Category : Conservation Easements

Tax-mitigation Strategy for Ordinary Income, a Case Study

Using charitable contributions of a conservation easement, A Charitable Contribution of a Conservation Easement (CE) IRC § 170(h), may be used to mitigate taxes due to ordinary income. IRC § 170 (h) allows users to make contributions for charitable purposes that result in a reduction in tax liability.

A CE can occur when a property owner gives up a viable right (such as a development, or a mineral right, etc.) associated with a property in perpetuity, via easement, that is monitored by an NGO or government entity, as long as it creates a public benefit.

The CE is structured as a real estate investment that has three operational and exit strategies one of which is voted to be the strategy that will be used by the investors. Generally, the strategies are: hold the property for appreciation, develop the property to its highest and best use, or create a Conservation Easement.

To determine the value of the conservation easement, two MAI appraisals of the subject property, meeting specific governmental criteria, are completed: the first appraisal is the before condition of the property’s highest and best use, the second is the after condition of the property’s highest and best use.  The difference in value between the first and second appraisal may provide a tax deduction to the investor.

The tax benefits generated by a Conservation Easement are limited to 50% of adjusted gross income (AGI). Historically, the economics of a CE are such that for a $1 contribution into the CE, an investor’s income is reduced by approximately $4.00. At a 39.6% tax rate, for every $1 contributed, the investor’s taxes may be reduced by approximately $1.60.

It should be noted the IRS is aware that Conservation Easements are subject to abuse because of the tax benefits received. The IRS put forth Notice 2017-10 January 23, 2017 to address these issues. CEs are now listed transactions. In the event the deduction is equal or greater than 250% of the amount invested, they are subject to further scrutiny and potential audit as being abusive. The CEs referenced in this case study have a deduction of approximately 1.6 to 1. Furthermore, in an abundance of caution, the sponsor has recently sought to get tax loss insurance on all CEs going forward. They have been successful in obtaining that insurance for all CEs since that decision.

As with any tax strategy, clients should consult with their tax professional. Neither IREXA, LLC nor Great Point Capital are attorneys or tax professionals. All work regarding Strategic Tax Mitigation™ relies on collaboration with a tax professional.

This example was in accordance of the applicable laws at the time of the transaction. The maximum deduction taken via Conservation Easement reduced the effective tax rate from 34.12% to 26.84%, a savings of $198,000 in federal taxes.

 

*IRS tax code is subject to change and the IRS could disallow some or all of the benefits discussed above.  The above numbers are for specific cases. Past performance is not guaranteed.

IREXA® Financial Services / Wealth Strategies collaborates with CPAs, attorneys, and other tax planning professionals to assist clients with tax mitigation strategies.  IREXA® and Great Point Capital, LLC are not tax professionals or attorneys. IREXA® only provides client tax mitigation strategies through, and with the approval of, the client’s professional counsel. You should review any planned financial transaction that may have tax or legal implications with your personal tax or legal representatives or advisors.

Securities offered through Great Point Capital, LLC, Member FINRA/SIPC, 200 W Jackson Blvd #1000, Chicago, IL 60606, telephone (312) 356-4872. IREXA® Financial Services / Wealth Strategies is not affiliated with Great Point Capital, LLC

Redeploying Tax Savings From a Conservation Easement to Provide Tax Free Retirement Income

  • Robert L. Boggess
  • May 10, 2018

A married couple in their mid-forties approached me to have a financial analysis based on my Strategic Tax Mitigation™ protocol. Their chief concerns included: the lack of strategies they had to reduce their current taxes and to develop a better retirement income program. After the review, I developed a plan to meet the clients’ goals and objectives.

  1. The clients currently generate approximately $467,000 annual income.
  2. The clients each have older Variable Universal Life (VUL) Insurance policy

With regards to income, a Charitable Contribution of a Conservation Easement (IRC § 170h) could be used to reduce taxes due to Ordinary Income (see Conservation Easement case study). In this couple’s case, a tax savings of approximately $24,500/yr could be achieved. Using this strategy, their taxes could be reduced from $123,500 to $99,000 in the proposal year.

