Note #4: Amending Conservation Easements – Are There Really Any Rules? (continued)
To bring new (and prior) readers of Notes up to date, here are the Examples from Note #3.
Example 1. Aunt Sally has a farm. The farm is four hundred acres, two hundred acres to the west of the county road and two hundred acres to the east of the county road. And the eastern half of the property is itself bounded to the east by a river. Aunt Sally has a home and barn and other outbuildings on the western parcel (to the west of the road), and there are no structures on the eastern half.
In 2009, Aunt Sally put a perpetual (and deductible) conservation easement on the eastern half of the farm, that is, on the property between the road and the river. The conservation easement allows the construction of one new home, plus a garage and shed, within a five-acre area (identified in the easement) that is close to the river. The holder of the easement, the local Happy Valley Land Trust, would have preferred the reserved house site to be a greater distance from the river, but on the whole both Aunt Sally and the land trust are very happy with the easement.
This year, Aunt Sally approaches the land trust with this request. “I have been thinking about this and I’m going to make the change you would have preferred in the first place. I think I’d like to move the reserved house site away from the river. I think it should be close to the road.”
The good news is that a house site close to the road has a very minor impact on the conservation values of the property, and, from that perspective, is a much better site than the original site down by the river. The land trust is delighted.
However, as it turns out (more on this below), assume that the house site down by the river is worth $150,000, and a house site close to the road is worth $175,000 (in part because it will no longer be necessary to build a long road across the property to the site by the river, which is also a significant conservation benefit of the proposed amendment).
Can Happy Valley Land Trust agree to the amendment?
Example 2. All the facts are the same as in Example 1, but in addition to making the request to amend the easement to relocate the permitted house lot, Sally says, “Just to make this easier for you, if you agree to the amendment I will put a new easement on 100 acres I own across the road.”
Can Happy Valley Land Trust agree to the amendment?
Example 3. Uncle Bob owns 50 acres of mostly wooded property in a fairly rural area outside of town. The property is undeveloped. Uncle Bob would like to put the property under conservation easement and reserve the right to build a small cabin and shed near the back of the property. Bob will need to construct a road to access the cabin, and under local zoning the road would not have to be paved.
Happy Valley Land Trust accepts the easement. Bob is not absolutely clear about the precise location of the road, but he and the land trust agree on a 45-foot-wide strip, within which Bob can construct a road not to exceed 15 feet wide, and the 45-foot strip is identified as “Accessway Area” on an exhibit attached to the easement and recorded with the easement, along with an identified “Building Area” for the cabin and the shed.
Two years pass and Bob is ready to construct the cabin and shed. However, after spending more time walking the property, he thinks construction of the road would be simpler if he moved it about 90 feet east of the 45-foot-wide “Accessway Area.” Bob asks the land trust to amend the easement to allow him to relocate the permitted road.
Can Happy Valley Land Trust agree to the amendment? Would your answer be any different if the construction of the road at the preferred site would be less expensive to Bob?
As I said at the beginning of Note #3, when we were writing the regulations at IRS in the early 1980s, and in fact when the tax statute was being drafted in 1979 and 1980, the issue of amending easements did not come up. And there has been no formal “guidance” from the IRS, or from the courts, on amending easements. So, today, there is no “official” law that applies to this issue, which is one of the reasons that there is a very wide range of good faith opinions about amending conservation easements among people with experience in this field.
There is one absolutely fundamental tax code rule that does apply (although, of course, with the controversial nature of this entire topic, some may even disagree with this point). The fundamental tax code rule is that the land trust cannot amend the conservation easement in a manner that would result in the value of the encumbered property increasing. Another way of putting this is to say that there can be no private economic benefit conveyed to the landowner through an easement amendment. This rule is not unique to the conservation easement field. In general, under the rules governing charitable organizations, a charitable organization cannot convey private economic benefit on any individual. Be that as it may, some significant issues can come up in actually implementing this rule.
The second rule, and this rule is clear but sometimes not so clear, is that the land trust cannot agree to any amendment that would have an adverse impact on the conversation values of the property. This rule is certainly consistent with the rule in the tax statute that the conservation values of the protected property must be protected in perpetuity. However, some significant issues can come up in actually implementing this rule.
