Colorado has created a grand experiment using private markets to preserve open space through a transferable state income tax credit. Landowners who agree not to develop their land and place it in a permanent conservation easement are able to earn up to $100,000 in state income tax credits that they not only can use themselves, but can sell to other taxpayers in the state.
The rationale behind the legislation is that tax deductions or state credits that cannot be transferred only benefit the wealthy. In Colorado, however, some of the best land to conserve is owned by low-income farmers and ranchers. The new Colorado law, implemented in 2000, was meant to level the playing field so all landowners could benefit from preserving their land from development by allowing them to sell their credits for cash. It worked with amazing speed. The first year the tax incentives were in place, the state awarded $1.3 million in tax credits. By 2005 and 2006, the amount of tax credits swelled to more than $80 million each year. By this time, a healthy market was established for the transfer of these credits. This fact is interesting from the environmentalist’s perspective because it shows that a tax incentive with a private market component has had an impact unlike any earlier tax incentives.
The Nuts and Bolts
Buyers originally paid 90 percent of the face value of the tax credits and sellers received 80 percent of the value. The broker made a 10 percent commission. So, if a farmer donated a conservation easement for a $100,000 tax credit that he chose to sell, he would have netted $80,000 from the sale. The buyer would have $90,000 (thereby saving $10,000 versus paying his or her taxes directly) and the broker made $10,000.
A few laws influenced the shape of the market. First, there was a cap on the amount of credits a landowner could earn on a donation. The cap was $100,000 for donations in years 2000–2002; $260,000 for donations in years 2003–2006; and $375,000 for donations in 2007 or later. Initially there was a cap on how many credits a buyer could purchase, but that was lifted early in the process, essentially allowing buyers to purchase an unlimited number of credits in a given year.
It is easy to see that buyers had more bargaining power than sellers in these transactions and the market rewarded the buyers accordingly. Once a few buyers approached the brokers, demanding a larger discount for their purchase of several million dollars in credits, the brokers began to see the light. Within the second year of the program, the buyers had convinced the brokers to give a bigger discount by reducing the broker’s commission to 5 percent. Thus, the new formula was that sellers received 80 percent, buyers paid 85 percent, and brokers’ commissions were 5 percent. This formula stayed in place through 2004.
Another interesting rule is that through 2004, credits had to be purchased by Dec. 31 in order to be used on the buyer’s tax return for that year. Starting in 2005, credits could be purchased as late as the following April 15 for use on the previous year’s tax return. Allowing procrastinators to purchase tax credits created an influx of buyers entering the market in 2005.
As tax credits became hot commodities, sellers realized they had more power. Tax credit brokers had hungry buyers who were willing to take a smaller discount in order to obtain the credits. When faced with not being able to purchase credits, they were willing to pay more to get the scarce supply, especially as the April 15 deadline approached. Sellers were receiving 80 to 82 percent of the value of their credits in 2005—the transition year.
By 2006, the market had stabilized at 82 percent to sellers and 87 percent for buyers. Buyers were still standing in long lines trying to purchase tax credits and some were told that if they didn’t sign up for credits by January, they might not get any credits by April 15. My company, Tax Credit Connection, ended the year with several million dollars worth of buyers whom we could not supply with credits.
In 2007, it appeared the market would continue to climb. Prices went up to 83 percent for sellers and 88 percent for buyers. Then, a perfect storm occurred. Prices started spiraling down over a period of only a few months. Several things contributed to the collapse of the sellers’ profits. For the first time, sellers received the higher ($375,000) cap on tax credits (up from the $260,000 cap in 2006). Many sellers who were planning to make a donation at the end of 2006 realized they would earn more credits on the same donation in 2007—more donations occurred in 2007 that normally would have taken place in 2006.
In addition, there were federal tax incentives expiring at the end of 2007. People who were considering a donation in 2007 or 2008 rushed to make their donation in 2007. Add to that the fact that the maximum credit limit on single donations was raised 44 percent. The result was a glut of credits on the market. Figures have not yet been released for the total 2007 tax credits created.
Supply was up, which is not a bad thing, but demand was down. In October 2007, the state launched an investigation into fraudulent appraisals, which made headlines in the Denver newspapers almost weekly from October through the following February. Tax credit brokers received frantic calls from accountants and wealth managers asking what to tell their clients about the tax credit market. Was it safe to purchase credits? Unfortunately for sellers, many of the buyers were too concerned and confused to buy any tax credits, even ones that were created by the most reputable appraisers and land conservation organizations. Demand nearly evaporated during January through March of 2008 the time of year when most of the transactions usually occur.
In classic economic textbook fashion, the market pendulum swung the opposite direction and prices started going down. By February 2008, many of the tax credit brokers had lowered their commissions by a point to try to stimulate demand. By and large that didn’t work. Brokers then started talking to their sellers about lowering their prices. The sweet spot seemed to be 80 percent for sellers and 84 percent for buyers. In fact, it worked so well that my company sold as many credits in the first two weeks of April as in the previous 50 weeks combined.
Tax Credits for Conservation
What does this mean for conservation and the people of Colorado? Since the inception of the program, nearly 1.2 million additional acres have been preserved in Colorado, farmers and ranchers are still able to get a valuable cash infusion (albeit a bit smaller than a year ago) for agreeing not to develop their land, and taxpayers can save more than they had in the recent past for investing in tax credits. To date, $292 million in credits have been claimed by Colorado taxpayers, putting those dollars (or at least 80 percent of those dollars) in the hands of Colorado’s farmers, ranchers, and owners of wildlife habitat for the services they have been providing to residents free of charge. Coloradoans now know that the scenic vistas, wildlife habitat, and productive farm and ranchland, which they have valued for many generations, have been permanently preserved through the payment to the landowners by way of conservation easement tax credits. So far, two other states (New Mexico and Virginia) have followed Colorado’s lead and, according to land conservation specialists in other states, it is likely that more will follow once there is evidence that Colorado has weathered the storm of fraud.