Easements can take different forms depending on how the land is used and the duration of the easement. The income tax ramifications of selling an easement are just as varied, too.
Before you accept any payment in exchange for an easement on your land, make sure you have a tax strategy in place. Easements are generally classified as permanent or temporary, and each type is treated differently with respect to tax law.
Tax considerations for permanent easements
Permanent easements are perpetual or don’t have a specified end date. Permanent easements often remove all your rights to the property except for the title itself, so they are treated as property sales for tax purposes. This comes with multiple tax advantages:
- Cost basis: The cost basis of the affected land can offset the sale amount and reduce the income taxes on the deal.
- Tax rates: Generally, permanent easement income is taxed at favorable capital gains tax rates.
- Exchanges: Permanent easement sales (and temporary easements of 30 years or longer) may qualify for like kind exchange treatment.
Tax considerations for temporary easement exchanges
Temporary easements exist for a limited number of years and are treated as rent or lease income, as opposed to a sale. As such, they generally don’t qualify for like kind exchanges.
Other easement sale issues
There are other considerations too, such as how the easement will be used by the buyer. If the land use impacts your farming business or changes the land’s purpose, the easement may be treated differently from a tax perspective or have unique tax implications. If the land becomes unusable for agriculture, the easement would generally be treated as a sale. And if you grant the easement to a qualifying charitable organization, it could trigger a charitable deduction.
If the buyer’s land use causes surface or crop damage and you receive compensation, payments must be reported as ordinary income from farming.
Other considerations outside taxation
Evaluate all the accounting, legal and business implications of a transaction before you make a deal, including non-tax factors. An easement sale could affect your farming practices, future land improvements, cash flow and valuation. It could also influence how future generations use or inherit the property.
How Wipfli can help
Wipfli’s tax specialists can help you navigate complex easement sales. Our tax specialists take a whole company view of the business to help you make smart, long-term decisions. We want your agricultural business to thrive today — and for future generations. Learn more about how we can help.