Passing and Preserving Family Land Using Conservation Easements

You can manage forests for climate and water with timber and timber products as complementary goods if you shift the economic drivers. Conservation easements realign those economic forces for landowners, and the more you protect the public trust, the more money you as a landowner get paid.
—Laurie Wayburn, co-founder, co-CEO and President, Pacific Forest Trust

What does much of the farmland in the U.S. have in common with over half the country’s timberland and many of the vineyards and wineries in California?

It is owned by family businesses, and there will be an enormous generational or ownership change –mostly likely within a decade.

By and large, most of the capital in these businesses is tied up in the land. And for many of these families, their identity and family culture is immersed in this property as well. Unlike financial assets, though, land is not easy to divide. And this illiquid asset does not generate a big cash flow, so it does not allow a family to carry out the generational transfer techniques most businesses use.

Fortunately, though, there are ways.

The first question to ask in determining the value of land is its “highest and best use”–not what’s on it, says Stephen J. Small, a Newton, Mass.-based attorney specializing in the preservation of land and conservation. “Highest and best use” is somewhat of a misnomer–it is more about how the value of the land can be maximized financially, not in terms of the amount of, say, clean air or water it might generate. For most farmland or timberland, that means the “highest and best use” is development–not farms or forests.

According to Small, one of the first tools in the toolkit for passing family farms, ranches or forests is the conservation easement. An easement is a legal removal of a right of use. Conservation easements generally protect wildlife habitat and recreational land by eliminating development rights, thus reducing the value of the land subject to estate tax. Landowners who donate these rights also get substantial income tax breaks.

Historically, most conservation easements were “forever wild,” meaning all economic use of the land was prohibited. But since the l990s, there has been sizable changes in their use. Today, conservation easements can reserve the right to do some timber cutting, farming, or ranching while protecting conservation values. In Maine, they’ve even been used to preserve some of the state’s working waterfront.

Here’s how a conservation easement works: the landowner maintains ownership of the land, but sells or donates the easement to a “qualified conservation owner”–usually a land trust (though it can be a government agency). If it’s a donation, the landowner receives charitable deductions on her income tax return for an amount equal to the value of the easement over several years. Whether it’s a sale or a donation, it can reduce the value of the land by at least 30%–and up to 90% in some cases, depending on where it is. This reduction in the value of the land is the value of the easement or the development rights.

In this way, the development rights are not really given or sold, but rather extinguished, and the landowner gives the donee organization the right to monitor and enforce the recorded restrictions on the property–forever.

Some families don’t want to tie up their kids’ hands with an easement, Small says, but he emphasizes that it is a good multigenerational tool. “I’ve had some clients who want to put a conservation easement on the property so future generations don’t fight about selling the land for top dollar,” he says.

From the perspective of the estate, the value of the land has been reduced, and so the estate taxes due on the land have also been reduced. If the value of the land (post-conservation easement) exceeds the federal estate tax exclusion (currently $5.45 million for an individual), there still will be taxes to pay. In this case, it’s possible that the proceeds from the sale of the development rights can be used to pay the estate taxes. Or the proceeds can be used to buy life insurance, which can pay the taxes and/or expand the pie. More on that later.

In addition to reduced estate taxes due to the reduced value of the land, there is usually a reduction in property taxes. And as mentioned, if the landowner donates the easement, it is considered a tax-deductible charitable donation. A non-farm donor may deduct up to 50% of adjusted gross income for a period of up to 15 years. For farmers and ranchers (assuming 51% or more of their income comes from farming), it’s even a better deal: They can deduct up to 100% of adjusted gross income for the same time period.

And there may be even more benefits. In Massachusetts, for example, there’s a tax credit for 50% of the value of the donation up to a maximum donation of $150,000. If you don’t use up the tax credit in the first year, the state sends you a check for the balance. According to Keith Ross, a senior advisor at Landvest, a high-end real estate brokerage, and consultancy based in Boston, the program is so popular that it’s oversubscribed by a couple of years.

Let’s be clear; the sale of development rights can be complex–and not just on large deals. In order to purchase development rights, a land trust has to raise the funds, which often requires several funding sources. Depending on the project, it can include grants from government programs such as the U.S. Department of Agriculture’s Wetlands Reserve (WRP) or Forest Legacy programs. Ross says he helps the conservation groups figure out how to raise the money to buy the rights.

