THE CONSERVATION EASEMENT

AS A PLANNING TOOL

Thomas N. Masland, Esq.

Ransmeier & Spellman, Professional Corporation

One Capitol Street P. O. Box 600

Concord, New Hampshire 03302-0600

(603) 228-0477

e-mail: tom@ranspell.com

I. INTRODUCTION: What is a conservation easement

A. A conservation easement is a conveyance by deed of certain interests in real estate by the landowner to a qualified organization or agency that permanently restricts and proscribes commercial and industrial development and limits certain other uses of the land, including residential development, to protect open space and natural resources. Conservation, agricultural and historic preservation easements, or restrictions, are authorized by NH RSA 477: 45-47.

1. The advantages of a conservation easement to a family can include:

a. It leaves the property in the ownership of the landowner, who may continue to live on it, sell it or pass it on to heirs, as well as to reap economic benefits through forestry and agricultural uses.

b. It can significantly lower estate taxes–sometimes making the difference between heirs being able to keep land in the family and their needing to sell it.

c. A conservation easement deed can be a flexible document, and can be written to meet the particular needs of the landowner’s family while protecting the property’s resources.

d. It is permanent, and remains in force when the land changes hands.

e. The donation of an easement may result in a federal income tax deduction.

B. Property with significant conservation or historic preservation values can be protected by an easement, including forestland, farms and agricultural lands, wetlands, wildlife and endangered species habitat, and scenic areas.

C. A conservation easement can be granted to:

1. A public agency, such as:

a. Federal — US Forest Service, US Fish & Wildlife Service

b. State — Dept. of Resources and Economic Development, NH Fish & Game

c. Local municipality — most often through the Conservation Commission

2. A private nonprofit land trust, such as:

a. National — The Nature Conservancy, American Farmland Trust

b. Statewide — Society for the Protection of NH Forests, Audubon Society of NH

c. Regional — Monadnock Conservancy, Upper Valley Land Trust, Rockingham Land Trust

d. Local — Squam Lakes Conservation Society

II. THE CONSERVATION EASEMENT AS A PLANNING TOOL

A. A conservation easement will be a tool for family real estate where the property includes significant acreage that can be protected as open space, significant natural resource value or endangered species habitat, significant scenic values, working forest land, or other attribute the protection of which will provide a “public benefit”, as will be discussed in greater detail in this outline. It is may be a tool for cottages with adjoining undeveloped land (even as small as an acre or two), but is generally not an appropriate tool for small lakeshore lots, or other properties without excess acreage.

B. The conservation easement provides open space and natural resource protection, and generally prohibits commercial uses except for forestry and agriculture.

C. The economic value of the land may bear no relation to the “value” of the land to the family: The cottage and land along the Lake is still the “rustic camp”, and not considered an asset valued at its potential “retail” market price, to those who have used and loved it for three generations; the working forest or farm might have greater economic value as a commercial development.

D. The economic value of the land may cause estate and wealth transfer tax problems to the matriarch and patriarch. The classic problem has been the “forced” sale of the family property to pay the estate tax. The conservation easement can reduce the economic value of the property and not affect the way the property is actually used by family members.

E. By eliminating the right to further subdivide or to commercially develop the property, the grant of a conservation easement may eliminate temptations and reduce possible sources of friction among members of future generations.

F. From a tax standpoint, the gift (or bargain sale) of an easement can result in a significant income tax charitable contribution deduction, and lead to significant estate tax savings. These issues are discussed in greater detail later in this outline.

III. CONSERVATION EASEMENT APPRAISALS

A. A conservation easement is valued by a “qualified appraisal”, a term described in detail in Treasury Regulation 1.170A-13(c). Not all appraisers are trained to value conservation easements in the detail required to meet the IRS standards.

B. The appraiser will conduct a detailed examination of the characteristics of the land (including the size and topography of the parcel, access, local land use regulation and market conditions) in order to value the land.

C. The appraisal report generally values the land both before and after the easement is granted to determine the value of the easement.

D. The appraiser should also take into account terms of the easement deed, as well as any enhancement of value to other property of the landowner or the landowner’s family.

E. IRS Form 8283, signed by the appraiser, and by the donee organization, is filed with the donor’s income tax return for the year of the gift.

IV. NEW HAMPSHIRE LOCAL PROPERTY TAXES

A. If the real estate is enrolled in current use at the time an easement is granted, there will be little, if any, additional local property tax relief, as the current use rates would apply to the land restricted by the easement.

B. Parcels that may not qualify for current use may qualify for favorable property tax under RSA 79-B. This section allows a “conservation restriction assessment” for parcels subject to permanent conservation restrictions that are less than 10 acres, the current use minimum. In addition, this section protects the landowner against possible adverse changes in the current use statute that might diminish the tax advantages offered by current use.

