STATE CONSERVATION TAX CREDITS IMPACT AND ANALYSIS CONSERVATION RESOURCE CENTER 2007 Published by The Conservation Resource Center 820 Pearl Street, Suite F, Boulder, CO 80302 Conservation Resource Center staff includes attorneys Mike Strugar, Debra Pentz, and Tina Burghardt Graphic design and production by Molly Ruttan-Moffat Copyright © March 2007 The Conservation Resource Center All rights reserved. This document is the property of the Conservation Resource Center and may not be copied or utilized in whole or part without its express written consent. Cover photo: Autumn mountains, Colorado Back cover photos: Conserved land in Colorado and Virginia STATE CONSERVATION TAX CREDITS IMPACT AND ANALYSIS Authored by Debra Pentz, Conservation Resource Center with research assistance by Roman Ginzburg and Ruth McMillen Conservation Resource Center The Conservation Resource Center's Tax Credit Exchange Tax Credit Exchange 820 Pearl Street The Conservation Resource Center's CRC Tax Credit Exchange Suite F is a nonprofit land conservation organization and a Colorado tax credit facilitation organization. It is run by conservation Boulder, CO 80302 attorneys with more than 30 years of combined experience in conservation law and policy. In 2000, the Conservation Resource Center established the first transfer market for conser- 303.544.1044 phone vation tax credits. The Tax Credit Exchange also works at the 303.544.1043 fax state and national levels on tax credit law and policy. www.taxcreditexchange.com 4 table of contents Special Thanks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 The Purpose of This Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 PART ONE: Effectiveness of State Income Tax Credits in Advancing State Land Conservation Goals . . . . . . . . . . . . . . . . . . 8 A. Background ­ What Is a Conservation Credit?. . . . . . . . . . . . . . . . . . . . . . 9 B. Conservation Credit Program Effectiveness . . . . . . . . . . . . . . . . . . . . . . . 10 1. Effectiveness in driving additional land protection ­ Statistics. . . . . . . . . 10 a. Enacting a Conservation Credit program. . . . . . . . . . . . . . . . . . . . . 11 b. Increasing credit value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 SIDE c. Making credits transferable. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 2. Effectiveness in driving additional land protection ­ Expert opinion . . . . 13 a. Effectiveness where credit value is less than $100,000. . . . . . . . . . . 13 b. Effectiveness where credit value is equal to or greater than $100,000 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 3. Effectiveness in protecting important conservation values at a reasonable cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 IN PART TWO: Creating a State Conservation Credit Program: Drafting Considerations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 A. What type of land will be protected? Fee title, conservation easement, or both? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 B. What conservation values are to be protected? . . . . . . . . . . . . . . . . . . . . 18 1. Broad definitions of conservation values and IRC §170h. . . . . . . . . . . 18 2. More detailed definitions of conservation values . . . . . . . . . . . . . . . . . 18 C. What Financial Limitations Will Be Placed on the Credits? . . . . . . . . . . . . . 19 1. Credit valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 2. Caps that may be placed on credit transactions. . . . . . . . . . . . . . . . . . 19 a. Maximum value of credit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 b. Amount of credit that may be applied to taxes in any given year . . . . 20 c. Number of credits earned annually. . . . . . . . . . . . . . . . . . . . . . . . . 20 d. Statewide cap on tax credits that may be earned. . . . . . . . . . . . . . . 20 3. Sunset date . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 CONSERVATION RESOURCE CENTER 2007 table of contents 5 D. Who Will Be Eligible to Earn a Credit? . . . . . . . . . . . . . . . . . . . . . . . . . . 21 E. What Entities Will Be Eligible to Hold a Donation? . . . . . . . . . . . . . . . . . . 22 1. IRC §170h . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 2. Additional state requirements on land trusts or other entities holding easements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 3. State-approved land trusts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 F. How Can the Effectiveness of the Tax Credit be Maximized? Carry-Forward, Transfer, and Refund Provisions . . . . . . . . . . . . . . . . . . . . . 23 1. Carry-forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 2. Transferability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 3. Refundability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 G. What Information Should be Tracked for Reporting Purposes?. . . . . . . . . . 24 H. What Is the Appropriate Level of Program Oversight? . . . . . . . . . . . . . . . 25 1. Audit approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 2. Certification approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 3. Transactional screen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 PART THREE: Conclusion and Appendices . . . . . . . . . . . . . . . . . 30 Appendix A: Summary of State Conservation Credit Programs . . . . . . . . . . . 32 Appendix B: Sample Transactional Screen . . . . . . . . . . . . . . . . . . . . . . . . . 35 Appendix C: Footnotes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 CHARTS & GRAPHS Figure 1: States Using Income Tax Incentives for Land Conservation. . . . . . . . 10 Figure 2: Enacting a Conservation Credit program: Virginia Outdoors Foundation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11 Figure 3: Increasing Credit Value: North Carolina Conservation Tax Credit Statistics . . . . . . . . . . . . . . . . . . . . 12 Figure 4: Making the Credits Transferable: Virginia Department of Taxation Statistics . . . . . . . . . . . . . . . . . . . . . . . . . . 13 STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 6 special thanks California Council of Land Trusts California Wildlife Conservation Board Colorado Coalition of Land Trusts SPECIAL Connecticut Land Trust Service Bureau THANKS Conservation Trust for North Carolina Delaware Department of Natural Resources and Environmental Control Environmental Edge, South Carolina Georgia Land Trust Service Bureau Kentucky Sierra Club Special Thanks Maryland Environmental Trust to the following Massachusetts Chapter of The Nature Conservancy land conservation Mississippi Chapter of The Nature Conservancy Mississippi Land Trust organizations Nebraska Land Trust for sharing their New Mexico Land Conservancy valuable time and New Mexico State Forestry Division experience to New York Chapter of The Nature Conservancy support this project. North Carolina Department of Environment and Natural Resources Virginia Outdoors Foundation West Virginia State Senator John Unger Wetlands, Florida the purpose of this report 7 The purpose of this report is to assess the effectiveness of state income tax credits (Conservation Credits) in advancing land conservation and to guide states through issues related to the development of a tax credit program.1 THE It has been twenty-three years since North Carolina enacted the nation's first PURPOSE state tax credit program for land conservation donations. Since that time, the tool has become increasingly popular, with eleven additional states passing tax credit legislation since 1999. With many programs at least five years old, OF THIS it is an appropriate time to evaluate the effectiveness of Conservation Credits in advancing land protection and to provide guidance to other states considering REPORT such programs. Part One of this report addresses the effectiveness of state tax credit programs. Part Two provides guidance for program development. The Conservation Resource Center CRC has conducted an in-depth analysis of the nation's twelve Conservation Credit programs. The information and conclusions presented in this report are based on: * Detailed examination of state Conservation Credit legislation and supporting regulations. * Interviews with land conservation professionals in each of the twelve states having state tax credits. * CRC's nearly ten years of work in Conservation Credit law, policy, and transactions. This report is intended both to provide a snapshot of the current effectiveness of Conservation Credit programs and to serve as an aid to states that are rethinking existing legislation or drafting new programs. Sunset, Texas STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 8 part one Effectiveness of State Income Tax Credits in Advancing State Land Conservation Goals ONE PART CONSERVATION RESOURCE CENTER background 9 A. A Conservation Credit is an income tax credit available to landowners who voluntarily preserve their land through the donation of a conser- vation easement and/or fee title. The donation must protect conservation values as defined by individual states and must be made to an entity qualified to BACKGROUND: hold such property interest by the terms of the legislation creating the credit. Typically, this includes state and local governments and 501c3 land conserva- WHAT IS A tion organizations. Whether stated explicitly or not, Internal Revenue Code IRC CONSERVATION §170h, pertaining to federal tax deductions, is often the starting point for setting eligibility guidelines for a program.2 Most states also add their own layer of CREDIT? requirements to those required by IRS guidelines for federal deductibility. Conservation Credits were developed to complement existing state and federal incentive structures for land conservation. Depending on their value, Conservation Credits can provide greater and more direct financial benefits to landowners than those provided by federal tax deductions. State Conservation Credits, as distin- guished from federal