A conservation easement is a legal tool originally created for the purpose of protecting and preserving natural landscape and acreage from development. In theory, a landowner agrees to keep a large section of his land free from development and in a natural state in return for some kind of benefit, usually financial. Many government agencies have used this kind of tool or offered it with the benefit of a tax credit, allowing for private landowners to take advantage of the tool if eligible through a medium that is auditable.
For years, conservation easements have been used by golf course owners to enhance their financial position and reduce their tax liability, and in many opinions legally so. Many local governments have been quite cooperative with the process, but the big benefit is from the federal taxation level, administered and reviewed by the Internal Revenue Service (IRS). While the federal income tax benefits may not have as much application to a tax-exempt club, the rationale listed below is still important.
In fact, there are many other reasons for a tax-exempt club to provide an easement. Many clubs provide conservation easements at the request of a government agency or to reduce the value of the course to lower real property taxes. However, providing an easement must be done carefully and correctly. The following provides an important case study on the consequences of improperly handling a conservation easement.
The St. James Plantation Case
2015 was the year of reckoning for the concept of conservation easement as it applied to golf courses. In December, the United States Tax Court issued a ruling on the matter, denying an existing conservation easement and creating clarity on what clearly had been a long-running dispute of interpretation between the filing golf course owners and the IRS dating back to 2003.
The St. James Plantation entered the litigation process on the tax matter after the IRS ruled against its claim of charitable tax deductions using a conservation easement as the legal umbrella. The two courses involved were the Members Club and the Reserve Club. These courses were surrounded by gated access and a limited perimeter, staffed security, and included two 18-hole courses as well as one 9-hole course. The only people who had access to the grounds were club members and those scheduled to golf on the grounds during its operations.
The easement itself dated back to 2003 when the legal tool was first created for St. James Plantation with the North American Land Trust (NALT). The NALT is a nonprofit organization first established in 1992 with the goal of natural conservation. The NALT advertises its ability to set up conservation easements in a manner that meets both general conservation goals and enhances the landowners’ financial position as well. Working with the NALT, St. James Plantation established an easement around its 9-hole course and detailed the conservation as meeting two primary conservation goals per the Internal Revenue Code Section 170: The land provided a natural habitat for local animals at risk, endangered or protected, and that the project enhanced and benefitted nearby conservation areas, essentially adding to the regional conservation impact.
However, the easement created in 2003 also included language that the landowner could still use the property as a functioning golf course. These legal allowances and rights included the use of landscaping chemicals to enhance lawns and kill off insects, the removal of trees so that human facilities such as restrooms and storm shelters could be constructed for golfing members, and paved or asphalt paths for golf carts to travel the conserved territory grounds.
The most notable and physical change was, of course, the removal of the trees for the above-mentioned construction. Once removed, a major portion of the large tree and flora in the easement was eliminated. Add in all the other changes required for operating the golf course, and there was very little that resembled natural habitat left to natural growth and ecosystems. In short, it raised a significant question about anything being left to conserve as nature. In particular, the remaining pine trees dropped acidic, dead needles inhibiting any other growth.
Natural conservation easements do allow for water ponds and streams to be created, enhancing ecosystems’ growth. However, St. James Plantation had no interest in creating pond banks or natural water bases for wildlife in the region. Further, the typical landscaping chemicals used made it impossible with runoff for any fish or amphibian wildlife to get a start, poisoning any low points with tainted run-off. Ergo, there was nothing about the St. James Plantation easement that provided any kind of benefit or enhancement to the region and wildlife migrating from nearby easements, although this was claimed as a benefit in the golf course’s justification for a tax deduction.
Finally, one of the remaining arguments of a conservation easement under the tax code is that the area is to be kept natural for the “scenic enjoyment of the general public.” However, as mentioned earlier, the only people who had access on the affected land were the club members and the club staff. The general public clearly would not be able to pass a gated entrance, security guards and perimeter limitations without permission. No surprise, the tax court was unlikely to arrive at any conclusion agreeing that the public had open access to the easement territory when they saw fit.
Case Impact Summary
The impact of the tax court’s decision was a clear restriction on the immediate case, but it didn’t bar golf courses entirely from the benefits of Section 170. Rather, the court went through the factors required and eliminated St. James Plantation for not meeting the established threshold for a conservation easement to be in place for them. Thus, technically, the legal door and tax shelter is still open for golf courses, but the space to get through is a bit tighter, metaphorically speaking. It’s also very likely that this case, spanning 12 years of legal dispute, will be the foundation for more clarity via precedence citations and further application in future rulings. That will likely include increasingly tighter scrutiny on the idea that a for-profit golf course operation with artificially-planned landscaping and practices could still count as a natural conservation easement in general. However, until then, the door is still open for those far closer to the definition of the tax code criteria.
