This material is for informational purposes only and is not intended to provide tax, legal, or accounting advice. Please consult your own tax, legal, and accounting advisors before engaging in any transaction.
Albert Einstein once said “[Filing income taxes] is too difficult for a mathematician. It takes a philosopher.” Timberland owners are in fine company, as they too could benefit from the auspices of a philosopher to determine the appropriate “purpose,” as required by the IRS, of their timberland.
Treatment of income, expenses and losses for federal income taxes is based on a staggering number of variables including how timber management activities and timber basis are classified, and tax laws are constantly being reviewed and updated. For instance, Congress passed tax law changes in 2017 to provide relief to timberland owners impacted by Hurricanes Harvey, Irma, and Maria.
Per the IRS, the “purpose” of timber landownership falls into three categories: trade or business; investment; or personal use. Material participants in a business growing timber for profit can deduct all timber carrying costs (e.g., timberland, timber management and maintenance costs) from any source using Schedule C or F of Form 1040; investors can deduct property taxes but must report expenses on Form 1040 as miscellaneous itemized deductions; owners who use timberland for personal purposes may not be eligible for any deductions.
Timber Basis, for tax purposes, is the cost of forest land and timber acquisitions. It can be adjusted based on: (1) the method of acquisition; (2) the purchase price against fair market value (FMV) unless inherited or gifted; (3) timber volume, value and age; (4) planting costs; and (5) recovery costs, etc. Timberland owners should establish different capital accounts for each type of property - land, timber, buildings - to take advantage of permissible deductions.
The IRS Form T “Forest Activities Schedule” is required for timber depletion deductions, timber sales under IRC section 631(b), and timber sales or exchanges under IRC section 631(a).
Tax law specifying deductions for timberland varies by the type of activity. A few of those activities include:
- Carrying costs for ordinary timber management activities (timber cruise fees, consulting fees, protection from fire and pests) and planting costs can be capitalized (applied to the basis) and recovered at the time of a timber sale or deducted annually. If capitalized, carrying costs must be capitalized each year.
- Annual planting costs, under IRC section 194, may be deducted outright up to $10,000 and additional costs can be spread out over the next 84 months.
- Cost-share payments for reforestation generally must be included as income.
- Casualty loss (sudden, unexpected and unusual loss due to natural or outside forces, i.e., wind, fire, hurricane) deductions can be reported using Form 4684. For timber investment property, the loss is then entered into Schedule A of Form 1040. For timber business property, the loss is entered on Form 4797. In general, you can deduct a casualty loss only in the tax year in which the casualty occurred. However, for Federally declared disasters, you may elect to apply the casualty loss in your prior year’s tax return.
- Non-casualty loss (loss due to events spread out over a period of time, i.e., extended drought, insect attack, etc.) deductions are limited to the adjusted basis in the property.
- Theft (timber trespass) can be claimed when the loss is discovered.
Income from timber sales can be treated as either a long-term capital gain or ordinary income. Timber that is held for longer than 12 months is eligible for long-term capital gain, which is taxed at lower rates than ordinary income. Report the sale of standing investment timber on Form 8949 and Schedule D. Sales of standing timber by a business qualify for long-term capital gain (Sec. 1231 gain) if the timber has been held for more than 1 year (Sec. 631(b)). Report the sale on Form 4797 and Schedule D. Timber sale expenses such as fees paid to foresters are deductible from the sale proceeds. Form 1099-S is required for lump-sum and pay-as-cut standing timber sales, except for corporate and high-volume business sellers.