Conservation Easements as an Estate Conservation Easements as an Estate Planning ToolPlanning Tool

Megan E. Thomas, Esquire

June 18, 2007

Doc ID

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Essentials of Estate PlanningEssentials of Estate Planning

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Federal Estate TaxFederal Estate Tax

Tax on value of all property owned at death– Due 9 months after death– Estates of $2 million or less may pass free of estate tax

In 2006 Unified Credit of $780,800 eliminates tax on estates of $2 million—i.e., “applicable exclusion amount”In 2006 estate tax rate is 45%

– No tax on property passing to or for benefit of surviving spouse—“Marital Deduction”

Unified Credit + Marital Deduction = No federal estate tax– No tax on property passing to or for use of charity

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Federal Gift TaxFederal Gift Tax

Donor who transfers property to others during life, in excess of $1 million, may be subject to gift taxGift and Estate tax exclusions are no longer coupled

– In 2006, gift tax Unified Credit is $345,800; lifetime gift tax exemption is $1,000,000

– Annual ExclusionNo tax on gifts up to $12,000/year/donee

– No tax on gifts to or for the use of charity– To extent donor uses part or all of lifetime gift tax

“exemption” it consumes first $1 million of estate tax exemption available at death

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Whither The Estate Tax?Whither The Estate Tax?

Year Exemption Top Marginal Rate2007 $2 million 45%2008 $2 million 45%2009 $3.5 million 45%2010 0 02011 $1 million 55%

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New Jersey Has 2 Death TaxesNew Jersey Has 2 Death Taxes

New Jersey Estate Tax– “Decoupled” from federal estate tax

NJ exemption = $675,000Calculate as if died in 2001Result: NJ tax on difference between $2 million federal exemption and $675,000 NJ exemption = $99,600

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New Jersey Has 2 Death Taxes New Jersey Has 2 Death Taxes (cont(cont’’d)d)

New Jersey Inheritance Tax– Based on relationship to beneficiaries

Transfer to lineal ancestors and descendants (Class A) -exemptTransfer to siblings and son/daughter-in-law (Class C) –first $25,000 exempt; start @11% on excessTransfer to nieces/nephews, others (Class D) –less than $500 exempt; if $500 or > no exemption; start @15%Transfer to charity (Class E) –exempt

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Special Planning for Estates Owning Special Planning for Estates Owning Interests in LandInterests in Land

Special Use Valuation under Sec. 2032A for land used in business

– Limits family’s ability to plan (e.g., easement gift can cause recapture)

Discounts for partial interest in land, land held in FLP or LLCPost-mortem conservation easement underSec. 2031(c)Extension of time for paying estate tax for estates consisting of closely-held business (e.g., farm) under Sec. 6166

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The Charitable DeductionThe Charitable Deduction

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Donative IntentDonative Intent

Gift must be made from “detached and disinterested generosity”No quid pro quo

– If donor receives “greater than incidental” benefit with value equal to or greater than gift, no charitable deduction

No expectation of personal benefit, such as– Receive zoning variance– Enhance value of donor’s other property

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Permissible Permissible DoneesDonees

By states, U.S. possessions, political subdivisions exclusively for public purposeBy corporation/trust/fund/foundation

– Created or organized in U.S. “exclusively” for religious, charitable, scientific, literary or educational purpose

– No part of net earnings benefits private individual– Does not attempt to influence legislation or intervene in

political campaign on behalf of candidates

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Income Tax Charitable DeductionIncome Tax Charitable Deduction

IRC Sec. 170 allows income tax deduction for charitable contribution to or for the use of tax-exempt charitable organization

– A voluntary transfer of money or property with no expectation of procuring a financial benefit commensurate with the amount transferred. Rev. Rul. 83-104.

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Income Tax Charitable Deduction Income Tax Charitable Deduction (cont(cont’’d)d)

Amount of deduction generally limited to percentage of donor’s “contribution base” (i.e., AGI), based on

– Type of donee organization (e.g., public charity; private foundation)

– Type of property (ordinary income property; capital gain property)

See IRC Sec. 170(b)(1)

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Percentage LimitationsPercentage Limitations

For individual donors– 50% limitation

Gifts to public charity and certain private foundations (e.g., private operating foundation)

– 30% limitationGifts to most private foundations

– Gifts for the use of charitable organization– Gifts of capital gain property to public charity if donor

elects to deduct FMV

– May carryover contributions for 5 years

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Percentage Limitations Percentage Limitations (cont(cont’’d)d)

For corporate donors– 10% of corporate taxpayer’s net taxable income– S Corp. shareholders face reduction in stock basis

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““For a limited time only. . .For a limited time only. . .””

Increased deduction available for gifts of conservation easement under new IRC Sec. 170(b)(1)(E)Special Rules for farmers and ranchers giving LTCG property used in agriculture or livestock production

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Gifts of Partial InterestsGifts of Partial Interests

No charitable deduction allowed for gifts of partial interests, with certain exceptions“Vertical Slice” – undivided portion of donor’s entire interest

– 50% to D&R Greenway as tenant in common

Development

Easements

Mineral extraction

Leasehold

Life estate & remainder

Terms of years

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Gifts of Partial Interests Gifts of Partial Interests (cont(cont’’d)d)

“Horizontal Slice” – charitable deduction allowed for– Gift of remainder in personal residence or farm– Qualified Conservation Contribution

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Planning With Conservation EasementsPlanning With Conservation Easements

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Reasons for PlanningReasons for Planning

To protect natural and agricultural resourcesTo preserve a way of lifeTo minimize tax burden on next generationTo avoid forced sale to pay taxesTo provide income during donor’s or family member’s life

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Lifetime PlanningLifetime Planning

Gift by deed to a public agency (e.g., county for parkland) or conservation organization for open space

– Significant charitable contribution– Avoid capital gains tax on sale of appreciated property– Income tax charitable deduction– Removes a valuable appreciating asset from estate– Lose source of income, future realized cash value

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Lifetime Planning Lifetime Planning (cont(cont’’d)d)

Bargain sale (part gift/part sale) for less than FMV– Affordable for conservation organization– Realize cash from sale– Recognize capital gain on the sale part of the

transaction under IRC Section 1011(b)– Obtain income tax charitable deduction for the gift part

A gift or sale of land already subject to a conservation easement, to a conservation organization, ensures

that the land will be preserved.

