Key Conservation Easement Due Diligence

by Russell Putnam

As we move toward the end of the year, you may find yourself reviewing a land syndication that gives investors the option to encumber the property with a conservation easement, which would generate a charitable deduction for federal tax purposes. We thought that a brief primer on conservation easement due diligence may be helpful for our clients during this season.

First, a couple developments over the past year had potential impacts on taxpayers’ ability to take conservation easement charitable deductions:

  • In December 2016, prior to the end of the previous administration, the IRS published Listing Notice 2017-10, which imposes additional reporting requirements for taxpayers claiming these deductions, as well as material advisors to taxpayers on deduction-generating transactions. (For a summary of how this may impact broker dealers, investment advisors, and their clients, see FactRight’s overview.)
  • Now that the bill’s text has been made public, we can say for certain that the new proposed House GOP tax legislation would not meaningfully alter section 170(h), the provision of the Internal Revenue Code that provides the framework for conservation easement charitable deductions.

What Exactly Is a Conservation Easement?

A conservation easement is a contract between a property owner and a qualified organization (i.e., a non-profit conservation organization or government agency) that limits the development or other uses of the property in perpetuity in order to serve a conservation purpose. If the conservation easement donation complies with certain requirements of the Internal Revenue Code and Treasury Regulations, the property owner may take a charitable contribution deduction against its federal income tax liability based on the fair market value of the easement.

Critical Due Diligence

Due diligence on investment programs with conservation easement options is particularly important because of the IRS’s recent track record of challenging conservation easement values, given the potential for significant tax benefits. Certain documents should be reviewed closely in order to identify any significant concerns or technical grounds upon which the IRS may challenge a conservation easement charitable deduction (or its claimed value). These key documents include:

  • the conservation easement deed
  • the baseline documentation
  • the qualified appraisal
  • the tax opinion
  1. Start with the deed

The qualified organization will hold the conservation easement deed, which will detail the restrictions on the property’s use. This qualified organization is then responsible for protecting the easement’s conservation purpose and enforcing its restrictive covenants in perpetuity. Under federal tax law, the deed must show that the easement satisfies at least one of the four following conservation purposes in order to qualify for the charitable contribution deduction:

  • Preservation of land for outdoor recreation by, or the education of, the general public
  • Protection of a relatively natural habitat of fish, wildlife, plants, or similar ecosystem
  • Preservation of open space that provides scenic enjoyment to the public or advances a governmental conservation policy
  • Preservation of a historical area or structure


Such restrictions will likely significantly limit the potential for future income from the property. In addition, the deed should state whether the property owner will reserve any permissible uses on the property. For example, a property owner might reserve certain development rights (such as construction of homes, roads, utilities, or fences) or activity rights (such as harvesting of timber, hunting, and fishing). The property owner may reserve these rights so long as they do not interfere with the conservation purpose or prevent the easement from existing in perpetuity.

  1. Does the baseline documentation establish what it needs to?

The donor of a conservation easement must provide the donee certain baseline documentation to establish the property’s pre-easement condition. Baseline documentation is generally prepared by a professional who has specific experience in assessing conservation values, such as a conservation biologist, and this documentation may include survey maps, maps identifying certain distinct features of the property, aerial photographs, and on-site photographs.

Specific questions to consider when reviewing baseline documentation include:

  • What conservation values are evidenced in the baseline documentation? The documentation should establish that the property has environmental or ecological significance that is supported by the conservation purpose stated in the conservation
  • What governmental conservation policies are advanced by the easement?
  1. Is the appraisal qualified?

In order to be deductible under the Internal Revenue Code, a conservation easement’s fair market value must be substantiated through a qualified appraisal that meets specific qualifications. The IRS has a track record of challenging valuations, and a portion or all of the deduction may be disallowed if the value is adjusted. Therefore, review of the qualified appraisal is critical in determining if the appraisal methodology has any deficiencies.

According to Treasury Regulations, if no substantial record of comparable easement sales exists—and such records are rare—the value of the easement is equal to the difference between the fair market value of the property before the easement and the fair market value of the property after it is encumbered by the easement. These valuations are based on objective assessments of the value of the property if it were to be developed to its “highest and best use” both with and without the easement restrictions.

To determine the easement’s fair market value, the qualified appraisal should first establish the property’s before value. The before valuation should also consider any applicable zoning, conservation, or historic preservation restrictions. For example, the qualified appraiser may determine that residential development would be the property’s highest and best use in an area where such demand is expected to grow. In reviewing the qualified appraisal, it is important to evaluate whether the underwritten use is actually viable, given the property’s specific characteristics. Common standards in addressing the highest and best use include the following:

  • Is the proposed development legally permissible according to applicable zoning laws and other restrictions?
  • If the development physically possible?
  • Is there sufficient market demand for the proposed development?

Next, the qualified appraisal should establish the property’s “after” value. Here it is important to consider the qualified appraiser’s methodology in calculating the after encumbered value, specifically whether the qualified appraiser uses a cost, sales comparison, or income approach to valuation.

Additionally, the qualified appraisal should be reviewed to identify whether the qualified appraiser allocated value to any permitted reserved rights in reaching its after encumbered value.

  1. Another opinion

Review of the tax opinion from the issuer’s counsel is critical to determining whether the program has satisfied certain technical requirements necessary for investors to obtain a charitable contribution deduction from the donation. Important issues related to the availability of a contribution deduction that may be addressed in the tax opinion include, but are not limited to, the following:

  • Will the conservation easement deduction pass through to investors?
  • Does the conservation purpose satisfy the requirements in the Internal Revenue Code?
  • Is the holder of the easement a qualified organization?
  • Will any mortgages prevent the easement from existing in perpetuity?
  • Does counsel provide an opinion on the qualified appraisal’s fair market value determination or the likelihood of a misstatement penalty?

Imperative for all investments with potential tax benefits…

Review of these four key documents for conservation easements (the deed, baseline documentation, qualified appraisal, and tax opinion) is imperative in order to identify any technical grounds upon which the IRS may challenge a conservation easement charitable deduction. Also, investors should consult their own tax advisors before investing in a land-use program that features a conservation easement proposal because their individual tax brackets and individual circumstances may affect their ability to use the full amount of any conservation easement charitable deduction, if the investors elect that option.

To learn more about how FactRight assesses offerings involving conservation easements, see a recording of the webinar we hosted last year.

 Access FactRight Reports

Filed Under: Due Diligence, Real Estate