deductions, are dollar-for-dollar write-offs of state income taxes. However, as with federal deductions, landowners with little or no taxable income derive less benefit from tax credits than do wealthier landowners with higher taxable incomes. To partially address this inequity, nearly all Conservation Credit programs allow credits to be carried forward so that the credit may be applied to reduce taxes over a number of years. While this can help, many times landowners still can not realize the full benefit of their credit. To further address this issue, several states have made their credits transferable or refundable. This will be discussed later in greater detail. Twelve states (California, Colorado, Connecticut, Delaware, Georgia, Maryland, Mississippi, New Mexico, New York, North Carolina, South Carolina, and Virginia) and Puerto Rico3 currently offer state Conservation Credits to landowners who donate lands for con- servation.4 Georgia and New York are the states that most recently enacted new programs, having done so in 2006. Several of the states with tax credit programs anticipate running leg- islation to increase program incentives in 2007. Another six states have either attempted to pass legislation within the past year or are actively considering a Conservation Credit program. Massachusetts and Idaho are currently working to create programs. Nebraska and West Virginia both introduced legislation in 2006, but their plans for 2007 are uncertain. Groups in Kentucky and Minnesota are Desert Plateaus, New Mexico STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 10 part one in the very early stages of considering programs. See Figure 1, Map of State Conservation Credit Programs, for states with current or pending programs. Attachment A, Summary of State Conservation Credit Programs, can be found on pages 32-34 of this report. B. A Conservation Credit program can be a highly effective tool to promote land conservation. With a thoughtfully crafted program, everyone benefits. CONSERVATION Landowners receive a financial reward for protecting their land, the state advances its goals of land conservation through tax policy rather than general- CREDIT fund expenditures, and the public reaps the benefit of lands preserved as open space at a fraction of their cost. As a tool that provides tax relief, benefits PROGRAM agriculture, and encourages land conservation, Conservation Credit programs receive strong bipartisan support. EFFECTIVENESS For the purposes of this report, program effectiveness is judged by the extent to which the programs drive additional land conservation and protect important conservation values. 1. Effectiveness in driving additional land protection ­ Statistics The effectiveness of Conservation Credit programs in driving additional land protection varies widely among the twelve states. This is attributable to substantial STATES USING INCOME TAX INCENTIVES Figure 1 FOR LAND CONSERVATION States with Tax Credits States with Transferable Tax Credits States Considering Tax Credits *Beginning January 2008, New Mexico credits will be transferrable CONSERVATION RESOURCE CENTER 2007 effectiveness 11 differences among programs. In a perfect world, program success in spurring greater land protection would be determined by comparing donation statistics before and after enactment of a program. Unfortunately, according to the organi- zations interviewed, accurate protection numbers are unavailable due to a lack of comprehensive statewide tracking of donations before legislation was passed. Virginia has the most reliable statewide donation statistics prior to the creation of its Conservation Credit program. The Virginia Outdoors Foundation VOF holds approximately 90 percent of conservation easements in the state and has tracked its easement donations since 1968. Fortunately, once Conservation Credit programs are created, states typically keep detailed records of donations that generate tax credits. To demonstrate program effectiveness in driving land protection, this report relies on detailed statistics from both Virginia and North Carolina. The statistics provide documentation of what can occur when a credit program is enacted Figure 2, when credit value is increased Figure 3, and when credits are made transferable Figure 4. Please note that the statistics from Virginia and North Carolina are from programs having high-value credits and, in the case of Virginia, transferability. Not all programs include these elements. a. Enacting a Conservation Credit program Virginia Outdoors Foundation statistics demonstrate that after passage of Virginia's Conservation Credits, the average number of conservation easements donated and the acres represented in those donations nearly quadrupled from ENACTING A CONSERVATION CREDIT PROGRAM: Figure 2 VIRGINIA OUTDOORS FOUNDATION 250 45 40 Number of 200 Donations 35 Before Conservation 30 Credit Program 150 ransactions 25 Virginia State Income Tax Credit Program 20 100 Number of Implemented in 2000 15 Donations After Program 10 was Enacted Number of T 50 5 Acres Donated 1000 acres Number 0 0 of Acres 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Bars represent the numbers of transactions, and the line represents the number in thousands of acres conserved. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 12 part one the six years prior to enactment of the program to the six years after enactment. Please note that these numbers repre- sent conservation easement donations only and do not include fee title donations. b. Increasing credit value North Carolina first enacted Conservation Credits in 1983, making its program the oldest ongoing state Conservation Credit program. The statistics gathered by the state demon- strate how increasing the value of a conservation tax credit can impact both annual donations and annual acres donat- ed. Over the years, the maximum allowed credit was raised from $5,000 to $250,000 for individuals and from $5,000 to $500,000 for corporations. The average number of conservation easements donated more than doubled when the credit cap was raised from $25,000 to $100,000 per individual and from $25,000 to $250,000 per corporation. The average number of dona- Sand Dune, Texas tions more than doubled again when the cap was raised to $250,000 for an indi- vidual and $500,000 for a corporation. While not shown in Figure 3, average annual acres donated also rose significantly from 1983 to 2004, climbing from an average of 397 acres to 11,500 acres. INCREASING CREDIT VALUE: Figure 3 NORTH CAROLINA CONSERVATION TAX CREDIT STATISTICS 120 250,000 Ind 500,000 Corp 100 100,000 Ind 80 250,000 Corp 60 40 5,000 25,000 Number of Donations Ind & Corp Ind & Corp 20 0 Year 83 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 6.2- average 16- average 38 average 85 average CONSERVATION RESOURCE CENTER 2007 effectiveness 13 c. Making credits transferable Figure 4 demonstrates the impact of making credits transferable. It compares donation activity in the first two years of Virginia's program, when the credit was not transferable, with activity in the next four years of the program, when credits were transferable. The average number of donations doubled and the acres pro- tected tripled once credits were made transferable. Since 2002, the average per- centage of credits transferred by landowners to third parties has been 75 percent. 2. Effectiveness in driving additional land protection ­ Expert opinion To assess program effectiveness where accurate statistics are not readily available, CRC relied on the estimates of land conservation professionals in each state. The experts shared their opinions about what level of increased land protection, if any, is directly attributable to their states' Conservation Credit programs. Generally, programs with credits valued at less than $100,000 reported no significant increase, and programs with credits valued at or greater than $100,000 reported varying degrees of increased donations. The two states with transferability reported the highest increases. a. Effectiveness where credit value is less than $100,000 Five states-Delaware, Maryland, Mississippi, New York and South Carolina - have credit values less than $100,000. Legislation in Delaware, Maryland, and Mississippi explicitly caps credit value at some amount less than $100,000. MAKING THE CREDITS TRANSFERABLE: Figure 4 VIRGINIA DEPARTMENT OF TAXATION STATISTICS 250 50 45 200 40 Number of 35 Donations Before Transferability 150 30 25 Number of 100 20 Donations After 15 Transferability Number of Donations 50 10 Number 5 Number of Acres 1000 acres of Acres 0 0 2000 2001 2002 2003 2004 2005 Bars represent the numbers of transactions, and the line represents the number in thousands of acres conserved. