Purchasing Forest Land (Timberland)
is a big decision. It is important to properly plan
for taxes. The following information is based on information
published by the U.S. Department of Agriculture and
offers important considerations for you to keep in
mind.
PURPOSE FOR OWNING TIMBER
Forest owners must classify their timber management
activities into one of three categories for tax purposes:
- Trade or business
- Income-producing (or “investment”)
- Personal use
The distinction of activities is important
in terms of how income, expenses and losses are treated
and reported for tax purposes. The type
of forms that are required and the ways in which you
can classify expenses are determined by how you classify
the timber. For example, owners who are active participants
in a timber business can fully deduct ordinary and
necessary management expenses on Schedule C or F of
Form 1040. In contrast, owners who hold timber for
investment purposes must report these expenses as
miscellaneous itemized deductions on Form 1040, Schedule
A, where they are subject to income limitations.
Note: There is no tax advantage
to holding timber for personal use.
TAX BASIS FOR TIMBER
The tax concept of the cost of your forest land and
timber is known as "basis". When properly
documented, timber basis can reducing the taxable
proceeds from timber sales, thereby lowering your
taxes. This enables reforestation cost recovery or
allows timber loss deductions. Setting
up your basis, and documenting it properly, helps
avoid missing important deductions.
The tax law describes how to determine the basis of
property acquired by purchase, gift, inheritance,
tax-deferred exchange, replacement in an involuntary
conversion, or through reforestation.
The records necessary typically include:
- Purchase price
- Timber volume and value (or the per-acre value
of premerchantable timber)
- Survey, legal and accounting fees solely for acquisition
- For timber received as a gift, the basis in the
hands of the person making the gift, plus any gift
taxes paid
- Separate value of land, timber and other capital
assets such as bridges or roads (i.e., their individual
fair market value) on the date of acquisition, by
purchase or inheritance
- Costs of planting, such as site preparation,
seedlings, hired labor, fertilization and depreciation
on equipment used.
Gathering this data in a timely manner (preferably
when the property is acquired) can prevent future
problems. Setting up timber basis retroactively is
acceptable, but typically needs the help of a professional
forester. An excellent way to keep track of timber
basis is to use IRS Form T (Timber) “Forest
Activities Schedule,” Part II (see “Form
T,” below).
TIMBER MANAGEMENT EXPENSE
Generally when there is a profit motive, ordinary
and necessary expenses incurred for managing forest
land as a business or an investment are deductible
even if there is no current income from the property.
Interest and property tax are currently deductible,
but you may elect to capitalize them if doing so provides
a tax benefit. For example, owners who hold timber
as an investment and take the standard deduction may
elect to capitalize interest and property tax since
they are itemized deductions.
Ordinary and necessary expenses associated with timber
management generally include the costs of post-establishment
timber cruises, consultation fees paid to foresters
and brush control, the cost of protection from fire,
insects and disease, precommercial thinning, timber
stand improvement, tools of short useful life, travel
directly related to timber activities, and the cost
of hired labor and mid-rotation fertilization (Revenue
Ruling 2004-62).
Costs associated with a timber sale, including a
pre-sale timber cruise, should be deducted from the
sale proceeds. Costs associated with establishing
a timber stand, including supervision by a consulting
forester and brush control, are part of the timber
basis and can be deducted and amortized accordingly
(see “Timber Planting Costs,” below).
TIMBER PLANTING COSTS:
Under IRC section 194 a taxpayer may elect
to deduct outright up to $10,000 per year of qualifying
timber establishment costs, and amortize any additional
amount over 84 months (8 tax years,
due to the half-year convention), rather than capitalizing
and recovering them at the time of a timber sale.
Example 1: Mrs. Johnson
plants 50 acres of timber in 2007 at a cost of $7,000.
She can elect to deduct all $7,000 of the cost on
her 2007 income tax return because it is less than
$10,000.
Example 2: If Mrs. Johnson’s
planting cost was $14,000, her total deduction for
2007 would be the $10,000 limit on deductions, plus
1/14 of the amount over $10,000, or $287 ($4,000 ÷
14, due to the half-year convention). She can deduct
$571 ($4,000 ÷ 7) on her returns for 2008 through
2013, and the final $287 on her return for 2014.
Note: Once Mrs. Johnson has filed
her income tax return for 2014, the contribution to
her timber basis from the planting will be $0. Elect
to use this provision on Form 4562 (Part VI) on a
timely filed return (including extensions).
