Easements: Protection without Ownership Using Easements to protect properties that are not for sale

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1 Easements: Protection without Ownership Using Easements to protect properties that are not for sale A preservation organization doesn t have to acquire real estate to gain control over its future. Preservation easements are an effective tool for assuring the long-term preservation of significant historic properties that are in sympathetic ownership in a community. Easements have emerged as a very useful legal tool for protecting land and historic properties. Since under specific conditions a property owner may qualify for tax incentives for the gift of an easement, an organization might be able to parlay an easement program into a revenue source. The rules for easement deductions are complex, and once again skilled personnel and conscientious counsel are required. An easement is a legal agreement between a property owner and a qualified preservation organization or public agency, in which the property owner (the grantor/donor) promises to protect the property's historic integrity without inappropriate alterations, additions or demolition, and the organization or public agency (the recipient/donor) is granted the right to enforce the covenants of the easement and to monitor the property. The owner retains the right and duty to manage and care for the property, pays taxes on it, and can continue to use it just as before, and may sell or lease it or pass it on to heirs. The easement is a legal document that restricts the use of privately owned property. Usually a permanent restriction, it is written in deed form and is filed with the county register of deeds, thereafter running with the title to the land and affecting each succeeding owner just as it does the original grantor. The easement is simply a legal agreement between the property owner and a preservation organization into which the parties enter for the mutual benefits of historic preservation, continued private ownership, and possible tax advantages or other compensation to the owner. The organization takes on the responsibility and legal right to enforce the easement. If a future owner or someone else violates the easement (for example, by erecting a building the easement does not allow), the organization has the authority and obligation to require that the violation be corrected and may resort to legal means if necessary. A preservation easement may be very similar in its terms and conditions to the preservation covenants that organization places on its properties upon sale, but it differs in its origin. The preservation organization must own a property in order to place covenants in its deed. The organization doesn t have to own the property in order for an easement to be placed on it. The owner of the property voluntarily places the restrictions on the property. Easements are flexible tools. The easement should protect the historic resources on the property, but it can be custom designed to meet the personal and financial needs of the landowner. Historic preservation easements are intended to protect the architectural and historical integrity of a structure by imposing limitations on the types of alterations that may be made. In some cases, the owner may choose only to protect the exterior of the building. A preservation easement may also be designed to protect a building's interior and important elements of the landscape surrounding a structure, such as trees, outbuildings or associated archaeological remains. The easement may be drafted to restrict or prohibit future subdivision of land. The extent of the restrictions placed on the property is decided together by the parties to the agreement. The duration of the easement is the choice of the landowner and the recipient and must be decided at the time of negotiation. However, if the landowner wishes to claim any income or estate tax deduction, the easement must be granted in perpetuity. In most cases, the owner will prefer a perpetual easement. Because the preservation easement generally is entered into for the preservation and protection of a cultural resource, it is not designed to allow for Chapter 13 Page 1

