© C. Timothy Lindstrom 20111 2011 Wyoming Conservation Easement Conference Income Tax Benefits and...

© C. Timothy Lindstrom 2011 1

2011 Wyoming Conservation Easement Conference

Income Tax Benefits and Requirements

Estate Taxes and Planning OpportunitiesUsing Conservation Easements

June 2, 2011

c. timothy lindstrom, esq.p.o. box 7622, jackson, wy 83002

[email protected]


IRS Activity

• Currently 344 easement audits open; including 84 in CO

• 2005-2009 Closed audits on 1,115 easement cases; including 418 in CO

• 3,500 to 4,000 easement contributions per year

• Chances of audit +/- 5% based on foregoing (outside of CO)

• Fifteen judicial decisions regarding easement tax compliance since 2005

Land Trust Alliance (2010)


IRS Scorecard (twelve out of fifteen)Glass v. C.I.R. 124 T.C. 258 (2005) LostTurner v. C.I.R. 126 T.C. 299 (2006) WonGoldsby v. C.I.R. T.C. Memo. 2006-274 (2006) WonBruzewicz v. U.S. 604 F.Supp.2d 1197 (2009) WonHughes v. C.I.R. T.C. Memo. 2009-94 (2009) WonKiva Dunes v. C.I.R. T.C. Memo. 2009-145 (2009) LostHerman v. C.I.R. T.C. Memo. 2009-205 (2009) WonSimmons v. C.I.R. T.C. Memo. 2009-208 (2009) Won

Lord v. C.I.R. T.C. Memo. 2010-196 (2010) Won Klauer v. C.I.R. T.C. Memo 2010-65 (2010) LostKaufman v. C.I.R. 134 T.C. 6 (2010) WonTrout Ranch v. C.I.R. T.C. Memo 2010-283 (2010) WonSchrimsher v. C.I.R. T.C. Memo 2011-71 (2011) Won1982 East, LLC V. C.I.R. T.C. Memo 2011-84 (2011) WonBoltar v. C.I.R. 136 T.C. No. 14 (2011) Won


To be deductible conservation easements must comply with:

• Internal Revenue Code section 170(h)

• Treasury Regulations section 1.170A-14

• Wyoming Uniform Conservation Easement Act:

W.S. Sections 34-1-201 through 34-1-207


The “Partial Interest Rule”

A deduction under section 170 is generally not allowed for a charitable contribution of any interest in property that consists of less than the donor's entire interest in the property. . .

Regulations section 1.170A-14(a); txt 15-16, 23-24, 77


Exceptions to the Partial Interest Rule

Certain gifts in trust

Remainder interest in personal residence or farm

All of the donor’s undivided interest in property

A “Qualified conservation contribution”

“. . . a deduction may be allowed under section 170(f)(3)(B)(iii) for the value of a qualified conservation contribution if the requirements of this section are met.”

Regulations section 1.170A-14(a); txt 15-16, 23-24, 77


Qualified Conservation Contributions

• Contribution (includes “bargain sales”) of:

• A qualified real property interest

• To a qualified organization

• Exclusively for conservation purposes

• In perpetuity

Regulations section 1.170A-14(a); txt chapter 3


Qualified Real Property Interests

-- The entire interest of the donor other than a “qualified mineral interest”

A qualified mineral interest is the donor's interest in subsurface oil, gas, or other minerals and the right of access to such minerals.

Regulations section 1.170A-14(b)(1)

-- A remainder interest in a farm or personal residence

Code section 170(h)(2)(B) [not found in Regulations]

-- A “perpetual conservation restriction”

Regulations section 1.170A-14(b)(2); txt 25-28


Perpetual Conservation Restriction

• A restriction, in perpetuity, on use of real property including an easement or other interest in real property that under state law has attributes similar to an easement (e.g., a restrictive covenant or equitable servitude)

Regulations section 1.170A-14(b)(2)


Importance of State Law

• State real property law governs the creation, modification and termination of conservation easements; therefore:

• Failure to create a perpetual restriction on the use of real property under state law may disqualify easement for federal tax benefits.

Conservation easements are “easements in gross” because they do not benefit any specific property (i.e. they are not “appurtenant”)

Generally, under common law, easements in gross were unenforceable. Enabling legislation has been enacted in 49 states recognizing conservation easements and pre-empting common law.

• All states except North Dakota have enacted some form of authority for the creation and enforcement of perpetual conservation easements.


Qualified Conservation Contributions





• In perpetuity

Regulations section 1.170A-14(a)


Qualified Organizations

• Qualified Organizations include:

• Publicly supported tax-exempt organizations recognized by the IRS under Code sections 501(c)(3) and 170(b)(1)(A)(vi) (“land trusts”)

• Public agencies

• Governmentally-affiliated organizations

Regulations section 1.170A-14(c)(1); txt 28-34

• Transfers must be limited to “qualified organizations” agreeing to carry out the conservation purposes of the easement.

