Gifts of Conservation Easements and Other Interests in Real Property for Conservation Purposes in Virginia
Importance of Conservation in Virginia. Conservation is important to Virginians. Virginia's constitution states that the Commonwealth's policy is to conserve, develop, and utilize its natural resources, and to protect its atmosphere, lands, and waters from pollution, impairment, or destruction, for the benefit, enjoyment, and general welfare of the people of the Commonwealth.1
At least since 1962, easements in gross,2 whether affirmative or negative, have been recognized as interests in real property in Virginia and have been transferrable by deed or by will.3 The laws of Virginia in 1973 recognized as valid a negative easement in gross created for the purpose of land conservation and historic preservation. In 1988, the Virginia legislature enacted the Virginia Conservation Easement Act (the "VCEA").4 The Virginia Supreme Court has said that the apparent purpose of the VCEA was to codify and consolidate the law of conservation easements to promote the granting of such easements to charitable organizations.5 The VCEA provided a clear statutory framework under which tax exemptions were made available to charitable organizations devoted to those purposes, and tax benefits and incentives were provided to the grantors of such easements.6
The VCEA applies to conservation easements held by "holders". A "holder" is a charitable corporation, charitable association, or charitable trust which has been declared exempt from taxation pursuant to 26 U.S.C.A. §501(c)(3) and the primary purposes or powers of which include: (i) retaining or protecting the natural or open-space values of real property; (ii) assuring the availability of real property for agricultural, forestall, recreational, or open-space use; (iii) protecting natural resources; (iv) maintaining or enhancing air or water quality; or (v) preserving the historic, architectural or archaeological aspects of real property.
The Open Space Land Act7 applies to public bodies. A public body is a state agency having authority to acquire land for a public use, or any county or municipality, any park authority, any public recreational facilities authority, any soil and water conservation district, any community development authority formed pursuant to Article 6 of Chapter 51 of Title 15.2 or the Virginia Recreational Facilities Authority.8 The Open Space Land Act defines the term "open-space easement" but never uses the term in the act itself. The Open Space Land Act gives public bodies the authority to acquire title to or any interests or rights of not less than five years' duration in real property that will provide a means for the preservation or provision of open-space land and designate any real property in which it has an interest of not less than five years' duration to be retained and used for the preservation and provision of open-space land.
The Open Space Land Act is an enabling statute. Public bodies, such as the Virginia Department of Conservation and Recreation, that otherwise have authority under another statute to acquire property do not necessarily have to acquire land under the Open Space Land Act. The Open Space Land Act allows public bodies, who otherwise are not given authority by statute, to acquire interests in property to preserve open space land.
What Is a Conservation Easement? A conservation easement is an interest in real estate. It can protect the real estate's natural resources, natural or open-space, air or water quality, architecture or archaeological aspects. It can also assure the property's availability for agricultural, forestal, recreational, or open-space use.
The terms of the easement are described in a deed. In the deed, the landowner gives another person the right to do certain things on the land or the landowner may agree to do certain things, or not do certain things the landowner could otherwise do, in order to conserve the property.
Under the VCEA,9 a conservation easement is not valid if the limitations or obligations in the easement do not conform, in all respects, to the comprehensive plan10 at the time the easement is granted for the area in which the real property is located. Similarly, under the Open Space Land Act, the use of the real property for open-space land must conform to the official comprehensive plan for the area in which the property is located.
Tax Benefits. The making of a charitable gift always requires charitable intent. Although there are some tax benefits that result from a charitable gift, the underlying premise of a gift to charity is the transfer of something of value for public benefit without compensation. No charitable gift should be made without this understanding, and no charitable gift will receive any tax benefit without this charitable intent. The gift will be permanent. If for some reason the tax benefits are disallowed, there is no way to take the gift back and recapture what has been given up.
If a person makes a gift of an interest in land located in Virginia for conservation purposes to a qualified charity, the person may be entitled to a federal charitable deduction under section 170 of the Internal Revenue Code and to Virginia land preservation tax credits under section 58.1-512 of the Code of Virginia.
Federal Tax Benefits. Charitable contributions may be allowed as a federal tax deduction. Generally, an individual's federal charitable deduction is limited to 50%, 30% or 20% of his or her contribution base.11 ("Contribution base" is essentially the same as adjusted gross income.) A gift of an interest in real estate (that would have resulted in capital gain to the donor on sale) to a public charity or a governmental unit is allowed to the extent it does not exceed 30% of the donor's contribution base, with a five-year carryover.12 In 2011, if the gift qualifies as a "qualified conservation contribution", then the limitation is 50%, with a 15-year carryover.13
A qualified conservation contribution must be a partial interest in real estate.14 Three interests in real estate qualify as qualified conservation contributions: (1) the taxpayer’s entire interest less a qualified mineral interest, (2) a remainder interest, and (3) a restriction (granted in perpetuity) on the use which may be made of the real property (e.g. a conservation easement).15 Treasury Regulations provide that the value of the taxpayer’s entire interest less a qualified mineral interest is the value of the surface rights.16 The value of a remainder interest is determined under IRS tables.17 The value of a perpetual conservation restriction is, practically speaking, the value of the real property before the gift less the value of the property after the gift.18 A qualified appraiser values the gift.