2 quick and simple alterations to its terms. If after the easement has been recorded, the donor wishes to change the easement, it may be altered only by mutual agreement of the parties. However, when the donor wishes to take an income or estate tax deduction, the easement must provide that it may be terminated or substantially altered only with the approval of a court of law, upon a showing that the original purpose is no longer attainable. In practice, easements are rarely altered. An easement seldom significantly restricts the owner's current use and enjoyment of the property. Most landowners will continue to use their property just as before, but with the granting of the easement, the future of the property is no longer left to chance. The land and structures are protected, and the protection will usually run in perpetuity. An owner considering granting an easement may benefit from savings in estate taxes, income taxes and property taxes. If the IRS's rules for granting an easement are followed, a property owner may deduct the value of the easement as a charitable deduction from his or her federal income tax. Assume the property owner has his property appraised without an easement at $200,000. He then has the property appraised with the easement in force and it is now worth $150,000, perhaps because the parcel can t be subdivided. The $50,000 difference is the value of the easement gift for tax purposes. For property taxes, the county tax assessor must take into account the reduction in value caused by the easement and should tax the property at its restricted value, not at its highest and best use as if development were unrestricted. Since the easement appraisal process is highly susceptible to tax fraud, Congress added in 2006 complex new qualification rules for the tax deductibility of preservation easements. Most of these new provisions are directed at easements in urban neighborhoods. In this legislation, Congress sought to close loopholes that have allowed deductions for easements that gained little public benefit or for easements given to nonprofit organizations with little capacity or intention of enforcing them. These new regulations make it more important than ever that a nonprofit preservation organization know the rules and communicate them well. Internal Revenue Service has added a number of new qualification requirements for appraisers and instituted sizeable fines for both donors and appraisers for overvaluation of an easement s value. As with any charitable donation of an asset, the donor is responsible for the appraisal, and the charity should be circumspect in any involvement with the appraisal process. The financial incentive for the donation of an easement can legitimately be significant, but the prudent preservation organization will advise an owner to follow the IRS s rules carefully. Most preservation easements can be divided into two sections: affirmative rights given to the organization, and covenants (i.e., promises) made by the property owner concerning the future use of the land. Affirmative rights might, for example, give the organization the right to bring researchers to the property with the consent of the landowner. Covenants concerning the future use of the property can be "positive" (requiring the landowner to take an action) or "negative" (preventing the landowner from taking an action). The federal and state governments provide tax incentives only for easements given for certain qualified purposes. To qualify as a charitable contribution, and thus to earn federal and state income tax reductions, the easement must be perpetual, must be made to a qualified donee (such as a non-profit preservation organization or a public agency) with the resources and commitment to manage and enforce the easement s restrictions, and must meet one or more of the conservation purposes, set out in the federal tax code: Chapter 13 Page 2

3 Preservation of historically important land or buildings (generally, the property must be listed on the National Register of Historic Places) Preservation of land for outdoor recreation or education Protection of relatively natural habitats of fish, wildlife or plants Preservation of open space pursuant to a clearly delineated governmental conservation policy Only the owner of the land or building may decide to grant an easement. In the end, the decision to give an easement is a personal one made by the property owner alone, but the owner should always consult competent legal and tax counsels to assure that his or her wishes are successfully translated into the provisions of the easement agreement and to assure that every advantage is taken of all possible tax benefits. The easement may be granted to a qualified preservation organization, either private nonprofit or governmental. The property owner chooses the best recipient to administer the intended preservation project. Many statewide and local preservation organizations, as well as the National Trust for Historic Preservation, accept easements. Governmental agencies, such as State Historic Preservation Offices or local historic preservation commissions, may also accept easements. In choosing, an owner should consider the size and location of the property, the kind of protection contemplated, and the stability and sophistication of the prospective recipient. Many owners may prefer making an easement donation to a nonprofit organization rather than a governmental unit because of concerns about future enforcement. The prospect of receiving an enforcement letter from the Attorney General s office about a minor infraction of an easement may be daunting. There are some costs for the donor. Generally, the donor of the easement pays the title search, land survey, appraisal, accounting fees and legal fees for preparing the easement. Some organizations charge a fee for accepting easements. These fees, deductible for the owner, are justified since the organization receiving the easement will incur costs in the transaction of receiving the easement and, more significantly, in providing for long-term monitoring and enforcement costs. An easement might include a modest administration fee to be paid when future changes in ownership take place. Easements are most effective as a financial incentive for property owners where land values are high relative to building values. That ratio occurs where there are mounting development pressures on a property. Examples include a historic structure that is considerably smaller than its neighbors (for example, the small historic building amongst tall downtown commercial buildings), a historic structure on land that has a high development value (such as a historic house adjacent to a flourishing commercial district), or a building sited on substantial acreage with development potential. Anywhere a historic parcel could be subdivided and the resulting lots easily sold for a substantial price, an easement will have value as a donation. (The new rules for easements passed in 2006 place limits on deductions for easements on land in designated historic districts.) Owners of numerous properties have donated easements to Preservation North Carolina and received significant tax deductions. Owners of houses sitting on several acres of land in mountain resorts have placed easements on their properties in order to assure that the properties won t be subdivided into multiple lots. Their donations clearly reduce the market value of their real estate, but the owners have benefited through the charitable deductions and property tax savings described above. An owner s heirs may also benefit financially at his or her death since the property will be assessed at a lower value for estate purposes. Rarely will the owner ever fully recoup the loss of value for the donation through tax incentives, but Chapter 13 Page 3

