Conservation Easements and Appraisers

October 31, 2012

Disclaimer

• The comments and views expressed by the presenter do not reflect the policy or position of the Internal Revenue Service. Commentaries offered are the opinions of the presenters.

Conservation Easement I.R.C. §170

• Must be a voluntary gift to qualified organization. IRC §170(c).

• Transfer of money or property without receipt of adequate consideration.

• Made with charitable intent.• No conditional gifts.

Conservation Easement cont.

• No earmarking• Deductible in taxable year delivered to the

donee.• Property substantiated-IRC & Regs.

Deduction Amount

• Quid pro quo and charitable intent• Bargain sale• Type of property (ordinary income, short-

term capital gain, long-term capital gain)• Basis• Percentage limitations

Qualified Conservation Contribution IRC 170(h)

• Qualified real property interest• Granted in perpetuity• Qualified organization• Exclusively for conservation purposes

Qualified Real Property InterestIRC 170(h)(2)

• Any of the following interests in real property– Transfer of an entire interest in property

except for qualifying mineral interest– A remainder interest in real property– A restriction on the use of the real property

granted in perpetuity (referred to as a conservation easement)

Perpetuity IRC 170(h)(5)(A)

• Permanently restricting the use, modification, or development of the property.

• Restriction remains on the property forever.• Binding on current and future owners of the

property.• Cannot be amended.• Easement deed must be recorded-state law

controls.

Perpetuity – Other Requirements

• Subordination– Pre-existing mortgagee or lien holders must

subordinate their interest. Treas. Reg. 1.170A-14(g)(2).

• Allocation of Proceeds on Extinguishment– Donee has vested property interest.– FMV equal to at least the proportionate value

of the easement restriction at the time of the gift to the value of the property as a whole. Treas. Reg. 1.170A-14(g)(6)(ii)

Qualified Organization IRC 170(c)

• Governmental unit, publicly-supported charity, and some non publicly supported charities.

• Not all 170(c) organizations are eligible to accept deductible conservation easements. Treas. Reg. 1.170A-14(c)(1).

• Must be received by an eligible donee. IRC 170(h)– Organized or operated for one of the conservation purposes in

IRC 170(h)(4)(A).– Must have the resources to enforce the restrictions of the

conservation easement.– Special Rules for Buildings in Registered Historic Districts-IRC

170(h)(4)(B)(ii).• See Publication 78-Cumulative List of Organizations.

Conservation PurposeIRC 170(h)(4)(A)

• Preservation of land for outdoor recreation by, or for the education of, the general public.

• Protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem.

• Preservation of open space for the scenic enjoyment of the general public or pursuant to a clearly delineated governmental conservation policy. Needs significant public benefit.

• Preservation of historically important land or a certified historic structure.

Inconsistent Use

• A donation must be exclusively for conservation purposes. IRC § 170(h)(1)(C).

• With certain exceptions, a deduction will not be allowed if the contribution would accomplish one of the enumerated conservation purposes but would permit destruction of other significant conservation interests.

Substantiation

• A charitable contribution is not deductible unless it is substantiated in accordance with the Internal Revenue Code and applicable regulations.

Substantiation Requirements

• Contemporaneous Written Acknowledgement

• Form 8283 (Appraisal Summary)• Qualified Appraiser and Appraisal • Façade Filing Fee• Baseline study

Contemporaneous Written Acknowledgement IRC 170(f)(8)

• Required content:– Name of the qualified (donee) organization– Amount of any cash contribution– Description (but not the value) of the conservation

easement granted– Goods or services statement (even if none received)– Description and good faith estimate of the value of

goods or services provided by donee• Form 8283 is not a substitute for CWA.• Substantial compliance does not apply.• No reasonable cause exception.

Form 8283 – Appraisal Summary

• An appraisal summary is required with respect to noncash contributions in excess of $5,000.

• Specific requirements set forth in Treas. Reg. § 1.170A-13(c)(4).

• Must be signed and dated by the donee.• Must be signed and dated by the qualified

appraiser who prepared the qualified appraisal.

Other Substantiation Requirements

• Façade Filing Fee-IRC 170(h)(4)(B), 170(f)(13)– Filing Fee ($500) for easements on buildings in

registered historic districts> $10,000 (contributions on or after February 13, 2007).

• Baseline Study-Treas. Reg. 1.170A-14(g)(5)– Must be made available to donee prior to the

donation.– Identifies conservation attributes and the condition of

the property at the time of the donation.– Specific information about the types of natural habitat

and ecosystems on the property, scenic or historic aspects, historic structures, existing restrictions and the impact of any reserved rights.

