Transcript Christian Dietrich - Montana Association of Land Trusts

CONSERVATION EASEMENT LAW,
PRACTICE AND TAX IMPLICATIONS
CHRISTIAN DIETRICH
HUGHES, KELLNER, SULLIVAN & ALKE, PLLP
PART I—THE LAW
170(h) Qualified conservation contribution
(1) In general
For purposes of subsection (f)(3)(B)(iii), the term
“qualified conservation contribution” means a
contribution—
(A) of a qualified real property interest,
(B) to a qualified organization,
(C) exclusively for conservation purposes.
170(h)(5)(A) and Treas. Reg. 170A-14(a) further
require that the conservation purpose “must be
protected in perpetuity.”
QUALIFIED REAL PROPERTY INTEREST
(2) Qualified real property interest
For purposes of this subsection, the term
“qualified real property interest” means any
of the following interests in real property:
(A) the entire interest of the donor other than a
qualified mineral interest,
(B) a remainder interest, and
(C) a restriction (granted in perpetuity) on the use
which may be made of the real property.
QUALIFIED ORGANIZATION
• Governmental entities
• 501(c)(3) nonprofit organizations
• Must have a “commitment to protect
conservation purposes of the
donation.”
• Must have “the resources to enforce
the restriction.”
EXCLUSIVELY FOR CONSERVATION
PURPOSES
170(h)(4) defines conservation purpose as:
(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 will yield a significant public benefit, or
(iv) the preservation of an historically important land
area or a certified historic structure.
“NATURAL HABITAT” IN ACTION:
GLASS V. COMMISSIONER
• Easement protected ~400 feet of shoreline (about 1 acre).
Allowed for construction of walking paths, boathouse, shed,
etc., but restricted most development.
• IRS position was that no valid conservation purpose was
present.
• IRS lost at every level. Implicit argument that there is a size
requirement for natural habitat was unsuccessful.
• Takeaway: include recitation of natural habitats present on
property unless need for flexibility outweighs advantages.
• The IRS has also lost on natural habitat challenges in other
cases, including Butler and Kiva Dunes.
PRESERVATION OF OPEN SPACE
(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 will yield a significant public benefit.
PERPETUITY
170(h)(5):
(A) Conservation purpose must be protected
A contribution shall not be treated as exclusively for conservation
purposes unless the conservation purpose is protected in
perpetuity.
1.170A-14:
“To be eligible for a deduction under this section, the conservation
purpose must be protected in perpetuity.”
But:
“[a] deduction shall not be disallowed . . . merely because the
interest . . . may be defeated by the performance of some act or
the happening of some event, if on the date of the gift it appears
that the possibility that such act or event will occur is so remote as
to be negligible.”
MINERAL DEVELOPMENT
• Surface mining must be prohibited at
all times. Gravel extraction must be
treated with extreme caution.
• Certain “limited, localized” subsurface
mineral extraction that is “not
irremediably destructive of significant
conservation interests” may be
permissible.
RESTRICTIONS ON TRANSFER
Easement deed must:
• Require any transfer of the easement
to be only to another qualified
organization.
• Transfer must be conditioned on the
“conservation purposes which the
contribution was originally intended to
advance” continuing to be carried
out.
RESTRICTIONS ON INCONSISTENT USES
• Deduction disallowed if easement
permits destruction of other significant
conservation purposes.
• Some IRS-approved uses of easementencumbered property:
•
•
•
•
Selective timber harvest
Limited mineral extraction
Some commercial recreation (e.g., outfitting)
Limited development
BASELINE DOCUMENTATION
1.170A-14(5) explains:
“when the donor reserves rights the exercise
of which may impair the conservation
interests associated with the property, 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.”
NOTIFICATION AND INSPECTION
Notification: landowner must notify donee in
writing before exercising any reserved right
that may adversely affect conservation
interests.
Inspection: easement deed must allow
inspection to determine compliance with
the terms of the easement, and must permit
legal action to enforce restrictions.
MORTGAGE SUBORDINATION
Deduction is disallowed “unless the
mortgagee subordinates its rights in
the property to the right of the
qualified organization to enforce the
conservation purposes of the gift in
perpetuity.”
Necessary to protect against
consequences of foreclosure.
