Understanding Easements: Types, Uses, and Benefits in 1031 Exchanges

Easements are generally legally binding agreements allowing property owners to grant specific rights for use of the land within the easement to third parties while retaining overall ownership of the land. Beyond their traditional uses, easements can be Relinquished or Replacement Property in 1031 Exchanges, enabling property owners to utilize the proceeds of the easement to reinvest into more productive like-kind property while deferring traditionally associated taxes with real estate transactions. This blog explores the general concept of easements, their various types and uses, and how they can be utilized in the context of 1031 Exchanges to maximize financial benefits and investment opportunities.

What is an Easement? 

An easement is a type of real property interest wherein a landowner grants another party specific rights to use the landowner’s real property for a designated purpose, typically in exchange for compensation. These agreements are often created to address needs such as providing access to land, facilitating the installation of utilities, or preserving the land for conservation purposes. For example, a utility easement allows utility companies to install and maintain infrastructure like electrical, water and gas lines. A conservation easement on the other hand, is created when a landowner restricts development on their land to protect natural or historical features. Easements can be either perpetual, lasting indefinitely, or for a fixed term, based on the easement agreement. As recognized real property interests, easements may be sold as part of 1031 Exchange transactions, allowing property owners to defer associated taxes while reinvesting in like-kind properties. 

Types of Easements 

Easements serve various purposes and can assume different forms depending on the needs of the property owner and the rights granted. Below are examples of easements: 

• Access Easements: Access easements grant specific rights to the grantee of an easement to use another landowner’s property for purposes like ingress and egress (access) to the property of the person acquiring the easement. Examples are creation of a common driveway, livestock driveways, access roads to irrigation ditches or canals or temporary access rights for construction, access to equipment, etc.  

• Utility Easements: Utility easements allow utility companies to install and maintain infrastructure such as power lines, water pipes, or telecommunication cables on private property. These easements are typically restricted to specific areas of the property and do not transfer ownership.  These easements may involve a small easement area to provide utilities to one parcel or huge multi-state utility transmission lines. 

• Conservation Easements: Conservation easements are agreements designed to protect land for environmental, recreational, or historical purposes by restricting development or changes that could harm the land’s natural or cultural value. These easements are often used to preserve open spaces, natural habitat, protect endangered or threatened species, create greenbelts, or preserve historic structures. Unlike the other types of easements described herein, the grantor of a typical conservation easement is agreeing to restrict the use of their land. Typically, those purchasing conservation easements are government agencies or conservation organizations.  

• Ditch, Canal and Water Line Easements: These easements are created when a landowner grants a third party, sometimes a government entity, the right to construct, maintain and repair ditches, canals or waterlines across a landowner’s property to transport water for irrigation, domestic or municipal uses. These easements may also allow the easement owner to access water diversion structures. These easements may involve just one relatively small property parcel but can involve multiple landowners and large water conveyance systems  

• Gas and Oil Pipeline Easements: These easements typically involve large projects allowing for underground or above ground transport of oil and natural gas across multiple states and multiple landowners.   

• Cell Tower, Billboard, Wind and Solar Easements: These easements are created when landowners grant rights to others to build and maintain structures like cell towers, billboards, windmills and huge solar panel installations on a landowner’s property. These easements can be granted by private landowners or in some instances by governmental agencies. In some cases, these easements may include long-term lease agreements to the easement holder for the pads or area utilized by the structure, creating an additional revenue stream for the landowner. 

Terms of Easements 

Easements can be structured with different durations, depending on the needs of the parties involved. The terms of an easement can significantly influence property management, income potential, and long-term planning. Easements are typically written agreements, there is an entire area of the law that deals with prescriptive easements, easements by necessity and the like. For purposes of this article, we will only address written, legally binding easement agreements.   

• Perpetual Easement: A perpetual easement has no fixed end date and lasts indefinitely. These types of easements are often preferred because of their simplicity and long-term stability. They offer property owners a reliable and consistent income stream, making them especially beneficial in cases where ongoing access or preservation is required, such as with utility or conservation easements. In the 1031 Exchange context, perpetual easements are “like kind” to fee ownership of real estate and the proceeds from the sale of perpetual easements can be used to acquire any other real property interests meeting the like kind standard.  