On the other hand, conservation easements are not all or nothing affairs. Many families exclude a few acres from an easement, often with the hope of building a house or selling the acres for development purposes. It’s also possible to break up the land and put one type of conservation easement on one portion, and another type of conservation easement on another part. A few years ago, Ross worked on a conservation plan for a 120-acre farm (with an agricultural conservation easement) surrounded by 680 acres of forestland (with a forest easement).

The flexibility does not end there. As we mentioned, the value of the easement is the value of the property’s development rights. But in practice, these financial values are far more nuanced and flexible.

Property rights include a “bundle” of rights including development rights, public access rights, mineral rights, wind power siting rights, water rights, rights to harvest land, and so on. Depending on which rights are included, t he value of the easement can be altered.

According to Dick Ludington, a ranch broker at Fay Ranches, 90% of most easements consist of “thou shalt not”…put up a cell tower, develop a shopping mall, sub-divide the property, etc. The other 10% of the easement consists of “thou shalt”–and those are often restorative activities. In fact, restoration clauses are present in all of the USDA’s WRP program easements, the biggest conservation easement program in the country.

Although the law stipulates public access on properties is subject to conservation easements, Ludington notes that there are more easements these days with exceptions than actually have public access. Those easements must include an explicit exception that still benefits the public such as a landscape view-shed or watershed management.

It’s worth noting that neighbors can often work together. In 2012, 23 landowners collaborated to conserve key linkages among 50,000 acres in the watershed of the Quabbin and Wachusett reservoirs, which provide some of the cleanest drinking water in the country to 2.5 million people in the Boston metropolitan area–40% of the population of Massachusetts. The plots of land, which were not contiguous to each other, but rather to already-protected land, totaled 3275 acres.

And while it’s not likely, it’s also possible to sell or donate an easement on a very small plot of land. Ross worked with one family that wanted to donate an easement on just 5 acres in order to protect the land surrounding their home from development, and because that land was part of a key wildlife corridor between a nearby pond and hundreds of acres the local land trust already had protected. But when the land trust said the plot was too small, three other abutters joined in, so that a total of four families donated 23 acres to make the project happen.

We all like this do-gooding, of course–and we understand landowners who love their property so much that they want to preserve it in either its wild state or as the farm, ranch, or forest they love. But if this illiquid asset (illiquid because they don’t wish to sell it) is a significant part of the family estate, how can it really pencil out–especially if there are multiple heirs?

That’s where life insurance can help turn this entire concept into what Small calls, well…..” a home-run!”

Let’s say you have two children. Your son works the farm you love and want to preserve–and your daughter wants to cash out. After you put the easement on the farm to protect it, you use either the income tax savings from the conservation easement donation (because it shelters income) or cash from the sale of the development rights (if that is what you do) to buy life insurance in any amount equal to or greater than the value you have given up with the easement.

We often write about maximizing cash value and minimizing the death benefit. In this case, though, it makes sense to structure the policy to maximize the death benefit and minimize the cash benefits. In this way, your son eventually gets the farm; your daughter, her cash.

“The next generation has both the land and as much dollar value as they would have had in the first place,” Small points out. “And part of it is liquid.”

There are, of course, many iterations of this. As Ross points out, conservation easements don’t just help with estate taxes and being able to pass land from one generation to the next. “They can also help people to capture the development value that they never to intend to use anyway,” he notes,” and do whatever they want with the cash.” With the proceeds, that means they can do things like invest in machinery for the farm, buy more land, pay taxes, and/or-or buy whole life insurance, which can pay taxes or pay off other heirs.

Conservation easements and life insurance can operate together as twin tools to create new opportunities we’d normally think are impossible. “Most tax people don’t think of charitable donations with life insurance,” Small says. “But it’s a great planning technique.” We agree!

If you have land and are interested in exploring some of these options, we urge you to reach out to us. Land is something we value and understand. I (Kim Butler) grew up on a dairy farm in Oregon, and today, the Partners for Prosperity office is in a home built on multi-generational family land (also an alpaca farm) in Texas.

Even if you don’t have land of this sort, there’s a good chance life insurance can help you deal with your estate in other creative and fairways. For an excellent primer on creative life insurance strategies that help families create and sustain wealth in unexpected ways, pick up a copy of Live Your Life Insurance.  Based on many examples and “mini-case studies,” it illustrates how to create a financial foundation that can benefit you as well as your heirs.