MORTGAGE SUBORDINATION IN
ACTION: MITCHELL
• Mortgage had not been subordinated
at time of donation, but was two years
later
• Taxpayer argued possible foreclosure
was “so remote as to be negligible”
• Tax Court agreed with IRS that
mortgage subordination at time of
donation is a hard-and-fast rule.
MORTGAGE SUBORDINATION,
EXTINGUISHMENT AND RIGHT TO
PROCEEDS
• Lender must also subordinate right to
proceeds.
• Donee organization must be entitled “to a
portion of the proceeds at least equal to
that proportionate value of the perpetual
conservation restriction.”
• Requirement applies in foreclosure,
extinguishment, condemnation settings
MORTGAGE SUBORDINATION AND
RIGHT TO PROCEEDS IN ACTION:
KAUFMAN
• Lender subordinated mortgage but retained priority
in insurance or condemnation proceeds.
• IRS prevailed in first two (of four) decisions, arguing
that donee must be absolutely entitled to its portion
of proceeds (the easement’s proportionate value).
• IRS lost on appeal to First Circuit, which rejected the
IRS’ position on absolute entitlement.
• Taxpayers won the battle but lost the war—in March
2014 all deductions were disallowed because the
easement had zero value.
EXTINGUISHMENT IN ACTION:
CARPENTER
• Easement deed provided it could be
terminated by mutual written consent if
“circumstances arise in the future such that
render the purpose of [the easement]
impossible to accomplish.”
• Taxpayer argued the “so remote as to be
negligible” standard applied
• IRS prevailed in Tax Court on argument that
extinguishment requirement (must occur by
judicial proceeding) is not subject to the “so
remote as to be negligible test.”
OTHER PERPETUITY CASES
• Belk: property subject to easement must be clearly
defined.
• Graev: provision that easement would be
reconveyed if tax deduction failed is
unacceptable; “so remote as to be negligible”
standard did not save the deduction.
• Simmons: taxpayers successful with “so remote as to
be negligible” standard with respect to provision
that allowed donee to consent to changes or
“abandon some or all of its rights hereunder.”
PERPETUITY AND AMENDMENT OF
CONSERVATION EASEMENTS
• The Land Trust Alliance’s Model
Conservation Easement allows the donor
and donee organization to amend the
easement jointly, provided the amendments
are:
(1) consistent with the purposes of the easement,
(2) do not affect the status or qualification of the
easement or the easement holder under
applicable laws, including federal income tax
laws, and
(3) do not affect the perpetual duration of the
easement.
AMENDMENT AND
CHARITABLE TRUST LAW DEBATE
• Largely academic.
• Reasonable support for both positions given
the unique legal background of
conservation easements.
• Thank the Montana Legislature for letting
you ignore the issue completely:
The newly-enacted § 72-38-402 provides: “A conservation
easement created or conveyed under Title 76, chapter 6,
does not create a charitable trust unless the settlor
expresses a clear intention in the conservation easement
instrument to create or convey the conservation
easement as a charitable trust.”
DONATIVE INTENT
• Question asked is: was there a quid pro quo
for the easement donation?
• Examples:
• Donor gives easement to secure subdivision
approval
• “Reciprocal” easements.
• Bargain sales do not run afoul of this rule.
• Stewardship gifts should also be OK, but be
careful (Scheidelman).
SUBSTANTIATION REQUIREMENTS:
APPRAISALS
• Qualified appraisals required for all
deductions greater than $5,000.
• Must be attached to return if deduction
exceeds $500,000, but good practice to
include for all donations.
• “Qualified appraisal” and “Qualified
appraiser” now defined by statute.
• Do not rely on substantial compliance with
appraisal requirements! Some taxpayers
have prevailed, but these decisions cannot
be relied upon.
OTHER SUBSTANTIATION
REQUIREMENTS
• Requirements include:
• Contemporaneous written
acknowledgment
• Form 8283 and Supplemental Statement
• Again, do not rely on substantial
compliance, even though there is
some support for the doctrine’s
application.
CONTEMPORANEOUS WRITTEN
ACKNOWLEDGMENT
The CWA must be issued by the time
the return is due, and must include the
following information:
• The amount of cash donated and a description
of any noncash property donated
• A statement on whether the donee
organization provided any goods or services in
consideration for the donation
• A description and estimate of the value of any
goods or services provided in consideration for
the donation.