V. INCOME TAX RULES FOR A GIFT OF A CONSERVATION EASEMENT

A. Generally, an income tax deduction for the charitable contribution of real estate is available only if the taxpayer/landowner contributes or transfers his or her entire interest in a parcel of real estate (IRC §170(f)(3)). One exception to this rule is the gift of a conservation easement that meets the qualifications of the Code and Treasury Regulations.

1. IRC §170(h) allows a charitable contribution deduction for the gift of a “qualified conservation contribution”, which is defined as the gift of:

a. “a qualified real property interest” to

b. “a qualified organization”, exclusively for

c. “conservation purposes”.

d. The gift must be in perpetuity. IRC §170(h)(5)(A)

2. Treasury Department Regulations 1.170 A-14 define and describe each of these three requirements in detail.

a. A “qualified real property interest” includes a conservation easement as allowed by and defined in RSA 477:45, granted in perpetuity.

b. “Conservation purpose” is specifically defined to include five categories of resources that may be protected by the easement:

(i) Public recreation and/or education

(ii) Significant natural habitat

(iii) Open space for scenic enjoyment

(iv) Open space pursuant to local government policy

(v) Historic value

c. While an easement must provide a public benefit, it need not require public access to the property to qualify.

d. A “qualified organization” includes government agencies such as those identified above, as well as certain tax-exempt non-profit organizations that are dedicated to, and have the capability to provide long-term stewardship of the land.

3. The amount of the income tax deduction available to the landowner/taxpayer is limited. Because the gift of a conservation easement is a gift of capital property, the charitable contribution deduction is usually limited to 30 per cent of the taxpayer’s adjusted gross income. Unused amounts may be carried over for a maximum of five years after the year of the gift. Therefore, the taxpayer has up to six years to take advantage of the value of the easement as a tax deduction.

VI. FEDERAL ESTATE AND GIFT TAX CONSIDERATIONS

A. The Federal wealth transfer (estate and gift) tax scheme taxes the transfer of wealth for less than full consideration. It is a essentially a "unified" tax structure, and it applies to transfers during lifetime and at death. The rates are high and the estate tax is due to be paid, in cash, nine months after the date of death. There are a number of key exclusions that assist the planner:

1. The Applicable Exclusion Amount for Estate Tax, which allows the transfer at death of a certain amount of assets free of tax. The estate tax exclusion increased to $2,000,000 for decedents dying in 2006, 2007 and 2008, and will increase to $3,500,000 for 2009. In 2010 the estate tax is scheduled to be repealed, for one year only. In 2011, under current law the exclusion amount is scheduled to return to $1,000.000. The gift tax exclusion remains at $1,000,000, however. Appendix A includes a chart showing the increases, which were enacted as part of the 2001 Tax Act.

2. The unlimited Marital Deduction, which allows unlimited gifts and transfers between spouses during lifetime and at death free of estate and gift tax. The marital deduction may not result in avoidance of the tax altogether, but only the deferral of the payment of tax that will be due upon the death of the second spouse to die.

3. For married couples, proper planning can preserve the credit of the first spouse to die through the use of a Trust (commonly called a “credit-shelter”, or a “by-pass” trust), so that (in 2006 - 2008) $4,000,000 may be protected from federal estate taxation — the total of the exclusion for each spouse. The actual mechanics of this are beyond the scope of this outline, but any planning for a married couple with significant assets should consider this device.

a. If a couple owns valuable real estate as joint tenants with right of survivorship, title to the parcel may have to be placed in the name of one only, or changed to a tenancy in common, so that an interest in the land goes into the credit shelter trust. If the property passes by survivorship to the surviving joint tenant, the advantage of the credit shelter will be lost.

4. The Annual Gift Tax Exclusion allows a person to make gifts to any number of recipients each year free of tax. The amount of the exclusion has been $10,000 for many years; as of January 2002 it increased to $11,000, and in January 2006 increased again to $12,000. A married couple may transfer $24,000 to each donee (recipient of the gift) annually, regardless of which spouse holds title to the gifted asset ("split gifts"). Annual exclusion gifts are in addition to the amount protected by the unified credit.

5. The Charitable Deduction, which allows unlimited gifts to qualifying charitable organizations and institutions free of estate and gift taxes.

B. As noted above, the lifetime exclusion for gift tax is $1,000,000, and will remain there, despite the increase in the estate tax exclusion. If an individual makes gifts during lifetime in excess of the annual exclusion, the gifts are not immediately taxable, but are credited against the available gift and estate tax credit. The use of the credit is cumulative, and once the limitation is exceeds, the gifts are subject to tax. If, for example, a person has made taxable gifts of $450,000 during her life, no tax is due, but her estate tax exclusion would be reduced by that amount. Thus if this person died in 2006, she would have $1,550,000 available as a credit against her estate ($2,000,000 - $450,000 = $1,550,000).

