Estate & Income Tax Considerations

Conservation easements offer beneficial tax incentives, making it possible for rural landowners to prevent development while still being able to actively pursue agricultural operations and other activities, like hunting, recreation, and nature tourism.

The potential tax benefits of a donated conservation easement are two-fold. First, income tax benefits may accrue at the federal level,  and second, the conservation easement works as an estate planning tool to reduce estate tax liability, thereby allowing family ranches and farms to be passed from generation to generation with the potential of a substantially lower tax burden. Conservation easements do not affect Texas property tax levels.

Qualifying for a Tax Deduction

To qualify for a tax deduction, your donation must be considered a charitable gift by the Internal Revenue Service. To ensure your gift meets IRS requirements, it is strongly recommended the proposed gift be reviewed by an experienced attorney or accountant. A deductible, charitable donation can be made only to an IRS-qualified, tax-exempt organization. It must be a gift motivated by a charitable intent and not granted as a requirement for getting something in return. For example, a conservation easement donated by a developer, in exchange for government approval of a subdivision, is not considered a gift. A gift must also be complete and irrevocable, without strings or contingencies.

Qualifying for a Conservation Easement Appraisal

To qualify for a tax deduction, your donation must be considered a charitable gift by the Internal Revenue Service. To ensure your gift meets IRS requirements, it is strongly recommended the proposed gift be reviewed by an experienced attorney or accountant. A deductible, charitable donation can be made only to an IRS-qualified, tax-exempt organization. It must be a gift motivated by a charitable intent and not granted as a requirement for getting something in return. For example, a conservation easement donated by a developer, in exchange for government approval of a subdivision, is not considered a gift. A gift must also be complete and irrevocable, without strings or contingencies.

Qualifying for a Conservation Easement Appraisal

For tax deductions on gifts worth more than $5,000 (other than cash and publicly traded securities), landowners must obtain a “qualified appraisal” by a “qualified appraiser.” (These terms are defined by the tax code; check with your attorney or accountant for details.) You should consult with a professional appraiser who has direct experience with charitable gifts or easements. The Texas Agricultural Land Trust can refer you to appraisers with experience in this field, but cannot provide the appraisal. The appraisal cost is a necessary expense if you wish to pursue a charitable tax deduction.

INCOME TAX

Contribution Value

For illustrative purposes, let’s assume you are the owner of a ranch and you would like to donate a conservation easement on the property. Working with TALT staff, you negotiate the terms of the easement, which allows you to continue agricultural use, protect important native wildlife habitat, construct an additional residence if desired, and prevent commercial development. The conservation easement will also prohibit surface mining and any commercial waste dumping, although oil and gas activities are allowed.

To calculate the value of the charitable contribution generated by the easement donation, you must obtain a “qualified appraisal” by a “qualified appraiser.” As recipient of the donated conservation easement, TALT needs to be detached from the appraisal process.

In the example below, the appraisal sets the fair market value of a hypothetical ranch at $2 million. This is the value of the property before the conservation easement. The appraisal also consists of sales figures for comparable properties already under conservation easement, sales data on comparable developed and undeveloped properties, information on appraised values of other conservation easements, and the specific terms of this particular conservation easement. All of this information is used to arrive at what the property’s market value will be after the conservation easement is in place, also known as the after value. In the example below, the property receives an approximately 30% reduction in value after the proposed restrictions are factored in by the appraiser:

Before conservation easement property value    =    $2,000,000
After conservation easement property value     =    $1,300,000
Value of charitable contribution     =    $700,000

NOTE: The before-value of a conservation easement donated within the first 12 months of purchasing a property must be the acquisition price.

30% Limitation

For donations of conservation easements, a deduction of up to 30% of the taxpayer’s adjusted gross income can generally be taken. The 30% deduction can be used in the year the donation was made, and then carried forward to the succeeding five years.