CWA IN ACTION:
SCHRIMSHER, BRUZEWICZ
• Schrimsher: façade easement deduction denied entirely
for lack of CWA. IRS attacked the deduction on
numerous grounds, but won on sole ground that no
documents in the transaction stated that no
consideration was provided for the gift.
• Bruzewicz: IRS attacked on valuation and insufficient
CWA (donee provided the donors a basic thank you
letter that listed two cash contributions but not the
easement contribution).
• Other cases have turned out differently (see materials),
but no consistency in these taxpayer-friendly rulings.
Bottom line, again: do not rely on substantial
compliance! 170(f)(8) means what it says.
FORM 8283 AND
SUPPLEMENTAL STATEMENT
• Together, these forms require significant detail
concerning the transaction.
• Some success in court for substantial compliance
with 8283 requirements, but follow instructions and
don’t risk it.
• The IRS has been perfectly willing to challenge
deductions on the basis that 8283s aren’t properly
filled out—even for the most technical of
deficiencies. See cases.
• Links in materials. Be an overachiever and do not
leave this until the last minute—signatures of donee
and individual appraiser are required.
FORM 8283 IN ACTION: SCHEIDELMAN
• Scheidelman submitted two Form 8283s, which
together contained the information required. One
contained the necessary information and signatures
from the appraiser and donee organization; the
other contained all of the rest of the information
required.
• Tax Court stated this did not comply with regulatory
requirements (!) while denying deduction for lack of
a qualified appraisal.
• This portion of the tax court’s opinion was
overturned, and the 8283 failure was excused on
two grounds: "reasonable cause," see 26 U.S.C. §
170(f)(11)(A)(ii)(II); and the doctrine of substantial
compliance.”
LESSONS FROM CASE LAW
• The IRS has learned from early losses and has shifted
to making technical arguments it thinks it can win.
• Easements attacked have thus far been “problem”
easements for a number of reasons—façade
easements, overvalued easements, clear lack of
charitable intent.
• An aggressive, litigious IRS is here to stay in the
conservation easement arena, and Max is in China.
• Take advantage of the wealth of resources at your
disposal and develop familiarity with all of these
requirements. Make it easy for the IRS to pick on
someone else instead!
PART II-THE MATH
Current law on deductibility of easements
• The “Fifty-percent limitation” generally applies to
contributions of property held less than one year.
• The “Thirty-percent limitation” generally applies to
contributions of long-term capital gain property.
• Excess deductions may be carried forward for five
years after the year of the gift.
DEDUCTION ALLOWED UP TO 50% OF CONTRIBUTION BASE
IRC § 170(B)(1)(A)
•
•
•
•
Adjusted gross income: $400,000
Value of land without easement: $2,000,000
Value of land with easement: $1,200,000
Amount of gift: $800,000
• A deduction is allowed up to 50% of $400,000 adjusted
gross income ($200,000) in the year of the donation.
• The remaining $600,000 can be carried forward for up
to five years.
• Assuming a steady income, the taxpayer will be able to
deduct an additional $200,000 each year for the next
three years before the full gift is deducted.
DEDUCTION ALLOWED UP TO 50% OF CONTRIBUTION BASE
IRC § 170(B)(1)(A)
•
•
•
•
•
•
Adjusted gross income: $400,000
Value of land without easement: $6,000,000
Basis in land: $5,000,000
Value of land with easement: $3,000,000
Easement value: $3,000,000
Basis in easement: $2,500,000
•
Amount of deduction: $2.5M (would be $3M, but is limited to basis)
•
A deduction is allowed up to 50% of $400,000 ($200,000) in the year
of the donation
•
The balance of the donation, $2.3M, can be carried forward for up
to five years
•
Assuming a steady income, the taxpayer will be able to deduct an
additional $200,000 each year for the next 5 years
•
Only 40% of the full value of the gift, will be deductible
DEDUCTION ALLOWED UP TO 30% OF CONTRIBUTION BASE
FOR CONTRIBUTIONS OF LONG-TERM
CAPITAL GAIN PROPERTY: IRC § 170(B)(1)(C)
•
•
•
•
Adjusted gross income: $400,000
Value of land without easement: $2,000,000
Value of land with easement: $1,200,000
Amount of deduction: $800,000
• A deduction is allowed up to $120,000 in the year
of the donation (30% of the taxpayer’s $400,000
income)
• A further $120,000 will be deductible each of the
next five years
• 90% of the full gift will be deductible
DEDUCTION ALLOWED UP TO 30% OF CONTRIBUTION BASE
IRC § 170(B)(1)(C)
•
•
•
•
Adjusted gross income: $400,000
Value of land without easement: $6,000,000
Value of land with easement: $3,000,000
Amount of deduction: $3,000,000
• A deduction is allowed up to 30% of $400,000, or
$120,000, in the year of the donation
• The balance of the donation, $2.88M, can be carried
forward for up to five years
• Assuming a steady income, the taxpayer will be able to
deduct an additional $120,000 each year for the next 5
years
• Only 24% of the gift will be deductible
WHEN MIGHT 30% BE PREFERABLE?