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 14 part one Credits in New York and South Carolina are kept under $100,000 by virtue of their valuation5. In Delaware, Maryland, and South Carolina, programs have been in place for several years. Professionals in these states noted that although Conservation Credits provide additional incentives, they "are not a driving force for land conservation," and that there has been "no significant increase" in land donations as a direct result of the credits6. Experts in each state implied that pro- gram effectiveness would be enhanced if credit values were increased. South Carolina is the only state with credits valued at under $100,000 that offers transferability. While generally, transferability increases program effectiveness, this has not been the case in South Carolina due to the low credit value, the unlimited carry-forward period, and the require- ment that all transfers must be approved by the state. These factors combine to make transferring credits less appeal- ing, as landowners can realize much of the value of the credit through an unlim- ited carry-forward period without the burden of state review. b. Effectiveness where credit value is equal to or greater than $100,000 Seven states-California, Connecticut, Colorado, Georgia, New Mexico, North Carolina, and Virginia-offer credits valued at or greater than $100,000. Land conservation profes- sionals in five of these states reported that their programs were effective (or, for Georgia, were expected to be effec- tive) in driving additional land conser- vation.7 Conservation Credit programs in North Carolina and New Mexico Everglades, Florida were credited with generating 20 per- cent and 25 percent increases in land conservation donations, respectively. While these gains are important, professionals in both states believe that land donations would greatly increase if the credits were either transferable or refundable. Please note that at the time of the publication of this report, New Mexico passed legislation that raises the cap on its credit to $250,000 and makes them transfer- able, effective January 2008. Colorado and Virginia both have transferable credits. Professionals in these states estimate that land donations have tripled in Colorado and quadrupled in Virginia as a direct result of the creation of transfer- able Conservation Credit programs. Not surprisingly, existing statistics and expert opinions together confirm that Conservation Credit programs with high-value, transferable credits will drive sig- nificant additional land protection. Programs with high-value credits that are not transferable and programs with low-value credits that are transferable do not approach the success of programs that combine high-value credits with transferability. CONSERVATION RESOURCE CENTER 2007 effectiveness 15 3. Effectiveness in protecting important conservation values at a reasonable cost Although Conservation Credits can work well to encourage donations, the number of donations made and acres of land protected are not the only gauges of pro- gram success. For programs to be successful, there should also be assurance that sufficient conservation values are being protected in perpetuity at a reasonable cost to the public. Most experts interviewed for this report stated that their programs effectively protected important conservation values at a reasonable cost. Programs with certification programs and/or appraisal reviews (discussed later in this report) were most confident of this. However, experts in several states expressed concern about what they believed was a small percentage of donations that may have: had low conservation values, were overvalued, and/or had been accepted by entities lacking the intent or resources to preserve the conservation values of the land in perpetuity. Fortunately, each of these concerns can be minimized or eliminated through careful drafting of program guidelines. In fact, Colorado and Virginia each recently amended their existing legislation to directly address some of these concerns. States with newer legislation, such as Georgia, have designed their legislation and supporting regulations to avoid these pitfalls from the outset. It is clear that through drafting, states can enact Conservation Credit programs that successfully drive additional land donations with high conser- vation values at a reasonable cost to the public. By looking to other states' experiences, propo- nents of Conservation Credit programs and state legislatures can increase the chances of develop- Forest, New Hampshire ing effective programs and can minimize or avoid risks. The remainder of this report walks those drafting legislation through the major issues to be considered in program development. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 16 part two Creating a State Conservation Credit Program: Drafting Considerations TWO PART CONSERVATION RESOURCE CENTER 2007 drafting considerations 17 States have not followed a uni- form model in creating their Conservation Credit programs. While the programs all share the same basic elements-limitations on credits, definition of conservation values, and eligibility of entities that may claim credits- they vary dramatically within these categories. For example, Connecticut offers only corporate tax credits. Mississippi's credit is valued at 50 percent of a project's transaction costs rather than the value of donated land, and credits may be earned only through donations of land of a certain type. New York's credit, while it is applied to income taxes, is valued at 25 percent of a landowner's property taxes. California's program requires a Forest, Alaska significant investment of time and resources from both donor and donee prior to earning a credit, severely curtailing use of the program. Colorado and Virginia offer high-value transferable credits, attracting many landowners to make use of the program. Legislatures, land conservation organizations, and other program supporters must determine exactly what they are trying to accomplish with a conservation tax credit program to ensure that the provisions in their legislation will achieve the desired results. This section presents the primary questions to be considered in program development and includes lessons learned from existing programs to assist those currently developing or amending Conservation Credit legislation. A. Land protection through both fee title and conservation easement donations is important to an overall land protection strategy. However, WHAT TYPE drafters must determine which type of donation they want to encourage through OF LAND WILL BE their Conservation Credit program. The majority of programs award credits for both. In contrast, Colorado, Maryland, and New York award Conservation PROTECTED? Credits only for the donation of conservation easements. In Colorado, where one-third of the State's land is already in public ownership, the general prefer- FEE TITLE, ence is that lands remain in the hands of private landowners rather than be donated in fee to a government or land conservation entity. The structure of CONSERVATION programs in Maryland and New York is also more consistent with providing incentives to landowners who continue to hold title to their properties. Maryland's EASEMENT, Conservation Credit ($5,000 per year with a 15-year carry-forward) layered an additional incentive on existing property tax credits for land donations. In OR BOTH? form, New York's credit is an income tax credit, but it functions more like a property tax credit. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 18 part two B. WHAT Conservation Credit programs must sufficiently define the conservation values they are established to protect. Some states have broadly defined CONSERVATION conservation values, while other states narrow the definitions to promote specific land preservation goals. Somewhere in between is where most states end up. VALUES ARE TO More precisely defining the conservation values to be protected will provide guid- ance to landowners and will make the program more effective in achieving state BE PROTECTED? land protection goals. 1. Broad definitions of conservation values and IRC §170h Many Conservation Credit programs characterize conservation values or benefits very broadly, defining them either in the Conservation Credit statute or referring to preexisting definitions in conservation easement enabling legislation. In addition, seven of twelve programs specifically require that donations satisfy the require- ments of a "qualified donation" pursuant to IRC §170h. 8 Requiring compliance with IRC §170h for a donation to earn a state tax credit allows a simplified method of setting program rules. However, drafters should consider the full implications of doing so. States may have different goals for their state tax credits than the federal government does for its deductibility program. If certain provisions are acceptable and desired for use in a state's program, it might be better to use the specific language rather than merely requiring compli- ance with IRC §170h. Otherwise, when IRS requirements are amended or interpretations evolve over time, states may not be happy with the resulting impact on their programs. 2. More detailed definitions of conservation values Many states go beyond IRC §170h by providing additions to or restrictions on those requirements. Delaware, for example, provides within its Conservation Credit statute its own brief definition of open space and natural habitat. Georgia and North Carolina list categories of eligible conservation benefits in their legislation. Both also provide much more detailed guid- ance in supporting regulations and procedural documents. In 2006, Virginia passed legislation authorizing the Virginia Land Conservation Foundation to describe "the objective char- acteristics of lands that have important conservation values." California and Mississippi provide the most guidance on lands eligible to earn a credit. In addition to setting out broad categories of conservation lands that qualify, California goes further, requiring a donation to meet one or more requirements such as the land being a part of a conser- vation plan.9 Mississippi goes the furthest, requiring that only lands designated as priority sites by the state's Natural Heritage Program or lands adjacent to and along streams nominated for the state's Scenic Streams Stewardship are eligible to earn a credit. Field of wildflowers, Virginia CONSERVATION RESOURCE CENTER 2007 drafting considerations 19 Finally, some states have chosen to specifically make certain types of lands ineligi- ble for tax credits. For example, both South Carolina and Georgia explicitly exclude golf courses and lands directly associated with golf courses from eligibility. C. Another critical decision for program drafters is the level of financial incentive the program will provide. Most often, credit value is set as a WHAT percentage of the fair market value of the donated land or some predetermined cap on value, whichever is less. FINANCIAL Some state legislatures express concern over the potential fiscal impact of a LIMITATIONS WILL Conservation Credit program. However, as is discussed in the following sections, there are numerous ways to limit the fiscal impact of a program while still maxi- BE PLACED ON mizing the public benefit. These include offering a credit for only a portion of the donated value of the land, placing caps on the credits, and setting a sunset date THE CREDITS? at which time costs and benefits of the program can be reviewed. In addition, it should be noted that the full value of each potential tax credit that could be earned is not always realized. There are pipeline losses. First, not all landowners claim credits. Second, in states with certification, some credits may be rejected. Finally, a landowner may not be able to make use of the entire value of the credit, especially in states without transferability. 