Standards & Practices

Issue 1 – Tax Appraisals and Easement Valuation

Discussion

Of the established Standards & Practices, one of the most vexing for land trusts (no matter what size or level of experience) surrounds the issue of tax code benefits and land valuation. An organization may feel from time to time that there needs to be a tax code attorney and professional appraiser on staff to field the many questions that come up while putting together an easement agreement. And routine business can be made more challenging by changes in the tax code, valuation procedures, and differing interpretations of the law. The following discussion covers valuation, liability, impact on the land trust business, and some issues that come into play in Texas. We've also included some helpful links.

Valuation

According to the IRS bulletin 2004-28, "A qualified conservation contribution is a contribution of a qualified real property interest to a qualified organization exclusively for certain conservation purposes."¹ This succinctly details the tax code requirement of IRC 170. For the most part, this definition is fairly straight-forward. Land trusts serve as the qualified organizations; conservation purposes are also clearly outlined; but what passes as a 'qualified real property interest' depends largely on the appropriateness of the estimated value.

According to Stephen J. Small, a core concept of valuation is that, "the correct 'fair market value' of any piece of real estate at any point in time must take into account its true development potential. In valuing a conservation easement, some appraisers mistakenly think it is possible to go through a theoretical economic exercise that somehow ignores this rule" (from Exchange, Fall 2003). IRS Commissioner Miller points to some egregious examples of "proposals to place conservation easements on small parcels of land that lie between the holes on a golf course" or "…for the spaces between houses in gated communities." So an important question to ask is: If development assumptions are used to estimate the value of the property, are they reasonable?

As one professional recently described it, appraising property value is a 'sticky wicket'. The value of a piece of property is not something that can be absolutely known. Market value, by definition, is an estimate. The valuation is an appraiser's best estimate of what something should sell for if it were marketed under all the prerequisites of a fair sale. Landowners, and the land trusts they work with, should keep in mind that if a deal sounds too good to be true, then it probably is. Small reminds us that, "…if you have any doubt at all about whether a particular transaction is appropriate or not, seek experienced counsel and err on the side of caution." (from Exchange, Fall 2004)

Liability

The second major facet to this issue is that of responsibility or, more to the point, liability. The IRS has promised increased scrutiny of conservation easements. For those transactions which it deems fraudulent, who then will be held to account? Certainly the land owner/taxpayer and the appraiser in cases where the value and/or deduction is found to be inappropriate. But what ramifications should the land trust (donee) be aware of?

As you all know, land trusts are now required to sign Form 8283, which identifies the asset and its value, is signed by the appraiser and by the organization accepting the donation. Form 8283 includes the following disclaimer: "This acknowledgment does not represent agreement with the claimed fair market value." However, there's some disagreement about whether this line would absolve a land trust of any responsibility if the valuation were ever called into question or deemed inaccurate by the IRS.

From a purely legal standpoint, by signing Form 8283 a land trust is simply acknowledging the gift and is not responsible for judging the validity of the valuation claim. And many land trusts would agree. However, there is growing concern in the land trust community about how the IRS, the media, or even Congress might view (and respond to) such a situation. As recently as March of this year, Steven T. Miller, Commissioner, Tax Exempt and Government Entities of the IRS, noted that, "Section 6701 imposes a penalty for aiding and abetting an understatement of tax liability."²

Naturally, it's easy to read that as a potential threat to land trusts. Additional comments from the IRS may be cause for concern as well. Also noted in Internal Revenue Bulletin 2004-28 was a comment about consequences: "The Service intends to assess excise taxes under §4958 against any disqualified person who receives an excess benefit from a conservation easement transaction, and against any organization manager who knowingly participates in the transaction. In appropriate cases, the Service may challenge the tax-exempt status of the organization, based on the organization's operation for a substantial non-exempt purpose or impermissible private benefit." The key word in this case is "knowingly." Still, it's arguable whether the tenor of this notice indicates the IRS is issuing a resounding threat or simply "rattling its saber."