•
•
•
Adjusted gross income: $1,000,000
Land value without easement: $5,000,000
Basis in land: $1,000,000
30% limitation
•
•
•
Land value with easement: $3,000,000
Easement value: $2,000,000
Basis in easement: $400,000
50% limitation
Gift amount is $2M
Gift amount is $2M
Up to 30% of their $1M income($300K) can be
deducted in the year of the gift
Up to 50% of their $1M income ($500K) can
be deducted in the year of the gift; but the
deduction is capped at $400K, the taxpayers’
basis in the easement
Additional ($300K)×(5) or $1.5M can be
deducted in years 2-6
No additional deductions permitted.
Able to deduct 90% of the gift’s value
(1.8 M of $2 M)
Able to deduct only 20% of the gift’s value
($400K of $2M)
30% AND 50% (SAME RESULT)
•
•
•
Adjusted gross income: $1,200,000
Land value without easement: $10,000,000
Basis in land: $6,000,000
30% limitation
•
•
•
Land value with easement: $6,000,000
Easement value: $4,000,000
Basis in easement: $2,400,000
50% limitation
able to deduct 60% of gift
able to deduct 60% of gift
30%×$1.2M=$400k/year for 6 years, or $2.4M
50% x1.2M =$600K/year for 4 years, or $2.4M
More favorable if income is greater.
More favorable if basis in property is greater.
Income of $2M enables deduction of 90% of
gift
Basis of $9M enables deduction of 90% of gift
30% of $2M is $600k annually, over 6 years this
totals $3.6M in deductions ($600K x 6)
easement basis is $3.6M, which is fully
deducted over 6 years ($600K x 6)
ENHANCED INCENTIVES (FOR ALL)
• Increased applicable percentage limitation for
contributions of easements on property held longer
than one year for all donors from 30% to 50%,
without limitation to basis.
• Excess contributions can be carried over for up to
15 years.
• Special rules apply for farmers and ranchers and
small ranching corporations.
•
•
•
Adjusted gross income: $400,000
Land value (held more than one year) without easement: $6,000,000
Land value with easement: $3,000,000
General Rules
Enhanced Incentives
Amount of deduction: $3,000,000
A deduction is allowed up to 30% of
$400,000, or $120,000, in the year of
the donation.
Able to deduct up to 50% of $400K
income in the year of contribution
($200K)
The balance of the donation, $2.88M,
can be carried forward for up to five
years under § 170(d)(1).
The balance of the donation ($2.8M)
can now be carried forward up to15
years.
Assuming a steady income, the
taxpayer will be able to deduct an
additional $120,000 each year for the
next 5 years.
Only $720K of $3M, or 24% of the gift,
will be deductible.
Able to deduct full $3M value of gift
over next 15 years (with year to
spare).
ENHANCED DEDUCTIONS—FARMERS
AND RANCHERS
Who qualifies? Under IRC 170(b)(1)(E)(v):
[T]he term “qualified farmer or rancher” means a taxpayer
whose gross income from the trade or business of farming is
greater than 50 percent of the taxpayer’s gross income for
the taxable year.
The contribution of an easement must be on property
either “used in agriculture or livestock production” or is
available to be used, and which is “subject to a restriction
that such property remain available for such production.”
(170(b)(1)(E)(iv)(II)).
“FARMING”
IRC 2032A(e)(5):
(A) 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;
(B) 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
(C)
(i) the planting, cultivating, caring for, or cutting of trees, or
(ii) the preparation (other than milling) of trees for market.