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Lifetime Planning Lifetime Planning (cont(cont’’d)d)

Conservation Easement is– A partial interest in real property transferred by deed to

a qualifying conservation organization in perpetuityProperly structured, the gift of a conservation easement qualifies for federal income and gift tax deductionsA conservation easement given at death qualifies for estate tax charitable deduction

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Conservation EasementsConservation Easements

Ordinarily no deduction for partial interestsGift of conservation easement is exception under Sec. 170(h)Transfer is made by deed from landowner to qualifying conservation organization

– Deed states restrictions on use of land, rights and responsibilities of landowner and organization, special exceptions for use (e.g., to permit hunting, to create a building envelope for future residence)

Recorded with County Clerk

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Conservation Easements Conservation Easements (cont(cont’’d)d)

Only easements granted in perpetuity qualify for income tax charitable deduction

– Gift must be for a public purpose– Gift should not enhance the value of donor’s property– No quid pro quo

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Some issues to consider . . . Some issues to consider . . .

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Mortgaged Property Mortgaged Property

No deduction unless mortgagee subordinates its rights to the conservation organizationEasement must remain in effect after foreclosure and saleNotify the lender

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Allocation of Basis Allocation of Basis

Treasury Regulations require donor’s basis be allocated to easementLowers basis in retained interestSee Regs. Sec. 170A-14(h)(3)(iii) and (4)

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Public Access Public Access

Not generally required by federal tax law for open space, farm or forest landScenic enjoyment requirespublic enjoyment, not access

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Reserved Rights Reserved Rights

Future residential development: building envelopeUse of appurtenant structures for residential purposes: riding stable, guest houseHunting, fishing, low-impact recreationAgricultural usesOther limited commercial activity

Anything not expressly prohibited should be permitted, if not inconsistent with easement’s conservation purpose.

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Grantee OrganizationGrantee Organization’’s Rights s Rights

To inspect the property- Landowner should receive notice

To enforce easementTo restore property and possibly enhance conservation values

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Who Pays for What? Who Pays for What?

Baseline data reportAppraisalAttorneys feesMonitoring and enforcementRestoration

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Valuation Valuation

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What is the Value of An Easement? What is the Value of An Easement?

Fair Market Value is price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant factsFMV of land is its “highest and best use”

– What use will produce the highest net return over a reasonably foreseeable period?

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What is the value of an easement? What is the value of an easement? (cont.)(cont.)

Easement value = FMV of unencumbered property less FMV of encumbered property“Value before minus value after”Easement may reduce value of restricted property by 25% - 40%, even as high as 90%. See Stotler v. Comm., T.C. Memo 1987-275.

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Appraisal RequirementsAppraisal Requirements

Written appraisal required for gifts of property other than cash and marketable securities > $5,000Form 8283 appraisal report still requiredNew oversight penalties under Sec. 170(F)(11)(E)Effective for contributions for which a deduction of $5,000 or more is claimed on returns filed after 8/17/2006Notice 2006-96 provides transitional guidance

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Appraisal Requirements Appraisal Requirements (cont(cont’’d)d)

Qualified Appraisal– Made within 60 days before gift, but not later than due

date (w/extensions) for return– Prepared, signed and dated by “Qualified Appraiser”– Contains description; FMV on date of gift; basis upon

which valued; purpose; appraiser’s signature, TIN and qualifications; declaration re substantial and gross misstatement penalties

– Fee not based on percentage of value– Follows “generally accepted appraisal standards”; see,

e.g., Uniform Standards of Professional Appraisal Practices @ www.appraisalfoundation.org

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Appraisal Requirements Appraisal Requirements (cont(cont’’d)d)

“Qualified Appraiser”– Has earned designation from professional appraisal

organization, or meets education and experience requirement

– Regularly performs appraisals, for which paid– Demonstrates experience appraising the particular

type of property– Has not been barred from practice before IRS during 3

years before appraisal

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Other Lifetime GiftsOther Lifetime Gifts

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Remainder Interest in Home or FarmRemainder Interest in Home or Farm

By deed to organizationDonor has “life estate”

– Right to use and enjoy until death – Charity has “remainder”

Charitable deduction based on life expectancy, interest ratesMonitorCombine with conservation easement?

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Charitable Remainder TrustCharitable Remainder Trust

Donor funds with land, appreciated property Trustee pays donor stream of income

– Annuity or – “Unitrust” amount

Trustee can sell without recognizing gain.Charitable deduction = value of charity’s interest

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Appreciated Property Appreciated Property –– Other than LandOther than Land

Publicly traded securitiesTangible personal property -- keep or sell?

Vehicles ArtLivestock Machinery

Closely held stock– Due diligence!– Appraisals– IRS Form 8283– Acknowledgment– Recognition