Written By Jim Sullivan, Land Conservation Consultant with Forever Forests LLC.
Did you know there are ways to balance oil and gas production with conservation, so society can enjoy the benefits of both? These two activities do not have to be exclusive of one another. You can explore for gas and oil, with conservation intentions. How? Through what is known as a conservation easement.
“What is a conservation easement?” A conservation easement (also known as a conservation restriction or conservation agreement) is a voluntary legal agreement between a landowner and a land trust or government agency that permanently limits uses of the land in order to protect its conservation values. It allows landowners to continue to own and use their land, and they can also sell it or pass it on to heirs. The limits of the conservation easement “runs with the land,” meaning that even if the land is inherited or sold the restrictions stay in place.
The tax treatment of a conservation easement is laid out in the Tax Code in IRC Section 170(h). You get a charitable deduction for the value of the easement when the easement is donated to a qualified land trust or governmental agency. This can be a nice income tax break, especially since you are not giving up your land. You are just determining to preserve it in its current state. The value of your deduction should be determined by a sound valuation, which must be done by a qualified appraiser experienced with conservation easements. This choice can also make a lot of sense for estate planning purposes because it saves your heirs money on estate taxes. Long after you’re gone, a conservation easement will ensure your land is used according to your wishes too.
A conservation easement can work with sub-surface gas and oil exploration, if you follow the rules.
On the topic of mineral rights the tax code is clear—a conservation easement prohibits surface mining. Period. That said, a conservation easement can work with sub-surface gas and oil exploration, if you follow the rules. It’s what’s known as a “qualified mineral interest.” So, as a landowner, you shouldn’t automatically dismiss the possibility of a conservation easement for fear that it would tie your hands from potential oil and gas development on your land. Under certain circumstances, oil and gas development can occur on lands placed under a conservation easement. Sometimes it can work, sometimes it cannot. In occasions where it makes sense, this lesser known (and often misunderstood) provision in the tax code may provide an answer for some land owners and investors.
Although placed in the tax code 35 years ago during the Reagan Administration, this strategy is particularly relevant in our present era. You may have noticed that in certain financial sectors, there has been a call for investors to vacate fossil fuel investment entirely. However, for varied reasons, many land owners and investors are not convinced they should take such sweeping measures. Yet these same individuals might openly embrace oil and gas investments that were pursued with responsible environmental stewardship in mind. For this type of investor or land owner, the approach I am suggesting might be a better fit for them.
In circumstances where it works, the economic implications can be huge. Take a minute to imagine—a conservation easement that preserves a ranch’s splendor in perpetuity, all the while generating a charitable deduction useful to offset up to 50% of your Adjusted Gross Income. (For farmers and ranchers, it has been up to 100% of their AGI). You get to carry forward surplus deductions, possibly up to sixteen years till you are done using them. Now combine that with income from successful mineral exploration. This deduction can make some (if not much) of that mineral income tax free. And further consider this – the CE tax benefits are not in lieu of the tax benefits already provided to gas and oil exploration. They are in addition to them! That’s right – the depletion allowances typically allowed, as well as the deductions for tangible and intangible drilling costs are all still intact to offset your risk in the deal. That’s what you could call a “Double Barrel Deduction”!
Something else your accountant is likely to love is that the tax benefits from neither CE’s nor those from gas and oil exploration are subject to “passive income limitations”. Therefore, these deductions can offset taxes on all income – from real estate rentals, REIT’s, active stock trades, businesses, royalties, capitals gains, salaries, etc. You’ve got to check with your tax professional to determine what your tax savings outcome would be. All told, this can add up to meaningful environmental benefits, and great financial returns.
The gas and oil exploration cannot be irremediably destructive of significant conservation interests.
Like anything else, it’s all about following the rules. I like to say “the divine is in the details”. With mineral exploration that starts with limited, localized impact. The gas and oil exploration cannot be irremediably destructive of significant conservation interests. In addition, a written plan for the remediation of the limited surface disturbance after exploration is complete is an important part of the process.
Another rule which must be considered is known as “screening.” That means essentially taking reasonable steps to camouflage, or minimize the visual impact of the facilities while mineral exploration is in process. This can be done just by choosing the right color or design of the paint applied to equipment. Have you ever seen a cell phone tower made to look like a tree? Or another type of antenna made to look like a flagpole? If so, you get the idea. This can be done at a reasonable cost, and goes a long way in honoring the provisions in the Tax Code that allow you to enjoy the benefits of conservation easements as well as the income benefits derived from successful oil and gas exploration.
It is also critically important before you get started to determine who actually owns the mineral rights. Run the title search early! Your state’s laws can be complicated, and you might not own (or control) as much as you might think.
If all this sounds complicated, it’s because it can be. But taking the extra effort to do your homework is well worth gaining the added benefits. The conservation easement process must follow exact procedures, and that’s where experienced guidance is vital. Don’t try a CE alone. Even more so, don’t try a CE in tandem with exercising sub-surface gas and oil exploration without the right team of professionals.
This type of effort can reap great environmental and financial rewards, but here is a three step road map to success:
- STEP ONE is utilizing a team with a strong background in conservation easements, protecting wildlife, open space, farms and forests – but that is not enough.
- STEP TWO is utilizing experts versed in oil, gas and mineral laws in your state, and…
- STEP THREE is working with tax professionals who understand the requirements of IRC Section 170(h).
Following these steps, you can conserve the beauty of your land for generations to come. With the right land opportunity, expert geologists to tap into the minerals, and a qualified team of professional outlined above, gas and oil can “go green” too!