ENHANCED DEDUCTIONS—QUALIFIED
FARMERS AND RANCHERS
The deduction also applies to corporations meeting
the 50% of income test, as long as:
• Stock “is not readily tradable on an established
securities market at any time during such year” (i.e.,
no giant agribusiness), and
• The contribution of an easement is on property
either used in agriculture or available to be used,
and which is subject to a restriction that it remain
available for such production.
•
•
•
•
•
•
Adjusted gross income: $100,000 (60% from ranch operations)
Land value without easement: $3,000,000
Land value with easement: $1,000,000
Amount of gift: $2,000,000
Basis in land: $300,000
Basis in easement: $200,000
30% Limitation
able to deduct $50k annually for 6
years, or $300k (15% of gift)
Enhanced Incentives for
Farmers/Ranchers
able to deduct $100k annually for 16
years, or $1.6M (80% of gift)
50% Limitation
able to deduct $50k annually for 4
years (deduction capped at basis of
$200k in easement) (10% of gift)
Enhanced Limitation
able to deduct $50k annually for 16
years, not subject to basis limitation,
for total of $800k (40% of gift)
FACTORS TO CONSIDER IN
DETERMINING ACTUAL SAVINGS:
OTHER CHARITABLE CONTRIBUTIONS
•
•
•
•
•
Adjusted gross income: $400,000
Land value without easement: $2,000,000
Land value with easement: $1,200,000
Amount of deduction: $800,000
Other charitable contributions (each year): $40,000.
• Deduction up to $120k in year of donation (30% of $400K
income)
• Further $120k/year for next five years
• $40k of other contributions is used against the cap before
the easement contribution is considered
• $80k worth of gift attributable to the easement donation
will be deductible in each year, resulting in only $480k
(60%) of the $800k gift being deductible under current law.
ACTUAL SAVINGS: DIFFERENCE
BETWEEN TAX SAVINGS AND TAX
DEDUCTIONS
The amount of deduction is obviously not the same as the
amount of tax savings, as in the case of a tax credit. Consider
Taxpayer A, an unmarried individual donating an easement
on property held for less than one year (assume basis is same
as value)
•
•
•
•
Adjusted gross income: $400,000
Land value without easement: $2,000,000
Land value with easement: $1,200,000
Amount of gift: $800,000
Deduction allowed of $200,000, in the year of donation and in
succeeding years (full gift used up in 4 total years)…
ACTUAL SAVINGS: TAX SAVINGS VS.
TAX DEDUCTIONS
Federal tax rates for 2014
• 10% on taxable income from $0 to $9,075, plus
• 15% on taxable income over $9,075 to $36,900, plus
• 25% on taxable income over $36,900 to $89,350, plus
• 28% on taxable income over $89,350 to $186,350, plus
• 33% on taxable income over $186,350 to $405,100, plus
• 35% on taxable income over $405,100 to $406,750, plus
• 39.6% on taxable income over $406,750.
Montana income tax rates for 2014:
$620 tax on the first $16,700, plus 6.90% on remaining income.
ACTUAL SAVINGS: TAX SAVINGS VS.
TAX DEDUCTIONS
WITHOUT the donation of the easement, Taxpayer A will pay tax
on his full $400k of income in 2014: $115,858.25 in federal income
tax and $27,067.70 in state income tax, for an overall effective
tax burden of $142,925.95 (an effective rate of 35.7%).
WITH donation of easement: Taxpayer A’s taxable income is
reduced from $400k to $200k. Taxpayer A will owe $49,858.25 in
federal income tax, $13,267.70 in state income tax, and
$63,125.95 overall (an effective rate of 15.8%).
The actual tax savings in year 1 is $79,800 for the 200K deduction.
Future years’ tax savings may differ due to changes in tax rates,
income, other charitable contributions, etc.
ACTUAL SAVINGS: VALUE
REPLACEMENT
While many easement donations may never recover the “full value”
of the easement, this omits consideration of what the saved money
could be doing in the meantime.
Example:
Taxpayer E (H&W) donate an easement worth $10M. Their annual
income is $600k. Under enhanced incentives, over the life of the
easement they can deduct $300k annually over the next 16 years for
a total deduction of $4.8M (less than half the value of the
easement) and total tax savings of ~1.6M at a 33% effective tax
rate.
However, each year they will have an extra ~$100k of tax savings in
their pockets. Assuming that they invest this savings at a 5% rate of
return, 16 years later they will have over $2.8M as a result of their
annual investment of the $100k in tax savings. At a 8% rate of return,
this balloons to $3.8M.