Land Preservation Tax Credits. Under Virginia law, a gift of an interest in land for conservation purposes entitles the donor of the land to a land preservation tax credit (“credit”) equal to 40% of the value of the gift.19 This is in addition to any charitable deduction. After the gift is made by recording the deed, the donor applies to the Virginia Department of Taxation, using form LPC-1, for credits. Until the Department of Taxation issues the credits, the credits cannot be used or transferred.
The Department of Taxation may seek to reduce the credits either before (a "pre-audit") or after it issues the credits. The authority for a pre-audit is new (as of July 2011). Before pre-audits, the Department of Taxation would examine a gift when it audited the income tax return of a taxpayer who used on that return a credit that was already issued with respect to that gift. With a pre-audit, the Department of Taxation can order its own appraisal before issuing the credits.20 The Department of Taxation has 30 days from the time the LPC-1 is filed to notify the donor if it intends to order its own appraisal.21 The Department of Taxation can withhold the issuance of credits until it and the donor agree on the proper value of the gift or the fair market value is determined by adjudication in court.22 A limited number of credits are issued each calendar year. A donor's place in line for the credits is determined by when the donor's application for the credits (Form LPC-1) is complete. Credits are issued in the order of when complete applications are received.23 If the Department of Taxation does not order its own appraisal, applications are deemed complete in the order filed. If the Department of Taxation orders its own appraisal, the application is not complete until the Department of Taxation has finally determined the fair market value of the donation.24 If the Department of Taxation rejects the donor's valuation, and if the donor appeals this decision, the donor's place in line for the credits may be postponed until the value is finally determined by a court.25 Because a donor's place in line and the right to receive credits can be postponed, donors who are selected for a pre-audit risk the possibility that changes in the law will affect their receipt of credits.
The credits are transferable.26 The credits are transferred by filing a form LPC-2 with the Virginia Department of Taxation. The transfer of the credits is subject to a 5% transfer fee.27 If the credits are held by a pass-thru entity, the entity will pay the transfer fee to have the credits allocated among the owners of the pass-thru entity. The pass-thru entity itself can retain the credits and transfer the credits to third parties.
The value of the credits depends on many factors. The person who purchases the credits cannot use the credits for tax years before the year in which the credits were purchased. For example, a credit purchaser buying on January 1, 2011, credits issued in 2010, must wait to use the credit on his or her 2011 tax return. If instead the credit purchaser had purchased the credits on December 31, 2010, the credit purchaser could use the credits on his 2010 tax return. Therefore, the market for credits tends to be strongest in the last quarter of each calendar year. Consequently, a donor may receive its credits early in the year and find there is less demand for the credits until later in the year.
If the donor sells his or her credits, the donor will likely be required to indemnify and hold the purchasers of the credits harmless in the event any or all of the credits are reduced or denied by the Department of Taxation. The donor may also be required by the purchaser of the credits to place a portion of the sale proceeds in escrow for three or more years as security.
The IRS may audit the gift for federal tax purposes. An adjustment in the value of the gift made by the IRS may require the donor to notify the Department of Taxation. Virginia taxpayers have an obligation to notify the Department of Taxation within one year of any IRS adjustment to a return. The Department of Taxation could then adjust the amount of credits.
Use of the credit by the landowner himself or herself does not cause recognition of any income for federal or state tax purposes.28 There is no gain or loss from the transfer of land preservation tax credits under Virginia law.29 Under federal law, a landowner who sells his or her credits recognizes income on the sale of the credits.30 The gain is capital gain.31 It is short term capital gain if the credits are sold within one year of receipt of the credits.32
Getting Started. Experienced advisers can assist persons interested in making a gift of an interest in land for conservation purposes. The following will need to be considered:
Donee. The donor must select the recipient organization. The organization must be a charitable organization. More specific requirements will apply depending on the type of gift and tax benefits desired.
Deed. The terms of the gift must be negotiated with the donee. The gift must be made for conservation purposes, which include (i) the preservation of land areas for outdoor recreation by, or the education of, the general public, (ii) the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem, and (iii) the preservation of certain open space (including farmland and forest land). The donee must agree to hold the property for at least one of these purposes, and the donor must decide for which of these purposes the gift will be made.
