Appraisals and Valuations - How the Gift is Valued

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For purposes of the tax rules, the "value" of a property is equal to what it would sell for if it were put to the most valuable economic use that is possible under the circumstances.  In many cases (though not all), with land that is generally undeveloped or only partially developed, the "value" for estate tax purposes is equal to the highest amount someone would pay for it if it were sold for development.

Let's say that Riverview is worth $2,500,000 to a developer (who would then subdivide the property, build homes on it, and sell homes and/or house lots). 

If Riverview were subject to a conservation easement, however, and could not be subdivided, the development potential would be non-existent and the value of the property would be considerably lower (although Riverview would still retain some significant value).  For example (and remember, this is just an example), let's say the value of Riverview as a 200-acre "estate" that could never be further developed is $1,000,000.  For the Landowners' property, then, the value before the easement or restriction would be $2,500,000, and the value after the restriction would be $1,000,000.

Now, here is the rule.  In the case of a gift of a conservation easement, the value of the gift is generally equal to the difference between the value of the property before the easement and the value of the property after the easement.

Using the example above, the value of Riverview before the easement or restriction is $2,500,000, the value after the restriction is $1,000,000, and that means the value of the gift is $1,500,000.  That represents the income tax deduction John and Mary are allowed, subject to limits discussed below.

Consider another possibility for John and Mary.  As I suggested earlier, as long as Riverview's conservation values continue to be protected, John and Mary could donate a conservation easement on Riverview and still retain the right to do some limited development on Riverview in the future.  For example, they could donate a conservation easement on Riverview and reserve the right to build four more houses there, subject to certain restrictions and limitations.  In this limited development possibility their house and lot could be worth $900,000 and each of the four "reserved" lots could be worth $150,000.  The total value after the restriction would be $1,500,000 ($900,000 plus the four lots at $150,000 each).

In this example, the value of Riverview before the easement is $2,500,000, and the value of Riverview after this easement is $1,500,000, so the value of the gift is $1,000,000 ($2,500,000 minus $1,500,000).

For Bob and Sue Farmowner, a conservation restriction on Diamond Farm would likely have a similar, dramatic effect.  If Bob and Sue donate an easement that restricts the future use of Diamond Farm to agricultural and/or ranching uses, they will significantly reduce the value of Diamond Farm.

Diamond Farm will now be valued as farmland (say that's $1,000 an acre in their area) rather than as a potential subdivision.  With Diamond Farm worth $1,700,000 before the easement, and $500,000 ($1,000 an acre) after the easement, the value of the easement is $1,200,000.  Their income tax deduction, then, is $1,200,000.

The ability of any family to use these deductions for income tax purposes is limited, as discussed below.  But John and Mary have "given away" much or all of that development value that was pushing their estate tax so high, the Farmowners have reduced the value of their estate by more than $1,000,000, and both families can continue to own, use, and enjoy their family land.  If either family at any point does decide to sell, any future owner will be subject to the same restrictions, and Riverview and Diamond Farm can be saved.