Note #12: Claiming a Deduction for Donating a Conservation Easement (or a Gift of Land) – FILING YOUR TAX RETURN, THE IRS, AND GETTING IT RIGHT (Part II)
Your tax returns are due soon.
If you donated a conservation easement in 2014, in Note #11 I discussed some of the things you need to file, along with your tax return, to increase the chance that your conservation easement donation will not be audited, or, if you are audited, so that you will have a better chance of a better audit result.
As I said in Note #11, there are a few very very important caveats here. First, there is no way anyone can ever guarantee that you will not be audited, for a conservation easement donation, or for a gift of land, or for anything else that might show up on your tax return. Second, most of the time, going through an IRS audit is an awful experience, and there is no way anyone can guarantee any kind of result short of terrible. Third, as these Notes always say, this is not legal advice. If you donated a conservation easement in 2014 (or if you ever plan to donate a conservation easement), you should be working with an experienced tax advisor who understands every single point in these Notes. If you did make a donation in 2014, these Notes should be immediately helpful. If you are going to make a donation in the future, these Notes can serve as a “primer” for some of the things you should be thinking about.
Keep in mind, there are no guarantees.
This Note #12 is rather dry. The bottom-line purpose of this Note is to supplement Note #11, and, in particular, to walk through an illustration of how to fill in the Federal Form 8283, Noncash Charitable Contributions, which must be filed along with your federal tax return when you claim a deduction for the contribution of a conservation easement.
The last section of this Note #12, “Audit Strategy in a Few Paragraphs,” is not so dry.
Filing Your Tax Return
In Note #11, I discussed a number of things you should be aware of, and be careful about, and get right, when you file your federal income tax return and claim an income tax deduction for a conservation easement donation. I discuss all of these points, briefly, in Note #11. I will discuss a few of them in greater detail in this Note #12.
- Work with an experienced advisor.
- The easement document must be done right and must meet all the relevant tax rules, and a copy of the easement document should be filed along with your tax return.
- The Baseline Documentation Report must be done right and I recommend you file a copy along with your tax return.
- The qualified appraisal report must be done right and should (almost always) be filed along with your tax return.
- The federal Form 8283 must be done right and should be filed along with your tax return.
- The Supplemental Statement that is required must be done right and should be filed along with your Form 8283.
- Your “gift letter,” or “contemporaneous written acknowledgement,” as the IRS calls it, must be done right, and I recommend you file a copy along with your tax return.
- If there was a mortgage on your property, the mortgage must have been subordinated to the conservation easement before or at the time of the donation. If there was a mortgage subordination, it must be done right and I recommend you file a copy along with your tax return.
Let’s look at a few of these in greater detail.
Federal Form 8283, Noncash Charitable Contributions
If you pay attention, and if you read the Instructions to Form 8283, this Form is not all that difficult to fill out, but there are some important and potentially tricky issues that come up.
Let’s walk through the Form. You may want to print out my version of a completed Form 8283, which is on my www.stevesmall.com site, and print out the Instructions for the Form 8283, and refer to them as we go through this discussion.
And remember, most of the discussion here is about how to fill out the Form 8283 when you have made a contribution of a conservation easement, although obviously some of the observations in this Note #12 also apply to other kinds of charitable gifts.
The first page of the Form 8283 is easy. For conservation easement gifts, you need the name of the donor at the top, and the “Identifying number,” which in the case of an individual is your social security number, and in the case of a limited liability company (“LLC”) or partnership donor is usually the “employer identification number” of the entity.
I would add one very important aside here. We get the question often, if an LLC or partnership makes the donation, who files what forms in how many places? See the first page of the Instructions for a discussion of this issue.
Nothing else needs to be filled in on page 1 of the Form 8283.
On page 2 of the Form 8283, top line, once again, you need to fill in the name of the donor and the Identifying number.
Part I — Information on Donated Property
Now we need to pay careful attention.
For number 4, check box “b” for Qualified Conservation Contribution. This is not difficult, but don’t forget to do it. If you made a gift of land, that is, not a conservation easement but a gift of the property itself, check box “e,” Other Real Estate.
