The Preservation Group

FROM THE END TO THE BEGINNING

Conservation Easements

THE PRESERVATION GROUP Chris G. Allen, King Howington, Co-Founders

FROM THE END TO THE BEGINNING

Conservation Easements

THE PRESERVATION GROUP Chris G. Allen, King Howington, Co-Founders i

About the Authors:

Chris G. Allen has over 30 years of experience in investment strategy, management, structure, and operations in both public and private markets. Primarily working with private taxable investors and entities, he has consistently focused on after tax investment returns. After receiving his MBA from the Wharton School in 1989, he was instrumental in the development of two family offices with assets in excess of $1 billion. He has deep experience in investment policy and strategy, alternative investments, and corporate finance.

King Howington has specialized in the assemblage and acquisition of investment properties, commercial and development sites since 1980. He has extensive rezoning experience and his assemblage record includes the second largest mixed use land acquisition in Gwinnett County, Georgia. As a respected source of investment properties for domestic and foreign clients King’s investment strategies have produced excellent returns. Since 1988 King has closed in excess of $1 billion in real estate investments.

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About The Preservation Group:

that there is little funding for it when all the incentives are tax based?

The Preservation Group mission is “Preserving What Matters Most”. For the world at large, we preserve Nature, the habitat for all living things. For Communities, we preserve historical structures and the natural environment which we believe enhances social interaction and communication, and ultimately reflects the connections among all life under God. At the individual level, we preserve financial resources by minimizing tax erosion utilizing government incentives for conservation and historic preservation.

Preservation Group has a strategy that changes that.

We have created a plan that shares the financial benefit of tax incentives with the non-taxpaying investor, creating and expanding the available capital for our mission.

We have created a plan for bundling these benefits with other worthy causes, both for-profit and non-profit.

Most importantly, we have created a transparent, investor driven, market based business model that captures the best aspects of conservation related investing. These transactions will preserve what matters most; our planet, our communities, and our individual financial resources.

The financial incentives provided by the United States government for conservation and historic preservation come from income tax deductions and income tax credits. While these incentives are significant, they are not often utilized because most American capital does not pay tax. The majority of capital is sheltered from tax within pension and endowment plans which ultimately distribute income subsidies for the retired population. In that conservation and historic preservation require enormous capital assets, is it any wonder

We look forward to saving the planet with you.

Contact for the Preservation Group: www.thepreservationgroup.net

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Sustaining Stewardship

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" Understanding conservation easements requires we begin with the end in mind. Where do we want to end up?

A good steward of anything understands fully the consequences of their actions, and strives to operate intentionally. As stewards of the Earth we must do better in understanding our human impact here and champion creative strategies that will enhance the future for our descendants.

and preservation will set a good example for others to follow. Our business model recognizes the importance of sustaining wealth, recurring revenue, and cost control.

Through our combined creative vision, and with the support of 45 years of Congressionally-mandated fiscal incentives for land preservation, we solve a myriad of problems. " It is critical to the success of conservation that the strategies discussed here not be construed solely as a tax arbitrage. We expect every property the Preservation Group acquires to generate cash flows unrelated to tax deductions. All of our efforts will have commercial intent; e.g. genuine, achievable business purposes. Every conservation decision will be weighed in light of the commercial development value, and vice versa. Our efforts and potential businesses include cattle ranching, timber farming, permanent and row crops, fisheries, environmental research, education, retirement communities, eco-tourism, and alternative energy generation. The list and value of our long term business purposes will vary with the lands we acquire.

Our attention to tax incentives is a fiduciary matter that couples well with our desires for the future.

" Mankind’s development and consumption of our natural resources has reached a pace where we must contemplate our future. For the last century, technology has enabled such enormous and rapid change in human behavior that we now expect it to bail us out of any problem we might face. Lifetimes are extended by pharmaceuticals and replaceable body parts. Food production is expanded through genetically modified seeds. Unlimited consumption is provided through electronic currency and a nearblind faith that solutions for global financial problems will present themselves in the nick of time. While we know epic problems exist, we routinely distract ourselves or change the subject, and avoid the challenge of difficult solutions. " Stewardship seems to be a lost art. Lost in favor of short term answers to long term problems. Dealing with the symptoms of problems instead of the causes is the norm, and thus good stewards are nearing extinction.

" A better future is in store as more and more investors begin using the benefits of land preservation to achieve: 1) More profitable and environmentally sensitive rural and urban development,

" The Preservation Group is doing its part in preserving stewardship. We expect our efforts in land management v

2) Sustainable and increasing assets for retirement plans and endowments, 3) Reduced international border conflicts, 4) Improved research and fact sharing on the future of our planet, 5) Improved communities and educational systems, 6) New and increased funding for charitable causes, 7) Increased green space for perpetuity. " The preservation of our culture, our values, and our future relies on the stewardship of our lands. We hope you will join us in the effort.

