To private landowners, participation in the Forest Service\u2019s Forest Legacy Program can be an opportunity to do good by conserving forest lands in perpetuity \u2013 and to do well through a variety of lucrative benefits.<\/p>\n
\tIn the case of the Kealakekua Ranch easement, assuming that the roughly $30 million appraised value of the easement is confirmed by an independent appraisal done by the state, the total benefits could approach $31 million. They include:<\/p>\n
Finally, although it is not directly linked to the Forest Legacy program, the owners will benefit from long-term cost sharing in managing the forested areas through the state Department of Land and Natural Resources\u2019 Forest Stewardship Partnership program; for the first 10 years of the 30-year plan, this will amount to $750,000.<\/p>\n
\tOther benefits are more difficult to quantify but just as real. Logging is not only allowed under the Forest Legacy easement proposed for the ranch, it is anticipated. The management plan submitted for matching funds to the Forest Stewardship Partnership program calls for timber production and livestock management, among other things. Both activities may be expected to bring additional income to the ranch owners. A \u201cconservation land use plan\u201d for the ranch submitted to the Hawai`i County Planning Department shows a \u201cmauka lodge\u201d near the upper ranch border and an area designated for \u201cupland hunting.\u201d An equestrian trail is planned to run from the makai border up to the 6,000-foot elevation.<\/p>\n
\tIntangible benefits accrue, as well. According to one source, the ranch was initially purchased to protect neighboring land held by the Paces from encroaching development that would occur under the full build-out scenario anticipated in zoning approvals given more than a decade ago. As it stands, the Paces will be able to ensure that their house is well screened from the riff-raff that may build on the 98 lots they can still subdivide on the ranch property. (Those lots, ranging in size from 5 to 40 acres, are anticipated in the appraisal to sell for $420,000 and up.)<\/p>\n
\tFor the last four years, the Internal Revenue Service has been giving extra scrutiny to conservation easements, which have often been subject to abuse. Inflated appraisals, exclusive benefits to donors, easements of questionable value \u2013 all have been cited by IRS officials in explaining their efforts to crack down on such abuses.<\/p>\n
\tIn a talk to administrators of land trusts last year, Steven Miller, IRS commissioner for tax exempt and government entities, told the administrators of nonprofit organizations and government agencies receiving such easements that they, too, had a role to play in eliminating abusive practices. For tax purposes, the receiving organizations (including, in the case of the Kealakekua easement, the state of Hawai`i) have to give the donor a form acknowledging the gift, and while the donor assumes responsibility for assigning value, Miller urged them not to sign off on what are obviously inflated assessments of an easement\u2019s worth. \u201cI hear all the time that I should not hold charities and the recipients of easements accountable for the misconduct of their donors, but I must,\u201d Miller said. \u201cCharities and recipients cannot sit idly by while donors poison the charitable environment. A donor\u2019s aggressive acts bring discredit to all involved\u2026 If you perceive that there is something out of whack with a transaction, if it does not pass the smell test, if it is not fairly valued, walk away.\u201d<\/p>\n
\tGreg Hendrickson, the attorney who is the architect behind the Kealakekua easement, is one of the top practitioners in his field and is no doubt more than able to defend its particulars to any IRS auditor. He has been working nearly full-time for the ranch owners since shortly after they acquired the property, although he retains an affiliation with the San Francisco law firm of Coblentz, Patch, Duffy & Bass, whose web site describes his work as \u201cadvising business, individuals, and tax-exempt organizations in land conservation, estate planning, and the income, gift, and estate tax implications of complex transactions.\u201d<\/p>\n
\tThe Pace family\u2019s \u201cpreliminary valuation\u201d appraisal in 2005 suggests that the gross income from developing the land remaining after the easement is conveyed will come to $52 million over the next 10 years, offset by roughly $30 million in development and associated costs. With the tax liability diminished by the carry-over tax credits stemming from the \u201cdonated\u201d value of the easement, that would mean that the income tax on anticipated profit of $21,682,503 from sales of subdivided land called out in the appraisal could be substantially reduced. If the value of the deduction exceeds the tax obligation in a given year, the remainder of the deduction can be carried over for up to 15 years. State tax obligations are similarly reduced.<\/p>\n
\tIn a phone interview, Hendrickson stated that the tax consequences did not drive the design of the easement. \u201cThere\u2019s no way they can take advantage of a $30 million tax deduction at this point,\u201d he said. \u201cIt would require $90 million in gross income, and that\u2019s never been achieved in the history of their company.\u201d<\/p>\n
The Appraisal<\/b><\/i><\/p>\n