C. Estate and gift tax rates are very high, so it is important to plan estates to minimize the impact of the tax. The tax rate is “graduated” and increases to a maximum of 46% for decedents dying in 2006. As shown on Appendix A, the top rate is scheduled to drop in future years, until 2011, when, after one year of no estate tax, the top rate jumps back up to 55%, and the exemption drops back down to $1,000,000.

D. The estate tax is levied against the decedent's gross estate. The gross estate includes all property that a person owns or holds an interest in at death (including life insurance proceeds and property held in a living trust). For cash, stocks and bonds, etc. valuation is a simple procedure, but for many assets, an appraisal is necessary. In addition, real estate is generally appraised at the highest and best use (i.e. fair market value, or what price a willing buyer would pay to a willing seller, and which therefore includes development potential) regardless of actual use by the decedent or intended use by the beneficiaries. Land that is enrolled in "Current Use" for New Hampshire real property taxation is still valued at highest and best use for estate tax purposes.

1. A special rule may be available to reduce the estate tax imposed on farm, ranch or actively forested real estate. Internal Revenue Code §2032A provides a method of valuation based upon the actual use of "qualified real property" that is included in the gross estate. This is a very technical section of the Code.

2. The maximum amount by which the gross estate can be reduced by this method is $750,000.

3. Simply stated, if at least fifty percent of the gross estate is "qualified property" used in farming, etc., and at least twenty five percent of the gross estate is real estate used in the "qualified use", and if the real estate passes to "qualified heirs" who agree to continue the "qualified use" for at least ten more years, the property may be eligible for special valuation treatment. For woodlands, this really means that there must be management plans for past and future forestry.

VII. THE PROBLEM OF THE ILLIQUID ESTATE

The federal estate tax is due to be paid nine months after the date of death. If the estate has cash, or readily marketable assets, the tax may be paid without difficulty. However, if the estate is illiquid, and has significant taxable assets but little cash, problems arise. The classic example is the forced sale of real estate, at less than an optimal price, to have cash available to pay the tax. Planning for the payment of the tax that may be due is as important a function for the estate planner as minimizing the potential tax impact.

A. An Example: Husband and Wife jointly own real estate worth $1,800,000, and other assets worth $600,000. The gross estate is thus $2,400,000. If the second spouse to die passed away in 2005, the estate tax imposed is about $413,000; in 2006 — 8 the tax is $184,000.00. The credit of the first spouse to die is lost, and some of the cash or liquid assets are needed to pay the tax. If a credit shelter trust had been utilized to preserve the credit of the first spouse to die, and appropriate allocation of assets between the spouses is made, the credit of each spouse could have been utilized, and the federal estate tax is eliminated.

B. Another example: The couple again has real estate valued at $1,800,000 but in this case has other assets of an equal amount, for a total gross estate of $3,600,000. If everything is owned jointly, or simply passes outright to the surviving spouse, and the second to die passes away in 2005, the tax is $977,000. If the couple had utilized a credit shelter trust, the tax could have been reduced to $272,000. Utilizing the credit shelter trust, if the surviving spouse dies in 2006, the tax could be reduced to less than $50,000. Without the tax-planning trust, and if all the property had passed to the survivor, the tax in 2006 would be $736,000.00.

VIII. POSSIBLE SOLUTIONS

Even if there are funds available to pay the tax, most families are interested in reducing the tax that might otherwise be payable. There are a number of estate planning tools and possible solutions to this problem.

A. One solution is the conservation easement. The restrictions on the use of land imposed by a conservation easement reduce the economic value of the property. While most easements allow continuing commercial use for forestry and agriculture, not all economic benefit is lost. In addition, the property is protected for its open space and natural resource protection and for outdoor recreational uses. In many cases, the actual use of property does not change after the conservation easement is granted.

B. Another way to reduce the estate tax is to give estate assets away, thus reducing size of the gross estate that will be subject to tax. Once assets are out of the estate, subsequent appreciation after the gift and prior to death will also go untaxed, leading to potentially greater tax savings. The gift tax exemption amount will remain at $1,000,000.

C. A common technique is to take advantage of the annual exclusion. If there are a number of potential beneficiaries, i.e. children and grandchildren, substantial wealth can be transferred out of an estate. $12,000 gifts of real estate may present logistical difficulties, as deeds are required with each transfer, and updated appraisals are necessary. This difficulty may be remedied, however, by the creation of a family trust, family limited partnership, or Limited Liability Company (LLC), and the gift of shares or interests in the trust or partnership, rather than gifts of the real estate itself. (The Internal Revenue Service is scrutinizing these transactions closely, and in a number of contested cases recently the taxpayer has lost.)