1. Credit valuation All but three programs base credit values on some percentage of fair market value of the donated land.10 This ensures that there is a significant public benefit for any dollars awarded as tax credits. For example, when credits are valued at 50 percent of the fair market value of the donation, the public receives $2 of land protection for every $1 offered as a tax incentive. Credit valuations range from 25 percent the donated value in North Carolina to 100 percent in Maryland. The average credit value is 48% of the donated value.11 2. Caps that may be placed on credit transactions States have capped credit transactions in four different ways, as described here. a. Maximum value of credit All but five states have a cap on the total value of the credit. Considering the pro- grams that value credits based on the fair market value of the donation, individual and corporate caps range from $50,000 in Delaware to an unlimited credit in Virginia, Connecticut and California. Blooming cactus, Arizona STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 20 part two Connecticut's credits are available only to corporations. California's credit program, due to its onerous program requirements, is not readily accessible to the typical landowner. Virginia faces the greatest fiscal impact because its credits are both unlimited and transferable. However, after scrutinizing its program in 2006, Virginia elected to keep both an unlimited credit and credit transferability, recognizing the importance of these elements in dramatically increasing land conservation in the state. As discussed earlier, New York and South Carolina do not set explicit limits on credits, but credits are kept low through valuation methods. b. Amount of credit that may be applied to taxes in any given year Three states allow a higher credit to be earned than can be applied to taxes in a given year. In Maryland, credits of up to $80,000 can be earned, but only $5,000 can be applied to offset taxes each year. There is no upper limit on credit values in Virginia and New York (25 percent of each year's property taxes). However, in Virginia no more than $100,000 can be applied by the donor to his or her state income tax annually and in New York the maximum amount that can be applied in a given year is $5,000. c. Number of credits earned annually In Colorado and New Mexico, landowners may not earn more than one credit a year. Colorado's law goes on to require that when a landowner earns a credit, he or she may not earn another credit until all value from the first credit is applied to income taxes or is relin- quished.12 Mississippi allows only one credit in a lifetime. Most other states do not have a similar limitation. So long as the cap on the amount of credit that may be applied to taxes in any given year is not exceeded, multiple credits may be earned. d. Statewide cap on tax credits that may be earned Statewide caps offer state legislatures certainty regarding the maximum annual fiscal impact a program may have. California, Delaware, and now Virginia have caps on the total value of credits that may be earned statewide. California's cap is $100 million (or whatever has been spent by FY 2007­2008, whichever is less). Delaware's cap is $1 million in any given year. Virginia's cap is set at $100 million a year. No other programs have a statewide cap on the overall value of credits that may be earned. The difficulty with statewide caps is that if credits are awarded on a first-come, first-served basis, projects that are pushed through most quickly-and not necessarily those projects with the highest conservation value-may be the projects that receive funds. Conservation easement donations can be com- plex and time-consuming transactions when done correctly. Donors and donees trying to put together solid deals thus may be punished for their diligence. Other methods of allocating limited funds also come with unintended consequences. A lot- tery system leaves too much to chance, and setting standards Redwood forest, California CONSERVATION RESOURCE CENTER 2007 drafting considerations 21 and criteria turn the tax credit program into more of a grant award program with its associated layers of bureaucracy. Each of these allocation methods reduces the certainty of whether a credit will be earned, thereby reducing the effectiveness of the program. 3. Sunset date Finally, two states have sunset dates in their Conservation Credit legislation. Conservation Credit supporters generally disfavor sunset dates because of the addi- tional investment of time and resources Rock formations, Utah necessary to extend the sunset or make the credits permanent at the time the program expires. However, if a legislature is unwilling to make the leap to a permanent program, this offers a more conservative approach. California and Delaware both have sunset dates for their legislation in fiscal years 2008 and 2010, respectively. These restrictions on Conservation Credit programs are valuable tools to limit the overall fiscal impact of a program. However, such limitations may work against strategic use of the credit program. If an entity is working to preserve land in a particular geographic area, it may be important that a particular landowner be able to earn more than one credit over a certain period of time. Landowners may own multiple parcels in a given protection area. In trying to maintain a high degree of control over a program through tight drafting, one must be watchful of unintended consequences that may impair the program's effectiveness. D. With regard to who will be eligible to earn a Conservation Credit, WHO WILL it must be considered whether the program is intended to protect as much land as possible, to provide incentives to the greatest number of BE ELIGIBLE taxpayers, or to reward a specific group of landowners. Having more eligible land donors provides the greatest opportunity to protect land. However, TO EARN several states have decided to limit eligibility in this area. Although most states allow both individual and corporate taxpayers to claim tax credits, three A CREDIT? do not. Connecticut offers credits only to corporations, while Maryland offers credits only to individuals. Colorado provides credits only to individuals who are residents. Arizona's program, in existence until January 2006, was available only to agricultural districts. In one western state, a pending program may make benefits available only to agricultural landowners. Related considerations include the treatment of pass-through entities, married couples, trusts, and estates, and whether there should be residency requirements on individuals and/or corporations. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 22 part two E. Conservation Credit programs vary widely in the entities they deem WHAT eligible to accept donations of land or conservation easements that generate credits. This is an important issue to consider, as some of the actual ENTITIES WILL and perceived program abuses relate to the qualifications of the entities that accept the donations. The concern is that some entities may form for the specific BE ELIGIBLE purpose of holding fee or conservation easement donations deemed inadequate by the more established land trusts and government open space programs. To TO HOLD protect the public investment of dollars, states should ensure that the entities eligible to hold Conservation Credit land or easement donations possess sufficient A DONATION? expertise and funding for long-term management and monitoring. 1. IRC §170h Most Conservation Credit programs provide that the entities that qualify under IRC §170h are eligible to hold easements earning a tax credit. This includes government entities and nonprofit 501c 3 organizations. Nine states specifically require compliance with §170h. 2. Additional state requirements on land trusts or other entities holding easements Other programs have added requirements beyond the general provisions of IRC §170h. These additional requirements may exist in the state's conservation easement enabling legislation or may be within its Conservation Credit legislation. Georgia requires that eligible entities must adopt and implement the standards and practices of the Land Trust Alliance. It also places annual monitoring requirements on the land trusts and requires that copies of monitoring reports be sent to the state. Colorado requires a two-year waiting period before an entity may hold conserva- tion easements. Virginia requires that an entity accepting a donation have an office in the state for at least five years. In 2008, the Land Trust Accreditation Commission, an independent pro- gram of the Land Trust Alliance, plans to initiate a national accredita- tion program for land trusts. In the future, Conservation Credit legisla- tion may cite accreditation as an eli- gibility requirement for accepting donations that generate tax credits. Blossoming tree, Virginia CONSERVATION RESOURCE CENTER 2007 drafting considerations 23 3. State-approved land trusts Finally, California and Maryland have taken the strictest line, allowing only approved land trusts to hold easements