Chris Allen and King Howington September, 2013

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CHAPTER 1

Beginning with the End

Sometimes I describe the work we do as getting paid for what we don’t do. If we persist in building on every beach, every mountain top, every hill and valley, the inspiration of beautiful vistas such as this one in Kentucky, will cease to exist. Inspiration from nature was best articulated by John Muir, who said “Everybody needs beauty as well as bread, places to play in and pray in, where nature may heal and give strength to body and soul.”

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Fortunately, since 1969 the Congress of the U.S. Government has supported the preservation of Nature with fiscal incentives in the form of income tax deductions.

Thus, in a sense, as a proponent of conservation, we can be paid for not building on every hilltop, beach, and valley. These fiscal incentives create a balance between short term gains required by capital and long term pains resulting from man’s nature to exploit his environment.

has legislated that the value of the contribution can be deducted from income. " Defining value and using it for an income tax deduction is the best incentive available for conservation.

Without it, the only way to prove the value of the opportunity is to engage it, and in so doing, the conservation opportunity is lost. The debates surrounding valuation are obvious, and fortunately we have public records and the tax court to guide us. Although valuation of property “development rights” is not an exact science, a comparable sale of like kind property gives the land owners a provable and defendable methodology as to value. The mythology and fears of the extent of abuse of the deduction leave us incredulous. Any thoughtful look at the numbers dissipates the notion that this issue is material. Here is the context we need to comprehend before we look at the process of valuing conservation:

" If we are to preserve environment, animal habitat, the availability of “Nature’s healing” for the future, then we must choose to give up the financial benefits of building development in favor of the qualitative benefits of nature. Nature has no bank account, it cannot negotiate with us or argue its fate. It simply leaves us with regret as we observe its loss and destruction. Defining the value of preserving nature has been accomplished through the “highest and best use” method.

Whatever is the most financially profitable feasible developed use for land defines its value. The opportunity cost of not pursuing that “highest and best use” is recognized as a charitable contribution. When properly documented and verified by multiple experts, the Congress

" The concern that the deductions are used unfairly or are an excessive expense to the national purse seems misguided when we look at the numbers. In 2011, the U.S. Government spent $435 million per hour, every hour of the year. This equates to over $10 billion dol8

lars per day. Between 2003 and 2008, the most recent years for which we have accurate numbers, conservation deductions cost the government an average of $563 million in potential revenue. If we assume that every

landowner, the appraiser, and a 501(c)(3) it appears the abuse concern is superfluous. Clearly there is value to preserving our land and this is the only financial incentive available. We support the rules and regulations for documenting conservation related deductions, and consider them essential. " Understanding opportunity cost is essential to proper valuation of land suitable for conservation.

Choosing one plan over another has long been defined by quantitative methods, such as net present value analysis. Rather than evaluate the dollar cost of one plan versus another, we begin with the assumption that if money were no object, we would always deploy capital such that it returns the maximum yield attainable.

We discount every cash flow by an agreed interest rate.

In this way, we create apples-to-apples comparisons and can make reasonable decisions. The formula contemplates a notional residual asset value in the future, which is also discounted at the agreed interest rate to arrive at a present value for the cash flow stream. These present values of the various future cash flows are then compared to the cost of each endeavor and a NET present value is calculated. Financial experts always

deduction was exaggerated by 100%, the cost of the conservation incentive was misplaced by approximately $230 million. If the deduction was entirely fabricated and had no benefit to the public whatsoever, the cost averages less than 2/10 of a basis point (0.00017) of our national budget. In that the valuation process is confirmed by at least 3 responsible citizens in writing (the 9

choose the opportunity with the highest net present value (NPV).

maintains the highest extinction rate of plant life and habitat destruction ever seen or contemplated. Which leads us back to issues of NPV.

" By creating this simulation of proposed cash flows we circumvent argument about opportunity cost. We simply argue about the viability of the forecast cash flows and the cost to attain them. The highest NPV wins every time. Given the universal adoption of NPV for all financial decisions, it is no wonder there is debate about how to value opportunity cost related to an income tax deduction. In fact, because the deduction falls within the charitable deduction rules, many improperly believe a deduction beyond cost basis is inappropriate or worse. The incentives have been set to compete with the present value of development, without them, there would be no incentive at all.

" Why would China make such tragic decisions leading to such devastating environmental consequences?

