In the United States, conservation easements allow private investors and entities to take control of a parcel of land to maintain or improve the land. Across the country, conservation easements have been set up and purchased by sustainability-conscious investors to improve water quality, perpetuate the growth of forests, protect wildlife habitats, and more.
Owning conservation easements is a bit different in each state, with significant tax reductions and exclusions in different parts of the country, which leads to many investors purchasing conservation easements as a tax shelter. In many cases, these tax shelters are proven to be less legitimate; the buyer does not put forth efforts towards the conservation of the land.
If you own a conservation easement, selling to a government body, enterprise, or private investor typically involves a large cash influx. With this, the loss of tax reductions is met with significant taxation on the price of the sale. One of the best ways to recoup losses from the sale of conservation easements is to utilize a 1031 exchange to trade the property for another asset.
In this article, we will outline how to sell a conservation easement in a 1031 exchange. In doing so, taxpayers can defer capital gains taxes by reinvesting in a new property such as mineral rights and royalties.
How to Sell Your Conservation Easements
As efforts to protect our country’s land is at an all-time high, it has never been easier for private and public buyers to find and purchase conservation easements. In many cases, individual purchases are made with the assistance of at least some local, state, or federal funding. Programs from Partners for a Clean Environment (PACE) and other organizations can drastically bring the appraised value of conservation easements down so that buyers can afford designated land.
Determining the Value of Your Conservation Easements
Conservation easements are typically reviewed by qualified appraisers in order to determine their market value. While some investors choose to donate their conservation easements for the tax benefits, a highly valued conservation easement can end in a large check written in the former landowners’ name. Appraisers typically look at the following factors in order to determine the market value of a conservation easement:
- Property size (acreage)
- Property features (water, forest, etc.)
- Property history (new or established easement)
- And more
In some cases, conservation easements may actually lower a property’s value. This is the primary reason why investors typically donate their conservation easements to farmers or landowners that can further financially benefit from the land.
Taxes Paid on the Selling Conservation Easements
If you choose to sell, rather than donate or bequeath your conservation easements, then you will be forced to pay a few different taxes based on your location. In regions across the United States, taxpayers may expect the following to be applied to the sale of conservation easements:
- Capital Gains Taxes
- Federal Income Taxes
- Sales Taxes
- Local Taxes
- And More
Of course, experienced investors are well aware that the IRS offers a 1031 exchange to help taxpayers retain their wealth by deferring capital gains taxes. As capital gains taxes can reach rates as high as 20% on the sale of a conservation easement, purchasing a new property with a 1031 exchange is one of the most popular ways to maximize the earnings from an outright sale.
Selling Conservation Easements with a 1031 Exchange
With a 1031 exchange, capital gains taxes can be completely avoided if sellers choose to reinvest in a property that is of equal or greater value than the conservation easement. If the new property is of less value than your conservation easements, some capital gains taxes can be deferred.
As in most government procedures, 1031 exchanges used in the sale of conservation easements can be highly complicated endeavors with detailed paperwork and strict deadlines to meet. For this reason, most busy investors choose to work with a 1031 exchange intermediary when selling a conservation easement.
Conservation Easements Like-Kind Properties
The primary function of a 1031 exchange is to “trade” a conservation easement or other personal property for a new asset. The IRS designates that both properties in a 1031 exchange should be of “like-kind,” although the definition of this is somewhat loose. In most cases, investors and their accounting teams are able to justify most personal property types as like-kind to conservation easements. Today, these include:
- Vacant lots
- Commercial buildings
- Water and ditch rights
- Mineral rights and royalties
- And much more
Conservation Easements 1031 Exchange Timeline
As soon as you sell your conservation easement, your eligibility for a 1031 exchange begins. Within the first 45 days, all taxpayers using a 1031 exchange must identify at least one “reasonable” property that they may purchase to avoid capital gains taxes. This property does not necessarily have to be the one that is actually used in the exchange and investors have precisely 180 days (or about 6 months) to finalize the acquisition of the new asset.
Why Purchase Mineral Rights and Royalties?
To some environmentalists, mineral rights may seem like the opposite of conservation easements when looking at the individual assets in a portfolio. While most mineral rights are used to source and sell natural resources, they can also be purchased without the intent of extracting the land’s energy-producing substances. In this regard, mineral rights can actually be a logical purchase for those selling conservation easements.
On the other hand, today’s technology has made it easier and safer than ever for oil and gas companies to mine and sell the resources found below the earth’s surface. With a strong mineral rights lease, subsurface property owners can generate a consistent income stream as a fixed percentage of monthly oil and gas operation sales.
In conclusion, if you plan to sell your conservation easements, the best way to retain the most of your capital is through a 1031 exchange. With a specialized 1031 exchange intermediary, investors in the United States may be able to transform their conservation easements into a strong and profitable mineral rights portfolio.