Equine Business Year in Review 2002 Dean, Dorton & Ford, P.S.C. Page 1

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1 is published by Dean, Dorton & Ford's Equine Industry Group. We hope you find the information we present to be interesting and helpful. We welcome your feedback. Located in the heart of central Kentucky, known for its world-class horse farms, racing, and sales, Dean, Dorton & Ford has provided accounting, tax, and business consulting services to the horse industry since our inception in Our clients cover a broad spectrum of organizations involved in the horse industry, from small boarding farms to large multi-departmental farms involved in boarding, breeding, selling, stallion management, and crop production; from racing stables to a racetrack; from bloodstock agents to equine veterinary firms to equine insurance agencies; and from industry associations to industry publications. Not all of our clients are based in central Kentucky; horse industry clients from other parts of the country and from outside the United States also gain comfort by having our industry specialists work with them. As a firm, we endeavor to know the business of horses, not just accounting and tax rules relating to the industry. We accomplish this in a number of ways, including meeting periodically, often with outside experts, to discuss business topics of interest in the industry; by reading industry periodicals; by studying the abundance of statistical data available regarding different measures of industry performance; and most usefully, by working with our clients in the industry on their business matters. We perform a variety of services for our clients involved in the equine industry and welcome inquiries, whether from new participants in the industry who want assistance in properly structuring and administering their stables or farms, or from long-time industry participants seeking to improve the performance and administration of their equine operations. Members of our Equine Industry Group will be pleased to answer any questions you may have. Please call any of the following: Doug Dean, Richard Dorton, Joe Ford, Martha Jones, Leigh McKee, Steve Schnettler, Emily Dixon, or Lesley Howard. ADDRESS: 106 West Vine Street, Suite 600 Lexington, Kentucky TELEPHONE: (859) FAX: (859) WEB SITE: ddean@ddfky.com Dean, Dorton & Ford, P.S.C. Page 1

2 Dean, Dorton & Ford, P.S.C. - Equine Industry Group Accounting For smaller enterprises, directly performing many accounting, payroll, and clerical functions. Designing and implementing farm accounting and management information systems. Business Consulting Developing strategies to use the optimum forms of organization in which to conduct horse and farm businesses. Developing financial and business plans for farms, breeding operations, and racing stables. Financial analysis of stallion prospects. Designing and implementing retirement plan and other employee benefit programs. Tax Developing strategies to make maximum use of potential tax losses. Avoiding exposure to the hobby loss rules. Structuring transactions to avoid or minimize sales and use taxes. Avoiding or managing the potential impact of the passive activity loss rules. Using current and deferred trades of horses and farms to avoid or postpone income taxes. Using the involuntary conversion tax rules to defer income taxes on insurance recoveries related to horse and farm casualties. Estate planning designed to use special use valuation and family farm conservation incentives, family limited partnership strategies, and deferred tax payments. Handling multi-state tax allocations. Helping foreign owners and breeders to minimize exposure to U.S. taxes and comply with filing requirements. Developing tax accounting systems to comply, where required, with rules requiring capitalization of preproductive period costs. Representing clients with federal and state tax audits. Taking advantage of unique tax depreciation rules. Dean, Dorton & Ford, P.S.C. Page 2

3 Table of Contents Information and Commentary on Thoroughbred Public Auction Markets 4-8 Information and Commentary on Thoroughbred Breeders' Costs and Profits 9-11 Information and Commentary on Stud Fee Multiples Information and Commentary on Changes in Production Costs and Yearling Selling Prices for Thoroughbred Breeders Information and Commentary on Racing Purses Income Tax Consequences of Dispositions of Development Rights Dean, Dorton & Ford, P.S.C. Page 3

