Tax Law Insights

A landowner who donates a conservation easement to a qualifying organization can benefit from state tax incentives, in addition to the available federal income tax deduction. South Carolina provides an important transferable income tax credit for landowners who donate a conservation easement on property located in South Carolina. The income tax credit is equal to twenty-five percent of the amount of a charitable deduction resulting from the donation of a conservation easement.

The twenty-five percent credit is subject to several caps. First, the credit may not exceed $250 per acre. Second, the total credit a taxpayer may use in any particular tax year is limited to $52,500. Any income tax credit that cannot be used in the year of donation may be carried forward to succeeding tax years.

In addition to the carry-forward option, a taxpayer is permitted to transfer any unused credits. The ability to transfer unused credits creates opportunities for both the landowner and other taxpayers. A landowner can sell unused credits for cash. Other taxpayers can purchase the tax credits at a discount, thereby lowering their effective state income tax liability.

Several exchanges and private firms in South Carolina facilitate the transfer of South Carolina conservation easement credits. Credits are ordinarily sold at a discount negotiated by the seller and buyer. Discounts of 20% - 30% of the face amount of credits are common.

Tax issues lurk for both buyers and sellers of conversation easements. Both may realize taxable income related to an exchange and buyers may in fact not receive the expected benefit

A landowner does not incur any tax consequences when claiming South Carolina conservation easement tax credits; the credits are simply claimed on the return and reduce the landowners South Carolina income tax liability. However, the United States Tax Court has recently determined that (1) a taxpayer who sells state income tax credits recognizes capital gain income on the sale of the credits; (2) the holding period for determining whether the sale of the state income tax credits gives rise to short-term capital gain (subject to tax at ordinary income tax rates) or long-term capital gain (subject to tax at favorable income tax rates) does not begin until the tax credits are granted; and (3) that a taxpayer does not have any basis or cost in the tax credits. Thus, a landowner who sells conservation easement credits will have to report taxable income in an amount equal to the selling price of the credits.

A conservation easement tax credit purchaser may incur tax consequences when tax credits are utilized. The Internal Revenue Service has indicated in an internal memorandum that the purchase of state tax credits should be treated as the purchase of property and that gain or loss is realized when the tax credits are utilized. Thus, a purchaser may have to report taxable income in an amount equal to the difference between the face value of credits and the purchase price of the credits.

A conservation easement tax credit purchaser should also understand that any purchased credits are valid only to the extent the seller was entitled to the credit. If the Internal Revenue Service or South Carolina Department of Revenue audits a conservation easement donation and determines that the claimed deduction should not be allowed, then the South Carolina income tax credit may be reduced. This may result in the purchased credits being disallowed.

Taxpayer Impact

Landowners who donate conservation easements and other taxpayers can both benefit from South Carolina conservation easement income tax credits. Landowners may be able to realize value from credits that they are otherwise unable to use and buyers may be able to lawfully reduce their South Carolina income tax liability. Both parties should fully understand the tax impact of buying and selling credits in order to avoid being surprised by the tax consequences that flow from a transaction. Buyers should conduct adequate due diligence on the conservation easement which generates a credit to minimize the likelihood that the credits will be disallowed in the event the conservation easement is audited. While purchase contracts may include an indemnification provision that requires the seller to compensate the buyer in the event the credits are disallowed, such a provision only gives a buyer a claim against the seller. Whether the seller will be solvent when a claim is made or otherwise able to pay is unknown. The South Carolina Department of Revenue will seek payment of the disallowed credit from the buyer immediately.