If your timber property is located in a special hurricane
zone (i.e., Gulf Opportunity Zone or the Rita or Wilma
GO Zone) and you own no more than 500 acres of forest
land altogether, the $10,000 deduction
is increased to a maximum of $20,000 per tax year
for planting costs incurred through the end of 2007
(IRC section 1400N(i)(1)). The hurricane zone provisions
are not available to publicly traded corporations
or real estate investment trusts.
COST SHARE PAYMENTS
Cost-share payments generally must be included in
income unless a section 126 election is in effect.
Under this election, cost-share payments from qualified
government programs may be wholly or partially
excluded from income. Federal cost-share
programs that qualify for exclusion include the Conservation
Reserve Program (CRP), Environmental Quality Incentives
Program (EQIP), Forest Land Enhancement Program (FLEP),
Wildlife Habitat Incentives Program (WHIP) and Wetlands
Reserve Program (WRP). Various state programs also
qualify.
The process of calculating the maximum excludable
amount of a qualifying cost-share payment is shown
here by example:
Example: Mr. Drew, a Texas
landowner, sells $21,000 worth of timber in 2007 and
reforests his 30-acre tract at a cost of $6,000, including
a $2,000 cost-share. He uses the 6.08% interest rate
under Farm Credit System for the Texas region in 2007
to calculate how much of the cost share he can exclude.
Answer: The maximum excludable
amount of the cost-share payment is the present value
of $2.50 per acre or 10% of the average annual income
from the tract over the last 3 years, whichever is
larger: $2.50 x 30 = $75; 10% x ($21,000 ÷
3) = $700; the present value of $700, the larger of
the two amounts, is $700 ÷ 6.08%, or $11,513;
Mr. Drew can exclude the entire cost-share payment.
Without the harvest, the maximum excludable amount
of the costshare would be only $1,234 ($75 ÷
6.08%). Mr. Drew would have to include the remaining
$766 ($2,000 – $1,234) in his income, but he
could then deduct it using the reforestation deduction
and amortization provisions.
TIMBER INCOME
In almost every situation, it is to your benefit
for your timber sale income qualify as a long-term
capital gain. One important reason is
that long-term capital gains are taxed at lower rates
than ordinary income, and are not subject to self-employment
taxes.
To qualify for long-term capital gain treatment,
you must hold your timber for more than
12 months. Timber held as an investment
qualifies under IRC section 1221. Report a sale on
Form 1040, Schedule D, Part II. Timber held as part
of a trade or business qualifies
under IRC section 631(b). Report a sale on Form 4797,
Part I, whether it was outright (lump-sum) or pay-as-cut.
If you as the owner, cut standing timber
yourself, and sell cut products to a
mill, all the proceeds are ordinary income unless
you elect on Form T, Part II, to treat
it as an IRC section 631(a) transaction.
If you have a section 631(a) election in effect, the
income from holding the standing timber is a capital
gain and only the additional amount from converting
the timber and transporting it to the mill is ordinary
income.
When you sell or dispose of timber, you can take
a timber depletion deduction
against the proceeds. The deduction allows you to
recover a part of your adjusted timber basis that
is proportional to the volume of timber harvested.
TIMBER LOSSES
In general, loss deductions are permitted to property
held for business or investment purposes. It is important
to note that your deduction for a loss is limited
to your adjusted basis in the asset lost, minus any
insurance or other compensation received.
A casualty loss is caused
by natural or outside forces that are sudden, unexpected,
and unusual – e.g., by fire, ice storm or hurricane.
A loss that is unexpected and unusual but occurs over
time – e.g., by disease or insect attack –
is a non-casualty loss.
Other kinds of loss, timber theft and
condemnation, result from human activity.
A timber theft loss is deductible in the year you
discover it.
To calculate a loss deduction, start with the adjusted
basis in the account you use to keep track of the
“block” that includes the damaged area.
If you keep track of all your timber in one account,
use the adjusted basis in that account. Next, determine
the difference in the fair market value of the property
in the block immediately before and immediately after
the loss. Court cases have established that a salvage
sale is a separate event from a loss, so the “after”
figure should include the value of any salvageable
timber in the block. Your loss deduction is the lesser
of your basis in the block or the decrease in value.
Keep in mind that basis verification and reasonableness
of valuation are two of the main audit areas by the
IRS.
FORM T:
If you claim a timber depletion deduction, make a
Section 631(a) election or sell timber outright under
section 631(b), you are required to file a Form
T (Timber) “Forest Activities Schedule”.
Owners with occasional sales may be excepted from
this requirement, but it is considered prudent to
file. Even if you are not required to file Form T
in a given year, it is an excellent way to keep your
timber tax records. An electronic version of the form
can be found at: http://www.irs.gov/pub/irs-pdf/ft.pdf.
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