• Fixed or Short-Term Easements: Easements that are less than perpetual can be of any length. Some easements may be temporary and very short term in the case of construction easements. Other easements can be of any stated term. The important feature of these less-than perpetual easements in the 1031 Exchange context is that they are not like kind to other fee interests in real property. However, a 1031 Exchange is still possible, as long as the proceeds from the sale of a fixed or short-term easement are used to exchange into another fixed or short-term easement

Ways Property Owners can Achieve Tax Benefits with Easements 

Donating an Easement

Donating a conservation easement allows property owners to restrict land use for preservation or conservation without transferring full ownership, offering significant tax benefits. These qualified conservation contributions, often used to protect open spaces, natural habitats, or historic structures, are donated to charitable organizations or government entities. The key to these transactions is that the property owner does not receive any monetary consideration for the easements, choosing instead to avail themselves of the charitable contribution tax deductions. The Exchanger should consult with their CPA or other advisors to determine the various deduction benefits available to them based upon the type of easement being granted. 

In 2006, President Bush signed The Pension Protection Act, the first substantial change to the conservation easement tax system in over two decades. Before the Act, Section 170(b) of the Internal Revenue Code imposed stricter limits on the deductibility of a qualified conservation easement. Individuals could typically deduct the value of a conservation easement donation up to 30% of their Adjusted Gross Income (AGI) for the year (50% for qualified farmers and ranchers), with any unused deductions eligible to be carried forward for an additional five years. The Pension Protection Act increased the tax incentives for easement donations, as it allowed individuals who donate an easement to deduct up to 50% of their AGI in a given tax year (100% for qualified farmers and ranchers), with any unused contributions eligible to be carried forward for up to 15 years. Donations of appreciated property remain the same, limited to 30% of income with a 5-year carryover.

Nine years later, the Conservation Easement Incentive Act of 2015 was enacted, permanently amending the Internal Revenue Code to solidify the tax incentives introduced in the Pension Protection Act for charitable contributions of real property interests aimed at conservation purposes.

Conservation Easements as Relinquished Property in a 1031 Exchange 

The conveyance, or sale, of a conservation easement may be treated as a Relinquished Property in a 1031 Exchange, allowing Exchangers to defer associated taxes by acquiring like-kind Replacement Property. To qualify under IRC Section 1031, an easement must represent a perpetual interest in the land and most conservation easements are structured in that fashion. Since payments for easements are typically made upfront, utilizing an easement sale as a relinquished real property interest aligns well with the 1031 Exchange process. Temporary easements do not meet the requirements set forth in the Section 1031 regulations 

To execute a 1031 Exchange, the transaction must follow specific requirements. A Qualified Intermediary (QI), such as Accruit, must enter into an exchange agreement with the Taxpayer/Seller and manage the sale proceeds and acquisition of qualifying Replacement Property(ies) to ensure compliance with the tax code. Additionally, the transaction must be structured as an exchange rather than a straightforward sale. Improper structuring of the sale of a conservation easement can lead to unintended tax consequences. 

Evolution of Conservation Easements for Tax Benefits 

Conservation easement donations have been tax-deductible since 1976, when Congress established this incentive. Initially, the tax benefits were limited to deductions for conservation purposes, allowing landowners to donate easements to protect natural resources and claim charitable tax deductions. However, the initial activity in conservation easements was relatively slow because Taxpayers in the agriculture sector who were the natural source of conservation easements didn’t need or want charitable contributions due to harsh economic conditions; many of them were operating at a loss. The incentives for conservation easements changed dramatically when government agencies and conservation groups began offering substantial sums of money to property owners for conservation easements. Landowners now leverage easements not just for land preservation, but for reinvestment in more productive properties or other investment opportunities. 

Donating an easement, while still an option, may no longer make as much sense for many property owners as it may have in the past. Charitable contributions of easements can yield tax deductions, but these benefits are typically capped by IRS limits on charitable contributions. However, some landowners are still motivated by a conservation ethic and not the money and the charitable contribution is sufficient incentive. In contrast, selling a conservation easement and redeploying the cash proceeds in an exchange can result in significantly greater financial diversification coupled with tax deferral. By choosing to sell rather than donate, property owners can better optimize the value of their real estate while still contributing to broader land-use or conservation goals. 

Easements are more than just legal agreements. They are tools enabling property owners to optimize land use and reinvest proceeds from easement sales into other like-kind property. Whether preserving natural resources through conservation easements, enabling infrastructure development with utility and other energy related easements, or enhancing highway and road systems, easement sales offer significant flexibility and benefits to property owners, third parties involved, and the general public. By leveraging easements effectively, property owners can strike a balance between private rights and public interests while maximizing the value of their real estate assets. 

The material in this blog is presented for informational purposes only. The information presented is not investment, legal, tax or compliance advice. Accruit performs the duties of a Qualified Intermediary, and as such does not offer or sell investments or provide investment, legal, or tax advice.