Click here to download a PDF of Valuation Viewpoint Fall 2009
By Scot A. Torkelson
A conservation easement creates a land preservation agreement that is legally enforceable, extends in perpetuity, and is intended for public benefit. Specifically, a conservation easement is defined as "a restriction that limits the future uses of a property to preservation, conservation, or wildlife habitat." A conservation easement is a legally binding contract between a landowner and the conservation easement Trustee. Most conservation easements are granted to governmental bodies, land trusts, or other charitable entities that engage in conservation or preservation activities.
In order to understand the process of valuing a conservation easement, one must have an understanding of fee simple interests. "A fee simple estate implies absolute ownership unencumbered by any other interest or estate, subject only to the limitations imposed by the governmental powers of taxation, eminent domain, police power, and escheat." A conservation easement must be of a property owned in fee simple by the owner, with the exception that the fee simple ownership does not necessarily need to retain mineral rights. This adjustment is made to accommodate many fee simple-owned properties in the United States where the Federal Government retains mineral rights in all instances. "An easement represents the conveyance of use in real property, but not the ownership."
The right to convey a conservation easement can take many forms. A simple conservation easement may restrict land to an open space use only - no development is permitted. Alternatively, it may restrict the level of development to designated uses. In all instances, the primary purpose of a conservation easement is to preserve and protect natural resources by restricting the right to build on the property and/or the right to alter the land. Thus, wildlife habitats, clean air and water, open spaces, scenic views, and riparian habitats are retained for public benefit. An easement may be crafted in such a way that it provides for a specific use in perpetuity. For example, land may be designated as agricultural, timber, trail, park, or golf course use only. The easement may also provide for limited human alteration if it facilitates a particular use such as fencing, wind breaks, or other necessary improvements to sustain an agricultural conservation easement. Finally, in some instances, the easement may include and protect existing improvements. Archaeological structures, historic monuments, or other human improvements of public significance sited on the land in their original form are included in this category.
The decision to make a conservation easement donation is entirely voluntary. The landowner who gives up development rights, in the form of a conservation easement, continues to own the land. In accordance with Treasury Regulations, such an easement is perpetual and binding not only for the present owner, but also for future owners of the site. The restrictions are permanently associated with the title and are clearly outlined in a legal document and recorded in land records.
APPRAISAL METHODOLOGY FOR CONSERVATION EASEMENTS
Once the decision has been made to set up a conservation easement, the first step is to identify the larger parcel that is owned fee simple by the individual wishing to make the donation. A conservation easement may not extend over the entire parcel that is owned by the donor. Thus, there remains contiguous land relative to the conservation easement parcel that must be valued as part of the conservation easement analysis. In order to value the easement, one must determine the value of the larger contiguous parcel. The appraiser conducts both a before-the-easement appraisal and an after-the-easement-appraisal. Treasury Regulations guiding the valuation of conservation easements require the valuation of the larger contiguous parcel in addition to the portion being encumbered with the Conservation Easement.
Because it is the fee simple interest that is subject to valuation, any enhancement that may accrue to the remaining contiguous land site owned by the donor and not associated with the conservation easement must be considered in the before and after valuations. As a result of its proximity to an undevelopable parcel of land, the remaining land may become more desirable to developers. Even in cases where the conservation easement will encumber the entire contiguous parcel, it is recommended that a before and after valuation be conducted. Land parcels subject to conservation easements retain some market value because the fee simple value of the land (that is subject to the conservation easement) is yet retained by the owner. This value is distinct from and should not be comingled with the conservation easement value.
BEFORE & AFTER VALUATIONS (Federal rule)
In simplified terms, the before and after method used when valuing conservation easements is as follows:
Estimated Market Value of Larger Contiguous Parcel (full development rights)
- Market Value of Larger Parcel after Consideration of the Easement Restriction
= Market Value of the Conservation Easement
Initially, the appraiser considers the market value of the subject land parcel before the conservation easement, including the portion being restricted and any contiguous land under fee simple ownership with the donor. Next, it is necessary to obtain a full valuation of the land parcel reflecting the development restrictions created by the conservation easement. The difference in value between the before and after scenarios represents the market value of the conservation easement.
Treasury Regulations pertaining to conservation easements also stipulate that the appraisal must include two distinct highest and best use (HBU) discussions. The first is based on the HBU before the conservation easement donation. The second reflects the HBU of the parcel giving full consideration to the impact of all restrictions/enhancements associated with the conservation easement.
As an example, let’s consider the valuation of a forested and ecologically significant land site with a total area of 5,000 acres. It is suitable for immediate sub-development with residential housing, but a conservation easement is made over 3,000 acres of the larger contiguous parcel. The area subject to the conservation easement now prohibits the anticipated residential development. However, the remaining 2,000 acres of the land parcel owned in fee simple is still available for development. In the before situation, the HBU of the 5,000-acre parcel is for residential development. In the after condition, only the 2,000-acre larger parcel retains the HBU of residential development. In the after scenario, the value of the 3,000-acre donation represents the loss in value attributable to the conservation easement (highest and best use before condition vs. highest and best use after condition).
Treasury Regulations require two distinct before and after condition analyses, under two HBU scenarios, because the impact of the conservation easement relates to the larger contiguous parcel. The before and after methodology is the only methodology that takes into account all the impacts of the donation, including the lost value of the conservation easement and special benefits/enhancements to the remaining contiguous parcel. It’s possible that the remaining 2,000 acres could be developed with higher density housing, and/or the resulting housing units may take on higher values due to their proximity to a significant amenity - a conservation easement that precludes additional development in the area. The market may or may not recognize an increased value due to the adjoining conservation easement amenity, and/or higher allowed densities. However, if there is an enhancement or loss to the remaining contiguous parcel, it must be taken into consideration. Likewise, the appraiser must factor in the loss of value due to restricted development rights on the 3,000 acres associated with the conservation easement itself.
CONCLUSION
Valuing conservation easements is a complex process. Depending on the terms of the conservation easement, the fee simple parcel in the before scenario may be different from the fee simple parcel in the after scenario. Easement valuations have been challenged by the Internal Revenue Service. The two most common reasons for rejection are that the appraiser uses an incorrect methodology or neglects to value the entire fee simple parcel of the donor. The appraiser must select the appropriate methodology and apply it correctly.
