Conservation Partners, LLC

Evaluating the Quality of Tax Credits

Virginia’s land preservation tax credit program provides an unprecedented opportunity for high-income Virginia individual and corporate taxpayers to participate directly in conserving our state’s remaining farms, forests, and other open spaces.

The program offers transferable state income tax credits as an incentive encouraging landowners to donate qualifying conservation easements that protect their land from development. Easement donors can sell credits they don’t use to other Virginia taxpayers, who in turn can use the credits to offset their own Virginia income tax liability. The purchasers generally buy their credits at a discount, allowing them to realize tax savings when they use the credits.

Land preservation tax credits are attractive to many purchasers because they offer high returns along with the ability to participate in the protection of important wildlife habitat, scenic vistas, watersheds, and other open space values in Virginia. Not all credits are created equal, however, and some are more likely than others to accomplish both the tax incentive program’s land conservation goals and the purchaser’s tax savings goals.

This page is designed to provide information that may be helpful to prospective credit purchasers and their professional advisors as they assess the quality of various land preservation tax credits on the market. This page does not provide legal or tax advice, and readers should seek such advice based on their particular circumstances from their own personal advisors.

Conservation Easements

A conservation easement is a legally binding agreement between the owner of land and a government agency or private non-profit organization whereby the development and some uses of the land are restricted in perpetuity to achieve certain conservation goals. Conservation easements are complex legal agreements that must meet certain state and federal requirements to qualify for tax benefits.

Credit Quality and Compliance With Requirements

To be eligible for a Virginia land preservation tax credit, the donation of a conservation easement must satisfy various legal requirements. In addition, the value of the easement must be estimated by a fully-supported appraisal prepared by an experienced, independent appraiser in compliance with all applicable standards.

Evaluating the likelihood that a particular easement donor’s tax credit will comply with the applicable requirements is fundamental to estimating the risk associated with purchasing land preservation tax credits generally. Unfortunately, the rules applicable to conservation easements and conservation easement appraisals are very complex and relatively uncertain in their application, and federal and state tax authorities have provided few “safe harbors” in this area.

Most credit purchasers will not be able to fully evaluate the easements and appraisals underlying the credits they buy, but instead should look for credits with certain characteristics indicating they are likely to entail low amounts of risk and support genuine land conservation. That is, purchasers should look for high quality credits.

High Quality Credits

High quality credits have four primary characteristics:

• Deed of Easement – The credit is based upon an easement that has been drafted and/or evaluated by a licensed attorney experienced with land conservation law and who provides written assurances to the easement donor that the easement is likely to satisfy the applicable requirements.
• Appraisal – The easement appraisal report provides a realistic, fully-supported estimation of the easement’s value. Estimating the value of a conservation easement in compliance with the various applicable requirements requires significant specialized appraisal expertise, and the credit purchaser should be satisfied that the appraiser has such expertise. If the appraised value is particularly large or the appraisal assignment is particularly complex, the appraisal report should be formally reviewed by a second easement appraisal expert of regional or national caliber.
• Warranty – The credit is supported by a warranty or other strong contractual assurances protecting the purchaser in the event the credits ultimately are adjusted by tax authorities.
• Conservation – The credit seller or transfer agent is able to make a convincing case that the tax credit transaction will support genuine land conservation benefiting the public. That is, the land under easement has important conservation values, and those values are adequately protected by the terms of the easement.

Tax Authority Oversight

The Virginia Department of Taxation—with direct and indirect assistance from the Internal Revenue Service—is charged with ensuring that the Commonwealth does not invest public funds (in the form of foregone tax revenue) in conservation easements that do not adequately protect significant conservation values and/or are overvalued for purposes of calculating the tax incentive.

Risks of Non-Compliance

Despite the best intentions of the donor, an improperly drafted or improperly valued easement may be challenged by federal or state tax authorities. If the Internal Revenue Service or the Virginia Department of Taxation determines that a donated easement failed to satisfy the necessary requirements or was overvalued, the following negative consequences could ensue:

• The federal and/or state tax benefits from the donation transaction could be reduced or denied altogether.
• The donor and any buyer of the disallowed state tax credit may have to file amended federal and/or state income tax returns and pay additional income tax, plus interest and penalties.
• The buyer of the disallowed credit will likely seek a refund of the purchase price of such credit, along with any interest and penalties imposed on the buyer by federal or state tax authorities.
• Even in situations where such recovery from the donor is possible, it may be an expensive and time-consuming process for all involved.

Enforcement

Some contend that easement donors and credit purchasers may safely ignore the risk of federal or state enforcement of the applicable legal and appraisal requirements. To support their position, these individuals often point to the IRS’s historical failure to aggressively enforce the requirements in connection with the federal income tax deduction for conservation easement donations.

