. . . . -- -.-.c . z

Department of Agriculture

Forest Service

Southern Region

R&TP 34

April 2001

A Key to Your Most Frequently Asked Questions

By: Harry L. Haney, Jr., Wtlliam C. Siegel, and Larry M. Bishop
Introduction

This publication examines the most common situations noncorporate taxpayers. face when calculating Federal income tax on their timber holdings.

It addresses aspects of each situation using a three-column format. The columns are: Type of Forest Activity, How to Qualify for Best Tax

Treatment, and Reporting and Tax Forms. The responses are necessarily brief, and taxpayers should consult the other sources of information listed

at the end of this publication for a more comprehensive discussion of these issues.

The major purpose of this publication is to provide taxpayers with a quick reference to the Internal Revenue Service (IRS) forms necessary when

filing Federal income tax returns for forestry-related activities. Nonetheless, each taxpayer must first determine whether he or she operates his or

her timber activities as an investment, a trade or business (hereafter referred to simply as business), or for personal use.

The Internal Revenue Code (IRC) of 1986 and IRS regulations do not specifically define these categories. Nevertheless, investments and

businesses must have a profit motive for management and operating expenses to be deductible. Profit for tax purposes occurs when income from

an investment or business exceeds the expenses in a given year. Profit also includes the appreciation in value of assets. This concept is

particularly relevant to timber, which increases in value through physical growth and enhanced quality even though it may not be

harvested for a period of years.

In addition, a business must rise to a higher level than an investment, in terms of scope, regularity, and continuity of activities. Once the

determination is made, the taxpayer must report income and expenses in a consistent manner.
A Key to Your

Most Frequently Asked Questions

Page

1 . Made a Timber Sale

l Capital gains or ordinary income for investors . ..*.............................................................. 4

l Capital gains or ordinary income for a trade or business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

l Expenses of sale . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..I. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..*.....*..*.... 6

l Installmentsales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

2 . Incurred a Capital Expense

l Capitalization and basis ..*...**.....................*.....*...*** ..*.....................................*.......... 8

l Reforestation Expenses

o Reforestation tax credit . . . . . . . . . . . . . . . . . . . , . . . . . ..*..*......*.............................................. 9

0 Reforestation amortization .,....................................*......*.*....*........................... 1 0

l Depreciable assets . . . . . , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ...*. 1 1

3. Incurred Forestry Operating, Management, and Protection Expenses

l Timber management expenses, property taxes, and interest (general) ........................................ 1 2

l Timber trade or business in which you materially participate ................................................. 1 3

l Timber trade or business in which you do not materially participate ......................................... 1 4

l Investment ............................................................................................................ 1 5

4. Received Cost-share Payment

l Included in income .*.....,.....*...........*......*........... . . . . . . . . . . . ..*.......*...................*............ 1 6

l Excluded from income . . . ..*.*.......*..................e.... . . . . . . . . . . . . ..*....................................... 1 7

5. Incurred a Timber Loss or Realized an Involuntary Gain *

l Casualty loss ........................................................................................................ 1 8

l Timber theft ......................................................................................................... 1 9

l Public condemnation ............................................................................................... 2 0

l Gain from involuntary conversion ................................................................................ 2 1

3
UIIILCU xares

Departnlent of

Agriculture

Forest Service

Southern Region

! R8-TP 34

April 200 1

Federal Income Tax on Timber

A Key to Your Most Frequently Asked Questions

Harry L. Haney, Jr., Garland Gray Professor of Forestry, Department of Forestry,

Virginia Polytechnic Institute and State University, Blacksburg, Virginia

/

William C. Siegel, Attorney and Forest Service Volunteer, River Ridge,

Louisiana

i Larry M. Bishop, Forest Management and Taxation Specialist, USDA Forest

Se&ice, Southern Region, Atlanta, Georgia
1. Made a Timber* Sale

l Capital gains or ordinary income for investors

Type of Forest Activity

Timber held as an investment (rather than as a

business) is a capital asset. Generally, profits from the

sale of investment timber can be treated as a long-term

capital gain. Long-term capital gain status is

advantageous because it lowers tax liability; because

self-employment taxes do not apply; and, whereas the

offset of capital losses against ordinary income is

limited to $3,000 per tax year, capital losses can offset

capital gains in the same tax year without limit. An

additional advantage is discussed on p. 2 1, “Gain from

involuntary conversion.” Generally, the maximum

long-term capital gains tax rate for timber is 20 percent

(for taxpayers in the lowest ordinary income tax

bracket, the maximum long-term capital gains rate is

10 percent).

