The U. S. Department of Agriculture has just released their annual Tax Tips for Forest Landowners newsletter. The information presented in this article is current as of September 15, 2012 and may be used to assist you and your tax preparer in filing your income tax returns.
The first question you must address is: Is your property for Personal Use, Investment or Business?
If you do not own your forest land at least partially for timber production for profit, your property is Personal Use. (Unless, of course, you are using your land for another profitable purpose such as running a camp or selling hunting trips etc. Personal Use means the land is economically just sitting there.) Tax deduction opportunities for Personal Use land are very limited.
Your land is Investment Property if your income from the land and its forest relies mostly on your assets’ appreciation in value without your active participation in managing your land. This is the case when you hold your land, then visit periodically to harvest the growth, but you don’t actively replant or maintain your infrastructure. Investment Property is subject to IRS passive loss rules, since you are not an active participant in your property’s management.
If you materially participate in managing your land, your land may qualify as Business Property. Markers for active participation include having a forest management plan that documents your profit motive, an expense and investment trail that includes infrastructure improvements like roads, planting and thinning activities and other signs of active management.
After you have assigned a category to your property, you next need to determine its Basis. Basis is the value of your property at the time your acquired it. If you bought the property, the basis is the total price you paid for it, including your purchase price, survey, legal fees, title search, and so forth. If you inherited the property, the basis is its fair market value on the day of your donor’s death, and if you received it as a gift, the basis is usually the lower of the donor’s original basis or the basis on the day you received it.
After you have a basis, you now need to divide all the assets of the property into separate accounts. Divisions may include the basis of the land itself, the basis of its infrastructure, such as roads, bridges and retaining walls, and then, most importantly, the timber itself. The why of this exercise lies in how the timber tax is calculated when you harvest. There is a deduction called the timber depletion deduction which is calculated by dividing your timber basis by the total volume of your timber at the time you acquire the property then multiplying that value/unit of timber number into the volume of timber you harvested.
Now comes the part where the actual timber tax is calculated. The options are Sale of Standing Timber and Sale of Cut Timber. Sale of Standing Timber is equivalent to liquidating a portion of an investment and is subject to capital gains taxes, and Sale of Cut Timber, where you cut the timber yourself or hire a contractor who works under your direction, is ordinary income and subject to income taxation. There are variations on how this is categorized, so make sure you and your tax professional talk over the choices. In either case, only the net gain, or profits are taxed; expenses and the timber depletion deduction are subtracted from the sale before the tax is applied.
Timber is not harvested annually by most timber owners, but expenses happen every year. Be sure to record all of your expenses, including your costs to protect your forest from insects, diseases, fire, and the costs of activities like controlling brush and maintaining roads, firebreaks and erosion control measures. Investors deduct these expenses on Schedule A and businesses on Schedule C.
Capital expenditures, those that qualify as permanent or long term improvements, may be deducted over a set number of years via depreciation. Expenses of this class include logging equipment, trucks, tractors and their attachments, bridges, culverts, fences, temporary roads and resurfacing permanent roads.
Be sure to record and report cost-share payments from qualified government programs. Federal Programs include the Forest Health Protection Program, Conservation Reserve Program, Environmental Quality Incentives Program, Wildlife Habitat Incentives Program, and the Wetlands Reserve Program. California State Programs include California Forest Improvement Program. The Fire Safe Councils may have qualifying grants and cost-share assistance for building and maintaining fuel breaks.
If you have participated in a cost-share program, keep in mind that those expenses that were reimbursed through the cost-share program are not deductible.
Finally, if your forest was significantly impacted by fire, storm damage, epidemic bug or disease kills or theft, these losses may be deductible from your taxes. You will need a competent appraisal to file for this type of loss.
See http://www.timbertax.org/developments/TaxTips2012-Final.pdf for the full article, including examples of the various ways timber taxation can be addressed.