4 In millions of dollars $1,200 $1,000 $800 $600 $400 $200 Graph I Size and Composition of the Public Auction Market in Dollars 1987 to 2002 Data from The Blood-Horse $1,200 $1,000 $800 $600 $400 $ Yearlings Weanlings Two-Year-Olds Broodmares Inflation Adjustment 10,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 Graph II Number of Horses Sold at Public Auction by Type of Horse 1987 to 2002 Weanlings Yearlings Broodmares Two-Year-Olds ,000 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 Data from The Blood-Horse 0 Dean, Dorton & Ford, P.S.C. Page 4

5 Commentary on Graphs I and II A decline in the aggregate amount of dollars involved in thoroughbred public auction sales occurred again in 2002, the second down year after eight consecutive up years. On an inflation-adjusted basis, 2002 s dollars lagged 1987 s, but remain well above the 1992 level (nominally and inflation-adjusted), the lowest of the previous downturn. Sales by category (in dollars) as a percentage of the total auction market are as follows in recent years: Weanlings 10.9% 9.9% 7.8% 6.3% 6.5% Yearlings Two-Year Olds Broodmares The total number of horses sold at auction reached its highest level in 2000 (after seven consecutive years of increases), decreased 9% in 2001 and 4% in There were decreases in every category in 2002, with weanlings (19%) and broodmares (7%) decreasing the most. Yearlings and two-year-olds sold at auction each decreased 1% in % of the 2002 North American foal crop sold at public auction as weanlings, and 25% of the 2001 North American foal crop sold at public auction as yearlings. The following shows the relationship of these numbers to the three previous years: Weanlings 7% 7% 5% 5% Yearlings 27% 29% 25% 25% Dean, Dorton & Ford, P.S.C. Page 5

6 $65,000 Graph III Average Price at Public Auction by Type of Horse 1987 to 2002 Yearlings Weanlings Two-Year-Olds Broodmares $65,000 $55,000 $55,000 $45,000 $45,000 $35,000 $35,000 $25,000 $25,000 $15, $15,000 Data from The Blood-Horse Graph IV Average Price by Type of Horse by Decile 1998 to 2002 Yearlings Weanlings Two-Year-Olds $350,000 $350,000 $350,000 $250,000 $250,000 $250,000 $150,000 $150,000 $150,000 $50,000 $50,000 $50,000 Top 10% 2nd 10% Upper20-50% Top 10% 2nd 10% Upper 20-50% Top 10% 2nd 10% Upper 20-50% Data From Auction Review, The Thoroughbred Times Dean, Dorton & Ford, P.S.C. Page 6

7 Commentary on Graphs III and IV After average prices of each category - yearlings, weanlings, two-year-olds, and broodmares - declined in 2001, average prices of each category except yearlings turned back up in Average yearling prices, which had increased eight consecutive years , decreased 4% in 2001 and a whopping 17% in s average yearling price approximated 1998 s s average price for two-year-olds exceeded the average yearling price, the first time since Average broodmare price had declined a precipitous 33% in 2001, followed by an 11% increase in Average weanling price had declined 17% in 2000, then 24% in 2001, followed by a 15% increase in Graph IV examines the top 50% (by price) of each market segment yearlings, weanlings, and two-year olds - over the last five years. The following table shows the ratio by category of the top decile to the second decile in terms of average prices. Note how much more the top decile of prices has been than the second decile from at least three to more than five times: Yearlings Weanlings Two-Year Olds Dean, Dorton & Ford, P.S.C. Page 7

8 Note that the top decile average yearling price experienced a 27% decrease in 2002, following a 1% decrease in The second decile remained constant and combined third through fifth deciles increased 14% in Although not shown, each of the sixth through tenth deciles of yearling prices all increased from 2001 to This demonstrably reversed a general trend in which upper tier yearling prices had been increasing while all others had been generally stable or declining over several years. For two-year-olds, the average price in the top decile increased 3% in 2002 after dropping in 2001 (9%) and 2000 (4%). The average price in the top decile for weanlings increased in 2002 by 7% after declines in 2000 (13%) and 2001 (26%). The overall average price increase for weanlings of 14% in 2002 was comprised of an increase in each decile. Dean, Dorton & Ford, P.S.C. Page 8

