The new federal range war:
IRS attack on conservation easements
by Jim Walker
submitted by Steven Goodroad
Last year, the Internal Revenue Service (IRS) opened an extensive audit
program challenging income tax deductions earned from granting conservation
easements. Although the program’s scope has not been formally
disclosed, the IRS is challenging at least 250 Colorado conservation
easements.
The IRS focus on Colorado is not accidental. With pressure and support
from Washington, D.C., the IRS is specifically targeting Colorado taxpayers
and Colorado conservation easements.
What is a conservation easement?
A conservation easement is a written instrument typically in the form
of a deed that limits land use. When recorded in the land records and
accepted, the deed conveys valuable property rights to a charitable
organization—most often a land trust.
One type of a conservation easement is an agricultural conservation
easement. This easement limits the landowner’s use of the property
to farming and ranching uses and limits construction except for buildings
used for agricultural purposes or homes for the rancher and his family
and employees. The easement also prohibits removal of minerals and other
natural resources if that removal adversely affects the land’s
conservation use.
Even after granting the easement, the rancher remains the “fee
owner” reserving the right to operate and manage the property
consistent with sound management practices. The rancher also can leave
the ranch land to his heirs.
By granting a qualifying conservation easement, the rancher secures
an immediate federal and state income tax benefit. The amount of this
benefit is supported by a written appraisal report. The value described
in the appraisal is the difference between the land’s value before
the restriction and the land’s value after the restriction. This
difference is the value given away to charity.
What is the IRS asserting?
The IRS is asserting a twofold challenge to Colorado easements. First,
the IRS attempts to deny or disallow the entire federal income tax deduction.
Second, and alternatively, the IRS claims that the deduction amount
is far too large and the amount deducted was “overvalued.”
Based upon our review and involvement in these audits, the IRS’s
position is not based on a solid understanding of conservation easements.
Nor does the IRS approach respect established conservation practice.
The IRS is pushing a narrow definition of a “qualified conservation
contribution.” The intent is to reduce the number of qualifying
Colorado conservation easements.
By pushing a narrow definition, the IRS challenge runs counter to 26
years of accepted best practices (many of such practices were established
to meet long-standing IRS regulations). And importantly, this IRS attempt
to narrow the qualifying definition was just rejected by the federal
courts.
Why target Colorado?
The IRS focus on Colorado is not an accident. The focus stems from Colorado’s
tax credit program since Colorado is among only a handful of states
that offer state tax credits. In other words, a Colorado landowner granting
a conservation easement secures both a federal income tax deduction
(in the form of a charitable contribution deduction) and a state income
tax credit.
With these dual tax benefits, Colorado landowners have special financial
incentives for granting qualifying conservation easements. Both the
federal and state treasuries subsidize Colorado’s conservation
protection efforts.
Colorado credit program is unique
Since its inception in 2000, the Colorado conservation easement tax
credit program has helped preserve thousands of acres of Colorado’s
most cherished private landscapes. Colorado has benefited from the protection
and preservation of these valuable ranch- and farmlands, wildlife habitats,
water resources, and scenic vistas. This achievement was secured by
a Colorado income tax credit for Colorado landowners who donate a conservation
easement to a qualified organization such as a land trust.
Colorado’s “credit” is generous. The landowner may
take up to a $375,000 income tax credit (i.e., a dollar-for-dollar reduction)
for 50 percent of the fair market value of a conservation easement.
By using this credit, landowners may offset their own state income tax
obligation and apply an excess amount forward for up to 20 years. As
an alternative to using the credit, the landowner can transfer (sell)
the credit to a third party (who in turn can should not be shy in asserting
their rights and standing up for their tax deductions.When the IRS takes
an extreme position, landowners can even ask that their attorney’s
fees be paid by the IRS.
Colorado’s legislators also may help. Colorado Senators Allard
and Salazar have drafted strong letters to the IRS Commissioner expressing
their concern over the Colorado audits. They reiterated the important
value of Colorado conservation easements to protect open space and agricultural
lands.
At this juncture, the outcome of the Colorado IRS audits is unknown.
Tax audits can take months to conclude and defending tax deduction can
require several types of protests. Rothgerber Johnson & Lyons LLP
is well experienced in handling IRS tax audits and defending conservation
easement transactions. When necessary, we also defend tax positions
through the federal courts.
About the author
Jim Walker is RJ&L’s senior tax partner and a Fellow of the
American College of Tax Counsel. He regularly represents taxpayers before
federal and state administrative agencies, including the IRS, the Justice
Department, and the Colorado Department of Revenue. He can be reached
at 303-628-9510
