Adapted from Preserving Family Lands: Book III by Stephen J. Small, copyright 1998 - 2002.

Introduction

People who donate conservation  easements to the Five Valleys Land Trust generally share a desire to keep their land’s special qualities intact for their children and for future generations.  Five Valleys works one-on-one with landowners to craft easements reflecting the unique needs of each piece of land, as well as the specific concerns of each landowner. With a conservation easement, you still own your land.  You can continue to live on it and use it, and can sell it or pass it on to heirs, all while potentially taking advantage of important tax benefits.

The potential tax benefits are as follows: a donated conservation easement may provide income tax benefits at the federal level, and may lower estate tax liability, enabling the passage of family lands from one generation to the next.  Recent changes in federal tax law provide further incentives for private, voluntary land conservation by allowing beneficiaries of qualified land to exclude from their taxable estate 40 percent of value of the land under easement, in addition to the reduction in the value of the land resulting from the donation of the easement.  Most land in western Montana meets the criteria for this reduction, providing landowners with the potential for substantial savings.
 
It is important to emphasize that not every easement restricting the future development of a property will meet the tax law requirements.  As a rule, the following generalization works: the more significant the conservation values of the land, and the more that the easement adds to public good, then the more likely it is that you will qualify for the deduction.  An easement must be donated to an IRS-qualified, tax-exempt organization such as the Five Valleys Land Trust, and must be considered a true gift for which no benefit is anticipated in exchange.  Determining whether a gift qualifies is usually straightforward, but you should have your attorney review the gift’s terms and advise you as to its deductibility.

The following examples are provided to show generally how the tax benefits work, and reflect Five Valleys understanding of federal tax law as of January 2001.  They are not provided to guide you in calculating your own benefits.  Your personal tax outcome in any particular situation will depend on factors such as the value of your donation, your income, the extent of your other deductions, the availability of state and local tax deductions, and so on.  To fully understand how current law affects your conservation plan, consult with an attorney, CPA, or tax advisor.

INCOME TAXES:

Contribution value - for tax purposes, the “value” of a property is equal to what it would sell for were it put to the most valuable use possible under the circumstances.  This is called the fair market value.  For income tax purposes, the value of an easement is the difference between the fair market value of the land before the easement and the fair market value after the easement.

EXAMPLE #1:
For the sake of illustration, let’s say that you own land next to publicly owned property on Mt. Jumbo.  You work with Five Valley staff to craft an easement that allows agricultural uses and the construction on one additional residence, but prohibits subdivision and commercial development.  The appraiser sets the fair market value of the property before the easement at $600,000, and the after value at $420,000.  The amount of the charitable contribution (the before value minus the after value) is $180,000:

Before fair market value = $600,000
After fair market value = $420,000
Contribution value = $180,000

30% Limitation- no matter how much any individual gives to charity, limitations in the tax law make it impossible to eliminate the total amount of income tax due in a given year.  Generally, for gifts of land and conservation easements, the amount you can deduct is limited to 30 percent of your adjusted gross income annually.  If the value of your gift exceeds 30 percent, you can carry forward that excess for up to five additional years. 

Following the example above, let’s assume that you make a gift of an easement valued at $180,000 to Five Valleys this year.  If you have an annual income of $90,000, your tax deduction for the year of the gift is limited by tax rules to $30,000 (30% of your $90,000 income).  The “unused” portion of your gift ($150,000) can be “carried forward” and used as a deduction against your income for each of the next five years.

EXAMPLE #2:
Easement Deduction (assuming $90,000 annual income)

Year 1 ...... $30,000
Year 2 ...... $30,000
Year 3 ...... $30,000
Year 4 ...... $30,000
Year 5 ...... $30,000
Year 6 ...... $30,000
Total ...... $180,000

For the family that cares about its land, state and federal estate taxes may pose the single greatest threat to long-range planning.  Generally, estate taxes are based on the fair market value of the property at the time of a landowner’s death, and not on the original purchase price or current use value.  Dramatic increases in land values often force families to subdivide or develop land in order to meet estate tax requirements.  

ESTATE TAXES:

The unified credit - according to tax laws, every individual can give a total of $1,500,000 worth of assets to others without any federal gift or estate taxes. This is called the unified credit. With the unified credit, married couples may pass on $3,000,000 of tax-free property to their heirs ($1,500,000 each). However, federal estate and gift taxes levied on amounts that exceed these exemptions ranges between 37 and 50 percent, due within nine months of death. This can result in a potentially debilitating tax burden. By donating a conservation easement, however, a landowner can lower the developmental potential of his or her land. This, in turn, lowers the fair market value of the land, which can reduce estate tax liability.

40% Deduction: the 1997 Taxpayer Relief Act provides further incentive for private, voluntary land conservation. The new law allows heirs to exclude from the taxable estate 40 percent of the value of the land subject to a qualifying conservation easement. To qualify for this deduction, the land under easement must be within 25 miles of any county included in an official metropolitan statistical area, within 25 miles of a federally-designated wilderness area, or within 10 miles of any Urban National Forest. Likewise, the property must have been owned by the decedent or a member of his or her family for at least three years prior to death.

EXAMPLE #3:
Let’s say that John and Sue Landowner own an large ranch in the Mission Valley. John and Sue want to leave the ranch to their son, but they know that growth and development in the valley have caused the value of the ranch to appreciate considerably over the past three decades. John and Sue contact Five Valleys Land Trust, indicating their concerns.  A qualified appraiser determines that the fair market value of the ranch is $4 million. With the unified credit, John and Sue can pass on $3,000,000 worth of tax free property to their son, leaving $1,000,000 worth of estate tax liability. At graduated rates of 37 to 50 percent, the son’s estate taxes without any action on the parents’ part would range from $370,000 to $500,000 (depending on marital status, ownership, and the value of other assets at the time of death), forcing him to subdivide or develop parts of the ranch.

To avoid that possibility, John and Sue donate a conservation easement to Five Valleys that limits development of the property, but allows for operation of the ranch and construction of another residence. The appraiser determines the value of the easement to be $700,000, reducing the value of the ranch for tax purposes from $4 million to $3,300,000. With the unified credit deduction, $300,000 remains subject to estate taxes, ranging from $111,000 to $150,000 (at graduated rates of 37 to 50 percent, depending again on marital status etc).

Further reductions may apply if the land under easement qualifies for exemptions under the new 1997 tax law. With the new law, heirs may exclude 40 percent of the value the land subject to the easement. For the Landowners, this would result in a reduction of $120,000 (40% of $300,000), leaving $180,000 in taxable estate. At graduated rates of 37 to 50 percent, the son’s estate taxes would range from $66,600 to $90,000. With the easement and the 40 percent deduction, the son will save between $303,400 and $410,000 in estate taxes, allowing him to honor his parents’ wishes and keep the ranch intact and in the family. And the easement benefits not only the Landowners: for the general public it protects the values that an intact, productive ranch provides, including open space and critical wildlife and riparian habitat.