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Winter 2008 RECon News March 12, 2008 Turning Conservation Easements into Tax Credits By Christopher J. Truitt, Cherry, Bekaert & Holland, L.L.P. (CB&H) Email: firstname.lastname@example.org In addition to protecting and preserving natural habitats, wetlands, farmlands and open space, conservation easements present a wide variety of tax benefits to landowners who choose to restrict future development on their property in favor of land preservation. From income tax deductions to reductions in assessed value for estate tax purposes, the federal government offers many attractive tax incentives to landowners who donate qualified easements to tax-exempt organizations that specialize in land conservation, such as land trusts. A growing number of states have also identified the value that conservation easements can have in promoting private, voluntary land conservation, and several states have enacted favorable tax credit programs in recent years as a result. When a landowner grants a conservation easement against a property to a land trust organization, the easement and the right to enforce that easement may qualify as a charitable donation for federal income tax purposes. While the land remains the property of the landowner, the easement becomes perpetually attached to the deed. The organization then assumes responsibility for enforcing the easement and ensuring that the specific conservation restrictions detailed in the easement are observed for all current and future development. If the donated easement complies with applicable IRS regulations, then the landowner can claim a federal income tax deduction for the value of the easement. That value, as determined by a qualified appraiser, is equal to the reduction in the fair market value of the property’s land as a result of the easement. Currently, the value of the deduction is limited to 30 percent of the landowner’s adjusted gross income for the first year. Any unused deductible amount is then eligible to be deducted over the subsequent five years subject to the same annual limit. Aside from the federal income tax savings, the estate tax benefits of donating a conservation easement can be very attractive to many landowners. A conservation easement places certain prohibitions against a land’s future development, which usually reduces the overall fair market value of a property. Accordingly, this lower property value then becomes the basis for calculating estate taxes. Federal law also allows an estate’s beneficiaries to reduce the estate’s land value by 40 percent for estate tax purposes in certain qualifying circumstances when a conservation easement exists on the estate. The reduction in fair market value that generally accompanies a conservation easement may also reduce a landowner’s property tax liability. Some states, like Wisconsin, require property tax assessors to factor conservation easements when considering a property’s value. However, since property tax assessment is conducted at the local level, it may be necessary for a donor to inform their local assessor’s office about conservation easements when appealing an assessment. Many states also now offer a state tax credit to taxpayers who donate conservation easements, providing an additional incentive to landowners beyond the federal benefits outlined above. While tax deductions can be used to reduce a taxpayer’s taxable income, tax credits can be used to offset a taxpayer’s tax liability. It is notable that a number of states with the highest total acres of privately conserved land, including California, Colorado, New Mexico, New York, and Virginia, offer tax credits for conservation easements. However, simply because a conservation easement may qualify for federal income tax benefits does not qualify that easement for a state tax credit. Consulting with a tax professional experienced with the regulations that govern a particular state’s conservation tax credit program is recommended because the laws vary significantly from state to state. In addition to specific rules regarding what type of land qualifies for a conservation easement credit, each state’s program has very detailed guidelines regarding the credit’s size, basis, annual cap, refundability, as well as the number of years the credit can be carried forward. A key early step in securing a state conservation tax credit is to obtain an appraisal of the conservation easement from an independent appraiser qualified to conduct development rights appraisals. The appraiser’s specific experience with regard to easement appraisals is very important and will need to be detailed in the appraisal summary submitted with the donor’s income tax return. The appraisal must consider the specific restrictions imposed by the easement as well as any further development rights maintained by the landowner. Moreover, the report must also contain sufficient documentation, including comparable easement appraisals, to support the value appraisal. Many taxpayers may believe that their state income tax liability is not significant enough to render state tax credits a credible option, but the conservation tax credit programs of some states offer a number of additional incentives. For example, New York recently implemented a program that actually offers a refundable conservation easement tax credit, whereby the state issues a payment to the donor for any amount of the credit remaining in the event that the landowner’s tax liability has been satisfied. Furthermore, the conservation easement tax credit programs of some states, such as Colorado and Virginia, allow the credits to be transferable, and taxpayers can actually sell and receive cash payments for their credits. Since a donor will often need a number of years to fully use all of their available tax credits, selling all or just some of these credits may be an attractive short-term option. Even with a discount on the credit amount, many donors will find that cashing in on their credits’ current value is often more favorable than waiting many years to use the credits. Effective January 1, 2007, taxpaying residents, corporations, estates and trusts who donate a conservation easement on a Colorado property are eligible to receive a state tax credit for 50 percent of the easement’s fair market value up to a maximum of $375,000. For easements donated prior to 2007, taxpayers can claim a credit worth 100 percent of the first $100,000 of the easement’s fair market value, plus 40 percent of any additional fair market value over $100,000 but not to exceed $260,000. Any credit amount remaining can be carried forward for 20 succeeding years, or sold or transferred to other Colorado taxpayers. Virginia’s program also allows conservation easement donors to sell or transfer unused portions of the state’s tax credit to other Virginia taxpayers. In Virginia, every landowner who donates land or an easement for conservation is entitled to a credit against state income tax. The credit is worth 40 percent of the land’s fair market value, up to $100,000 per year. The credit is available to qualified individual taxpayers, corporations, partnerships, organizations, trusts or estates. If the credit is not used up in the year of the easement donation, it can be carried forward for an additional five years. The Colorado and Virginia state-sponsored programs have developed a mature secondary market for the transfer of unused tax credits between easement donors and taxpayers looking to offset their current state income tax liability. These popular programs essentially allow landowners who donate conservation easements on their property to sell unused credits to a taxpayer and recover a percentage of the easement’s value. Although individuals and businesses can buy and sell tax credits directly with each other, it is advisable that they work with a broker experienced in matching tax credit buyers with pre-qualified sellers. In particular, donors looking to capitalize on the value of their unused credits should always use a qualified state tax credit broker, since sellers of tax credits assume a legal obligation to provide 100 percent indemnification protecting buyers against any future federal or state challenges related to the tax credits, including any applicable legal fees. The broker’s role is to act as a facilitator of the tax credit transfer between a willing buyer and seller. The broker pre-qualifies tax credits sold within their network, and helps prospective buyers take advantage of pre-negotiated purchase discounts. Landowners looking to sell unused tax credits should register their credits with a broker early will help ensure that their credits pre-qualify for transfer and can be sold in a timely manner. The broker will then review all documents related to the easement donation, including the appraisal; identify potential buyers; prepare any sales documents needed to facilitate the tax credit transfer; and complete all applicable tax credit forms needed to claim the credit on an individual or business tax return. In addition to realizing gross tax savings, individuals and businesses that purchase these state tax credits contribute directly to the intrinsic value of land conservation, and are entitled to deduct, as a federal itemized deduction, the amount of land preservation tax credits purchased. According to the 2005 National Land Trust Census Report recently published by the Land Trust Alliance, private land conservation through state and local land trust organizations more than tripled in the five- year period from 2000 to 2005. With the growing use of conservation easements cited as one of the key factors behind this expansion, legislators at both the state and federal level will no doubt continue to strengthen tax incentives as a primary way to foster the continued preservation of America’s natural heritage.
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