9 Note: Dollar figures above bars on bar graph represent amounts remaining after other costs to cover mare and profit. Graph V Breakdown of Price of Yearling Sales into Cost Components -- Stud Fees, Sales Commissions, and Mare and Foal Board and Incidental Expenses -- Balance Available to Cover Cost of Mare and Profit YEARLINGS -- By Stud Fee Range 1998 to 2002 $800,000 $700,000 Stud Fees and Up $556,392 $567,224 $542,131 $499,500 $800,000 $700,000 Stud Fees $50,000 to $99,999 $800,000 $700,000 Stud Fees $30,000 to $49,999 $600,000 $600,000 $600,000 $500,000 $243,823 $500,000 $500,000 $164,954 $161,133 $146,015 $64,237 $24,112 $67,157 $84,715 $76,061 $79,434 $36,359 $800,000 $700,000 $600,000 Stud Fees $20,000 to $29,999 $800,000 $700,000 $600,000 Stud Fees $10,000 to $19,999 Balance After Other Costs to Cover Cost of Mare and Profit $500,000 $500,000 Sales Commissions Mare and Foal Board and Other Incidental Expenses $52,531 $24,302 $37,906 $12,855 $13,733 $11,183 $15,732 $5,984 $512 $762 Stud Fees Underlying Data from Auction Review, The Thoroughbred Times Dean, Dorton & Ford, P.S.C. Page 9

10 Note: Dollar figures above bars on bar graph represent amounts remaining after other costs to cover mare and profit. Graph VI Breakdown of Price of Weanling Sales into Cost Components -- Stud Fees, Sales Commissions, and Mare and Foal Board and Incidental Expenses -- Balance Available to Cover Cost of Mare and Profit WEANLINGS -- By Stud Fee Range 1998 to 2002 $800,000 Stud Fees and Up $800,000 Stud Fees $50,000 to $99,999 $800,000 Stud Fees $30,000 to $49,999 $700,000 $700,000 $700,000 $600,000 $500,000 $456,510 $302,244 $292,166 $235,729 $600,000 $500,000 $600,000 $500,000 $54,496 $95,551 $92,355 $31,335 $13,055 $26,692 $54,076 $31,741 $48,784 $24,729 $10,594 $800,000 Stud Fees $20,000 to $29,999 $800,000 Stud Fees $10,000 to $19,999 $700,000 $600,000 $700,000 $600,000 Balance After Other Costs to Cover Cost of Mare and Profit $500,000 $500,000 Sales Commissions Mare and Foal Board and Other Incidental Expenses $14,622 $21,975 $12,193 $5,546 $3,860 $6,502 $9,137 $1,377 $867 $600 Stud Fees Underlying Data from Auction Review, The Thoroughbred Times Dean, Dorton & Ford, P.S.C. Page 10

11 Commentary on Graphs V and VI We have analyzed data which shows the relationship of yearling (Graph V) and weanling (Graph VI) sales results to stud fee costs over , segmented by stud fee ranges (for the breeding year). These graphs show the portion of average sales price consumed by related stud fees, and add two other significant components of cost, a 5% sales commission and the cost of boarding and otherwise caring for the foal from an approximate weaning date until sold and the dam for a year. For this latter cost, primarily board and veterinary, we used $20,000 and $13,000 for yearlings and weanlings, respectively. We have not included sales tax on stud fees, because not all states tax stud fees and because stallion owners who use their seasons are not subject. The balance of average sales prices not consumed by the specific costs outlined above is available principally to cover the cost of using the mare for a year to produce the foal and, hopefully, to provide a profit to the breeder. We note in Graph V that for 2002 yearling sales where the dams were bred to stallions with fees of or more, there was a large decline (55%) in the amount available to cover the cost of the mare and provide the breeder with a profit. The decline also was quite substantial for breeders to $50,000 to $99,999 stallions (62%), the fourth consecutive decline in this tier. Breeders to stallions whose fees were in the $30,000 to $49,999 range also experienced major declines on average (54%), but in the $20,000 to $29,999 and $10,000 to $19,999 stud fee ranges, some increases occurred. In Graph VI, we note that the coverage for weanling sellers dropped in each stud fee range we present, except breeders in the $50,000 to $99,999 stud fee range, who experienced a 104% increase. For weanling sellers who bred to + stud fee stallions, average coverage of mare cost and profit declined 77%. Dean, Dorton & Ford, P.S.C. Page 11

