American
Farm and Ranch Protection Act: Estate Taxes
The legislation, designed to provide a major new incentive for voluntary land
conservation in America a well as estate tax relief for rural landowners, was
enacted August 5,1997, as part of the $95 billion Taxpayer Relief Act.
How it works
The new law became
subsection 2031(c) of the Internal Revenue Code. In brief, 2031(c) allows a
landowner’s executor to exclude 40% of the value of land subject to a
permanent, donated conservation easement from the landowner’s estate for
Federal estate tax purposes. The exclusion applies to the value of the land
after subtracting the value of the easement.
The maximum amount which may be excluded from an estate under this new provision
is $500,000, to be phased in $100,000 increments over the next five years
beginning in 1998. The amount excluded may be doubled to $1 million for a
husband and wife using a simple estate plan designed to allow the estate of each
the maximum benefit of the exclusion.
Estate tax savings provided by 2031(c) range from $37,000 for an unmarried
easement donor dying in 1998 whose land is subject to the lowest effective
estate tax rate of 37% to $550,000 for a husband and wife dying after 2001 and
whose land is subject to the highest rate of 55 percent.
For an example of how 2031(c) works, assume Mrs. Smith donates a permanent
conservation easement on land valued at $1 million which reduces the value of
that land to $700,000. 2031(c) allows Mrs. Smith’s estate to exclude 40
percent of the remaining $700,000 after taking the value of the easement into
account, in calculating Federal estate taxes due. In this case the amount of the
exclusion is $280,000 (40% x $700,000).
Existing easements
It will be good news to many
easement donors that the exclusion is available no matter when the easement was
donated, so long as the land is included in the estate of the donor or a member
of the donor’s family.
The exclusion will not be
available for decedent’s dying prior to January 1, 1998, however. In addition,
the benefit of the exclusion passes on from generation to generation, so long as
the land remains in the family of the original donor.
Development rights
Any development rights retained in the easement agreement do not qualify for the
exclusion. Development rights are defined in the law as the right to use the
land for any commercial purpose not subordinate to and directly supportive of
the use of the land as a farm for farming purposes. Farming includes growing
crops; raising livestock; forestry and preparing timber for market; the training
and management of animals; and the "handling, drying, packing, or
storing" of commodities at least 50 percent of which were produced on the
farm.
Although the law has yet to be officially applied or interpreted, it would
appear that retaining the right to maintain, or establish, a residence to be
used by the landowner and dependencies such as garages, barns, and guest houses
(for non-paying guests) would not be considered retained development rights.
Rights retained to sell portions of the land for development, or to establish
residential structures for rent or sale would most likely be considered retained
development rights.
The law allows heirs nine months from the date of the decedent’s death to
agree to terminate some of all of the retained rights and have the estate tax
"reduced accordingly." Heirs have two years from the date of the
decedent’s death to actually implement that agreement.
Combining benefits
The exclusion allowed by 2031(c) is in addition to the estate tax benefits
resulting from the reduction in land value due to the easement.
The combined effect of the exclusion and the reduction in value means that, in
the example of Mrs. Smith, her heirs will be able to eliminate $580,00 in the
value of the protected land from the estate for estate tax purposes. This is
because the easement reduced what was originally a $1 million piece of land to
$700,000 (eliminating $300,000 from her estate) and the exclusion allows the
removal of another $280,000 from her estate. If Mrs. Smith’s land were subject
to the top estate tax bracket of 55 percent the donation of the easement would
save her heirs $319,000 in Federal estate taxes!
These estate tax benefits are also in addition to the deduction allowed from the
donor’s income for Federal and state income tax purposes. Taken together, the
combined value of these tax benefits makes a powerful new argument for the
voluntary conservation of land.
Retroactive easements?
A new opportunity provided by 2031(c) is to allow heirs of landowners who failed
to donate an easement during their lifetime to donate an easement after the
landowner’s death and qualify for the benefits of the exclusion.
