Although he can easily sell the farm for a large sum as a subdivision of residential homes, perhaps the farm has been in his family for generations and he really wants to see it remain available for agriculture. Unfortunately, the value of the farm is well beyond the reach of most farmers. He laments the loss of productive farmland to development and faces a substantial capital gains tax if he sells the land. The farmer considers donating the land to a charitable organization, but tax benefits will not fund his retirement. He also understands that some charitable organizations simply sell donated land to the highest bidder, without conservation restrictions.
But it does not have to be that way. Alternatives can satisfy the farmer's needs and goals. Many conservation organizations will accept the donation of real estate, protect it from development or subdivision, and accomplish some or all of the following benefits:
oProvide the landowner with an income stream for life,
oEliminate or reduce capital gains, income, and estate taxes,
oFor the absentee landowner, remove the headache of managing the land long distance,
o?Arrange for the transition to another conservation-minded agricultural family—perhaps a young farmer who can afford only a farm restricted with a conservation easement, and
oProvide charitable support to the conservation organization.
A landowner with plenty of liquid assets and a strong conservation ethic may make an outright gift of property to a qualified conservation organization or may donate a conservation easement. A landowner may also donate the farm and retain life use of the property, obtaining a charitable income tax deduction for the value of the remainder interest. The owner who needs some cash may opt for a bargain sale, selling the property to a conservation organization at less than fair market value and receiving cash proceeds and an income tax deduction for the difference between the sale price and the fair market value of the property.
Frequently, though, a landowner is not in a position to make an outright gift of property. A farmer, rancher, or absentee agricultural landowner may want to retire and give up ownership of the land and the responsibilities connected with it, including farm operations, maintenance of equipment and facilities, and property taxes. At the same time, the owner needs income. Most importantly, the owner has a strong commitment to farming and does not want to see the land developed. Landowners who want to preserve their land and receive an income stream for life might consider an agricultural conservation easement (ACE) coupled with a charitable remainder trust (CRT) or a charitable gift annuity (CGA). These techniques tie traditional planned giving with land conservation. A CRT or a CGA would be particularly appropriate if the landowner is over the age of 60, because the rates used to determine annuity or trust payments are attractive. A CGA, for example, would currently provide income of 5.7% or more depending upon age.
It is important to recognize that a landowner will likely receive more in proceeds if he or she sells the farm at fair market value with no restrictions. With the acceleration of the estate and gift tax exemption under the Economic Growth and Tax Relief Reconciliation Act of 2001, some landowners may no longer need to reduce the size of their estates to avoid the estate tax. In the end, landowners who consider the techniques mentioned in this article will have a strong charitable intent and a conservation ethic. As a plus, these techniques do provide an income stream for those who may need it.
Agricultural Conservation Easement
The first step in using one of these planning tools usually involves placement of a conservation easement on the donated property. A conservation easement must restrict the use of the property in perpetuity so as to preserve the conservation purpose. Treas. Reg. § 1.170A-14(b)(2 ). The easement is created by a written agreement between the landowner and a conservation organization. Like all legal agreements affecting the chain of title, a conservation easement is recorded on the local land records. It can then be monitored in perpetuity by the conservation organization holding the easement.
An agricultural conservation easement may allow a variety of farm uses on the land but restrict all future subdivision. Assuming the conservation test is met, the difference between the value of the land with development rights intact and the "conserved value" (after the easement is granted) can be taken as a charitable income tax deduction. The deduction can be taken against up to 30% of the landowner's adjusted gross income for the current year, and the remainder can be carried forward and applied against five subsequent years of adjusted gross income. Code § 170(b) and (d).
Conservation Easement Combined with a Charitable Remainder Trust
A CRT is an irrevocable trust established by the landowner that will provide a lifetime income to the landowner and his or her spouse or other beneficiaries. Code § 664. Several types of charitable trusts exist, but generally, the annual income may fluctuate year-to-year depending on the structure of the trust, the ages of the landowner and other beneficiaries, and the value of the property subject to the conservation easement that is used to fund the trust. This planning strategy is accomplished in two steps: the donation of the easement to a qualified conservation organization, followed by the donation of the restricted fee interest to a CRT. The landowner receives an income tax deduction for both the easement donation and the donation of the land to the CRT.