12 6.00 Graph VII Ratio of Sales Price to Stud Fee - Yearlings 1994 to 2002 and up $50,000 to $99,999 $30,000 to $49,999 $20,000 to $29,999 $10,000 to $19, Underlying Data from Auction Review, The Thoroughbred Times Graph VIII Ratio of Sales Price to Stud Fee - Weanlings 1994 to 2002 and up $50,000 to $99,999 $30,000 to $49,999 $20,000 to $29,999 $10,000 to $19, Underlying Data from Auction Review, The Thoroughbred Times 0.00 Dean, Dorton & Ford, P.S.C. Page 12

13 Commentary on Graphs VII and VIII Considerable published data is available to breeders on stud fee multiples (sales price of yearling or weanling as a ratio of related stud fees) on a stallion-by-stallion basis. We have taken the data that groups stallions by stud fee ranges see Graphs V and VI and looked in Graphs VII and VIII at trends over time and relationships among different stud fee ranges. In doing this analysis, the stud fees are from the breeding year, not the sales year. The following table shows stud fee multiples for yearlings sold in 1994 through 2002, by stud fee range: Stud Fee and up $50,000 to $99, $30,000 to $49, $20,000 to $29, $10,000 to $19, We note that yearlings sired by the higher-priced stallions had multiples below the other stud fee categories in the mid-1990s, had substantially greater multiples in , but declined substantially in Dean, Dorton & Ford, P.S.C. Page 13

14 This table shows stud fee multiples for weanlings sold in 1994 through 2002, by stud fee range: Stud Fee and up $50,000 to $99, $30,000 to $49, $20,000 to $29, $10,000 to $19, Note that weanling sellers who bred to the highest-priced stallions have not on average achieved the highest multiples, except in stud fee multiples were less in the $50,000 and up stud fee ranges than in those ranges covering $10,000 to $49,999 stud fees. Dean, Dorton & Ford, P.S.C. Page 14

15 40% Graph IX Changes in Production Costs and Yearling Selling Prices for Breeders by Stud Fee Range and Decile Tier 1 Tier 2 Tier 3 Tier 4 Tier 5 Overall & up $50,000 - $99,999 $30,000 - $49,999 $20,000 - $29,999 $10,000 - $19,999 Average / 1st decile / 2nd decile / 3rd decile / 4th decile / 5th decile All Ranges Shown 20% 17% 17% Change in Price 0% -20% 6% -5% -8% 6% 4% 6% -16% -16% 0% 8% -8% -26% -32% -29% -23% -40% -39% -60% Change in Average Broodmare Change in Average Stud Fees Change in Average Yearling Selling Price by Decile (2001 to 2002) by Stud Fee Range (2002 to 2003) Price by Stud Fee Range (2001 to 2002) Data from the Blood-Horse and Thoroughbred Times Dean, Dorton & Ford, P.S.C. Page 15