BARGAIN SALES
Example:
Taxpayer D agrees to accept $1.5M for an easement
that reduces the value of the family ranch (long-term
capital gain property) from $12M to $5M.
The easement thus has a value of $7M.
The uncompensated $5.5M ($7M-$1.5M) is treated as
a gift.
Taxpayer D’s annual income, not including the
amount from the bargain sale, is $350,000. (Less than
half of this amount is from the business of
farming/ranching.)
BARGAIN SALE—30% LIMITATION
In year 1, Taxpayer D has income of $1,850,000 ($1.5M from
the bargain sale and $350k annual income). He may
deduct up to $555k (30% of contribution base).
In years 2-6, Taxpayer D may deduct up to $105k.
Total deductions: $1,080,000 (~20% of easement value).
Total value recovered, assuming an effective 35% tax rate:
$378k tax savings + $1.5M from sale = $1.878M, or 34% of
easement value.
(A pure donation would result in only ~4% of easement
value recovered: 35% of a deduction of $105k annually for
6 years).
BARGAIN SALE—
ENHANCED INCENTIVES
Year 1 deduction = 50% of 1.85M, or $925k.
Years 2-16 deduction = $175k.
Total deductions: $3.55M (~65% of easement value).
Total value: $1.24M tax savings + $1.5M from sale = $2.74M,
or ~50% of easement value.
(Pure donation: ~18% of easement value recovered).
If the bargain sale payment and all tax savings are
invested throughout the life of the deduction at an 8% rate
of return, in year 16 the total value of these investments will
be ~$8.6M, or over 150% of the value of the gift!
C CORPORATIONS
C corporations are subject to a 10% annual limitation on
their taxable income, unless they are qualified farming and
ranching corporations. Taxable income is smaller than
adjusted gross income because it is reduced by all
deductions.
Corporation C has an adjusted gross income of $2M and a
taxable income of $1.5M, and donates a conservation
easement reducing the value of land it owns from $10M to
$5M. It may deduct up to $150k (10% × $1.5M) in the year
of the donation and in the following 5 years, for a total
deduction of $900k (18% of gift).
S CORPORATIONS
• As with partnerships and LLC’s, charitable contributions
are “passed through” to shareholders in proportion to
their ownership interests.
• Under existing law, deductions for contributions made by
the corporation will only pass through to shareholders to
the extent of their basis in their stock in the corporation.
• Under enhanced incentives, deductions are no longer
limited to basis in stock and S corporation shareholders
may deduct their proportionate share of the
corporation’s contribution (like partnership or LLC interest
holders). Shareholders’ basis in stock is reduced by the
shareholder’s proportionate share of corporation’s basis
in the easement.
• Each individual must independently qualify for qualified
farmer/rancher status.
SIMPLIFIED EXAMPLE: S CORP—”FIX” IN
PLACE
Corporation S is owned in
equal shares by Taxpayers W,
X, Y and Z. It donates an
easement reducing the value
of land it owns from $4M to
$2M. The corporation’s basis in
the land is $2M (basis in the
easement is thus $1M). W has
a basis in stock of $100k. Each
of the other shareholders have
a basis in their stock of $400k.
Each of X, Y and Z are entitled
to $500k of deduction (1/4th of
the total $2M contribution);
bases in stock are reduced
from $400k to $150k.
W reduces his basis in the stock
to 0, and may not (yet) take
the full deduction because his
basis in stock is exceeded by
his share of the basis in the
donated easement. He is
entitled to deduct his full
amount of the “gain” portion
of the easement, or $250k
(1/4th of the total $1M of the
donation attributable to gain),
but may only take $100k (his
basis) of the remaining $250k
attributable to the basis portion
of the easement (1/4th of $1M
of the basis portion of the
donation.)
SIMPLIFIED EXAMPLE: S CORP—”FIX”
NOT IN PLACE (CURRENT LAW)
Facts
Application
Corporation S is owned in
equal shares by Taxpayers
W, X, Y and Z. It donates an
easement reducing the
value of land it owns from
$4M to $2M. The
corporation’s basis in the
land is $2M (basis in the
easement is thus $1M). W
has a basis in stock of $100k.
Each of the other
shareholders have a basis in
their stock of $400k.
Instead of the full $500k, X, Y
and Z are only able to
deduct up to their basis in
stock: $400k. W is limited to
a $100k deduction.