How to Qualify for Best Tax Treatment

An investor may consider lump-sum timber sale

proceeds long-term capital gains when certain holdingperiod requirements have been met. For purchased

timber, the holding period is one year. Generally, no

holding period applies to timber received through

inheritance. Special holding-period requirements

apply to timber received as a gift, depending on details

of the transaction; but the beneficiary does not need to

have held the timber for longer than 1 year.

Investors may also claim capital gains under a “pay-ascut contract” (a Section 63 l(b) transaction) or by

electing to treat the cutting as a sale (a Section 63 l(a)

transaction).

Reporting and Tax Forms

Net capital gains from a lump-sum timber sale are

determined by deducting from the gross sale price

(sfumpuge, or price of the standing timber) its adjusted

basis, as well as any sale costs. Adjusted basis is the

original cost, inheritance value, or donor’s basis (gift

tax is included in some instances), as adjusted for

subsequent transactions. Adjusted basis is discussed in

more detail on p. 8 through 11. Lump-sum timber

sales for all investors are reported on Schedule C,

Profit or Loss from Land and Timber Sales, of

Form T (Timber), Forest Activities Schedules. They

are also reported on the appropriate Schedule D,

Capital Gains and Losses.

See p. 5, for information about reporting Section 63 1

transactions.

* The term “timber” includes the parts of standing trees that could be used to manufacture lumber, pulpwood, veneer, poles, piling, crossties, chip-n-saw, and other wood

products. Also included are evergreen (conifer) trees aged 6 years or older when severed from their roots and sold for ornamental purposes; e.g., Christmas trees.
1. Made a Timber* Sale

l Capital gains or ordinary income for a trade or business

Type of Forest Activity How to Qualify for Best Tax Treatment

Proceeds from timber held for use in your business,

or which is sold to customers, as stumpageincluding timber specified in a right-to-cut

contract-will qualify for long-term capital gains if

both holding-period and method-of-disposal

requirements are met. Disposal includes sales where

the owner maintains an economic interest or elects

to treat the cutting as a sale. Sole proprietors and

members of a partnership whose timber holdings

constitute a business may be required to pay selfemployment tax on ordinary income, but on capital

gains they pay none.

Landowners holding timber assets, or individuals or

entities that have contracted to cut timber as part of

their business, may generally qualify proceeds from

timber disposal as a long-term capital gain.

However, the timber must be disposed of under a

pay-as-cut contract, and the landowner must

maintain a retained economic inferesl. Holdingperiod requirements and capital gains rates apply

(see pi 4, Capital gains or ordinary income for

investors). When timber is cut by the owner, or his

or her agent, rather than sold as stumpage, part of

the proceeds also may be considered long-term

capital gains, but only if he or she elects to treat the

cutting as a sale and the holding period includes the

first day of the owner’s tax year. The part that may

be considered a capital gain is the difference

between the timber’s adjusted-basis (see p. 12

through 15) and its fair market value as stumpage on

the first day of the tax year when cut, less expenses

directly associated with the cutting.

Reporting and Tax Forms

Net taxable gain is determined for timber

disposed of when there is a retained

economic interest by deducting from gross

receipts the adjusted-basis and sale costs (a

Section 63 1 (b) transaction). When the owner

cuts timber and elects to treat the cutting as a

sale (a Section 63 1 (a) transaction), net

taxable gain is determined by deducting the

adjusted-basis (depletion allowance) from the

fair market value of the standing timber on

the first day of the tax year in which the cut

occurs. Timber disposals are recorded on

Schedule C, Profit or Loss From Land and

Timber Sales, of Form T (Timber), Forest

Activities Schedules. Net gains or losses are

then reported on Form 4797, Sales of

Business Property, and transferred to the

appropriate Schedule D, Capital Gains and

Losses. The election to treat the cutting as a

sale under Section 63 1 (a) is made on

Schedule F of Form T (Timber).

* The term “timber” includes the parts of standing trees that could be used to manufacture lumber, pulpwood, veneer, poles, piling, crossties, chip-n-saw, and other wood

products. Also included are evergreen (conifer) trees aged 6 years or older when they are severed from their roots and sold for ornamental purposes, e.g., Christmas trees.
1. Made a Timber* Sale

l Expenses of sale

Type of Forest Activity

Sale expenses include the costs of timber cruising

and marking, sale advertising, and log scaling. Fees

paid to consulting foresters, appraisers, attorneys,

and other advisors directly related to sale activities

also may be included.

