5) (D). Rights to maintain a residence for the owner's use,

as well as normal farming, ranching and forestry practices would not be considered retained

development rights. The retained right to subdivide land for development, and to carry on

commercial recreational activities are retained development rights and should be terminated

within the due date required under IRC § 2001 and related Regulations. PLR 2000 1403. The

"Permitted Uses" provision of a conservation easement should be analyzed post-mortem to

eliminate retained development rights, to ensure qualification under IRC § 2031 (c).

       The amount of any outstanding debt incurred to acquire land must be subtracted from the

land's value before calculating the: exclusion. For example, if land has a value of $700,000 after

subtracting the value of an easement, and it is subject to a $300,000 mortgage, the exclusion can

be applied to $400,000 ($700,000 minus $300,000). The exclusion amount in this case is


       The law makes the exclusion available for an easement donated by a decedent's executor

or trustee even though the decedent failed to donate the easement before his death. This "post

mortem election" is an extremely valuable estate planning tool, provided state law empowers the

personal representative to make this election. See, e.g. MCA §72-3-613(8), by which Montana’s

Probate Code specifically allows a personal representative to “dedicate easements to public use

without consideration.”

       The exclusion for land subject to a conservation easement may be elected in addition to

the IRC § 2032A special use valuation and the IRC § 2057 qualified family owned business

deduction. 143 Cong. Rec. H6409-01, H6511. As a consequence, every estate planner advising

their client on conservation easements must take into account provisions of the new Act.

Easements that have been recorded should be reviewed because of these new provisions, and the

new law makes planning immediately after death necessary because a post-death election under

the Act is required.


                                                      Part Two


         Part One of this Article covers the general federal law requirements for the income tax

deduction and estate tax exclusion for conservation easements. Part Two of this article outlines,

in summary fashion, state law requirements enabling the use of open space conservation

easements. Part Two also sets forth an example of an open space conservation easement used in

the Western United States (with extensive permitted and prohibited uses language) and discusses

practical considerations in the drafting and amendment of a conservation to qualify for both the

federal income deduction and the estate tax exclusion. Part Two concludes with a discussion of

the effect of conservation easements on state real property taxation (ad valorum) statutes.


         In the 1960’s land use planning and development experts urged the use of conservations

for open space and historic preservation.1 In response, states began to enact statutes enabling

governmental entities and nonprofit entities to acquire conservation easements.2 By November

of 1999 taxpayers voted to set aside ten billion dollars in bonds and referendums for the

preservation of open space.3             In 2000, only the state of Wyoming lacked a special statute

enabling open space easements.4

         There are four distinct types of conservation easements: (1) a public recreation or

education conservation easement; (2) a conversation easement for the protection of a natural

habitat or eco system; (3) a conservation easement for the preservation of open space, scenic

1 Powell on Real Property 34A, §34A.03[3]
2 Id.
  Daniel B. Wood, “Backlash Against Urban Sprawl Broadens”, Christian Science Monitor, Dec. 16, 1999
  See Exhibit A, attached to this outline, which constitutes a table of all states enabling statutes for conservation

view, or agricultural lands; and (4) a historic preservation easement.5 The open space, scenic

space or agricultural land easement is the broadest type of conservation easements and was

added in 1980. It is the principle focus of this article.

          Open space conservation easements are mixed creatures of both state and federal law.

From a state law perspective, the drafter must consult applicable local law to identify whether

common law impediments to the enforceability and alienation of a conservation easement are

allowed under that state’s jurisdiction. Federal law must be consulted to determine whether the

conservation easement grantor may claim an income tax deduction or estate tax exclusion.

Accordingly, an analysis of state law enabling statutes is in order.

                                          LAW IMPEDIMENTS
          Of the states enacting conservation easement statutes, twenty-two (22) have enacted the

Uniform Conservation Easement Act (“UCEA”). Contrarily, three (3) states, Wyoming, North

Dakota and Pennsylvania, have no or insufficient legislation authorizing perpetual conservation

easements.6 This article will use the UCEA as the primary model of state enabling legislation.

