What is a discount for conservation easements?

A permanent restriction on property

A conservation easement is a restriction you make on the use of certain land. This restriction is permanent. You or a member of your family grants this easement to a qualified organization that has been selected as the holder or enforcer of the easement. The purpose of a conservation easement is to protect land that has significant conservation value.

An irrevocable post-mortem election used to minimize potential federal estate taxes

After your death and after the easement has been granted, your personal representative or trustee may elect to take a discount and exclude from your estate a portion of the value of the land on which the easement has been granted. This election is irrevocable. Once made, it cannot be changed. If you are concerned about protecting the environment or keeping land in its natural state, this post-mortem estate planning tool can be a great way to accomplish this and possibly save federal estate tax, too.

Subject to limitations

There are some limitations that are imposed when a discount for conservation easements is elected. For instance, no income tax deduction may be taken with respect to the property if the election is made post-mortem, and the exclusion amount is subject to relatively low limits. Due to such limitations, this election may not be advantageous for everyone, and it is unlikely to benefit the wealthy.

Example(s): Delores owns several acres of undeveloped land on Cape Cod. She has been pressured lately to sell to a group of developers who plan to build another motel and strip mall. Delores wants to keep the property as it is, so the piping plovers and other birds can nest and feed undisturbed. Delores grants an easement to the Audubon Society on the condition that it keeps the property in its natural state forever. Five years later, Delores dies. Since the easement qualifies and all other requirements are satisfied, her executor makes an election and reduces Delores’s estate by the value of the property on which the easement was granted.

What are the advantages?

May save estate taxes

If the easement qualifies and a proper election is made, the value of your estate may be reduced by a portion of the value of the property on which the easement has been granted. The exclusion amount is calculated on the value of the property after the easement has been placed on the property.

Protects the environment

A conservation easement allows you to save property for future generations to enjoy. The holder of the easement will protect the property from being spoiled or used up.

Can be taken in addition to special use valuation

Electing a discount for a qualified conservation easement does not preclude your estate from electing the special use valuation method.

What are the disadvantages?

Transferee receives a carryover basis

The transferee of land subject to a conservation easement that is acquired at death receives a carryover basis (as opposed to the stepped-up basis usually received at death) to the extent that the value of the land is excluded from your taxable estate. This can be a distinct disadvantage if the election creates more income tax than it saves in estate tax.

Example(s): Delores’s estate qualifies for a discount of $80,000. Her estate saves $36,000 in estate tax at a 45 percent rate in 2008. Delores purchased the property for $100,000. Delores leaves the property to her son, Neal, who later sells it for $400,000. Neal has a capital gain of $300,000, which is taxed at 15 percent. Neal pays income tax of $45,000 (assuming no other variables).

No income tax charitable deduction is allowed

If the discount is elected, no income tax charitable deduction may be taken by either your estate or your beneficiaries with respect to the property if the election is made post-mortem. However, if you conveyed the easement during your life and took a charitable income tax deduction, this does not preclude the use of the estate tax exclusion.

The easement must be permanent

The restriction on the use of the property must be granted in perpetuity. Generally, this will decrease the fair market value (FMV) of the property and make it more difficult to sell.

The election is irrevocable

Once made, the election cannot be reversed. So, if some time in the future it is discovered that the election does not make economic sense, it is too late.

What is a qualified conservation easement?

In order to make the election, the easement must be a qualified conservation easement. A qualified conservation easement is a qualified conservation contribution as defined by Internal Revenue Code (IRC) Section 170(h)(1). That is, it is a grant of a qualified real property interest to a qualified organization exclusively for a qualified purpose.

Qualified real property interest

A qualified real property interest means any of the following interests in real property:

• The entire interest (other than a qualified mineral interest)
• A remainder interest, or
• A restriction (granted in perpetuity) on the use that may be made of the real property

Technical Note: A qualified mineral interest means subsurface oil, gas, or other minerals and the right to access such minerals.

Qualified organization

In order to qualify for the exclusion, easements must be granted to either a federal, state, or local government agency or a private charitable organization as defined by IRC Section 501(c) (3) that has the capacity to enforce the terms of the easement. Such an organization need not be an environmental organization. For example, a local educational institution could qualify as long as it is dedicated to the conservation of the features identified in the easement.

Qualified purpose

Conservation purposes are defined by IRC Section 170(h)(4)(A). In general, a conservation purpose must be protected in perpetuity (forever), and it must include the following:

• The preservation of land areas for outdoor recreation by, or for the education of, the general public
• The protection of a relatively natural habitat of fish, wildlife, plants, or similar ecosystem, and
• The preservation of open space (including farmland and forest land) where such preservation is for the scenic enjoyment of the general public, or pursuant to a clear governmental policy, and will yield a significant public benefit

Caution: The preservation of a historically important land area or a certified historic structure does not qualify as a conservation purpose for qualified conservation easement purposes.

Tip: De minimis commercial recreational activity (e.g., granting hunting and fishing licenses) will not cause the property to fail to qualify for the exclusion.

What is required to make the election?

To qualify for the exclusion, all of the following requirements must be met:

• The date of death must be after December 31, 1997
• The property must be a qualified conservation contribution of a qualified real property interest granted by you or, after your death, a member of your family
• The land must be located in the United States or any possession of the United States
• The land must be owned by you (the decedent) or a member of your family at all times during the three-year period ending on the date of your death
• Your personal representative or trustee must make the election on or before the due date for filing your estate tax return (generally, within nine months of your death)
• No income tax deduction can be taken for the grant of the easement if the easement is granted post-mortem

Technical Note: A member of your family, for conservation easement purposes, means your ancestors, your spouse, your lineal descendants, your spouse’s lineal descendants, your parents’ lineal descendants, and the spouses of any such described lineal descendants.

How much can you deduct?

Your executor may elect to exclude from your taxable estate the lesser of (1) 40 percent of the value of any land subject to a qualified conservation easement (that is, the value after the conservation easement has been placed), or (2) the maximum exclusion of $500,000.

In addition, if the value of the conservation easement is less than 30 percent of the value of the land without the easement (and reduced by the value of any retained development rights), then the exclusion percentage (40 percent) must be reduced by two percentage points for every point that falls below 30 percent.

Example(s): Delores dies owning land subject to a qualified conservation easement. Delores did not retain any development rights. The FMV of the property on the date of Delores’s death without the easement is $500,000; with the easement, it is $400,000. The value of the easement is $100,000 ($500,000 – $400,000) or 20 percent of the value of the property without the easement. Thus, the percentage excluded is 20 percent (40 percent reduced by twice the difference between 30 percent and 20 percent). Therefore, the exclusion amount is $80,000 (20 percent of $400,000).

Technical Note: Retained development rights are defined as any rights retained to use the land for any commercial purpose that is not subordinate to and directly supportive of the land as a farm or for farming purposes.

Does debt-financed property qualify?

Debt-financed property is eligible for the discount but only to the extent of the net equity in the property.

How does your personal representative make the election?

The election is made by filling in the correct amount on the estate tax return (Form 706) and completing and attaching Schedule U.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2017.