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TAX IMPLICATIONS OF CONSERVATION EASEMENTS
Expanded Tax Incentive
(Note: This information is taken from the
Land Trust
Alliance website, and does not constitute legal advice. Please contact your
attorney or accountant to determine how these rule changes would effect you.)
1. How does the bill change the current tax incentive for conservation
donations?
The new law:
Raises the deduction a donor can take for donating a conservation easement from
30% of their adjusted gross income in any year to 50%;
Allows qualifying farmers and ranchers to deduct up to 100% of their income; and
Extends the carry-forward period for a donor to take tax deductions for
voluntary conservation agreements from 5 to 15 years.
2. Can you give me an example?
Under the previous rules, a landowner earning $50,000 a year who donated a $1
million conservation easement could take a $15,000 deduction for the year of the
donation and for an additional 5 years – a total of $90,000 in tax deductions.
The new rules allow that landowner to deduct $25,000 for the year of the
donation and then for an additional 15 years. That’s $400,000 in deductions. If
the landowner qualifies as a farmer or rancher, they can zero out their taxes.
In that case, they could take a maximum of $800,000 in deductions for their
million dollar gift.
3. Can anyone deduct more than the value of their gift?
One can never deduct more than the fair market value of the gift. This change
simply allows landowners who previously could not deduct the full value of their
gift to deduct more of that value.
4. Who qualifies as a farmer or rancher?
The new law defines a farmer or rancher as someone who receives more than 50% of
their income from “the trade or business of farming”. The law references an
estate tax provision (Internal Revenue Code (IRC) 2032A(e)(5)) to define
activities that count as farming. Specifically, those activities include:
cultivating the soil or raising or harvesting any agricultural or horticultural
commodity (including the raising, shearing, feeding, caring for, training, and
management of animals) on a farm;
handling, drying, packing, grading, or storing on a farm any agricultural or
horticultural commodity in its unmanufactured state, but only if the owner,
tenant, or operator of the farm regularly produces more than one-half of the
commodity so treated; and
the planting, cultivating, caring for, or cutting of trees, or the preparation
(other than milling) of trees for market.
The qualified farmer or rancher provision also applies to farmers who are
organized as C corporations. For an easement to qualify for the special
treatment, it must contain a restriction requiring that the land remain
“available for agriculture”.
5. Do these changes apply to gifts of land?
This expanded incentive applies to the various specific gifts of partial
interests in land specified as a “qualified real property interest” under IRC
170(h)(2).
The new law provides special treatment for certain donations (those qualifying
under section 170(h), allowing the donor to deduct 50% of AGI and carry forward
their deductions for 15 years. They can deduct 100% of their AGI if they are a
"qualified farmer or rancher."
That treatment clearly does NOT apply to gifts of land in fee, gifts of a
donor's entire interest in a piece of land, or to gifts of an undivided interest
in a piece of land, which are deductible under the same terms as other
charitable donations of capital gain property -- up to 30% of AGI, with 5 years
carryover).
A person whose income is modest compared to the value of their land, who has
been considering a gift of land in fee, may want to consider a gift of a partial
interest qualifying under section 170(h) instead, if the more favorable
treatment of such gifts is important to them.
They have three options:
A gift of a conservation restriction;
A gift of a remainder interest (they donate the land, in fee, but retain a life
estate, the right to live on and use the land until they die); or,
A gift of all their rights to a piece of land reserving for themselves the right
to certain mineral rights.
All of these have their complications and expenses. But there is nothing in
these gifts that would preclude the landowner's option to donate the remainder
of their rights (the rights not previously given to the donee in the
conservation easement, their life estate interest, or their mineral rights) at
some later date.
Such a second donation would be treated as an ordinary charitable donation of
capital gain property, subject to the 30%, 5 year carryover rules.
A caveat: A "qualified farmer or rancher" who wishes to do this will not, in
most cases, be able to benefit from the 100% AGI deduction by this means,
because to qualify, their donation must, according to the legislation, include a
restriction requiring that their land remain "available to agriculture".
Please note: This is our careful reading of the legislative language, and we
think it is a reasonable one and consistent with Congressional intent. It is not
legal advice.
6. Does the expanded tax incentive apply to bargain sales of land?
The new incentive does apply to bargain sales of conservation easements that
qualify under IRC 170(h). It will not apply to donations of land in fee, or to
bargain sales of fee title to land.
In order for a landowner selling a conservation easement in a bargain sale to
qualify as a "farmer or rancher" they may need to consider an installment sale.
The income received from the sale of the conservation easement probably will not
be viewed as "income from the trade or business of farming" by the IRS, and this
income could disqualify them. However, to be qualified as a farmer or rancher
the IRS only needs to qualify the donor's income in the year of the donation, a
farmer could arrange an installment sale that would provide him little sale
income in that year, but provide the balance to him in the next year, which
could allow him to qualify for the 100% deduction.
7. Does this only apply to conservation easements?
The expanded incentive applies to all donations covered in IRC section
170(h)(2), which includes donations of the entire interest of the donor other
than a qualified mineral interest; a remainder interest; or a permanent
conservation or historic preservation easement.
