October 3, 2014
Authored by: Andrew Bleyer
The increasingly popular conservation easement charitable deduction allows a landowner to deduct a portion of the value of a piece of land by limiting the land’s use. In a typical scenario, a landowner records a conservation easement on the land and then donates the conservation easement to a conservation organization. The landowner receives an appraisal of the value of (i) the developable land and (ii) the land once the conservation easement has been recorded. The landowner then deducts the difference as a charitable contribution. In such a scenario, Section 170 of the tax code allows a deduction as long as the easement is perpetual, made to a qualified organization, and for a valid conservation purpose.
The typical scenario is changing, however, as more and more landowners are holding their property in trust. When the land is held in trust, it is more difficult to deduct a conservation easement.
If it is not a grantor trust the charitable deduction will not flow through to the beneficiary. The trust itself may take the charitable deduction, but only if it meets the more onerous requirements of Section 642(c). Under Section 642(c), a trust is allowed a deduction for a charitable contribution only if three requirements are met.
- Qualify as charitable under Section 170
- Be authorized by the terms of the trust, and
- Be made out of the gross income of the trust.
Although a conservation easement could conceivably meet the first two requirements, it is not clear whether a conservation easement could ever be made out of the gross income of a trust.
A non-grantor trust is allowed a charitable deduction only to the extent that the contribution was paid, used, or permanently set aside from the gross income and not the corpus of the trust. The line between gross income and corpus was famously set in the Frank case in 1931.
In that case, several trusts exchanged original principal for securities and then gifted those securities, in kind, to charitable beneficiaries. Each trust then deducted the fair market value of the securities from its gross income. The W.K. Frank Trust, for example, deducted $14,322.50 in contributed securities from its $74,198.03 of gross income.
Notwithstanding the fact that the trusts had sufficient taxable income from which to deduct the contributions, the court disallowed the deductions because the contributions were traceable to the principal and not the gross income of the trusts. The court conceded that if the trusts had sold the securities and recognized capital gains on the sale, they could have contributed the resulting capital gains to charity and taken a deduction. However, because the securities were exchanged directly for the original principal of the trusts, no part of the charitable contributions were out of the gross income of the trusts and thus no part of the contributions could be deducted.
Land held in trust is necessarily part of the principal of that trust, whereas, if the land were sold then any gain would be gross income to the trust. The question in the case of a conservation easement is whether the donation is simply a contribution of principal or more similar to a sale of the land and donation of the proceeds.
The IRS considered precisely this issue in Revenue Ruling 2003-123. There, a trust with gross income of $20x granted a conservation easement, valued at $10x, in property it held since the inception of the trust. The easement qualified as a charitable contribution according to Section 170(h) and the contribution was authorized by the trust. Nonetheless, the IRS did not allow a charitable deduction.
The Ruling explained that under 642(c) a trust is allowed a charitable deduction “only if the source of the contribution is gross income.” Because the conservation easement was granted in property owned by the trust, it was from principal and not from gross income. For that reason, the trust was not allowed a charitable deduction.
Further, because it was not a grantor trust, the deduction did not pass through to the beneficiaries. In the end, no one was able to claim the deduction for the conservation easement. The clear message from this ruling is that a conservation easement must be carefully planned to qualify for a charitable deduction. If you are planning on permanently limiting the use of your land, make sure you check with a qualified tax attorney to avoid getting stuck with a non-deductible conservation easement.