What are the tax benefits of an easement?
Federal and Virginia Income Tax Deduction
Conservation easements, when properly structured, can result in a charitable contribution deduction for the donor. The potential deduction amounts to 100% the theoretical decline in property value before and after the easement is established. The maximum deduction for any one year, however, is limited based on the income level of the donor. For tax year 2012, the maximum deduction for an individual donor is 30% of the donor’s Adjusted Gross Income (AGI). If any portion of the deduction is disallowed due to this AGI limitation, then the remaining deduction carries forward for a maximum of five years. The allowable deduction reduces taxable income for both Federal and Virginia purposes.
Example 1: Benefits of the Tax Deduction
Stephen donates two dwelling unit rights to the Clarke County Easement Authority. A qualified appraiser determines that the values before and after the appraisal were $3,000,000 and $2,800,000, respectively. Stephen’s AGI for 2012 is $300,000. The charitable deduction is calculated as $200,000 (100% of the decline in land value due to easement). The first year deduction for Stephen will be $90,000 (30% x $300,000) with a remaining $110,000 deduction carrying forward to 2013. Stephen will save approximately $30,000 between Federal and State taxes for tax year 2012, and will likely utilize the full $200,000 charitable deduction by 2014.
Virginia State Tax Credit
In addition to the charitable deduction, Virginia allows a 40% tax credit for conservation easements. Tax credits are more beneficial than tax deductions, in that credits provide “dollar for dollar” tax benefit. If the credit amount exceeds the individual’s Virginia tax liability, the excess credit will carry forward for up to ten years. Credits may also be transferred to other taxpayers, as Virginia allows these credits to be bought and sold. Proceeds from the sale of Virginia land preservation credits are taxed as a capital gain transaction on the Federal income tax return, and can receive a more favorable tax rate if the credits are held for longer than one year. While taxable for Federal purposes, the proceeds are not taxable on the Virginia income tax return.
Example 2: Benefits of obtaining and selling Virginia Income Tax Credits
Stephen (same facts as Example 1) applies for Virginia Land Preservation Tax Credits. As a result of his $200,000 donation, Virginia grants $80,000 (40% x $200,000) of tax credits. Stephen must utilize the credits within 10 years. Given that his annual Virginia income tax liability is approximately $9,000, he decides to keep only $45,000 of the credits, which should cover his Virginia income tax liability for the next 5 years. He sells the remaining $35,000 of credits for a price of $28,000. Stephen waits for over one year prior to selling the credits in order to ensure long term capital gain tax treatment. Assuming the current 15% (for tax year 2012) Federal tax rate on long term capital gains still applies in 2013, Stephen’s after tax proceeds from the sale for 2013 will be $23,800. ($28,000 – $4,200 Federal income tax).
Estate Tax Benefits
Individuals expecting to have an estate tax liability can potentially reduce this tax as well. Estate taxes are based on the value of the taxpayer’s estate at death, and the establishment of a conservation easement serves to reduce this value. In addition to this benefit, up to 40% of the land value can potentially be excluded from the estate up to a maximum of $500,000.