How many farmers reading this blog have received payment in exchange for granting an easement on your lands?
We’ve seen a fairly significant increase in this over the past few years, which leads to today’s topic: the income tax ramifications of selling an easement on your lands.
An easement can take different forms, which depend on its purpose and duration. The income tax ramifications of selling an easement can also differ.
Sale of easement tax treatment
You probably know you’re required to report the sale of an easement for income tax purposes. If you’re granting the easement to a qualifying charitable organization, you can trigger a charitable deduction. But let’s focus on the other option, which is selling the easement, and go over some tax planning strategies.
It will depend on whether the easement is temporary or permanent.
Temporary easements exist only for a limited number of years. They are treated as rent or lease income.
Permanent easements are perpetual or don’t have a specified end date. They are treated as a property sale. This means you can treat the easement as a sale, which has multiple advantages:
- The cost basis of the affected land can offset the sale amount. This reduces the income taxes on the deal.
- Generally, the income will be taxed at favorable capital gains tax rates.
- The sale could qualify for like kind exchange treatment.
IRS regulations allow the sale of a leasehold interest of 30 years of more to qualify for like kind exchange treatment. This causes a dilemma, however, because there is no authority to treat easements of this duration as a sale for tax calculation purposes. If the sale of a 30-year leasehold qualifies as a sale for like kind exchange purposes, then why would it not qualify for cost basis offset and capital gain treatment?
As the frequency of significant easements continues to grow, I suspect that the IRS and the courts will provide guidance in this area.
Another matter farmers need to be aware of is that any payment for surface or crop damages should be reported as ordinary income from farming.
Contact us with your questions
When evaluating a sale of an easement, you should also make sure to take into account the significant non-tax factors. These include the impact of the sale on: your farming business and farming practices, future improvements on the land, future generations of farmers who will be using the property, and cash flow and land valuation.
All this, plus the legal details, should be carefully reviewed and evaluated when deciding how and when to move into an easement sale. Having a tax advisor assist you can be very valuable. If you have any questions related to easement tax analysis, reach out to us.