Essentially in their NPV analysis they are making a large error in the estimate of their residual value. By wiping out environment and numerous species in perpetuity, they declare they have no residual value, or they are claiming the value of their government enterprise and laboring population will always have more residual value than the environment it inhabits. " We beg to differ and it is an important financial consideration. If in the comparison of development pro forma we add to the residual value a negative value for the permanent loss of habitat or species, the permanent loss of landscape, the permanent loss of Muir’s defined “nature’s healing” what impact would that have? Or conversely, if we could evaluate the benefit of undisturbed nature in perpetuity what would it look like?

" The greatness of our nation and our endeavors is a function of our ability to self govern. The model set forth for conservation incentives requires substantial collaboration and independent, arms-length verification of value. This self-governance is essential to the future management requirements of land and its proper stewardship. If this seems doubtful, simply compare the U.S. model to that of China where a totalitarian state

" At the core of this issue is the nature of the calculation (no pun intended). By any calculation due to the

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compounding of interest, cash flows in the future are worth less than they are today. More noteworthy is that the difference in value, the delta between cash flows Yr 1 and 2 versus Yr 30 and 31 is tenfold. Yet we know that land preserved 30 and 60 years from now is still preserved (by definition it is for perpetuity), and yet our financial model declares it is worth nothing. Could there be an argument to add value instead of discounting value? This reflects the complexity in valuing a residual. For most financial matters this is irrelevant, as John Maynard Keynes said, “in the long run we are all dead”, but in terms of global environmental stewardship it is highly relevant. Intuitively we recognize that preserved lands are invaluable to our future. Our financial incentives to induce conservation need to recognize the costs of sustainability and the negative cost of losing nature to extinction, and our inability to calculate them precisely.

1% of our nation’s charity is the only asset we can be sure will still be here in the future. " Ronald Reagan regularly said the American citizen can do a better job spending his money than the government can. Given the $12 billion of deferred maintenance unfunded in our National Parks, the Preservation Group is convinced Reagan was right. Incentivizing privately held property conserved for perpetuity is one of the best investments our government can make. " The financial incentives for conservation today are harnessed within the majority of Preservation Group’s investments. The work of PG and other conservationists instigates potential for new medicines, new food sources, new enabling technologies that constantly reflect the connection among us all. We are all connected. Preserving land is essential to staying that way

" In terms of incentives for conservation, what is available today is working. At a nominal cost to the government, individuals are preserving land. 38% of charitable contributions are non-cash. Perhaps 3 % of all non-cash charitable contributions are for land. This

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CHAPTER 2

Before, After

Conservation incentives rely on two valuations of property. There is a value to be determined before the land is conserved, and there is a value to be determined after it is conserved. The difference between the two is the value of the income tax deduction incentivizing the conservation effort. This value is defined by professional appraisers, and acknowledged by a legally certified 501(c)(3) entity.

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Recognizing the difficulty of valuing anything is the first step. Estimates based on national averages, cost plus inflation adjustments, historical norms, or any generalization do not properly define value. For example, in any given year, the difference in value between the high and low share price of a NYSE listed company is 100%. Determining the real value of those companies is up to the professionals engaged in the work of investing and directing them. Notably, if a public company is acquired by another, there is invariably a “control premium” paid to the seller. At times this premium will be 50 - 100% of the stock price at the time of the purchase offer. Does this indicate the market value of the shares was invalid? Of course not, it simply means that another party saw value where others did not. So it is with valuing land for conservation. Information, vision, and creativity all lead to value creation. Ascribing value to land is a function of all three and more.

returns are often driven by availability of financing. Depending on market expectations and investor demand, capital is more or less available for various forms of development.

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" Every market is susceptible to herd mentality. This is also heavily influenced by the predominance of relative performance measurement. Investment managers are largely compensated for their success versus an index and so momentum investing creates large swings in capital availability. As managers seek return, the participants focus on “cap rates” which reflect a net rate of return for capital. Investment performance is driven by buying high cap rate assets and selling them for lower cap rates to create multiples of investment value in as short a time as possible. Market participants keep a close eye on each other and rarely take investment positions that could hurt their relative performance. This “herding” can create significant value differentials between markets and accordingly there is excess capital for some, and it is unavailable for others.

" Key to ascribing value for land is the capital markets for its intended use. These uses include among others, agricultural, residential, commercial, and industrial. In each of these categories you have a wide variation of specific use and expected financial returns. The

" In the current market, now 2013, the demand for multi-family property has driven cap rates to historical lows. Cash flowing properties have access to capital, 13

non-cash flowing properties do not. Mortgage and construction financing is limited due to the severe regulatory constraints on bank lending, and the general liquidation of single family housing inventory. These factors create severe under-valuations and over-valuations regularly, and it is the astute investor who knows the difference.

