It seemed certain that part of the family's 5,115-acre tract in the beautiful Davis Mountains, where they'd been ranching since 1886, would have to be sold to pay grandpa's death tax. Then the executrix, a family member who was an attorney, spotted something on the IRS estate-tax form that would ultimately rock her world: qualified conservation easement exclusion. "I got a call from her on a Monday, she said she needed the easement completed within 10 days, and we got it done," says James King, West Texas Programs Manager for The Nature Conservancy, the preservation charity to whom the estate donated the easement. By agreeing not to develop the property save for two places to build a house, the family got to keep its entire heritage ranch and cut taxes by a whopping $400,000. A qualified conservation easement is an environmentally-kind covenant, or restriction (on development, mining, etc.), placed on land for perpetuity to meet a tax-code-defined conservation purpose. For years, clients have been able to garner substantial income tax deductions by conveying an easement, during lifetime, to a public charity or governmental unit. But many of the landed gentry find themselves in income brackets in which they can't take full advantage of the income-tax benefit. So in 1997, Congress began legislating estate tax incentives, and today the little-known exclusion for a conservation easement-which can be elected post-mortem, through the extended due date of the estate-tax return-has quietly grown to a $500,000 maximum (subject to other limitations, discussed later). Moreover, the exclusion is now allowed for easement property located anywhere in the United States or its possessions so long as the decedent or his family owned the land for three years prior to the death, says Philip Tabas, deputy general counsel for conservation strategies at The Nature Conservancy. The exclusion is even available for land owned by a partnership, corporation, or trust of which the decedent owned at least 30% (the three-year rule must still be met). But if Congress doesn't make permanent the estate-tax changes enacted in 2001, Tabas says, landowners dying after 2010 will get the exclusion only if their property meets the pre-2001 requirement of being located within a specified proximity to a metropolitan area, national park, wilderness area or urban national forest. Because an easement is forever, the restriction remains even if the property is later sold. Therefore, the value of land drops when an easement is applied, decreasing the client's net worth and, concomitantly, estate tax. This benefit is in addition to the estate tax exclusion. In fact, sometimes the exclusion and the reduction in net worth attributable to the easement combine to completely eliminate the death tax; in other cases the estate tax bill is lowered so dramatically that the family need not liquidate its land holdings, as the Texas-ranch case demonstrates. Besides clients seeking transfer-tax shelter, the arcane conservation-easement technique aids folks keen to keep pristine lands undeveloped. "For those who love their land, a conservation easement is the best tool available for protecting and preserving it," says Stephen J. Small, a Boston attorney. From a planning standpoint, of course, a special property is just one part of the equation. "The planning has to take into account family issues, economic issues, tax consequences and cash flow," Small says. Which makes the comprehensive financial planner the ideal professional for analyzing conservation-easement opportunities for clients. Advisors should only team with attorneys and appraisers who are experienced in conservation easements. Saving The Environment To qualify for the estate tax exclusion, the conservation restriction must a) preserve land for outdoor recreation by, or for the education of, the public; b) protect a habitat or ecosystem (e.g., wetlands); or c) preserve open space for the public's scenic enjoyment. The easement must also prohibit all but minimal commercial recreational use of the land, says tax and estate planning attorney Patricia Templar Dow of The Dow Law Firm LLC, in Fort Collins, Colo. (Note: An easement preserving a certified historic structure yields an income tax deduction but not the estate tax exclusion.) Easements don't necessarily include rights for public access. Consider the open-space purpose. The scenic-enjoyment requirement means to look at, not trample upon, says Dow. "You're giving the public the benefit of being able to drive by and say, 'Wow. There's open space.'" On the other hand, preserving lands for public education may result in visitors. The Trustees of Reservations, a Massachusetts-based conservation and preservation not-for-profit, received an easement from a woman who owns 18 shorefront acres on Martha's Vineyard that contain the historic ruins of a brick works. "We have the right to bring educational tours to that site, and we actively utilize that right," says Wesley Ward, director of land conservation for The Trustees. Despite the intrusion, the property will remain forever undeveloped, which is the goal of the elderly landowner, who recalls from