Can Selling a Conservation Easement Count for a 1031 Exchange?

A conservation easement is an agreement between the landowner and another entity (usually a government agency but potentially a nonprofit organization) that limits specified development activity on the property. Typically, the purpose is to protect some aspect of the land, possibly recreational or scenic attributes, historical value, or geologic or ecological sensitivity. Often the easement allows the owner to continue living on or using the land while ensuring long-term protection from prohibited uses like development.

An easement protects the land from specified uses in perpetuity, not just during the current ownership. Across the U.S., more than 540 million acres are protected by such easements, restricting both current and future owners from prohibited activities. The landowner volunteers for the easement, but the agency or nonprofit assumes the responsibility for enforcement. Because an easement limits the landowner’s right to develop the land in specific ways, the taxpayer typically gets a tax deduction for the value even though they remain the owner of record. The reason for the deduction is that the landowner has partially or wholly reduced the land's value by binding future owners to the stated conservation requirements.

Easements may be donated, sold, or exchanged.

A property owner can donate the easement and receive the benefit of a charitable contribution or sell the easement for a portion of the land’s appraised value. Some nonprofits seek easements on ecologically or otherwise sensitive lands, offering payment for the conservation restrictions. If an owner accepts payment for the restrictive covenant of an easement, that act will limit their entitlement to a tax deduction.

Owners can also trade easements for other properties through the execution of a 1031 exchange. The 1031 exchange is named for section 1031 of the Internal Revenue Code, which allows investors to defer payment of capital gains taxes when they sell an asset and reinvest the proceeds. In standard 1031 exchanges, a taxpayer sells a designated parcel and replaces it with one or more properties with an equal or greater value, reinvesting the entire proceeds from the sale. If the taxpayer successfully adheres to the IRS’ requirements for conducting the exchange, they can defer recognition of any appreciation on the relinquished property, leveraging their ability to use the entire sales proceeds.

Usually, a 1031 exchange is employed to sell one piece of property and reinvest in another. The motivation might be to change locations, switch from one sector to another, or change from active management to passive investment. With an exchange using a trade of an easement for more land, the motivation could be to offset the relinquished value of the easement by acquiring additional property. The investor gets the benefit of the capital gains tax deferral and can fully utilize the value of the easement.

In Private Letter Ruling 9621012, the IRS allowed a landowner to trade a conservation easement for an additional property using a 1031 exchange for the transaction. The landowner provided the easement in trade for timberland in 1996. As a result, they were able to defer recognition of the gain obtained by trading the conservation easement for additional acreage.