" In conservation, properly ascribing land value is a highly specific exercise. As Andy Johnson of the North American Land Trust told us, there are generally three types of land. Land that can be conserved, land that is too expensive to conserve, and land that holds those two together. Occasionally there is a significantly uninformed seller where this is not the case, and the conservation buyer can make a terrific purchase. It doesn’t happen often, but it does happen. A great analogy in the public markets would be the spin-off of Polaris Industries by Textron in the late 1980’s. The company traded for $1.25 a share soon after it was spun off, and over the next few years it paid out a multiple of that in dividends. Today its shares are $125 and the dividend is $1.68. Clearly in the 80’s the market did not realize the value of the company (and its extraordinary management). Changes in value can be extraordinary and land development is no exception.

" Understanding these market dynamics is critical to accurate valuation. Accurate valuation needs to take into account short and medium term fluctuations in cap rates as well as market trends and changes in consumer appetites. Significant changes in value and market direction occur quickly, which impacts whether transactions close or not. " For land investors, the greatest returns are often achieved when property is repositioned from one use to another. For example, changing residential use property to commercial use has created enormous profits for insightful investors. Equally large losses have occurred when markets become over built and demand exceeds supply. This can create opportunities for land conservation as well.

" Land that can be readily conserved will generate a sufficient return from conservation incentives and additional residual value from limited commercial endeavors. Identifying this kind of property requires exceptional experience, strong financial skills, and significant,

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local information sources. While Polaris was available on a public stock exchange and the opportunity freely available, land deals are still largely a private concern.

With access to property records and transactions it is possible to know where to look, but acquiring the best tracts will always be accomplished through highly qualified individuals.

" An obvious concern must be the pencil. Many believe all that is needed to maximize returns with this strategy is a pencil. We are valuing an opportunity rather than an existing capital asset. For some reason the numbers that are relied on to build something are more reliable than the numbers used to “not build” something. The fact of the matter is nothing could be further from the truth. The opportunity for “fudging the numbers” is available in every transaction, land or otherwise, built or not built. Is there an opportunity to abuse the system? Of course there is, and the penalties for abuse are draconian. At this juncture the lack of conservation should be a far greater concern than the possibility someone’s deduction was 2% to 5% inaccurate.

Of course, fraudulent comparable sales or assumptions should never be tolerated. That said, the Preservation Group favors very conservative valuation approaches and recognizes that conservation values are esoteric to each property.

" Repositioning land for a new market is very helpful in creating returns from conservation incentives.

Through proper structuring, investors can acquire land that when repositioned adds significant value. When that value is appraised, and the property conserved, the resulting tax savings serve to reduce the cost basis of the land, enhancing the profitability of its commercial use as well as enhancing the sustainability of its conservation. " Keep in mind, the only fiscal incentive for conservation is the income tax deduction. Maximizing this incentive implies maximizing the value of the land’s highest and best use. The before-after spread is the key to financing more and more conservation. The higher this spread, the more financially competitive conservation efforts become.

" Properly achieving the best results in before and after valuations requires significant thought, planning, and expertise. Successfully conserving land for the future requires the investment community recognizing

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the inherent difficulties of valuation, the esoteric nature of each conservation asset, and the long term necessity of land preservation.

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CHAPTER 3

The Who

In this chapter we cover the relevant roles in successful conservation. We include the role of the land in question, the appraiser, the land trust (501(c)(3)), the land owner/entity, investors, and consultants.

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The Land

(Palm Beach). Value has been created through new forms of transportation. For example, interstate highway access changed the destiny of Chattanooga (Chattanooga was almost skipped in the planning of Interstate 75, now considered the most livable city in the country), airport access totally reinvented the State of Georgia (Atlanta comprises 60% of the population of Georgia). As industry and transportation technologies evolve, land can be either the beneficiary or the victim of changing values. Financial markets also affect value, but to a lesser extent over the long term. While in the bottom of the Great Recession many real estate professionals thought there would never be another resort built, properly located properties are back to near peak values.

Government backed flood and hurricane insurance allows development of beach property at values and densities when it started, were never thought possible.

Just like people, land was created equal, it’s what happened to it after that, that makes all the difference. The old adage, location, location, location is true for all real estate. Value for conservation easements is no different.

Before value can be established, the first requirement is the land must fulfill a conservation purpose which is clearly outlined in the Internal Revenue Code Section 170(h). Two parcels of land can be contiguous, the same zip code, and have dramatically different values.

While certain properties may be essential to the future existence of a plant or animal, its financial value as a conservation easement is more impacted by its prospects as a development site than as a home for an endangered life. This is unfortunate, but it is a fact of life.