1.        Common law Impediments

          Under the common law, conservation easements are not “appurtenant easements” which

“run with the land” and do not survive the sale or transfer of the easement-encumbered property

or the assignment of duties of the land trust required to enforce the easement.7 Rather, such

easements at common law are considered “in gross” and often do not survive a transfer by the

  See Powell on Real Property 34A, §34A.04[3][c][i-iii]
  North Dakota’s Statute limits conservation easements to 99 years: N.D. Cent. Code § 55-10-08 (1983);
Pennsylvania authorizes agricultural conservation easements only: Penn. Stat. § 914.1; Wyoming has no legislation
  Hollingshead, John L., Conservation Easements “A Flexible Tool for Land Preservation” 3 Envtl. Law 319, 326
(1997) citing Restatement of Property, ss 451, 453-454, (1944); See also, Powell on Real Property, Chapter 34A ss
34A.01 “The Conservation Easement is a Common Law Servitude Strengthened by Statutory Enhancements”

initial owner and therefore expire.8             In addition, conservation easements typically impose

negative restrictions that are disfavored under the common law.9 Furthermore, a charitable

organization or governmental agency, under the common law, lacks privity because it has no real

estate interest in the dominant estate and has questionable standing to take affirmative actions to

enforce easement violations by injunctive relief.10

2.       UCEA Provisions

         The UCEA frees state law from the rigid common law requirements. This enables the

owner of a fee interest in land to transfer a conservation easement to a land trust or governmental

entity that will be enforceable by the land trust, governmental unit, or third party, whether or not

the land trust, governmental unit or third party actually has an interest in the property.11 The act

also enables the land trust or governmental agency to have enforcement powers over affirmative

obligations (such as maintenance for an historical façade easement) undertaken by the grantor

notwithstanding the common law’s reluctance to enforce such obligations.12                            Further, the

easement will be enforceable as against any subsequent owner of the fee interest in the property,

even though the easement is not attached to the property as an appurtenant easement.13 The Act

also enables the parties to establish a right in a third party to enforce the terms of the transaction

if the possessor of that right is also a governmental unit or charity.14

         In the words of the Commissioner’s Prefatory Note:

         The Act thus makes it possible for Owners to transfer a restriction upon the use of
         Blackacre to Conservation, Inc., which will be enforceable by Conservation and
         its successors whether or not Conservation has an interest in the land benefited by

   Unif. Conserv. Easement Act, §3(a)
12 Unif. Conserv. Easement Act, §1(2)(i)(ii)
   Unif. Conserv. Easement Act, § 4
   Unif. Conserv. Easement Act, §3(a)3, (i.e.) a party having a “third party enforcement” right; Unif. Conserv. Act

       the restriction, which is assignable although unattached to any such interest in
       fact, and which has not arisen under circumstances where the traditional
       conditions of privity of estate and “touch and concern” applicable to covenants
       real are present. So, also, the Act enables the Owner of Heritage Home to
       obligate himself and future owners of Heritage to maintain certain aspects of the
       house and to have that obligation enforceable by Preservation, Inc., even though
       Preservation has no interest in property benefited by the obligation. Further,
       Preservation may obligate itself to take certain affirmative actions to preserve the
       property. In each case, under the Act, the restrictions and obligations bind
       successors. The Act does not itself impose restrictions or affirmative duties. It
       merely allows the parties to do so within a consensual arrangement freed from
       common law impediments, if the conditions of the Act are complied with.

       These conditions are designed to assure that protected transactions serve defined
       protective purposes (Section 1(1)) [of the UCEA] and that the protected interest is
       in a “holder” which is either a governmental body or a charitable organization
       having an interest in the subject matter (Section 1(2)) [of the UCEA]. The
       interests may be created in the same manner as other easements in land (Section
       2(a)). The Act also enables the parties to establish a right in a third party to
       enforce the terms of the transaction (Section 3(a)(3)) if the possessor of that right
       is also a governmental unit or charity (Section 1(3)).