For the deal to go through, the state must obtain an independent appraisal of the property that confirms the value of the easement is at least $5.334 million (the $4 million from the Forest Service plus the $1.334 donation of the remaining value by the landowner).<\/p>\n
\tThe appraisal done in 2005 for Kealakekua Ranch concluded that the \u201cinferred value\u201d of the conservation easement came to $30,750,000 \u2013 this for just an easement<\/i> over a 8,457-acre portion of 11,500 acres that was sold in fee simple a year earlier for $11,500,000.<\/p>\n
\tThe high value of the initial appraisal seemed to have been a concern for Sheri Mann, who heads up the Forest Legacy program for the state. In an email to another staffer at the Department of Land and Natural Resources last May, Mann wrote, \u201cThe issue I am most interested [in] at the moment is the appraisal. The landowner (Pace family) just had a[n] \u2026 appraisal done \u2026 and it is well over $50m.\u201d (Actually, the appraisal came in at $44 million before the easement, and $13.25 million after, but Mann had not yet seen it and was apparently relying on second-hand accounts of the results.)<\/p>\n
\t\u201cThe landowner,\u201d Mann continued, \u201cis worried that our request for an appraisal \u2026 will be so much lower\u2026. The landowner is much more interested in the tax benefits from the land donation than the $2 m for the actual [first] easement.\u201d<\/p>\n
\tAppraisals for the Forest Legacy program have to follow the guidance set forth in the \u201cYellow Book\u201d (Uniform Appraisal Standards for Federal Land Acquisitions<\/i>). The 2005 appraisal, called a \u201cpreliminary valuation\u201d of the easement, was based on the Yellow Book guidelines, according to the cover letter to Hendrickson from the Honolulu-based Hallstrom Group. The easement\u2019s value was \u201cestimated through inference\u201d by subtracting the value of the property after the easement from the property\u2019s value before.<\/p>\n
\tThe appraisal assumes that all the entitlements for development included in the 1995 and 1998 Hawai`i County ordinances are still in place. Yet, with the 2003 deadline for compliance with ordinance terms and conditions having come and gone, the current status of the zoning is, as Planning Director Chris Yuen says, \u201cin limbo.\u201d<\/p>\n
\tAside from that, whether the \u201cpreliminary valuation\u201d can withstand a more rigorous, thorough appraisal (with comparable sales called out, among other things) remains an open question. Also, how different would it be if the development rights in the rezoning ordinance on which the Hallstrom valuation was based were no longer in effect?<\/p>\n
\tHendrickson said that without the zoning allowed in the 1998 ordinance, the appraised value would probably be somewhat less. If the zoning were to revert to Ag-20 (minimum 20-acre agricultural lots) throughout the entire 11,500 acres of the ranch, \u201cyou\u2019d have 575 units. I think the values would go down,.. [but] I don\u2019t think they would go remarkably down. We\u2019re doing something very similar next door [at Hokukano Ranch], an Ag-20 subdivision. And we have made a couple of sales on Hokukano Ranch in the upper elevation, large acreage sales. This year we made one in January and the value was $10,000 per acre. At Kealakekua, $10,000 per acre on 11,490 acres would be $114.9 million.\u201d In a bulk sale, he said, the value of the ranch could easily reach $50 million at this point in time.<\/p>\n
\t\u201cIt\u2019s not out of the range of reasonable,\u201d he said, \u201cbut we haven\u2019t tested the market on that.\u201d<\/p>\n
\tIn any event, \u201cthat preliminary appraisal was done to give us an idea,\u201d Hendrickson added, and when the final appraisal is done, it will be \u201cmore cautious,\u201d he said. Appraisers who do inflate values face harsh penalties by the IRS, he noted: \u201cThere\u2019s been a lot of attention to appraisals lately, and appraisers over the last four or five years have become much more conservative in the way they approach these easements. That\u2019s good.\u201d<\/p>\n
Quid Pro Quo?<\/b><\/i><\/p>\n
One of the elements of any easement that the IRS considers in deciding whether it qualifies as a tax deduction is the \u201cquid pro quo\u201d rule. One national expert in the tax laws relating to conservation easements is Boston attorney Stephen Small, who, in a 2004 article, addressed this issue.<\/p>\n
\tSuppose, Small writes, a developer approaches a town \u201cwith a plan to put houses on the eastern half of the 100 acres the developer owns and the zoning board says, \u2018We will let you do that, but as a condition of approval we are going to require that you put a conservation easement on the western half of your 100 acres.\u2019 That is an exaction by the zoning board, and the conveyance of the conservation easement is neither charitable nor deductible because it is required.\u201d<\/p>\n
\tIn the case of the upper 8,100 acres of the proposed Kealakekua easement, one could argue that the case Small describes fits it to a T. As a condition of the rezoning, no development could occur on those acres for a minimum of 40 years.<\/p>\n
\tHendrickson notes that the Forest Legacy easement will be perpetual, as opposed to the 40-year moratorium on development called out in the county zoning ordinance. Yet the value of a perpetual easement over lands that can be used for limited purposes for 40 years or longer can\u2019t amount to too much.<\/p>\n