Note the “Note” at the bottom of Part I: “In certain cases, you must attach a qualified appraisal of the property. See Instructions.” Very simply, if you claim a deduction greater than $500,000, you must file a copy of your appraisal with your tax return. In many cases when the value is less than that, I also recommend including a copy of the appraisal report with your tax return. As I have said many times, if you have a good, competent, well-written, and well-presented appraisal report, it’s good to let the IRS know that.
Number 5, or line 5, is where the rubber hits the road. There is a lot of important information here and it must be included and it must be presented correctly.
The IRS has said that the information included on Line 5(a) needs to be clear enough so that the reader knows something specific about the property. In other words, “conservation easement” or “conservation easement on land in Texas” isn’t enough. There really isn’t enough space under 5(a) to include very much information, so I do what you see on the Form: “Conservation easement under IRC 170(h) on land in Pomona County, Texas, to protect wildlife habitat.” And then I add, “See Attached Deed of Easement and Supp. Statement.”
The Instructions to the Form 8283 are quite clear that if you donate a conservation easement, you MUST attach a separate statement providing certain additional information. See the discussion on pages 2-3 of the Instructions about what needs to be included in the Statement. See the form of Supplemental Statement I have included on the site. See the longer discussion about the Supplemental Statement, below, in this Note.
A conservation easement is not tangible personal property, so Line 5(b) is blank.
Line 5(c) asks for the appraised fair market value of the charitable gift. In some cases, this is quite straightforward. Aunt Sally has a 500-acre farm, she donates a conservation easement on the farm, the fair market value of the easement is determined by a qualified appraisal to be $1,000,000. See Note #8, Note #9, and Note #10 for a discussion of the conservation easement appraisal rules in the regulations. If none of Aunt Sally, members of her family, or “related persons” own any other property in the area the value of which is increased by the donation of the conservation easement, the discussion is over and the entry on Line 5(c) is $1,000,000.
But what if there is say $100,000 of enhancement to any of such other property (again, see Note #10)? According to the Treasury Regulations, that reduces the deduction to $900,000. Note, that does not reduce the value of the easement to $900,000, it reduces the deduction to $900,000. I think the correct way to fill in Line 5(c) in such a case is to do what the Form asks for, that is, the fair market value is still $1,000,000. I believe the Supplemental Statement should include a discussion to the effect that there is $100,000 of enhancement, and that pursuant to the Treasury Regulations the deduction is reduced to $900,000, and that deduction is shown on the donor’s tax return.
Lines 5(d), (e), and (f) seem innocuous enough, but they are not. I call your attention to what the Instructions say about this information: “If you have reasonable cause for not providing the information in columns (d), (e), or (f), attach an explanation so your deduction will not automatically be denied.” (emphasis added) I won’t repeat this statement from the Instructions. I will just say, read that again. “Automatically be denied” are the operative words here.
Sometimes, in some cases, especially with older landowners who have owned property for decades, the date of acquisition is not clear and the cost or adjusted basis is not clear, and in those cases the donors should explain that on the Supplemental Statement.
What is the IRS looking for here? If the donor acquired the property in 2012 for a cost of say $1,500,000, and claims a $3,000,000 deduction for the donation of a conservation easement in 2014, those particular numbers might make the IRS uncomfortable. The IRS could easily ask, “If you paid $1,500,000 for the property in 2012, how did the value of the property more than double, how did the value of the property increase by so much, so quickly?” In some cases, these numbers are completely defensible, but in many cases they are not. So under no circumstances should these lines be left blank with no explanation about why they are left blank.
Also note, with respect to Line 5(f), the Form itself is not completely clear whether the information requested is for the basis of the easement or the basis of the property itself. The Instructions simply state that you have to tell the IRS which one you are using – the basis of the easement or the basis of the fee. Honest people of good faith can disagree about which is “correct,” but the IRS is telling us, really, it doesn’t matter which one you use, just tell us which one you use.
If the easement was sold in a bargain sale (see Note #2), the amount received should be entered in Line 5(g). Otherwise, (g), (h), and (i) are left blank.
Part II – Taxpayer (Donor) Statement
For the gift of a conservation easement, this is left blank. I have seen these with the donor’s signature here, but that is not required.
Part III – Declaration of Appraiser
There really aren’t many tricks here, but there is one. Of course, all the blanks have to be filled in correctly and the appraiser has to sign and date where indicated.
