REQUIRED READING: The creation of conservation easements, which are land preservation agreements between landowners and qualified environmental organizations or governmental bodies, is currently on the rise across the country. In fact, many environmental and tax lawyers are creating niche practices devoted entirely to structuring conservation easements for individuals and corporations alike.
While the overarching purpose of this manifestation of restrictive covenant is an environmental one – specifically, to protect land from real estate development and industrial use – landowners electing to create conservation easements are often incentivized primarily by significant state and federal tax advantages that accompany such arrangements. In addition, conservation easements allow landowners to reap these tax benefits while simultaneously retaining ownership of the property.
Appraisers play a significant role in creating conservation easements, as the encumbrances and the tax breaks that often accompany them must be justified by detailed market valuations.
As mentioned above, landowners are often motivated to create conservation easements by the encumbrances' attractive tax breaks. Not only may landowners qualify for a federal income tax deduction equal to the value of the easement donation, as determined by a qualified appraiser, but a number of states also offer income tax credits for conservation easements.
Finally – and, perhaps, most significantly – conservation easements can create a significant reduction in estate taxes for inheriting parties. Not only can a conservation easement reduce the value of an estate, and thereby reduce the associated inheritance tax; in addition, federal tax code allows for a further reduction (up to 40%) in ‘death taxes’ for estates with qualified conservation easements.
Because the tax breaks are significant, it is becoming a common trend for estate lawyers to present the option of creating conservation easements to property-holding clients with tracts of qualifying land.
Two methods exist for appraising a conservation easement: The ‘before-and-after method’ (which subtracts the value of the land post-easement from the value of the pre-encumbered land, and then divides that amount by the value of easement interests) and the direct comparison method, which takes into consideration the actual sales of easements, which are then directly compared to the easement being appraised.
An appraiser using the before-and-after method values the property prior to the conservation easement and then again after the encumbrance of the property. The difference represents the value of the rights held by the easement. In some cases, the resulting value may end up close to the full fee value of the property.
The after value may be estimated either by considering sales that are encumbered by similar easements, or by considering sales that are encumbered in the same way, but under different theories – for example, zoning or access encumbrances. While this approach has historically been the accepted way to easement valuation, many appraisers are now employing the direct comparison method.
In the direct comparison method, appraisers compare existing market easement sales with the easement requiring appraisal. Appraisers employing the direct comparison method must consider a number of factors, including:
- The physical comparability of the real estate;
- Any motivating forces behind the easement sales;
- Interests transferred in the easement sale;
- Offsetting benefits and severance damages unique to the sales;
- Market opportunities for realizing economic potential;
- Availability of capital for easement purchases; and
- Public attitude toward the resource being protected.
As we prepare for a new year – and, as of this writing, the potential for changes in tax rates and the real estate market – the importance of valuations in conservation easements has never been as strong. This aspect of the appraisal process could easily be among the most significant in 2013.
Jessica A. Edgerton is chief legal officer at U.S. Appraisal Group, based in Chicago. She can be reached at jedgerton@usappraisalgroup.com.