generating tax credits. In California, nonprofits must be designated by a qualified government entity and must have experience in land conservation. In Maryland, only the Maryland Environmental Trust and the Maryland Agricultural Land Preservation Foundation are eligible. F. Research demonstrates that by far the most important element of a successful Conservation Credit program is making the credits transfer- HOW CAN THE able. Legislatures have been averse to make credits refundable.13 However, it would be expected that full refundability would likewise increase the effective- EFFECTIVENESS ness of Conservation Credit programs. Having a carry-forward provision helps, but alone it is insufficient to significantly improve the performance of a program. OF THE TAX CREDIT These provisions also work to make Conservation Credit programs more equi- table. Without transferability and/or refundability, the wealthy will disproportion- BE MAXIMIZED? ately benefit from the program. Carry-Forward, 1. Carry-forward Transfer, and To help ensure that landowners can realize much of the value of their credits, all Refund Provisions Conservation Credit programs allow their credits to be applied to state income tax for a minimum of five years. Some programs offer the option to carry-forward for an unlimited amount of time. However, in circumstances where credits are large but landowners have a low taxable income, these carry-forward provisions may be insufficient to ensure equitable treatment of both the wealthy landowner and the land rich/cash poor landowner. In these cases, the best way to ensure that conservation tax credits are an incentive to all landowners is to make credits transferable or refundable. 2. Transferability Currently, South Carolina, Colorado, and Virginia all have transferable credits. Reliable transfer markets exist in Colorado and Virginia, making it simple for landowners to transfer credits to third parties and realize an immediate financial benefit for their credits.14 Market rates can fluctuate, but currently landowners receive between 70 percent and 82 percent of the value of their credits.17 Third parties purchase the credits at a discount and in turn reduce their own tax liability. In Virginia, an average of 76 percent of the total credit value earned in the state is transferred each year. In states with transferability, Conservation Credit facilitators provide an additional layer of due diligence review to ensure that easement donations that earn Conservation Credits meet program standards. In addition, facilitators negotiate for the highest price for their landowners and schedule credit transfers to meet the landowners' needs. Facilitators are often reimbursed for their services from the proceeds of the credit transfer. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 24 part two Of the professionals interviewed for this report, in the eight states that do not currently have transfer- ability or refundability, five stated that they would like to see their states' credits be made transfer- able. Two others wanted to wait to see the experi- ence of other states with transferability, and only one said he did not want his state's credits to be transferable. 3. Refundability Legislatures are generally loath to make any type of tax credits refundable. Although refundable credits clearly streamline the process, most legisla- Smoky Mountains, Tennessee tures find credit transfers more palatable than writing government checks to refund credits. Only two states offer refunds, and both are capped at a low annual value. Colorado's legislation has a rarely used partial-refund provision; landown- ers may seek refunds of up to $50,000 per year during state surplus years. However, since the enactment of the program, there have only been two surplus years.15 In New York, where credits have a maximum annual value of $5,000, if the income tax credit earned exceeds taxes due, the remainder may be refunded. G. Any tax credit program should have methods by which to track usage WHAT to allow future analysis of program effectiveness. Both Virginia and North Carolina have the ability to obtain detailed information regarding the Conservation INFORMATION Credits earned in their states. Colorado has less ability to access program data, and organizations are currently working to devise a detailed and reliable tracking SHOULD BE system for Colorado credits. States considering Conservation Credit programs should determine what information they would like to have available and how TRACKED they intend to collect it for the for future evaluation of program effectiveness. Information to track might include the following: FOR REPORTING PURPOSES? * Annual number of credits earned, * Value of credits earned, * Value of land protected, * Number of acres protected through donation, * Types of land protected through donation (agricultural, wildlife, wetlands, and so on), * Type of donor claiming credit individual, corporation, other, * Type of holder of the conservation easement (land trust, government, other), * Number of credits transferred and * Value of credits transferred. Most tax credit programs already have a form that must be filed with the tax department to claim the credit. It will be a simple matter to expand this form to include requests for the types of information discussed above. The state department of revenue or taxation may then compile these statistics on an ongoing basis. CONSERVATION RESOURCE CENTER 2007 drafting considerations 25 H. To ensure wise use of public funds, it is important to consider the appropriate mechanisms to guarantee that credits earned are support- WHAT IS THE ed by qualified land donations. Land Conservation professionals in four of the ten states with established Conservation Credit programs reported one or APPROPRIATE more transactions that pushed the envelope too far, suggesting that the easement donation might be unqualified. Issues of concern include: LEVEL OF PROGRAM * Overvaluation of the donation, * Questionable conservation benefits, OVERSIGHT? * Inappropriate phasing of a transaction,16 and * Conservation easement donations being made to entities that may be inexperienced or that lack a true dedication to land conservation. These are the same issues that have been of potential concern for the federal government for decades. The creation of state Conservation Credit programs has not created these problems. However, such programs have suddenly put these issues into play at the state level. Without checks on the system, the opportunity for significant financial reward poses the risk that some may attempt mediocre deals that may not have otherwise been pursued. Two principal approaches have been used to ensure that credits are supported by qualified transactions. One is the audit approach, which allows taxpayers to unilaterally claim tax bene- fits on their tax returns, and those benefits are allowed unless a post-return audit disallows them. The second approach involves certifica- tion of the credits, whereby the tax credits involved must be certified by the government before a taxpayer can claim them on a tax return. Each of these approaches has its benefits and drawbacks. 1. Audit approach The general approach employed in the world of taxation relies on taxpayers honestly reporting their taxes on tax returns, followed up by the potential for a post-return audit, which could happen at any time before the expiration of the statute of limitations. For example, a credit springs to life as soon as a donation is made. A state would review the credit, if at all, only after the credit has been claimed on a tax return. Programs in Colorado, Connecticut, and New York rely exclusively on this approach for con- trolling the use of the credits. South Carolina and Virginia rely primarily, but not exclusively, on the audit approach. However, South Carolina Forest stream, Michigan STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 26 part two requires certification where a credit will be transferred to a third party. New in 2006, Virginia requires certification of a credit valued at more than $1 million. The chief benefits of an audit approach are speed and simplicity. Because there are no governmental prerequisites for creating credits, the credits spring into existence as soon as a donation is made. Practice shows that many easements are finalized at the end of the tax year; the audit approach thus allows the maximum number of easement donations to occur in any given year. Also, because a system already exists for post-return audits, this approach does not require any new governmental infrastructure or bureaucracy to administer the credit program. One disadvantage of an audit-based approach is that users of credits do not know for certain that the credits are valid, because the credits could later be reversed upon an audit. This is of particular concern when a pro- gram allows the credits to be transferred, because the transferees of the credits cannot be certain that they are acquiring good credits. Instead, many transferees rely on indemnification provisions from credit sellers and/or on credit facilitators, who perform due-diligence review on transactions before placing them with buyers to ensure their interests are protected. Another disadvantage of an audit-based system is in determining who will conduct the audits. If a state creates the credits, the financial bur- den is on the state budget. In such a case, if the state is relying on the IRS to conduct the audits, the state might find that the IRS is not auditing all of the transactions that the state would like to see reviewed. On the other hand, states often lack the resources and expertise to conduct full audits on their own.17 Despite these shortcomings, the audit approach is elegant in its simplicity. Virginia recent- ly upheld the use of the audit approach for credits val- ued at under $1 million. 