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INSIGHT: Land Conservation Erodes From State Tax Credit Treasury Regulations

Jan. 16, 2020, 2:00 PM

New York State land conservation donations already shriveled to a small fraction of normal contributions by June 2019 when the IRS issued a final regulation regarding contributions in exchange for state and local tax credits (SALT). The NYS state tax credit is 25% of the property tax bill for the land, every year in perpetuity, up to $5,000 per year. The annual cap is of no assistance in calculating the value of the tax credit that lasts forever. Some New York donors stopped conservation donations because of this uncertainty.

The regulation intends to prevent states from bypassing a cap on the federal deduction for state and local taxes included in the tax bill signed into law in December 2017. It also affects other tax credits, including those for conservation, and erodes tax incentives for donors of land or conservation easements. The Land Trust Alliance is pursuing new legislation in Congress to exempt conservation tax credits from these new regulations since it affects land not cash as in other state tax credits.

What is the issue?

The Alliance’s analysis shows the regulation may, to varying degrees, adversely affect conservation donors in Arkansas, California, Colorado, Delaware, Florida, Georgia, Iowa, Maryland, Massachusetts, Mississippi, New Mexico, New York, South Carolina, Virginia, and the Commonwealth of Puerto Rico. The new regulation applies to contributions made after Aug. 27, 2018. Conservation donors would be prudent to consult expert tax advisors regarding SALT.

Do you have any details?

Conservation transactions in California do not qualify for a state tax credit unless the taxpayer submits an application under the Natural Heritage Preservation Tax Credit Act to the Wildlife Conservation Board and a funding source has been committed to reimburse the General Fund for the tax credit amount prior to the grant and recording of a conservation easement. If the grantor has not submitted such an application and a funding source has not been committed first, some California attorneys suggest that the project will not qualify for a state tax credit. The SALT regulations apply where a taxpayer “receives or expects to receive” a state tax credit and the taxpayer, the attorneys argue, does not “expect to receive” a tax credit in California unless it has been applied for and approved prior to closing.

A conservative approach may be to assume that the IRS will adhere to its statements that it will count the mere existence of a tax credit against the taxpayer. The uncertainty of whether SALT is inapplicable in California may lead some donors to officially disclaim the tax credit using a form such as the example at the end of this article.

Colorado has a similar statute to California—both require pre-approval before a state tax credit is issued—with the one critical difference being that California requires credit approval before the grant of the conservation easement. Colorado requires approval after the grant. Colorado’s conservation tax credit appears to be subject to SALT because most donors likely granted an easement with the expectation of receiving a tax credit.

A conservative interpretation of the Florida property tax exemption statute is to treat it as a tax credit subject to SALT. Some Florida practitioners assess that this is an unlikely result. Whether the lack of reference to a “tax credit” in the statute is sufficient to remove this from SALT is unknown. This uncertainty may lead some donors to officially disclaim the tax credit using a form such as the below example or possibly even delay a conservation donation.

Maryland has state and county property tax credits and a state income tax credit, all of which are subject to SALT.

Some New York attorneys assess that Comment 5, titled Conservation Easement Contributions, in the preface to the new regulations, includes the possibility of a “good faith valuation” of a perpetual tax credit. The tax code and Treasury Regulations have many long-standing valuation methods that could be applied if the IRS is willing to accept that. The statement does not give any approved formula so this approach has risk even though it is quantitative.

At the same time, Comment 8, titled Disclaiming the Tax Credit, in the preface to the new regulations, does not give the form of disclaimer, so that this approach also has risk. However, the new Treasury Regulation 170A-1(h)(3)(ii) suggests that the IRS expects a disclaimer.

Virginia has a 40% state tax credit, which may significantly reduce the federal deduction depending on the facts.

SALT does not apply to residents of an exempt territory who do not pay federal taxes. Puerto Rico citizens, as residents of an incorporated territory, do not pay federal taxes. Donors who are citizens residing in states, however, do pay federal taxes. The SALT regulation will apply in cases where the donors of a conservation easement on land in Puerto Rico are citizens residing in a state, subject to paying federal taxes.

Now that the regulation is permanent, how exactly will it affect people?

Under the new regulation, a donor who takes a federal tax deduction for the value of the gift and receives a state or territory (hereafter collectively referred to as “state”) tax credit now has to reduce the federal tax deduction by the amount of the state credit. The impact of the regulation will vary depending on the state or local tax credit.

For example, the tax credit in Virginia is very generous, so after running all the numbers and consulting tax experts, a taxpayer may decide it is preferable to accept the state tax credit and forego the federal deduction, if that is what the tax expert running the numbers concludes. In which case, the taxpayer would not use a disclaimer. Note that the regulation does not affect federal wetland or mitigation credits; SALT solely focuses on state and local tax credits.

What exceptions exist in the SALT regulation?

If the total amount of the state and local tax credits received, or expected to be received, by the donor is 15% or less of the fair market value of the conservation easement transferred (or other property contributed or bargain sold), then the new regulation disregards the state tax credit. Thus the taxpayer need not offset the allowable deduction. Note that in the case of a bargain sale, the value of the “transfer” is the full fair market value of the property, not just the contributed portion.

For example, if a landowner sells a conservation easement valued at $1 million for $700,000, so that the charitable contribution is $300,000, and receives a tax credit equal to 40% of the contribution amount ($120,000), the credit will be only 12% of the value of the property transferred and can be disregarded.

Might the state tax credit be more valuable than the federal deduction?

Yes, so you must run the numbers with your expert tax advisors. Be certain that any tax software you are using actually incorporates the SALT calculation; some do not. Many states, but not all, with an income tax allow deductions for any charitable contribution recognized by the federal government. States often use tax credits as incentives because a credit is much more valuable than a deduction: A deduction saves the taxpayer the tax rate times the deduction, and state and local tax rates together top out at about 15%.