How to Qualify for Best Tax Treatment

It is essential to keep good records-supported by

receipts, travel logs, and other evidence tying

expenses directly to sale operations or cutting

activities. As the scope and scale of operations

increase, a business journal and appropriate recordkeeping procedures are particularly useful.

Reporting and Tax Forms

Sale expenses are deducted Tom the gross sale price

received for timber. If the revenue is reported as

ordinary income, the deduction is made on

Schedule A, Itemized Deductions & Interest and

Ordinary Deductions, for investors; Schedule C,

Profit or Loss From Business, for sole proprietors;

or Schedule F, Profit or Loss From Farming, for

farm income, of Form 1040, U.S. Individual

Income Tax Return. For C corporations, S

corporations, partnerships, estates, and trusts the

corresponding schedules and forms are used. If the

revenue is reported as a capital gain, the deduction is

made directly on the appropriate Schedule D,

Capital Gains and Losses, for investors, or on

Form 4797, Sales of Business Property, for

businesses. In all cases (ordinary income or capital

gains, investment, or business), sale expenses also

must be reported on Schedule C, Proftt or Loss

From Land and Timber Sales, of Form T

(Timber), Forest Activities Schedules.

* The term “timber” includes the parts of standing trees that could be used to manufacturer lumber, pulpwood, veneer, poles, piling, crossties, chip-n-saw, and other wood

products. Also included are evergreen (conifer) trees aged 6 years or older when they are severed from their roots and sold for ornamental purposes, e.g., Christmas trees.
l Installment sales

Type of Forest Activity

The sum of payments received by timber owners

whose holdings qualify as an investment, as well as

the payment from lump-sum sales reported as

ordinary income by owners who treat their holdings

as a business, may be spread over any number of tax

years to smooth cash flow and avoid moving into

higher tax brackets. The only requirement is that at

least one payment must be received after the year of

sale. No payment is required in the year of sale.

Payments due more than 6 months after the sale date

must include interest and must not constitute

constructive receipt (the ability to enjoy benefits of

future income by demanding immediate payment,

borrowing against it, or by other beneficial use in the

present) prior to actual receipt.

How to Qualify for Best Tax Treatment

Installment-sale election is automatic, and payments

are reported in the year received. If sale proceeds

are reported as capital gains, only lump-sum sales

are permitted. The gross profit (contract price less

adjusted basis and sale costs) is prorated over the

time during which payments are to be received. If

part of the payments received is interest, that sum

must be reported as ordinary income.

Reporting and Tax Forms

Form 6265, installment Sale Income, must be filed

in the year of sale regardless of how much (if any)

revenue has been received that year. Form 6265 also

must be filed in any subsequent year installment

payment(s) is (are) received.

* The term “timber” includes the parts of standing trees that could be used to manufacture lumber, pulpwood, veneer, poles, piling, crossties, chip-n-saw, and other wood

products. Also included are evergreen (conifer) trees aged 6 years or older when they are severed from their roots and sold for ornamental purposes, e.g., Christmas trees.
2. Incurred a Capital Expense

0 Capitalization and basis

Type of Forest Activity

Capital assets include tree farm holdings that are

purchased, inherited, received as a gift, or otherwise

acquired. Examples are land, merchantable timber,

premerchantable timber, buildings and equipment that

have a useful life greater than 1 year, plus capital

acquisition costs (e.g., legal, surveying, and cruising

costs). The costs of site preparation and reforestation

are also capital expenditures. Capital expenditures

must be capitalized (i.e., recorded in a set of books) for

recovery (deduction) as the assets are sold, worn out,

become obsolete, or are used up. The amounts

recorded are known as the basis. In addition to actual

out-of-pocket expenditures, “basis” also includes the

value for probate purposes (inherited assets) and the

donor’s basis (possibly adjusted for gift taxes) for

gifted property. As additions or subtractions are made

over time, the basis becomes the “adjusted-basis.”

How to Qualify for Best Tax Treatment

When selling or cutting timber, or when claiming a

casualty deduction (see p. 18, “Timber loss or

involuntary gain, Casualty loss”), capital expenditures

allocated to basis - either when the property was

acquired or when the cost was incurred - are

deductible. Retroactive allocations to basis are

permitted, subject to IRS approval.