2. Certification approach Seven programs rely primarily on a state certification Birch Trees, Maine process for donations prior to awarding a credit.18 The certification means that the transaction meets state standards for earning a state tax credit. State certification generally empowers a state department of natural resources or some other authorized arm of the state to conduct a substantive review of a conservation easement credit transaction. Such certification programs vary greatly in their requirements. In California, a donor must submit materials to the Wildlife Conservation Board to ensure that the project is generally consistent with the requirements of the program. If approval is granted for the project to advance, the donor and donee must then hold a public hearing about it. After the public hearing, an application must be submitted to the Wildlife Conservation Board for consideration. Although this procedure is atypical, it exemplifies one extreme example of what a certification process might entail. CONSERVATION RESOURCE CENTER 2007 drafting considerations 27 New Mexico's legislation requires that donors must submit deed information, mineral reports, baseline reports, appraisals, and title work by January 31 of the year in which the credit will be earned. This timing does not work well for landowners. Based on the normal timeline for land donations, this information would not be available until very late in the year. The state has decided to accept materials up until April 16 to, in part, address this hardship. Georgia's certification program sets a 90-day turnaround time from submittal of materials to decision. For a landowner to be certain he or she may earn a credit in the year in which the donation is made, all materials must be in final form and submitted to the state by early October. However, if any materials are missing or if changes need to be made, they may not receive a decision by December 31.19 Before adopting a certification pro- gram, states must consider what their standards for certification are. Is the goal of certification to reject the clearly abusive transactions? Such transactions might lack any real con- servation values, have highly over inflated appraisals, or have unquali- fied entities accepting the donation. At the other end of the spectrum, certification standards might be set to ensure that only the highest-quality transactions are approved. This might include a detailed examination of conservation values and baseline documentation, appraisal reviews to ensure that appraised values are indisputable, and review to ensure that entities accepting donations of Shoreline, New Mexico conservation easement and/or fee title meet standards and practices set by the Land Trust Alliance. The latter purpose of identifying the highest quality transac- tions can be difficult to achieve. Unless the meaning of the term "conservation value" is clearly defined in a state's statute, nearly every parcel of land may con- tain an important conservation value in someone's opinion. As appraising is not an exact science, there is often room for debate with respect to the value of a donation. In-depth investigation of each entity accepting a donation would also be a lengthy process.20 Bad transactions are typically fairly easy to identify. Attempts to award credits to only the best transactions requires a much higher level of investigation and oversight. Based on responses from experts in the field, there seems to be a need for some middle ground between the audit and certification approaches. Several experts in states that rely on audit systems (without certification) wished there was more pro- STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 28 part two gram oversight and infrastructure. Several experts in states with certification said that their certification procedures were too onerous and that they would simplify the process and shorten the time required to determine certification. Moreover, several expressed concern that certification, if too onerous, serves as a deterrent to landowners, curtailing the effectiveness of the programs. Given the desire for some level of oversight to protect against gross violations and the concern that too onerous a process will harm the program, the appropriate level of oversight is probably somewhere in between an audit system and a full certification process. 3. Transactional screen A transactional screen is a limited, nonbinding review of a transaction that occurs either before or after a donation is made.21 It allows states to immediately reject the worst deals while preserving the right to raise objections on more detailed questions at a later date. The review is expedited to ensure that the transaction meets minimum standards. The screen may review three basic areas: the technical aspects of appraisal methodology, whether land donated meets the conserva- tion-value criteria of the program, and other basic due diligence to ensure the transaction is complete and correct. As soon as a transac- tion passes this screen and the donation is made, a credit may be claimed. Such a screen is similar to the review most tax credit facilita- tors conduct in states with transfer- able credits. However, there is no reason a state could not provide a similar review. Field of poppies, Arizona If a project is approved through a transactional screen, credits may be earned and claimed on a tax return. However, there is no guarantee that credits will not be reduced or disallowed upon a subsequent audit. For several reasons, transac- tional screens appear well suited for regulating conservation easement donations. Most important is the fact that the transactional screen may be the only regulatory scheme that would be acceptable to the state revenue departments that must enforce it. Any system that is more thorough and final poses problems for those reviewing the credit. First, the short turnaround time that the timeline of a land conservation donation requires would be a significant hardship to those doing the review, especially in connection with appraisal review. Many easement transac- tions involve high-value lands and are increasingly accompanied by exceedingly thorough and sophisticated appraisals some contain hundreds of pages of text whose in-depth review might require months. Additionally, as noted previously, the IRS may choose to conduct its own audit of the subject transaction. It is uncertain how a state would react if it approves a CONSERVATION RESOURCE CENTER 2007 drafting considerations 29 certain transaction that is subsequently disqualified by the IRC.22 This uncertainty is further complicated if the state's legislation makes compliance with IRC §170h a requirement of the program. In addition, most states have conformity laws that allow the state to rely on adjustments in tax value made by the IRS. It is highly unlikely that a state taxing authority would be willing to waive that right in favor of a binding certification. Aside from the pragmatic basis discussed above, transactional screens have immediate practical benefits. First, they cull many bad transactions from the system before damage can be done. As noted previously with respect to programs that allow transferability, once credits are sold, it can be very difficult to get the toothpaste back into the tube.23 Any kind of after-the-fact audit will not prevent that unfortunate problem. Additionally, it appears that a competent transactional screen can be accomplished in a manner that will not interfere with an efficient market for the sale of the credits. This is an essential component that allows the powerful tool of transferability to accomplish its ends. Finally, the experience of Conservation Credit facil- itators seems to provide real-world evidence that transactional screens work and that they can be done in a reasonably short time frame so as to not interfere with the marketability of credits. As noted previously, almost all of the facilitators of tax credit sales conduct some sort of due diligence. The expe- rience of the Conservation Resource Center in reviewing more than five hundred transactions has shown that a substantial number of the transactions had problems that initially prevented their sale. However, the vast majority of these problems were fixed relatively easily, ultimately permitting the credits to be sold. It is certainly preferable to find and fix these problems at an early stage rather than to identify them long after the fact, at a time when repair may no longer be practical or possi- ble. See Appendix B, Sample Transactional Screen, for one example of a transactional screen. Sunset, New Jersey STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 30 part three Conclusion and Appendices THREE PART CONSERVATION RESOURCE CENTER 2007 conclusion and appendices 31 A Conservation Credit program can be a valuable tool in a state's over- all land protection strategy. It has the potential to dramatically increase volun- tary land protection. The amount of additional land protection attributable to a Conservation Credit program is primarily driven by two factors: 1 the maximum value of credit that may be earned and 2 whether the credit may be deferred over several years, transferred, and/or refunded. The continued success of tax credit programs will depend on diligent attention to such issues as 1 ensuring that transactions earning credits are worthy of public investment and 2 tracking the lands conserved and conservation benefits protect- ed so that program success can be shared with the legislature and the public. As a compendium to this report, the Conservation Resource Center is developing model conservation tax credit legislation that states may use as a starting point for developing new legislation or amending existing programs. Its release is anticipat- ed in mid-2007. Green mountains, Virginia STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 32 part three A. CALIFORNIA COLORADO CONNECTICUT LEGISLATION Natural Heritage Credit Against Tax ­ Tax Credit For