Qualified Appraisal IRS 170(f)(11)(C)

• Required for noncash donations > $5,000 (other than publicly traded stock).

• Special substantiation requirements. Treas. Reg. 1.170A-13(c)(3).

• Codified definitions of qualified appraisal and qualified appraiser (appraisals prepared for returns or submissions filed after August 17, 2006). IRC 170(f)(11)(E).

• Proposed Regulations-Notice 2006-96.

Qualified AppraisalIRC 170(f)(11)(E) & Treas. Reg.

1.170A-13(c)• Must meet all of the requirements of Treas. Reg.• Prepared, signed, and dated by a qualified appraiser.• In accordance with generally accepted appraisal

standards.• No earlier than 60 days before and not later than return

due date (including extensions).• No prohibited appraisal fee.• Must attach to return for donations > $500,000. Special

rule for post Pension Protection Act (PPA) easements on buildings in registered historic districts.

Qualified Appraisal RegulationsTreas. Reg. 1.170A-13(c)(3)(ii)

• Description of the property

• Physical condition• Date/expected date of

contribution• Agreement terms related

to the property’s use, sale or other disposition

• Appraiser’s name, address and identification number

• Appraiser qualifications• Statement that appraisal

was prepared for tax purposes

• Appraisal date• FMV of the contribution• Valuation method• Specific basis for

valuation

Qualified Appraiser 170(f)(11)(E)(ii)

• Appraisal designation from a recognized professional appraiser organization OR met minimum education & experience requirements.

• Regularly performs appraisals for compensation.• Meets such other requirements as prescribed by

the Secretary in regulations or other guidance.• Verifiable education and experience in valuing

the type of property subject to the appraisal.• Not been prohibited from practicing before the

IRS any time in the 3-year period ending on the date of the appraisal. IRC 170(f)(11)(E)(iii).

Qualified Appraiser Notice 2006-96 Pension Protection Act (PPA)

• Appraisal designation awarded on demonstrated competency in valuing type of property being appraised.

• Appraiser self-qualification declaration in the appraisal.

• Minimum education and experience requirements.

Minimum Education & Experience Real Property

• For returns filed on or before October 19, 2006– Treas. Regs. 1.170A-13(c)(5)

• For returns filed after October 19, 2006– Licensed or certified– For type of property appraised– In the state property is located

Minimum Education & Experience Other than Real Property

• For returns filed on or before February 16, 2007– Treas. Regs. 1.170A-13(c)(5)

• For returns filed after February 16, 2007– College or relevant coursework– 2 years experience– Fully describe qualification in appraisal

Guidance Resources• Internal Revenue Code Section 170• Sections 267 and 707• Treasury Regulation Sections 1.170A-13 and 1.170A-14• Notice 2006-96, Guidance Regarding Appraisal

Requirements for Noncash Charitable Contributions• Publication 526, Chartable Contributions• Publication 561, Determining the Value of Donated

Property• Publication 1771, Charitable Contributions-

Substantiation and Disclosure Requirements

Recent Cases• Trout Ranch v. Commissioner T.C. Memo. 2010-283

• Boltar v. Commissioner 136 T.C. No. 14, April 5, 2011

• Sheidelman v. Commissioner T.C. Memo. 2010-151

• 1982 East, LLC v. Commissioner T.C. Memo. 2011-84

• Herman v. Commissioner T.C. Memo. 2009-205

• Schrimsher v. Commissioner T.C. Memo. 2011-71

• Dunlap v. Commissioner T.C. Memo. 2012-126

• Rothman v. Commissioner T.C. Memo. 2012-163

Recurring Errors

• Encumbered parcel isolated and valued independently without consideration of contiguous property.

• Market analysis and support is nonexistent in the report.

Recurring Errors

• Highest and best use is not developed or supported. No Market Analysis provided to drive the HBU conclusions. Missing the tests of investment return for alternative uses.

• Qualitative grids without explanation or support for the conclusion. Reviewer should be able to duplicate the process.

Recurring Errors

• Use of another appraiser’s sales data without independent reconfirmation.

• Reliance on bargain sales.• Easement sales or easement encumbered

land sales used without adequate assessment of comparability.

• Enhancement not thoroughly addressed or conclusions adequately supported.

Taxpayer/Appraiser Misconceptions

• IRS will not go to court.• IRS will not pursue appraiser penalties.• Easements automatically impose a

significant loss in value.• Subdivision Development/Discounted

Cash flow never accepted by IRS.

Taxpayer/Appraiser Misconceptions

• Percent diminution is a method.• Direct Sales Comparison is required.• IRS will not consider sales of easements.• IRS will not consider easement

encumbered sales.