Reporting and Tax Forms

Capital assets must be allocated to appropriate

accounts on Schedule B, Acquisitions, of Form T

(Timber), Forest Activities Schedules. Allowable

basis deductions for timber sales and cutting are

computed on Schedule F, Capital Returnable

Through Depletion, of Form T (Timber), Forest

Activities Schedules. Depletion deductions not taken

when the timber income is reported are lost if not taken

on an amended return; they may not be offset against

future timber sales or cutting. Allowable basis

deductions are subtracted from gross revenues in

calculating taxable income (see p. 4 through 7, Made a

Timber Sale).
2. Incurred a Capital Expense

l Reforestation expenses

o Reforestation tax credit

Type of Forest Activity

A timber owner can claim a IO-percent reforestation

tax credit for qtralifed reforestation expenditures.

The credit may be claimed in conjunction with

reforestation amortization (see p. 10, Incurred

Capital Expense, Reforestation amortization) or

independently. The credit is a direct deduction from

taxes owed.

How to Qualify for Best Tax Treatment Reporting and Tax Forms

Qualified reforestation expenditures are direct costs

incurred for timber stand establishment; e.g., site

The reforestation credit is computed on line 3 on

Form 3468, Investment Credit, which must be

preparation, seeds or seedlings, labor, and tools attached to the tax return.

(including equipment depreciation). The reforested

property must be 1 acre or larger, within the United

States, and capable of commercial timber

production. Up to $10,000 per year of qualified

reforestation expenses (a maximum reforestation

credit of $1,000) may be claimed (per individual,

per partnership, per controlled group, and per

estate). Trusts do not quality.

9
2. Incurred a Capital Expense

l Reforestation expenses

o Reforestation amortization

Type of Forest Activity

A timber owner may elect to amortize (deduct) a

certain amount of qualified reforestation

expenditures over an 84-month period (actually

spanning 8 tax years due to a “half-year

convention”). The election may be made

independently or together with the reforestation tax

credit discussed on page 9. Generally, taxpayers

gain the greatest benefit by amortizing reforestation

expenditures and claiming the tax credit.

How to Qualify for Best Tax Treatment

Qualified reforestation expenditures for amortization

are the same as for the reforestation tax credit

discussed on p. 9. The taxpayer must elect

amortization on a timely filed return (extensions

included), for the year expenditures were made. Up

to $10,000 per year may be claimed. Ifowever, if the

reforestation credit is also taken, the amortization

must be reduced by half the credit.

Reporting and Tax Forms

Amortization deductions are subtracted from gross

income, even by taxpayers reporting as investors

who do not itemize deductions. Due to a tax

accounting procedure known as the “half-year

convention,” only one half the annual amortizable

amount can be claimed in the year in which the costs

are incurred. Hence, in the year the costs are

incurred, the taxpayer deducts one-fourteenth of the

qualified expenditure. In the second through the

seventh tax years, one-seventh is deducted, and in

the eighth tax year the final one-fourteenth is

deducted. The election to amortize is made in Part

VI of Form 4562, Depreciation and

Amortization. The election must be done on a

timely filed return (extensions included) for the tax

year in which the expenditures are made. The

election cannot be made on an amended return.

Deductions are then itemized in Part VI of Form

4562, Depreciation and Amortization. A

description of the expense must be attached to the

return on Schedule E, Reforestation and Timber

Stand Activities, of Form T (Timber), Forest

Activities Schedules, or in writing on a plain piece

of paper. Deductions are then reported on Form

1040, U.S. Individual Income Tax Return, as an

adjustment to income (enter “RFST” on line 32 on

2000 forms) for investors; on Schedule C, Profit or

Loss From Business, of Form 1040, for sole

proprietor businesses; or on Schedule F, Profit or

Loss From Farming, of Form 1040, for farm

income. Corresponding tax forms are used for C

corporations, S corporations, partnerships, and

estates.
2. Incurred a Capital Expense

l Depreciable assets

Type of Forest Activity

Costs incurred for business or investment property

with a service life of more than 1 year can be

capitalized and recovered through depreciation.

Generally, depreciation deductions are calculated

using the Modified Accelerated Cost Recovery

System (MACRS). Alternatively, timber owners

may elect other depreciation methods when

permitted and advantageous to do so (see IRS

Publication 946, “How to Depreciate Property”). Up

to $24,000 (for 2001 and rising to $25,000 in 2002)

of the cost of depreciable active business property

(investment property excluded) may be deducted,

under IRC Section 179, from active business income

in the year the costs are incurred. If the taxpayer

elects to use a Section 179 deduction, the property

must be used in business activities more than 50

percent during each year of the entire recovery

period.

How to Qualify for Best Tax Treatment

If a timber owner’s investments in capita1 assets

(e.g., bridges, fences, equipment, culverts) have a

useful life of more than 1 year, the costs may be

recoverable using MACRS (or other permitted

depreciation methods). If filing as a business, the

taxpayer should maintain an active role in

management of that business. (See p. 13.)