Donation Preservation Tax Credit Conservation Easements of Open Space Date of Enactment Act of 2000 1999 2000 Statutory Citation 2000 Colo. Rev. Stat. Conn. Gen. Stat. APPENDIX A: Cal. Public Resource § 39-22-52 §12-217dd Code §§37000-37042 SUMMARY LANDS ELIGIBLE TO * Fee Title & Conservation * Conservation Easement * Fee Title & Conservation EARN CREDITS Easement only Easement * Fee title, Conservation * IRC § 170h * IRC § 170h * Conservation of easement, or both * Water conservation for * Agriculture lands i water resources, * IRC § 170h = explicit protection of threatened and environmental ii soils, wetlands, requirement to meet or economically important quality benefits are beaches or tidal marshes, federal eligibility species. Wildlife habitat recognized per se. iii agriculture lands, requirements related must be identified by (iv) forestry lands (over to conservation values CESA/ESA. Agricultural 25 acres), and (v) promo- land must be threatened tion of orderly urban or * State additions to/ by development. suburban developments restrictions on federal is recognized per se. standard CREDIT VALUE AND * 55% FMV * 50% FMV * 50% FMV LIMITATIONS * Unlimited credit * $375,000 max credit. * Unlimited credit * Value as a % of FMV * Statewide cap of * $375,000 cap on credit of donated land unless $100,000,000/program applied to taxes/yr. otherwise noted. lifetime. * Individual/entity limited * Maximum credit, if any * 2008 sunset date. to one credit /yr. * Cap on credits applied to taxes/yr., if any * Limitation on # credits that may be claimed by one individual/entity, if any * Statewide cap, if any * Sunset date, if any ENTITIES ELIGIBLE Individual/Corporate/ Resident Individual/ Corporate TO EARN CREDITS Pass-Through Entities Corporate/Pass-Through Entities ENTITIES ELIGIBLE TO * IRC § 170h * IRC § 170h * Governmental entities HOLD A DONATION * Governmental entities * Nonprofits must have limited to State or its * IRC § 170h = explicit limited to State or its operated for 2 years. subdivisions; Nonprofits requirement to meet federal subdivisions; Nonprofits must be conservation eligibility requirements must be designated by a organizations; Water Companies eligible. * State eligibility qualified governmental requirements entity and have experience in conservation. CARRY FORWARD? 8 yrs. 20 yrs. 15 yrs. TRANSFERABLE? No Yes No REFUNDABLE? No Conditional on State No Surplus and limited to $50,000/yr. CERTIFICATION? Yes ­ by CA Wildlife No No Conservation Board. Scope of review: appraisal, conservation value, donor/ donee eligibility, public comments etc... CONSERVATION RESOURCE CENTER 2007 conclusion and appendices 33 DELAWARE GEORGIA MARYLAND MISSISSIPPI N. CAROLINA* Delaware Land & Historic Credit for Donation of Real Income Tax Credit for Tax Credit [for] Natural North Carolina Resources Protection Property for Conservation Preservation and Heritage Priority Conservation Tax Credit Incentives Act of 1999 Purposes Conservation Easements Conservation or Scenic Program 2000 2006 2001 Streams Land Donations 1999 Del. Code Ann. tit. 30, Ga. Code Ann. § 48-7-29.12 Md. Code Ann §10-723 2003 N.C. Gen. Stat. §105-151.12 §§1801-1807; tit. 7, §§6901- Miss. Code Ann. §27-7-22.21 and §105-130.34 6902. * Fee Title & Conservation * Fee Title & Conservation * Conservation Easement * Fee title & Conservation * Fee Title & Conservation Easement Easement only Easement Easement * IRC § 170h * IRC § 170h * Conservation of * IRC § 170h i agriculture lands, * Wildlife habitat should * Conservation of water * Conservation of ii forest lands, * Land must be listed by exceed 25 Acres. resources is recognized i water quality, iii watersheds, and the MS's Scenic Streams Forest land should be per se. ii wetlands, iv view sheds is Stewardship Program, managed under a Forest iii prime agricultural lands, recognized per se. or Land be priority site Stewardship Plan using vi forestry lands, v from under MS's Natural best practices, with floods, and vi from erosion Heritage Program. restrictions on prescribed is recognized per se. burning, timber harvesting, Agricultural land must be and herbicide application. cultivated under a USDA Conservation develop- developed conservation plan. ments are recognized. * 40% FMV *25% FMV * 100% FMV * 50% Transaction costs * 25% FMV * $50,000 max credit. * $250,000 Ind. max credit/ * $80,000 max credit. * $10,000 max credit. * $250,000 Ind. max credit/ * Statewide cap of $350,000 Corp. max credit. * $5,000 cap on credit * individual/entity limited $350,000 Corp. max credit. $1,000,000/year. applied to taxes/yr. to one credit/lifetime. * 2010 sunset date. Individual/Corporate/ Individual/Corporate Individual Individual/Corporate/ Individual/Corporate Pass-Through Entities Pass-Through Entities * IRC § 170h * IRC § 170h * Only Maryland * IRC § 170h * Governmental and * Governmental entities Environmental Trust and Nonprofit entities are limited to State or its Maryland Agricultural eligible. subdivisions; Nonprofits Land Preservation must adopt LTA Standards Foundation are eligible. and receive IRS Determination Letter. 5 yrs. 5 yrs. 15 yrs. 10 yrs. 5 yrs. No No No No No No No No No No Yes ­ by the DE Division Yes ­ by GA Department Yes ­ by the MD Board Yes ­ by the MS Scenic Yes ­ by NC Department of Revenue of the of Natural Resources. of Public Works. Scope Streams Stewardship of Environment and Department of Finance. Scope of review: of review: cost-benefit Program or MS Natural Natural Resources. Scope of review: conservation values, analysis. Heritage Program. Scope Scope of review: appraisal issues. legality of CE, and of review: conservation conservation values. donee's eligibility.... values and 170h. * North Carolina's first credit program was enacted in 1983. However, the legislation in its current form was enacted in 1999. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 34 part three A. summary continued NEW MEXICO* NEW YORK S. CAROLINA VIRGINIA LEGISLATION Land Conservation Conservative Easement South Carolina Virginia Land Conservation Incentive Act Tax Credit Conservation Incentives Act Incentives Act of 1999 Date of Enactment 2004 2006 2001 2000 Statutory Citation NM Stat. §§75-9-1-5, §7-2- NY Tax §606kk S.C. Code Ann. §12-6-3515 Va. Code Ann. §§ 58.1-510-513 18.10; N.M. Code R. §3.13.20 LANDS ELIGIBLE TO * Fee Title & Conservation * Conservation Easement * Fee Title & Conservation * Fee title & Conservation EARN CREDITS Easement only Easement Easement * Fee title, Conservation * IRC § 170h * IRC § 170h * IRC § 170h * IRC § 170h easement, or both * Conservation of agriculture * Preservation of agricul- * Conservation of water * IRC § 170h = explicit lands, forest lands, and ture lands and watersheds resources is recognized requirement to meet watersheds is recognized is recognized per se. per se. federal eligibility per se. requirements related to conservation values * State additions to/ restrictions on federal standard CREDIT VALUE AND * 50% FMV * 25% Property Tax * Lesser of $250/Acre * 40% FMV LIMITATIONS * $100,000 max credit. * Unlimited credit or 25% of Federal Conservation Easement * Unlimited credit * Value as a % of FMV * $100,000 cap on credit * $5,000 cap on credit deduction * $100,000 cap on credit of donated land unless applied to taxes/yr. applied to taxes/yr. otherwise noted. * Unlimited credit applied to taxes/yr. (Note unlimited amount * Individual/entity limited * Maximum credit, if any * $52,500 cap on credit may be transferred and to one credit/yr. applied to taxes/yr. used by 3rd parties.) * Cap on credits applied to taxes/yr., if any * Statewide Cap of $100,000,000/year * Limitation on # credits that may be claimed by one individual/entity, if any * Statewide cap, if any * Sunset date, if any ENTITIES ELIGIBLE Individual/Corporate/ Individual/Corporate/ Individual/Corporate/ Individual/Corporate/ TO EARN CREDITS Pass-Through Entities Pass-Through Entities Pass-Through Entities Pass-Through Entities ENTITIES ELIGIBLE TO * IRC § 170h * IRC § 170h * IRC § 170h * IRC § 170h HOLD A DONATION * Governmental entities * IRC § 170h = explicit limited to State or its requirement to meet federal subdivisions; Nonprofits eligibility requirements must have office in State for 5 yrs. * State eligibility requirements CARRY FORWARD? 20 yrs. ** Unlimited 10 yrs. TRANSFERABLE? No No Yes Yes REFUNDABLE? No Yes No No CERTIFICATION? Yes ­ by NM Energy, No No, unless credits are Yes ­ but only on transactions Minerals, and Natural being transferred. If where credit value is greater Resources Department. transfer, certified by SC than $1 million. Scope of Scope of review: Department of Revenue. review: conservation values conservation values. and appraisal issues. * In March 2007, New Mexico passed legislation raising the cap on its credits to $250,000 and making them transferable, both effective January 2008. ** Annual credit of 25% of the property tax, up to $5,000, runs with the land and continues in perpetuity. CONSERVATION RESOURCE CENTER 2007 conclusion and appendices 35 B. SAMPLE TRANSACTIONAL SCREEN A transactional screen might look like the following:i APPENDIX B: 1. Before state credits can be used either by the original donor or by a transferee, Sample the credits must be screened and registered with the state. 2. To pass the screening process, an easement donor must submit certain easement Transactional documents to a review board. These documents would include, at a minimum, the easement and the appraisal. The system should be set up to allow review of Screen both the completed transactions and the draft documents (before the easement is executed and recorded) so donors can make modifications to any deficiencies that may be found. 