For most Non-Industrial Private Forest (NIPF) landowners, the most favorable treatment for timberland in the US Tax Code belongs to a category identified as “timber trade or business.” When timberland owners actively participate in the management of their timberland, all the expenses of managing a forest are deductible against any source of income and all tax credits offset taxes owed on any source of income. If timberland owners do not significantly participate in the management of their land, the expense deductions and tax credits can only be applied to income received from timber activities.
To qualify for this favorable tax status, timberland owners must meet material participation standards. One of the following requirements must be met. (For the purpose of qualification, a married couple is considered a single individual.)
- Participation in the activity exceeded 500 hours during the tax year.
- Personal participation in the activity substantially constituted all material participation during the tax year.
- Participation in the activity exceeded 100 hours during the tax year, and no other individual participated more.
- 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.
- Material participation has occurred in the activity for any 5 of the preceding 10 tax years.
- 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.
If a timberland owner meets one of these standards, the next issue to explore is whether the tax savings will be high enough to offset the amount of time and money it takes to set up the record keeping system that managing land as a business entails. The following items are necessary in order to establish timberland as a business. When many of these items already exist, the transition will be easier and more cost effective.
- A forest management plan that outlines an intention to manage the timberland for production.
- The fair market value (FMV) of all the assets of the timber business: land, timber, equipment (tractors, trucks, logging equipment), and depreciable real estate improvements (bridges, fences, culverts, etc.). Each asset class must be valued individually. By separating out the FMV of each asset class, you can then account for all additions and subtractions from the value of the asset, including land purchases or sales, timber sales, and depreciation on equipment and property improvements.
- The cost basis of each asset class, which is generally different than the FMV. For purchased land, the purchase price plus the costs associated with acquisition (timber cruise, land survey, legal assistance, title insurance, etc.) is used. For inherited land, use the evaluation from the federal or state estate tax form. If this is not available, the value on the date of the deceased’s death is used. If the timberland was gifted, the cost basis is the same as the giver’s.
- Record of operating expenses (consulting forester fees, hired labor, travel expenses related to property management and income potential, silvicultural activities, tools of short life, and fees for educational workshops and tours).
- Record of reforestation expenses.
To do additional research on whether this type of management decision is right for your circumstance, the National Timber Tax Website provides a wealth of up-to-date information. Another good way to understand all the information needed to qualify for additional tax benefits that come with actively managing timberland as a business is to study IRS Form T, which provides a comprehensive schedule for recording forest activities.
Every timberland owner is unique and may therefore have a unique ownership structure, as well as distinctive goals, costs, qualifications, etc. As always, a conversation with an attorney or tax advisor is also recommended.