Reporting and Tax Forms

The recovery period for depreciation of both real

and personal property is based on the midpoint of

the property’s useful life under the Class Life Asset

Depreciation Range (CLADR). The IRS publishes

CLADR values in IRS Publication 946, “How to

Depreciate Property.” Depreciation of property is

reported on Form 4562, Depreciation and

Amortization, Part II. The Section 179 election to

claim up to $24,000 (for 2001and $25,000

thereafter) of depreciable business property is

reported on Form 4562, Depreciation and

Amortization, Part I.
3. Incurred Forestry Operating, Management, and Protection Expenses

0 Timber management expenses, property taxes, and interest (general)

Type qf Forest Activity How to Qualify for Best Tax Treatment

Forestry operating, management, and protection

expenses can be currently deducted from a

landowner’s income as limited by the passive-loss

rules. (See p. 13 for the rules on those deductions.)

The ordinary and necessary business or investment

costs of producing a profit from timber qualify as

operating expenses or carrying charges. Examples

include salaries and wages, legal fees, business

travel costs, costs of tools with a short useful life of

less than I year, protection costs, timber stand

maintenance expenses, property taxes, and interest

on loans. Profit includes appreciation in timber

value that results from growth and enhanced quality.

Businesses must qualify for deduction of thesecosts

under the passive-loss rules discussed on p. 13.

Reporting and Tax Forms

A taxpayer who files as a business may elect to

capitalize operating costs and carrying charges if the

limitations discussed on p. 13 would prevent

deducting them for the current tax year. Investors

who do not itemize deductions on Schedule A may

also capitalize these expenditures. The election to

capitalize operating expenses and carrying charges

may be made for any year that the property is

undeveloped (lacking commercial improvements)

and unproductive (not generating income). The

taxpayer should attach a written description of the

nature of the carrying charges and the amount to be

capitalized on a plain piece of paper. Operating

expenses and carrying charges capitalized to the

timber account are also reported on Schedule F,

Capital Returnable Through Depletion, of Form

T (Timber) Forest Activities Schedules.

Taxpayers who materially participate irz a trade or

business see p. 13.

Taxpayers who are in a trade or business but do not

maierially participate see p. 14.

Taxpayers who are investors see p. 15.

12
3. Incurred Forestry Operating, Management, and Protection Expenses

l Timber trade or business in which you materially participate

Type of Forest Activity How to Qualify for Best Tax Treatment

Under the passive-/ass rztles, management expenses,

as well as taxes and interest paid, are fully

deductible against income from any source each year

they are incurred by taxpayers who materially

participate. Similarly, credits may offset taxes owed

from any source.

The passive-loss rules define “material

participation.” It is a taxpayer’s “regular,

continuous, and substantial” involvement in a

business. Material participation is measured

annually by the taxpayer meeting at least one of six

tests. These apply conjointly to the taxpayer and

spouse in managing the timber activities:

(1) Participation in the activity exceeded 500 hours

during the tax year.

(2) Personal participation in the activity

substantially constituted all material participation

during the tax year.

(3) Participation in the activity exceeded 100 hours

during the tax year, and no other individual

participated more.

(4) Aggregate participation in all of the “significant

participation activities, including actual timber

management, exceeded 500 hours during the tax

year. A significant participation activity is one in

which participation exceeded 100 hours during the

tax year.

(5) Material participation has occurred in the

activity for any 5 of the preceding 10 tax years.

(6) Based on facts and circumstances, participation

in the activity was on a regular, continuous, and

substantial basis for at least 100 hours during the tax

year; no other individual participated more; and a

paid manager is not employed.

Reporting and Tax Forms

Sole Proprietor businesses list deductions on

Schedule C, Protit or Loss from Business, of

Form 1040, U.S. Individual Income Tax Return,

and farmers list deductions on Schedule F, Profit

or Loss From Farming, of Form 1040 if timber is

managed in conjunction with the farm. An excess of

deductions over gross income will result in a net

operating loss (NOL), making the taxpayer eligible

for a 2-year carry-back to earlier tax returns or a 20-

year carry-forward to future tax returns.

Corresponding tax forms are used for C

corporations, S corporations, partnerships, trusts,

and estates.