3. An application for screening would be accompanied by a nonrefundable pro- cessing fee, which would be used by the state to fund the cost of the prescreening system.ii 4. The review board would be required to rule on screening requests within 60 days of submittal. In cases of resubmittals (in which deficiencies pointed out by the review board have been corrected), the board would be required to issue a ruling within 30 days. 5. The scope of review of the review board would be limited to three areas, and in all three cases the standards would be intentionally low: a. Appraised value: Does the appraisal appear to meet minimum standards for a qualified appraisal; does the valuation appear to be manifestly abusive? b. Conservation values: Does the property arguably have values worthy of conservation, and do the restrictions set forth in the easement arguably protect those values? c. Documentation: Does the easement document (and any other documents that may be reviewed as part of the process) arguably comply with minimum standards for a qualified easement? 6. The board would be composed of three members (who may be floating, and may change for the review of any easement or group of easements): a. A tax and valuation expert (presumably an appraiser from a state depart- ment that deals with property tax valuations) who would be familiar with appraisals of conservation easements see a. above. b. A conservation expert (presumably from the State Department of Natural Resources or Agriculture and/or some other appropriate state agency) who would be familiar with the conservation elements involved see b. above. c. A land conservation attorney from the state or private practice, familiar with the legal requirements of conservation easements. Challenges to decisions of the review board would generally be in the form of resubmissions to the board for reconsideration. True appeals would take place under the state's applicable administrative procedures act. It is anticipated that there would be few if any such appeals, since even if a transaction were approved through a screen, it would always be subject to future full audit by the state or IRS under a much more rigorous standard of review. i Please note that this is merely one example of how a screening process may be structured. The particulars of any screening process could easily be crafted to meet a state's individual needs. ii At $500 per transaction, programs like Colorado's would raise in excess of $100,000 per year, which should cover the costs of a modest-sized review board. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 36 part three C. 1 State tax incentives for land conservation include income tax credits and deductions, property tax credits, and low property assessment categories. Each has varying levels of effectiveness, but by far the most successful has been the APPENDIX C: state income tax credit. For this reason, the focus of this report is on state income tax credits rather than other state tax incentives. FOOTNOTES 2 The federal government has long allowed federal income tax deductions for conservation easements. A body of conservation easement law has been developed around 170h, and consistency seems appropriate as landowners claiming state tax credits are often also claiming federal tax deductibility. 3 The unofficial English translation citation for Puerto Rico's program is Act No. 138, June 4, 2004. However, an evaluation of this program is not included in this study. 4 A thirteenth state, Arizona, had a state income tax credit of $33,000 a year for conservation easements donated in an agricultural preservation district. Although this program showed promise, there were no agricultural preservation districts in existence to accept donations. The income tax credit sunset in January 2006. 5 New York's credit is valued at 25 percent of the property taxes on the land. It is an annual credit of up to $5,000. Because this is an annual credit, it could eventually exceed $100,000, but as it is a remote possibility it is treated as having a cap of under $100,000. South Carolina's credits are valued at $250/acre or 25% of an individual's federal tax deduction, whichever is less, limiting the value of its credits. 6 Although experts in Maryland stated that Maryland's income tax credit has not had significant impact, they believed that its property tax credit has been a strong incentive. The property tax credit predated the income tax credit and credits 100 percent of property taxes over fifteen years, after which time the property under easement is taxed at the lowest property tax rate. 7 California's credit program, due to significant costs involved in meeting procedural requirements, has not been accessible to most landowners. Connecticut's credits are only available to corporations. As a result, credits in these states have generated important donations, but not a significant number of additional donations. 8 A "qualified donation" includes the preservation of land areas for outdoor recreation by, or the education of, the general public; the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem; and the preservation of open space (including farmland and forest land) where such preservation is for the scenic enjoyment of the general public or for other "significant" benefit. Note that conservation values for the purpose of federal tax deductibility and some state programs include the donation of land for historic uses as eligible for receiving a tax credit. Historic purposes are outside the scope of this report and are not discussed here. 9 Additional California requirements include that the protected land must: meet the goals of a conservation plan; protect species or habitat; conserve threatened CONSERVATION RESOURCE CENTER 2007 conclusion and appendices 37 farmland in unincorporated areas, areas zoned for agricultural use, including water rights; and/or must be used for access to parks and open space. 10 As mentioned, Mississippi and New York base their credits on transaction costs and property taxes, respectively. South Carolina bases its valuation on a percentage of federal tax deduction earned, or $250 per acre, whichever is less. 11 To discourage the fragmentation of conservation easements, valuation should be set at a flat percentage or a lower percentage rising to a higher percentage. For example, Colorado originally set its valuation at 100% of the value of the donation up to $100,000 and then 40 percent for the next $400,000, for a max- imum credit of $260,000. This had the unintended consequence of encouraging landowners to donate in $100,000 increments of value, thus requiring many smaller easements over a larger parcel of land. Legislation was passed in 2006 that corrected this by setting the valuation at a flat 50 percent up to a maximum credit of $375,000. 12 This is true even if it is a third party that has purchased the credit. If the third party does not use the entire credit, the landowner originally earning the credit may not generate a new credit until the third party uses the entire value or relin- quishes the remainder. 13 Only one state, New York, has full credit refundability. However, its credit is capped at $5,000 per year. 14 Note that while South Carolina's program permits credit transfers, it does not have an active transfer market. There is less need for one, as credits are capped at $52,500 and transferred credits must be certified by the state. 15 Further, due to legislation passed in 2005, there will not be another surplus year until after 2010. 16 Project phasing-dividing a parcel into several conservation easements to maximize the benefit a landowner receives from the Conservation Credit pro- gram-has been mentioned as an issue of concern. However, so long as each phase of a transaction can stand on its own and meet the conservation benefits test, phasing may be appropriate in many circumstances. 17 Colorado has language in its easement statute making it clear that the state is empowered to audit all matters related to the easement, including compliance with IRC §170h and related federal matters. However, as a practical matter, the state typically relies on the IRS for audit of all federal matters, including the appropri- ateness of the easement valuation. 18 In addition, Virginia's and South Carolina's programs require certification in limited circumstances, as discussed earlier. 19 Georgia also offers a nonbinding precertification review that may be conduct- ed before a donation is made. STATE CONSERVATION TAX CREDITS IMPACT & ANALYSIS 38 part three C. footnotes continued 20 This may be simplified once the Land Trust Alliance's Land Trust Accreditation Program is implemented. 21 Georgia's nonbinding pre-certification option is similar to the transactional screening process discussed here. 22 At least one state with certification has clarified that the credits are still subject to audit even after certification. For example, the North Carolina Conservation Tax Credit Issue Paper written by the Conservation Trust for North Carolina and the North Carolina Land Trust Council notes that both the IRS and the state revenue department have existing authority "to audit any tax returns, including those claiming the CTC (Conservation Tax Credit), and both have authority to pursue significant civil and crimi- nal penalties against appraisers that aid individuals in filing fraudulent tax returns." 23 The state of Virginia is now running into this problem. The Virginia Department of Taxation has undertaken the review of at least one very large transaction (with a donated amount well in excess of $10 million dollars). This state review was initiated several years after the easement donation was made and also after the resulting state credits had been sold to a large number of purchasers. Although the reviews are not complete and may not be for years, the result of any adjust- ments to the donation amount may require the further adjustment of a large num- ber of individual tax returns. CONSERVATION RESOURCE CENTER 2007 STATE CONSERVATION TAX CREDITS IMPACT AND ANALYSIS CONSERVATION RESOURCE CENTER TAX CREDIT EXCHANGE 820 Pearl Street * Suite F * Boulder, CO 80302 303.544.1044 phone * 303.544.1043 fax * www.taxcreditexchange.com