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IRS Activity

2011 Wyoming Conservation Easement Conference Income Tax Benefits and Requirements Estate Taxes and Planning Opportunities Using Conservation Easements June 2, 2011 c. timothy lindstrom, esq. p.o. box 7622, jackson, wy 83002 ctlesq@hotmail.com. IRS Activity.

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IRS Activity

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  1. 2011 Wyoming Conservation Easement ConferenceIncome Tax Benefits and RequirementsEstate Taxes and Planning OpportunitiesUsing Conservation EasementsJune 2, 2011c. timothy lindstrom, esq.p.o. box 7622, jackson, wy 83002ctlesq@hotmail.com © C. Timothy Lindstrom 2011

  2. IRS Activity • Currently 344 easement audits open; including 84 in CO • 2005-2009 Closed audits on 1,115 easement cases; including 418 in CO • 3,500 to 4,000 easement contributions per year • Chances of audit +/- 5% based on foregoing (outside of CO) • Fifteen judicial decisions regarding easement tax compliance since 2005 Land Trust Alliance (2010) © C. Timothy Lindstrom 2011

  3. IRS Scorecard (twelve out of fifteen) Glass v. C.I.R. 124 T.C. 258 (2005) Lost Turner v. C.I.R. 126 T.C. 299 (2006) Won Goldsby v. C.I.R. T.C. Memo. 2006-274 (2006) Won Bruzewicz v. U.S. 604 F.Supp.2d 1197 (2009) Won Hughes v. C.I.R. T.C. Memo. 2009-94 (2009) Won Kiva Dunes v. C.I.R. T.C. Memo. 2009-145 (2009) Lost Herman v. C.I.R. T.C. Memo. 2009-205 (2009) Won Simmons v. C.I.R. T.C. Memo. 2009-208 (2009) Won Lord v. C.I.R. T.C. Memo. 2010-196 (2010) Won Klauer v. C.I.R. T.C. Memo 2010-65 (2010) Lost Kaufman v. C.I.R. 134 T.C. 6 (2010) Won Trout Ranch v. C.I.R. T.C. Memo 2010-283 (2010) Won Schrimsher v. C.I.R. T.C. Memo 2011-71 (2011) Won 1982 East, LLC V. C.I.R. T.C. Memo 2011-84 (2011) Won Boltar v. C.I.R. 136 T.C. No. 14 (2011) Won © C. Timothy Lindstrom 2011

  4. To be deductible conservation easements must comply with: • Internal Revenue Code section 170(h) • Treasury Regulations section 1.170A-14 • Wyoming Uniform Conservation Easement Act: W.S. Sections 34-1-201 through 34-1-207 © C. Timothy Lindstrom 2011

  5. The “Partial Interest Rule” A deduction under section 170 is generally not allowed for a charitable contribution of any interest in property that consists of less than the donor's entire interest in the property. . . Regulations section 1.170A-14(a); txt 15-16, 23-24, 77 © C. Timothy Lindstrom 2011

  6. Exceptions to the Partial Interest Rule Certain gifts in trust Remainder interest in personal residence or farm All of the donor’s undivided interest in property A “Qualified conservation contribution” “. . . a deduction may be allowed under section 170(f)(3)(B)(iii) for the value of a qualified conservation contribution if the requirements of this section are met.” Regulations section 1.170A-14(a); txt 15-16, 23-24, 77 © C. Timothy Lindstrom 2011

  7. Qualified Conservation Contributions • Contribution (includes “bargain sales”) of: • A qualified real property interest • To a qualified organization • Exclusively for conservation purposes • In perpetuity Regulations section 1.170A-14(a); txt chapter 3 © C. Timothy Lindstrom 2011

  8. Qualified Real Property Interests -- The entire interest of the donor other than a “qualified mineral interest” A qualified mineral interest is the donor's interest in subsurface oil, gas, or other minerals and the right of access to such minerals. Regulations section 1.170A-14(b)(1) -- A remainder interest in a farm or personal residence Code section 170(h)(2)(B) [not found in Regulations] -- A “perpetual conservation restriction” Regulations section 1.170A-14(b)(2); txt 25-28 © C. Timothy Lindstrom 2011