Regulations section 1.170A-14(c)(2); txt 39


Qualified Organizations (cont.)

• A “qualified organization” must have

• a commitment to protect the conservation purposes of the donation, and

• the resources to enforce the restrictions.

Regulations section 1.170A-14(c)(1); txt 34-35; 37-38

• LTA Standards and Practices

• Accreditation

Txt 38

• Land Trust Alliance: www.lta.org


Qualified Conservation Contribution





• In perpetuity

Regulations sections 1.170A-14(d)(1) – (5); txt 39-60


Qualified Conservation Purposes:

1. Public Recreation/ Education

2. Protection of significant, relatively natural

habitat for plants or animals

3. Protection of historic structures or land areas



Qualified Conservation Purposes (cont.):

4.Protection of open space

a. For scenic purposes and/ or

b. Pursuant to a clearly delineated governmental conservation policy

c. Resulting in a significant public benefit



Two types of inconsistent use prohibitions

• Inconsistent Use prohibition applicable to “open space” easements:

• “A deduction will not be allowed for the preservation of open space under section 170(h)(4)(A)(iii), if the terms of the easement permit a degree of intrusion or future development that would interfere with the essential scenic quality of the land or with the governmental conservation policy that is being furthered by the donation.”

Regulations section 1.170A-14(d)(4)(v) (emphasis added); txt 74-76


General inconsistent use prohibition

• Inconsistent use. Except as provided in paragraph (e)(4) of this section, a deduction will not be allowed if the contribution would accomplish one of the enumerated conservation purposes but would permit destruction of other significant conservation interests. However, this requirement is not intended to prohibit uses of the property, such as selective timber harvesting or selective farming if, under the circumstances, those uses do not impair significant conservation interests.

Regulations sections 1.170A-14(e)(2) and (3)(emphasis added); txt 71-74


Inconsistent Uses (cont.)

• Example, the preservation of farmland pursuant to a State program for flood prevention and control would not qualify under paragraph (d)(4) of this section if under the terms of the contribution a significant naturally occurring ecosystem could be injured or destroyed by the use of pesticides in the operation of the farm.

Regulations sections 1.170A-14(e)(2)


Sample inconsistent use provision

• The “Conservation Purposes” of this Easement are (i) to preserve the Conservation Values, and other significant conservation interests (to the extent that it is not necessary to impair such other interests in order to protect the Conservation Values), and (ii) to restrict the use of the Property to those uses that are consistent with

such values and interests.


Sample Inconsistent Use Provision 2

Reserved Uses:

The following uses, properly undertaken, are consistent with the Conservation Purposes, and are reserved by the Grantor, subject to the condition that such uses are undertaken in a manner that is consistent with the Conservation Purposes:


Qualified Conservation Contribution

The Contribution (includes “bargain sales”) of:




• In perpetuity

Regulations section 1.170A-14(a); txt 61-71


Perpetuity

• Amendment and Termination (txt 64-70)

• Contract vs. Charitable Trust (txt 4, 64, 89-90)

“§ 2. Creation, Conveyance, Acceptance and

Duration.

(a) Except as otherwise provided in this Act, a conservation easement may be created, conveyed, recorded, assigned, released, modified, terminated, or otherwise altered or affected in the same manner as other easements.” [Emphasis added.]

Uniform Conservation Easement Act §2(a) (txt Appendix C)


“because conservation easements are conveyed to governmental bodies and charitable organizations to be held and enforced for a specific public or charitable purpose -- i.e., the protection of the land encumbered by the easement for one or more conservation or preservation purposes -- the existing case and statute law of adopting states as it relates to the enforcement of charitable trusts should apply to conservation easements.”

Uniform Conservation Easement Act comment to §3 (emphasis added)


Wyoming Uniform Conservation Easement Act§ 34-1-202. Creation; conveyance; acceptance and duration

(a) Except as otherwise provided in this article, a conservation easement may be created, conveyed, recorded, assigned, released, modified, terminated or otherwise altered or affected in the same manner as other easements. The provisions of W.S. 34-1-141 [governing description of easement location] shall apply to this article. [Emphasis added.]

§ 34-1-203. Judicial action; modification; termination

(a) An action affecting a conservation easement may be brought by:

(i) An owner of an interest in the real property burdened by the conservation easement;

(ii) A holder of the conservation easement;

(iii) A person having third-party rights of enforcement, as named in the instrument creating the conservation easement.

(b) This article shall not affect the power of a court to modify or terminate a conservation easement in accordance with the principles of law and equity.


Wyoming Law Regarding Charitable Trusts

• In the absence of special provisions in the trust instrument, the trustees have no power of their own motion to decide that it has become impossible or inexpedient to carry out the trust as originally planned and then to substitute another scheme. If the trustees feel that an emergency of this type has arisen, they should bring the situation to the attention of the court and ask for instructions. [Emphasis added].

