Timber Sale Proceeds and Federal Taxes

There are also additional benefits of treating timber proceedsas a capital gain.  If the timber sale qualifies for capital gaintreatment, the income is not subject to self-employment tax.  Also, if aforestland owner has capital losses, these losses can be used to offset thecapital gain.  If the timber sale proceeds were declared as ordinaryincome, capital losses may be used to offset only $3,000 dollars of ordinaryincome.

When standing timber, or the right to cut standing timber, issold the income may be treated as long-term capital gain if the timber has beenowned for more than one year.  This holding period requirement must also bemet when disposing of timber acquired by gift.  However, both the donor'sand recipient's time of ownership is counted.  For inherited timber, thereis no required holding period in order to qualify for long-term capital gainstatus.

In order to determine the amount of the capital gain, a"basis" must be determined.  The "basis" of an asset isthe capital investment that one has in property that produces income.  Formost forestland owner's, the capital investment is the acquisition cost whichwould include commissions and fees, foresters and surveyors, and the purchase price.

The commissions and fees element and the foresters and surveyorselement of the capital investment are usually quite evident.  The purchaseprice, however, is dependent on how the property was acquired.  If theproperty was acquired as a gift, the basis (purchase price) of the property is equal to the donor's basis plus tax.  For example, if an individual held aproperty for 20 years and then gifted it to another person, the receiving parties basis is equal to what the donating parties basis was.

If the property was inherited, the basis (purchase price) is "stepped-up".  Property acquired by inheritance has a basis equalto the fair market value on the date of death of the decedent or the alternativevaluation date if an alternate date is chosen.  The fair market value isusually greater than the basis to the decedent.

If the property is purchased, the purchase price is what waspaid for the property.  However, this purchase price must be allocated toall of the assets of the property.  Forest property typically includesseveral assets.  Separate accounts should be established for each type of asset in order to receive the proper tax treatment.  For example, a typical property will have three capital accounts.  The first would be depreciable items, the second bare land value, and the third would be timber value.  Dealing with depreciable assets can become complex, and is beyond the scope of this article.  The reader just needs to be aware that in some instances depreciable assets should be looked at.

The allocation of original cost basis can be completed bydetermining each asset's proportionate share of total fair market value and thenmultiplying the total cost of acquisition by this share.  For example, if aproperty is acquired that has buildings valued at $50,000 dollars, bare land at$10,000 dollars, and timber at $40,000 dollars, the fair market value of that property is $100,000 dollars.  The building asset accounts for 50% of the total fair market value and the bare land and timber account for 10% and 40%respectively.  If the property were purchased for $80,000 dollars, thebuilding basis would be $40,000 dollars ($80,000 x 50%), the bare land basis would be $8,000 dollars ($80,000 x 10%), and the timber would be $32,000 dollars($80,000 x 40%).

The original cost basis allocated to marketable timber, using the above procedure, is available as a deduction from the timber sale receipts.  If all the marketable timber is sold, the total revenue received is reduced by the cost basis in determining taxable gain.  If only a part of the marketable timber is sold, then a proportionate part of the basis may be deducted from the amount received.  This is done through the use of depletion units which will be discussed in further detail in a future NEFCo newsletter.

The introductory paragraph of this article encourages landowners to declare timber sale proceeds as a long-term capital gain.  In order to do that, the long-term capital gain amount must be determined.  Essentially, the long-term capital gain will equal the gross timber sale proceeds less the timber sale expenses and the depletion.  The long-term capital gain can be declared a number of different ways and you will receive various opinions from different accountants as to which way to file.  However, in most cases where a landowner files an IRS form 1040, the long-term capital gain can be declared on Schedule D.  An attachment should be filed along with Schedule D showing how the "purchase price" and gain have been calculated.

There is also a specific tax form relating to forestry.  This is Form T (Timber) - Forest Activities Schedules.  Once again you will receive various opinions as to the need of filing this form.  It is my understanding that this form should be submitted annually, however that the IRS has not enforced this requirement.  Consultation with your accountant will provide you with more detailed guidance, but at a minimum I recommend that you complete this form, keep it up to date, and keep it on file.

Taxes on timber sale proceeds can be significant.  However, proper planning can reduce the affects of taxes and allow the landowner the greatest financial return.  Insuring that timber sale proceeds are accounted for as a long-term capital gain will, in most cases, be financially advantageous.  However, in order to do this some pre-planning must be done.  Communicating with a NEFCo forester and your accountant concerning a potential timber harvest will allow you to make a decision that is financially advantageous to you and in your best interest.