Have you heard about Louis Bacon? He is the manager for the hedge fund Moore Capital Management. No, I am not mentioning his name because I am a client of his firm (I wish), but because I was reading that he donated a conservation easement, meaning that he got a (sizeable, I’m certain) tax deduction. The easement is on his Colorado ranch, Trinchera Blanca, which extends over 90,000 acres.
COMMENT: I wonder how long it takes to reach your house upon turning from the roadway when your property is 90,000 acres.
This gives us an opportunity to talk about conservation easements. Let’s be upfront, however: this is a high-end tax strategy. This has as much to do with your or my daily life as piloting a fighter jet.
There are three requirements if you want this deduction:
- Qualifying real property
- Donated to a qualified organization
- For conservation purposes
The third requirement includes:
- The preservation of land for substantial and regular use by the public for outdoor recreation or education
- The protection of natural habitat of fish, wildlife or plants
- The preservation of open space, where the preservation is for public enjoyment or pursuant to government conservation policy
- The preservation of historically important land or a certified historic structure
An easement makes sense if you think of real estate as more than just … well, real estate. Let’s say, for example, that you own the last remaining farm in a now heavily-developed suburban area. That farm is more than just soil. It is also a bucolic view, a possible watershed, the remaining redoubt for an endangered amphibian, and the source of great wealth from a potential sale to developers. It has layers, like a good lasagna.
We are going to donate one or more of those layers to a charity. We might be able to fit under the “preservation of open space” category above, for example. You could donate a restriction that the property will never be commercially developed. You still own the farm, mind you, but you have donated one of the rights which as a bundle of rights comprise your full ownership of the property.
We next have to put a value on this layer. This is where the horsepower to the conservation easement kicks in.
Let’s say that our farm has been in the family since before there were telephones. Chances are that its cost is relatively negligible.
COMMENT: Before someone comments, I know that the property’s basis would have been reset to its fair market value when it transferred at an ancestor’s death. Let’s compromise and say that the family is extremely long-lived.
Meet a few qualifications and that pennies-on-the-dollar cost has nothing to do with calculating the deduction. We instead are going to get an appraiser to value the property, and he/she is likely to value the easement as follows:
- The value of the property intact and before any donation, less
- The value of the property after the donation of the easement
The numbers can get impressive.
There is a famous case, for example, about an easement in Alabama.
The story begins with Mr. E.A. Drummond, who bought 228 acres on the Fort Morgan peninsula in 1992 for $1,050,000. Two years later he started a planned resort community featuring a 140.9 acre golf course. He started selling lots in 1995, and in 2002 he transferred the golf course to an entity known as Kiva Dunes.
He then donated a perpetual conservation easement on Kiva Dunes.
He valued the easement at over $30 million.
Kiva Dunes also wrote a check to the charity for $35,000.
The IRS got wind of this and they were unamused. They disallowed the $30 million. They also disallowed the $35,000 cash donation, which seems odd. They must have been having a very cranky week.
The case went to Tax Court. The IRS immediately backed off on the fact of a donation, perhaps because by then they were having a better week. They argued instead on the amount of the easement donation. Mr. Drummond brought in an expert who had lived and worked in the area for decades and performed more appraisal work there than anyone else. The IRS brought an expert from Atlanta who had visited the peninsula only twice, and that was to appraise Kiva Dunes.
You can guess which appraiser was more persuasive. The Court reduced the donation to a little over $28 million, which means they effectively agreed with Mr. Drummond. It was a landmark taxpayer win.
The Administration did not like this result at all. They were quite determined to shut down golf course conservation easements, although little has occurred since. They had a point. After all, we are talking about a golf course.
The benefit of a conservation easement on a private golf course, especially in a luxury development, is likely to accrue to a limited number of people and not to the general public. You or I may not even be permitted to drive through some of these communities, much less see or otherwise enjoy the easement.
On the flip side, I have a friend who used to install golf courses in Cincinnati, primarily on the northern Kentucky side. For the locals, I helped him with one of the greens at Devou Park Golf Course, although I do not remember how he talked me into it. I presume I was temporarily insane. Nonetheless, he was very passionate about golf courses serving as respites and nature sanctuaries in otherwise developed urban environments. Kiva Dunes, for example, included broad swaths of wetlands which served as a stopover for migratory birds, as well as being home for a number of threatened species.
One can argue - if there is a socially-desirable ecological, wildlife or preservation outcome – whether it matters that the benefits will be enjoyed by the few. What is of true import here: ecology, wildlife and preservation or the politics of envy? Non-wealthy people do not donate easements. The alternative, unfortunately, is to do … nothing.
Kiva Dunes had a point.
However, a $28 million point?
One can see the controversy.
About the author
Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.