See Uniform Conservation Act, Commissioner’s Prefatory Note, p.1


       Although any open space easement draws from a mixture of state and federal law

requirements, and the facts unique to the individual transaction, many provisions recur. This

portion of this Article discusses standard issues encountered by grantor’s counsel. An open

space conservation easement (“Model Easement”) is attached as Exhibit B; its contents will need

to be conformed to state law requirements and the particular transaction involved.

1.     Preliminary Considerations

       Elementally, a conservation easement is a recorded grant of a real property interest but

the grant is perpetual, if so allowed under applicable state law (only North Dakota limits

conservation easements temporarily to ninety nine years).15 The Grantor is typically the fee

owner in the property and if not an individual or a pass through entity, the charitable deduction

income tax deduction may be severely limited.16              Timing is important: the grant should occur

no earlier that one year after the initial acquisition of the property to maximize the charitable

deduction.17 If the grantor’s land is mortgaged, negotiations with the grantor’s lender for a

subordination agreement should be initiated.

        The Grantee must be a grantee authorized under the applicable state’s conservation

easement statute and must be a qualified organization under IRC 1.170(A)-14(c), usually either a

governmental agency or 501(c)(3) corporation-land trust established locally. Comparison among

land trusts qualified to accept conservation easements will illuminate for the grantor the

flexibility of the land trust and its interpretation of the conservation values it seeks to protect; this

inquiry may avoid midstream roadblocks in negotiations regarding permitted uses and prohibited


        If the land trust elects to hold the easement, the land trust will perform a base line study

inventorying the conservation values to be protected and will require the grantor to acknowledge

the study. See Section IX, Model Easement. An appraisal of the property will be need to be

performed by an independent appraiser, who will establish the value of the conservation

easement granted; this must be filed by the regular due date with the taxpayer’s return.18

Selecting an appraiser having a data bank of comparable conservation easement data and familiar

   North Dakota’s Statute limits conservation easements to 99 years: N.D. Cent. Code § 55-10-08 (1983)
   IRC §170(b) Limitations on C Corporations Contributions
   See IRC §170(e)(2) and Strasburg v. Commissioner, T.C.Memo 2000-94
   See IRS Form 8282

with conservation easement appraisals is critical, especially since the Grantor will pay for the


2.         Physical Public Access is not Required

           Potential conservation easement grantors may be dissuaded from granting conservation

easements because they mistakenly believe that an open space easement requires public access.

Public access is not required for an open space easement if it is granted pursuant to a clearly

delineated government policy.           See Treas. Reg. 1.170A-14(d)(4)(i).   In contrast, a scenic

enjoyment easement requires visual (rather than physical) access to or across the property by the

general public.        Treas. Reg. 1.70A-14(d)(4)(ii)(B).     Accordingly, § 2(b) of the Model

Conservation Easement expressly states that the public does not have any right to enter onto the

property. However, the land trust/grantee under the easement, upon prior notice to the grantor,

has rights to enter upon the property to inspect the same and to monitor the grantor’s compliance

with the terms of the easement. See Exhibit B, § 2(b).

3.    Clearly Delineated Public Governmental Policy can be Achieved through
Coordination with Local Planning Authorities

           The recitals of the conservation easement state that the conservation easement is

consistent with a local county comprehensive plan to preserve open space in agricultural lands in

the area. In order to assure compliance with Federal Treasury Regulations, some recitation of

the clearly delineated federal, state or local government policy should be inserted, as required

under Treas. Reg. § 1.170A-14(d)(4)(iii).20 The criteria to be used to develop the government

policy declaration is set out in Reg. 1.170A-14(d) 4(iv). Practically, the clearly delineated

government policy can be achieved with a simple meeting with local county commissioners or

     Strasburg v. Commissioner, T.C. Memo 2000-94

municipal planning authorities who resolve to accept the easement as part of the comprehensive

plan of the city or county.21

4.       Prohibited Uses Depend on Nature of Land and Policy of Land Trust or Agency

         Uses expressly prohibited under any open space conservation easements will include

subdivision, mineral exploitation, and the establishment of commercial or industrial facilities.