• Town of Cody v. Buffalo Bill Memorial Association, 196 P.2d 369 (Wyo. 1948) [quoting 2 Bogert, Trusts and Trustees § 435]


Charitable Trust Doctrine -- Conservation Easements

A conservation easement may only be amended or terminated if:

1. Such a power is expressly reserved in the easement itself;

2. a court applies the doctrine of “administrative deviation” to alter a provision that would defeat or substantially impair the conservation purposes of the easement; or


Charitable Trust Doctrine -- Conservation Easements (cont.)

3. the charitable purpose of the easement is impossible to accomplish due to changed circumstances and a court, through the doctrine of cy pres authorizes a revision or termination.

Paraphrasing Nancy A. McLaughlin, Rethinking the Perpetual Nature of Conservation Easements, 29 Harv. Int’l L.J. 421, 435–436 (2005)


Federal Requirements Pertaining to Amendment and Termination

None of the assets of a land trust may “inure” to the benefit of any “disqualified person” (“excess benefit transactions”).

Internal Revenue Code section 501(c)(3); txt 65-66

-- A disqualified person is anyone in a period beginning five years before a transaction in a position to exert “substantial influence.”

-- Board members, staff, “substantial contributors” more than 2% of the land trust’s annual receipts, or $5,000, whichever is greater (may include easement value).


Federal Requirements Pertaining to Amendment and Termination (cont.)

Consequences:

-- Excise tax of 25% plus repayment of benefit

-- Up to $10,000 penalty on land trust managers

-- Loss of exempt status

Regulations section 53.4958-7; txt 65-66


Federal Requirements Pertaining to Amendment and Termination (cont.)

• A land trust’s assets must be used “exclusively” for charitable purposes

Internal Revenue Code section 501(c)(3); txt 66-67

• A land trust must have a “commitment to protect the conservation purposes of the contribution.

Internal Revenue Code section 170(h)(3); txt 67-68


Other Regulatory Requirements:

• Documentation (available prior to grant) (txt 83-85) • Donee's right to inspection (txt 86)

• Donee’s right “to enforce the conservation restrictions by appropriate legal proceedings, including but not limited to, the right to require the restoration of the property to its condition at the time of the donation.” (txt 86-88)

• Landowner must give notice before exercising any reserved rights that may impair the conservation interests protected by the easement. (txt 85)

Regulations sections 1.170A-14(g)(5)(i) and (ii)


Other Regulatory Requirements (con’t.)• Mortgages must be subordinated

Regulations section 1.170A-14(g)(2); txt 70-71

• Payment of proceeds in event of of extinguishment

“. . .when a change in conditions give rise to the extinguishment of a perpetual conservation restriction under paragraph (g)(6)(i) of this section, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction. . .”

Regulations section 1.170A-14(g)(6)(ii); txt 91-99


Mortgage Subordination Requirement

Kaufman v. Commissioner, 134 T.C. 6 (4/26/10); 1982 East, LLC v. Commissioner, T.C. Memo 2011-84 (4/12/11) rule that conditional subordinations are not acceptable.

Lender “shall have a prior claim to all insurance proceeds as a result of any casualty, hazard or accident occurring to or about the Property and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged, notwithstanding that the Mortgage is subordinate in priority to the Agreement.”

What about other matters of title that could pre-empt a conservation easement, e.g. covenants with reversionary provisions?


Acceptable Subordination Forms• [Name and address of financial institution] (“Mortgagee”), present

holder of a mortgage from, [donors] (“Mortgagor”), recorded on [date] in the [County] Registry of Deeds in Deed Book [ ] Page [ ], for consideration paid, hereby recognizes and assents to the terms and provisions of a Conservation Restriction running to the Conservation Trust, to be recorded herewith, and agrees to subordinate and hold its mortgage subject to the terms and provisions of said Conservation Restriction to the same extent as if said mortgage had been recorded subsequent to the recording of the Conservation Restriction, and the undersigned shall, in the exercise of its rights pursuant to said instrument, recognize the terms and provisions of the aforesaid Conservation Restriction. Compact of Cape Cod Conservation Trusts Form

• The Lender hereby consents to the terms and intent of this Easement, and agrees that the lien represented by said Deed of Trust shall be held subject-to this Easement and joins in this Deed to reflect its direction to the Trustee to execute this Easement to give-effect to the subordination of such Deed of Trust to this Easement. Virginia Outdoors Foundation Form


Minerals

• Deductible easements must prohibit strip mining

• Other forms of mining and mineral extraction must be “limited” “localized” and “not irremediably destructive of significant conservation values”

Regulations section 1.170A-14(g)(4); txt 25, 77–83


Mineral Issues:

• Gravel pits

• Subsurface minerals

• Severed minerals and easement deductions

• Federal plans for BLM and other federal lands

• “Carve-out” provisions

• “Remoteness letter”