16 Commentary on Graph IX In Graph IX, we try to provide insight into a critical question for breeders: Are your production costs increasing at a higher or lower rate than the prices you re receiving for your products? For costs of production, we focus on the two major elements: (1) broodmare costs based on public auction prices and (2) stud fees. For sales prices of breeders products, we examine auction prices of yearlings. The analysis is based on current production costs and current sales prices and does not attempt to correlate sales prices with the costs of producing these foal crops. In other words, we are focusing on current costs replacement costs and current sales prices. Specifically, we are measuring changes in stud fees by the change in published stud fees by stallion from 2002 to For broodmares, we are measuring the change in this cost by reference to changes in average auction prices from 2001 to Similarly, the change in sales price of yearlings is measured by reference to average auction prices from 2001 to We segment our analysis into five tiers: Tier Stallion cost stud fees of: Mare cost prices for reported sales at public auction: Sales prices yearlings sold at public auction and produced from stallions with these fees: 1 + Top 10% + 2 $50,000-99,999 2 nd 10% $50,000-99,999 3 $30,000-49,999 3 rd 10% $30,000-49,999 4 $20,000-29,999 4 th 10% $20,000-29,999 5 $10,000-$19,999 5 th 10% $10,000-19,999 These tiers can be considered to represent approximately the top one-half of the thoroughbred breeders market. We also show the overall changing cost and price levels for all the tiers we analyzed. Dean, Dorton & Ford, P.S.C. Page 16

17 The data shows mixed results. In the highest end of the market, broodmare prices are increasing but stud fees declining, providing some relief to breeders who generally are receiving substantially lower yearling prices. The same is true in the second tier. Overall, for the tiers we ve defined and analyzed, broodmare costs are up 8% and stud fees down 8% in the face of a 23% decline in yearling prices. Dean, Dorton & Ford, P.S.C. Page 17

18 Graph X Racing Purses and Numbers of Horses Racing $1,300 Gross U.S. & Canadian Purses 100,000 Number of U.S. & Canadian Runners $1,200 $1,100 90,000 In millions of dollars $1,000 $900 $800 $700 $600 80,000 70,000 60,000 $ , $18,000 Average U.S. & Canadian Purses per Runner 8.50 Starts per U.S. & Canadian Runner $17,000 $16, $15,000 $14, $13,000 $12, $11,000 $10, $9,000 $8, Data from the Blood-Horse and Thoroughbred Times Dean, Dorton & Ford, P.S.C. Page 18

19 Commentary on Graph X From 1990 to 2002, average purses per runner have increased from $8,700 to $16,800 93% (40% inflation adjusted). From 1990 to 1994, the increase in purses per runner was due primarily to a decrease in the number of runners (by 17%) gross purses changed only negligibly from 1990 to 1994 and were slightly lower in 1994 than in From 1994 to 2001, on the other hand, the increase in purses per runner was due primarily to an increase in gross purses available to owners (by 53%). The number of runners continued to decline during that period (by 5%). Note that 2002 showed the third consecutive year of increases in the number of runners and the ninth consecutive year of increases in gross purses. In 2002, the rate of increase in runners outpaced the rate of increase in purses, causing the first decline in our measurement period of average purses per runner. We also note that the increase in average purses per runner from 1990 to % - has more than kept pace with the increase in the average cost of purchasing yearlings and weanlings over the same period 49% and 72%, respectively, but is below increases in the cost of purchasing two-year-olds 135%. Starts per runner continued to decline in 2002, the tenth consecutive year. Dean, Dorton & Ford, P.S.C. Page 19

20 Income Tax Consequences of Dispositions of Development Rights Disposing of the Development Rights to Your Land Can Provide Beneficial Tax Results SUMMARY Generally the entire basis in the land affected by a conservation easement is recovered before gain is recognized upon a sale of development rights. It is possible to do a like kind exchange in conjunction with a sale of development rights. When development rights are sold for less than the reduction in fair value resulting from restricting development on the land, a charitable income tax deduction and an estate tax exclusion may be available. Proper planning early in the process is essential to maximize tax benefits. For more information on PDR programs in your area, check The American Farmland Trust s website ( The Nature Conservancy s website ( or your local land trust. There are a number of governmental and charitable programs for the purchase of development rights. In these programs, farm owners sell their development rights by placing a perpetual easement on the land restricting the rights of current and future owners to develop the land. Typically the sale is for the difference between the fair market value of the land before and after the easement. General Tax Rules Affecting Sales of Development Rights When a landowner sells his development rights, he is selling an interest in land. Under general tax rules, when a taxpayer sells a part of a larger property, his basis in the entire property must be allocated between the interest sold and the interest retained. However, in the case of easements, there is substantial authority in the tax law to the effect that it is impossible to allocate basis between the development rights sold and the other rights retained by the landowner. In that case, tax law provides that the landowner recovers his entire basis in the land before recognizing gain on the sale. Note that when a landowner sells his development rights to only a portion of the land owned by him, only basis in the land affected by the easement may be used to offset proceeds from the sale. Note also that sales of development rights typically do not reduce the value of improvements on the property. The discussion that follows assumes this more typical case. However, it is possible for an easement to reduce the value of improvements with the result that some of the proceeds from the sale will be allocated to the improvements, and the landowner will reduce basis in those improvements as well. Dean, Dorton & Ford, P.S.C. Page 20