In addition, to qualify for land preservation tax credits for gifts valued at more than $1,000,000, the Virginia Department of Conservation and Recreation must verify that the gift has conservation value. For example, a conservation easement on a golf course or private beach may not have conservation value.33 The donor qualifies for Virginia land preservation tax credits only if the Department of Conservation and Recreation determines that the property has conservation value to protect.34
Lender Approval. Anyone with a security interest in the property must release or subordinate the security interest in the property. Lenders may substitute for collateral the land preservation tax credits. Loan documents may need to be renegotiated and modified.
Appraisal. A qualified appraiser determines the fair market value of the donation.
Disclaimer: The foregoing shall not be construed as legal or tax advice and does not create an attorney-client relationship. This communication is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that the Internal Revenue Service may impose on the taxpayer or for promoting, marketing or recommending to another party any transaction or other matter addressed herein. The law is subject to change and its application to any particular situation requires competent legal advice.
1 Virginia Constitution, Article XI.
2 An easement in gross is an easement that is personal and not tied to adjacent land.
3 See United States v. Blackman, 270 Va. 68 (2005).
4 Va. Code Ann. § 10.1-1009 et seq.
5 See United States v. Blackman, 270 Va. 68 (2005).
6 See id.
7 Va. Code Ann §10.1-1700, et seq.
8 Va. Code Ann. §10.1-1700.
9 Va. Code Ann. § 10.1-1009 et seq.
10 A comprehensive plan is adopted by the governing body of a locality that shows the locality's long-range recommendations for the general development of the territory covered by the plan. For example, it may designate certain areas for various types of development and use, such as residential, business, industrial, agricultural or conservation.
11 Internal Revenue Code §170(b).
12 Internal Revenue Code §170(b)(1)(C).
13 Internal Revenue Code §170(b)(1)(E).
14 In a private letter ruling, which has no precedential value, the IRS ruled that the contribution of a fee interest to charity is not a “qualified conservation contribution”. PLR 8626029. However, in Forte v. Commissioner, TC Memo 1991-36, the taxpayers contributed a fee simple interest in real estate to the New Hampshire Fish and Game Department. The taxpayer and the IRS stipulated that the gift was a qualified conservation contribution.
15 IRC §170(h)(2).
16 Treasury Regulation §1.170A-14(h).
17 Treasury Regulation §1.170A-14(h).
18 Treasury Regulation §1.170A-14(h).
19 Virginia Code Ann. §58.1-512.
20 Virginia Code Ann. §58.1-512(4)(a) (effective July 1, 2011).
21 Virginia Code Ann. §58.1-512(4)(a) (effective July 1, 2011).
22 Virginia Code Ann. §58.1-512(4)(a) (effective July 1, 2011).
23 Virginia Code Ann. §58.1-512(4)(a) (effective July 1, 2011).
24 Virginia Code Ann. §58.1-512(4)(a) (effective July 1, 2011).
25 Virginia Code Ann. §58.1-512(4)(a) (effective July 1, 2011).
26 Virginia Code Ann. §58.1-513(C).
27 Currently, the Department of Taxation prorates the transfer fee. (See Tax Form LPC-2.) The statute itself does not prorate the fee. For example, suppose taxpayer A donates property worth $1,000,000. A receives credits of $400,000. Two percent of $1,000,000 is $20,000. If A wants to transfer five thousand ($5,000) dollars of credits to another taxpayer, the statute literally requires that A pay a fee of $20,000 (being 2% of the value of the $1,000,000 donated interest). Suppose the next year A then transfers another $5,000 of credits to another taxpayer. The statute requires that A pay a fee of $20,000 again. Instead, suppose A transfers at one time all $400,000 of credits, $100,000 each to four different taxpayers. The fee may be $20,000 (if this is treated as one transfer) or it may be $80,000 (if it is treated as four separate transfers - $20,000 for a transfer to each of the four taxpayers). Under current policy, A would only pay a fee of 5 cents on each credit transferred. For example, under current policy, if A transfers five thousand dollars of credits, the fee is $250 (i.e. 5% of 5,000). There is a minimal risk that the Department of Taxation could change its policy.
28 Chief Counsel Advice 200211042 (Feb. 5, 2002); cf. Va. Code Ann. §58.1-513(E).
29 There is no gain or loss from the transfer of land preservation tax credits under Virginia law. Va. Code Ann. §58.1-513(E).
30 See Tempel v. Comm'r, 136 T.C. No. 15 (2011); McNeil v. Comm'r, TC Memo 2011-109.
31 See id.
32 See id.
33 Virginia Land Conservation Foundation, Land Preservation Tax Credits – Conservation Value Review Criteria, Adopted November 21, 2006 and amended August 7, 2008 and March 27, 2009.
34 Va. Code Ann. §58.1-512(D)(3).
