Are you a landowner who has donated a conservation easement? If so, your charitable deduction may be at risk if the deed is not modified to include the safe harbor language prescribed by the Internal Revenue Service (IRS) by the deadline of July 24, 2023.
When a landowner donates a qualified real property interest exclusively for conservation purposes made in perpetuity, it is considered a "qualified conservation contribution." This lowers the property's value for federal tax purposes and reduces estate tax liability.
Typically, if a donor gives less than their entire interest in a property, they can't claim a charitable contribution deduction. However, there is an exception for the contribution of real property, including an easement, for conservation purposes to a charitable organization, as long as the purposes are protected forever. In some cases, the easement may no longer be practical for conservation purposes, and it might have to be removed.
If this happens, a judicial proceeding is the only way to extinguish the perpetual conservation restriction, but only if unexpected changes to the property's conditions have made it impossible or impractical to continue using the property for conservation purposes. The Treasury regulation regarding easement extinguishments is found in Section 1.170A-14(g) of the Internal Revenue Code. This Section provides guidance on the tax treatment of charitable contributions of easements and the effects of extinguishing easements that were previously donated for conservation purposes.
Of significant note, the regulations regarding the extinguishment of conservation restrictions require the donor to agree, at the time of the donation, that the gift of the perpetual conservation restriction creates a property right vested in the donee with a fair market value (“FMV”) that is at least equal to the proportionate value of the restriction in relation to the whole property's value at the time of the donation (referred to as the "proportionality requirement"). The donee's proportionate value of the property right must remain constant, and as such, the donee must be entitled to receive a portion of the proceeds from the extinguishment that is at least equal to the proportionate value of the restriction. Thus, the donee must have a right to receive the extinguishment proceeds multiplied by the following fraction: the restriction’s value at the time of the gift divided by the whole property’s value at the time of the gift.
The regulation holds that a tax deduction from a conservation easement would be blocked if the easement deed reserves for the donor the value of post-donation property improvements in its specification of how proceeds from selling the property should be divided between the donor and recipient if a judge later extinguishes the easement. The regulation spurred legal challenges from taxpayers, which made their way past U.S. Tax Court and through to the appellate courts.
The Treasury Department and the Internal Revenue Service have issued Notice 2023-30, which provides safe harbor deed language for extinguishment and boundary line adjustment clauses as required by the SECURE 2.0 Act of 2022. The Notice is aimed at making it easier for taxpayers to comply with the regulations and provides a standardized approach to the extinguishment and boundary line adjustment of easements. The Notice provides two separate safe harbor clauses for use in conservation easement deeds, one for extinguishment and another for boundary line adjustments. Taxpayers who use these clauses in their deeds will be deemed to have satisfied the requirements of the Treasury regulations. However, despite the efforts of the Treasury Department and the Internal Revenue Service to provide clarity on the tax treatment of easements, there is still a split between the Sixth and Eleventh circuit courts of appeals over the Treasury regulation regarding easement extinguishments.
In 2020, the Sixth Circuit Court of Appeals ruled that the Treasury regulation was valid and enforceable under Oakbrook Land Holdings LLC v. Commissioner. However, in 2021, the Eleventh Circuit Court of Appeals reached the opposite conclusion in Hewitt v. Commissioner, holding that the regulation was invalid and "procedurally defective” because the IRS failed to respond to a significant comment concerning the post-donation improvements issue as to proceeds. The Court thus concluded that the IRS’ regulation to disallow the subtraction of the value of post-donation improvements to the easement property in the extinguishment proceeds allocated to the done to be arbitrary and capricious and therefore invalid.
The determination by the Eleventh Circuit in Hewitt v. Commissioner that the Treasury regulation is invalid has significant implications for taxpayers with easements located in Florida, Georgia, and Alabama. Without the support of the Treasury regulation, the IRS may have a harder time challenging the tax treatment of easement donations based on the extinguishment of easements or boundary line adjustments.
However, it is important to note that the IRS may still challenge the tax treatment of easement donations based on other grounds, such as the specific language used in the easement deed or the valuation of the easement donation. Taxpayers in these states should consult with qualified professionals to ensure that their easements are structured and valued in compliance with applicable laws and regulations.
For additional information or questions regarding conservation easements or updating deed language, we urge you to contact the authors of this article or a representative of Jones Foster here.
Rachel Sears is a member of both the Corporate & Tax and Private Wealth, Trusts & Estates practice groups. She concentrates her practice in the areas of estate planning, trust and estate administration, and corporate law and provides counsel to personal representatives, trustees, and beneficiaries in probate and trust administration, guiding them through the legal and personal challenges that can be involved in administering an estate.
Rachel also advises clients on corporate transactions, including transfers of business interests, LLC creation, mergers and acquisitions, and corporate restructuring, and handles the drafting of comprehensive legal documents to ensure that her clients’ interests are protected at every stage of the transaction process.
Rachel is actively involved in several industry organizations, including The Florida Bar’s Real Property, Probate & Trust Law Section and Young Lawyers Section, the Palm Beach County Bar Association’s Young Lawyers Section, the American Bar Association’s Real Property, Trust & Estate Law Section, and the East Coast Estate Planning Council.
David Bowers, Chair of Jones Foster's Private Wealth, Trusts & Estates and Corporate & Tax Practice Groups, has over thirty years of experience in complex tax, trusts and estates, and business planning. David is a Florida Bar Board Certified specialist in Tax and has extensive experience in estate planning, pension and profit-sharing plans, non-qualified deferred compensation plans, and business transactions.
David has a unique ability to take complex tax concepts and make them understandable. He leverages his knowledge to develop practical solutions for his clients, many of whom he has developed decades-long relationships with as a trusted legal advisor in all aspects of their individual, family, and business needs.
David has held leadership roles in several industry organizations. He is currently Chair of the Florida Tax Institute as well as an Operating Board Member and served as a past Chair of The Florida Bar’s Tax Section, The Florida Bar’s Tax Law Certification Committee, and the Palm Beach Tax Institute.
Jones Foster is a commercial and private client law firm headquartered in West Palm Beach, Florida. Established in 1924, the Firm has served as an integral part of South Florida’s growth and prosperity for nearly a century. Through a relentless pursuit of excellence, Jones Foster delivers original legal solutions that help clients, colleagues, and the community to move forward. The Firm’s attorneys focus their practice in Real Estate, Litigation & Dispute Resolution, Private Wealth, Trusts & Estates, Corporate & Tax, and Land Use & Governmental. For more information, please visit www.jonesfoster.com.