Federal and Virginia Income Tax Deduction
Conservation easements, when properly structured, can result in a charitable contribution deduction for the donor. The potential deduction amounts to 100% the difference in property value before and after the easement is established. This decline in value must be determined by a qualified appraiser. The maximum charitable deduction for any one year is limited based on the income level of the donor. Generally, the maximum deduction for an individual donor is 50% of the donor’s Adjusted Gross Income (AGI). If any portion of the deduction is disallowed due to this AGI limitation, the remaining deduction carries forward for a maximum of 15 years. For a qualified farmer, the qualified contribution deduction is limited to 100% of AGI. The allowable deduction reduces taxable income for both Federal and Virginia purposes.
Example 1: Benefits of the Tax Deduction
Stephen donates two dwelling unit rights to a county easement authority. A qualified appraiser determines that the values before and after the easement were $3,000,000 and $2,800,000, respectively. Stephen’s AGI for 2017 is $300,000. The charitable contribution is calculated as $200,000 (100% of the decline in land value due to easement). The first year deduction for Stephen will be $150,000 (50% x $300,000) with a remaining $50,000 deduction carrying forward to 2018. Stephen will save approximately $50,000 between Federal and State taxes for tax year 2017, and should save an additional $17,000 of taxes when the $50,000 charity carryover is utilized in 2018.
Virginia State Tax Credit
In addition to the charitable deduction, Virginia allows for tax credit for conservation easements equal to 40% of the appraiser determined easement value. Tax “credits” are more beneficial than tax “deductions”, in that credits provide a “dollar for dollar” tax benefit whereas deductions are applied to a taxpayer’s marginal tax rate. For 2017, the Virginia credit amount is limited to $20,000 per taxpayer. The limit for 2018 and subsequent years is scheduled to increase to $50,000 per taxpayer. Credits in excess of the annual limitation or the individual’s Virginia tax liability will carry forward for up to 10 years. Credits may also be transferred to other taxpayers, as Virginia allows these credits to be bought and sold. Proceeds from the sale of Virginia land preservation credits are taxed as a capital gain transaction on the Federal income tax return, and can receive a more favorable long term gain tax rate if the credits are held for longer than one year prior to the sale. While taxable for Federal purposes, the credit sale proceeds are not taxable on the Virginia income tax return.
Example 2: Benefits of obtaining and selling Virginia Income Tax Credits
Stephen (same facts as Example 1) applies for Virginia Land Preservation Tax Credits. As a result of his $200,000 donation, Virginia grants $80,000 (40% x $200,000) of tax credits. Given that his annual Virginia income tax liability is approximately $9,000, he decides to keep only $45,000 of the credits, which should cover his Virginia income tax liability for 5 years. He sells the remaining $35,000 of credits for a price of $31,000. Stephen waits for over one year prior to selling the credits in order to ensure long term capital gain tax treatment.
Estate Tax Benefits
Individuals expecting to have an estate tax liability can potentially reduce this tax as well. Estate taxes are based on the value of the taxpayer’s estate at death, and the establishment of a conservation easement serves to reduce this value. In addition to this benefit, up to 40% of the land value can potentially be excluded from the estate up to a maximum of $500,000.
Josh has provided income tax and advisory services to a broad range of business and individual clients with complex needs for 18 years. He has worked his entire career at YHB, having spent his first 12 years in the Winchester office and the last 6 years in the Middleburg office. In addition to serving clients, Josh provides mentoring and training for YHB staff members and is a member of the firm’s Human Resources Committee.