Evaluating conservation easements

Open space conservation easements on golf courses have been a source of considerable debate for some time.

Conservation easements are interests in real estate that restrict the future development of property while preserving the land and its resources in perpetuity. It is a legal vehicle for monetizing the preservation of open space that can, if all the ducks are in a row, be an opportunity for golf courses to continue operations and be paid for the incremental value sacrificed by not alternatively developing the land.

Golf course properties are often an excellent opportunity for conservation easements, in many cases legitimately. However, when the highest and best use, sometimes, at least a partially subjective analysis, is fabricated as it is in some cases, a donation can be made to seem more than it really is. Both property owners and appraisers had better follow the rules. The Internal Revenue Service can make your life miserable, even if you don’t try to fabricate a larger-than-allowable deduction.

Back in 2016, I read with great disappointment an article in the Wall Street Journal about a conservation easement denied by Federal Tax Court for St. James, a golf property in North Carolina. Having experience with these cases and seeing first-hand the havoc the IRS can bring, I question not the science of “native vegetation and wildlife” or the difference between “fairways and bird flyways,” but rather the fairness of the IRS denying deductions for clear reductions in property value as a result of sacrificing development rights. While there is no doubt that abuses have occurred, it is equally clear that preserving open space is a common goal, and that some form of compensation is appropriate. Many golf courses and clubs sit on sites that could most certainly be put to “higher and better use.” Accordingly, in order to preserve these courses as open space, one option to make it economically feasible to do so is the granting of a conservation easement. I’m not sure the characterization of the benefit as a “tax break” is appropriate given that the owner is sacrificing significant flexibility and both present and future value by giving up his or her development rights. While there are potential alternatives for clubs to monetize the preservation of open space through local, regional and state programs, the conservation easement is perpetual and doesn’t require cash payments beyond the (not insignificant) costs of establishing the easement. In today’s golf economy, that’s a biggie.

The St. James case dealt a blow to the conservation community as well as the golf industry because it further squeezes the economic profile by taking away an option as golf courses struggle for profitability. As with most issues, this one will probably become politicized. However, I don’t see this as a Democratic/liberal or a Republican/conservative issue, but rather an issue of whether open space is important and how to incentivize potential donors of easements (especially in the golf industry) and make it affordable to do so. From my perspective, science is less important from an economic perspective. It simply comes down to the difference in market value between a site that can become a 400-unit housing development and one that remains a golf course. With many golf course properties trading for 1+/- times gross revenue, the owner is potentially devaluing the property by a significant amount.

It’s no secret that former President Donald Trump owns several golf course properties. One garnering particular attention relating to conservation easements is the Trump National Golf Club in Rancho Palos Verdes, California. Trump purchased the property in 2002 and planned luxury housing adjacent to the course. A major obstacle to Trump’s plans occurred when city geologists denied clearance for development of 16 homes because of unstable soil underlying the course. After eight years of litigation, in 2014, the development plan was scrapped and Trump sought — and secured — an open space conservation easement on the site (11½ acres), which would allow him to continue using it as a practice area for the club. The resulting income tax deduction was reportedly $25 million.

All that seems legit, right? There’s one catch. In order to benefit from donating a conservation easement, there has to be value before the donation that isn’t there after the donation. This method of valuation is known as the “Before and After” method of valuing an easement. The “highest and best” use of property must be a use that is reasonably probable in the foreseeable near future, though it need not be the current use or an intended use of the property. Highest and best use is that which meets the following four tests:

1. Physically possible
2. Legally permissible (zoning or restrictive covenants)
3. Financially feasible
4. Maximally productive

Whichever use meets each and all of those four tests is the property’s highest and best use. When the highest and best use changes, so does the value.

While Trump, his lawyers and appraisers apparently claim that the highest and best use went from being developed with 16 luxury homes to remaining as a golf practice facility, the question is whether those homes could ever really be developed. Without approvals, and with a questionable likelihood of getting those approvals, the highest and best use of the property is uncertain. Now, since I haven’t seen the appraisals and don’t know if the property’s highest and best use would’ve been for development were it not for the instability, or if the instability could have been corrected for a cost and time period making the development feasible, I can’t be sure this is the case. I’m not opining on whether it was or wasn’t.

What this brings to light is the issue of highest and best use in conservation easements. You have to give up something to get the deduction. If the property could not have been approved for the “before” use, the highest and best use would’ve been the “after” use to begin with. Thus, there’d be nothing to “donate” and no right to a deduction. Qualified appraisers are (or should be) well-trained in the analysis of highest and best use.

Highest and best use is generally defined as “that use which nets the property the highest present value.” The four tests are quite logical and the process pretty straightforward. Unfortunately, there are investors — and appraisers willing to please them — who seek a “free lunch.” As a supporter of the theory of conservation easements, and a big fan of their use on golf course properties, I think it’s great that some golf courses can remain as golf courses in perpetuity even as real estate values evolve. However, as an appraiser dedicated to objective valuations with high levels of integrity, I support doing them the right way.