There are other “guidelines” (and some would say “rules”) that have emerged when it comes to considering an easement amendment, but this Note #4 is not the forum for a longer discussion of these. Let’s just work with the “no private economic benefit” and “no damage to the conservation values” rules.
Example 1. This example alone illustrates how tricky the entire easement amendment business is. Aunt Sally wants to move the house lot to a location that is much better for protection of the conservation values of the property. The entire purpose of the tax code conservation easement rules is to protect important conservation values in perpetuity. But on the facts here, because the new location is worth more money, there would be private economic benefit to Aunt Sally so the land trust should not agree to the amendment. Some readers might, in good faith, disagree with this analysis. But that is what I think and we have been told, informally and unofficially, that is what many Internal Revenue Service people think.
From one perspective, one could argue that this is a perverse result. But it is also understandable. Aunt Sally took an income tax deduction for the value that she gave up when she donated the conservation easement, and this amendment would in fact give her back some of that value.
Example 2. So, given the analysis in Example 1, and assuming Aunt Sally understands these rules and the land trust follows them, what if Aunt Sally says, “Look, the house lot is more valuable by $25,000, so I’ll put an easement on another 100 acres and convey that to you as part of the deal. My appraiser tells me that easement is worth well in excess of $25,000, so that should make you happy. And, by the way, my attorney tells me that if I do it this way I can’t take a deduction for the new easement, because it is part of the deal to get you to agree to amend my first easement, so I won’t take a deduction for the new easement.”
Or, what if Aunt Sally says, “Look, the house lot is more valuable by $25,000, so I’ll write the land trust a check for $35,000 if you do the deal, so I come out losing money, and, by the way, I won’t deduct the $35,000.”
There is a great divide in the land protection business, and a great deal of uncertainty, about how to handle this situation, and there are a few different issues that come up. Some thoughts follow.
Here is one question, and to date there is no clear “law” on the answer to this question.
If you are considering an easement amendment, must you confine your analysis of the issues to the property under easement, or can you take into consideration other property? Put another way, if the consideration of Aunt Sally’s proposal to relocate the house lot to a better “conservation” location but a more economically valuable location is confined to the property under easement, if the wiggle room is confined to the property under easement, Aunt Sally’s proposal may well be dead in the water. If the land trust can take into account Sally’s offer to put an easement on other property, her proposal might work.
But here is the next question. Is it one thing to say, “If you do this, I’ll give you an easement on another 100 acres,” and something else to say, “If you do this I’ll write you a check for $35,000”? Or is it the same thing? Taken to a logical conclusion, in both cases isn’t Sally actually buying her way out of a perpetual conservation easement? This is a very slippery slope indeed.
What if we change the facts a bit. What if the original reserved house site under Sally’s easement is up by the road, and what if she wants to amend the easement to move the house close to the river? Now, we have an adverse impact on conservation values but a lower economic value, so the “no private economic benefit” rule isn’t an issue.
With the adverse impact on conservation values, it seems like the answer is, “No, you can’t do that.” So, Sally says, “If you let me do that, I’ll put a conservation easement on 100 acres across the road, so there is quite a significant net conservation gain for the land trust and for the community you serve.”
Where does that leave us?
I’m not sure. Is Sally buying her way out of a perpetual conservation easement? Or does the net conservation gain outweigh that issue? Different people of good faith in the land protection business will have different answers to these questions. Many people would argue, and it certainly is a respectable argument, that we will amend the existing easement and take the new easement because more important conservation land is protected, and overall we get a better conservation result. Others would argue, and it certainly is a respectable argument, that the IRS rules simply prohibit amending an easement in a manner that results in an adverse impact on the conservation values the land trust agreed to protect when the land trust accepted the initial conservation easement.
Like it or not, conservation easements for which an income tax deduction was taken are governed by tax code rules. More on this point below.
In my old age and increased understanding of the complexity of these issues, I’m going to let this all twist slowly in the wind for a while, or at least until a future Notes.
