Easements are a sharing of certain rights in the bundle of rights that constitutes full ownership in real estate. Landowners may grant easements in real estate to accommodate a neigh-bor. Easements may arise out of the law where a roadway is necessary to reach a landlocked parcel. Utility companies acquire easements to deliver services essential to the community, for example, pipelines for water and gas, and power lines and cables for electricity and communications.

What is a Conservation Easement?

A conservation easement is a promise not to make or permit changes in the property, but instead to leave land as it is for its value as open space, as farmland, for recreation, or for scenic, natural or historic value. This is a granting of rights associated with adding improvements to property or otherwise changing its use or character—it is a conservation restriction.

Conservation easements are significant alternatives in the management of development in rural or “undeveloped” areas. They are recorded deed restrictions. (A sample form for a deed of a conservation easement may be obtained by contacting the author or the American Farmland Trust.) Landowners may gift or sell conservation easement to an appropriate private or public agency (e.g., a land trust or a park service). Individuals may gift part and sell part (bargain sale) of a conservation easement to make an arrangement feasible or practical from a financial planning point of view.

Government agencies and private land trusts may purchase full title to property to provide scenic, recreational, and other land-based benefits to the public. However, to manage development by limiting acquisitions to easements reduces the cost of attaining policy objectives. Cost savings adds to the trend toward acquiring conservation easements to attain real estate development rights. Landowners may trade a conservation easement for replacement property to avoid recognizing taxable income under the Internal Revenue Code’s like-kind exchange rules.

To satisfy the federal income tax charitable deduction requirements, and for public policy reasons, “qualified” conservation easements must be established to last forever. Restrictions on transfers of real estate that last forever are contrary to common law. Indiana has adopted the Uniform Conservation Easement Act (See IC 32-5-2.6-1 to -7), which provides legality for a conservation easement in Indiana. The Act also permits assignment of conservation easements between agencies and entities. This provision permits land trusts and similar charitable institutions to acquire and sell conservation easements to state or federal agencies. A sale of easements may be an important source of capital and operating funds for land trusts.

Conservation Purpose

Generally, for the taxpayer’s qualified conservation easement (QCE) to obtain the income and trans fer tax deductions, the agency that acquires a conservation easement must have a charitable or similar standing under the Internal Revenue Code and Treasury Regulations. It is essential that the acquisition agency have a “conservation purpose.” According to the Regulations a conservation purpose is satisfied by one or more of the following:

➤ the preservation of land areas for outdoor recreation by, or the education of, the general public,

➤ the protection of a natural habitat of fish, wildlife, plants, or similar ecosystem,

➤ the preservation of open space (including for farming and forestry) where such preservation is:

            — for the scenic enjoyment of the general public, or

            — pursuant to a clearly delineated federal, state or local governmental conservation pol-icy, and will yield a significant public benefit, or

➤ the preservation of a historically important land area or a certified historic structure.

Tax Benefits from the Gifts of a QCE

Potential for Income Tax Savings: Gifts of all or part of a QCE provide a charitable income tax deduction to the contributing taxpayer. An annual deduction may be limited to 30% of the donor’s adjusted gross income. The amount, not deductible in the year of the easement gift, is deductible in each of the next five years, but subject to the 30% limitation.

For example, if the fair market value of a donated QCE is $200,000, and the taxpayer has an adjusted gross income of $80,000, the charitable deduction for the year of the transfer is $24,000 (30% x $80,000). This leaves $176,000 ($200,000 – $24,000) to carryover. A lifetime gift of a QCE does provide substantial income tax savings, however at the$80,000 level of adjusted gross income, only $144,000 of the $200,000 would be deductible over a six-year period.

If the taxpayer is in a 28% income tax bracket, a $24,000 reduction in taxable income provides an income tax savings of $6,720 (.28 x $24,000). If that were the savings in each of six years, the tax savings would total more than $40,000. Individuals in a higher tax bracket (say 31%) would realize a greater savings. A reduction in the Indiana income tax adds to the savings. Taxpayers might structure gifts over many years to overcome the annual limitation on their charitable deduction.

Property Tax Savings: Since the value of the remaining real estate is reduced after granting a conservation easement, a property tax savings may result. However, in the case of farmland in Indiana, the assessment for real estate tax is based on agricultural use and/or soil productivity, and not on the fair market value of the property. Thus, the granting of a conservation easement on farmland in Indiana may not have a big impact on the current property tax assessment.

