Tax Tips for Forestland Owners

By Darwin L. King and Edward D. King *

Timber Tax Overview - The Big Picture

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The IRS has three possible classifications or categories for forestland owners. The timber owner may be holding the property as either a hobby, an investment, or as a for-profit business. There are different tax regulations affecting each of these categories. If the taxpayer is holding the property as a hobby the land is typically used for personal hunting and recreation and there is no profit motive. In this situation, annual operating expenses may be capitalized and deducted in a later year when timber sales are made. However, hobby expenses are limited to the amount of hobby income. This means that hobby losses are not deductible. This would rarely be the case as most timber sales will result in the taxpayer reporting a profit. The good news is that timber hobby income does qualify for capital gains treatment which in recent years has been taxed at a maximum of 15% which is well below the tax rates for ordinary income.

Hobby gains or income are taxable as is most any other form of earnings. This is often shown on the tax form as some type of other income. Hobby expenses or losses are not directly netted against the hobby income. Instead, hobby costs must be claimed by a taxpayer as itemized deductions on Schedule A. This presents a problem for taxpayers who do not itemize their deductions and would therefore have to pay tax on the full amount of timber sales. This emphasizes the importance for taxpayers to determine if the timberland is not a hobby for them but instead either an investment or a business. These categories are appropriate if the taxpayer can demonstrate a profit motive.

If the taxpayer owns the timberland with the intention of selling the timber at a profit in the future or holding the forestland for capital appreciation, the property is considered to be an investment...

The key trait of holding timber as an investment is that there are only "occasional sales" of timber. Unfortunately, the Internal Revenue Service has not defined "occasional sales." The only example of this term is found on IRS Form T (Timber Activities Schedule) which is required to be filed any year that a taxpayer has a reportable sale of timber or timber products. According to Form T instructions, occasional sales mean "one or two sales every three or four years." ...

When the timber property is actively managed with frequent sales the IRS considers the activity to be a business. This normally entails the taxpayer developing a business plan for the property and working annually to improve the woodlot. If the timberland is considered a business, the taxpayer reports income and expenses on an IRS Schedule C if the business is a proprietorship, a Form 1065 if it is a partnership, or a Form 1120 if the activity is incorporated. The taxpayer is expected to follow the "matching concept" which requires revenues to be matched and netted against current operating expenses. Recent legislative changes in the American Jobs Creation Act of 2004 provide for capital gain treatment of timber income regardless of the sales method. In addition, business owners are allowed to deduct the first $10,000 of reforestation expenses annually and excess costs are amortized over seven years (84 months). This provides furhter benefits for business owners.

* Darwin L. King is a Professor of Accounting at St. Bonaventure University. Edward D. King is holds an MA and BS from St. Bonaventure University.

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