The “trick” (which really isn’t a trick) is that if one appraiser signs the qualified appraisal report, that one appraiser should sign where indicated. But if two appraisers sign the qualified appraisal report, both should sign where indicated. And if three appraisers, etc. This is a very important rule (see the Instructions) and one that donors have missed in many situations.
Part IV – Donee Acknowledgement
There are a few important observations here.
First, the Form calls for the date on which the donated property was received. In the case of a conservation easement, the easement is not deductible until it is recorded, and the easements we draft generally have language to the effect that the easement isn’t effective and the restrictions in the easement aren’t effective until all necessary signatures have been affixed and the document has been recorded. So we generally put in here (see the Form 8283) the date the easement was recorded, and we note that.
If the gift is of a conservation easement, the donee organization does not intend to “use the property for an unrelated use,” so that “No” box should be checked. That question is relevant for certain other charitable gifts but the related tax issues are not relevant for gifts of conservation easements.
The other issue that has come up from time to time is that the person who signs the Form 8283 on behalf of the donee organization must have the authority to do so. This is a standard bit of due diligence. A messenger can’t just show up at the donee’s office with the Form 8283 and have the volunteer receptionist sign it and date it (unless of course the receptionist also happens to be “an official authorized to sign the tax returns of the organization,” as the Instructions state).
Read the Instructions!!! There really is a tremendous amount of useful and important information in the Instructions.
See the example of the Supplemental Statement on the site. (The example on the site is not keyed to the example of the Form 8283 I am using for this Note.)
If the donation is a gift of a conservation easement, the Instructions are specific about what information must be provided in a statement attached to the Form 8283. Read the Instructions!! We also use the Supplemental Statement to make a further clear case that this particular conservation easement on this particular property meets all of the tax code requirements for deductibility. Often, and I think this is good practice, excerpts from the Baseline Documentation about the conservation values of the property are incorporated into the recitals in the conservation easement, and then repeated again in the Supplemental Statement. As that old saw goes about teaching, “Tell ‘em what you’re gonna tell ‘em, then tell ‘em, then tell ‘em what you just told ‘em.”
As you will see from reading the Supplemental Statement, it tells the reader a lot about the property but it also tells the reader a lot about other IRS and tax code requirements that are relevant here, i.e., the easement meets various of the “conservation purposes” tests, the donor has the so-called “gift letter” required by Section 170(f)(8), there is no mortgage on the property, the appraiser has considered the “enhancement” rule.
Audit Strategy in a Few Paragraphs
There is a lot more to say on this issue, and I hope to devote a future Note to IRS audits of conservation easements and how best to survive same. But for now, I share just a few thoughts.
Be prepared. If you follow the checklist and advice in Note #11 and this Note #12, if you are audited you will have a better chance of achieving a better result in the end.
Be prepared. If your donation of a conservation easement is audited, expect that an initial IRS appraiser’s or engineer’s report on the value of your easement will be way, way below the value of the deduction you claimed. This does not always happen, but it mostly happens. Sometimes the IRS is fair, but in my experience this first hit is a very very lowball number.
Be more than fully responsive. Answer all document requests in full, and in a timely manner. And make the best possible case you can, in writing, in response to the IRS appraiser’s report. If and when you get to this point in an audit, you should be sure to work with an advisor who has particular expertise in IRS audits of conservation easements. This is a different world. Rebut every single point with your best possible arguments. I have read a lot of IRS appraiser reports and some of them seem sound and convincing, until the donor’s appraiser starts to point out the flaws and incorrect assumptions. Make the best possible case you can in response to the IRS appraiser’s report.
Then, after you have made a thorough, competent, convincing rebuttal of the IRS appraiser’s lowball report, as polite and professional as many IRS employees are, be prepared, substantively, on the issues, to have all of your arguments ignored.
In other words, and, again, there are exceptions to this but they are few, assume you will not agree with the IRS at this “Exam” or audit level, and your case will go to Appeals, and, almost all of the time, you will be able to settle there.
Bottom line: be prepared for what is often an unfair fight. In spite of that do your very very best to respond in full and in detail. Build the best possible case you can so you can achieve a fair settlement at the next audit level.
Again, I hope to have a future Note with more specifics about the audit process.