Income and Estate Taxes
Tax incentives help many landowners take advantage of conservation opportunities. This chapter offers examples of income and estate tax reductions from donating land or conservation easements. The tax effects of your conservation plan will depend on the gift’s value, your financial circumstances, and other factors, so consult with an experienced attorney and accountant.
Tax discussions in this chapter reflect federal and Maine tax law as of February 2003. Since changing political winds invariably reshape tax systems, you should seek the most current information from reliable advisors.
Landowners whose gifts meet federal tax guidelines can enjoy significant tax benefits by donating land and easements. photo: Sara Gray
To qualify for a tax deduction, your donation must be considered a charitable gift by the Internal Revenue Service (IRS). Review the proposed gift with an experienced attorney or accountant to determine whether it meets IRS requirements.
A deductible charitable donation can be made only to an IRS-qualified, tax-exempt organization. It must be considered a true gift motivated by charitable intent and not granted to get something in return. For example, a conservation easement donated by a developer in exchange for government approval of a subdivision is not considered a gift.
A gift must also be complete and irrevocable, without strings or contingencies. If donors specify that land will revert to their family if mismanaged, their donation is not deductible. However, they can name alternate charitable gift recipients.
For a gift of land to be deductible, the owner must transfer his or her entire interest in the land (with special exceptions for conservation easements, remainder interests and undivided partial interests). Rent-free leases, for example, are not deductible. A landowner who donates property but retains a private right to use it will lose the income tax deduction for that gift and the land trust receiving the gift may not qualify for property tax exemption.
For tax deductions on gifts worth more than $5,000 (other than cash and publicly traded securities), landowners must substantiate the value with a “qualified appraisal” by a “qualified appraiser.” (These terms are defined by the IRS; check with your attorney or accountant for details.) If you plan to give a conservation easement, consult with a professional appraiser who has direct experience with charitable easement gifts. A conservation organization can refer you to experienced appraisers but cannot provide the appraisal. The appraisal cost is a necessary expense if you want to pursue a charitable tax deduction.
Federal Income Tax Deductions
The 30-percent Limitation
Federal income tax law limits the maximum annual charitable deduction that a donor can take. For combined gifts of appreciated property (which include most gifts of land and conservation easements), the amount you can deduct in one year is generally limited to 30 percent of your adjusted gross income (AGI). If your gift’s value exceeds that level, you may carry forward the excess for up to five years (applying the 30 percent limit each year). Any portion of the deduction that remains after the sixth year cannot be used.
Special Deduction Limits for Conservation Easement Donations
In 2006, Congress passed legislation to temporarily enhance the tax benefits associated with the donation of conservation easements. The legislation raised the income tax deductions donors can take for donated easements from 30% of their adjusted gross income in any year to 50%; extended the carry-forward period for donors to take deductions from 5 to 15 years; and allowed qualifying farmers, ranchers, and forest landowners to deduct up to 100% of their income each year. The legislation had a sunset date of December 31, 2007, but in 2008 Congress extended the provisions with a second sunset date of December 31, 2009. In December of 2010, Congress extended the provisions once again, this time until December 31, 2011. The Land Trust Alliance is leading an effort to make these conservation tax provisions permanent. For more information on this subject matter visit the Land trust Alliance website.
Effect of the 30-percent Election
A landowner donates a conservation easement valued at $80,000 to a land trust. His adjusted gross income in the year of the gift is $50,000. Assuming that this is his only gift and his income remains constant, he could use the charitable deduction resulting from the easement as follows:
30 percent of $50,000 =$15,000
Note that if the landowner’s gift was worth more than $90,000, he would not have been able to use up the entire deduction. To spread the deduction out over a longer time period, he might choose to grant an easement on part of the land initially, while making a legally binding pledge to protect the remaining land in stages.
The 50-percent Election
Another approach involves claiming as a deduction only the appreciated property’s basis (usually the original purchase price or its value when inherited, rather than the current fair market value). An annual deduction of up to 50 percent of adjusted gross income is allowed, with any excess carried forward at 50 percent of AGI for five additional years.
Where property has appreciated greatly, the 30 percent option may be more advantageous. The 50 percent election is most appropriate for taxpayers whose property has appreciated little, who anticipate a large drop in income, who recently purchased or inherited land, or who do not expect to live to take advantage of the full five-year carry-forward period.
Some of the costs incurred in making a charitable deduction are themselves deductible. Legal and appraisal fees can generally be deducted (as costs of securing a tax deduction, not as charitable donations) if, in combination with other permitted deductions, they exceed 2 percent of your adjusted gross income. Any cash or securities given to endow stewardship of a conserved property are deductible as charitable contributions.
