Congress has provided timberland owners with some favorable tax provisions. Here are five tips designed to help you make the most of these provisions and avoid paying unnecessary income tax or making costly mistakes. Please review the full Tax Tips document for more detailed information. This report is only an introduction. Consult the references and links provided for complete information on the topic.
Also understand that we are discussing Federal income tax here. Many states have their own taxing systems which can be dramatically different from federal taxation and is usually an ad valorum, severance or yield tax.
Remember these five points when filing your Federal income taxes on timber:
1. Establish your basis as soon as possible and keep good records. Basis is a measure of your investment in timber as opposed to what you paid for the land and other capital assets acquired. Record your cost of acquiring forestland or the value of inherited forest land as soon as possible. When selling your timber in the future, you can use these costs as a depletion deduction.
Adjust or step up your basis for new purchases or investments. Step down your basis for sales or other disposals.
Keep records to include a management plan and map, receipts for business transactions, diaries, and landowner meeting agendas. Report basis and timber depletion on IRS Form T,“Forest Activities Schedule, Part II".
You are required to file a Form T if you claim some timber depletion deductions or sell timber. Owners with occasional sales may be excepted from this requirement, but it is considered prudent to file. File your years documentation using this electronic version Form T.
2. If you have expenses for managing a forest, performed reforestation work or established significant timber stand regeneration costs, they may be deductable.
If you own a forest to make money, ordinary and necessary expenses incurred for managing forest land as a business or an investment are deductible even if there is no current income from the property.
You can deduct outright the first $10,000 of qualified reforestation expenses during the taxable year. In addition, you can amortize (deduct), over 8 years, all reforestation expenses in excess of $10,000. (Due to a half-year convention, you can only claim one half of the amortizable portion the first tax year, so it actually takes 8 tax years to recover the amortizable portion.)
3. If you sold standing timber during the taxable year held for over 12 months, you may be able to benefit from the long-term capital gains provisions on timber sale income which will lower your tax obligation. When you sell standing timber either lump-sum or on a pay-as-cut basis the net proceeds generally qualify as a long-term capital gain. Remember, you can qualify for this long-term capital gains treatment on timber only if you hold the timber over one year. You do not have to pay self-employment tax on capital gains.
4. If you had a timber loss during the taxable year, you can, in most cases, only take a deduction for (casualty) losses that are physical in nature and caused by an event or combination of events that has run its course (fires, floods, ice storms and tornadoes). Remember that your deduction for a casualty or qualifying non-casualty loss is limited to your timber basis, minus any insurance or salvage compensation.
5. If you had Federal or State cost-share assistance during the taxable year via receiving a Form 1099-G, you are obligated to report it to the IRS. You may choose to exclude some or all of it but you must report it. But if the program qualifies for exclusion, you can choose either to include the payment in your gross income and make full use of beneficial tax provisions or to calculate and exclude the excludable amount. Excludable cost-share assistance includes the Conservation Reserve Program (CRP payments only), Environmental Quality Incentives Program (EQIP), Forest Land Enhancement Program (FLEP), Wildlife Habitat Incentives Program (WHIP) and Wetlands Reserve Program (WRP). Several states also have cost-share programs that qualify for exclusion.