Wetland Reserve Program

Wetlands are valuable to different people for different reasons. Some prize wetlands for the rich wildlife and fish resources found there. Others see wetlands as important areas for sediment retention, ground water recharge and flood control.

Small, seasonally flooded wetlands along streams and rivers provide places for animals to feed and reproduce. In these areas, small invertebrates occur in great numbers and become food for larger animals which, in turn, become food for even larger animals.

Many wetlands are valuable as roosting sites. For example, hollow trees in a wetland may be used by many cavity-nesting birds from wood ducks to chickadees. Some mammals, like squirrels, use standing, hollow trees as den sites. Others, like raccoons and otters, use hollow trees after they fall.

Three-fourths of the wetlands in the United States are controlled by private landowners. These remaining wetlands provide essential habitat for waterfowl and other wetland-dependent wildlife and if we are to ever increase their population, incentives such as the Wetland Reserve Program (WRP) will not only enable interested landowners to develop waterfowl habitat, but will help compensate them for removing their land from agricultural production.

WRP is one of the landmark environmental steps in the 1990 and 1996 Farm Bills. It is a voluntary program that offers financial incentives to landowners who have previously converted wetlands to cropland or pastureland. Mississippi, which ranks second in the nation in WRP enrollment, has restored over 89,000 acres since 1990. The Magnolia State has approximately 300 landowners participating.

The program was authorized for 975,000 acres. Recently, the program was about to come to an end until U.S. Senators Thad Cochran and Trent Lott added an additional 100,000 acres to WRP in the past session of Congress.

According to Peyton Self, President of the Mississippi Fish and Wildlife Foundation, "Senator Cochran's and Senator Lott's efforts have rescued the nation's largest wetland restoration program from being zeroed-out in the appropriations process. We are very blessed to have Senator Cochran and Senator Lott in Washington to provide the leadership to make sure we have sound conservation programs. They are to be strongly commended for their efforts to fund this important conservation program."

Landowners who apply and are accepted into WRP are compensated for the value of their land in exchange for restoring these areas. If the land offered is eligible, and the compensation requested is acceptable, cost-share assistance will be provided for restoring the land under a 30-year or permanent easement. Land will be restored to bottomland hardwoods and shallow water areas for wildlife. Certain compatible uses of the land under easement by the landowner will be permitted in exchange for continued maintenance of the land.

Under WRP, the Natural Resources Conservation Service (NRCS), the federal agency that administers WRP, acquires conservation easements on marginal, high risk lands that are vulnerable both to the vagaries of floods and droughts because of the nature of hydric soils. These marginal lands detract from a farmer's cash flow, and tend to experience repeated losses requiring disaster recovery assistance.

The average easement payment is approximately $600 per acre and the average cost of restoration is approximately $250 per acre. WRP provides a lump sum easement payment that may be used to payoff current debts or to meet current operating fund needs.

Additionally, WRP may provide farmers with both a temporary alternative source of income through the wetlands restoration contract and a permanent source of income from the recreational and lease hunting income generated by the valuable restored wetland wildlife habitat.

The public benefits from both the reduced financial demand for disaster assistance and crop insurance funds from lands that experience repeated losses and from significant long-term conservation benefits obtained from the protection of wildlife habitat, the improvement of water quality, the increase of flood storage and the reduction of soil erosion.

Landowners should contact their local office of the Natural Resources Conservation Service in their local U.S. Department of Agriculture Service Center for further information.

Tax Consequences of Wetlands Reserve Program

The Wetlands Reserve Program (WRP) is an important step forward in the conservation of natural resources. It provides a financial incentive for landowners to restore and maintain wetlands that benefit wildlife and water quality. To accomplish this, the landowner and the USDA Natural Resources Conservation Service (NRCS) enter into an agreement called a "conservation easement".

Many landowners who are considering the enrollment of land in WRP have questions about how the compensation they receive for the conservation easements will be taxed. Invariably, many participants in WRP ask, "Is the sale of an easement to the NRCS a taxable transaction?" Unfortunately, the answer is very complex and dependent on a number of different factors. Hopefully, this article will explain some of the more commonly asked tax questions in a way that is understandable to our readers.

According to John P. Paris, a Certified Public Accountant and Associate Partner with May and Company in Vicksburg, Mississippi, "Generally speaking, if the amount received in payment for the easement is greater than the basis of the easement, a taxable transaction has occurred. If there is a gain (amount realized minus the basis in the property), and the property has been held by the seller for more than one year, the gain will generally be treated as long term capital gain. The difficulty begins in trying to determine the basis in the easement, as the law in this question is unsettled. There may be at least two approaches, depending on the particular facts."

