Cellular communications companies may purchase perpetual land easements for placement of cellular repeater radio towers. Since a perpetual easement provides the companies with permanent property rights, the Internal Revenue Service treats sales of perpetual easements as sales of real property. For the landowner, this treatment has significant tax benefits.
Easements as Sale
When you sell an easement that limits the purchaser's property rights to a fixed period of time, the IRS treats the transaction as a lease agreement. The lease payments you receive are subject to the higher ordinary income tax rates. However, when you sell a perpetual easement, the permanency of the purchaser's rights in the land warrants tax treatment as a property sale rather than a lease. Since property sales are subject to the capital gains rules, selling a perpetual easement can save you a significant amount of income tax as a result of the lower tax rates on long-term capital gains.
Allocating Property Basis
As is the case with the sale of any capital asset, you must first determine what your tax basis is in the land upon which that the easement was sold. However, you cannot use the tax basis for your entire property; instead, you must allocate only that portion of the tract of land that is subject to the perpetual easement. Suppose, for example, you acquire 10 acres of land for a basis cost of $1 million. If only one of those acres is subject to the easement, you allocate 10 percent ($100,000) of your total tax basis to the one acre since it represents 10 percent of the 10 acres.
Calculating Taxable Gain
Once you allocate your tax basis, calculate your capital gain as the price you obtain for the perpetual easement minus the tax basis. For example, if the cellular company offers you $5 million in exchange for the perpetual easement, you will report a capital gain of $4.9 million. Provided you have owned the property for more than one year at the time of selling the easement, you can report the $4.9 million as a long-term capital gain on Schedule D and take advantage of lower tax rates. However, if you owned the land for one year or less, you must report the transaction as a short-term capital gain, which is subject to ordinary income tax rates.
1031 Exchange Deferral
Selling a perpetual easement presents you with an opportunity to defer the resulting taxable gain by entering into a like-kind exchange transaction. The fundamental requirement of the like-kind exchange rules is that you reinvest the easement's sale proceeds in a similar piece of property. However, you must identify the like-kind property within 45 days of selling the perpetual easement. Moreover, the purchase of your like-kind property must be complete within 180 days of selling the easement or the filing deadline of your next tax return, whichever is earlier. If you choose to purchase like-kind property, your basis in the new property is identical to the basis you have in easement. Therefore, you don't recognize a taxable gain until you sell the like-kind property.