Avoiding the Worst Case Scenario
Obviously, golf courses will have to make a clear effort in showing that their “easement” has the qualities of a natural greenbelt or acreage. That includes creating obvious natural water habitats, not removing the natural tree line and forestry, allowing for natural paths versus any kind of paving or cement, and limiting obvious human-use facility construction, especially when it eliminates the natural element of an easement area.
The first step every course manager or owner/partnership should take before even considering a conservation easement attempt is to perform a frank assessment as to whether any part of a golf course comes close to being considered a natural habitat by any measure. While personal opinion and even experienced course perspective is often available, the assessment should be done by an uninterested third-party licensed to evaluate and confirm a habitat or eco-system is present or can be constructed. This assessment will pay dividends later on as a professional evaluation usable in an audit defense.
Next, a legal opinion from an experienced tax attorney on a proposed easement is a necessary basic step. Once the easement proposal is crafted and assessed as described above, it should be thoroughly evaluated by a tax attorney with experience litigating against the IRS, especially on the matter of easements in particular or property-related tax shelters. A general business attorney is not going to have the depth of tax code understanding necessary to truly vet the needs of a golf course in this kind of matter, especially in light of the above 2015 decision on St. James Plantation.
Finally, go to the source. One of the most avoided and least used resources for avoiding a tax mistake is the IRS itself. There is a prevailing myth that by simply making contact to ask a question, a business puts itself on some kind of automatic audit radar. In fact, the IRS can and does offer opinions on a regular basis as to what its interpretation of the tax code is likely to be for a given situation. Since the IRS is the government agency that applies the tax code interpretation, why shouldn’t their opinion count ahead of time when planning how to construct a legal tax shelter in the form of a conservation easement? Not taking advantage of this option is literally leaving one’s flank open to the wind. Unfortunately, again, this kind of idea often gets a bad reaction from those who prefer to “stay under cover.” In reality, taking the “under cover” approach is often more expensive.
Go a Step Further
With the above three steps in green light mode and completed, a golf course land owner should look to see if the government can be involved to assist with the creation of an easement. While it is quite possible to do so with a nonprofit organization, a number of states have conservation easement programs through their forestry and natural resource agencies. These programs specifically look for land by which easements can be created to preserve natural habitat. More importantly, the easement created under such programs is done so under the onus of a state official’s approval, a far greater weight in an audit than the opinion of a nonprofit organization.
Once the course’s easement agreement is drawn up but not executed—and definitely before it is filed with an annual tax return—it should be thoroughly audit-tested. This means it should be reviewed by an expert who understands how the IRS thinks and how they audit. The expert can ask difficult questions, highlight the risks and challenge the responses given in test form before they arise in a real audit. Remember, under federal law, information that seems to be misleading or an intentional omission of required information can be grounds for assessing civil or criminal penalties. This is not the arena to get fussy, sloppy or cynical with knee-jerk responses.
Yes, these steps may seem like a lot of work and involve the hiring of industry experts to get to the level of a valid conservation easement. However, they are extremely necessary now, especially in light of the tax court’s recent decision reinforcing a much higher threshold of proof from golf course landowners as to having a bona fide natural habitat for valid conservation.
And considering that St. James Plantation has been under an ambiguous cloud of its tax status regarding its own easement for 12 years, having some certainty going forward is a far better defendable position to be in than not making an attempt to create an easement that complies with the intent of the current code. Unfortunately, until the tax courts make more clarifying decisions in the current direction, the full legality of golf courses and conservation easements will still be a bit of a legal guessing game. Section 170, until rewritten, leaves the opportunity open, but the particulars are still being refined. Thus, a golf course landowner needs to show every effort in complying with what seems to be the intent of the code, the protection and enhancement of natural habitat. This is a far higher wall for the IRS to climb; especially if its own staff originally agreed the given easement was theoretically valid, as suggested earlier.
As mentioned, there are many reasons for a tax-exempt club to provide an easement. With restrictions on what can be built on the property, the local government can no longer assess at the “highest and best” use of the property. After the easement is placed, the highest and best use generally is as open space. There is a direct reduction in the value of the real estate with these restrictions and in many cases a reduction in real estate tax. Additionally, many states provide tax credits for conservation easements, which may be used to offset a state tax liability. While these credits may not be usable by a tax-exempt club, several states provide a mechanism where the holder of the credits may sell them to third parties thus generating revenue for the club. As previously stated, before taking this step, consult with professionals who specialize in this field.
Kevin Reilly, JD, CPA, CGMA, is a partner at PBMares, LLP. He is Treasurer of the National Club Association and serves on the board of NCA Foundation. He can be reached at [email protected].