13
3. Incurred Forestry Operating, Management, and Protection Expenses

l Timber trade or business in which you do not materially participate

Type of Forest Activity How to Qualify for Best Tax Treatment

According to the passive-loss rules, a business

activity is passive if the taxpayer does not materially

participate (see p. 13). Deductions are allowed only

to the extent that aggregate losses (deductible

expenses exceeding gross income) from all passive

activities do not exceed aggregate income from

those activities. Losses that cannot be deducted in a

particular year may be carried forward indefinitely

to offset passive income from any source. Credits

(such as the reforestation tax credit discussed on p.

9) may be offset against taxes associated with

passive income. A credit that cannot be taken in a

particular year may be carried forward indefinitely

until there is passive income.

Management expenses, taxes, and interest charges

associated with passive activities are deductible only

against passive income. They arc not deductible

against income from business activities in which the

taxpayer materially participates.

Reporting and Tax Forms

Taxpayers who have passive income (e.g., annual

land-rental, hunting-lease income) may annually

deduct business expenses associated with these

activities and from other passive activities from

which no income was derived during the year (not to

exceed aggregate passive income). Sole proprietor

businesses list these deductions on Schedule C,

Profit or Loss From Business, and farmers list

them on Schedule F, Profit or Loss From

Farming, of Form 1040, U.S. individual Income

Tax Return, if timber is managed as a passive

activity in conjunction with passive farm income.

The taxpayer must report tax credits (e.g., the

reforestation tax credit discussed on p. 9) against

taxes associated with passive income on Form 3468,

Investment Credit. Form 8582, Passive Activity

Loss Limitations, may also have to be filed (refer to

insh-uctions on Form 8582). Alternatively, a

taxpayer may elect to capitalize operating costs and

carrying charges. The election is available in any

year the property is undeveloped (lacking

commercial improvements) and unproductive (not

generating income). Capitalized expenses are added

to the basis or the adjusted basis and are recovered

by any offsetting gain from the sale or cutting of

timber. The election to capitalize is done by filing

with the original return (for the year the election is

made) a written statement on a plain piece of paper

describing the costs that are being capitalized. This

election cannot be made on an amended return.

14
3. Incurred Forestry Operating, Management and Protection Expenses

l Investment

Type of Forest Activity How to Qualify for Best Tax Treatment

For noncorporate investors, management expenses

are usually miscellaneous itemized deductions that

are deductible against income from any source, but

only to the extent that the total of miscellaneous

itemized deductions exceeds 2 percent of adjusted

gross income (AGI). Deductible taxes are fi.dly

deductible against income from any source. Interest

is deductible against the total net investment income

from all sources. Interest not deductible in the

current year may be carried forward indefinitely for

deduction against investment income in future years.

Investors include landowners whose timber

management activities do not constitute a business.

The distinction between business and investment

depends on the facts and circumstances of each

taxpayer as discussed on p. 13, 14.

Reporting and Tax Forms

Individual investors itemize deductions on Schedule

A, Itemized Deductions & interest and Ordinary

Dividends, of Form 1040, U.S. Individual Income

Tax Return. If management expenses (other than

deductible taxes and interest) are itemized, amounts

under 2 percent of AGI are permanently lost.

Deductions that exceed gross income do not qualify

as a net operating loss. Corresponding tax forms are

used for C corporations, S corporations,

partnerships, trusts, and estates.

Alternatively, a taxpayer may elect to capitalize

deductions, but this option does not apply to

management expenses below the 2 percent of AGI if

the expenses above that level are deducted. The

election may be made for any year that the property

is undeveloped (lacking commercial improvements)

and unproductive (generating no income).

Capitalized expenses are added to the basis or

adjusted basis, and are recovered by offsetting any

gain from the sale or cutting of timber. Election to

capitalize is made by filing with the original return

(for the year the election is made) a written

statement, on a plain piece of paper, describing the

costs that are being capitalized. This election cannot

be made on an amended return.

1 5
4. Received Cost-Share Payment

l Included in income

Type of Forest Activity

At the taxpayer’s option, some forestry incentive

cost-share payments for reforestation may either be

included with gross income or excluded (in full or in

part) from gross income. Federal programs that the

IRS has approved for exclusion include the Forestry

Incentives Program (FIP), the Forest Stewardship

incentives Program (SIP), the Wetlands Reserve

Program (WRP), the Environmental Quality

Incentives Program (EQIP), and the Wildlife Habitat

Incentives Program (WHIP). In addition, many

State programs have been approved (check with

your State forestry agency). Payments included in

gross income qualify for reforestation amortization

and credit (see p. 10).