If man can’t use it, sell it, or create some financial value from it, there is not much in the way of incentives to prevent its destruction in favor of something that generates cash. Which is why the conservation easement incentives are so great! At least we can save habitat somewhere, and get paid for it. Visionary real estate developers have created extraordinary value on everything from desert (Las Vegas) to sand dunes and mangroves

" Finding and acquiring land is a unique expertise that is only acquired over time. While education and training are very helpful, experience is the best teacher.

Experienced eyes can see opportunities that text books can’t describe, and academics can’t imagine. When Mac Taylor invented the office park his bankers regu-

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larly chastised him for his poor use of land. Most thought all that green space was a waste, increasing overheads and inefficient. Little did he know at the time that this style of development would change office development forever, and land valuation at the same time.

tion. For example, knowledge of multi-family markets and their values is far different from industrial development. This is clearly evident in the vast array of real estate investment trusts. Appraisers need to be selected by their experience as well as their analytical qualifications.

The Appraiser

The Land Trust

" Appraisers for conservation easements are carefully monitored by the IRS and most are overly cautious when it comes to valuing land in terms of its opportunity cost. For that reason, many conservation easement investments are valued strictly on comparable land sales. When an appraiser is adequately informed on a development plan, its appropriate context and regional comparable assets, they truly help the cause of conservation. Understanding what is being “given up” allows conservationists to pursue truly incredible properties such that the appraised value of the land rights donation will compete with the present value of long term development profits.

" After the rules for conservation easements were first clarified in the mid 1980’s, the Land Trust industry exploded. There are now over 1,700 land trusts around the United States, of all shapes and sizes. These entities are the recipients of the donated land development rights under the conservation easement law. They provide the evidence of a charitable gift, as well as acknowledge the appraisal that valued the gift. Land Trusts can operate locally, regionally, nationally and even internationally as they desire. They bear significant risks as a legally certified non-profit in ensuring compliance by the land owner to the terms of the easement. " Land Trusts do charge fees related to the supervision of the easement as well as providing base-line studies for habitat and other environmental concerns. These

" Just like any investment analyst, appraisers’ expertise varies by the specific use of the property in ques-

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fees are generally quite reasonable and serve to perpetuate land conservation operations. Not all land trusts are created equal. These trusts are a function of their leadership, their financial backing, and their willingness to pursue all avenues for the preservation of land. They are constrained like any business by their available resources. The more conservation easement investments that are made, the better funded these land trusts become, and that is a good thing.

taking. Land owners should stay informed and proactive in assisting the new position the land now holds.

Managing the land for Nature’s benefit doesn’t mean total disengagement. On a property specific basis, the Preservation Group seeks to involve the scientific community to aid its understanding of the lands it maintains, and how it should be best protected for the future. Having options to sustain management usually involves segregating portions of the property from conservation so that future revenues may be generated, if needed.

Investors in Conservation " Taxable investors in conservation generally seek a return that is stable, and commensurate with the risk and variability of the cash flows they anticipate. The tremendous backlash in 2004 from tax shelter scams dramatically affected investor perspectives on conservation easement assets for the past 9 years. Returns now are declining as those risks dissipate and predictability improves. Declines in interest rates have also reduced competition for capital, leading to lower returns overall.

Returns are always a function of the specific real estate parcel in question. As the legendary O. Wayne Rollins

The Land Owner " Placing property under a conservation easement is not a simple under20

said of his vast land holdings, “I make half my money when I buy the property, and the other half when I sell it.�

Sensible due diligence, expert negotiation, and credible, moral behavior in the market place are essential to long term success in land investing.

temporarily to allow the clients time to evaluate them.

Presumably, the assets and the business prospects secured will be suitable to the clients such that the properties are acquired. " Preservation Group will also function as an advisor to a land owner that seeks to conserve their own property and keep the fiscal incentives for themselves and/ or their family and friends. Many groups provide this service, and some land trusts are very good at providing this advice.

" Tax Exempt Investors currently have no significant way to participate in conservation investments. The Preservation Group Land Bank intends to change that as it collects base capital for buying and holding land for future potential conservation. When that land is acquired, it will be held in special purpose LLC’s that can issue warrants for their equity. Those warrants will represent potential conservation value which can be traded among accredited investors. Ultimately the fiscal incentives are only for tax payers, but the process of valuing the incentive and sharing in that value can be achieved for tax exempt investors in this vehicle.

"

Other Advisors " The Preservation Group is a consultant wrapped around a search fund. Clients retain the Preservation Group to seek out opportunities suitable to them and when they are found, those opportunities are secured

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CHAPTER 4

Costs & Benefits

Understanding the tax economics of charitable contributions is essential to successfully capitalizing on the fiscal incentives for conservation. This is an example of the calculations required to evaluate those economics. Please consult a professional tax advisor for your specific situation. The Preservation Group does not give tax advice.

