Tax strategies come in all shapes and sizes. Some strategies are simply best practices that every real estate investor should use. Other strategies are hard-hitting and have the potential to save you boatloads of money.
Today I’m going to discuss one such hard-hitting strategy that your tax advisor may not even know about. That strategy is investing in land and placing conservation easements.
What is a land conservation easement?
Easements are used for a multitude of purposes. You may see easements for driveways when a plot of land is inaccessible to the main road. Or you may see easements for fences, wells, parking, etc.
Conservation easements are a bit different. A conservation easement is placed on land by a landowner to achieve certain conservation purposes.
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.
The conservation easement “runs with the land” meaning it applies to current and future owners of the land. A landowner who places a conservation easement on their land will continue to privately own and manage the land but will preserve the land for the stated conservation purpose.
Basically, if a conservation easement is placed on a plot of land, that land cannot be developed now or in the future.
Why would I want to conserve my land and not develop it?
The obvious answer here is that you simply love wildlife so much that you want to preserve it, on your land, forever.
Of course, there are also tax benefits.
When you donate land with a qualifying conservation easement to a qualified land protection organization, you may be eligible for a federal tax deduction equal to the value of your easement donation. The value of your easement donation is the difference between value of the encumbered property at its highest and best use prior to the easement and the value of the property’s highest and best use after the easement. This value is written off on Schedule A as a Charitable Contribution subject to a 60% limit of your Adjusted Gross Income (AGI).
To determine the value of the land before and after the conservation easement takes effect, you must hire a qualified appraiser. A qualified appraiser must “demonstrate verifiable education and experience in valuing the type of property subject to the appraisal.” (PL109-280) Generally, two or three appraisals are required.
But why would Congress allow for a tax deduction for placing a conservation easement on land you own?
Conservation easements encumber the property and, as a result, the property loses value. Yet Congress wanted to encourage the conservation of our great nation’s land. So they incentivize landowners to conserve land and receive a tax deduction as a result.
Show me the tax benefits
As mentioned above, when you place a conservation easement on a property you own (or are a partial owner of), you can receive a tax deduction taken as a charitable contribution on Schedule A. The value of that charitable contribution is the difference between value of the encumbered property at its highest and best use prior to the easement and the value of the property’s highest and best use after the easement.
Let’s look at an example.
If you have land with a fair market value of $1MM, and after you place a conservation easement on the land it is worth only $300k, the value of your conservation easement is $700k. This means that you can take a $700k deduction as a charitable contribution on Schedule A assuming your AGI is high enough to capture the entire deduction (your excess deduction will roll forward).
That’s great if you already own land or have inherited land. But what if you don’t?
Another option is a syndicated land conservation easement. With a syndication, you will be investing alongside other investors in a partnership that will acquire land. The syndication will generally show the investor that several strategies are being analyzed, such as agriculture, development, and conservation.
Investing in a syndicated land conservation easement can yield the investor great tax benefits. Per the IRS, in 2017 the average deduction per dollar invested in syndicated land conservation easements was $4.74. That means if you invest $50k into a syndicated land conservation easement, you could theoretically receive a charitable contribution deduction on Schedule A equal to $273k.
At the highest tax bracket of 37%, a $273k charitable contribution deduction yields $87,690 in tax savings. So, theoretically, your $50,000 investment turned into $87,690 in tax savings.
What are the risks?
There are certainly risks, especially related to syndicated land conservation easements.
For all conservation easements, one of the biggest risks relates to valuation. How you determine the fair market value of the land and the conservation easement is extremely important. The regulations have many requirements and pitfalls related to valuation that need to be carefully dissected by your appraiser and advisor. The IRS has been cracking down on inflated valuations.
Another key risk is to simply understand that you cannot buy and sell federal tax deductions. This risk is prevalent with syndicated land conservation easements that are not structured correctly or have not performed the proper due diligence to prove out that their investors are indeed not just buying a federal tax deduction. In order to avoid “buying” a tax deduction, there must be economic substance to the transaction. If there is no economic reason that an investor would participate in the deal other than to receive a federal tax deduction, then the deal will not have economic substance and the deduction could be disallowed. In order to have economic substance, there must be a real risk of loss and potential for economic upside.
The last risk that pertains to syndications is related to the syndicate’s structure. The IRS is cracking down on syndicates that are not in compliance with the substantial economic effect doctrine which generally requires income and tax benefits to be allocated among partners in the same proportion as the partners’ interest in the syndicate. So, generally speaking, if you own a 5% stake in a syndicate, you need to receive 5% of the pass-through tax benefits.
Lastly, IRS Notice 2017-10 identified syndicated conservation easements as “listed” (tax avoidance) transactions. This designation did not change the actual law governing syndicated conservation easements. However, taxpayers are now required to meet certain disclosure requirements and can be heavily penalized if they fail to do so.
Land conservation easements can be an awesome tax strategy assuming you are in compliance with IRS regulations. We have helped accredited and high net worth clients understand how land conservations easements can benefit and how to access some of these deals.
Land conservation easements are one of our “ace of spades” strategies. It’s a trump card. If you’re interested in learning more, fill out a prospective client form to see if we’re a good fit!