SALT does not affect state deductions or credits that are 15% or less of the value of the donation (the contribution in the above example). If a state were to give a deduction for three times the value of the donation, that would be treated as a credit under the new regulation and would have to be offset against the federal deduction, provided that it exceeded 15% of the value of the donation.

Is a disclaimer of the state or local tax credit permitted?

A taxpayer may disclaim the use of a state tax credit and take the full federal deduction without an offset. Paragraph 8 of the explanation of Treas. Reg. 1.170A-1(h)(3) by the Department of the Treasury states, “If a taxpayer properly declines receipt of a benefit, the taxpayer will not be treated as receiving or expecting to receive the benefit, and the charitable contribution deduction will not be reduced by the amount of the benefit” and cites Revenue Ruling 67-246, Example 3.

Neither the Service nor the Treasury has issued or plans to issue further guidance in the near future (as of November 2019) on how and when to disclaim and decline receipt of a state tax credit. The Federal Register; however, published a notice regarding the new rule:

8. Disclaiming the Tax Credit. …

“Although not specifically stated in the regulations, taxpayers who prefer to claim an unreduced [federal] charitable contribution deduction have the option of not applying for a state or local income tax credit where such an application is required in order to receive the credit. Alternatively, taxpayers may apply for a lesser amount of the credit. The Treasury Department and the IRS request comments as to how taxpayers may decline state or local tax credits in other situations.” [FR Doc No: 2019-12418] (Emphasis and clarification added)

What is the quid pro quo issue discussed in the introduction to the regulation?

Quid pro quo involves a bargained-for exchange of property or cash for property, or vice versa. The IRS and Treasury argue that a state tax credit is one such bargained for or expected exchange. The Alliance and others argue that the unilateral conferral of a tax benefit by a state for the unilateral charitable contribution of a conservation easement to a third party is not a quid pro quo transaction.

The donor has no legal right to compel the state to grant the credit, and so, according to U.S. Tax Court, does not meet the test for quid pro quo. (See Tempel v. Commissioner, which was affirmed by the U.S. Court of Appeals for the Tenth Circuit in Esgar Corp. v Commissioner, and followed by the Tax Court in Route 231LLC v. Commissioner and SWF Real Estate LLC v. Commissioner.)

If the state, as it has every right to do, terminates the credit after the taxpayer has contributed the easement, the taxpayer has no legal claim against the state. As the Tax Court pointed out in Tempel, the taxpayer has no property right in a credit until the state issues the credit. That only occurs after the taxpayer’s position changes unilaterally by contributing a perpetual conservation easement, which the taxpayer cannot retract, and only if the state has not changed its credit policy.

While other types of cash tax credits may or may not be quid pro quo, given prior court rulings, the in-kind tax credit for a conservation easement donation is most certainly not.

Do you have an example of a disclaimer?

The following is one example—for illustration purposes only—of a Tax Credit Disclaimer. Please note that each disclaimer will be specific to state law. The form of notary acknowledgment is state-specific. Any users of this form should attach the correct acknowledgment. Each grantor’s own tax attorney should also determine the state specific document type for a complying disclaimer. For example, an affidavit form might be more preferable in some states. If the donor is a pass-through entity, all members of the entity should sign individually as well as having the entity sign. Donors must consult a competent tax professional licensed in the relevant state to evaluate this example under your state laws. This is not legal or tax or other advice.

What is the risk involved?

Please assess the various risk-balancing judgment calls embedded in this example. The example flags various such judgment calls with footnotes. Please examine this information carefully to address your risk tolerance in various other drafting decisions that may not be indicated by a footnote. If you decide to move forward, your own individual tax expert must advise you on a proper and unique disclaimer.

The most conservative approach is to sign and record the Disclaimer prior to contribution of the conservation easement so that the disclaimer is automatically available once the easement goes to record. This is a risk decision based on state law and IRS preferences, so the donor’s attorney should thoroughly examine the decision. While it is startling and debatable whether a donor may disclaim a tax credit for the donor’s successors if such tax credit could be available to the donor’s successor owners, it is nonetheless the most conservative posture for a disclaimer. Donors must consider this matter in light of individual state laws with donor’s tax expert attorney.

Did the IRS approve this example?

No. The IRS has not reviewed or approved this or any other example, nor issued its own form or guidance on the disclaimer. Therefore, anyone using this or any disclaimer, or any good faith valuation method, is doing so at the person’s own risk entirely.

For a PDF of this form, click HERE.

For a PDF of this form, click HERE.

QUESTIONS?

Please call or write to Leslie Ratley-Beach, Conservation Defense Director, at 802-262-6051 or
Lori Faeth, Director of Government Relations, at 202-800-2230.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

AUTHOR INFORMATION

Leslie Ratley-Beach led the national effort that created the only conservation defense liability insurance program (Terrafirma Risk Retention Group LLC) and she leads service delivery to the over 520 land trust insured owners in 48 states. Leslie leads the Land Trust Alliance’s conservation defense initiative and is a national author and speaker. Previously, Leslie led the Vermont Land Trust conservation stewardship program responsible for more than 1430 conservation easements on over 470,000 acres of land with more 1200 landowners and drafted and helped negotiate more than 600 conservation easements. Leslie practiced law in Massachusetts and Vermont. Many professionals contributed information to this article including Tim Lindstrom, Ross Baxter, Melinda Beck, Lori Ensinger, Jessica Jay, Tom Kay, Kirsten Maneval, Peter Paden, Misti Schmidt, Russ Shay and Eva M. López Zayas.