Chapter 1: Introduction to Conservation Easements

Statement of Purpose

The purpose of this audit technique guide (ATG) is to provide guidance for the examination of charitable contributions of conservation easements. Users of this guide will learn about the general requirements for charitable contributions and additional requirements for contributions of conservation easements.

This ATG includes examination techniques and an overview of the valuation of conservation easements. It also includes a discussion of penalties, which may be applicable to taxpayers, and others involved in the conservation easement transaction.

This guide is not designed to be all-inclusive. It is not a comprehensive training manual on the valuation of conservation easements.

Overview

To be deductible, donated conservation easements must be legally binding, permanent restrictions on the use, modification and development of property such as parks, wetlands, farmland, forest land, scenic areas, historic land or historic structures. Current and future owners of the easement and the underlying property are bound by the terms of the conservation easement.

Internal Revenue Code (IRC) § 170(h) states that a qualified conservation contribution is a contribution of a qualified real property interest (i.e., a restriction granted in perpetuity on the use which may be made of the real property) to a qualified organization exclusively for conservation purposes. The IRC and accompanying Treasury regulations outline the requirements to be met before a contribution is deductible.

Qualified organizations that accept conservation easements must have a commitment to protect the conservation purposes of the donation and must have sufficient resources to enforce compliance with the terms of the easement agreement.

IRC § 170(h)(4)(A) specifies the four deductible types of conservation easements:

• Preservation of land areas for outdoor recreation by, or the education of, the general public.

• Protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem.

• Preservation of open space (including farmland and forest land).

• Preservation of a historically important land area or a certified historic structure.

The value of a conservation easement is determined in a qualified appraisal. The value of the contribution is the fair market value (FMV) at the time of the contribution. To the extent there is a substantial record of sales of easements comparable to the donated easement, the FMV is based on the sales price of such comparables. If there is no substantial record of market-place sales, the value is generally the difference between the FMV of the underlying property before and after the easement is transferred. Various statutory provisions may limit the amount of the deduction.

To conduct a quality examination, in-depth development of facts is necessary. Examiners have primary responsibility for addressing the taxpayer's compliance with all statutory and regulatory requirements. Valuation is also an important component of this tax issue. A multi-divisional approach, working with LB&I Engineering, Counsel, and Tax Exempt and Government Entities (TEGE), may be needed to properly develop tax issues in a conservation easement examination.

Taxpayers, return preparers, appraisers, and others involved with an improper or overvalued conservation easement may be subject to various penalties.

While the charitable contribution of a conservation easement may be the most significant issue on the tax return, Examiners should be alert to other related tax issues such as a sale of state tax credits or a recapture of rehabilitation tax credits.

Getting Started

Information about conservation easements including contacts, job aids, and other reference materials are on the IRS Intranet at MySB/SE under Examination, Issues and Procedures.

Definition of Conservation Easement

"Conservation easement" is the generic term for easements granted for outdoor recreation, natural habitat, open space, scenic and historic preservation of land and buildings.

Conservation easements permanently restrict how land or buildings are used. The "deed of conservation easement" describes the conservation purpose(s), the restrictions and the permissible uses of the property. The deed must be recorded in the public record and must contain legally binding restrictions enforceable by the donee organization under state law.

The property owner gives up certain rights but retains ownership of the underlying property. The extent and nature of the donee organization's control depends on the terms of the conservation easement. The organization has an interest in the encumbered property that runs with the land, which means that its restrictions are binding not only on the landowner who grants the easement but also on all future owners of the property.

Tax Issues

Taxpayers must satisfy numerous statutory provisions in order to claim a noncash charitable contribution deduction for the donation of a conservation easement. Some deficiencies revealed in examinations of conservation easements include:

• Failure to meet charitable contributions rules.

• Noncompliance with substantiation requirements.

• Inadequate documentation or lack of conservation purpose.

• Lack of perpetuity evidenced by deeds allowing for abandonment or termination of easement.

• Reserved property rights inconsistent with the claimed conservation purpose.

• Failure to comply with subordination rules.

• Failure to provide the donee organization with a right to proceeds in the event of termination.

• Use of improper appraisal methodologies and overvalued conservation easements.

• Failure to report income from the sale of state tax credits.