Federal Gift and Estate Tax Savings: There may be an additional benefit from a conservation easement due to the reduction of the federal estate tax value in a decedent’s estate. Federal unified gift and estate transfer tax is based on the fair market value at the time of the lifetime gift or at death. Amounts that qualify as charitable transfers are exempt from federal gift or estate transfer tax. Thus, land in a decedent’s estate that has been reduced in value by the value of a conservation easement has less expo-sure to the federal gift and estate tax. Whether there is an actual estate tax savings for a decedent’s estate depends upon the taxable value of the estate, and whether other features in the estate tax law will allow for avoiding the estate tax. The Indiana Inheritance tax may also be reduced by the granting of conservation easement since the inheritance tax is based on the value of interests passing from a decedent to individual heirs.

Estate Tax Exclusion for QCEs: There is a new (1998) federal estate tax provision for excluding land value from a decedent’s estate if the land is subject to a qualified conservation easement (QCE). When a QCE meets the requirements of the new law, as much as 40% (or the applicable percentage) of the land value as of the date of death may be excluded from the federal estate tax estate. This exclusion from the value of land is after the value of the conservation easement is subtracted from the fair market value of the land.

The maximum amount that can be excluded is the lessor of the “applicable percentage” (40% max.) or the “exclusion limit:” $100,000 in 1998, $200,000 in 1999, $300,000 in 2000, $400,000 in 2001 and $500,000 in 2002 and thereafter.

The “applicable percentage” is a maximum of 40%, but it is reduced by two percentage points for each percentage point (or fraction thereof) by which the value of the qualified conservation easement is less than 30% of the value of the land. For this purpose, the value of the land is determined without regard to the value of the easement, and it is reduced by the value of any retained development rights.

To illustrate the above rule, consider a landowner who died and a qualified conservation easement was granted on his land. The fair market value of the land on the date death before considering the easement is$900,000. The value of the QCE is$200,000. First of all, the $200,000 of the QCE is fully deductible from the estate tax estate. The $200,000 value of the QCE is 22.22% of the value of the property without the QCE. Since the rule requires a reduction of applicable percentage by 16% [twice the difference between 30% and 22%], that leaves an applicable per-centage of 24% (40 – 16). The exclusion is $48,000 (24% x $200,000), and for estate tax purposes this land has a value of $652,000 ($900,000 -$200,000 – $48,000).

An election under this exclusion is irrevocable. The income tax basis for the land that benefits from this new exclusion is reduced by the amount of the allowable exclusion. If the election to grant a conservation easement is done in an estate, there is no income tax deduction for the estate or the heirs.

However, a location rule limits the use of this new exclusion. For land subject to a qualified conservation easement to qualify for this exclusion, the land, at the date of the owner’s death must be located (1) in or within 25 miles of a metropolitan area as defined by the Office of Management and Budget, or (2) within 25 miles of a national park or wilder-ness area, or (3) within 10 miles of an urban national forest.

Other features in the federal estate tax law providing estate tax relief include: the applicable exclusion amount of $625,000 in 1998; special use valuation of farmland (which may remove up to $750,000 in value of land from an estate); and the new family-owned business interest deduction (which may allow a tax deduction of up to $675,000 from a decedent’s federal estate tax estate). These three features permit an individual who is in a farming business (or whose family is in farming in the case of the retired individual) to avoid the federal estate tax on up to $2.05 million. Also, the tax law permits the granting of a conservation easement on the land that enjoys the benefit of a special use valuation.

To the extent an individual has an estate tax concern, provisions in the law that provide tax avoidance may help keep land in its current use.

Summary & Conclusion

Conservation easements are an important tool for managing real estate development. Indiana law was modified to permit the establishment of conservation easements to last for-ever. The federal tax law provides that gifts for a “conservation purpose” of “qualified real property interests” to a “qualified organization” are deductible for federal income, and gift and estate tax purposes. Another feature in the tax law allows for a an additional exclusion of land value from an estate tax estate under limited circumstances.

Other features in the federal tax law, such as special use valuation of farmland and the new family owned business interest deduction are available for avoiding substantial amounts of estate tax. Further, the applicable exclusion amount avail-able to all decedents increases from$625,000 in 1998 to $1 million in 2006. These features also work to keep farm land in an agricultural use.

Land trusts and other entities exist in Indiana for acquiring and holding conservation easements. Though land trusts exist for the purpose of preserving farmland, they may or may not accept an easement without additional money provided to help protect the easement.

Further, there may be few individuals willing to make substantial gifts of conservation easements. However, increased advantages, such as the new estate tax exclusion, and education about the advantages of existing tax provisions may persuade individuals and heirs to con-tribute conservation easements.

In a few states, have programs for the purchase and transfer of conservation easements. That is, where a community decides to protect agricultural and open spaces, there is a systematic process for acquiring development rights and applying these rights where development is permitted. Local governments in Indiana may wish to become more involved in the management of local growth by establishing a program for the transfer of development rights.

* Gerald A. Harrison, Extension Economist, may be reached by phone:

765-494-4216; toll free: 1-888-398-4636; E-mail: harrison@agecon.purdue.edu.