Attachment C2 of the Model Easement contains an elaborate recitation of various prohibited

uses. The governing principle underlying this section of the conservation easement is Treas.

Reg. 1.170A-14(e) requiring that the contribution be given:

         exclusively for conservation purposes. Any use that is destructive of the
         conservation easement will be permitted only if the use is necessary for the
         protection of the conservation interest that it is subject to the contribution.22

Prohibited uses obviously vary depending upon the particular transaction involved, as well as the

collective philosophy and mission of the land trust’s board of directors or the governmental

agency which will “hold” the easement. Understanding the standards and practices of the

individual land trust or governmental agency and reviewing other conservation easements

accepted by that land trust or governmental agency is critical in negotiating the prohibited and

permitted uses section of the easement.

5.     Commercial Permitted Uses may Create Private Inurement Problems and Prevent
Estate Tax Exclusion under 2031(c)

         Permitted uses and practices are set out in Attachment B to the Model Open Space

Easement document. Broad permitted uses are commonly negotiated between the grantor and

the land trust and make open space easements attractive to ongoing agricultural operations and

   See also PLR 199952037 and PLR 20002020
   See Sentie Willis, The Internal Revenue Service’s Interpretation of Clearly Delineated Federal, State, or Local
Governmental Conservation Policy, “The Back Forty”, Vol. 7 No. 4, March/April 1997
   See Treas. Reg. Examples illustrating the exclusivity requirement. Treas. Reg. 1.170A-14(f), examples 1 - 5

recreational buyers of large tracts of Western real estate, allowing substantial income tax

deductions. The Treasury Regulation is deceptively simple: “Any use of the property for

purposes unrelated to a conservation purpose is permitted so long as the use does not impair the

conservation purpose.” Treas. Reg 1.170A-14(e)(2). Examples of permitted uses are set out in

paragraphs 1 through 10 of the Exhibit B. In practice, however, prior to expending considerable

time in drafting the permitted uses provision of the easement, the grantor should consider what

land will not be part of the conservation easement grant; the retention of a “development

envelope” for building or other purposes should be considered by the potential conservation

easement grantor before granting the easement. The land trust may be concerned about activity

occurring on in holdings surrounded by conservation easement encumbered property which

jeopardize the conservation values sought to be protected under the easement.                In this

connection, any taxpayer granting a conservation easement must be concerned with the concept

of private inurement and whether the conferring of private benefits or the retention of private

benefits outweigh the public benefit under the conservation easement. See McLennan v. United

States, 24 Cl.Ct 102, 106 aff’d 994 F.2d 839 (1993). In the event the service is successful in

claiming that private inurement has been conferred by the land trust, its tax-exempt organization

status may be at risk and the taxpayer’s charitable deduction may be at risk. McLennan v.

United States, 23 Cl.Ct. 99, 103 (1991). See also General Counsel Memorandum 39862, which

sets forth the private benefit rules: “any private benefit arising from a particular activity must be

‘incidental’ in both a qualitative and quantitative sense to the overall public benefit achieved by

the activity if the organization is to remain exempt.”

       The permitted uses provisions of an open spaces conservation easement may jeopardize

the estate tax exclusion under IRC 2031(c) as those permitted uses can be characterized as

retained development rights under § 2031c(5)(d).         Under that section, the term “development

right” means any right to use the land subject to the qualified conservation easement in which

such right is retained for any commercial purposes which is not subordinate to and directly

supportive of the use of such land as a farm for farming purposes within the meaning of

2032(a)(e)(5).       The statute is unclear, no regulations implement it and only one private letter

ruling has interpreted this provision.        See PLR 200014013. Broad permitted uses retained by

the conservation easement grantor which are not “subordinate to and directly supportive of the

land for farm purposes” can be characterized as retained development rights under the existing

statutory definition of IRC § 2031(c)(5)(D).           Fortunately, the conservation easement grantor’s

personal representative or executor can modify the easement post mortem and excise the retained

development rights and obtain the estate tax exclusion; the election must be made by the time of

the filing of the 706 Federal Estate return.23

6.         Amendments: Retain Property outside of the original Grant for Unanticipated
           Amendments Which May be Otherwise Prevented by Private Inurement