1. There is s significant string attached: the donee's basis in the property is the donor's basis. If the donee later sells the property, a substantially higher capital gains tax could result than if the donee had inherited the property and received a stepped-up, date of death value, basis in the property. (However, the income tax may be less than estate tax, depending on the applicable tax rates.)

2. In addition, donor may not use the property as in the past, or risk inclusion for estate tax purposes of the date of death value of the property under IRC §2036, Transfers with retained life interest.

3. Lifetime gifts may be most useful if long-term intention is not to sell, but to keep the property within a family.

4. If an easement or other form of permanent protection is contemplated, it should no doubt be completed before the gifting program, so that the value is reduced and larger portions of the property can be gifted, or the gifting program can be completed sooner.

D. In some instances, and with sophisticated planning, it is possible to discount the value of the property given away. Use of these techniques can "leverage" the annual exclusion gift, as well as the unified credit amount, and lead to the transfer of significant assets at a relatively low tax cost. The original owner may also be able to maintain control of the management of the property.

IX. IRC. §2031(c): THE CONSERVATION EASEMENT TAX INCENTIVE

AND POST-MORTEM EASEMENT

A. The 1997 Taxpayer Relief Act added a new section to the Internal Revenue Code that provides additional tax incentives for donating a conservation easement. New section 2031(c) excludes from estate tax up to 40% of the value of land subject to an easement. As with any section of the Code, however, there are special rules and qualifications that apply, and not every conservation easement qualifies for the additional tax relief. Also, because the law is new, the Treasury Department has not yet issued regulations, interpretations of it are evolving, and Congress may make additional technical amendments.

B. The maximum amount of the exclusion is $500,000. (The exclusion began at $100,000 in 1998, and has increased by $100,000 each year.) The actual tax savings depends on the top tax rate; for an estate taxed at the 50% level, the maximum tax savings is $250,000.

C. Also, the amount of the exclusion will be reduced from 40% by a formula if the value of the easement does not reduce the value of the land by at least 30%.

D. Another important feature of the new law is that the executor of a landowner's estate may grant a conservation easement after the landowner dies and still qualify for reduced land valuation in the estate and the additional exclusion. This is referred to as a "post-mortem easement".

E. The law also imposes special qualifications for the new tax exclusion:

1. Easement requirements: The easement deed must preclude all but a minimum use for commercial recreational activity. Certain development rights must be specifically accounted for in the tax calculation. A historic preservation easement does not qualify for the exclusion or the post-mortem easement.

2. Ownership requirements: The easement must have been granted by the decedent or a member of the decedent's family, and the decedent must have owned the property for at least three years prior to date of death.

F. The impact of the new tax code and the availability of the exclusion and the post-mortem easement can be dramatic. However, all of the heirs must consent to the easement transaction, and potential income tax benefits are lost, so for many landowners concerned about the protection of their property, the better course of action remains an easement granted during lifetime.

This Outline was prepared as an introduction to important tax, property law, and estate planning concepts, and is subject to becoming outdated as the law changes. It is not intended to address anyone's individual circumstances. Please consult with an attorney familiar with these matters, and your own tax advisor, when considering or implementing any land conservation transaction, or engaging in estate planning when land is an important asset and planning consideration.

February 2006

334268

SUMMARY OF ESTATE, GIFT AND

GENERATION-SKIPPING TRANSFER TAX

as affected by the

Economic Growth and Tax Relief Reconciliation Act of 2001

Calendar Year	Estate Tax Exemption	Gift Tax Exemption	Generation Skipping Transfer Tax Exemption	Highest Estate & Gift Tax Rate and GST Tax Flat Rate
2002	$1,000,000	$1,000,000	$1,100,000	50%
2003	$1,000,000	$1,000,000	$1,100,000**	49%
2004	$1,500,000	$1,000,000	$1,500,000	48%
2005	$1,500,000	$1,000,000	$1,500,000	47%
2006	$2,000,000	$1,000,000	$2,000,000	46%
2007	$2,000,000	$1,000,000	$2,000,000	45%
2008	$2,000,000	$1,000,000	$2,000,000	45%
2009	$3,500,000	$1,000,000	$3,500,000	45%
2010	ESTATE TAX REPEALED	$1,000,000	GST TAX REPEALED	35% (GIFT TAX ONLY)
2011 and thereafter Return to 2001 Law	$1,000,000	$1,000,000	$1,100,000** ( ** to be adjusted for inflation)	55%

All of the provisions of the 2001 tax law expire after December 31, 2010, which means that we return to current tax law, unless Congress makes additional changes or extends the new law beyond that date.

As of January 1, 2006, the Gift Tax Annual Exclusion has been adjusted for inflation for the second time as a consequence of the 1997 Tax Act, and is now $12,000.00. It will increase in $1,000 increments as future inflation adjustments occur.

The Conservation Easement Exclusion is limited at $500,000 for 2002 and thereafter.