The trustee (usually a bank or other financial institution) immediately sells the property (with the easement in place), typically to another farmer, free of any capital gains tax. The trustee then invests the sale proceeds to generate income for the beneficiaries. Upon the death of the original landowner (and other beneficiaries, if any), title to the assets in the trust passes to the conservation organization. Upon creation of the CRT, the landowner receives an immediate tax deduction equal to the present value of the remainder interest in the trust that will pass to the conservation organization. This deduction is in addition to the value of the donated conservation easement. Because the assets in the trust pass to the conservation organization at the landowner's death, no portion of the trust corpus is included in the landowner's taxable estate.
As an example, a farm owner and spouse, ages 71 and 64, decided they were ready to part with their 46-acre sheep farm in Vermont, provided they could obtain permanent protection for the farm. They wanted to avoid a large capital gain that would result from the outright sale of the property, and they also wanted income payments for the remainder of their lives. The landowners first donated an agricultural conservation easement on the property to a qualified conservation organization. Then, with the assistance of the conservation organization, they established a CRT with a Boston bank.
The trust was structured to make payments to them for their joint lifetimes equal to the lesser of 8% of the trust assets (calculated each year) or the net income received by the trust. This type of CRT is called a net income charitable remainder unitrust. As soon as title to the property was conveyed to the trust, the trustee sold the conserved farm to a local farmer and reinvested the proceeds to provide lifetime income to the original landowners. Upon the death of the second spouse, the assets left in the charitable remainder trust will pass to the conservation organization, which will use the funds for other conservation purposes. Chart 1 shows an example of how a CRT might work financially.
Conservation Easement Combined with a Charitable Gift Annuity
Unlike a CRT, the CGA is created by transferring title to the farm to a conservation organization that will then contractually agree to pay the donor (and up to one other beneficiary) a specified annual payment for as long as they live. The amount of the annuity payment will depend upon the value of the farm subject to a conservation easement, the age of the donor and the other beneficiary, the annuity rate selected and the federal discount rate in effect at the time of the gift. The conservation organization will sell the farm to another farmer and use the proceeds to establish the annuity. The landowner may donate the conservation easement first, or rely on the conservation organization to restrict the property upon resale. As with a CRT, the donor receives an immediate income tax deduction and the value of the farm will be excluded from his or her taxable estate at death. Capital gains are apportioned over the donor's actuarial life. When the landowner and other beneficiary of the gift annuity die, any remaining assets used to establish the annuity pass to the conservation organization. A few states—for example, New York—do not allow a CGA to be established with a gift of real estate.
An example of a CGA used with a conservation easement is the case of a 78-year-old Wisconsin woman who inherited a farm in central Indiana. Rental income from the farm was erratic and minimal; the challenges of managing property long distance were considerable. She donated the farm to a conservation organization and received a substantial income tax benefit. Proceeds from the sale of the now-conserved land to a local farmer were used to establish a CGA that brings the landowner consistent and reliable payments almost twice what she was netting previously. Chart 2 compares outright sale for development with a CGA.
Costs and Other Considerations
The landowner must understand at the outset that the costs of these transactions can be significant. Expenses usually include a qualified appraisal, a land survey, and legal and accounting fees. In addition, because the qualified conservation organization will monitor the easement in perpetuity, the landowner typically makes a significant contribution to a stewardship endowment for the conservation organization accepting the easement.
The conservation organization will conduct its own analysis of the property, including a site inspection, a market analysis, and an environmental study. Setting up the CRT or CGA may also require analysis and involve accountants and lawyers skilled in planned-giving techniques. The organization may not want to consider property with multiple owners or property encumbered with debt.
Notwithstanding the complexities and risks of donations of real estate, a conservation easement tied to a CRT or CGA may be a perfect vehicle for some agricultural landowners. These transactions may appeal to landowners who are over 60 years of age, have a strong conservation ethic, and either have no heirs or have heirs who support the conservation and planned-giving techniques.