State and Federal Estate and Gift Taxes
State and federal estate and gift taxes, based on a property’s fair market value at the time of the landowner’s death, are levied on amounts above specified exemptions and exclusions for gifts to spouses and charities. The taxes run upwards of 35 percent and are due within nine months of the death. Maine levies an estate tax on land located within its borders, regardless of where the owner lived. The federal estate tax return grants credit for the full amount of estate tax paid to Maine, so the combined tax does not exceed the amount that would be owed in federal tax if Maine had no separate estate tax. If your legal residence is outside Maine, check on your state’s estate or inheritance tax rules.
As the Conservation Easement section demonstrates, placing a conservation easement (either during your lifetime or by will) lowers your land’s value in your estate. Income deductions are limited, but no such restrictions apply to estate tax savings so they can be even more advantageous for donors. Further information on estate tax savings can be found in Stephen Small’s book series on Preserving Family Lands (see Appendix F).
Under the Tax Reconciliation Act of 2001, the value of assets that can be transferred free of any estate tax (beyond gifts made to spouses or charities, which are not taxed) will increase from $1 million in 2002, to $1.5 million in 2004, to $2 million in 2006, and to $3.5 million in 2009.
The highest rate of estate and “generation-skipping transfer” tax under the new act will be 50 percent, applied to estates valued at over $2.5 million. This rate will decrease by one percentage point each year until 2007 when it reaches 45 percent, where it will stay until 2009. All of these new estate tax provisions will be repealed on January 1, 2010–resurrecting the previous system–unless Congress acts to extend the new plan or institutes another plan.
The new tax act uncouples the gift tax from the estate tax. The gift tax exemption is now $1 million and will remain at that level indefinitely. There is no limit, as before, on gifts made to spouses or charities. In addition, lifetime gifts of up to $11,000 a year can be given to any number of individuals ($22,000 if spouses give jointly) without gift or estate tax liability. The top gift tax rate on taxable gifts more than $2.5 million, now 50 percent, will decline at the same rate as the estate tax diminution through 2009. By 2010, the highest gift tax rate will be equivalent to the highest income tax rate (currently planned to be 35 percent).
The 30-percent Limitation versus the 50-percent Limitation
A couple donates property with an appraised value of $200,000 that they bought three years ago for $175,000. Their combined adjusted gross income is $70,000 and they have deductions and personal exemptions of $8,500.
|Year||Item||50% Limitiation||30% Limitation|
|Value of gift||$175,000 (basis)||$200,000|
|Adjusted gross income||70,000||70,000|
|Charitable deduction (50% or 30% of income)||-35,000||-21,000|
|Other itemized deductions||-8,500||-8,500|
|Tax payable (from IRS tables)||3,975||7,473|
|Annual Tax savings (versus no gift)||9,378||5,880|
|Adjusted gross income||70,000||70,000|
|Deductions and personal exemptions||-8,500||-8,500|
|Tax savings (versus no gift)||0||5,880|
|Six-year Tax Savings||46,890||35,280|
The 50-percent election provides more tax savings in this case because their basis in the property ($175,000) is close to the current appraised value and they could use the higher annual deduction that results from the 50-percent option. If their income were to decline over the six years, though, the results would differ.
More Ways to Reduce Estate Taxes through Conservation
The Taxpayer’s Relief Act of 1997 created a new estate tax program, Internal Revenue Code–2031(c), to help families keep protected land. If a person dies owning land that has been in the family at least three years and is subject to a qualified conservation easement (placed by the owner prior to his demise, his executor or heirs), up to 40 percent of the restricted land’s value can be excluded from estate tax. There are complex rules to follow and exclusions to calculate, and the election will reduce the property’s basis when heirs take title, but savings from this exclusion can be significant (up to $500,000).
The tax benefits are available even when land is held by a partnership, corporation or trust, provided that the deceased person owned at least 30 percent of the entity. Commercial farming and forestry are allowed, but the exclusion is not available if significant commercial recreational activity occurs on the land. The 40 percent reduction applies only to undeveloped conserved land, not to areas that retain development rights. If the property is subject to a mortgage, only the net equity in the land (not counting the value of the structures) is eligible for tax benefits under IRC 2031(c).
Another part of Section 2031(c), known as a post-mortem election, permits heirs to donate or amend a conservation easement on the land they inherit in order to qualify for or increase benefits available under the 2031(c) election.
To secure benefits under these provisions, an easement must be placed on the land before estate taxes are filed (generally within nine months of the landowner’s death). The time for amending an existing qualified easement is two years, providing that a binding pledge to do so is signed by the heirs within nine months of death.
While post-mortem provisions can benefit conservation and reduce inheritance taxes, they are no substitute for good estate planning. A lifetime gift is the most advantageous since it can provide substantial income tax benefits that are not available if the easement is granted by will or post-mortem. Post-mortem donations also can be thwarted by disagreement among heirs or by limits that state probate law places on an executor’s power.