22 March 2019 - Article
Well before a Massachusetts television network aired the first episode of “This Old House” in 1979, America has entertained a fascination with renovating and restoring historic structures. Preserving our architectural heritage has become increasingly difficult, however, as a parcel of land is often viewed as more valuable than an “old” structure built upon it. Owners of property of historical interest who desire to preserve the past may be able to recognize a significant tax benefit for doing so through the use of a qualified conservation easement (“QCE”).
What is a QCE?
A QCE is essentially an agreement between the donor-owner of real property and a qualified donee organization which is then recorded in the property records of the city or town where the property is located. Most typically, such an agreement relates to land and restricts the property owner (and any subsequent property owners) from using the land for a commercial purpose or in a way that would change its original character. However, QCEs can also be used to preserve the original character of a historic building or other structure. Essentially, a property owner who makes a gift of a QCE can limit his or her use of the property in perpetuity or agree to retain the original facade, or other physical aspects of all or a portion of the building.
A qualified donee organization is a public charitable organization or governmental body that has a commitment to protect the gift’s conservation purpose, as well as the resources to enforce the restrictions. Conservation groups generally qualify, as do some community funds and historical societies.
After establishing a QCE, the property owner can continue to use and enjoy the property as long as the QCE restrictions are not violated. Thus, for example, an individual can establish a QCE on a historic structure he is using as a home while continuing to reside in the home. The property owner can retain rights traditionally associated with property ownership, such as the ability to sell, mortgage, lease or otherwise transfer the property, albeit subject to the perpetual easement for conservation purposes.
To help ensure a public benefit from the QCE, the property owner must allow some visual public access to the property. If the property is not visible from a public road, the terms of the easement must provide that the general public is given the opportunity on a regular basis to view the characteristics and features of the subject property consistent with the nature and condition of the property. However, there are balancing rules in effect in order that the visibility requirement does not invade privacy or threaten the preservation interests. Often, a bi-annual “open house” is sufficient to allow the general public the opportunity to enjoy the historical characteristics of the property.
What Historic Properties Qualify?
Although permitted conservation purposes include preservation of open space and recreational areas, they also include the preservation of a “historically important land area” or a “certified historic structure.” The first step in determining whether historic property qualifies is to ensure that it falls under one of these two categories. The term “certified historic structure” means any building, structure or land area which is:
- listed in the National Register of Historic Places, or
- located in a registered historic district and certified by the Secretary of the Interior to the IRS as being of historic significance to the district.
If the property meets any of the above criteria, it may be the subject of a QCE.
What Are the Benefits of a QCE?
For an individual owner, the tax benefits of a QCE can be three-fold. First, by relinquishing certain rights, the owner of a historic property can gain a current income tax deduction. The value of the deduction is generally equal to the diminution in value caused by placing the easement on the property. In our experience, an easement of this type can produce a deduction that represents a significant percentage of the property value, without forcing the owner to give up rights which he or she planned to exercise. The charitable deduction for a QCE is subject to the normal rules for charitable gifts of real property interests including the annual 30% of adjusted gross income limitation. If the value of the easement is in excess of that limit, the excess deduction may be carried forward for up to five taxable years.
Qualified conservation contributions can have two further favorable estate tax implications. First, the property is included in the donor’s gross estate at a reduced value; that is, the original fair market value of the property minus the value of the easement. Second, a property owner’s estate can qualify for an exclusion of up to 40% of the value of land subject to a QCE, disregarding the value of any structures on such land. The exclusion cannot exceed $500,000, although it is essentially “reusable,” as other members of the property owner’s family may be able to claim the exclusion in the future because of the perpetual nature of the easement.
These tax benefits are illustrated by the following example:
- Harvey Oldhouse owns a historic farmhouse and land which are together valued at $1,000,000 (the farmhouse being worth $250,000 and the land being worth $750,000)
- In order to ensure the property’s perpetual conservation, Harvey grants a QCE to the local historical society agreeing to maintain the original structural condition and façade of the house, and agreeing to refrain from commercial development of the land. On appraisal, it is determined that the entire property is worth $700,000 subject to the QCE, resulting in an income tax deduction of $300,000 (the value of the QCE). Assuming Harvey pays income tax at a 35% marginal rate, he realizes immediate federal income tax savings of $105,000.
- The following year, Harvey dies. The entire property potentially forms part of Harvey’s estate at a value of $700,000. However, Harvey’s estate may exclude an additional $210,000 of value, equal to 40% of the value of the land subject to the easement ($750,000 less a 30% reduction in value for the easement). As a result, assuming a federal estate tax rate of 46%, Harvey’s estate pays only $225,400 ([$700,000 – $210,000] × 46%) of federal tax. Without a QCE, the federal estate tax attributable to the property would have been $460,000 ($1,000,000 × 46%).
In addition to the tax benefits of a QCE, the property owner is of course furthering his personal interest in preserving a piece of the past, not just for a lifetime, but in perpetuity.
Fundraising to Support QCEs
While QCEs offer individuals tax benefits as described above, they may also be useful for certain organizations. Although qualified public charities can raise funds to renovate or restore historical property they own, it is often difficult for non-charitable organizations to maintain the character of a historic structure because they cannot offer prospective donors the same tax benefits. However, a QCE may be used in conjunction with a larger planning strategy to provide a favorable result, as illustrated in a noteworthy Internal Revenue Service ruling.
In Private Letter Ruling 199933029, a fraternity chapter house listed on the National Register of Historic Places was in urgent
need of repair. However, as a social club formed under Section 501©(7) of the Internal Revenue Code, the chapter
house was unable to receive deductible contributions to help fund the necessary restoration. As a solution, the chapter house granted a QCE in the façade and interior portions of the chapter house to a qualified public charity. Contemporaneously, a tax-exempt foundation was organized to conduct fundraising on behalf of the chapter house. The chapter house entered into a grant agreement with the foundation, requiring the chapter house to develop detailed plans for the maintenance and improvement of the property. The grant of the easement ensured that the contributions benefited only qualified donees – the foundation and the public charity – and only incidentally benefited a nonqualified donee – the fraternity. In the ruling the IRS held that contributions to the charitable foundation to maintain the façade and interior character of the fraternity house were tax deductible.
The QCE is not available to everyone, but for property that qualifies, it may provide a perfect planning opportunity by furthering financial, charitable and preservation goals.