Txt 76-85


Donative Intent

Conservation buyer transactions (txt 123-128)

Quid pro quo transactions (txt 118-119)

Cluster developments (txt 119-120)

Grants requiring easements

Reciprocal contributions (txt 121-122)

Qualified bargain sales (txt 6, 116-117)

Sham (“collapsible”) transactions (txt 18-19)

See U.S. v. American Bar Endowment, 477 U.S. 105, 106 S.Ct. 2426, 91 L.Ed.2d 89 (1986); txt 16-17, 115-116


Income Tax Benefits

Easement Valuation

• Value of land before c.e. $1,000,000

• Value of land after c.e. (700,000)

• Difference = c.e. value $ 300,000

Regulations § 1.1170A-14(h)(3)


Calculating the Federal Income Tax Benefit

2011 Maximum benefit:

Before c.e. value of land $1,000,000

After c.e. value of land (700,000)

C.e. value $ 300,000

Maximum federal income tax rate x 0.35

Maximum federal income tax savings $ 105,000


Limitation on deductions:2011

50% of “contribution base” (AGI) if donor’s farm income is less than 50% of all income

Internal Revenue Code §§ 170(b)(1)(E)(i) and 170(b)(1)(E)(vi).

100% of contribution base if donor’s farm income is 50% or more of all income

Internal Revenue Code §§ 170(b)(1)(E)(iv)(I) and 170(b)(1)(E)(vi).

[Note that proceeds from the sale of a conservation easement are not “income from the business of farming”]

2012

30% of contribution base after 12/31/11

Internal Revenue Code §§ 170(b)(1)(C) and 170(b)(1)(E)(vi).


Carrying deductions forward:

2011Unused portions of deduction may be carried forward for fifteen years

Internal Revenue Code §§ 170(b)(1)(E)(ii) and 170(b)(1)(E)(vi).

2012Unused portions of deduction may be carried forward for five years

Internal Revenue Code §§ 170(b)(1)(D)(ii) and 170(b)(1)(E)(vi).

“Phasing” contributions


Calculating the Federal Income Tax Benefit - 2011Assume:

Married filing jointlyDonor income $250,000Other contributions $50,000Other deductions $50,000Conservation easement deduction $500,000

Maximum charitable deduction allowed $125,000 ($500,000 x 50%)

Deduction available $75,000 ($125,000 - $50,000)

Taxable income prior to easement deduction $150,000 ($250,000 – $100,000)

Rate on income between $75,000 and $150,000 ($64,500 @ 25%; $10,500 @ 28%)

Tax savings in first year due to easement: $19,065 (25.42%)

Cumulative savings over 7 years $127,101 (25.42%)


Example of Operation of Current Limitations (2011)

• C.e. value $ 300,000• Donor’s annual income $ 54,000• Annual limitation x 50%• Annual cap on c.e. deduction $ 27,000• Sixteen-year deduction period x 16• Total deduction cap $ 432,000

• Amount of deduction unusable $0.00 (50% level)• Amount of deduction unusable $0.00 (100% level)

Example of Operation of Future Limitations (2012)

• C.e. value $ 300,000• Donor’s annual income $ 54,000• Annual limitation x 30%• Annual cap on c.e. deduction $ 16,200• Six-year deduction period x 6• Total deduction cap $ 97,200

• Amount of deduction unusable $ 202,800


Application of enhanced write-off to fee contributions

Contributions of qualified conservation contributions (i) In general Any qualified conservation contribution (as defined in subsection (h)(1)) shall be allowed to the extent the aggregate of such contributions does not exceed the excess of 50 percent of the taxpayer's contribution base over the amount of all other charitable contributions allowable under this paragraph.

(ii) Carryover If the aggregate amount of contributions described in clause (i) exceeds the limitation of clause (i), such excess shall be treated (in a manner consistent with the rules of subsection (d)(1)) as a charitable contribution to which clause (i) applies in each of the 15 succeeding years in order of time.

Internal Revenue Code §170(b)(1)(E)

(h) Qualified conservation contribution (1) In general For purposes of subsection (f)(3)(B)(iii), the term "qualified conservation contribution" means a contribution- (A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes.

Internal Revenue Code §170(h)(1)


Basis Issues

• Calculating the basis in a conservation easement

• Adjusting the basis of easement land for the grant of an easement

• Enhancement vs. larger parcel affect on basis

• Allocation of adjusted basis in 1031 exchanges


Basis Issues (cont.)Calculating Basis in Conservation Easements

• Needed for completing form 8283

• Needed to determine limitation on first year contributions

• Needed for other basis determinations


Calculating Basis in Conservation Easements (cont.)

