Doing a conservation easement without raising eyebrows at the IRS

July 27, 2012

Homeowners often consider granting a conservation easement to a charitable organization, for the purpose of obtaining some tax benefits. Currently, there are more than 200 cases involving these easements pending before the United States Tax Court, the court where taxpayers can appeal Internal Revenue Service determinations.

And the IRS has won all six cases that have been decided this year by that court. However, if you do it properly and the IRS challenges your easement, the IRS will lose.

What is an easement? It is often defined as giving someone other than the property owner the right to use the property (or a portion of the property) without actually owning or possessing the property. For example, you own property by a lake, and I own adjoining property by a road. The only way you can get to the road is through my land. You have an easement by necessity to cross my property to get to the road.

Public utilities have their pipes and conduits running under my land. They have an easement — recorded on local land records — allowing them to access my property in order to make repairs or correct problems.

Oversimplified, an easement is a restriction on your use of your property. A conservation easement (often called a facade or preservation easement) means that a deed of easement to your property is given to a legitimate conservation organization, and as a result, you are restricted from making changes to the exterior of the house without first obtaining permission from the organization that holds the easement.

Why do homeowners consider granting such an easement, thereby placing significant restrictions on what they can do with their house in the future? There are two basic reasons.

First, you want to preserve the historic nature of your house — and your neighborhood. You are troubled with the many buildings — condominiums or commercial — that are popping up all over your area, and you want to do your part to protect the architectural integrity of your house. Second, if you do it right, you may get some tax benefits.

How does it work? You must make arrangements with a qualified, legitimate organization that accepts such easements. According to the IRS, a qualified organization is either a governmental unit, a publicly supported charitable, religious, scientific, literary organization, or “an organization that is controlled by, and operated for the exclusive benefit of a governmental unit or a publicly supported charity.”

Several years ago, The Washington Post published a series of articles about many “fly-by-night” organizations claiming they could assist homeowners with these easements. It turned out those groups were interested only in taking consumers’ money, and were not qualified to accept easements. Congress tightened the law and now the IRS will carefully scrutinize any tax return that contains a credit for the easement.

The L’Enfant Trust — a recognized and reputable organization in the Washington metropolitan area — points out in its Web site: “Be careful about promoters who steer you to a particular easement holding group, and make sure you find out how and by whom the promoter is paid.”

Not all houses will qualify for the tax benefits. Your property either has to be specifically listed on the National Registry of Historic Places, or in a registered historic district (such as Greater U Street, 14th Street Historic, Anacostia or Georgetown) and be more than 50 years old. There are additional requirements. The restriction must preserve the entire exterior of the building — including its front, sides, rear and height. You must enter into a written agreement with the organization receiving the easement, certifying under penalty of perjury, that the organization is qualified.

Finally, your tax return must include a qualified appraisal, pictures of the building’s entire exterior and a description of all restrictions on development of the property — such as zoning laws. If you claim a deduction of more than $10,000, you will also have to pay a $500 filing fee to the IRS.

The tax court has been wrestling with these cases. According to the tax code, the interest conveyed by an easement must be protected in perpetuity. This means that it is permanent, and unless the charitable organization consents, it can never be changed. In one case, the easement was conveyed to a legitimate organization after the homeowners had a mortgage on their house. The tax court was concerned that should the house be destroyed by a fire or other casualty, the mortgage lender would be entitled to any insurance proceeds. Since the tax laws require that the charitable organization is absolutely entitled to these proceeds, the court held that the facade easement contribution “fails as a matter of law to comply with the enforceability in perpetuity requirements.”

But a year later, a conservation easement given on two properties in the Logan Circle neighborhood in D.C. was affirmed by the United States Court of Appeals for the District of Columbia.

In Simmons v. IRS, decided in 2011, the court found that the deed of easement to the L’Enfant Trust — a recognized and reputable organization in the Washington metropolitan area — made it clear that the mortgage lenders involved with the properties specifically agreed to subordinate their interests to the trust. According to the court, “the deeds impose an affirmative obligation upon Simmons ‘in perpetuity’ to maintain the properties.”

Interestingly, the IRS argued that the deeds did not contain any language providing for the perpetuation of the easements should the trust cease to exist.

The court flatly rejected this, stating that if L’Enfant dissolves, the “easements would be transferred to another organization” with activities similar to the trust.

As for the tax credit, Simmons’s appraiser concluded that the value of the facade easement should range between 10 percent and 15 percent of the value of the property. However, the tax court reduced the credit down to 5 percent, which the IRS did not appeal.

What are the tax benefits available should you have a successful easement approved by the IRS? Clearly, the minimum benchmark is the 5 percent authorized by the Simmons court.

If you contribute qualified property to a qualified organization, the amount of your charitable contribution is determined by the difference between the value of the property before the easement is recorded, and the value of the property afterward — the “before and after” test.

The IRS cautions, however, that if your property actually increases in value as a result of the easement, you will not be entitled to any tax credits.

It appears that the IRS is continuing its campaign against these conservation easements. And homeowners should understand that there is no “safe harbor” as to what tax benefits you will get — if any — should you decide to donate a conservation easement.

It’s a complex process, and you should consult not only a qualified charitable organization, but also your own tax and legal advisers.

For more information, see IRS Publication 526, “Charitable Contributions” available at www.irs.gov.

Benny L. Kass is a Washington lawyer. This column is not legal advice and should not be acted upon without obtaining legal counsel. For a free copy of the booklet “A Guide to Settlement on Your New Home,” send a self-addressed stamped envelope to Benny L. Kass, 1050 17th St. NW, Suite 1100, Washington, D.C. 20036.

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