CONSERVATION EASEMENTS

The decline in residential development has provided an unexpected opportunity for land preservation.  Large tracks of land that were slated for new homes are now being sold in whole or in part to local and regional municipalities and open space organizations.  Certainly the sale of the entire fee interest in the land would likely qualify for a 1031 exchange; however, the sale of less than a fee interest may also qualify for a 1031 exchange if certain criteria are met.

The IRS has issued several private letter rulings finding that certain types of conservation and agricultural easements are like kind to real estate.  A conservation easement is a voluntary agreement that allows a landowner to limit the type or amount of development on their property while retaining private ownership of the land. Generally, the easement needs to be perpetual in nature and considered an interest in real estate for state law purposes.

This position was affirmed fairly recently in PLR 200649028 when the IRS held that a stewardship easement was like kind to a fee interest in real estate.  The IRS based its decision on the fact that the stewardship easement was considered an interest in real property under state law and that the easement was perpetual. The ruling also discussed that the sale of the easement significantly and permanently restricted the future use of the taxpayer’s property such that the fair market value of the property, if sold, would be impaired.   The transaction discussed in this PLR was somewhat unique in its structure. First, the taxpayer conveyed the relinquished property by granting the county a perpetual restrictive stewardship easement over ranch land in return for a certain amount of stewardship credits. The value of the credits was equal to the value of the property rights that the taxpayer permanently relinquished to the county. During the exchange period, the taxpayer converted the credits to cash by selling them to a third party buyer. The cash was then used to purchase the replacement property.  The taxpayer was never in receipt of the credits or the relinquished property proceeds during the exchange period. The IRS held that this structure did not disqualify the transaction from 1031 tax deferral treatment.

In summary, a 1031 exchange opens many investment opportunities for land owners who wish to exchange conservation easements for any other real property.