• Example:

Appraised highest and best use before easement: $750,000

Appraised highest and best use after easement: $250,000

Easement value: $500,000

Percentage reduction due to easement ($500k/$750k): 67%

Original basis in easement property: $100,000

Basis in easement (67% x $100k): $ 67,000


Basis Issues (cont.)Basis Adjustment for Contribution

Assume:

25% (Percentage of appraised “before” value represented by easement)

$100,000 (Unadjusted basis in easement land)

Basis adjustment: $100,000 – (25% x $100,000) = $75,000

Additional amount subject to gain on sale of easement land: $25,000 ($100,000 - $75,000)

Additional tax if easement land sold: = $3,750 (15% x $25,000)

Regulations §1.170A-14(h)(3)(iii)


Basis Issues (cont.)Like-kind exchange example

• Taxpayer bargain sells conservation easement for $200,000.

• Easement value is $500,000.

• Deduction = $300,000 ($500,000 – $200,000)

• Percentage of easement value = to purchase price 40% ($200,000/$500,000)

• Basis in easement property $50,000.

• Appraised f.m.v. of easement property before easement = $900,000

• % of f.m.v. equal to easement 56% ($500,000/$900,000)

• Basis in easement $28,000 (56% x $50,000)

• Basis carried over to exchange property $11,200 ($28,000 x 40%)


Appraisal Issues

Attorney Client Privilege and Appraisals

Conservation easement appraisal work done by appraiser as consultant to an attorney representing easement donor is not entitled to the attorney client privilege or the work product privilege because (1) the consultant was not communicating about legal matters and (2) the work product was not prepared because of anticipated litigation but rather to satisfy federal requirements for substantiation of the easement donation.

U.S. v. Richey, No. 09-35462, 9th Circuit Court of Appeals, (2011)


Appraisal Issues (cont.)Contiguous (“Larger”) Parcel Rule

“The amount of the deduction in the case of a charitable contribution of a perpetual conservation restriction covering a portion of the contiguous property owned by a donor and the donor's family (as defined in section 267(c)(4)) is the difference between the fair market value of the entire contiguous parcel of property before and after the granting of the restriction.”

Regulations § 1.1170A-14(h)(3)(i)

“The family of an individual shall include only his brothers and sisters (whether by the whole or half blood), spouse, ancestors, and lineal descendants . . .”

Internal Revenue Code §267(c)(4)


Appraisal Issues (cont.)Enhancement Rule

“If the granting of a perpetual conservation restriction after January 14, 1986, has the effect of increasing the value of any other property owned by the donor or a related person, the amount of the deduction for the conservation contribution shall be reduced by the amount of the increase in the value of the other property, whether or not such property is contiguous.”

Internal Revenue Code §267(c)(4)


Appraisal Issues (cont.)Effect of Contiguous Parcel Rule on Basis

Contiguous Parcel (200 acres under easement, 50 acres unrestricted):

Property basis: $200,000

Appraised “before value” including all contiguous property: $750,000

Appraised “after value” including all contiguous property: $200,000


Deduction: $550,000

Reduction in property basis required: 73.3% ($550,000/ $750,000)

Adjusted basis to reflect contribution: $53,340 [$200,000 – (73.3% x $200,000]


Appraisal Issues (cont.)Effect of Enhancement Rule on Basis

Easement Parcel (200 acres)

Enhanced Parcel (50 acres)

Easement Parcel basis: $200,000

Appraised “before value” of Easement Parcel: $750,000

Appraised “after value” of Easement Parcel: $100,000


Value of Enhanced Parcel before easement: $100,000

Value of Enhanced Parcel after easement: $200,000

Deduction: $550,000

Reduction in property basis required: 86.7% ($650,000/ $750,000)

Adjusted basis to reflect contribution: $26,600 [$200,000 – (86.7% x $200,000]


Appraisal Issues (cont.) Comparison

Contiguous Parcel:

Easement value is $550,00Deduction is $550,000Basis adjustment required ($146,600)

Enhancement:

Easement value is $650,00Subtraction for enhancement: $100,000Deduction is $550,000Basis adjustment required ($173,400)


Appraisal Issues (cont.)Use of Percentages

Example:

Before value of easement property determined by comparable analysis: $800,000

Average reduction in value of properties subject to comparable easements: 70%

Diminution factor: 70%

After value of easement property: $240,000 [$800,000 – ($800,000 x 70%)]



Appraisal Issues (cont.)Use of Percentages

Johnston v. C.I.R. T.C. Memo. 1997-475 (allowed)

Strasburg v. C.I.R., T.C. Memo 2000-94 (2000) (rejected)

Nick R. Hughes v. Commissioner, T.C. Memo. 2009-94 (2009) (rejected)

Bruzewicz v. C.I.R. 604 F.Supp.2d 1197 (N.D. Illinois, 2009) (criticized)

Simmons v. C.I.R. T.C. Memo. 2009-208 (2009) (allowed)

Scheidelman v. C.I.R. TC Memo 2010-151 (2010) (criticized)

IRS Chief Counsel Advisory, IRS CCA 2007 38013 (rejected)

Instructions to Form 8283 (rejected)


Issues for Corporations and Other Entities

C corporations

Charitable deductions limited to 10% of “taxable” income

Five-year carry-forward period

No capital gains rate


Issues for Corporations and Other Entities (cont.)