Paris states that in one situation, assume that the landowner believes that the value of the easement is greater than the amount paid by the NRCS. A charitable deduction in connection with a bargain sale may be available to the landowner if the easement that is sold is a perpetual conservation easement. In this situation, the basis in the underlying property must first be allocated between the easement and the restricted use fee, and then the easement portion further allocated between the easement and the charitable contribution.

Paris gives a good example. Assume that John and Jane Smith own a 1,000 acre farm they acquired many years ago for $400,000. Local real estate prices have increased dramatically and the land is now worth $1,000,000. Because of extensive wetlands close by, the NRCS has expressed an interest in purchasing a perpetual conservation easement from the Smiths.

An appraiser for NRCS has determined that the agricultural value of the land is $800,000, and NRCS has offered the Smiths $800,000 for the easement. The Smiths hire an appraiser who determines that the easement is worth $900,000. The Smiths sell the easement to NRCS for $800,000 creating a $100,000 charitable contribution deduction.

The Smiths' $400,000 basis in the land is first allocated according to the portions of the value represented by the easement and the value represented by the restricted use fee. The easement represents 90% of the value of the land ($900,000 of total value of $1,000,000), and the restricted fee represents 10% ($100,000 of $1,000,000). Therefore, $360,000 of the Smiths $400,000 basis (90%) is allocated to the easement and $40,000 (10%) is allocated to the restricted use fee. Once this is done, the $360,000 basis of the easement must be allocated $320,000 to the "sale" portion of the transaction ($800,000 for the easement appraised at $900,000) and $40,000 to the "gift" portion ($100,000 of $900,000). On the sale portion, the Smiths have a gain of $480,000 ($800,000 sale price less $320,000 basis).

In a second situation, assume that a landowner does not claim a charitable contribution in connection with the sale of an easement to NRCS. In this situation, a 1977 Internal Revenue Service ruling suggests that the entire basis in the property may be used to offset potential gains realized on the sale of the easement.

Again, assume instead that the Smiths 1,000 acre farm they acquired many years ago for $400,000 is now worth $600,000. Assume the Smiths sell a perpetual conservation easement to NRCS for $600,000. The Smiths agree the value of the easement is worth $600,000 and do not claim a charitable deduction. In this situation, all of the Smiths basis in the land can be attributed to the easement. The gain subject to tax would be $200,000 ($600,000 minus $400,000).

"Another factor in determining the taxable effect of selling of an easement is the type of entity you are. In S Corporations and partnerships, income, gain, loss, etc., at the entity generally flow through to shareholders for tax purposes, although in some cases gain will also be taxed at the entity. The S Corporation taxation rules are quite complex; however, an advisor familiar with these rules should be consulted. For C Corporations, there may be very few income tax benefits from charitable contributions by the corporation, especially for most family farms, where there is very little income. Additionally, although there may be no gain at the corporate level from the sale of the conservation easement, the dividends paid to the shareholders to distribute the sales proceeds will produce taxable income to the shareholders," states Paris.

In addition to receiving a payment for the conservation easement, a landowner may also receive cost-share payments to restore and protect wetlands. Under a restoration cost-share agreement, a landowner agrees to undertake approved conservation-related improvements on the property in return for a cost-share payment, generally between 75 and 100 percent of the costs for restoring the wetland. A conservation easement and a restoration cost-share agreement may be combined in one agreement with the Department of Agriculture but separate payments are made for the easement and for the cost-share agreement. Under most circumstances, cost-share payments received are excluded from gross income.

"As a word of caution, we are often asked if the seller should be concerned if there is a mortgage on the property. The tax consequences discussed above are not affected by the existence of a mortgage. Do be aware that taxes may be due on the sale proceeds whether or not the mortgage holder requires payment of some or all of the easement sale proceeds. Without proper planning and communication with the mortgage holder, the seller of an easement may have to pay all of the sale proceeds to the mortgage holder and still owe taxes on the sale proceeds. Please note that this article is not intended to be an exhaustive recitation of all of the tax, legal, and financial issues and consequences, but is rather a summary of some to the most important federal tax points. In addition, this article includes a number of generalizations. A landowner who sells a conservation easement to NRCS should seek individual tax and legal advice," concluded Paris.

John P. Paris can be reached at May and Company, 110 Monument Place, Vicksburg, Mississippi 39180. His telephone number is (601) 636-4762. His e-mail address is jparis@maycpa.com.

Photos by Michael Kelly