By: Scott Kunde
Recent changes in the Internal Revenue Service’s (IRS) enforcement strategy may disincentivize taxpayers from choosing to use conservation easements in the future.[i] Conservation easements are when a person voluntarily and permanently restricts the use of real property in the pursuit of environmental conservation.[ii] To encourage this behavior, the government provides tax incentives in the form of tax deductions to those that donate conservation easements on their property.[iii] The tax deduction received is equivalent to the fair market value of the easement itself at the time of donation, the value of which is determined by taking the difference between the property’s fair market value immediately before and after the grant of the easement.[iv] To qualify, the conservation easement must meet several elements.[v] The easement must be placed on a qualified real property interest, donated to a qualified organization, and granted exclusively for conservation purposes.[vi] To satisfy the “exclusively for conservation purposes” requirement, the easement must protect the conservation purpose in perpetuity.[vii] In essence, the donor must grant an easement on their land to a qualified organization (like a government or charitable organization), thereby limiting the use of the property to only acceptable environmental purposes, such as the protection of natural habitats or preservation of open space and land areas for outdoor recreation.[viii] Conservation easements have been widely used and there are currently more than 32.7 million acres of property that have been conserved through over 191,000 easements as of March 2021.[ix]
In recent years, the IRS has begun to enforce conservation easement laws more strictly. Conservation easements are currently one of the most litigated tax issues.”[x] Withmore and more conservation easements being granted each year, the IRS is cracking down to recuperate lost potential tax revenue. One particularly hot litigation issue is the requirement concerning the protection of the conservation purpose in perpetuity and potential violations of the Proceeds Clause.[xi] The purpose of the Proceeds Clause is to guarantee to the donee[xii] Many taxpayers understood this regulation as a “fixed” value, meaning that if at the time of the donation, the conservation easement was worth $50,000, then in the case of a judicial extinguishment of the easement, the donee organization would be entitled to $50,000 of the property’s proceeds. However, the IRS has now interpreted the regulation to mean a “fixed” percentage, meaning that at the time of the donation, if the encumbered property had a proportionate value of 30% compared to the unencumbered property, then the donee[xiii]
This new interpretation of the regulation has also invalidated many easements that contained things like an “improvements clause,” which allowed the donor to subtract the value of improvements they made to the land before the donee organization took their share.[xiv] Many taxpayers included the clause in their easement deeds to protect the value they invested in the property and did so in reliance on a previous IRS Private Letter Ruling that supported the validity of an ‘improvements clause.’[xv]
As the IRS now seeks to enforce conservation easements more strictly, many taxpayers may choose not to donate their land due to the potential risks and costs of audits and litigation down the road.[xvi] This raises concern that the IRS’s actions may be working to undo precisely what Congress intended to encourage: protecting and conserving our environment.[xvii] Whether conservation easements will still be an attractive option to taxpayers in the years to come will depend on whether the courts uphold or reject the IRS’s new interpretations in the hundreds of conservation easement cases currently being litigated.[xviii]
[i] See PBBM-Rose Hill, Ltd. v. Comm’r, 900 F.3d 193, 208 (5th Cir. 2018).
[ii] What is a Conservation Easement?, Nat’l Conservation Easement Database, https://www.conservationeasement.us/what-is-a-conservation-easement/ (last viewed Oct. 23, 2021) [https://perma.cc/HP4Z-C9JZ].
[iii] See I.R.C. §170 (2021).
[iv] Conservation Easements, Ctr. for Agric. & Food Sys., https://farmlandaccess.org/conservation-easements/ (last viewed Oct. 23, 2021). [https://perma.cc/6Y2N-LJ5V].
[v] I.R.C. §170(h)(1)-(A-C) (2021).
[vi] Id.
[vii] I.R.C. §170(h)(5)(A).
[viii] I.R.C. §170(h)(4)(A)- (i-ii).
[ix] Nat’l Conservation Easement Database, https://www.conservationeasement.us (last viewed Oct. 23, 2021) [https://perma.cc/NC5A-3LD9].
[x] Nancy Ortmeyer Kuhn, The Eleventh Circuit Court of Appeals: The Current Focus for Conservation Easements, Bloomberg Tax (Apr. 1, 2021, 4:01 AM), https://news.bloombergtax.com/daily-tax-report/the-eleventh-circuit-court-of-appeals-the-current-focus-for-conservation-easements [https://perma.cc/VS75-8PS].
[xi] 26 C.F.R 1.170A-14(g)(6)-(ii) (2021).; See PBBM-Rose Hill, Ltd., 900 F.3d at 208.; Conservation Easements: Defending IRS Challenges, Overcoming Audits, Structuring Deed Language for Perpetuity, Strafford, https://www.straffordpub.com/products/conservation-easements-defending-irs-challenges-overcoming-audits-structuring-deed-language-for-perpetuity-2020-09-09 (last viewed Oct. 23, 2021) [https://perma.cc/7S9J-QDL4].
[xii] 26 C.F.R 1.170A-14(g)(6)-(ii) (2021), supra note xii.
[xiii] Id. at 208.
[xiv] Tax Court Holds IRS Properly Denied Charitable Deduction Because Purpose of Conservation Easement Wasn’t Protected in Perpetuity, Ernst & Young Global Limited (Nov. 6, 2019), https://taxnews.ey.com/news/2019-1980-tax-court-holds-irs-properly-denied-charitable-deduction-because-purpose-of-conservation-easement-wasnt-protected-in-perpetuity [https://perma.cc/W5RN-R48Q].
[xv] I.R.S. Priv. Ltr. Rul. 1536 (2008).
[xvi] See PBBM-Rose Hill, Ltd., 900 F.3d at 208.
[xvii] Peter M. Morrisette, Conservation Easements and the Public Good: Preserving the Environment on Private Lands, 41 Nat. Resources J. 375, 79 (2001).
[xviii] Kuhn, supra note x.; See PBBM-Rose Hill, Ltd., 900 F.3d at 208.