In 2011

100% write-off available for

C corporations if more than 50% of income is from the “business of farming”

and

Stock not listed on any recognized market

Internal Revenue Code §170(b)(2)(i)



S corporations

Charitable deductions pass-through to shareholders pro-rata

Shareholders may deduct no more than their basis in their shares

Shareholders’ unused deductions carry-forward for fifteen years and may be used against 50% of shareholders’ AGI

Internal Revenue Code §1366(d)



In 2011:

Unlimited pass-through for gain portion of easement contribution.

Basis portion of contribution limited to shareholder basis in shares.

Internal Revenue Code §1367(a)(2)


Example of S-corp Pass-through RulesS-corp contributes conservation easement worth $500,000

Two equal shareholders. John holds 25% of the shares with a $10,000 basis; Jane holds 75% of the shares with a $50,000 basis.

S-corp basis in land subject to easement $200,000.

Appraised fair market value of land before easement $1,000,000

Basis in conservation easement $100,000 [($500,000/$1,000,000) x $200,000]

Portion of conservation easement constituting gain $400,000 ($500,000 - $100,000) or 80%

John’s share of easement deduction $125,000 (25% x $500,000)

Jane’s share of easement deduction $375,000 (75% x $500,000)


Example of S-corp Pass-through Rules (cont.)

Portion of John’s share constituting basis $25,000 ($125,000 x 20%)

Portion of John’s share constituting gain $100,000 ($125,000 - $25,000)

Portion of Jane’s share constituting basis $75,000 ($375,000 x 20%)

Portion of Jane’s share constituting gain $300,000 ($375,000 - $75,000)

John’s pass-through in first year $110,000 ($100,000 + $10,000)

Jane’s pass-through in first year $350,000 ($300,000 + $50,000)


Example of S-corp Pass-through Rules (cont.)

• In 2012

– Amount of deduction passing to John is $10,000.

– Amount of deduction passing to Jane is $50,000.

– Balance may be passed through over the next five years provided that John and Jane establish a new basis in their shares.


Issues for Corporations and Other Entities (cont.)Trusts

Grantor trusts – ignored for purposes of taxation; i.e. the owner of the trust is treated as the recipient of all income and deductions (including charitable deductions) of the trust.

Internal Revenue Code §671

To ensure that contribution or bargain sale of a conservation easement by a grantor trust is effective the trust instrument should expressly authorize the trustee to make charitable contributions in general, or contributions of conservation easements in specific.

QPRT Trusts – QPRT trusts are grantor trusts. However, regulations prohibit the distribution of any income or corpus of the trust to or for the benefit of anyone other than the transferor prior to the termination of the trust.

Regulations §25.2702-5(c)(4)

Irrevocable Trusts – Contributions of conservation easements by irrevocable trusts are not deductible by the trust because they are not payments from income, but from corpus and they do not pass through to beneficiaries because they are not owners.

See Goldsby v. C.I.R., T.C. Memo. 2006-274 (2006)


Substantiation Requirements – Acknowledgment Letter

• “General rule No deduction shall be allowed under subsection (a) for any contribution of $250 or more unless the taxpayer substantiates the contribution by a contemporaneous written acknowledgment of the contribution by the donee organization that meets the requirements of subparagraph (B).”

Internal Revenue Code §170(f)(8)(A)

• “Content of acknowledgement: An acknowledgement meets the requirements of this subparagraph if it includes the following information:

“(i) The amount of cash and a description (but not value) of any property other than cash contributed.

“(ii) Whether the donee organization provided any goods or services in consideration, in whole or in part, for any property described in clause (i).

“(iii) A description and good faith estimate of the value of any goods or services referred to in clause (ii) or, if such goods or services consist solely of intangible religious benefits, a statement to that effect. For purposes of this subparagraph, the term "intangible religious benefit" means any intangible religious benefit which is provided by an organization organized exclusively for religious purposes and which generally is not sold in a commercial transaction outside the donative context.”

Internal Revenue Code §170(f)(8)(B)


Substantiation Requirements – Acknowledgment Letter (cont.)

“Contemporaneous: For purposes of subparagraph (A), an acknowledgment shall be considered to be contemporaneous if the taxpayer obtains the acknowledgment on or before the earlier of-

“(i) the date on which the taxpayer files a return for the taxable year in which the contribution was made, or

“(ii) the due date (including extensions) for filing such return.