  9. Perpetual Conservation Restriction • A restriction, in perpetuity, on use of real property including an easement or other interest in real property that under state law has attributes similar to an easement (e.g., a restrictive covenant or equitable servitude) Regulations section 1.170A-14(b)(2) © C. Timothy Lindstrom 2011

  10. Importance of State Law • State real property law governs the creation, modification and termination of conservation easements; therefore: • Failure to create a perpetual restriction on the use of real property under state law may disqualify easement for federal tax benefits. Conservation easements are “easements in gross” because they do not benefit any specific property (i.e. they are not “appurtenant”) Generally, under common law, easements in gross were unenforceable. Enabling legislation has been enacted in 49 states recognizing conservation easements and pre-empting common law. • All states except North Dakota have enacted some form of authority for the creation and enforcement of perpetual conservation easements. © C. Timothy Lindstrom 2011

  11. Qualified Conservation Contributions • Contribution (includes “bargain sales”) of: • A qualified real property interest • To a qualified organization • Exclusively for conservation purposes • In perpetuity Regulations section 1.170A-14(a) © C. Timothy Lindstrom 2011

  12. Qualified Organizations • Qualified Organizations include: • Publicly supported tax-exempt organizations recognized by the IRS under Code sections 501(c)(3) and 170(b)(1)(A)(vi) (“land trusts”) • Public agencies • Governmentally-affiliated organizations Regulations section 1.170A-14(c)(1); txt 28-34 • Transfers must be limited to “qualified organizations” agreeing to carry out the conservation purposes of the easement. Regulations section 1.170A-14(c)(2); txt 39 © C. Timothy Lindstrom 2011

  13. Qualified Organizations (cont.) • A “qualified organization” must have • a commitment to protect the conservation purposes of the donation, and • the resources to enforce the restrictions. Regulations section 1.170A-14(c)(1); txt 34-35; 37-38 • LTA Standards and Practices • Accreditation Txt 38 • Land Trust Alliance: www.lta.org © C. Timothy Lindstrom 2011

  14. Qualified Conservation Contribution • Contribution (includes “bargain sales”) of: • A qualified real property interest • To a qualified organization • Exclusively for conservation purposes • In perpetuity Regulations sections 1.170A-14(d)(1) – (5); txt 39-60 © C. Timothy Lindstrom 2011

  15. Qualified Conservation Purposes: 1.Public Recreation/ Education 2. Protection of significant, relatively natural habitat for plants or animals • Protection of historic structures or land areas Regulations sections 1.170A-14(d)(1) – (5); txt 39-60 © C. Timothy Lindstrom 2011

  16. Qualified Conservation Purposes (cont.): 4. Protection of open space a. For scenic purposes and/ or b. Pursuant to a clearly delineated governmental conservation policy c. Resulting in a significant public benefit Regulations sections 1.170A-14(d)(1) – (5); txt 39-60 © C. Timothy Lindstrom 2011

  17. Two types of inconsistent use prohibitions • Inconsistent Use prohibition applicable to “open space” easements: • “A deduction will not be allowed for the preservation of open space under section 170(h)(4)(A)(iii), if the terms of the easement permit a degree of intrusion or future development that would interfere with the essential scenic quality of the land or with the governmental conservation policy that is being furthered by the donation.” Regulations section 1.170A-14(d)(4)(v) (emphasis added); txt 74-76 © C. Timothy Lindstrom 2011

  18. General inconsistent use prohibition • Inconsistent use. Except as provided in paragraph (e)(4) of this section, a deduction will not be allowed if the contribution would accomplish one of the enumerated conservation purposes but would permit destruction of other significant conservation interests. However, this requirement is not intended to prohibit uses of the property, such as selective timber harvesting or selective farming if, under the circumstances, those uses do not impair significant conservation interests. Regulations sections 1.170A-14(e)(2) and (3)(emphasis added); txt 71-74 © C. Timothy Lindstrom 2011