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This is an example of a single taxpayer with a million dollar income and no deductions. He has property to conserve that he acquired for $111,111 and its appraised value is now $500,000. If he chooses to conserve the property, he can recover his cost in the property as well as improve his net cash flow an additional $78,000 from the available fiscal incentives for conservation.

Information contained above although believed accurate and compiled from credible sources is not guaranteed. This information is subject to change. This summary document is for general informational purposes only and does not address all the risks associated with this type of investment.

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To fully understand the chart on the previous page its important to know more details about the current rules (and its essential to have expert advice from a tax professional):

5. The incentives are not transferable. If they cannot be utilized by the taxpayer, they expire in 15 years from their receipt. " The sensitivity analysis provides insight for the investment returns from property with appraisals for various multiples of cost. When property is repositioned for a different use, it can appreciate significantly. When property is purchased from sellers under duress it can appreciate significantly. When property is purchased from sellers that are uninformed about its highest and best use, it can appreciate significantly. When financing for land purchases is restricted or unavailable, profit margins for land ownership increase due to what is called a liquidity premium. Ascribed land values do not necessarily decline when capital markets are tight, there are simply less transactions taking place. This also provides opportunity for significant appreciation.

1. The incentives (aka the income tax deductions) are only allocable to 50% of an individual’s income and only 10% of a corporation’s income.

2. Individuals whose income exceeds certain thresholds (in this example a single person earning over $400,000) are subject to limitations on their itemized deductions. This is called the PEASE limitation and effectively increases the net tax rate about 3%.

3. The IRS has 3 years to evaluate a return and notify the taxpayer of its intent to audit or review the partnership return that claimed the deduction. In other words the incentives should be stored for 3 years until the evaluation period is over.

" Opportunistic, informed buyers can achieve significant profits when they have available capital. Numerous successful land investors claim access to immediate cash earned them their most extraordinary returns.

4. If the conservation incentive cannot be fully utilized against the available 50% of the current taxable year’s income, the incentives can be carried forward for up to 15 additional years.

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The costs to conserve property properly can be significant, and so investment returns are higher for larger land tracts that can more readily absorb the cost. Below are the essential components of every conservation transaction:

tives. It is still a difficult process that requires significant involvement of highly paid professionals. The Preservation Group serves as an aggregator of these services and reduces marginal cost by enabling higher valued transactions.

1) Survey 2) Appraisal 3) Land Trust Recipient Fee 4) Attorney 5) Accountant Other costs may include: 6) Market study or Feasibility Analysis 7) Business or Development Plan 8) Land management 9) Audit defense

The management effort for conserving land has become more streamlined as awareness builds of the fiscal incen-

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CHAPTER 5

Hansel & Gretel

Any discussion of conservation easements must address the issues created by the tax rules. Dealing with the Internal Revenue Service is not unlike a ghost story. It can be very scary, but when we stay awake, we recognize it for what it is. The IRS serves a good purpose when they reduce fraud and abuse. In the case of conservation related income tax deductions, the tax court has turned the lights on, and told us there are no monsters under the bed, and given the IRS much needed directions.

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Entrepreneurial conservationists in general find the persistent fear of the IRS somewhat disheartening, as if the IRS equates profitable conservation efforts with tax fraud. In fact some of the best quotes about the importance of conservation to our nation come from the IRS Commissioner Steven Miller who has led investigation efforts on easements for most of the last two decades.

This from his address to the Appraiser Society in 2004,

tion of property with unique public value....Legitimate conservation easements serve an important role in the preservation of our open lands and our cultural heritage....”

“When the tax benefits granted for easement donations are appropriately used, we can all expect that they will bring real and enduring benefits to the American public. Conservation easements can help, and have helped, safeguard fragile ecosystems, critical watersheds, lands bordering national parks, and stunning views. We value this use of conservation easements, and we want to do nothing to hinder the continued and appropriate donations of conservation easements to provide these gifts to the public.”

“Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.”

What is not in these quotes above are the many ”however”s and his duly noted concerns about “abuse”.

Those quotes are provided below and should be read in light of the most important judicial comment about income tax in the last century:

Judge Learned Hand, Helvering v. Gregory, 69 F.2d 809, 810–11 (2d Cir. 1934)

Below are more excerpts from Miller’s 2005 testimony to the Senate finance committee. These are all important guidelines in properly utilizing conservation easements. When properly applied, the IRS admits “conservation easements play an important role...”

And this from his address to the Senate Finance committee in 2005, “....Congress has allowed an income tax deduction for owners of significant property who give up certain rights of ownership so that their land or structures might be preserved for future generations. The conservation contribution provisions of the Internal Revenue Code play a vital role in the preserva-

It is essential to note that these comments were made in 2005. In the 8 years since these comments were made, 27

the IRS has litigated and lost numerous cases involving valuation, forecast development and economic assumptions, even cases related to the documentation process.