According to personnel with the Virginia Department of Taxation, however, several land preservation tax credit claims are already under scrutiny by the Department, several large credit claims have been disallowed, and as the result of reports of abuse in the national media, Congress and the Internal Revenue Service have made abundantly clear their intention to escalate enforcement efforts with respect to the laws governing the federal tax incentives for easement donations.

The risk associated with the purchase of land preservation tax credits can be controlled through proper practices, but the risk is real, and in light of stepped-up enforcement efforts at the state and federal level, taxpayers should not purchase credits without seeking reasonable assurances that the credits (i) have been properly evaluated by experts,(ii) are supported by a credible warranty, and (iii) promote socially beneficial land conservation.

Who Protects the Credit Purchaser?

The government agencies and non-profit organizations that accept conservation easement donations do not warrant the qualification of easements or appraisals for purposes of federal or state tax benefits. Therefore, credit purchasers and their advisors must rely upon the assertions of quality offered by the seller or transfer agent.

Conservation Partners, LLC recommends that credit purchasers and their advisors verify that any credits they purchase have the characteristics of quality described above. In addition, a prospective purchaser should ask the following questions before committing to purchase credits:

• What are the qualifications of the persons who produced and reviewed the easement and appraisal?
• Does the land under easement have significant conservation values, and was the easement drafted to appropriately protect those values and thus provide significant benefit to the public?
• Does the seller of the credit and/or the transfer agent conduct an expert review of the underlying easement and its appraisal for compliance with a standard designed to protect the purchaser of the credits?
• If the credit is being purchased through a third party transfer agent, does the agent provide assurances of the credit’s quality or must the purchaser rely solely upon the seller’s indemnity?
• Will anyone be available to help answer questions about using the credit?
• If the credit is disallowed in whole or in part by the Virginia Department of Taxation, what happens, exactly? Can the purchaser easily get his or her money back? What about any penalties and interest the purchaser may have to pay? Do the transaction documents provide adequate protection for the purchaser?

Particular Cautionary Notes

Deed of Easement

• A credit purchaser should be wary of any credit that is not supported by an attorney’s written assurance to the easement donor that the document is likely to satisfy the applicable requirements.

Appraisal

• A credit purchaser should be skeptical if the credit seller and/or transfer agent cannot provide the purchaser with convincing assurances that the appraisal was made by a professional appraiser who has significant expertise in valuing conservation easements, and that the appraisal satisfies the applicable requirements.
• The appraiser is most often paid by the easement donor, and the donor may perceive that his or her interests are best served by an appraisal that employs aggressive techniques to create as much value for the donor as possible. Accordingly, an independent review of the appraisal by a qualified reviewer is recommended. Appraisals of very valuable easements should be formally “desk reviewed” by a well-known easement appraisal expert. The credit seller or transfer agent should provide this review; it is not cost-effective for each individual credit purchaser to engage in this level of due diligence.

Sellers and Transfer Agents

• A credit purchaser should be careful when purchasing from credit transfer agents or sellers whose advisors do not specialize in land preservation tax credits and may not fully understand the complexities involved in the drafting and valuation of conservation easements. A cursory review of a conservation easement and appraisal by non-experts may not provide an adequate basis for a purchase recommendation, particularly for risk-conscious purchasers.
• Additional scrutiny is warranted when a credit is offered on terms that appear on the surface to be extraordinarily beneficial to the purchaser.
• The credit purchaser should be particularly cautious of credits generated by “donors” who actually are commercial profiteers whose primary motivation is not land conservation for the benefit of Virginia citizens but profit through exploitation. Easements donated by profiteers are likely to attract a high level of scrutiny from tax authorities, and credits based on such donations may entail a higher level of risk than credits generated by easement donations made by farmers and other landowners who simply love their land and want to protect it.

Conservation

• The credit purchaser should be skeptical of credits generated by easement donations that do not provide obvious conservation benefits. The most common problem in this area is the donor who has retained too many development rights under the terms of the easement. What entails “too many” is an inherently subjective question, but a credit purchaser can pick and choose from among the many credits available, and purchasers often prefer to support the donation of easements that clearly protect the conservation values of the encumbered land.

To Purchase High Quality Credits

Many excellent conservation easements are being donated throughout Virginia and many of these donations result in credits that meet Conservation Partners’s Quality Standards. Risk-conscious taxpayers interested in purchasing high quality credits to claim against their Virginia state income tax obligation may place their orders through our secure website. Alternatively, prospective buyers may contact us to request additional information and a registration form.