21 Assume that a landowner has property purchased 10 years ago for $350,000 and used in his farming operation. At the time of purchase, of the purchase price was allocated to land. The current appraised value of the land (not including improvements) without a restriction on development rights is $500,000. The current appraised value of the land with a restriction on development rights is. If the landowner sells his development rights in the land for, he recovers his basis in the land and recognizes a gain of that will be taxed at favorable capital gain rates. The landowner has not used any of his basis in the improvements to offset the proceeds from the sale of his development rights. While this increases the capital gain recognized currently, it preserves depreciable basis in the improvements to offset ordinary income in the future. Bargain Sale of Development Rights What if the landowner sells his development rights worth for? This is considered a bargain sale. If the easement preserves open space either for the scenic enjoyment of the general public or pursuant to a federal, state, or local governmental conservation policy, and in either case yields a significant public benefit, and the organization receiving the easement is a qualified organization, then the landowner is entitled to a charitable income tax deduction (the difference between the value of the easement and the amount received on the sale). Assuming that the recipient organization is not a private foundation, this charitable deduction is limited to 30% of adjusted gross income and the landowner has the current year and five subsequent years to use the deduction. Note that in order to meet the scenic enjoyment requirement, it is not necessary for the general public to have physical access to the property visual access is sufficient. Tax law provides in the case of a bargain sale to a charity, the taxpayer must allocate a portion of his basis in the land to the charitable contribution. Using the facts in our example above, the taxpayer would allocate $40,000 of his basis in the land to the charitable contribution ( charitable value divided by $500,000 total value times basis). He would then use the remaining $60,000 basis to offset his proceeds from the bargain sale, resulting in a $40,000 gain taxed at capital gain rates. In this case, the taxpayer no longer has any basis in his land. However, because the value of the improvements was not decreased as a result of the easement, the landowner s basis in these improvements is undiminished. Like-Kind Exchange of Development Rights Tax law also makes it clear that a conservation easement is an interest in real estate that is of like-kind to a fee simple interest. Thus it is possible to do a like-kind exchange in connection with the sale of a conservation easement if all of the other requirements are met. As a result of the cost-recovery rules discussed above, a like-kind exchange of a conservation easement for other real property frequently will result in all of the landowner s basis in the land affected by the easement being transferred to the replacement property. Dean, Dorton & Ford, P.S.C. Page 21

22 If instead of taking the proceeds from the sale of the easement, our landowner exchanged the easement for other qualifying real estate, his basis in the land subject to the easement would be zero; his basis in the improvements on the retained property would be undiminished; and his basis in the replacement land would be the invested less the gain deferred, or. If the new property consists of land worth $75,000 and improvements worth $225,000, the landowner should allocate his basis between the two elements based on their relative fair market values - $25,000 to the land and $75,000 to the improvements and begin depreciating the improvements. Bargain Sale With Like-Kind Exchange Additionally, a landowner may couple a bargain sale of his development rights with a like-kind exchange of the proceeds from the sale. In that circumstance, using the example above, the landowner would receive a charitable income tax deduction. $40,000 of his basis in the land would be allocated to the charitable contribution. If he exchanged the rights to the sale price of the easement for qualified property, his basis in the replacement property would be the invested less the $40,000 gain deferred, or $60,000. Needless to say, there are many factors that a landowner should take into consideration when evaluating a sale of development rights, including his cash needs, his desire for additional property, his ability to absorb capital gains without current income tax due to tax losses, and his ability to use a sizable charitable income tax deduction. Early consultations with the organization accepting the easement, with tax advisors, and with a qualified appraiser will facilitate determining the best way to structure the sale and/or donation of a conservation easement. Summary of Results for Dispositions of Development Rights The following table summarizes the results in each of the examples discussed above. Note that the figures below discuss only the income tax consequences of dispositions of development rights. There are substantial estate tax benefits to making contributions (vs. sales) of development rights as well. These are discussed briefly below. Dean, Dorton & Ford, P.S.C. Page 22