  19. Inconsistent Uses (cont.) • Example, the preservation of farmland pursuant to a State program for flood prevention and control would not qualify under paragraph (d)(4) of this section if under the terms of the contribution a significant naturally occurring ecosystem could be injured or destroyed by the use of pesticides in the operation of the farm. Regulations sections 1.170A-14(e)(2) © C. Timothy Lindstrom 2011

  20. Sample inconsistent use provision • The “Conservation Purposes” of this Easement are (i) to preserve the Conservation Values, and other significant conservation interests (to the extent that it is not necessary to impair such other interests in order to protect the Conservation Values), and (ii) to restrict the use of the Property to those uses that are consistent with such values and interests. © C. Timothy Lindstrom 2011

  21. Sample Inconsistent Use Provision 2 Reserved Uses: The following uses, properly undertaken, are consistent with the Conservation Purposes, and are reserved by the Grantor, subject to the condition that such uses are undertaken in a manner that is consistent with the Conservation Purposes: © C. Timothy Lindstrom 2011

  22. Qualified Conservation Contribution The Contribution (includes “bargain sales”) of: • A qualified real property interest • To a qualified organization • Exclusively for conservation purposes • In perpetuity Regulations section 1.170A-14(a); txt 61-71 © C. Timothy Lindstrom 2011

  23. Perpetuity • Amendment and Termination (txt 64-70) • Contract vs. Charitable Trust (txt 4, 64, 89-90) “§2.Creation, Conveyance, Acceptance and Duration. (a) Except as otherwise provided in this Act, a conservation easement may be created, conveyed, recorded, assigned, released, modified, terminated, or otherwise altered or affected in the same manner as other easements.” [Emphasis added.] Uniform Conservation Easement Act §2(a) (txt Appendix C) © C. Timothy Lindstrom 2011

  24. “because conservation easements are conveyed to governmental bodies and charitable organizations to be held and enforced for a specific public or charitable purpose -- i.e., the protection of the land encumbered by the easement for one or more conservation or preservation purposes -- the existing case and statute law of adopting states as it relates to the enforcement of charitable trusts should apply to conservation easements.” Uniform Conservation Easement Act comment to §3 (emphasis added) © C. Timothy Lindstrom 2011

  25. Wyoming Uniform Conservation Easement Act § 34-1-202. Creation; conveyance; acceptance and duration (a) Except as otherwise provided in this article, a conservation easement may be created, conveyed, recorded, assigned, released, modified, terminated or otherwise altered or affected in the same manner as other easements. The provisions of W.S. 34-1-141 [governing description of easement location] shall apply to this article. [Emphasis added.] § 34-1-203. Judicial action; modification; termination (a) An action affecting a conservation easement may be brought by: (i) An owner of an interest in the real property burdened by the conservation easement; (ii) A holder of the conservation easement; (iii) A person having third-party rights of enforcement, as named in the instrument creating the conservation easement. (b) This article shall not affect the power of a court to modify or terminate a conservation easement in accordance with the principles of law and equity. © C. Timothy Lindstrom 2011

  26. Wyoming Law Regarding Charitable Trusts • In the absence of special provisions in the trust instrument, the trustees have no power of their own motion to decide that it has become impossible or inexpedient to carry out the trust as originally planned and then to substitute another scheme. If the trustees feel that an emergency of this type has arisen, they should bring the situation to the attention of the court and ask for instructions. [Emphasis added]. • Town of Cody v. Buffalo Bill Memorial Association, 196 P.2d 369 (Wyo. 1948) [quoting 2 Bogert, Trusts and Trustees § 435] © C. Timothy Lindstrom 2011