How to Qualify for Best Tax Treatment

Generally, forestry cost-share payments received for

purposes other than reforestation (such as timber

stand improvement) must always be included in

gross income. Such costs may then be deducted,

however, subject to the passive-loss rule limitations

discussed on p. 13, 14, 15. This rule does not apply

to SIP cost-share payments. All SIP cost-share

payments may be excluded as discussed on p. 17.

Reporting and Tax Forms

Cost-share payments included in gross income are

reported as miscellaneous income on the first page

of Form 1040, U.S. Individual income Tax

Return for individual investors; on Schedule C,

Profit or Loss From Business, of Form 1040 U.S.

Individual income Tax Return for sole proprietor

businesses; or on Schedule F, Profit or Loss From

Farming, of Form 1040, U.S. Individual income

Tax Return for farmers. Corresponding tax forms

are used for C corporations, S corporations,

partnerships, trusts, and estates

16
‘4. Received Cost-Share Payment

l Excluded from income

Type of Forest Activity

Gross income does not include the “excludable

portion“ of cost-share payments under Internal

Revenue Code Section 126.* Any “excludable

portion” of the payment does not qualify for

reforestation credit and amortization. See

qualifications and the example in the next columns

on this page.

How to Qualify for Best Tax Treatment Reporting and Tax Forms

A taxpayer may exclude part or all of reforestation

cost-share payments made under programs approved

by the IRS. Excludable portions include those

payments designated by the U.S. Treasury

Department that do not substantially increase

income from the property. Taxpayers can exclude

the greater of the present value of (1) the right to

receive $2.50 per acre times the number of acres, or

(2) the right to receive 10 percent of the average

income from the land for the 3 previous tax years.

Generally, landowners with high incomes and/or

expenditures for reforestation exceed’ing $10,000

per year gain a financial advantage by excluding the

maximum amount of cost-share payments permitted

from gross income.

Attach to the return, on a plain piece of paper, a

written statement that specifically describes what

cost-share payments were received and how the

excludable portion was determined.

For example, suppose a taxpayer has harvested

timber, receiving $400 per acre and reforestation

cost-share payments the next year. At a real interest

rate of 6 percent (without inflation), the present

value of the right to receive $2.50 per acre is $41.67

($2.50/.06). In contrast, the present value of the

right to receive 10 percent of the average income for

the 3 previous tax years is $222.22 ([($400/3) x

(. 10)]/.06j. Therefore, $222.22 is the greater

amount per acre. Up to this amount of cost-share

payment per acre may be excluded.

* See Temporary and Proposed IRS Regulation

16,4.126-l and 2.

17
5. Incurred a Timber Loss or Realized an Involuntary Gain

l Casualty loss

Type of Forest Activity

A casualty loss is physical in nature and caused by

natural or other external factors acting in a “sudden,

unexpected, and unusual manner.” Losses may be

deducted up to the adjusted-basis of the timber lost.

Casualty damage includes losses from fire,

windstorm, and hail. Generally, insect, disease, and

drought losses do not constitute casualty damage

because they do meet the suddenness criterion.

However, such losses may qualify as an allowable

noncasualty business or investment loss deduction.

How to Qualify for Best Tax Treatment

Timber loss must be traceable to an identifiable

event and must have occurred suddenly and

unexpectedly. The amount of loss must be

established using a fair and objective procedure.

Reporting and Tax Forms

Claim as a loss the difference between the adjusted

basis and the amount received horn salvage, if the

latter is less than basis. The deduction cannot exceed

the adjusted basis of the timber. Reimbursements

from insurance and other anticipated recovery must

be deducted in computing the loss. Report the loss

on Form 4684, Casualties and Thefts.
5. Incurred a Timber Loss or Realized an Involuntary Gain

l Timber theft

Type of Forest Activity

Theft losses may be deducted up to the adjusted

basis of the timber stolen.

How to Qualify for Best Tax Treatment

To qualify for a theft deduction, a landowner must

show only that the theft occurred and when it was

discovered.

Reporting and Tax Forms

Deduct theft losses in the year of discovery. ‘The

deduction cannot exceed the adjusted basis of the

timber. Adjusted basis is computed using values

current in the year the theft is discovered. Theft

losses are reported on Form 4684, Casualties and

Thefts.

19
5. Incurred a Timber Loss or Realized an Involuntary Gain

l Public condemnation

Type of Forest Activity How to Qualify for Best Tax Treatment

Taking of private property by a government entity

without the landowner’s consent, but with

compensation, is condemnation. Tax consequences

are the same as if property were sold under threat of

condemnation.