8. Does the new tax incentive apply to C-Corporations and S-Corporations?
Under the new law, C-corporations whose gross income from farming is more than
50% of their total gross income, and whose stock is not publicly traded on a
recognized exchange, are treated as an individual and qualify to take a
deduction for a conservation easement donation of 100% of their adjusted gross
income (AGI) and may carry over unused deductions for 15 years.
Other C-corporations remain limited to a deduction of no more than 10% of their
AGI for a gift of a conservation easement, and may carry over unused deductions
no more than 5 years.
Donations by S-corporations are passed through to their stockholders, and they,
as individuals, will benefit from the new law as other individuals. If the
S-corporation's income is solely from farming, however, at this time (pending
guidance from IRS) we believe that each stockholder would have to meet the test
for a "qualified farmer or rancher" on their own, as an individual, in order to
benefit from the 100% AGI deduction limit.
9. What is the timeline for this expanded incentive?
The new law applies to all easements donated in 2006 and 2007.
Land Trust Alliance will work hard to make this change permanent -- but as it
stands it will expire at the end of 2007. If a donor qualifies under this
provision, they can continue to apply its formulas to the amount of their
contribution that they carry over into years beyond 2007.
10. What other restrictions apply?
Conservation easement donations are subject to the same restrictions as they
were before. For example, easements must meet the “conservation purposes” test
defined in the existing law; they cannot be donated as part of a “quid pro quo”
agreement; and they must be donated to a qualified organization – a governmental
unit or a publicly-supported charity that has “a commitment to protect the
conservation purposes of the donation, and …the resources to enforce the
restrictions.”
Learn more about Treasury Regulations on conservation easement donations. U.S.
Treasury Regulations on Donations of Conservation Easements
The Federal Law on Donations Of Conservation Easements (and other partial
interests)
11. Will donors who use this provision be audited?
Taking advantage of this new law will not necessarily affect one’s likelihood of
being audited. All donors should note, however, that the IRS has been increasing
the number of tax returns it audits – the number has doubled in the last two
years. The IRS has also indicated that high value donations of property –
including donations of conservation easements -- will receive more attention
from the IRS than most tax returns.
That makes it particularly important for a donor to know and follow the law, and
utilize a reputable, professional appraiser who has experience in the appraisal
of conservation easements.
B. Reforms to the Rules for Easement Donors
1. How does the new law prevent abuse?
Under the new law, the definitions of substantial and gross misstatements of
value have been changed. Previously, a taxpayer whose donation was finally
determined to be worth $200,000 would have been guilty of a substantial
misstatement if they had claimed a value of $400,000, and guilty of a gross
misstatement if they had claimed a value of $800,000. Now, they would be guilty
of a substantial misstatement for claiming a value of $300,000, and of a gross
misstatement if they claimed a value of $400,000. There are substantial
additional tax penalties for such misstatements for the taxpayer, and they make
the appraiser subject to penalties of up to 125% of their fee plus potential
disbarment from working on federal tax matters.
The law also redefines who is a “qualified appraiser”, and gives the IRS the
power to issue new regulations on appraiser qualifications. This is important:
as of the date of enactment of this law, appraisers will need to show donors
that they are qualified under the new law and any new Treasury regulations or
guidance that may follow from it. Lastly, the law states that a qualified
appraiser must “demonstrate verifiable education and experience in valuing the
type of property subject to the appraisal.”
These new rules apply not just to conservation easements, but to all charitable
donations of property.
2. Will this make appraisals more expensive?
It is possible that appraisals for conservation easements will be marginally
more expensive. But these reforms are important steps towards ensuring that
appraisals accurately reflect the value of charitable gifts.
3. How does the new law affect easements that protect both conservation and
historic preservation values?
The new law tightens the rules for easements on “certified historic structures.”
If you are protecting a property that includes such a structure (e.g. a farm
with a historic stone barn that is listed in the National Register) these new
regulations may apply to you. Donors and donees of easements protecting historic
structures need to understand the new rules, which include a filing fee for
donors and specific appraisal requirements.
Some of the new rules apply to historic structure easements donated as early as
July 25, 2006. Any donor who has donated a historic preservation easement since
that date should be made aware of the new rules.
4. What about land with historic value, like battlefields and Native American
burial grounds?
There is no change in the law for easements covering battlefields or other land
with historic value. IRC 170(h)(4)(A)(iv) distinguishes between “historically
important land areas” and “certified historic structures”. Only easements
protecting the latter should be affected by the new law.
5. What is the timeline for the reforms?
The new law applies to all donations made after the date of enactment of this
new law. The law makes these reforms permanent. As noted above, sections of the
legislation applying to historic preservation easements are retroactive and
apply to easements donated since July 25, 2006.
6. Have there been other changes besides this tax bill?
Yes! The IRS has changed the instructions for Form 8283, and now asks for
additional information from easement donors. In addition, the IRS has revised
Form 990 – the tax return all charities complete. The IRS has also changed Form
1023, the application for nonprofit status, and in 2004 issued a cautionary
notice regarding conservation donations (Notice 2004-41).
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