  27. Charitable Trust Doctrine -- Conservation Easements A conservation easement may only be amended or terminated if: 1. Such a power is expressly reserved in the easement itself; 2. a court applies the doctrine of “administrative deviation” to alter a provision that would defeat or substantially impair the conservation purposes of the easement; or © C. Timothy Lindstrom 2011

  28. Charitable Trust Doctrine -- Conservation Easements (cont.) 3. the charitable purpose of the easement is impossible to accomplish due to changed circumstances and a court, through the doctrine of cy pres authorizes a revision or termination. Paraphrasing Nancy A. McLaughlin, Rethinking the Perpetual Nature of Conservation Easements, 29 Harv. Int’l L.J. 421, 435–436 (2005) © C. Timothy Lindstrom 2011

  29. Federal Requirements Pertaining to Amendment and Termination None of the assets of a land trust may “inure” to the benefit of any “disqualified person” (“excess benefit transactions”). Internal Revenue Code section 501(c)(3); txt 65-66 --A disqualified person is anyone in a period beginning five years before a transaction in a position to exert “substantial influence.” -- Board members, staff, “substantial contributors” more than 2% of the land trust’s annual receipts, or $5,000, whichever is greater (may include easement value). © C. Timothy Lindstrom 2011

  30. Federal Requirements Pertaining to Amendment and Termination (cont.) Consequences: --Excise tax of 25% plus repayment of benefit -- Up to $10,000 penalty on land trust managers -- Loss of exempt status Regulations section 53.4958-7; txt 65-66 © C. Timothy Lindstrom 2011

  31. Federal Requirements Pertaining to Amendment and Termination (cont.) • A land trust’s assets must be used “exclusively” for charitable purposes Internal Revenue Code section 501(c)(3); txt 66-67 • A land trust must have a “commitment to protect the conservation purposes of the contribution. Internal Revenue Code section 170(h)(3); txt 67-68 © C. Timothy Lindstrom 2011

  32. Other Regulatory Requirements: • Documentation (available prior to grant) (txt 83-85) • Donee's right to inspection (txt 86) • Donee’s right “to enforce the conservation restrictions by appropriate legal proceedings, including but not limited to, the right to require the restoration of the property toits condition at the time of the donation.” (txt 86-88) • Landowner must give notice before exercising any reserved rights that may impair the conservation interests protected by the easement. (txt 85) Regulations sections 1.170A-14(g)(5)(i) and (ii) © C. Timothy Lindstrom 2011

  33. Other Regulatory Requirements (con’t.) • Mortgages must be subordinated Regulations section 1.170A-14(g)(2); txt 70-71 • Payment of proceeds in event of of extinguishment “. . .when a change in conditions give rise to the extinguishment of a perpetual conservation restriction under paragraph (g)(6)(i) of this section, the donee organization, on a subsequent sale, exchange, or involuntary conversion of the subject property, must be entitled to a portion of the proceeds at least equal to that proportionate value of the perpetual conservation restriction. . .” Regulations section 1.170A-14(g)(6)(ii); txt 91-99 © C. Timothy Lindstrom 2011

  34. Mortgage Subordination Requirement Kaufman v. Commissioner, 134 T.C. 6 (4/26/10); 1982 East, LLC v. Commissioner, T.C. Memo 2011-84 (4/12/11) rule that conditional subordinations are not acceptable. Lender “shall have a prior claim to all insurance proceeds as a result of any casualty, hazard or accident occurring to or about the Property and all proceeds of condemnation, and shall be entitled to same in preference to Grantee until the Mortgage is paid off and discharged, notwithstanding that the Mortgage is subordinate in priority to the Agreement.” What about other matters of title that could pre-empt a conservation easement, e.g. covenants with reversionary provisions? © C. Timothy Lindstrom 2011