Internal Revenue Code §170(f)(8)(c)


Substantiation Requirements -- Appraisal• Donor must obtain a qualified appraisal of the easement

(A) A description of the property in sufficient detail for a person who is not generally familiar with the type of property to ascertain that the property that was appraised is the property that was (or will be) contributed;***(C) The date (or expected date) of contribution to the donee;

(D) The terms of any agreement or understanding entered into (or expected to be entered into) by or on behalf of the donor or donee that relates to the use, sale, or other disposition of the property contributed . . .***E) The name, address and (if a taxpayer identification number is otherwise required by section 6109 and the regulations thereunder) the identifying number of the qualified appraiser; and, if the qualified appraiser is acting in his or her capacity as a partner in a partnership, an employee of any person (whether an individual, corporation, or partnerships), or and independent contractor engaged by a person other than the donor, the name, address, and taxpayer identification number (if a number is otherwise required by section 6109 and the regulations thereunder) of the partnership or the person who employs or engages the qualified appraiser;


Substantiation Requirements – Appraisal (cont.)

• (F) The qualifications of the qualified appraiser who signs the appraisal, including the appraiser's background, experience, education, and membership, if any, in professional appraisal associations;

• (G) A statement that the appraisal was prepared for income tax purposes;• (H) The date (or dates) on which the property was appraised:

• (1) The appraised fair market value (within the meaning of §1.170A-1(c)(2) of the property on the date (or expected date) of contribution;

• (J) The method of valuation used to determine the fair market value, such as the income approach, the market-data approach, and the replacement-cost-less-depreciation approach; and

• (K) The specific basis for the valuation, such as specific comparable sales transactions or statistical sampling, including a justification for using sampling and an explanation of the sampling procedure employed.

• Regulations §1.170A-13(c)(2)(ii)


Substantiation Requirements – Appraisal (cont.)

• The appraisal cannot be done earlier than 60 days prior to the contribution or later than the date on which the return claiming the deduction is filed, or the due date for such return (plus extensions).

Regulations §1.170A-13(c)(3)(i)(A)

• If the value of the contribution exceeds $500,000 the full appraisal must be filed with the return.

Internal Revenue Code §170(f)(11)(d)


Recent Compliance Cases

Ney v. C.I.R. T.C. Summary Opinion 2006-154 (2006) [Failure to comply with statutory requirements for appraisal.]

Gomez v. C.I.R. T.C. Summ.Op. 2008-93 (2008) [Lack of timely acknowledgment.]

Bruzewicz v. C.I.R. 604 F.Supp.2d 1197 (N.D. Illinois, 2009) [Lack of adequate acknowledgment; failure to comply with statutory requirements for qualified appraisal.]

Simmons v. C.I.R. T.C. Memo. 2009-208 (2009) [Signature of land trust on easement sufficient acknowledgment.]

Consolidated Investors v. C.I.R., T.C. Memo. 2009-290 (2009) [Fact that appraisal was done more than 60 days prior to contribution; failure to state the appraisal was for tax purposes; failure to provide the date of the contribution; failure to provide the value of the contribution on the contribution date, were found to be “insubstantial.”]

Scheidelman v. C.I.R. TC Memo 2010-151 (2010) [Failure to provide evidence of the value, if any, of benefits received from the land trust.]

Lord v. C.I.R. T.C. Memo. 2010-196 (2010) [Failure of appraisal to included contribution date, the date the appraisal was performed, or the appraised fair market value of the easement contribution on the contribution date.]

Hendrix v. United States, 106 AFTR 2d 2010-5373 (S.D. Ohio, Eastern Division, 2010). [Failure to state the expected date of contribution; failure to include appraiser’s qualifications; failure to state that the appraisal was prepared for income tax purposes.]

Schrimsher v. C.I.R. T.C. Memo. 2011-71 (2011) [Failure of acknowledgement to describe goods and services given in exchange for contribution]


Substantial Compliance

“At the outset, it is apparent that the essence of section 170 is to allow certain taxpayers a charitable deduction for contributions made to certain organizations. It is equally apparent that the reporting requirements of section 1.170A-13, Income Tax Regs., are helpful to respondent in the processing and auditing of returns on which charitable deductions are claimed. However, the reporting requirements do not relate to the substance or essence of whether or not a charitable contribution was actually made. We conclude, therefore, that the reporting requirements are directory and not mandatory. * * *” [Failure to provide any appraisal at all was excused.]

Bond v. Commissioner 100 T.C. 32, 41 (1993)


Substantial Compliance (cont.)

“Reading the Tax Court's decisions on the subject of substantial compliance is enough to make one's head swim. Tax lawyers can have no confidence concerning the circumstances in which noncompliance with regulations governing the election of favorable tax treatment will or will not work a forfeiture. *** We think the doctrine should be interpreted narrowly, and point out that the courts of appeals owe no special deference to the Tax Court's legal views . . . The common law doctrine of substantial compliance should not be allowed to spread beyond cases in which the taxpayer had a good excuse (though not a legal justification) for failing to comply with either an unimportant requirement or one unclearly or confusingly stated in the regulations or the statute.”