\tThe high value of the easement, then, is to be found a little in the additional restrictions on the 8,100 acres of mauka lands \u2013 and a lot on the landowner\u2019s giving up rights to develop several hundred house lots. But was it ever the landowner\u2019s intention to develop these lots in the first place?<\/p>\n
\tUntil the Paces acquired the land, the previous owners were diligent in complying with the conditions of rezoning, filing annual reports and even requesting, in 2003, a one-year administrative time extension to secure a water source and develop a forest management plan. (The extension was not given.) Since the Paces took ownership, compliance has flagged \u2013 to the point the rezoning may no longer be valid.<\/p>\n
\tIf the landowners did not intend to develop the land to the full extent allowed by the zoning in the first place, then any appraisal based on full build-out could be suspect. In 2005, the congressional Joint Committee on Taxation noted that \u201cat least one court \u2026 has examined the subjective intentions of the contributing taxpayer\u201d in determining that the full fair-market value of the land at its highest and best use was not the appropriate standard for assessing the value of the easement. In a footnote, the committee notes that in McLennan v. U.S.,<\/i> 24 Cl. Ct. 102 (1991), the court found that \u201calthough the property could be subdivided into eight parcels, the taxpayer\u2019s \u2018strong aversion to development\u2019 meant that a valuation based on an assumption of subdividing the entire property was \u2018untenable\u2019 and \u2018directly contradicts [taxpayers\u2019] clear intention to preserve their land from development.\u201d \u201c[T]he reasonable and probable use of the property was as an undivided country estate, not as a subdivision,\u201d the court determined, and the easement did not impede this use.<\/p>\n
\tGiven the statement of one of the landowner\u2019s agents that the property was purchased with the specific intention of preventing the development of the land in accordance with the rezoning ordinance, the easement\u2019s value could well be diminished in light of this court ruling.<\/p>\n
\tHendrickson was asked about this. \u201cThe landowners wanted to come up with something different than what was entitled there,\u201d he said. \u201cIf the alternative had not been developed for them, they would have done what they needed to do to get the property to return to them whatever sum they needed in order to pay off the debt and to satisfy non-resident family members.\u201d<\/p>\n
\t\u201cThey knew that what was proposed [in the rezoning] was not entirely consistent with their ethic and were looking for an alternative, but they didn\u2019t know what that alternative could be\u2026. My hope and thought would be, yeah, they didn\u2019t intend to develop it, but it may be saying too much to assume that. I can\u2019t say that that\u2019s their intention right now.\u201d<\/p>\n
Disproportionate Benefits<\/i><\/b><\/p>\n
The growing popularity of conservation easements occurred with little public fanfare until The Washington Post<\/i> published in 2003 a series that put a cloud over many of the land deals entered into by The Nature Conservancy. The fallout from that series resulted in the IRS issuing a notice in July 2004 that spelled out its concerns with the practice. One of those dealt with disproportionate benefits to the owners from such easements: \u201cIf the donor (or a related person) reasonably can expect to receive financial or economic benefits greater than those that will inure to the general public \u2026 no deduction is allowable\u2026. If the donation of a conservation easement has no material effect on the value of real property, or enhances rather than reduces the value of real property, no deduction is allowable.\u201d<\/p>\n
\tSmall, the Boston tax attorney, points out that IRS rules say that when property values are enhanced by an easement, that needs to be factored into the appraisal. He explains, \u201cWhen a landowner donates a conservation easement and as a result there is an increase in the value of any other land \u2026 owned by the landowner, the landowner\u2019s family, or a \u2018related party\u2019 (broadly defined to include certain partners and partnerships, corporations and shareholders, trusts and beneficiaries, and so on), the value of the deduction is reduced by any such increase in value to such other property.\u201d<\/p>\n
\tThe Paces own adjoining land. Will its value increase by virtue of the enhanced \u201cview-shed,\u201d to use their architect\u2019s phrase, that they can expect as a result of the easement?<\/p>\n
\t\u201cAbsolutely,\u201d Hendrickson said, although he denied that the Paces would be able to view any of the lands under easement from their house. \u201cA ridge runs between Hokukano and Kealakekua ranches, so it\u2019s not a visual enhancement that occurs \u2013 just the knowledge that the open space is there.\u201d In any case, he added, \u201cthe enhancement already occurred under the ordinance.\u201d Under tax laws, he noted, \u201cthe appraiser is required by regulations .. to evaluate enhancement elements\u201d on adjoining lands, and take those into account in the final appraisal.<\/p>\n
— Teresa Dawson<\/p>\n
Volume 18, Number 7 — November 2007<\/p>\n","protected":false},"excerpt":{"rendered":"
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