In our example, the value of the charitable contribution generated through the donation of the conservation easement is $700,000. Let’s assume that the landowner’s annual adjusted gross income for income tax purposes is $390,000, which remains constant. The deduction resulting from the easement is as follows: (30 percent of $390,000 = $117,000):

Year of Contribution            $117,000

Carry Forward to Year 1        $117,000

Carry Forward to Year 2        $117,000

Carry Forward to Year 3        $117,000

Carry Forward to Year 4        $117,000

Carry Forward to Year 5        $115,000

Note: An enhanced tax incentive that allowed for deducting against 50% of AGI and a carry-forward of 15 years expired in December, 2011. The Land Trust Alliance is leading the effort to have this incentive re-enacted and made permanent. For more information, see www.lta.org.

Easement Costs Deductibles

Some of the costs incurred in making a charitable contribution are also deductible. Legal and appraisal fees and costs associated with compiling the “Baseline Documentation Report” can generally be deducted as business expenses if, in combination with other miscellaneous deductions, they exceed 2 percent of your adjusted gross income. Any cash or securities given to endow the conserved property’s stewardship are considered charitable contributions.

Estate Tax — Succession Planning

Federal estate tax is based on the fair market value of the property at the time of the landowner’s death, not the original purchase price or current use value. This can be a significant and potentially debilitating tax burden for farm and ranch families whose land values have appreciated over time, particularly if the appreciated value is due largely to increased development value. Sometimes caught unaware and without the benefit of estate planning, farm and ranch families may have to subdivide and sell some of their land just to meet the estate tax obligations. Conservation easements can be a useful estate planning tool to reduce estate tax liability and allow ranches to remain in the family.

For example: The Smith family has owned a large ranch in South Texas for four generations. The parents are in their mid-60s and want to pass the ranch on to their children. One child has moved away and is living in Wyoming. Another has stayed on the ranch and worked it with the parents over the years. The children and the parents want the property to remain whole as a working ranch. They are concerned that the value of the ranch has appreciated significantly over time and they will not be able to keep the ranch because of a potentially large estate tax liability.

Let’s assume that the ranch has appreciated to a current fair market value of $15,000,000 as determined by appraisal. The owners donate a conservation easement to TALT which generally limits development of the property but enables them to continue agricultural operations.

A “qualified” appraiser determines the value of the conservation easement to be 30 percent of $15,000,000, or $4,500,000.  The current exclusion allows each parent to pass on $5,000,000 of property to heirs through their estate free of tax.

The following analysis illustrates the effect a conservation easement would have on their estate tax at 2011 levels (assuming both parents die within the same year and their estate is taxed at the maximum rate):

Additional Estate Tax Exclusion

The tax law also allows beneficiaries who inherit land with a conservation easement to exclude from the taxable estate an additional $500,000. At the 35% tax rate, this saves an additional $175,000 in estate taxes. So, with the donation of a conservation easement, the Smith Family has wiped out any estate tax liability related to the ranch.

Estimated Estate Tax Liability (2011)

$15,000,000 Taxable Value Of Property

Without Conservation Easement
Estate Tax Due $1,750,000

With Conservation Easement
Estate Tax Due $175,000

With Conservation Easement and
Additional Estate Tax Exclusion
Estate Tax Due $0

Post-mortem Election

The federal tax law allows estate beneficiaries and/or the executor to elect to place the land under conservation easement after death, but before filing an estate tax return.

Estate Planning

Conservation easements are only one component of several estate-planning options available to effectively pass on a farm or ranch, as well as other assets, to the next generation. Currently, it is difficult to determine the absolute effect of conservation easement donations on the estate tax. Proper planning with a qualified estate planning team is essential.

Disclaimer

The comments in this article reflect TALT’s understanding of federal tax law. The examples used are for illustrative purposes only. TALT does not claim to give legal or tax advice about the consequences of a particular conservation easement. The tax implications of your conservation plan will depend upon the value of your gift, your finances and other factors specific to your situation. To fully understand how current law affects your conservation plan, you need to consult with your tax attorney, CPA and financial adviser.

If you would like more information or wish to discuss a conservation easement donation, please contact us:

Texas Agricultural Land Trust
P.O. Box 6152
San Antonio, Texas 78209

210-826-0074 (office)  210-828-5091 (fax)
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NOTE: The Texas Agricultural Land Trust extends our gratitude to the Montana Land Reliance for granting permission to adapt the above information from their website, www.mtlandreliance.org,  September, 2008.