It is not yet clear how extensive the benefits of such a "post mortem"
election may be, or how, in the absence of special authority contained in the
landowner’s will, such an election can be made in Virginia. However, the
provision, long sought by The Land Trust Alliance, opens the way for an
important new tool for land conservation and estate planning.
$5 million in farm protection
With a little thoughtful planning, a husband and wife who own and operate a
family farm as their principle asset and whose children want to continue the
operation, may be able to shelter over $5 million in farm assets. This is the
result of combining three important new benefits provided by the Taxpayer Relief
Act, all of which apply to family farms, with the existing provisions of the tax
code which allow family farms to be valued for farm use rather than fair market
value (Section 2032A of the Internal Revenue Code).
The three new benefits are the increase in the unified credit; a new exclusion
for family-owned business assets (including family farms); and the exclusion for
land subject to a permanent conservation easement. The combination of the
increased unified credit and the family-owned business exclusion shelters 1.3
million ($2.6 million for a husband and wife); the exclusion for land under
easement shelters $500,000 ($1 million for a husband and wife); and the use
valuation provisions shelter up to $750,000 ($1.5 million for a husband and
wife).
Summary of Provisions
The American Farm and Ranch
Protection Act Subsection 2031(c) of the Internal Revenue Code enacted August 4,
1997.
I. Subsection 2031(c) allows
(effective for decedents dying after 12/31/97) an Executor to elect to exclude
from a decedent’s estate for Federal estate tax purposes 40 percent of the
value of land subject to a conservation easement if the easement meets the
following requirements:
1. The land covered by the
easement is in or within a 25-mile radius of a Metropolitan Statistical Area as
defined by the Office of Management and Budget (typically an area with a
population over 50,000), a national park or national wilderness area, [203(c)
allows the Secretary of the Treasury to deny the exclusion for land within 25
miles of a national park or wilderness area if the Secretary can establish that
the land is not under significant development pressure] or 10 miles of a
national urban forest. [as designated by the U.S. Forest Service]
2.The easement is a
perpetual easement and has been donated.
3.The easement meets the
requirements of Sec. 170(h) of the Internal Revenue Code of 1986 (the I.R.C.)
except that easements qualifying solely under clause (iv) of this Section,
pertaining to historic structures and land areas, will not qualify.
4.The easement prohibits all
but minimal commercial recreational use of the land.
5. The easement was donated
by the decedent of a member of the decedent’s family.
6. Th land was owned by the
decedent or a member of the decedent’s family for at least three years
immediately prior to the decedent’s death.
II. The maximum which may be excluded under this provision is $500,000 per
estate, phased in $100,000 per year increments from 1998 to 2002.
III. Development rights (as
defined in 2031(c) retained in the easement will be taxed, however, heirs have
nine months from the decedent’s death to agree to eliminate some or all such
retained development rights in exchange for a proportionate reduction in estate
tax.
V. To the extent of the
exclusion, land will receive a carryover basis rather than a
stepped-up basis for
purposes of calculating any gain on a subsequent sale.
VI. The exclusion will be offset by any debt outstanding at the donor’s death
incurred for the purpose of acquiring land enjoying the exclusion.
VII. 2031(c) applies to land
held by family corporations and partnerships provided that the decedent held at
least a 30 percent interest therein at his death.
VIII. 2031(c) provides that
the amount of the 40 percent exclusion will be reduced by two percentage points
for each one percentage point by which the easement fails to reduce the value of
the land by 30 percent.
IX. The Act amends I.R.C.
Sec. 2032A(c) to provide that the donation of a qualified easement will not be
deemed a "disposition" thereunder.
X. The Act amends I.R.C.
Sec. 170)h) to
allow a deduction from
income for the value of a conservation easement even though the easement does
not extinguish surface mining rights, if the potential for such mining is do
remote as to be negligible.
