Conservation Easement: The Greener Side of 1031
Everybody wants to go green these days and as it turns out, there is a way for those owning real estate to do so as well (without installing solar panels or wind turbines). The solution is found within something known as a “Conservation Easement”, a government provision enacted to provide incentive for private owners who donate their land for conservation purposes. By applying the 1031 exchange to this process, a property owner can both preserve the environment and make a new real estate investment.
A conservation easement is essentially a deeded fee interest that Land Trust Commissions or other government entities buy in order to preserve the natural state of the land. It comes in handy in two distinct situations: 1. You own property and want to sell it but do not want it to be developed for environmental reasons, 2. You own property and want to sell it but cannot find a buyer. In both situations a conservation easement can be beneficial, as the government will use the land in an environmentally friendly way and provide consideration through its purchase of the easement.
An easements value is determined by taking the value of the land without the conservation easement and subtracting that from the value of the land with it. The 1031 comes into play when there has been sufficient appreciation on the property to make the sale of an easement subject to capital gains tax.
For Example:
Mr. Bolan has owned a plot of undeveloped land for 20 years. Over the course of these 20 years the land appreciated in value from $1 million to $10 million. Now Mr. Bolan wants to sell the land but does not want to see it developed, thus he pursues a conservation easement. The land is valued at $4 million with the easement, so $10 million (the lands unrestricted price) – $4 million (the lands price restricted by conservation easement provisions) nets a $6 million easement.
The issue Mr. Bolan runs into is that he will face a substantial capital gains tax, because of the properties appreciation, when he sells the easement. What he can do instead is trade his $6 million easement, in a 1031 exchange, for land of equal value.
Note: This transaction would have to be structured, from the very beginning, as a 1031 to work. To make a 1031 viable, a qualified intermediary would need to take title to both the land and the revenues gained from its sale NOT the actual owner. If the owner were to receive money directly from the sale of the easement a 1031 transaction would be impossible.
Continuing with the example, Mr. Bolan (through his intermediary) receives $6 million from his sale of the easement. The cash is then used to buy an apartment complex, which will provide Mr. Bolan with a steady flow of cash. All of this is done while avoiding the capital gains tax Mr. Bolan would have faced if he just cashed the easement. Through application of the 1031 exchange, he is able to both preserve his previous property and acquire a new one, all the while avoiding capital gains tax.
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Good stuff! I really think this is very interesting. Keep up with the good work!. Melita Kellerson