What are the Tax Rules on Easements?

With the increase in sale of easements for wind power or for recreational use, it is important to examine some of the rules and history of cases involving easements.

The general rule concerning the treatment of easements may be found in Treasury Regulation
Section 1.61-6 (a) which states as follows:

“When a part of a larger property is sold, the cost or other basis of the entire property shall be equitably apportioned among the several parts. The realized gain or sustained loss on the part of the entire property sold is the difference between the selling price and the cost or other basis allocated to each part. The sale of each part is treated as a separate transaction, and the gain or loss shall be computed separately on each part. Therefore, gain or loss shall be determined at the time of sale of each part and not deferred until the disposal of the entire property has been disposed of.”

Editors Note: The following story appeared in the December 2006 issue of Farm and Ranch Tax Letter. For more information on Farm and Ranch Tax Letter see the end of the story.

When there is a sale of an easement, there are two methods of allocating basis:

-The actual portion of the property affected by the easement.

-The rights created by the easement and the rest of the rights in the property.

If title to the land is retained, the payment for a permanent easement is applied against the basis of the land affected by the easement. If the payment exceeds the basis in the property, a taxable gain will be realized. However, Revenue Ruling 72-255 states that the entire basis in the property cannot be offset against the easement sale unless the entire tract is affected.

So, for example, Sam Farmer grants an easement that involves 2 acres of a 40-acre tract to an electrical utility company for $8,000. Sam purchased the entire 40-acre tract for $4,000 in 1952. Since only 2 acres of the tract were involved, the sale of the easement would essentially be the sale of the 2 acre tract. So, his basis for the purpose of calculating gain would be $ 200 ($4,000 purchase divided by the 40 acres in the tract times the 2 acres affected by the easement). Sam would recognize a $ 7,800 taxable gain to be reported in Part I, Form 4797 assuming the utility company.

Other Easement Issues:
The purchase price of an easement cannot be depreciated or amortized because an easement does not have a definite useful life. However, if the easement sold is only for a specific number of years, a deduction for amortization may be claimed by the individual purchasing the easement
Another type of basis allocation is between the rights retained by the taxpayer and the easement rights that are sold. This allocation can create a problem unless the easement covers the entire tract that holds the easement. Often an easement, such as a conservation easement, covers the entire property.

Two separate revenue rulings govern the allocation of cost basis:

Revenue Ruling 77-413 indicates that the basis in the property in question must be allocated between the interest sold and the interest retained based on the irrespective fair market value compared with the fair market value of the entire property.

Revenue Ruling 77-414 states that if it is impossible to allocate the basis between the interest that is sold and the bas is that is retained, then an amount received for the easement can be used to reduce the basis in the entire property.

More:

The Farm and Ranch Tax Letter is published monthly at a subscription rate of $49 per year. For subscription information or to receive one free copy contact frmandranchtaxletter@earthlink.net or send your adress to Ag Executive Inc., 115 East Twyman, Bushnell, IL 61422.

Note: As with all tax information, contact a qualified tax representative for more information.

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