Charitable Contributions of Conservation Easements
Know the rules for deductions for qualified conservation contributions of property.
November 21, 2011
Charitable contributions of conservation easements allow taxpayers to obtain a federal tax benefit while helping to conserve land for public use or enjoyment or to preserve a historic structure. Through the use of these easements, ownership of land or a historic building is kept in private hands but with restrictions on its use. The easement creates a discounted value for the property that provides a charitable contribution tax deduction and tax savings for the owner of these properties, while the public benefits from the conservation objectives.
Taxpayers can take a charitable deduction for qualified conservation contributions, which are contributions of a qualified real property interest to a qualified organization exclusively for conservation purposes (IRC § 170(h)(1)). A qualified real property interest for this purpose can be the taxpayer’s entire interest in the property, a remainder interest or an easement that restricts the use of the property in perpetuity. Conservation purposes under IRC § 170(h)(4)(A) are (1) preserving land for outdoor recreational use by or education of, the general public; (2) protecting relatively natural habitats of fish, wildlife or plants; (3) preserving open space (including farmland or forest space) for scenic enjoyment of the general public or under a governmental conservation policy yielding significant public benefit; and (4) preserving a historically important land area or a certified historic structure.
From 2003 through 2007 approximately 3,000 tax returns per year contained a charitable deduction for donation of a qualified conservation contribution. During this time and since, the Internal Revenue Service (IRS) has continued to scrutinize deductions for contributions of conservation easements, often challenging them on issues including the quality of the appraiser and/or appraisal, the appraisal technique employed, failure to comply with substantiation requirements or protection of the conservation purpose. Tax practitioners need to be aware of the rules and procedures to successfully support these transactions and their tax treatment. They must be able to select a qualified appraiser and assess an appraisal for compliance with procedural and substantiation requirements. Then they must be able to structure and document these transactions appropriately and correctly calculate the deduction.
History and Rationale for a Tax Deduction
Congress intended a tax deduction for donation of a conservation easement because property thus encumbered has certain limitations, added costs and loss of market value. In the case of historic easements, donors generally face restrictions and perhaps higher scrutiny by a historic trust or other donee organization for the owners’ use of and improvements to buildings subject to an easement and thus higher costs. Also, if a building is damaged or destroyed, the cost to restore it to its original form is higher than that of a normal building. For these reasons, Congress considered a tax deduction appropriate to offset the added maintenance and insurance costs as well as to compensate for the loss of fair market value of the building. Contributions of land easements usually entail significant use restrictions, diminishing the property’s potential commercial value. Typically, courts have allowed a deduction for 10 percent to 15 percent of the value of the property.
However, the IRS has historically held these deductions to have a high potential for abuse and has scrutinized them accordingly. In Notice 2004-41, the IRS announced its intention to disallow improper deductions of contributions of conservation easements and to review “promotions of transactions involving these improper deductions.” The IRS has been especially suspicious of transactions where a historic building is already subject to local ordinances that restrict the owner’s ability to modify the building. For open-space easements, the Service is especially attuned to donations where it considers the resulting public benefit less than significant. Practitioners, appraisers and the qualifying organizations promoting and facilitating these transactions need to be aware of the rules and procedures they must follow to successfully support these transactions.
Historic easements. Congressional interest in preserving our historical architectural heritage led to the Federal Historic Preservation Tax Incentives Program, passed in 1976. This program has allowed owners of historic buildings a means to preserve the architectural integrity of the exterior of historic buildings by giving them the ability to contribute a facade conservation easement to a historic trust. Facade easements are a common form of a historic conservation easement designed to protect and maintain the historic character of a building’s exterior.
By using a facade easement, the owner of the building agrees to never change the exterior of the building and in return receives a charitable contribution deduction equal to the fair market value of the easement. Once the easement is in place, the owner of the building generally must obtain approval from the historic trust to make any changes to the exterior of the building.
The charitable contribution deduction for facade easements is uncommon in occurrence but significant in amount. There were 1,132 claimed facade easement donation deductions in 2005, averaging $271,629 each; and 1,145 in 2006, averaging $231,167 each. In 2007 there were 242, but the average was $918,392. In 2008, there were 1,396, but their average amount dropped to $27,423 (“Individual Noncash Contributions,” IRS Statistics of Income Bulletin, Spring 2008, Summer 2009, Spring 2010 and Winter 2011.). Although these façade easement donations accounted for less than 0.05 percent of the total number of noncash charitable contributions in each of these years, the charitable contribution deduction per return was substantial.
This article has been excerpted from the Journal of Accountancy. View the full article here.