• Prussner v. U.S., 896 F.2d 218, 224 (7th Cir. 1990)


Substantial Compliance (cont.)

Did the taxpayer provide sufficient information to allow the government to evaluate its charitable contribution?

Simmons v. C.I.R. T.C. Memo. 2009-208, 16.

“The substantial compliance doctrine is not a substitute for missing entire categories of content; rather, it is at most a means of accepting a nearly complete effort that has simply fallen short in regard to minor procedural errors or relatively unimportant clerical oversights.”

Hendrix v. U.S. 106 AFTR 2d 2010-5373, 5377 (S.D. Ohio, Eastern Division, 2010).

“When a qualified appraisal has not been submitted, we have not applied the doctrine of substantial compliance to excuse a taxpayer's failure to meet the qualified appraisal requirement.”

Scheidelman v. C.I.R. T.C. Memo. 2010-151, 12.


Form 8283 Instructions:

Attach a statement that: • Identifies the conservation purposes furthered by your donation,

• Shows, if before and after valuation is used, the FMV of the underlying property before and after the gift

• States whether you made the donation in order to get a permit or other approval from a local or other governing authority and whether the donation was required a contract, and

• If you or any related person has any interest in other property nearby, describes that interest.


Recommended Substantiation DocumentationReturn should be accompanied by:

Qualified appraisal (contributions of $500k or more)

Copy of recorded easement

Fully completed Form 8283 – use attachment if necessary

Completed attachment required by instructions

Copy of mortgage subordination, if any

Copy of baseline document

If a bargain sale, copy of original executed contract

If enhancement exists, map showing location of enhanced parcels in relation to easement parcel


Estate Taxes and Planning OpportunitiesUsing Conservation Easements

Estate Tax Rates and Exclusion Amounts

2011: Exclusion Amount $5,000,000

2011: Top Rate 35%

2013: Exclusion Amount $1,000,000

2013: Top rate: 55%


Basic concepts

• 1. Unified Credit

• 2. Rate

• 3. Gift tax

• 4. Marital deduction

• 5. Maximizing use of the unified credit (beware of “I Love You” wills)

• 6. Estate planning goal: reduction of taxable estate• a. By-pass trusts• b. Annual gifting• c. Discounting• d. Special use value


Effect of conservation easements on estate tax

• “Reduction in value”

• 40% exclusion

– Extensive Criteria

– $500,000 cap on exclusion

– 30% threshold for reduction in value

– Retained development rights not subject to exclusion


Calculation of ESTATE TAX SAVINGS (2011)

• Before c.e. value of land $1,000,000• After c.e. value of land (700,000)• C.e. value $ 300,000

• Reduction in estate due to c.e. $ 300,000• Maximum federal estate tax rate x 0.35• Maximum savings due to reduction $ 105,000

• After c.e. value in estate $ 700,000• 40% exclusion x 0.40• Exclusion allowed $ 280,000• Maximum federal estate tax rate x 0.35• Maximum savings due to exclusion $ 98,000

• Maximum savings due to reduction in estate $ 105,000• Maximum savings due to exclusion 98,000• Total Maximum Estate Tax Savings $ 261,000


Post mortem election

• All heirs must authorize

• Within time for filing return, including extensions

Internal Revenue Code §§ 2031(c)(8)(A)(iii); 2031(c)(8)(C); and 2031(c)(9)


Doubling the $5 million Exclusion:

• Avoid joint tenancy w/ right of survivorship

• Avoid “I love you” wills

• Use by-pass trusts


Conservation Easements and Other Estate Planning tools

Conservation easements enhance other estate planning tools:

Exemption

Annual gift exclusion

Special use valuation


Easements and Annual Gifts

Without easement

$13,000 annual exclusion per donor

$5,000,000 lifetime exemption per donor

Value of land to transfer $7,500,000

Assume 6 children and joint gifts (6 x $26,000) $156,000/ year

Time for 100% transfer ($7,500,000/ $156,000) 49 years

Time for 51% transfer ($3,250,000/ $156,000) = 21 years

(annual appreciation not included)


Easements and Annual Gifts (cont.)

With easement

Value of land to transfer $7,500,000

Conservation easement value ($3,250,000)

Remaining value to transfer $3,250,000

Assume 6 children and joint gifts (6 x $26,000) $156,000/ year



(annual appreciation not included)


Value Replacement

• Donors’ ages: 51 (h) 43 (w)

• Easement value $ 1,942,000

• Tax savings $ 680,000

• $680K buys a second to die policy worth $12.5M • • Net policy pay-out (less premium) $ 11.8M

• Estimated forgone development value• (assuming appreciation) ($ 5M)

• Net increase due to value replacement $6.8M

© C. Timothy Lindstrom 20111 2011 Wyoming Conservation Easement Conference Income Tax Benefits and...

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Transcript of © C. Timothy Lindstrom 20111 2011 Wyoming Conservation Easement Conference Income Tax Benefits and...