Farmers and ranchers learn early in their careers that Congress has carved out special tax provisions for their industry. But, a farmer can be defined differently for different provisions. In general, the most common definition focuses on income from growing/raising activities associated with plants and animals. A Maryland farm family learned a harsh lesson on this issue in tax court.
THE CONSERVATION EASEMENT PRIVILEGE
A conservation easement (CE) involves placing a permanent restriction on real estate by its owner, usually preventing any development of the property. With farmland, that requires permanently restricting future use via a recorded easement to only farming. If the highest and best use of the land is commercial or residential development, the value may be significantly diminished by the CE, producing a large charitable deduction.
Assume agricultural land is located near a shoreline where it has a market value of $14,000 per acre. But as farmland, the going price for land without development potential in that locale is only $6,000 per acre. If a CE is placed on that land and conveyed to a conservation charity, there is an $8,000-per-acre charitable deduction. If the charity partially paid for the easement, say by paying $4,200 per acre to the farmer, the charitable deduction is reduced to $3,800 per acre.
THE ENHANCED CHARITABLE LIMIT
To encourage large CE deductions, the tax code has enhanced carryover provisions. Normally, charitable contributions are limited to 50% of current income; excess deductions carry forward for up to five years, subject to the same 50% of income limit, but then expire if unused. For CE donations, taxpayers have up to 15 years of future tax returns to use the deduction against the top 50% of their income. And, if the taxpayer is a farmer with more than half of gross income for the year from growing and raising activities, 100% of each year's income can be offset with the CE deduction.
THE RUTKOSKE CASE
The tax court recently issued an adverse opinion to a Maryland farm family that conveyed a CE in a manner similar to the example above. While these taxpayers were clearly active farmers in terms of profession, they failed the "over half of gross income from farming" test in order to qualify for the 100% of income offset. The capital gain from the bargain sale of the land to the charity did not count as farming income under the tax code's raising/growing definition. Their CE deduction was limited to only 50% of income. Thus, the large CE deduction could not be used to fully offset the land capital gain.
If you are undertaking any transaction with significant tax consequences, it's wise to obsess about the detailed requirements. Just because you are a farmer in real life, you may not be a farmer in a given year under tax code definitions. And finally, if conveying a CE, consider whether being a non-farmer isn't better: The 50%-of-income limit assures that the charitable deduction is used only against upper-bracket income each year.
Tax Columnist Andy Biebl is a CPA and tax partner with the accounting firm of CliftonLarsonAllen, in New Ulm and Minneapolis, Minn. Andy can be reached at firstname.lastname@example.org
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