1031 Treatment for Conservation Easements

The decline in real estate development has provided an unexpected opportunity for land preservation. Large tracts of land that were slated for new construction are now being sold in whole or in part to local and regional municipalities or open space organizations. Certainly the sale of the entire fee interest in land held for productive use in a trade or business or for investment would likely qualify for a §1031 exchange. Interestingly, the sale of less than a fee interest may also qualify for tax-deferral under §1031 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 still retaining ownership of the land[1]. Generally, the easement needs to be perpetual in nature and considered an interest in real estate for state law purposes.

Typically the land owner receives cash in exchange for granting the easement. Sometimes more than one government agency is involved in the transaction, such as a matching funds agreement between a county and state. In those cases there may be issues coordinating the timely payment of funds from each agency. It is a good idea to confirm how and when the sales price will be paid before entering the transaction.

There have been instances where the land owner received compensation other than cash in exchange for the easement. In a private letter ruling[2] the IRS approved an exchange where the taxpayer received stewardship credits as compensation.[3]

First, using a Qualified Intermediary, the taxpayer conveyed the relinquished property by granting the county a perpetual restrictive stewardship easement over ranch land in return for stewardship credits equal to the value of the property rights that the taxpayer permanently relinquished. 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 stewardship easement was held to be 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 how 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.

[1] The concept is similar to a “covenant running with the land”, which imposes binding conditions on future owners of a parcel of land.

[2] PLR 200649028.

[3] These credits were essentially development rights, which allowed the holder of the credits to build elsewhere in the county at an increased density that would not otherwise be permitted.