4 for the preservation-minded owner, the satisfaction of knowing that the property will be protected may suffice. In 2006, Congress passed legislation to encourage higher standards of practice for groups working with historic easements. These changes marked the first major reforms in the law relating to tax deductions for historic preservation easements in a quarter century. Among other things, the new reforms prohibit tax deductions for easements that protect only front façades, without safeguarding the entire exterior of a property. The legislation also increases overvaluation penalties for donors, imposes new overvaluation penalties for appraisers, and requires new qualification standards for appraisals and appraisers. These reforms will encourage higher standards of practice for easement-holding organizations, easement promoters, and appraisers. They also underscore the need for a preservation organization and its personnel to remain up-to-date about changes in easement laws and regulations, especially when a tax deduction is being considered. An easement can truly be critical to the long-term preservation of a property. The nephew of North Carolina State School of Design founding dean, Henry Kamphoefner, donated a preservation easement to Preservation North Carolina on the modernist house inherited from his uncle. The small house designed by Dean Kamphoefner and George Matsumoto in 1948 is noted for its architectural excellence in the design community. Sited on a large country club lot, the property was deemed by an appraiser to be more valuable without the house than with it, despite the house s prominence. The first purchaser of the property was enamored with the house and comfortable with the easement. Sadly, he died unexpectedly shortly after his purchase. The real estate agent working for the decedent s estate declared that he was not interested in the terms of the easement; his job was to get the best price for the estate. He asserted that the easement had no validity. A firmly worded letter from PNC threatening to report him for malpractice to the licensing board for real estate professionals caught his attention, and he went to work to find a sympathetic purchaser. Without the protection of the easement, the house would almost certainly have been lost. The dilemma of the Kamphoefner House also points out the need for the preservation organization to be vigilant in its monitoring of easements. Besides resulting in the potential loss of important historic resources, a failure to monitor and enforce preservation easements might lead to an action against the organization by the Internal Revenue Service, which has a stake in making sure that the public benefits financed through the tax incentives provided by easements are tangible. The monitoring and enforcement of covenants and easements is a major long-term obligation for a preservation organization working with real estate. Organizations that require a fee for easement monitoring should consider placing a substantial portion of that fee into an endowment or other restricted account to finance future monitoring requirements. Not all donations of preservation easements will necessarily result in charitable deductions for property owners. In some cases, an owner may not be willing to include all the provisions required by the Internal Revenue Service or the property may not meet all of the criteria for deductibility. In other cases, the prospective financial value of the easement may not be sufficient to justify the appraisal and legal costs of taking the deduction. (For example, a preservation easement on a house in a residential historic district is likely to have no value for deduction purposes. Its highest and best use is as a historic house in a historic district.) However, even these easements may be helpful to a property owner in reducing future property tax assessments and estate tax appraisals. Or, the owner may be donating the easement purely for reasons of the heart rather than the wallet. When no charitable deduction is being contemplated, the organization may choose to be more flexible about the terms of an easement agreement, and it may decide to institute lower Chapter 13 Page 4

5 fees or waive fees altogether. Although the monitoring obligations for those easements are still a liability to the organization, the goodwill of the property owners may in some cases be more important than a fee. Over the long haul, the owner s contributions to the cause or the importance of protecting the historic resource may exceed the value of any fee to be charged. Finally, easements may be useful protective tools for properties that are being reviewed for a public project s environmental impact or during rezoning decisions. For example, if the construction of a highway is going to unleash new development pressures on a historic property, a preservation easement given to a nonprofit organization might be stipulated as part of a Memorandum of Agreement between agencies under the National Historic Preservation Act. By protecting the historic resource from a newly created threat, the easement would allow the project to proceed without having an adverse impact on historic resources. Similarly, if the rezoning of surrounding property were to place a historic property in jeopardy, a local government might consider requiring a preservation easement to be placed on the property as a condition of the zoning change. Preservation easements are an invaluable tool in the preservation arsenal. By agreeing to accept preservation easements, an organization can help ensure the long-term protection of historic properties without ever owning them. It allows a reluctant organization to be involved directly in real estate, and it may even bring revenue to its coffers. However, in order for a preservation easement to provide long-term protection, the preservation organization accepting it must commit itself to a long-term obligation to monitoring and enforcement. Yet, isn t the long-term protection of historic resources what preservation is all about? Chapter 13 Page 5