The benefit of hindsight is tremendous and conservation efforts for the future should be much encouraged.

Although the conservation contribution provisions of the Internal Revenue Code play a vital role in the preservation of our open spaces, we are concerned with valuations of property that appear to be primarily influenced by tax considerations rather than actual property values. In challenging such valuations, our outstanding but small staff of appraisers (48 in all, 20 of whom work wholly or in part on 170(h) cases) must perform the detailed appraisal work using accepted and recognized valuation standards. It is not easy or quick work.

Our work to date raises the question of whether rules governing appraiser qualifications, appraisal standards, and the standards for referral to the Office of Professional Responsibility are sufficient.

More from Steven Miller: In the open space easement area, valuation can be difficult and can present opportunities for abuse and manipulation....Assumptions concerning future development have been particularly problematic... economic feasibility of the development may not be adequately considered, and there may be other unrealistic assumptions....

In a typical case, investors pool funds to buy a property. After one year, a conservation easement will be placed on the property using an appraised value for the property before the contribution that is much higher than the purchase price. The result is an easement deduction that is many times the value of the original purchase price. ...

Steven Miller resigned May 15, 2013 as IRS Chief Commissioner when the scandal surrounding abusive and improper IRS activity came to light in April, 2013.

It is also important to note the historical context of these comments. The Senate was concerned about the enormous amount of tax code abuse that had come to light in 2003- 2004. Between 1996 and 2004 most if not all of the major accounting firms had developed tax minimization strategies that undermined the intent of the tax code. Many of these strategies were based on paper

We are currently looking or have looked at the activities of more than twenty promoters, and five promoters involved in easements have been recommended for investigation....

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transactions between fictitious foreign companies without business purpose. Ultimately, senior level partners of some of these accounting firms were jailed for tax fraud, with massive penalties levied on the taxpayers.

The financial returns from paper companies generating paper losses reduced tax liabilities in the hundreds of millions. The litigation has been ongoing for over 10 years.

consequential effect on the government revenue pool while it garners an outsized amount of attention. " Unfortunately for conservation, the largest accounting firms’ reputations were so injured that they now refuse to publish any but the most simple tax minimization techniques. This lack of support for understanding and utilizing the incentives is not a function of its veracity and value, but a reflection of the complex dynamics of the advisory industry. The Nature Conservancy all but stopped utilizing the incentives and redirected its efforts to gathering direct government funding. The litigation related to the Nature Conservancy’s activities has also been hurtful to the inherent good of the tax incentives.

" At the same time these abuses were coming to light, the leading national entity for conservation, The Nature Conservancy was exposed by the Washington Post for its abuse of the charitable deductions rules.

This event coupled with the prosecution of leading exIRS Directors-turned-tax-advisors was a near nuclear explosion for tax incentive related investing.

" The only incentive for conservation is the income tax deduction. Without the support of those that prepare income tax returns, the incentives will not be used.

The natural leader (the Nature Conservancy) for promoting the incentives has a damaged reputation and thus inhibits the growth of the strategy. Now that there have been nearly 10 years of tax court rulings in favor of the use of the incentives, accountants and other tax advisors should endorse quality transactions more read-

" We know from the staff of the Joint Task Force on Taxation that in 2005 that there were 2,186 tax returns reporting conservation easements and in the same year there were 250 audits. The following year there were 3,402 returns reporting. Perhaps Miller’s comments brought fear that the incentives would be lost or limited, or perhaps it encouraged interest in the strategy.

We do know the general use of the strategy has an in29

ily. The Preservation Group actively promotes their use in appropriate transactions.

Hopefully now, Hansel and Gretel can find their way home.

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CHAPTER 6

The Money Tree

It has been estimated that over 95% of the investment capital in the financial markets today is from pension and endowment funds. Is it any wonder that there is very little funding for an asset whose major revenue source is an income tax deduction? If 95% of the capital doesn’t pay taxes, then 95% of the capital is unavailable for conservation. It has also been estimated that 27% of the nation’s income 31

is earned by 1% of the population. Thus, the incentive for conservation is not as appealing to the majority of the population.

sources for conservation. The returns can be a more stable and higher yield than much of what is currently available to those investors.

" The Money Tree for conservation will come from securities designed to share the fiscal incentives for conservation. Retirement plans and other tax exempt investors can finance properties that are potentially conservation targets. If they did so with participating debt instruments, a portion of the value of the land’s conservation incentives could transfer to them.