childhood the last vestiges of the island's once-prominent brick-making industry. "This property is very meaningful to her," Ward says. "She does not want a house built there, or a marina, or anything." Regardless of whether the public accesses the property, the entity to whom the client donated the easement will monitor it, Dow says. "They have the right to see that the easement is enforced, and some people don't like that. It is a bit of an infringement on private-property rights." Calculating The Exclusion The estate may exclude from taxation up to 40% of the restricted land's value-subject to the $500,000 maximum-even if the easement was donated before passage of the 1997 law that created the estate tax exclusion. In some cases, however, the exclusion percentage will be less than the 40% max. The easement must reduce the land's value by at least 30%, as of the date of the gift, to be eligible for the full 40%, says estate planning attorney David A. Handler, with Kirkland & Ellis in Chicago. When the land value falls by less than 30%, each percentage point under that threshold reduces the exclusion percentage by two points. For example, an easement that lowers the land value by 22% (eight percentage points less than 30%) decreases the applicable exclusion percentage by 16 points (eight times two), from 40% to 24%, Handler says. The exclusion percentage is applied to land value only, not the worth of structures. At estate tax time, therefore, the value of the land (with the restriction on it) and the value of any improvements are appraised separately, with the exclusion percentage applied only to the land value. Moreover, any mortgage on the property at date of death reduces the amount eligible for exclusion. If the land is worth $1 million but subject to a $250,000 mortgage, only $750,000 is eligible for the exclusion percentage, Handler says. Another subtraction: the value of retained development rights. Small says, "If the client has a farm with a principal residence and barn, and under the easement he reserves the right to have two more house lots, the value of those lots needs to be appraised out. Those retained development rights are not eligible for the exclusion." (The appraised values of the residence and barn are also ineligible.) Small notes that when the exclusion is elected, the land does not get full step-up in basis. But for families intending to hold their property, this is not an issue, he says. Planning Dilemma Is it better to donate a conservation easement during life or after death? Either way, you get the estate tax exclusion, but there are added benefits for doing it while alive, which is what experts typically recommend. For one thing, a lifetime easement donation makes the client's preservation objectives settled business. Then there's the income tax deduction: a charitable contribution, equal to the difference in the property's appraised market value before and after the easement, limited to 30% of adjusted gross income, with five-year carryforward. "So you've got six tax years to work off the deduction," says The Trustees' Ward. Unlike the estate tax exclusion, the income tax deduction does not require the client to have owned the property for three years. Therefore, conveying an easement during life on recently acquired property virtually guarantees a federal tax benefit, whereas doing it through the will does not. A few states (notably Virginia, Colorado and North Carolina) offer easement donors a generous income tax credit to boot. Further, a lifetime easement facilitates a program of gifting property interests. The reduced land value, post-easement, means that gifts consume less of the $1 million lifetime exemption. A final advantage to a lifetime easement is that it may reduce property taxes (since the restriction lowers market value) and, concomitantly, the client's cash-flow requirements. For those daunted by the specter of medical costs late in life, donating the easement via will may be more appropriate. "Generally I tell these clients, 'Put a conservation easement in your will. That way, you can sell the property if you need to, but if you die next week, you won't need money for a nursing home and your property will be protected, plus you'll save estate tax,'" Small says. In the will, simply stating, "A conservation easement shall be placed on my farm," may not be sufficiently clear, Small says. "You should include in the will, or as an attachment to the will, the text of an easement that works out all the details. That makes it easier for the estate, the donee organization and family members." When the easement is donated at death, the estate gets, in addition to the exclusion and the benefit of lowered land value, a charitable deduction for the value of the easement. If the will is silent about a conservation easement, the estate can elect the exclusion on a post-mortem basis, but this isn't a planning failsafe. The executor and/or heirs (depending on state law), along with a conservation organization, must agree to the terms of the restriction and finalize paperwork by the extended due date of the estate-tax return, and that's not always a deadline that can be met.