23 (000s omitted) Contribution Sale Bargain Sale Like-Kind Exchange Like-Kind Exchange & Bargain Sale Pre-easement value of land $500 $500 $500 $500 $500 Post-transaction values: Post-easement value of land $200 $200 $200 $200 $200 Cash received - $300 $ Charitable contribution deduction $300 - $200 - $200 Value of replacement property $300 $100 Pre-easement basis in land $100 $100 $100 $100 $100 Post-transaction basis: Post-easement basis in land $ Basis used to reduce gain recognized - $100 $ Basis allocated to charitable contribution $60 - $40 - $40 Basis in replacement property $100 $60 Gain recognized - $200 $ Net cash position after transaction Cash received - $300 $ Tax on gain recognized at 20% tax rate* - ($40) ($8) - - Value of charitable deduction at 40% rate* $120 - $80 - $80 Net cash position $120 $260 $172 - $80 Net cash position and replacement property values $120 $260 $172 $300 $180 *Rates used are for sake of simplicity. They are approximate and do not consider the interplay of numerous other items that may impact each individual s tax situation differently. ESTATE TAX BENEFITS FOR CONTRIBUTIONS OF DEVELOPMENT RIGHTS If an individual or a member of his family contributes a conservation easement, then at the individual s death, his estate may qualify to exclude some of the value of the land subject to the easement from the individual s taxable estate. To qualify for this estate tax exclusion, the easement must meet the requirements for a charitable income tax deduction, the individual or members of his family must have owned the property at all times within the three years immediately prior to the individual s death, and at the time of the contribution of the easement, the value of the easement must have been at least 10% of the value of the land without the easement. This exclusion is in addition to the reduction in the land s value resulting from the restrictive easement. Where the value of the easement contributed was 30% or more of the value of the land immediately prior to the contribution, then the estate tax exclusion is 40% of the value of the land for estate tax purposes. The exclusion percentage is reduced by 2% for every 1% that the value of the easement was less than 30% of the value of the land immediately prior to the contribution. For example, if the Dean, Dorton & Ford, P.S.C. Page 23

24 value of the easement at the time of the contribution was 15% of the value of the land immediately prior to the contribution of the easement, then the exclusion percentage would be 10% - the 40% maximum exclusion percentage minus 30% (2 times (30% minus 15%)). The value of the exclusion is capped at $500,000 for individuals dying in 2002 or later. Using our examples above and assuming that the value of the land remains unchanged between the time of the contribution of the easement and the time of the donor s death, the following table shows the estate tax exclusions available. (000s omitted) Contribution Sale Bargain Sale Like-Kind Exchange Like-Kind Exchange & Bargain Sale Pre-easement value of land $500 $500 $500 $500 $500 Post-transaction values: Post-easement value of land/value at date of death $200 $200 $200 $200 $200 Charitable contribution deduction $300 - $200 - $200 Value of easement contributed as a percentage of the value of 60% 0% 40% 0% 40% and immediately prior to the easement Maximum estate tax exclusion $80 $80 $80 An expanded version of this article was published in the December 2002 issue of THE JOURNAL OF TAXATION. Leigh McKee Dean, Dorton & Ford, P.S.C. Page 24