Donating historic preservation easements
The Internal Revenue Code allows taxpayers to take a charitable deduction for the donation of historic preservation easements on property they own. But some donors may have unrealistic expectations about the amount of the deduction they’ll qualify for. With the IRS aggressively challenging these donations in costly court battles, it’s important to understand what the IRS looks at when evaluating easement deductions.
Easements and charitable deductions
The IRS defines a historic preservation easement (sometimes referred to as a façade easement) as a voluntary, legal agreement made between a real property owner and a qualified easement-holding organization to protect a historic property by restricting future changes to or development of the property in perpetuity. The qualified contribution of such an easement gives rise to a charitable deduction equal to its fair market value (FMV).
Not every preservation easement contribution, however, justifies a charitable deduction. The FMV of the underlying property must decrease after the granting of the easement. A “qualified appraisal” by an appraiser is therefore required to substantiate the deduction. The IRS has noted that common deficiencies revealed in audits of preservation easements include noncompliance with substantiation requirements and use of improper appraisal methodologies.
Proper easement valuation
Because preservation easements typically aren’t bought and sold in a market that values them directly, federal tax regulations endorse the indirect “before and after” valuation method to determine FMV. This method values the underlying property before and after the grant of the easement, with the difference representing the easement’s FMV.
An appraiser should, when assessing the “before” value, consider not only the current use of the property but also the likelihood that the property, without the easement, would actually be developed. He or she should also take into account any effect from zoning, conservation or historic preservation laws that already restrict the property’s “highest and best use.” According to the IRS, an easement is likely to have no significant effect on the value of the property if the easement isn’t more restrictive than local preservation laws or other restrictions that are already in place.
For the “after” value, the appraiser should consider the amount of access the easement allows and the effect its restrictions will have on the property’s value. He or she must weigh both the specific restrictions imposed by the preservation easement as well as the specific restrictions imposed by easements on any “comparable” properties used to reach a value.
Note that the IRS doesn’t recognize any set “safe harbor percentage” (commonly believed to be 10 to 15%) by which an easement reduces the “before” value of property. The allowable deduction is determined by the facts and circumstances of each easement contribution. The IRS won’t accept an appraisal to substantiate the FMV of an easement if it merely reduces the “before” value by a set percentage without explanation or reference to the property’s specific attributes and the easement.
Do the math … first
Keep your eyes wide open before donating a historic preservation easement, especially if you’re counting on a substantial charitable deduction. Be sure to hire a qualified appraiser to so you can substantiate a deduction and withstand IRS scrutiny.