Example 3. It is ok for the land trust to agree to Bob’s request to relocate the road? Remember, one road was allowed under the easement in the first place, assume the landscape is the same, assume the impact on the conservation values will be the same and that the road is just in a different place. But, the new road would be in a different place, a place that was originally protected (and still is protected) by the conservation easement.
Some readers will say, “No.” Some readers will say, “Why not? What’s the harm?” Some readers will say, “The harm is to the concept that easement holders have to enforce the terms of the easements they accept.” And this discussion will continue, well beyond this Note #4. The principal purpose of Note #3 and this Note #4 is to illustrate just a few of the complex decisions facing the land protection community when it comes to amendment easements. I am planning at least one more Notes to discuss a bit more these and related issues.
Hemmed in by the IRS rules. As I said in Note #3, some people in the land trust business don’t like being hemmed in by the IRS rules, but to me that is akin to not liking that it gets cold in the winter. The current state of affairs is that most easements in this country have been donated, and the donors have claimed an income tax deduction, and that implicates the tax code rules and that brings the IRS to the table.
However, in a more constructive vein, and looking forward, I would like to repeat the thought that I first offered about a decade ago, and more recently wrote about in my newest book, The Business of Open Space: What’s Next??
What About A New Kind of Conservation Easement?
For decades, conservation easements have been the principal private land protection and open space protection tool. When a landowner protects her property in perpetuity, and meets all the requirements of the federal tax code for conservation easement donations, the landowner is entitled to an income tax deduction for the donation of that easement. I cover more about these issues in my Preserving Family Lands books.
Well-written and well-thought out conservation easements can preserve significant flexibility for the landowner, but as those of us in this field have learned, land changes hands, landscapes change, desirable uses of open space can change. Once a conservation easement is done and recorded, the federal tax code and other legal rules make it difficult, sometimes very difficult, to make changes to that conservation easement that respond to the need for flexibility, new approaches to land use, new science, new technologies. This is the price a landowner must be prepared to pay for the initial income tax deduction for the easement donation, and thousands of landowners have made and will be prepared to make that decision in years to come. Some have even suggested that, over time, in certain cases, it may be necessary to amend a conservation easement in order to be able to protect the conservation values in perpetuity.
Again, a well-drafted conservation easement can anticipate and provide for many changes that are compatible with keeping intact and preserving the conservation values of the protected property. But I suggest that people in the open space business need to start talking about a different kind of conservation easement, for which there would be no federal income tax deduction. We can call these “conservation agreements” or “conservation contracts.” As with “environmental commodities” such as carbon sequestration credits, and “natural values,” the concept is the key, not the terminology. (See my book, The Business of Open Space: What’s Next??, for a longer discussion of how we also need to get more creative with “environmental commodities.”)
There are no limits here on our ability to be creative and flexible. This kind of “conservation agreement” can provide for more flexibility, easier amendments, a greater ability to adapt to new ideas in science and the economics of land use (including, for example, global challenges like climate change and the economics of agriculture and energy sources). These conservation agreements, with their retained level of flexibility, might work much better in transactions that combine the potential sale of environmental commodities and the perhaps perpetual but perhaps simply very long-term, not permanent, protection of the subject property. Maybe these easements will be more easily “terminable” on the right set of facts.
Assuming there is no federal income tax deduction for this sort of new type of conservation agreement, one can also assume that most landowners who agree to such flexible restrictions will expect some compensation in return. There are no limits here on our ability to be creative and flexible.
In The Business of Open Space: What’s Next??, I discuss some of the few “environmental commodity” transactions that are being done around the country. Over time, and I think this is critical to the growth of private land protection in this country, new environmental commodity transactions will be done on a massive scale, in the tens of thousands, hundreds of thousands, even millions of acres. On a case-by-case basis, this new type of conservation agreement can certainly be an add-on as part of these larger environmental commodity transactions. And, of course, there are many other situations, beyond the scope of this Note, in which this new type of conservation agreement can also stand on its own.
Future Notes will cover some of these ideas and some of these transactions. But let me just conclude this Note #4 by repeating the point that like it or not, we are hemmed in by tax code rules, and, like it or not, we need to create a bigger toolbox.