Many high-net-worth clients are facing higher income taxes as a result of recent legislation, and higher tax rates make charitable contribution deductions more valuable.
For sizable write-offs, donations of conservation easements may be enticing. “The tax benefits definitely are appealing,” says Adam Miller, vice president at Elderado Financial in Montrose, Colo., “but these transactions work best when the client has a non-financial purpose for donating the easement.”
According to Miller, landowners may have various reasons for considering such a donation. A rancher might want to be sure no one ever constructs a big-box store on the property, for instance. “Some people might want to keep land for agricultural use,” Miller adds. “Some want to preserve a scenic view, to protect a historic building, or to maintain recreational pursuits—to know that someone always will be able to go fly fishing there.”
Regardless of the purpose, the process of obtaining a tax deduction for a conservation easement donation can be complex. Suppose Joan Client donates an easement to a qualified conservation organization. The terms of the donation will vary, but the usual idea is to agree to restrictions on the property’s future development. “Restrictions must be in perpetuity,” says Miller.
A before-and-after appraisal will show the loss of value, and that loss will be a charitable contribution. If Joan’s rural acreage drops from a $3 million value to $2 million, say, because no present or future owner can subdivide to build homes there, Joan can take a $1 million charitable income tax deduction. (Estate and property taxes also may be reduced.) Meanwhile, Joan continues to own the property; she can use it as she wishes, sell it, or bequeath it to heirs.
Not surprisingly, the IRS may take a hard look at such a large donation deduction, and at the appraisals indicating a loss of value. “You need a clean transaction to justify the tax benefits,” says Miller. “Donors should start by selecting the right land trust to accept the donation. The land trust can help by bringing in experienced appraisers, attorneys and tax professionals.”
If the land trust can play such a key role, where does a financial advisor fit in? “An advisor can help a client select the right land trust,” says Miller. “There may be several to choose from, but some land trusts will be better choices, depending on the purpose for donating the easement.”
A financial advisor also can help clients make the most of the resulting tax deduction. Tax code limits may force a client to carry forward part of the charitable deduction for years, and perhaps ultimately lose some of the tax benefit.
“In some cases,” says Miller, “we’ve helped clients pick up more income, to use more of the tax deduction. One tactic, for example, is to increase a client’s taxable income by converting a traditional IRA to a Roth IRA. The client might avoid a tax liability by using the charitable carry-forward deductions to offset the tax on the Roth IRA conversion.” After what can be a tax-free conversion, subsequent Roth IRA withdrawals also may be tax-free.