Clients who hold valuable land may receive generous tax breaks in return for a conservation easement, but the IRS has made an effort to keep the tax breaks from becoming too generous.

A recent Tax Court ruling shows that some tactics can be rejected.

Typically, a taxpayer granting a conservation easement agrees to permanent restrictions (generally on future development) on land with scenic or historic value. The land owner grants the easement to a local conservation agency that agrees to monitor the agreement. After obtaining pre- and post-easement appraisals, the taxpayer deducts the difference: the claimed value of the easement. The owner doesn’t donate the property—just future development rights.

In Belk v. Commissioner, the Belks had developed a residential community on land they owned in North Carolina. The community included an 18-hole golf course; the Belks executed a conservation easement stipulating the golf course couldn’t be used for residential, commercial, industrial or agricultural purposes.

Appraisals showed the value of the golf course acreage dropped from $10.8 million before the easement to $277,000 afterwards. Thus the Belks claimed a $10.5 million charitable deduction from the easement contribution. The IRS disallowed the deduction and the issue wound up in Tax Court.

Among the points in dispute, the easement allowed the Belks to swap the property subject to the easement, as long as the replacement property had the same or better ecological stability and similar value, and did not adversely affect the easement’s conservation purposes.

The tax court sided with the IRS, holding that the property that was originally subjectto the easement must remain restricted by the easement. If the original property could be swapped out, then the use restriction was not granted in perpetuity and the easement did not qualify for the tax deduction.

Donations of conservation easements offer the potential for substantial tax benefits, and the IRS has increased scrutiny of these transactions. About 200 cases dealing with conservation easements are now before the Tax Court, so advisors should urge clients to proceed with caution.

“These easements involve strict rules and significant skin in the game for taxpayers claiming the deduction,” said Blanche Lark Christerson, a managing director with Deutsche Bank in New York. “If, for example, the restrictions on the property subject to the easement can be circumvented (such as through a swap), the IRS probably will disallow the deduction."

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