  35. Acceptable Subordination Forms • [Name and address of financial institution] (“Mortgagee”), present holder of a mortgage from, [donors] (“Mortgagor”), recorded on [date] in the [County] Registry of Deeds in Deed Book [ ] Page [ ], for consideration paid, hereby recognizes and assents to the terms and provisions of a Conservation Restriction running to the Conservation Trust, to be recorded herewith, and agrees to subordinate and hold its mortgage subject to the terms and provisions of said Conservation Restriction to the same extent as if said mortgage had been recorded subsequent to the recording of the Conservation Restriction, and the undersigned shall, in the exercise of its rights pursuant to said instrument, recognize the terms and provisions of the aforesaid Conservation Restriction. Compact of Cape Cod Conservation Trusts Form • The Lender hereby consents to the terms and intent of this Easement, and agrees that the lien represented by said Deed of Trust shall be held subject-to this Easement and joins in this Deed to reflect its direction to the Trustee to execute this Easement to give-effect to the subordination of such Deed of Trust to this Easement. Virginia Outdoors Foundation Form © C. Timothy Lindstrom 2011

  36. Minerals • Deductible easements must prohibit strip mining • Other forms of mining and mineral extraction must be “limited” “localized” and “not irremediably destructive of significant conservation values” Regulations section 1.170A-14(g)(4); txt 25, 77–83 © C. Timothy Lindstrom 2011

  37. Mineral Issues: • Gravel pits • Subsurface minerals • Severed minerals and easement deductions • Federal plans for BLM and other federal lands • “Carve-out” provisions • “Remoteness letter” Txt 76-85 © C. Timothy Lindstrom 2011

  38. Donative Intent Conservation buyer transactions (txt 123-128) Quid pro quo transactions (txt 118-119) Cluster developments (txt 119-120) Grants requiring easements Reciprocal contributions (txt 121-122) Qualified bargain sales (txt 6, 116-117) Sham (“collapsible”) transactions (txt 18-19) See U.S. v. American Bar Endowment, 477 U.S. 105, 106 S.Ct. 2426, 91 L.Ed.2d 89(1986); txt 16-17, 115-116 © C. Timothy Lindstrom 2011

  39. Income Tax Benefits Easement Valuation • Value of land before c.e. $1,000,000 • Value of land after c.e. (700,000) • Difference = c.e. value $ 300,000 Regulations § 1.1170A-14(h)(3) © C. Timothy Lindstrom 2011

  40. Calculating the Federal Income Tax Benefit 2011 Maximum benefit: Before c.e. value of land $1,000,000 After c.e. value of land (700,000) C.e. value $ 300,000 Maximum federal income tax rate x 0.35 Maximum federal income tax savings $ 105,000 © C. Timothy Lindstrom 2011

  41. Limitation on deductions: 2011 50% of “contribution base” (AGI) if donor’s farm income is less than 50% of all income Internal Revenue Code §§ 170(b)(1)(E)(i) and 170(b)(1)(E)(vi). 100% of contribution base if donor’s farm income is 50% or more of all income Internal Revenue Code §§ 170(b)(1)(E)(iv)(I) and 170(b)(1)(E)(vi). [Note that proceeds from the sale of a conservation easement are not “income from the business of farming”] 2012 30% of contribution base after 12/31/11 Internal Revenue Code §§ 170(b)(1)(C) and 170(b)(1)(E)(vi). © C. Timothy Lindstrom 2011

  42. Carrying deductions forward: 2011 Unused portions of deduction may be carried forward for fifteen years Internal Revenue Code §§ 170(b)(1)(E)(ii) and 170(b)(1)(E)(vi). 2012 Unused portions of deduction may be carried forward for five years Internal Revenue Code §§ 170(b)(1)(D)(ii) and 170(b)(1)(E)(vi). “Phasing” contributions © C. Timothy Lindstrom 2011

  43. Calculating the Federal Income Tax Benefit - 2011 Assume: Married filing jointly Donor income $250,000 Other contributions $50,000 Other deductions $50,000 Conservation easement deduction $500,000 Maximum charitable deduction allowed $125,000 ($500,000 x 50%) Deduction available $75,000 ($125,000 - $50,000) Taxable income prior to easement deduction $150,000 ($250,000 – $100,000) Rate on income between $75,000 and $150,000 ($64,500 @ 25%; $10,500 @ 28%) Tax savings in first year due to easement: $19,065 (25.42%) Cumulative savings over 7 years $127,101 (25.42%) © C. Timothy Lindstrom 2011