Timberland must have been condemned or have

been threatened with condemnation. If timber is cut

or sold by the landowner prior to condemnation,

only the land is included in the loss calculation.

Reporting and Tax forms

Determine the loss deduction, if any, in the same

way as determining a casualty loss (p, IS). Report

on Form 4684, Casualties and Thefts.
5. incurred a Timber Loss or Realized an Involuntary Gain

* Gain from involuntary conversion

Type of Forest Activity

Involuntary conversion occurs when timber is

destroyed, stolen, condemned, or sold under threat

of condemnation, and the landowner receives

insurance payments, salvage payments, court

awards, or other compensation. If a gain results from

involuntary conversion, the landowner may elect to

postpone paying tax on all or part of the gain.

How to Qualify for Best Tax Treatment

A landowner may realize gain from involuntary

conversion if salvage, insurance, court awards, or

other compensation exceed the adjusted basis of the

timber and/or timberland that is converted. The

taxable gain may be deferred for tax purposes to the

extent the landowner uses the gain to replace the

converted property with similar (like-kind) property.

Reporting and Tax Forms

File an attachment to the tax return for the year of

loss stating that the election to defer gain is made,

and report information on both the conversion and

replacement property on a plain piece of paper. If

the landowner cuts the timber (rather than selling it

as stumpage), the only way to determine gain is by

making a Section 63 l(a) election and following the

necessary procedures discussed on p. 5.

For property lost by casualty and theft, replacement

must be made within 2 years foilowing the year of

loss; for property condemned for pubiic use, it must

be made within 3 years following the year of loss.

21
Sources of Information

Information in this publication is based on the following references and the Internal Revenue Code of 1986.

l Publications:

Bishop, Larry M. 2000. Tax Tips for Forest Landowners for the 2000 Tax Year. Atlanta, GA. U. S. Department of Agriculture, Forest Service,

Southern Region, State and Private Forestry, Cooperative Forestry. 2p. (See Web site below.)

Commerce Clearing House. 2000.2001 U.S. Master Tax Guide. CCH, Inc. Chicago: 720 p.

Haney, H.L., Jr.; and Siegel, W. C. 2001. Timber Income Tax. Annotated teaching notes [Revised annually]. Blacksburg, VA: The Division of

Continuing Education, Virginia Tech, 243 p.

Haney, H.L., Jr. 2001. Taxing Questions [A Quarterly Column]. Virginia Forests. Richmond, Virginia

Haney, H.L., Jr. 2001. Timber Tax Issues [A Bimonthly Column]. Forest Landowner. Atlanta, Georgia

Hoover, W.L., 200 1. Timber Tax Management FNR 80. West Lafayette, IN: Department of Forestry and Natural Resources, Purdue University,

196 p.

Haney, H. L., Jr,; Hoover, W.L.; Siegel, W. C.; and Greene, John L. 2001. Forest Landowners’ Guide to the Federal Income Tax. Agric. Handb.

718. Washington, DC: U.S. Department of Agriculture. 157 pp.

Siegel, W.C. 2001. Timber and Taxes [A Quarterly Column]. National Woodlands. Washington, DC

l Web Sites:

Internal Revenue Service: www.irs.gov

National Timber Tax Website: www.timbertax.org

USDA Forest Service, Cooperative Forestry, Southern Region, Atlanta, GA: www.r8web.com/spf/coop/taxation

USDA Forest Service, Cooperative Forestry, Washington, DC: www.fs.fed.us/spf/coop
l Tax Practitioners:

Tax attorneys are listed by most State bar associations. For a listing of certified public accountants, contact your State Association of Certified

Public Accountants (SCPA) in your State capital. Consult a telephone directory for a listing of other tax practitioners.

l Foresters:

Contact the local office of the State forestry organization or the local extension forester for a list of consulting foresters who are familiar with

timber taxation. The Association of Consulting Foresters of America has chapters in most States.

The U.S. Department of Agriculture (USDA) prohibits discrimination in all its programs and activities on the basis of race, color, national origin,

sex, religion, age, disability, political beliefs, sexual orientation, or marital or family status. (Not all prohibited bases apply to all programs.)

Persons with disabilities who require alternative means for communication of program information (Braille, large print, audiotape, etc.) should

contact USDA’s TAIZGET Center at (202) 720-2600 (voice and TDD).

To file a complaint of discrimination, write USDA, Director, Office of Civil Rights, Room 326-W, Whitten Building, 1400 Independence Avenue,

SW, Washington, D.C. 20250-9410 or call (202) 720-5964 (voice and TDD). USDA is an equal opportunity provider and employer.

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