A simple example illustrates how a conservation easement works in practice. Many people have asked us for a conservation easment example, so we've created the follow scenario: Let’s assume a rancher in Montana owns a tract of land that serves as a wildlife corridor for elk and other animals moving from summer to winter feeding grounds. Pressure from buyers building vacation homes has pushed the value of the tract up in recent years to the point where the family is concerned about how the next generation will pay the estate tax bill without selling the land. Fundamentally, the family loves the land the way they have always known it, whole and undeveloped.

To solve this problem, the landowner agrees to donate a conservation easement to a local land trust. Under the terms of the easement, the land will never be subdivided and future building on the property will be limited to a modest second home on a two acre-parcel at one end of the property. The landowner obtains an appraisal showing that the property is worth $7 million but that the value drops to $2 million with the development restrictions. Remember, a conservation easement “runs with the land,” binding all future owners and affecting the amount future buyers will be willing to pay.

In this example, the landowner is entitled to claim a $5 million dollar charitable contribution deduction on his income tax return. Like all charitable contributions, the charitable deduction for conservation easements is limited to a set percentage of the donor’s income. However, in 2006, Congress enacted special, more generous deduction limits for conservation easements to increase the tax incentives for these highly favored gifts. Under the new rules some landowners may be able to take deductions equal to 100% of their income and use excess deductions for up to fifteen more years. These more favorable rules are in effect only until the end of 2007.

The estate tax benefits for donating a conservation easement are similarly generous. First of all, to the extent that the conservation easement reduces the value of the property, it also reduces the amount subject to the estate tax. So in our example, the rancher’s estate includes land worth $2 million, not $7 million. But the benefits go further.

If a landowner dies owning land subject to a permanent conservation easement that protects certain favored conservation purposes, his executor can elect to have a portion of the value of his land, up to 40% of the land value or $500,000, whichever is less, excluded from his taxable estate, even though he has already claimed a charitable contribution deduction for the value of the conservation easement. On our example, this exclusion would further reduce the value of the land subject to tax by $500,000 to $1.5 million.

Many, but not all, of the conservation easements that are eligible for the charitable income tax deduction will also be eligible for these special estate tax benefits, because there are additional requirements for the estate tax benefits. Most important, certain conservation purposes that are eligible for an income tax deduction do not qualify for the 40% exclusion estate tax exclusion. In addition, the conservation easement must not permit more than a de minimus amount of a commercial recreational activity. For example, a landowner could not operate a “dude ranch” or a ski resort and claim the 40% exclusion, but he could grant a limited number of fishing or hunting licenses. Further, the property in question must have been owned by the decedent or a member of the decedent’s family for at least three years before the decedent died.

If the conservation easement permits development for commercial purposes that do not directly support the use of the land as a farm, then the value attributable to the development rights is disregarded for purposes of calculating the 40% exclusion. For example, if our rancher reserved the right to build house lots on a portion of the property for sale to the public, his taxable estate would include the value of those lots, though the rest of the property subject to the easement would be eligible for the 40% exclusion. In addition, if the landowner’s heirs extinguish the development rights, the estate would be eligible for the exclusion as if the development rights had never been retained at all.

In one of the very few examples of “postmortem tax planning” allowed under the federal tax law, a landowner’s estate can still benefit from the 40% deduction even if the landowner never contributed a conservation easement during his life. That is, the landowner’s heirs and certain other individuals may donate a conservation easement on the landowner’s behalf after he has died and still claim estate tax benefits. For example, if a landowner dies without donating a conservation easement, and he leaves the land to his only daughter, she can donate a conservation easement on the land. If she does, the estate will be eligible for a charitable estate tax deduction equal to the value of the easement as well as for the 40% exclusion, as if her father had donated the easement in his will.

Finally, the benefits of the 40% exclusion are not limited to the landowner’s estate. The estates of his heirs can benefit as well. Once a property is subject to a conservation easement that qualifies for the 40% exclusion, it is eligible for that exclusion every time it passes through an estate of an individual descended from the original owner who placed the easement on the property. So, for example, if our rancher places an easement on his property so that his estate can claim the 40% exclusion, the estate of his son could also take the same exclusion when he passes the property to his son, and so on through the generations.

As this summary should make clear, the tax code includes very valuable benefits for landowners who agree to preserve their land using a qualified conservation easement. These rules reflect the considered judgment of law makers that conservation easements deserve a tax subsidy because they further important public purposes while keeping land in private hands. Although there has been some controversy recently about conservation easements, the recent changes allowing an enhanced deduction for conservation easements given in 2007, clearly demonstrates that law makers continue to see these transactions as deserving of public support.