With regards to their life insurance policies, Variable Universal Life policies follow the market. Cash values in the policy can go up or down depending on the direction of the market. When I explained the volatility issues the clients also became concerned. The policies were out of date and didn’t meet the clients’ desire for creating additional income in retirement.

The following proposal was made:

Generate tax savings from the use of the conservation easement, then redeploy the savings to invest in a better life insurance policy. The tax savings from the Conservation Easement could be used to help create a life insurance policy more aligned with the clients’ goals and objectives.

The existing VUL insurance policy was converted into an Indexed Universal Life (IUL) insurance policy by using a IRC § 1035 exchange. The clients were lawfully able to make this exchange without paying taxes. The two VUL policies had a cash value of approximately $200,000. The annual $12,000 premium for both clients was increased by $18,000 for a total of $30,000/yr, using most of the annual savings from the Conservation Easement. The CE acquisition and tax savings is repeated annually. As long as the couple’s income stays above $400,000, the new life insurance policy should be fundable from the Conservation Easement savings, with no additional money from the clients.

Through the Indexed Universal Life policies, the clients may be able to create $161,541 per year tax-free retirement income for 25 years (65 to 90). The total cost of the policies is $830,000. If the clients survive for just over 5 years into retirement, they will have gotten their money back. If the clients live long enough to use all of the tax-free income available in the policy, they should be able to withdraw over $4,038,500, or nearly 5 times their cost.

As with any tax strategy, clients should consult with their tax professional. Neither IREXA, LLC nor Great Point Capital are attorneys or tax professionals. All work regarding Strategic Tax Mitigation™ relies on the client’s tax professional. This example was in accordance of the applicable laws at the time of the transaction.

Tax Deductions via Conservation Easements

Charitable contributions of conservation easement provides tax deductions to the contributors. They are a proven, effective way to provide for the public good by transferring properties into the public realm in perpetuity.

On December 30th Richard Rubin published an article in the Wall Street Journal about conservation easements primarily from the perspective of conservation easement abuse. He recognized that viable conservation easements do exist. However,  the purpose of his article was to outline abuse, as well he should.

The two primary areas of concern regarding conservation easement abuse include:

  • viability of the easement and
  • abusive land value appraisals.

Viability: Two important criteria for viability are: conveyance in perpetuity of a valid and valuable right, and a public benefit is gained from the conveyance.

Abusive appraisals: The IRS has well-defined rules for appraising conservation easements. The IRS will automatically red flag any conservation easement when the tax deduction is greater than 2.5 to 1. It is an attempt to curb overly aggressive appraisals which can be characterized as conservation easement abuse. Some sponsors are offering deductions as high as 5 to 1. It’s no wonder the IRS is actively seeking to curb such abuse.

As background, Congress uses the tax code to achieve its goals by encouraging investment in various sectors of the economy. Some examples are solar and wind credits, and conservation easements. Often, Congress rewards those who risk their capital with tax deductions and credits.

As part of my Strategic Tax Mitigation™ approach to financial planning, I use conservation easements where appropriate. The conservation easements with which I am familiar, from reputable sponsors, have deductions below the IRS investigation threshold. I also use a number of other sections of the tax code to provide tax benefits to my clients that ensures that they will only pay the minimum tax they are legally obligated to pay.

For a free tax-saving strategic plan, contact me at rboggess@irexa.net.

Learn more about Conservation Easements.  Review our 1031 exchange properties.

 

 

IREXA® Financial Services / Wealth Strategies collaborates with CPAs, attorneys, and other tax planning professionals to assist clients with tax mitigation strategies. IREXA® and Great Point Capital, LLC are not tax professionals or attorneys. IREXA® only provides client tax mitigation strategies through, and with the approval of, the client’s professional counsel.

Securities offered through Great Point Capital, LLC, Member FINRA/SIPC, 200 W Jackson Blvd #1000, Chicago, IL 60606, telephone (312) 356-4872. IREXA® is not affiliated with Great Point Capital, LLC. 

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