Taxpayer/Appraiser Misconceptions

• IRS will only consider sales comparison of easement encumbered sales.

• Bargain sales reflect market value.• Highest and best use is the owner’s

decision.

Taxpayer / Appraiser Misconceptions

• A simple statement of highest and best use is adequate support for the conclusion.

• Existing development or owner plans are by default the highest and best use.

• Easement value cannot be zero.• IRS position is easements have zero value.• “Contiguous owned parcel” analysis is not

required.

Omission and Commission

• Generally Accepted Standards (USPAP)• Conduct Section of Ethics Rule: An appraiser

must perform assignments with impartiality, objectively, and independence, and without accommodation of personal interests.– Must not communicate assignment results with the

intent to mislead or to defraud;– Must not use or communicate a report that is known

by the appraiser to be misleading or fraudulent.

Omission and Commission

• Generally Accepted Standards (USPAP)– Standards Rule 1-1(b): not commit a

substantial error of omission or commission that significantly affects an appraisal.

• Comment: An appraiser must use sufficient care to avoid errors that would significantly affect his or her opinions and conclusions.

Omission and Commission

• By omission; leaving out information or data that would be viewed as pertinent to a given assignment, that would change the results if considered.

• By commission; including erroneous or inappropriate information or data within a given assignment that would change results if not included.

6695A Appraiser Penalty

• Prior to PPA penalties subject to IRC 6700 or IRC 6701

• IRC 6695A Originated with the Pension Protection Act of 2006

• Not intended for minor differences of opinion• Treated as a separate case from originating tax

case• Practitioner has opportunity to support their work

6695A Appraiser Penalty

• 6695A. Substantial and gross valuation misstatements attributable to incorrect appraisals.

• 6695A(a) Imposition of penalty. –if-• 6695A(a)(1) a person prepares an appraisal of

the value of property and such person knows, or reasonablely should have known, that the appraisal would be used in connection with a return or claim for refund, and

6695A Appraiser Penalty

• 6695A(a)(2) the claimed value of the property on a return or a claim for refund which is based on such appraisal results in a substantial valuation misstatement under chapter 1, a substantial estate or gift tax valuation understatement, or a gross valuation misstatement, with respect to such property, then such person shall pay a penalty in the amount determined under section (b).

6695A Appraiser Penalty

• 6695A(b) Amount of Penalty – The amount of the penalty imposed under subsection (a) on any person with respect to an appraisal shall be equal to the LESSER of –

• 6695A(b)(1) the greater of – • 6695A(b)(1)(A) 10 percent of the amount of the

underpayment attributable to the misstatement described in subsection (a)(2), or

6695A Appraiser Penalty

• 6695A(b)(1)(B) $1,000, or• 6695A(b)(2) 125 percent of the gross income

received by the person described in subsection (a)(1) from the preparation of the appraisal.

• 6695A(c) Exception – No penalty shall be imposed under subsection (a) if the person establishes to the satisfaction of the Secretary that the value established in the appraisal was more likely than not the proper value.

Market Analysis and Highest and Best Use

• Most critical elements in conservation easement appraisals

• Market Analysis MUST be done before Highest and Best Use Analysis

• Must be a reflection of market performance and expectations, supported with FACTS!

Methodology Used to value Conservation Easements

• Direct Approaches:– Sales of Easements: By Regulation – If there is a

substantial record of sales of easements comparable to the donated easement (such as purchases pursuant to a governmental program), the fair market value of the donated easement is based on the sales process of such comparable easements. (Treas. Reg. 1.170A-14(h)(3))

– If none or not enough comparable easement sales then:

Before and After Approach

• Before Value• (less) After Value• Conservation Easement Value

Before Value

– Standard Appraisal• Highest and Best use (may already have a portion

under easement)• Three approaches to value• Typically nothing unusual

After Value

• Direct Sales Comparison Approach– Easement Encumbered sales

• Must be arm’s length• Must be similar to the subject – Size, Location,

Sale Date, Restrictions, etc.• Property must have similar Highest and best use

as the subject in both Before and After condition• Typically concludes $/acre• Value of Easement = Before Value – After Value• Rare but may be used more often as more and

more Easement encumbered sales occur

After Value• Indirect Sales Comparison Approach• In some cases with limited or no data in the

subject market the appraiser must use sales from out of the area, but the decision must be supported and full analysis shown.– Ideally, sales of encumbered property are compared

to sales of un-encumbered property• Comparables must be similar• Sales can be from other market areas• Encumbered sales must have similar restrictions and similar

H&B use conclusions• Typically conclude percent diminution in value as opposed to

$/acre

The End