An easement is a right wherein a property owner grants the use of all or part of his property without ceding ownership. Utility easements and conservation easements are the two most common. The IRS allows tax breaks for both, so it's vital to know the difference and be certain to use the correct forms when you file your tax return. Abuse of conservation easements has led the IRS to toughen reporting requirements, so you may find you need more paperwork than in the past to back up your deduction.
Utility easements are the more straightforward and traditional easements a residential property owner may come across. Your utility companies may need to use a portion of your property for telephone poles and wires, storm drains, electrical power lines or gas pipes below the surface. The utility companies compensate the property owner for permanent access, including possible damage to property in the contract when the easement is granted. Any payment received from a utility for permanent access easement is considered a sale of property, not treated as income or taxed in the year received. Instead, the basis of the property is decreased by the amount of the easement. This will affect the amount of annual depreciation and the capital gain subject to tax when you sell the property. In some cases, the city or utility may require temporary access to your property for maintenance, surveys or other reasons. If receive a payment for such access it is considered income, and should be reported on Form 1040, line 21 as other income.
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Conservation easements fall into several categories: preserving land for parks, recreation, natural habitat for wildlife; open space (including farm and ranch land); and preservation of historical structures. For tax purposes, conservation easements are treated as donations to the organization that oversees the conservation of the property. Generally, the IRS does not allow partial use contributions of property, but it has made an exception for qualified conservation contributions which are designed to benefit the public.To qualify as a conservation easement eligible to be used as a charitable donation for tax purposes, the IRS has strict requirements: the organization must be a government entity or a publicly supported charitable, educational, literary, religious or scientific organization; or it must be an organization controlled by and operated for the benefit of a governmental unit or publicly supported charity.
Historical easements are a popular category of conservation easements. If your property is located in a registered historic district, you may grant an easement of the exterior of the building, often called a facade easement, to a governmental unit or a publicly funded organization dedicated to the preservation of the historical architecture in your area. Qualified easements must meet all of these requirements: The restriction must preserve the exterior of the building and prohibit any change that interferes with its historic characteristics; you and the organization must prove in writing that the organization's purpose is conservation and has the resources to enforce building restrictions; and you must include a written appraisal, photographs of the building's exterior and a list of restrictions on zoning, construction, etc., which the charitable organization intends to enforce.
Taking the Conservation Easement Deduction
Due to abuse of facade and other historical conservation easement deductions, the IRS requires more supporting documents than for other types of charitable deductions. You'll want to make certain to include the necessary paperwork (appraisal and statements from the conservation organization) when you file your tax return to avoid a delay or further inquiry into your deduction. As with all charitable contributions, historical, facade and other conservation easements are reported on Form 1040 Schedule A Itemized Deductions. You are limited to a total of 50 percent of your adjusted gross income (AGI) minus any other contributions you make to other charities. You may carry over any unused portion of your contribution to the following year.
Penalties on Overstatement of Value
Penalties for the abuse of conservation easement deductions are assessed based on the amount of overstated value and on the amount of underpaid tax, and may be as high as 40 percent of the amount by which you underpaid your tax. Consider carefully any organization that promises a large tax break and choose a reputable appraiser to determine an accurate value of the property which you are granting to the organization. Be certain to include all supporting documents as required by the IRS when filing your taxes. Consult IRS Publication 526 Charitable Contributions for further specifics and useful worksheets for calculating your deduction.