Conservation Easement Deductions: A Primer on Key Provisions
The IRS has been focused on enforcement efforts targeting conservation easement transactions. And IRS data indicates that more enforcement efforts lie ahead. The Senate Finance Committee, which has been engaged in a years-long investigation into the tax play, recently released a report noting a “significant increase in conservation easement transactions,” and its chairman expressed concerns about what he characterized as the “serious and persistent abuse of the syndicated conservation easement program.” The IRS, in virtual lockstep, has used similar rhetoric, vowing to use “[e]very available enforcement option . . . including civil penalties and . . . criminal investigations” to carry out its “pursuit of everyone involved in the creation, marketing, promotion and wrongful acquisition of artificial, highly inflated deductions” associated with syndicated conservation easement transactions. See here.
This enforcement focus has given rise to newfound interest—both from politicians and the public—in conservation easements, though they are anything but a new phenomenon. And while the concept and focus has given rise to a fair amount of public fodder and rhetoric, the truth is that the tax-compliance aspects of conservation easements are quite complex. In this article, we will canvass a number of the fundamental tax provisions with respect to conservation easement deductions.
The Internal Revenue Code permits a deduction for a charitable contribution, as that term is defined in section 170(c). Under Section 170(c), a charitable contribution is a contribution or gift to or for the use of certain qualifying organizations.
Under section 170(f)(3)(A), a taxpayer generally may not take a deduction for a contribution of less than the taxpayer’s entire interest in property. Section 170(f)(3)(B)(iii), however, provides an exception to this general rule when it comes to a “qualified conservation contribution.”
Section 170(h)(1) and section 1.170A-14(a) of the Treasury Regulations define a “qualified conservation contribution” as a contribution of a qualified real property interest to a qualified organization exclusively for conservation purposes.
All of these phrases have some fairly nuanced definitions. Let’s explore them below:
- Qualified Real Property Interest. Section 170(h)(2)(C) of the Code defines a “qualified real property interest” to include a restriction granted in perpetuity on the use of real property. Treasury Regulation section 1.170A-14(b)(2) provides that a qualified real property interest includes a perpetual conservation restriction, which is a restriction granted in perpetuity on the use that may be made of real property — including an easement.
- Qualified Organization. Under section 170(h)(3)(A), the term “qualified organization” includes an organization that is described in section 170(B)(1)(A)(vi).
Section 1.170A-14(c)(1) of the regulations provides that for a qualified organization to be an eligible donee of a qualified conservation contribution, it must also have a commitment to protect the conservation purposes of the donation, and the resources to enforce the restrictions. It further provides that an organization organized or operated primarily or substantially for one of the conservation purposes specified in section 170(h)(4)(A) will be considered to have the required commitment.
Under section 1.170A-14(c)(2) of the regulations, the donor must prohibit transfers of the easement by the donee, unless, subsequent to the transfer, the donee organization requires that the conservation purpose continue to be carried out, and the subsequent transferee qualifies as an eligible donee under section 1.170A-14(c)(1).
- Conservation Purpose. Section 170(h)(1)(C) of the Code provides that a qualified conservation contribution must be exclusively for conservation purposes. Section 170(h)(4) provides that the term “conservation purpose” means (i) the preservation of land areas for outdoor recreation by, or the education of the general public; (ii) the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem; (iii) 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 conservation policy, and where it will yield a significant public benefit; or (iv) the preservation of an historically important land area or a certified historic structure.
The Exclusivity and Perpetuity Requirements
In order to qualify, the Code and the regulations provide that a contribution must be exclusively for conservation purposes. The Code provides that a contribution shall not be treated as exclusively for conservation purposes unless the conservation purpose is protected in perpetuity. Section 1.170A-14(g)(1) of the regulations provides that any interest retained by the donor (and the donor’s successors in interest) must be subject to legally enforceable restrictions (for example, by recordation in the land records of the jurisdiction in which the property is located) that will prevent use of the donor’s retained interest that is inconsistent with the conservation purposes of the donation.
Section 1.170A-14(e)(2) sets forth specific rules relating to inconsistent use. It provides that a deduction will not be allowed if the contribution would accomplish one of the enumerated conservation purposes but would permit destruction of other significant conservation interests.
Section 1.170A-14(g)(5)(i) of the regulations requires that for a deduction to be allowable under this section 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 in the case of a donation made after February 13, 1986 of any qualified real property interest when the donor reserves rights the exercise of which may impair the conservation interests associated with the property. The referenced documentation is designed to protect the conservation interests associated with the property, which could be adversely affected by the exercise of the reserved rights even though they are protected in perpetuity by the easement. This documentation may include:
- The appropriate survey maps from the United States Geological Survey, showing the property line and other contiguous or nearby protected areas;
- A map of the area drawn to scale showing all existing man-made improvements or incursions (such as roads, buildings, fences, or gravel pits), vegetation and identification of flora and fauna (including, for example, rare species locations, animal breeding and roosting areas, and migration routes), land use history (including present uses and recent past disturbances), and distinct natural features (such as large trees and aquatic areas);
- An aerial photograph of the property at an appropriate scale taken as close as possible to the date the donation is made; and
- On-site photographs taken at appropriate locations on the property. If the terms of the donation contain restrictions with regard to a particular natural resource to be protected, such as water quality or air quality, the condition of the resource at or near the time of the gift must be established. The documentation, including the maps and photographs, must be accompanied by a statement signed by the donor and a representative of the donee clearly referencing the documentation and in substance saying “This natural resources inventory is an accurate representation of [the protected property]at the time of the transfer.”
Required Right of Inspection and Legal Remedies. Section 1.170A-14(g)(5)(ii) provides that the donee must have a right of inspection and legal remedies. It states that in the case of any donation referred to in paragraph (g)(5)(i) of that section, the donor must agree to notify the donee, in writing, before exercising any reserved right, e.g. the right to extract certain minerals. 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. Additionally, the terms of the donation must provide a right of the donee to enforce the conservation 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.
Changed Circumstances. Section 1.170A-14(g)(6)(i) provides that if circumstances change making impossible or impractical the continued use of the property for conservation purposes, then the easement will be treated as protected in perpetuity if the restrictions are extinguished by judicial proceedings and all of the proceeds received by the donee are used by the donee in a manner consistent with the conservation purposes of the original contribution. Section 1.170A-14(g)(6)(ii) provides that the donor must agree that the donation of the perpetual conservation restriction gives rise to a property right with a fair market value that is at least equal to the proportionate value that the perpetual conservation restriction at the time of the gift bears to the value of the property as a whole. It further provides that proportionate value of the donee’s property rights shall remain constant.