In the end, each organization must consider the legal perspective as well as its own. An attorney can interpret liability but each land trust has to consider what the organization is comfortable with. Even many land conservation experts would agree that there's no clear, right answer. And, even if the IRS is looking to make a statement about the issue, land trusts are being called upon to ensure that their easements, the requirements of the tax code, and the appropriate valuations are sturdy and sound. Only in this way will our collective conservation efforts endure the test of time.

Why things are different in Texas…

Tax code and appraisal issues are important concerns for any land trust. Here in Texas, though, these matters are particularly important. As a sunbelt state, Texas has experienced rapid population growth in recent years. Between 1990 and 2000 alone, the State's population grew almost 23% - to just under 21 million. As you are all aware, this growth has spurred unprecedented land development. The real estate market continues to be one of the strongest areas of economic growth, even as other sectors have leveled off or declined overall.

This growth and development has produced a fast-paced real estate market with hot spots all across the State. Appraising value in a dynamic market scenario can be particularly challenging, especially when dealing with easements. There are still relatively few Texas appraisers who are familiar with easement work. Fortunately, that list is likely to grow as interest in conservation easements grows. The American Society of Farm Managers and Rural Appraisers (ASFMRA) and The Appraisal Institute offer a variety of education and training opportunities here in Texas. Of note, ASFMRA will offer a national Uniformed Standard of Professional Appraisal Practice (USPAP) update course in Austin on September 22, 2006.³

And, when you get right down to it, there's no recipe for correctly appraising an easement. There's no accepted way or set standard for this type of appraising. The market can be all over the place these days. Development potential is certainly a factor – more in some parts of the State than others. Lastly, the land trust movement is still a relatively new one here in Texas. Some of the concerns that have been faced by land trusts in other states are still on the horizon for us. It's in our collective best interest to prepare now for the challenges to come.

In closing, we are entering a pivotal phase in the evolution of the land trust movement. Attention to Standards & Practices (in general) and tax code and appraisal issues (specifically) will help prepare land trusts for future accreditation, which will formally begin in 2008. More immediately, land trusts have been given a window of opportunity to reach a broader audience of landowners through the recently passed pension bill (HR4). However, as tax benefits become more attractive, land trusts will need to be increasingly wary of landowners and developers who aren't putting the conservation ethic in the forefront. Now is the best time for land trusts to shore up long-term conservation efforts by structuring exemplary easement agreements under these new guidelines… agreements that will reflect the good work of all of us and stand the test of time (and IRS scrutiny!).

This discussion drives home the point of why land trusts should set high standards, adhering to sure and certain operating principles. Continuing and constantly improving our good work furthers the conservation efforts for us all. On the flipside, a single bad headline can 'poison the well' for us all, as well. To be sure, the vast majority of conservation easements have solid conservation purposes, are placed by sincerely motivated landowners, and are held by diligent and conscientious land trusts. But some land trusts have already been approached with questionable deals… and more will surely follow. Proper use of easements will help ensure their preservation and, thereby, hold safe the conservation values of the land which the easements are intended to protect.

Continue to Links…

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¹The IRS describes a qualified real property interest as a "conservation easement" and goes on to detail what conservation purposes are permitted: "natural habitat of fish, wildlife, or plants, or similar ecosystem" as well as "preservation of open space, including farm and forest land…"

²IRS Circular 230 and a discussion of Section 6701 are available from the IRS Web site."

³National USPAP Update Course (A-12 Part III): This constantly evolving seminar keeps appraisers up-to-date with the latest revisions and changes to the Uniformed Standard of Professional Appraisal Practice (USPAP) as adopted by the Appraisal Standards Board (ASB). In the morning session, USPAP changes recently adopted by the ASB will be discussed. In the afternoon session you will be afforded the opportunity to apply this information by case study, critique, and discussion of an agricultural appraisal report.