Helping high-net-worth clients save on taxes can propel a planner’s practice, and matching one shelter with another is a powerful parlay.
“My favorite story involves clients who were wrapping up a conservation easement,” says Adam Miller, president of Elderado Financial in Montrose, Colorado. “Working with their CPA, we helped them convert tens of thousands of traditional IRA dollars to a Roth IRA at an extremely low tax rate.”
Knowledge of such techniques may lure HNW prospects. “In our area, conservation easements are a big deal,” Miller says. “An adviser who understands them can connect with high-net-worth families. If someone has a large property, I always consider this idea. We’ll bring it up if we see this as the best fit.” Miller adds that CPAs may call his firm if they have clients who are placing an easement on their property or have already placed one.
“Word of mouth has attracted high-income clients to financial advisers who promoted easements,” agrees Marc Lewyn, CEO of strategic liquidity services at JOYN, a behavioral wealth management firm in Atlanta. “Easements have become the coin of the realm, so to speak. Having familiarity with the potential benefits and the risks allows advisers to provide a valuable filter for clients.”
The total number of acres in the U.S. under easments overseen by land trusts at the end of 2015 was almost 16.8 million, more than double the acreage under easement a decade earlier, according to the Land Trust Alliance. At the end of 2005, the total nationally was 6,113,108.
NATURAL TAX SHELTER
Conservation easements are designed to protect a property’s natural values. A land owner might donate an easement to a preservation group such as a land trust for the purpose of limiting future development on the property. The result will be a loss of value, supported by before-and-after appraisals, which can be claimed as a charitable contribution.
“These easements can provide tax deductions for property owners who give away a viable right (such as development rights) associated with the property in perpetuity,” says Robert Boggess, CEO of IREXA Financial Services/Wealth Strategies in Seattle. According to Boggess, a viable easement is one that is valid and valuable, providing a public benefit.
As an example, the Land Trust Alliance, a national conservation organization, cites an easement on property containing a rare wildlife habitat that might prohibit any development. On a farm, an easement might allow continued farming and the building of additional agricultural structures.
An easement may apply to only a portion of the property and need not require public access. Indeed, the donor continues to enjoy the use of the property. As the owner, the donor can sell it or keep it for the next generation.
Nevertheless, donating an easement that limits development rights will reduce the value of the property for future resale. If appraisals determine that the property’s value has fallen from $4 million to $3 million, for instance, the donor could be entitled to a $1 million income tax deduction. Beyond an income tax deduction, the landowner may also receive reductions in estate taxes and perhaps in property taxes after donating an easement.
After viability, the second primary issue of conservation easements is valuation. “This is accomplished,” Boggess says, “by undertaking two appraisals: first at its current highest and best use, then the second is at its highest and best use after the easement is put in place. The IRS has strict appraisal standards.” An easement deemed to be overvalued is likely to be challenged.
STEP BY STEP
Claiming a reasonable deduction for the easement is Step 1. Step 2 is actually taking the deduction. Even though a 2015 law permanently eases the rules, annual deductions for conservation easements are generally capped at 50% of a taxpayer’s adjusted gross income or 100% for qualified farmers and ranchers.
Unused deductions can be carried forward for up to 15 years. A moderate-income donor might take years to claim all the deductions or might never use them all.
That’s where Roth IRA conversions may pay off. “We converted some of the client’s traditional IRA to a Roth each year, utilizing credits and deductions from the easement,” Miller says. The partial conversions are added to AGI, allowing more of the tax deductions from the conservation easement to be used currently. Carefully monitoring the amount of assets converted and the amount of deductions taken, the Roth conversions may be executed at relatively low tax rates.
Miller mentions tax credits as well as deductions, which can further reduce the effective tax on a Roth conversion. “Certain states offer transferable tax credits,” he says. “Imagine a farmer who has never had a lot of income but now has a massive tax credit from a conservation easement. If the donor sells the credit, the transaction creates cash for the farmer and much-needed tax credit for a high-income buyer. We have seen buyers pay about 85 cents on the dollar, saving 15% on their state tax bill.”
If unusable tax credits might be sold, what about unusable tax deductions? Technically, deductions can’t be transferred, but such deals are appearing. “These offerings have become hugely widespread,” Lewyn says. “They’re on every street corner.”
Conservation easement tax shelters may not actually be as ubiquitous as Starbucks outlets, but they have become common enough to draw IRS Notice 2017-10, which states that “some promoters are syndicating conservation easement transactions.”
As the IRS explains these deals, one or more pass-through entities are involved in the ownership of the property covered by the easement. Investors in these entities are led to believe they’ll receive a tax deduction that “equals or exceeds an amount that is two and one-half times” the amount invested. Appraisals that “greatly inflate” the value of the donated easement underlie the claimed deductions, the notice asserts. Such deals were classified as listed transactions, subject to greater IRS scrutiny.
Boggess indicates that a syndicated offering might be worthwhile for investors, if the easement valuation is realistic.
As for clients who want to donate a conservation easement, Lewyn believes it may be a better idea to take the benefits personally. “I would find an attorney who has a documented specialty of creating and defending easements before I would consider creating a syndicated easement,” he says.
Given that easement donations may require the services of an experienced attorney and a reputable appraiser, what role remains for financial advisers?
“I have helped clients with conservation easement donations,” Lewyn says, “mostly by explaining the risks on the front end and supporting them emotionally when they learn their easement is under audit.”
Fully informed, HNW landowners can decide whether the risks are worth the potential tax reduction jackpot.