Pitfalls to Avoid with Conservation Easements
Agricultural operators and other landowners in the Rocky Mountain region may find compelling reasons to consider establishing a conservation easement on their property. For some farm and ranch owners, a conservation easement offers certainty that the family’s way of life will be preserved, at the same time providing substantial financial benefits. The success of a conservation easement, however, depends crucially on strict compliance with the requirements of both applicable state statutes and federal tax laws. If those requirements are not met or are later discovered not to comply, the conservation easement can be voided, with possibly dire consequences for the landowner.
A conservation easement can be understood at the most basic level to be a nonpossessory interest in land imposing restrictions or requirements on the possessory owner. Those burdens may include protecting the land’s natural or scenic values, assuring the land’s use for agriculture or recreation or maintaining or enhancing the property’s historical, architectural or cultural aspects. In order to qualify for a conservation easement and its tax benefits, the restriction or requirement must be granted in perpetuity.
In the wake of an enthusiastic embrace of conservation easements and their monetary incentives, the IRS has recently cracked down on tax deductions taken by easement sellers, scrutinizing the details of transactions in an effort to identify abuses. Recent cases reflect notable red flags for the IRS in conservation easement transactions, where easements have been invalidated and, in extreme cases, penalties have applied. In recent cases, conservation easements were jeopardized where sellers failed to subordinate mortgages to the easement, contemporaneous writings were absent or the boundary of the easement lands was subject to change.
The recent decision in Mitchell v. Commissioner, 775 F.3d 1243 (10th Cir. 2015) affirmed the underlying tax court holding that Mitchell, the seller of a conservation easement on 180 acres of land in Montezuma County, Colorado was not entitled to a deduction under 26 U.S.C.S. § 170(h). The lands were subject to a preexisting mortgage that was not subordinated to the conservation easement until two years after the easement sale. Before subordination, foreclosure of the mortgage rendered the easement defeasible. Subject to defeasance, the easement failed to comply with the federal mandate to protect the easement purposes in perpetuity as of the sale date. The case highlights the importance of accomplishing any necessary mortgage subordination concurrently with the establishment of the conservation easement on the mortgaged lands.
The absence of a contemporaneous written acknowledgment as required by I.R.C. §170(f)(8) may also lead to concerns, as the recent case of Irby v. Commissioner, 139 T.C. No. 14 (U.S.T.C. 2012) illustrates. I.R.C. §170(f)(8) requires a donor to receive from the donee organization a written acknowledgment substantiating the contribution of any gift over $250 in value. In this case, Irby conveyed two “bargain sale” easements to a donor on ranchland in Gunnison County, Colorado. The IRS claimed no contemporaneous written acknowledgment of the easement was provided, and the easement was therefore ineffective. The Tax Court ultimately concluded that the written acknowledgment requirement could be satisfied by a series of documents, including options, settlement agreements, letters and deeds. While the outcome was favorable to the easement seller, a better approach than mounting a tax court defense is to obtain the donor’s contemporaneous writing at the time of the easement sale.
Where boundaries of easement lands may shift, easements have been voided. In Belk v. Commissioner, 774 F.3d 221 (4th Cir. 2014), for example, the Tax Court’s denial of a charitable contribution deduction under 26 U.S.C.S. § 170(h) was upheld where the easement failed to restrict the use of the donated property in perpetuity. The case involved the donation of a conservation easement on a golf course. The easement contained a provision allowing the landowner to substitute, or “swap” land outside the easement boundaries for land within the original easement area. Although the easement provision required any swapped land to be both contiguous and approved by the land trust, the IRS challenged the deduction. The IRS claimed the easement land was not protected in perpetuity, as required by IRC § 170(h)(2)(C). The Tax Court agreed, and the Fourth Circuit upheld its decision. Similarly, in Bosque Canyon Ranch LP et al. v. Commissioner, docket numbers 1067-09 and 25946-11 in the U.S. Tax Court, a conservation easement on lands in Texas was disqualified from charitable contribution deductions where the parcel owners and the donor land trust could, under the easement provisions, modify the easement boundaries.
In sum, the importance of following applicable state and federal statutes and regulations in establishing conservation easements cannot be understated. Properly done, these real property interests can provide invaluable resources for agricultural owners and their families. Failure to be aware of and follow the rules assiduously, however, can yield an undesirable outcome.