In 2020, a lawyer friend sent me the 11th U.S. Circuit Court of Appeals decision in the case of Champions Retreat Golf Founders, LLC, Riverwood Land, LLC, Tax Matters Partner (CHAMPIONS) v. Commissioner of IRS (IRS). I’m no lawyer, but this decision seems significant for golf facilities seeking to benefit from the conservation easement process.

In short, a conservation easement, if placed on a property that could be otherwise developed and donated to an appropriately qualified third-party trust can provide income tax benefits to the donor in return for the amount of value lost by relinquishing those development rights. In this case, “The appellant taxpayer claimed a charitable deduction for donating a conservation easement over property that included a private golf course and undeveloped land. The Commissioner of Internal Revenue disallowed the deduction, and the Tax Court upheld the decision. The deduction was proper if the donation was made for ‘the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem,’ or was made for ‘the preservation of open space ... for the scenic enjoyment of the general public.’ I.R.C.”

What is particularly significant in this case is that the Appeals Court clearly viewed golf courses in a more favorable light (as compared to the IRS and Tax Court) with respect to the definition of a “natural habitat,” a key component of conservation easements, and reversed the Tax Court, in favor of the appellant.  Reportedly, this is the first time that an Appellate Court has reversed the Tax Court on what constitutes the preservation of a “Natural Habitat,” a key element of conservation easement purposes and attributes. The Tax Court had rejected CHAMPIONS’ biologist expert testimony regarding threatened or endangered species of birds despite documenting more than 60 different species because:

• The names were not found on all the lists published for such species and they were located outside the boundaries of the golf course which comprised about 70 percent of the conservation easement property, and;
• The birds had to be seen by both the taxpayer’s experts even if the birds were also seen by the Commissioner’s expert in order to qualify.

The appeals court found otherwise. Preservation of significant vegetation is a key component for qualifying as a conservation easement and the CHAMPIONS property is home to the dense flower knotweed. The Tax Court had rejected the expert testimony regarding the importance of preserving this plant, opting instead to conclude that commonly used chemicals for golf course maintenance would destroy it. The 11th Circuit Opinion observes that not only would development of the property destroy this species, but also that the recipient of the easement (the trust) had the right, under the easement to restrict or stop chemical use that would damage or destroy the plant.

Scenic enjoyment of a property for the public is also a legitimate element in assessing the bona fides of a conservation easement. The property is situated on the Savannah River, and on the opposite bank is a national forest. Someone kayaking on the Savannah River and the Little River, which runs through the easement, could see the site and that would be one of the attractions of kayaking on those waterways. The Tax Court, as it was in many cases before was so focused on the site’s use as a golf course making it seriously doubt whether the land was donated for “the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem,” or for “the preservation of open space ... for the scenic enjoyment of the general public (that) will yield a significant public benefit.”  The Appeals Court clearly cut through that prejudice, noting that, without the golf course, the deduction would have been allowed by the tax court. The Appeals Court approved the tax deduction despite less than 30 percent of the property containing the “Natural Habitat,” and the Scenic open space area covering a small portion of the 436-acre site.

Of particular interest to golf courses is that, “What matters under the Code and regulation is not so much whether all the land is natural, but whether the habitat is natural. Indeed, the regulation says it is not disqualifying that the land has been altered, so long as ‘the fish, wildlife, or plants continue to exist there in a relatively natural state.’ 26 C.F.R. § 1.170A- 14(d)(3)(i). The commissioner’s expert noted nothing unnatural about these birds’ existence; they apparently find the habitat quite suitable.”

This case should make it easier for golf course owners to donate conservation easements involving golf courses. There will continue to be the requirement that the highest and best use of the property be both legitimate and supported for an alternative use.

Even with the economic fortunes of golf courses having improved during the COVID-19 era, they still represent an inefficient use of land, and the current housing shortage that exists will continue to make golf course sites targets for residential developers — probably at higher prices than the golf facility or club can command in many cases. Thus, conservation easements and their attendant tax benefits can still be a much more viable options for those owners who seek to continue golf operations and preserve open space. The concept of open space preservation is one that often arises in conversation with my clients. Given the intense scrutiny from the IRS, substantial risk of being targeted, and cost of establishing conservation easements, I sometimes counsel them to seek alternatives, if available. Sometimes, there are state, regional and local programs available for funding the preservation of open space to consider. This may seem like the IRS is taking away rights, but with their unlimited resources and substantial powers, even if the taxpayer wins, he loses, after all the costs and time fighting them are added up. It’s unfortunate, but it may be the best business decision unless the benefit is significant. All of us in the golf industry support the concept of preserving open space, especially golf courses. Conservation easements are one tool to make it economically feasible to avoid development. However, it is not without challenges.

Larry Hirsh is the president of Golf Property Analysts and has executed assignments on more than 3,000 courses in the United States and Canada. He is a certified general appraiser, licensed real estate broker and author.