In our dealings with individuals wanting to use a Land Conservation Easement to lower their taxes, clients and/or their CPA’s/Accountant’s/Advisors will often take it upon themselves to do their own research on Land Conservation Easements. We actually encourage our clients to do so. However, many times they will come back confused about the difference between a Land Conservation Easement and a Historical Preservation Easement. First, there is a significant difference between the terms “conservation” and “preservation”. Typically conservation refers to conserving a natural resource such as land or water. While preservation typically refers to preserving a building, structure, or object.
Obviously, there is similarities in both strategies in terms of benefits, functions, and risk. But, as you will see, there are vast differences.
So let’s start with a definition of both:
· What is a Land Conservation Easement?
o A Land Conservation Easement is a private action taken by a landowner and a qualified land protection organization which recorded at the courthouse which will provide for permanent conservation of the land by restricting development, commercially or otherwise.
o They are considered by the IRS under section 170(h) to be a charitable donation.
o The owner maintains ownership of the land and can be bought or sold, however, it still cannot be commercially developed.
o In order to maintain its preservation status it must satisfy at least two of the IRS’s criteria.
§ Preservation of existing natural environments, views, and/or agricultural uses are most common.
o When one donates a conservation easement that is qualified, they may become eligible for a federal tax deduction equal to the value of their donation in exchange for giving up their right to develop the land.
§ The value of the donation is determined by a qualified appraiser. The calculation is determined by taking current value of the land and subtracting from the value of the land at its “highest and best use”.
· For example the highest and best use of a property could be a commercial complex or residential community.
§ According to legislature pass in December of 2015, one could use this type of federal tax deduction to deduct up to 50% of their Adjusted Gross Income and lower their tax burden.
· Residents in states that allow for itemized deductions could also see additional benefits at the state tax level.
o Often times and owner fully use the tax benefits because they are so great. Therefore, the owner of qualified conservation easement could also choose to share their benefits by raising capital from accredited investors allowing them to become a partner in the benefit of using the tax deduction the same way the owner does.
o Risks
§ The primary risk comes down to the appraisal.
· The appraiser should be a highly skilled and qualified appraiser that if needed, could defend his appraisal in federal proceedings.
· The IRS has seen abuses of this tax provision that compromise the policy Congress intended to promote. We have seen taxpayers, often encouraged by promoters and armed with questionable appraisals, take inappropriately large deductions for easements.
· It is of great importance that the appraisals are done conservatively in a way that can be defended in the case of an audit.
§ It must be a legitimate Conservation Easement. Meaning that the land must have something worth conserving.
· Under no circumstance must the charity or owners be allowed to modify the easement or develop the land in a manner inconsistent with the easement’s restrictions.
§ If you decide to partner into a Land Conservation Easement, be sure that it is done correctly with a team experienced in the formation, documentation, and valuation of these types of projects.
o Financial Calculation
§ Current Land Value $1,000,000 vs. “Highest and Best Use” Value $5,000,000 = Deduction Value $4,000,000
§ Based on this calculation, if an accredited investor bought into a Land Conservation Easement partnership he/she could see a $4 deduction for every $1 invested. Example: $100,000 invested = $400,000 deduction
· What is a Historical Preservation Easement?
o A Historical Preservation Easement is a historic property/building that must be designated by the National Registry of Historic Places in order to permanently protect it against demolition and/or neglect by future owners is through a preservation easement.
§ The owner of the building must agree both to maintain its historical significance, within the areas of architecture, archaeology, engineering, culture or history, and that they retain the historic designs, materials, workmanship and sense of time and place.
§ Like the Land Conservation Easement, even if the property is sold and passed on to heirs, it still must maintain its historical significance.
o A historical property may still be income-producing. This means that the building can still be leased out per its zoning allowance.
§ For example, the building can be multi-purposed and leased out to tenants both for business or residential or both depending on how the property is zoned.
o Like the Land Conservation Easement, there could be significant tax benefits to a Historical Preservation Easement exchange for donating the building to charity and giving up the right to fully renovate the building façade and all. Typically not as large a deduction, however, when combined with the possibility of income production from leasing out the property, the financial benefit can even out.
§ The IRS definition of historically important land areas includes:
· Independently significant land areas, including any related historic resources that meet National Register Criteria for Evaluation.
· Land areas within registered historic districts, including buildings that contribute to the significance of the historic district.
· Land areas adjacent to a property individually listed in the National Register of Historic Places (but not within a historic district) where physical or environmental features of the land area contribute to the historic or cultural integrity of the historic property.
o Also, like the Land Conservation Easement, one could share the financial and tax benefits of the Historical Preservation Easement by partnering with accredited investors who wish to partake in the benefits of participating in such a project.
o Risk
§ As with the Land Conservation Easement. The appraisal is very important.
· Must also be done by a highly skilled and qualified appraiser.
§ If the facade of a building was already subject to building restrictions under local zoning ordinances, the taxpayers may, in fact, be giving up nothing, or very little. A taxpayer cannot give up a right that he or she does not have and therefore could be subject to back pay and penalties.
§ If not done correctly a building can lose its historical significance, thus voiding many of the financial benefits. This is why a strong easement is very important.
§ There are a lot more hoops to jump through, so it is of the up-most importance to have a great team of experienced advocates to work with in designing these projects.
o Financial Calculation
§ Current Building Value $1,000,000 vs. Renovated Value $4,000,000 = Charitable Deduction $3,000,000 plus income from leasing out the property
§ Based on this calculation, if an accredited investor bought into a Historic Preservation Easement partnership he/she could see a $3 deduction for every $1 invested. Example $100,000 invested = $300,000 deduction, plus a share in any income production.
While both of the strategies for Conservation and Preservation are great ways to protect our lands and history. The Historical Preservation Partnership has been a little more scrutinized, however, with proper documentation and careful planning either of these could be a great benefit with the Land Conservation Easement partnerships providing more upfront value versus the Historic Preservation Easement partnerships providing more back-end value.
It goes without saying, but be sure to discuss this with your tax advisor before participating in either investment.