" Another fascinating opportunity with conservation incentives is to bundle them with other investment or charitable opportunities through LLC structures. The financing model described in the Costs & Benefits chapter illustrated a cash flow of 70% on cost. Just as investors can direct their development profits toward charity, they can also direct their conservation incentives toward charity. The 70% cash flow in the example could be reallocated to other investments, charitable or otherwise, in the discretion of the LLC members.

" Preservation Group Land Bank arranges financings that provide this sharing through Subordinated Debentures with Detachable Warrants. The Debentures provide the holding capital for the land targeted for conservation. The warrants are issued to the debt holder (the non-tax paying investor) who can sell them to the highest bidder. The sale of the warrant provides cash flow to the debt holder. The purchaser of the warrant will pay for the warrant to acquire the land investment capturing the fiscal incentives as well as the benefits of the land’s longer term business purpose (Ranching, farming, limited development, etc.). The beauty of this structure is it dramatically expands the available capital

" The long term benefit of conserved land is still more of an intuitive than common understanding. As these fiscal incentives find their way out of IRS mythology, the power of private land conservation will take hold. Preservation Group strategies can provide high returns for both taxable and tax exempt investors, harnessing great business management with fiscal incentives. The incentives reduce cost, and therefore increase profitability. Combining good management, low costs, with smart financing will create a Money Tree.

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CHAPTER 7

Conclusion

The opportunities to harness the fiscal incentives for conservation have only just begun to unfold.

The process of determining how to use and value them has been clarified by the tax courts and the IRS no longer views them as abusive transactions and has appropriately taken them off of their “dirty dozen� list. As tax advisors and investors recognize the extraordinary potential available to them the 33

popularity of conservation will expand dramatically.

for development. It is that the developer chooses not to develop, and thus save the land for perpetuity. The value received for that perpetual gift, is the value of roughly 30 years of use. Almost all real estate assets are financed and paid for in 30 years or less. The fortunes of dynastic families come from refinancing, not selling these old buildings. We should consider allowing the fiscal incentive to repeat itself sometime in the future. If it really has no value, than this would be an incentive with no cost. A small thank you for the financial loss to the owner would also be appreciated.

" There can be little doubt the perfect storm in 2004 of tax shelter fraud by the largest accounting firms in the nation, and the Nature Conservancy’s abuses exposed by the Washington Post stalled the use of these magnificent incentives from Congress. The IRS approach to valuations and the related deductions was over simplified and driven by ignorance of real estate investment strategy. The Nature Conservancy like many large organizations lost its balance and thus its moral high ground defending Nature from the onslaught of development. It is not surprising discussion of the strategy went into near hibernation until 2010.

" It is also important to remember that the acquisition price of land does not always reflect its value. It reflects what a seller was willing to take at that moment.

It reflects what a buyer was willing to pay at that moment. Proving the value is often a debate, and that will never change. Valuing conservation easements is a battle of appraisers. Until the need for conservation is diminished, or the value of the incentives becomes meaningful on a national scope, the IRS should spend its limited resources providing clear and vivid examples of proper valuation and documentation procedures.

" The clarity brought to the public by the tax court has been good. Total activity in conservation is still more closely correlated to the economy and total charitable giving then the relative value of its returns. As awareness for the strategy builds, it will grow rapidly and returns will be more in line with other financial markets. " It is important to remember that the value of land for conservation is no different from the value of land

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" One of the best aspects of conservation easements is that the preserved land remains in private hands. In this age of centralized government, controlled by the few and powerful, it is important to remember that every powerful nation in history at some point loses its leadership role. Maintaining private land ownership is central to our history and our success. Where national leadership has exerted their power in the taking of private land, invariable disaster occurs. The largest organizations in conservation are sustained by land sales to the government. This is not healthy long term. Private land is sacred. The right to preserve it and claim the opportunity lost for tax purposes is also right, good, and the law.

tect the landscapes and wildlife we love, for future generations. Conservation easements are the one tool available to every land owner to do their part for the future. " The purpose of the Preservation Group is to bring the benefits of conservation incentives to a wider and wider audience of investors. Without the work of PG, the transaction costs and access to this type of real estate investing prevents many investors from participating. Utilizing the strategies outlined here, investors can understand that their income can be increased, that land can be preserved, and that future profitability of land ownership can be enhanced. This is a new and better way to invest for the future.

" At its core, the conservation easement fiscal incentive celebrates all that is good in America. Individual freedom, exercising our rights to exploit our resources or not to, is what makes our country great. Through proper use of the fiscal incentives provided by Congress, Americans can create a greener, healthier, and more sustainable future. While the National Park Service wonders how it will pay for its $12 billion of deferred maintenance, we must wonder how can we pro-

Thank you John Muir for this quote: In every walk with nature one receives far more than he seeks.

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Preserving income is in our nature...and history.

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