The IRS Ups the Ante of Lucrative Conservation Easements

January 25, 2017

Conservation easements have long been tax-advantaged vehicles for taxpayers to permanently commit environmentally significant parcels of property to a conservation program in exchange for a tax benefit in the year of commitment. The original intent of the conservation easement was to allow individual taxpayers to receive some monetary benefit for not subdividing or otherwise developing their property in an attempt to preserve natural spaces and beauty. 

Soon after the debut of these programs, many companies have appeared on the conservation scene working with teams of buyers and appraisers to package and sell conservation easements in masse. These syndicated groups have been known to purchase properties in somewhat poor condition, receive lofty appraisals based on "highest and best use" scenarios that may not be financially or practically feasible, and sell the property off to investors with the promise of net cash gains after the tax deductions come through. 

In markets where building a multi-faceted development of high-rise condos and shopping centers would not pay off to the original syndicates, selling conservation easements is often one of the best ways for groups to profit on larger parcels of land they already have "in stock." The key to selling these properties to outside investors lies in making it profitable for the investor to get involved in the first place. Considering the highest individual tax bracket of 39.6%, investing in a property would require an appraised conservation value of 2.52 times the cost to investors to make high-income taxpayers receive any cash benefit in getting involved in the transaction. 

And so, it is not hard to imagine, that many of these conservation groups are able to find, package, and sell land to investors promising appraised values anywhere from 4-10 times the original investment cost. This allows the conservation syndicates to make a handsome profit on the land by selling it to outside investors, and for the individual investors to make a profit in the same year through tax write-offs. Because the tax deduction is based entirely on the appraised value of the property, it follows human nature that appraisers would gladly overstate the worth of a property to increase their own fees and the amount charged to individual investors. As the conservation easement program became more well known, abuses such as this have become more and more common.

In an effort to combat this, the IRS has issued Notice 2017-10, which requires taxpayers involved in conservation easements to file a new form, Form 8886, to report any conservation easement where the fair value of the donation deduction is more than 2.5 times the cost to the taxpayer. If you recall the 2.52 multiple stated above, it becomes clear that the IRS is increasing reporting requirements for conservation easements where possible charitable intent is overshadowed by immediate financial gain to investors. 

Form 8886 is due for all conservation easements entered into after 12/31/2009, meaning all years from 2010-2016 during which the taxpayer received a conservation easement deduction worth more than 2.5 times their investment must be reported to the IRS by 5/1/2017. 

If you were a part of such an investment during 2010-2016, please let your Beaird Harris advisor know as soon as possible so we can begin preparing these Forms for you. 

Penalties for non-filers are steep: 75% of the tax savings from each unreported transaction, not to be less than $5,000 or more than $100,000 per year for individual filers ($10,000 and $200,000 for trusts, businesses, and other filers).

While reporting requirements have increased for these tax-profitable conservation easements, that does not mean all of these easements are illegal or prohibited. These easements are statutorily permitted under the Internal Revenue Code, and still frequently make financial and ethical sense for many of our clients. 

The keys to watch out for with conservation easements are as follows:

  • A valid conservation purpose must exist (public use, preservation of historically important land/buildings, protection of valuable natural habitat that is threatened by human encroachment, etc.).
  • The conservation must be voluntary and legally binding (A Deed of Conservation Easement must be filed with the courts).
  • The conservation must be permanent and irrevocable.
  • The easement must be held by a qualified easement holder (a government entity or what is called a land trust).
  • The easement must restrict future development of the land to keep it in its pre-conservation state.
  • The easement must be periodically inspected to ensure all of the terms are being kept and no development has occurred.
  • The valuation of the easement must be calculated based on a qualified appraisal. A qualified appraisal must pass stringent requirements in order for the tax deduction to stand during audit:
    • Be prepared no earlier than 60 days before the date of the contribution of the easement to a qualified easement holder
    • Be prepared, signed, and dated by a qualified appraiser (nationally accredited appraiser who is actively practicing and is in good standing with the accrediting organization)
    • Not involve an appraisal fee based on some percentage of the final appraised value of the property
    • Include a myriad of details as defined in §1.170A-13(c)(3)(ii)

Conservation easements are logical, legal tax benefits which are available to all taxpayers in an effort to preserve the beauty of our country. However, they are under scrutiny from the IRS, so it is important to make sure that any easements you get involved with meet the IRS requirements, and that you notify your Beaird Harris advisor of such involvement so we can properly file Form 8886 and make sure you are protected against penalties and fraudulent deals. 

Given the complicated set of requirements surrounding these transactions, if you have questions about the tax implications of conservation easements, please contact Beaird Harris here.