Each owner’s basis in their
stock is reduced to 0 after
taking these deductions. If
their bases rise in the next
five years, the deduction
may be taken.
ESTATE TAX BENEFITS: IRC § 2055
Makes clear* that for purposes of estate tax
calculations, property encumbered by an easement is
counted at its restricted value.
• Regardless of whether the decedent was the
original grantor.
• Also regardless of whether the original donation
qualified for a federal income tax deduction at the
time it was made.
ESTATE TAX BENEFITS: EXAMPLE OF
LAND WITHOUT CONSERVATION
EASEMENT
H&W own a beautiful parcel of land between them, worth $15M,
using bypass trusts. They have other assets of $2.5M.
Total assets: $17.5M.
Estate Tax Consequences:
If H dies first, his taxable estate will include $7.5M (his share of the
land); the other assets pass tax-free to W under the marital
deduction.
40% estate tax will be due on the $2.16M not excluded by the
$5.34M exclusion: $864k.
W’s taxable estate then includes $7.5M (her share of the land) and
the remaining other assets less the estate tax already paid ($2.5M$864k = $1.636M), for a total of $9,136,000; she will owe 40% tax on
this amount less the $5.34M exclusion, for a total tax bill of $1,518,400
(40% × ($9.136M-$5.34M)).
Total estate tax paid by H&W: $2,382,400.
ESTATE TAX BENEFITS: EXAMPLE OF
LAND WITH CONSERVATION
EASEMENT
Assume the same facts as the previous example, except that during their
lives, H&W have the wonderful idea to donate a conservation easement
that reduces the value of their land from $15M to $7.5M.
Estate Tax Consequences—Easement donation
H dies first and has a taxable estate of $3.75M (half of the restricted value of
the land); the other assets pass to W free of tax under the marital deduction.
All is sheltered by his $5.34M exclusion.
W dies second and has a taxable estate of $3.75M plus the other assets of
$2.5M, for a total of $6.25M; she will owe tax of 40% on (6.25M-5.34M), for a
tax bill of $364k.
To avoid tax entirely, H could avoid the marital deduction by passing ~$1M
of other assets directly to children at his death, thereby obtaining a taxable
estate of $4.75M (still less than the $5.34M exclusion); W’s estate would then
fall under the $5.34M cap as well at $5.25M).
ESTATE TAX BENEFITS: IRC § 2031(C)
An additional exclusion is allowed by 2031(c) of 40% of the
restricted value of the land, up to $500,000. A number of
requirements make this provision difficult to take
advantage of:
• Ambiguous restriction on commercial recreational
activity
• Land must be owned by decedent or family member for
previous 3 years
• Easement must have been donated by decedent or
family member
• Historic preservation easements do not qualify
• Unclear relationship with a § 2032A election
2031(C): EXAMPLE
Taxpayer Q donates a conservation easement that reduces the
value of her land from $2M to $1.5M (the land is in a remote area
and is not subject to any development pressures). An additional
$200k worth of buildings are not counted for purposes of
determining value under the subsection. She meets all 2031(c)
requirements.
Q would be entitled to a further exclusion of 40% of $1.5M, or
$500k, whichever is lower (and here that is $500k as 40% of $1.5M
is $600k); however, because the value of the easement is less
than 30% of the unrestricted value of the land (it is only 25%), the
40% figure is reduced by 2 percentage points for each of the 5
percentage points by which 25% is less than 30%, leading to an
applicable exclusion percentage of 30%.
Q is therefore entitled to a $450k exclusion: 30% of $1.5M.
QUALIFIED PERSONAL RESIDENCE
TRUSTS
Can a conservation easement-encumbered property
be placed into a QPRT?
• Only property “reasonably appropriate for
residential purposes” may be placed into a QPRT.
(Treasury regulations state a 200-acre farm cannot
be placed into a QPRT as it exceeds this definition
of qualifying property).
• If residential area of property is excluded entirely
from the easement, QPRTs may be an available
tool.
• Size of what is an appropriate “residential area” will
be determined by facts and circumstances.
CONTACT INFORMATION
Christian Dietrich
Hughes, Kellner, Sullivan & Alke, PLLP
40 West Lawrence, Suite A
P.O. Box 1166
Helena, MT 59624-1166
(406) 442-3690
Or email me at: [email protected]