           Conservation easement donors often want to modify the easement for uses not

contemplated at the time of the original grant, for development, for gravel extraction, or other

uses which will not materially affect the conservation values protected. The inquiry is not

merely whether the use will not materially affect the conservation values protected. Rather,

Section XII, Paragraph F of the Conservation Easement states “Any amendment must be

consistent with the conservation purpose of this Easement, may not affect its perpetual duration,

and must enhance, or must have no effect on, the Conservation Values which are protected by

this Easement.”        Private inurement is again the underlying principle: the public benefit must

outweigh the private benefit retained or conferred.24

23   PLR 200014013
     See GCM 39862 and McLennan v. United States, 24 Cl.Ct 102, 106 aff’d 994 F.2d 839 (1993)

        In response to difficulties encountered in seeking permission to amend a conservation

easement, the conservation easement donor must exercise foresight at the time of the original

grant. Refraining from conveying all of the grantor’s property under a conservation easement,

with the idea of later encumbering that property in exchange for an amendment to the original

easement, may help prevent the grantor from being at the mercy of the land trust’s board which

may take an unduly restrictive interpretation of private inurement. Likewise, relinquishing

unneeded commercial activities under the permitted uses provision of an existing conservation

easement, which enhance the conservation values to be protected, may facilitate amendment of

the original conservation easement. The foregoing observations suggest the need for the grantor

to be independently represented at the time of the original grant and to not rely on and accept

without independent scrutiny conservation easements drafted by the land trust, government

agency or their counsel.


        By limiting the use and development potential of land, conservation easements generally

reduce the value of property, and therefore, the amount of real property tax assessed against

property.25 At least twenty four (24) states have enacted legislation expressly requiring that

conservation restrictions be considered in establishing the value of land for property tax

purposes.26 Assessed values range between thirteen and ninety five percent of fair full market

value as set out on one study conducted in Massachusetts.27 Although not part of the original

Uniform Conservation Easement Act, several states enacting it have adopted the following

section that expressly requires the consideration of a conservation easement by the tax assessor:

   Hollingshead, Supra Note 7, at pp. 359-360; See also Daniel C. Stockford, Property Tax Assessment of
Conservation Easements, 17 B.C. Envtl. Aff. L. Rev. 823, 827 (1990)
   Hollingshead, Supra Note 7 at p. 360
   Stockford Supra Note 25, citing Russell R. Sicard, Note, Pursuing Open Space Preservation: Massachusetts
Conservation Restriction, 4 Envtl. Aff. 481, 497 (1975).

        For valorem tax purposes, real property that is burdened by a conservation
        easement must be assessed and taxed on the basis that reflects the existence of the

        Other non-UCEA state statutes requiring property tax relief or income tax credits

attributable to conservation easements are: Colorado Revised Statutes Annotated 39-22-582

(2000); West’s Florida Statutes Annotated 193.501 (2000); Montana Code Annotated 76-6-208

(1999); New York Real Property Tax §543 (2000); Georgia Statutes 44-10-8 (2000); Tennessee

Code Annotated 66-9-308 (2000); Utah Code Annotated 57-18-7 (2000).                          This list is not

exhaustive and local appraisal policies of tax authorities must be consulted.

  South Carolina Statute 27-8-70 (2000); See also Indiana Statute 32-5-2.6-7. (2000) Idaho Code 55-2109 (2000)
and Virginia 101.1-1011 (2000)


1.     How to Save Time and Taxes Handling Estates, Matthew Bender
& Co., Inc. (1997)

2.   "Conservation Easements: A Flexible Tool for Land Preservation", John L. Hollingshead
3 ENVTL. Law. 319 (1997)

3.     "New Tax Act Incentives Make Easements More Attractive",
Stephen J. Small and C. Timothy Lindstrom, Exchange, Fall 1997

4.      "The American Farm and Ranch Protection Act: An Explanation of Subsection 2031(c )
of the Internal Revenue Code" C. Timothy Lindstrom, The Piedmont Environmental Council,