  44. Example of Operation of Current Limitations (2011) • C.e. value $ 300,000 • Donor’s annual income $ 54,000 • Annual limitation x 50% • Annual cap on c.e. deduction $ 27,000 • Sixteen-year deduction period x 16 • Total deduction cap $ 432,000 • Amount of deduction unusable $0.00 (50% level) • Amount of deduction unusable $0.00 (100% level) Example of Operation of Future Limitations (2012) • C.e. value $ 300,000 • Donor’s annual income $ 54,000 • Annual limitation x 30% • Annual cap on c.e. deduction $ 16,200 • Six-year deduction period x 6 • Total deduction cap $ 97,200 • Amount of deduction unusable $ 202,800 © C. Timothy Lindstrom 2011

  45. Application of enhanced write-off to fee contributions Contributions of qualified conservation contributions (i) In general Any qualified conservation contribution (as defined in subsection (h)(1)) shall be allowed to the extent the aggregate of such contributions does not exceed the excess of 50 percent of the taxpayer's contribution base over the amount of all other charitable contributions allowable under this paragraph. (ii) Carryover If the aggregate amount of contributions described in clause (i) exceeds the limitation of clause (i), such excess shall be treated (in a manner consistent with the rules of subsection (d)(1)) as a charitable contribution to which clause (i) applies in each of the 15 succeeding years in order of time. Internal Revenue Code §170(b)(1)(E) (h) Qualified conservation contribution (1) In general For purposes of subsection (f)(3)(B)(iii), the term "qualified conservation contribution" means a contribution- (A) of a qualified real property interest, (B) to a qualified organization, (C) exclusively for conservation purposes. Internal Revenue Code §170(h)(1) © C. Timothy Lindstrom 2011

  46. Basis Issues • Calculating the basis in a conservation easement • Adjusting the basis of easement land for the grant of an easement • Enhancement vs. larger parcel affect on basis • Allocation of adjusted basis in 1031 exchanges © C. Timothy Lindstrom 2011

  47. Basis Issues (cont.)Calculating Basis in Conservation Easements • Needed for completing form 8283 • Needed to determine limitation on first year contributions • Needed for other basis determinations © C. Timothy Lindstrom 2011

  48. Calculating Basis in Conservation Easements (cont.) • Example: Appraised highest and best use before easement: $750,000 Appraised highest and best use after easement: $250,000 Easement value: $500,000 Percentage reduction due to easement ($500k/$750k): 67% Original basis in easement property: $100,000 Basis in easement (67% x $100k): $ 67,000 © C. Timothy Lindstrom 2011

  49. Basis Issues (cont.)Basis Adjustment for Contribution Assume: 25% (Percentage of appraised “before” value represented by easement) $100,000 (Unadjusted basis in easement land) Basis adjustment: $100,000 – (25% x $100,000) = $75,000 Additional amount subject to gain on sale of easement land: $25,000 ($100,000 - $75,000) Additional tax if easement land sold: = $3,750 (15% x $25,000) Regulations §1.170A-14(h)(3)(iii) © C. Timothy Lindstrom 2011

  50. Basis Issues (cont.)Like-kind exchange example • Taxpayer bargain sells conservation easement for $200,000. • Easement value is $500,000. • Deduction = $300,000 ($500,000 – $200,000) • Percentage of easement value = to purchase price 40% ($200,000/$500,000) • Basis in easement property $50,000. • Appraised f.m.v. of easement property before easement = $900,000 • % of f.m.v. equal to easement 56% ($500,000/$900,000) • Basis in easement $28,000 (56% x $50,000) • Basis carried over to exchange property $11,200 ($28,000 x 40%) © C. Timothy Lindstrom 2011

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